TIGHTENING THE SCREWS ON RESTRAINT CLAUSES IN SALE OF BUSINESS AGREEMENTS

TIGHTENING THE SCREWS ON RESTRAINT CLAUSES IN SALE OF BUSINESS AGREEMENTS
By Robert Legh, Tamara Dini and Lubabalo Stemele
 
Goodwill restraints, given by the seller of a business, are widely regarded as being enforceable, subject to the constraints set out in our common law.  Typically, a new purchaser of a business seeks the comfort of knowing that the seller will not compete with it for an initial period which will allow the purchaser to establish itself in the market.  A decision by the Competition Tribunal (“the Tribunal”) in the Nedschroef case,[1] considered goodwill restraints from a competition law perspective and raises questions about their lawfulness.      
 
In this case, Nedschroef Johannesburg (Pty) Ltd (“Nedschroef”), a manufacturer of automotive fasteners, applied to the Tribunal for interim relief from a restraint of trade to which it had agreed when it purchased its fastener business from Teamcor Limited (“Teamcor”).  Nedschroef undertook to manufacture only specific types of fasteners and, in return, received an undertaking from the seller of the business that it would not manufacture any of those products.  Nedschroef also received a discount on the purchase price for agreeing to its restraint.  Teamcor sold its other assets, which could have been used to manufacture the same products, to a different purchaser.  The other purchaser paid a premium on the price of the assets, on the basis that the assets sold to Nedschroef would not be used by a competing interest.  It was also required to agree to the restraint in favour of Nedschroef.  The undertakings were given for a ten year period. 
 
Nedschroef subsequently came under pressure to diversify into more lucrative markets, including one of the restrained markets.  Five years into the restraint, it asked the Tribunal to suspend the operation of the goodwill restraints on the basis that these infringed the provisions of the Competition Act which prohibit market division.     
 
Section 4 of the Competition Act prohibits agreements or practices between competitors which involve “dividing markets by allocating customers, suppliers, territories, or specific goods or services.”  One of the defences raised against Nedschroef was that Nedschroef was not a competitor of the party to which it owed its restraint because it had not started business at the time that it concluded the sale agreement.  The Tribunal disagreed with this reasoning, finding that market division does not require that both firms are competitors before the act of division – it is enough if they are potential competitors.  The Tribunal considered that firms will divide a market before they become actual competitors precisely to avoid that outcome.  The Tribunal regarded the anti-competitive outcome of market division between potential competitors as no less serious than it is between pre-existing competitors. 
 
A further argument raised was that market division requires reciprocity between competitors while the restraints in this case were not reciprocal.  Here, the reciprocal restraint in favour of Nedschroef had been given by the seller of the business, Teamcor, and not by the other purchaser of Teamcor’s assets.  The Tribunal considered, however, that Nedschroef had contracted to not compete in the market in which the assets would otherwise allow it to compete.  As such, market division had occurred and competition in that market was lessened.  In any event, the Tribunal found that an element of reciprocity existed - Nedschroef had received a discount on the equipment for agreeing to the restraints while the other purchaser had received the benefit of an allocated market, free from competitive presence.  The Tribunal was satisfied that Nedschroef had established a prima facie case that the restraints contravened the Competition Act. 
On the basis of further evidence presented, Nedschroef demonstrated the need for interim relief.  Its business was troubled and its parent company was considering imminent closure of its business, with the consequent loss of jobs, if performance did not improve.  An obvious market for entry was that for short bolt fasteners, which Nedschroef was precluded from entering as a result of the restraint.  Nedschroef provided evidence to show that it was in a position to enter the market in the six month period for which an order for interim relief could run, before the complaint against the restraints could be assessed by the Competition Commission.  It submitted that the balance of convenience in granting interim relief lay in its favour.    
The other purchaser argued that the balance of convenience could never favour a party that seeks to escape from a contract where a definite finding of the lawfulness of the contract can only be made at a later stage.  Nedschroef argued that, at worst, if the order were granted there would be competition for as long as the order operated.  It also undertook to maintain separately in trust the profits arising from any business it engaged in pursuant to the suspension of the restraint and tendered that an order by the Tribunal in its favour would not preclude the other party from recovering damages for the period during which the restraint was lifted, provided that it could prove that it had suffered loss.  The Tribunal was satisfied that it was reasonable and just to grant the order for interim relief in Nedschroef’s favour. 
The decision in the Nedschroef judgment focuses on the particular facts of the case and unfortunately contains little analysis of a variety of potential permutations.  This creates uncertainty because, theoretically, any two firms are potential competitors of each other and, as such, any kind of restraint undertaking could be construed as infringing the provisions of section 4 of the Competition Act.  A firm wishing to dispose of any assets pursuant to a rational commercial decision is likely to dispose of its assets to a potential competitor – a party with knowledge of the industry or know-how in relation to the use of the assets.  A purchaser is likely to seek a restraint from the seller, in order to protect its position in the market initially, allowing it to establish itself.  On a strict application of the Tribunal’s decision, there seems little scope for such a restraint to survive Competition Law scrutiny.  Hopefully, if the point comes up again, it will be subject to more rigorous scrutiny by the Tribunal. 
 
It is too early to be able to state how far-reaching the implications of the Tribunal’s decision will be.  The application granted in this case was for interim relief, pending a final determination of the complaint.  What is significant, however, is that the Tribunal considered that there was sufficient strength in Nedschroef’s case that an allegation of a prohibited practice had been established.  The proposition has not been finally determined but the case is not going on appeal.  Although an appeal court could look at it differently, in the present situation, the matter will go no further and the judgment has tightened the application of the prohibition against market division.        
 

[1] Case No: 95/IR/Oct05.