A non-compete agreement or clause is a contractual limitation on a party which prevents it “from competing with a business after termination of employment or completion of a business sale” under specific circumstances. It may take different forms including restrictions on the time period during which the selling enterprise is precluded from competing with the buyer; restrictions on the territory of competition between two firms; restrictions on disclosing information obtained during the operation of the transferred business; and restrictions on the scope of activities that the selling enterprise may undertake, among others.
Contract law generally does not allow for the operation of any agreement in restriction of trade or business or practice of any lawful profession by a person and is therefore opposed to non-compete clauses. Section 27 of the Indian Contract Act, 1872 stipulates that an agreement for restraint of trade would be void to that extent. However, in business transactions, particularly mergers and acquisitions, non-compete clauses are an integral part of the agreement. They help an enterprise protect its trade secrets or business know-how, a highly valued component in establishing of market power and efficiency. This gives an enterprise a competitive edge over other players in the same field.
Non-compete agreements are therefore important to protect all proprietary rights in the form of intellectual property, business know-how, trade secrets and other such information. However, it is equally important that they do not restrict fair competition in the market. The law on competition focuses on averting this very situation.
The legal provisions governing non-compete clauses in India under the Competition Act, 2002:
A glimpse into the Indian Competition Act will show that it does not talk about non-compete clauses per se. However, various provisions in the Act govern its operation to curb any adverse effect on competition in the market.
Section 4 of the Competition Act states that “no enterprise shall abuse its dominant position”. It provides that any condition which limits or restricts production of goods or services or which restricts technical or scientific development would be tantamount to abuse of dominant position. Further, the provision also stipulates that any practice which results in denial of market access or culminates into manifest abuse of position to enter into new markets would also come into the ambit of non-compete clauses.
Section 5 of the Act essentially stipulates the procedure employed by the Competition Commission to enquire into the cases of non-compete clauses. However, the Act also stipulates that the non-compete clauses can be incorporated into agreements after suitable modifications have been made such that it does not result in an adverse impact on competition in the market.
Non-compete clauses have become an inevitable part of Merger and Acquisition agreements. An overview of various cases from Europe, the United States of America and India shows how non-compete clauses can and do affect competition in the market and the stand taken by Competition Authorities in this regard.
European Union
Telefónica and Portugal Telecom[1]:
In July 2010, in the context of the acquisition of the Brazilian mobile operator Vivo (then jointly owned by both Telefonica and Portugal Telecom) by Telefónica, the parties inserted a clause in the contract indicating they would not compete with each other in Spain and Portugal from the end of September 2010. This implied that the companies would not face competition in their home market which the European Commission said would hinder the integration process of the EU telecoms sector and restrict competition.
The European Commission imposed fines on Telefónica and Portugal Telecom for entering into this agreement and held it to be in breach of Article 101 of the Treaty on the Functioning of the European Union (TFEU) which prohibits anti-competitive agreements.
Areva and Siemens[2]:
In 2001, Areva and Siemens created the joint venture Areva NP and agreed on a specific non-compete obligation meant to apply for up to eleven years beyond the duration of the joint venture itself. Siemens exited the venture in 2009 and Areva acquired sole control over it.
In December 2011, the European Commission expressed concerns that the non-compete obligation and confidentiality clause may infringe Article 101 of the TFEU, which prohibits anti-competitive agreements. The Commission found that the non-compete clause was excessive as it prevented Siemens from selling its own goods in markets where Avera NP only re-sold Siemens’ products. For markets where the joint-venture sold its own products, the Commission found that the non-compete clause could be accepted in principle but that its duration was excessive. As a parent company, Siemens had had privileged access to the joint venture’s confidential business information, which Siemens could use to compete more easily against Areva NP after its exit from the joint venture. However, the Commission found that protection against such facilitated competition by Siemens was no longer necessary after three years, since this information would then become irrelevant or too uncertain.
United States of America
In the United States, the Federal Trade Commission and the Antitrust Division of the Department of Justice have looked into non-compete obligations in acquisitions, mergers and joint ventures and between competing firms.
On September 24, 2010, the Antitrust Division filed a lawsuit and entered into a settlement that prohibits six high-tech companies – Adobe Systems Inc., Apple Inc., Google Inc., Intel Corp., Intuit Inc. and Pixar – from entering into “no solicitation” or “no cold call” agreements for a period of five years.
In another case, the Federal Trade Commission in January 2013 ordered bulk bleach producer and seller Oltrin Solutions, LLC to release its competitor, JCI Jones Chemicals Inc. from an agreement not to sell bleach in North Carolina and South Carolina.[3] This non-compete agreement was part of a 2010 transaction between the two firms that the FTC alleges violated antitrust laws. The FTC’s settlement with Oltrin and JCI will restore competition between these two producers and sellers of bulk bleach.
