Drafting a correct merger filing in India for CCI approval – Part III (non-compete clause)

6.6 In case the agreements/ other documents relating to the combination contain a non-compete clause or the parties to the combination have executed/ or propose to execute a non-competition agreement, in relation to the combination, the following details must be provided:

6.6.1 Scope, including: (i) the enterprises covered by the non-compete provision; and (ii) period; geographic scope and the products/ services covered under the non-compete clauses.

6.6.2 Justification for the non-compete provisions covering each of the elements as mentioned above.

Practice followed

Execution of contracts with post-termination exclusivity clauses could be questioned by CCI as being restrictive and exclusionary if: (a) the term of such clauses exceeds a reasonable period; (b) the subject matter of exclusivity is extremely wide; and (c) the geographical scope of exclusivity is extremely wide.

As a general practice, duration of post-termination exclusivity or non-compete for more than 3 years (unless it can be justified on an objective basis) has not been looked upon favourably by the CCI because as per CCI such a practice leads to market foreclosure.

The CCI has sought behavioural commitments in - Orchid Chemicals and Pharmaceuticals Limited/Hospira Healthcare India Private Limited:[1]

The transaction in this case related to the pharmaceutical sector and the non-compete obligation as entered into between the parties is set out below:

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•  the product scope of the non-compete extended to the target enterprise and the promoter of the target enterprise in relation to certain business activities relating to the business division that was transferred, i.e. research, development and testing of injectable formulations of certain kinds of active pharmaceutical ingredients; and
•  the time period of non-competition extended to 5 years on the target enterprise and 8 years on the promoter.

As a justification for the same the parties to the Hospira-Orchid combination review contended that the incorporation of such non-compete clauses was a standard industry practice, which was ‘generally considered necessary for the effective implementation of the proposed combination and allows the acquirer to obtain full value from the acquired assets’.

Being questioned by the CCI, the parties suggested certain modifications in the Hospira-Orchid matter by offering to reduce the time period to four years in relation to the domestic market in India and removed certain R&D restrictions, which were accepted by the CCI

CCI in its order noted:

“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.”

While reviewing the combination notification, CCI may ask for the agreement to be submitted to it for review.

In view of the CCI, the non-compete clause should only cover those products which are being currently developed, manufactured or sold by the target entities; and thus acquirer was issued notice to provide a justification for the above non-compete clauses. The blanket restrictions as to scope (time period and the products covered) are generally questioned by CCI and are not favourably seen.

Guidance Notes

The justification for the length/ scope of the non-compete agreement may be provided by taking into account, inter alia, the following factors:

• Time taken by a new entrant to gain at least 5% in the relevant market
• Nature of the industry
• Time required for obtaining regulatory approvals in the industry and the gestation period specific to the sector
• Any other transaction with specific details

The above are very rough and very broad guidelines for determining/ assessing the AAEC of such non-compete clauses in the agreements. Therefore, it will be expedient for the parties to carefully draft the non-competition agreement and carefully conduct its due diligence while ascertaining the scope and nature of the industry involved and the non-compete sought.

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[1]       (C-2012/09/79).

Stay as promoter and get non-compete fee too in a Takeover transaction

In a recent verdict, the Securities Appellate Tribunal (SAT) [E-Land Fashion China Holdings Limited v. SEBI, 24 May, 2011], ruled that the non-compete fee can be paid to the promoters (without including the non-compete fee in the open offer price) by the acquirer even if (a) the promoters are still continuing as promoters of the acquired company; (b) the promoters are in joint control of the acquired company; (c) the promoters have the right to appoint the board of director, managing director of the acquired company; (d) the promoter shave the ROFR; (e) the promoters have a full tag along right in case of sale of the acquirers; (f) the promoters have mandatory put-option to sell its shares to the acquirer.

To me the judgment of SAT is erroneous and bad in law and SEBI must appeal before the honorable Supreme Court to get the correct the interpretation of non-compete fee paid under regulation 20(8) of the SEBI Takeover regulations, 1997 (SEBI Takeover code).

In the intent and domain of regulation 20(8) of SEBI Takeover code, is to stop and discourage the erstwhile promoters/ selling shareholders of the acquired company to directly/indirectly compete with the new promoters (and or acquirers).  If the selling shareholders are still the part of the acquired entity and exercising rights such as appointing the board of directors, managing director, having ROFR, put option etc., then paying non-compete fee to the selling holders is just like- paying non-compete fee to a non-competitor, which is not the intention (literal or implied) of the SEBI Takeover code.  These erstwhile promoters/ selling shareholders are no where competing with the acquirers-although it may be conceded that these erstwhile promoters/ selling shareholders have potential to compete with the acquirers, however, this remains a possibility only.  And, if we were to look the SPA/SSA signed by these erstwhile promoters/ selling shareholders and the acquirers, it can easily be inferred that the erstwhile promoters/ selling shareholders are still in the game and playing in the same team although under different captain.

The verdict of Tata Tea case, Cementrum IB.V case cannot be mindlessly applied in such cases (as above), as the facts of both the cases are entirely different.

Takeaways for Transactional Lawyers

Well, till the time this SAT order is challenged and reversed by the Supreme Court, a non-compete agreement may be entered into the selling shareholders and the acquirers under which the selling shareholders may still be a categorized as promoter and take major decisions of the acquired entity (for e.g., appointing of managing director, board of directors etc.).