Non-compete obligations are frequently incorporated in M&A transactions to facilitate the effective implementation of a proposed combination. However, as covenants that ultimately restrict or impede fair competition in the market, non-compete obligations can also raise potential antitrust concerns. Mature competition law regimes usually permit the imposition of a non-compete obligation if it is ancillary to a proposed combination (ie, directly related and necessary to the implementation of the combination).
The Competition Commission of India's (CCI) approach to the treatment of non-compete obligations has generally evolved on a case-by-case basis.
The CCI discussed the scope of non-compete obligations in a combination for the first time in Orchid Chemicals v Hospira Healthcare,(1) where the CCI observed that:
"non-compete obligations, if deemed necessary to be incorporated, should be reasonable particularly in respect of (a) the duration over which such restraint is enforceable; and (b) the business activities, geographical areas and person(s) subject to such restraint, so as to ensure that such obligations do not result in an appreciable adverse effect on competition."(2)
In Mylan v Strides Acrolab(3) the CCI observed that the non-compete covenant "should cover only those products which are either being presently manufactured/sold or are under development, by the Target Enterprises",(4) thus widening the scope as to what constitutes restrictive non-compete obligations.
However, uncertainty remains as to the scope and ambit of such non-compete obligations. Therefore, in accordance with international best practices, the CCI has issued a guidance note on non-compete restriction clauses to enable parties to a combination to achieve clarity and legal certainty with respect to the treatment of non-compete restrictions. However, the guidance note is not binding on parties to a proposed combination and is merely directive in nature.
In accordance with international best practices, the guidance note states that a non-compete restriction which conforms with the principles set out in the guidance note will be deemed to be an 'ancillary restriction' (ie, a restriction directly relating and necessary to the implementation of the combination). Only such ancillary restrictions will be approved under Section 31 of the Competition Act.
Further, a non-compete restriction will amount to an ancillary restriction only if it relates economically to the main combination and is intended to allow a smooth transition to the post-combination scenario.
In addition, any such non-compete restriction must satisfy the standards of 'necessity' (ie, in the absence of such restrictions, the combination could not be implemented or could be implemented only under more uncertain conditions, at a substantially higher cost, over an appreciably longer period or with considerably higher difficulty) and 'proportionality' (ie, the non-compete restriction should not exceed what is reasonably required; if equally effective alternatives are available for attaining the same objective, parties to a combination must choose the one which is the least restrictive of competition) laid down by the guidance note.
The guidance note also lays down the standard for the determination of necessity and proportionality, which is determined by taking into account the nature of the business and factors including the following:
- Duration of non-compete restriction:
- Where there is a transfer of both goodwill and know-how ? justifiable for a period of only up to three years.
- Where only goodwill is transferred ? justifiable for a period of only two years.
- Longer durations of non-compete restrictions ? permissible only in limited circumstances and specific sectors and industries where customer loyalty persists for longer durations or the nature of know-how transferred justifies an additional period of protection.
- Geographical scope of non-compete restriction:
- The geographical scope of a non-compete clause must be limited to an area in which the seller has offered the products or services before the transfer.
- Protection may also extend to those territories that the seller was planning to enter at the time of the transaction, provided that the seller has already invested in such a move. Protection does not extend to the acquirer where the seller has not previously operated.
- In case of joint venture, geographical scope of a non-compete should be limited to where the parents were operating before establishing the joint venture or planning to enter (investments evidencing such intention must be made).
- Where a joint venture is set up to enter a new market, the scope of non-competition clauses can be extended to the products, services and territories in which the joint venture is supposed to subsequently operate.
- Scope of application of non-compete restriction:
- Non-compete obligation must be restricted to the products or services which comprise the main activity of the transferred business or enterprise or the joint venture, which may include improved versions or updates of the products and successor models.
- Includes products or services at an advanced stage of development at the time of the combination or products which are fully developed but not yet marketed.
- Non-compete obligation to bind only the seller, subsidiaries and agents or on controlling the shareholders of an enterprise.
- Clauses which limit the vendor's right to purchase or hold shares in a competing enterprise are permissible. However, an acquisition made purely for investment purposes is excluded.
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For further information on this topic please contact Man Mohan Sharma at Vaish Associates by telephone (+91 11 4249 2525) or email (email@example.com). The Vaish Associates website can be accessed at www.vaishlaw.com.