Non-compete clauses under the new competition law

September 8, 2016

In a merger or acquisition (M&A) where a company purchases either the assets or shares of stock of a competing company, the buyer usually insists the inclusion of a non-compete clause that prohibits  the seller  from engaging in any business that competes with the buyer.

A question that has arisen is whether the clause is still valid in the light of the Philippine Competition Act (PCA). In other jurisdictions, there were cases where competition authorities challenged the validity of the agreement.

The PCA contains two kinds of prohibited agreements between or among competitors. The first is a price fixing and bid rigging agreement, which is a per se violation of the law. The second is an agreement which has the “object or effect of substantially preventing, restricting or lessening competition” (Sec. 14).

Under our law, a non-compete clause is not a price fixing agreement.   Neither is it bid rigging.  At most, it constitutes a form of market sharing or allocation, or an agreement that has the object or effect of preventing, restricting or lessening competition.  As such, it is not considered per se but at the most a non-per se violation.

As opposed to per se violations which are illegal by themselves without need of further inquiry into their actual effect on competition or intentions of the parties charged with the violation, non-per se violations are subject to a rule of reason analysis.   This type of analysis balances the pro-competitive benefits against the anticompetitive effects of the disputed act or conduct to determine whether it  is a violation of the competition law.

Being subject to rule of reason, the validity of non-compete clauses depends on the reasonableness of the non-compete agreement, geographic coverage, duration and whether the restraint is reasonably related to a legitimate purpose. Legitimate purposes include protecting a purchaser’s ability to reap the benefits of the purchased business.

An example in the United States of a case involving non-compete clauses is  Oltrin Solutions, LLC’s purchase of a customer list from JCI Jones Chemicals Inc. for $5.5 million along with JCI’s agreement not to compete in the bulk bleach industry in North or South Carolina for six years. The Federal Trade Commission challenged the validity of the non-compete agreement. It contended that it eliminated actual, direct and substantial competition between Oltrin and JCI in the relevant market; substantially increased the market concentration for bulk bleach sales; and increased Oltrin’s ability to raise bulk bleach prices. It appeared there was no legitimate business purpose advanced by the transaction.

The case was settled but the settlement agreement required Oltrin to release JCI from the non-compete clause, transfer a minimum volume of bulk bleach contracts back to JCI, and provide JCI a short-term backup supply agreement to facilitate its re-entry into the North Carolina and South Carolina markets.

In the European Union, where we patterned Section 14 of the PCA, a recent example of a case involving non-compete clause is the Telefónica/Portugal Telecom case. Telefonica and Portugal Telecom jointly owned and operated a wireless joint venture in Brazil called Vivo Participacoes S.A. In a share purchase agreement executed in 2010, Telefónica acquired sole control over Vivo. The share purchase agreement contained a non-compete clause, which provided   that Telefonica and Portugal Telecom would, “to the extent permitted by law,” refrain from competing against each other’s telecom businesses in the Iberian market, which covers Spain and Portugal. The clause was to apply for over a year from the signing of the agreement in September 2010 until  December 2011.

The European Commission fined Telefonica and Portugal Telecom about €66.9 million and €12.3 million for including the non-compete clause.  It considered the clause as a market sharing agreement that would exclude or limit competition on each other’s home markets (Spain and Portugal).  Using the rule of reason analysis, the General Court upheld the European Commission’s finding, stating that the clause had the potential to restrict competition by its very nature or “by object” because it was entered into by two potential competitors to preclude competition in liberalized markets where there were no insurmountable barriers to entry for electronic communication and television services. The court also upheld the European Commission’s assessment that the non-compete clause was not ancillary to the main transaction, which referred to the Iberian market whereas Vivo’s activity was limited to Brazil.  Notably, while the clause was qualified by the phrase “to the extent permitted by law” which allegedly required self-assessment before the clause became effective, the court indicated that there was no genuine self-assessment as, for example, the clause did not establish any terms and conditions that would govern the alleged self-assessment exercise.

Of course, these two cases have their own unique factual settings which must be carefully analyzed before putting them into use in a Philippine setting.  What is important is that the landscape has changed for non-compete clauses. There were cases in the past challenging non-compete clauses for being in restraint of trade. Relevantly, the PCA imposes administrative fines for anti-competitive agreements, the first violation meriting up to P100 million and the second up to P250 million.  The hefty fines alone should make people more sensitive to the antitrust implications of non-compete clauses.

(By Francis Ed Lim)