There are a number of legal aspects to take into account when considering an outsourcing transaction and competition law, although often overlooked, is one of them. Failure to do so could have detrimental consequences for the transaction and the companies involved.
The main issue to consider under competition law is whether the outsourcing transaction amounts to a notifiable transaction under merger control rules. Other issues linked to rules prohibiting agreements that restrict competition could also arise. This briefing takes a high-level look at these potential issues.
Merger control rules
Does the outsourcing transaction amount to a notifiable transaction under merger control rules?
Outsourcing can take many forms and it is important to bear in mind that not all types of outsourcing will be subject to notification under merger control rules. The position under most merger control regulations is that an outsourcing contract will only amount to a notifiable transaction if the assets to be transferred constitute the whole or part of a business and if the business has access to the market or at least the means of achieving market access.
The assets transferred must include all the core elements that would allow an acquirer to build up a market presence (production facilities, product know how, existing market access, relevant personnel, intellectual property rights etc) or increase its market presence, on a lasting basis. The outsourcing service supplier must therefore not only provide the service to the customer but also to third parties either immediately or within a short period after the transfer.
We have analysed below the merger control implications of some of the more common types of outsourcing:
- Intra-group outsourcing: an outsourcing contract whereby a service is outsourced to a separate unit within a corporate group (for example, transferring the running of the IT systems to an Indian subsidiary) will not amount to a notifiable transaction under merger control rules. This will be considered as a mere intra-group restructuring. The outsourcing activity will remain “captive” within the same corporate entity, albeit provided by a separate subsidiary.
- Simple outsourcing: simple outsourcing does not involve any transfer of assets or employees to the outsourcing service supplier and therefore does not amount to a notifiable transaction. Such an outsourcing contract is akin to a normal service contract and even if the outsourcing service supplier acquires a right to direct assets and employees of the customer, no notifiable transaction arises if the assets and employees will be used exclusively to service the customer.
- Transfer of assets: the transfer of a business unit with associated assets and personnel to an outsourcing service provider which will provide those services not only to the customer but also to other third party customers will amount to a notifiable transaction.
A notifiable transaction also arises where the outsourcing service supplier already has its own assets and employees but its market presence will be increased as a result of the transfer of the assets and/or employees (regardless of what it intends to do with those assets specifically).
- Joint venture: the creation of a joint venture for the provision of outsourcing services, which would be set up and jointly controlled by the customer and the outsourcing service supplier, could also amount to a notifiable transaction. Many (but not all) merger control rules in Europe only require notifications if the joint venture is “full function”, meaning that it must operate on a lasting basis, performing all the functions of an independent economic entity. Again, the main issue here is whether the joint venture will be considered as a real “market player” as opposed to taking only over one specific function within the parent companies’ business activities, without its own access or presence to the market.
Are the jurisdictional thresholds met?
If the outsourcing transaction amounts to a notifiable transaction, whether or not it actually requires notification will depend on whether the parties to the transaction meet the applicable jurisdictional thresholds of the merger control regime in question. These thresholds ensure that only transactions of a minimum size are reviewed by the relevant competition authority. Many jurisdictions employ thresholds based on the turnover of the acquiring group (the outsourcing service provider) and the business being acquired (the assets/employees being outsourced).
In practice, the calculation of the internal turnover of an outsourced business will not be easy to establish since it will rarely be considered as a distinct entity within the customer’s group and will not usually be allocated specific turnover. For example, very few companies would allocate an internal turnover to its IT system.
In the absence of any internal turnover calculation, when calculating the turnover of an internal business unit the practice is to use publicly quoted prices where such prices exist or, if this is not possible, the forecast revenues to be received by the acquirer on the basis of its agreement with the customer.
If a transaction is notifiable
If an outsourcing transaction does amount to a notifiable transaction and certain jurisdictional thresholds are satisfied, a merger control filing could have implications for the timing of the deal (regardless of whether the deal raises competition concerns):
- Timeframe: It is important to take into account the timeframe necessary to prepare a notification and obtain a decision from the relevant competition authority. Preparing a notification involves the gathering of information relating to the companies involved in the transaction and, depending on the potential competition issues, pre-notification contacts with officials of the competition authority. This could have an impact on the overall transaction timetable.
- Suspensory effect and potential sanctions: It is also important to note that, in most jurisdictions, there is an obligation to notify and get clearance from the competition authority prior to the implementation of the transaction. Implementing the transaction without obtaining prior approval - regardless of whether the deal raises competition concerns - can lead to the imposition of fines (up to 10 per cent of the aggregate turnover of the companies at EU level for example), the dissolution of the implemented transaction and/or a declaration that the transaction is invalid. Interim measures to safeguard effective competition (e.g. hold-separate orders) can also be imposed, pending final resolution of the matter.
Other potential competition issues
Regardless of whether an outsourcing deal falls with merger control rules, the normal competition rules prohibiting agreements that restrict competition will apply to clauses that restrict the freedom of the parties to conduct their business as they see fit or which impact on competition in a market. A couple of examples of the types of issues that could arise are set out below:
- Non compete clauses; long-term agreements; purchase/supply obligation clauses: long-term outsourcing agreements (whereby a customer agrees to use the supplier exclusively for a long period of time), clauses whereby a customer agrees not to compete with the outsourcing service supplier or clauses whereby the outsourcing service supplier agrees not to provide services to competitors of the customer are all types of clause that could raise competition issues under general rules prohibiting agreements that restrict competition. Such clauses need to be assessed to ensure that they do not lead to an infringement of those rules.
- Exchange of information: Outsourcing transactions create special links between the customer and the outsourcing service provider because, in the course of the transaction, the companies will exchange information which could be competitively sensitive, such as cost, commercial strategies or pricing information. If the companies compete against each other at another level of the supply chain, this could breach competition rules, unless appropriate safeguards are put in place.
- Potential sanctions: The consequences of breaching the general rules prohibiting agreements that restrict competition are potentially severe. The offending clauses/agreements will be void and unenforceable and there is potential for third parties to bring damages actions for any loss they have suffered as a result of the operation of the illegal agreement. In addition, for more severe breaches, companies may face fines (in the EU, fines of up to 10 per cent of group global turnover can be imposed) and, in certain jurisdictions, individuals may face criminal sanctions.