India
Mylan and Strides Acrolab[4]:
In the proposed acquisition of a Strides Arcolab subsidiary by Mylan Inc. the CCI had raised concerns about the ‘Restrictive Covenant Agreement’ between the entities, the effective time period for which was six years from the date of completion of the proposed combination. According to the terms of the agreement, Mylan would acquire the entire issued and outstanding share capital of Agila Specialties Pvt Ltd – a subsidiary of the pharmaceutical firm Strides Arcolab. As per the agreement, Strides Arcolab and its promoters were not to engage in “the business of developing, manufacturing, distributing, marketing or selling any injectable, parenteral, ophthalmic or oncology pharmaceutical products for human use, anywhere in the world”. The CCI observed that the “non-compete covenant” should have covered only those products which are either being made or sold or are under development by Agila and Onco. The firms have now reduced the duration of the non-compete obligation to four years besides reworking the scope of the agreement to the products manufactured by Agila and Onco.
Orchid Chemicals and Pharmaceuticals and Hospira Healthcare[5]:
The Business Transfer Agreement (BTA) for the sale of certain assets of Orchid Chemicals and Pharmaceuticals Ltd (OCPL) to Hospira Healthcare recently came under the scrutiny of the CCI. As per the agreement, OCPL agreed to sell its Betaculum API (Active Pharmaceutical Ingredients) business along with its manufacturing facilities to Hospira Healthcare India Pvt Ltd (HHIPL), a completely owned subsidiary of US-based Hospira Inc. The deal also contained a non-compete clause that stipulated that OCPL and its promoter K. Raghvendra Rao could not undertake certain business activities pertaining to the “transferred business” for a period of eight years and five years respectively. The non-compete clause also restricted research, development and testing of Penem (including Carbapenem) and Penicillin API (Active Pharmaceuticals Ingredients) for injectable formulations.
The CCI stated that non-compete obligations, if necessary, must be “reasonable” in terms of the time period of their operation, business activities, geographic areas and persons being subjected to any restraint.
OCPL and HHIPL offered to modify the terms to limit the duration of non-compete obligation to four years and excluded activities regarding research, development and testing of certain new molecules. Approving the modified deal, the CCI said that “the horizontal overlap between the products offered by OCPL and HHIPL in the domestic market in India is insignificant”.
As competition law regulators worldwide are taking suo motu action and pursuing merger and acquisition agreements to check for anti-competitive practices, it is imperative to ensure that non-compete clauses are well drafted, keeping in mind their commercial importance. Following the decisions from competition watchdogs across the world, certain general principles may be culled out with regard to validity of non-compete agreements. The most basic of these principles is that the non-compete clauses must be directly related and necessary for the operation of the transaction. The duration of the non-compete should be reasonable and its scope should pertain to the particular economic activity to check for agreements which go outside the scope of the transaction and restrict competition. If there is any territorial or geographical limitation, it should be ensured that the same does not amount to a market-sharing arrangement and the operation of the non-compete clause must not result in any appreciable negative effect on competition in the market.
The type of agreement is important as well. For employment agreements, factors which need to be kept in mind while checking for anti-competitive nature of a non-compete clause would include, in addition to the factors mentioned above, whether the non-compete involves a profession or skill-set that is not abundant in the market. Antitrust enforcers may be more aggressive in cases where there the supply of replacement workers is limited or the restrictions are against public interest. In case of purchase or service agreements, the general factors stated above must be kept in mind regarding reasonableness of time and geographical restrictions. Additionally, any non-compete agreement should be narrowed down to ensure that it is not overly broad in its scope and addresses only legitimate and justifiable business concerns (for example, allowing a service provider to protect its investment in its services or products).
Competition laws across states and countries are non-uniform as they apply differing standards to the extent to which non-compete clauses are allowed to operate and must also be kept in mind.
Therefore, the drafting of a non-compete clause in an employment, purchase, or service agreement should be done with the highest degree of care and in keeping with the various factors mentioned above to prevent the same from coming in conflict with competition law.
This post was authored by Sushruti Tripathi and Paridhi Poddar, students at the West Bengal National University of Juridical Sciences and members, Society for International Trade and Competition Law.
[1] Press Release, European Commission, Antitrust: Commission fines Telefónica and Portugal Telecom € 79 million for illegal non-compete contract clause (January 23, 2013) at http://europa.eu/rapid/press-release_IP-13-39_en.html (Last visited on September 30, 2013).
[2] Press Release, European Commission, Antitrust: Commission makes legally binding commitments by Siemens and Areva concerning nuclear technology markets (January 23, 2013) at http:,//europa.eu/rapid/press-release_IP-12-618_en.html (Last visited on September 2013).
[3] Press Release, Federal Trade Commission, FTC Puts an End to Bleach Non-Compete Agreement That Whitewashed Competition in North Carolina, South Carolina, and Southern Virginia (January 18, 2013) at http://www.ftc.gov/opa/2013/01/Oltrin.shtml (Last visited on September 30, 2013).
[4] CCI gives green signal to Strides Arcolab-Mylan deal, The Economic Times June 25, 2013 at http://articles.economictimes.indiatimes.com/2013-06-25/news/40186574_1_onco-therapies-strides-arcolab-proposed-combination (Last visited on Septmber 30, 2012).
[5] Orchid Chemicals gets CCI nod for Hospira deal, The Economic Times December 24, 2012 athttp://articles.economictimes.indiatimes.com/2012-12-24/news/35991967_1_cci-nod-r-d-facility-orchid-chemicals (Last visited on September 30, 2012).
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