HORIZONTAL AGREEMENTS

An overview of key elements and cases

Nkonzo HlatshwayoPartner

Webber Wentzel Bowens

3 October 2007

Overview

• the provisions of the South African Competition Act (by way of illustration) that regulate horizontal agreements

• the reasons why competition authorities are concerned about horizontal agreements

• the types of horizontal agreements that are absolutely prohibited or regarded as per se prohibited

• the types of agreements that may admit of a defence

Horizontal Restrictive PracticesSection 4

• some horizontal agreements give rise to what is known as horizontal restrictive practices

• the most egregious restrictive practices occur in the horizontal field : between competitors

• section 4 prohibits anti-competitive agreements (including concerted practices and decisions) between parties in a horizontal relationship

• some of these agreements can be justified on pro-competitive or efficiency grounds whilst others are incapable of any justification whatsoever

Section 4(1)(a)

“(1) An agreement between, or concerted practice by firms, is prohibited if it is between parties in a horizontal relationship [i.e a relationship between competitors] and if-

(a) it has the effect of substantially preventing or lessening competition in a market, unless a party to the agreement, concerted practice, or decision can prove that any technological, efficiency or other pro-competitive gain resulting from it outweighs that effect;”

Section 4(1)(a)Rule of reason prohibition

An agreement between or concerted practice by firms or a decision by an association of firms is prohibited if it is between parties in a horizontal relationship (a relationship between competitors) and has the effect of substantially preventing or lessening competition in the market, unless a party to the agreement or concerted practice can show that any technological, efficiency or other pro-competitive gains resulting from it outweighs that effect.

Essential features of section 4(1)(a)

• agreement or concerted practice

• between firms or association of firms

• in a horizontal relationship (between competitors)

• that substantially prevents or lessens competition

• without any efficiency justifications that outweigh the anti-competitive effects

Key terms

“Agreement”• a contract, agreement or understanding, whether or not

legally enforceableNB: Informal gentlemen's arrangements or understandings, whether in writing or not, can constitute a contravention of the prohibitions set out in section 4(1)(a)

• coordination is usually established in:

- explicit coordination which includes meetings or formal agreements between members of various companies (There must be definite proof of coordination between competitors such as a record of meetings).

- implicit or tacit coordination i.e. an understanding between members of various companies

• the burden of proof lies with the authorities and is usually based on circumstantial evidence.

Elements of circumstantial evidence

- firms acting contrary to their self interest or are not making decisions unilaterally

- the existence of platforms for collusion such as trade associations; and

- price uniformity

Trade associations

• the competition authorities are generally suspicious of industry associations

• provide platform for fixing of trading conditions and prices exchange of competitive information division of markets allocation of customers provide a mechanism for monitoring of

performance/adherence to cartel decisions punishing mechanism for breaking the rules

• collusive tendering - dealers

Key terms

“Concerted practice”

• co-operative, or co-ordinated conduct between firms, achieved through direct or indirect contact, that replaces their independent action, but which does not amount to an agreement

Parties in a horizontal relationship

YOUR BUSINESS

Competitors:substitutes

Competitors: new entrants

HORIZONTAL RELATIONSHIP

What are competitors?

• to establish whether two firms are competitors, there must be proper market definition

• two principal constituents of market definition:

relevant product market; and

geographic market

Horizontal Restrictive Practices

• in National Association of Pharmaceutical Wholesalers v Glaxo Wellcome (Pty) Ltd (68/IR/JUN/00) the Competition Tribunal considered whether an exclusive distribution agency (“EDA”) jointly owned by the manufacturers constituted a prohibited practice under section 4(1)(a) of the Act

• in other jurisdictions, an agency agreement is considered not to be anti-competitive if the agent does not bear any risk

Horizontal Restrictive Practices Section 4

• in the Pharmaceutical case, however, the Tribunal held that the EDA was anti-competitive, as it constituted three important features that give rise to horizontal problems: it was a joint exclusive initiative between competing

manufacturers; the manufacturers jointly controlled the EDA; the manufacturers played a significant role in a

number of therapeutic product categories in which they had competed

Horizontal Restrictive Practices Section 4

• the Tribunal also held that the EDA was anti-competitive as it arose from a concerted initiative by competing manufacturers

• as the Respondents did not satisfy the Tribunal that the alleged pro-competitive gains outweighed its anti-competitive effects, or that the claimed pro-competitive efficiencies could not be achieved through any other means other than a jointly owned EDA, the Tribunal found the EDA to be in violation of section 4(1)(a) of the Act

Horizontal Restrictive Practices Section 4

• although this matter was subsequently set aside on review, it is important to note that the Competition Commission settled a similar matter with pharmaceutical manufacturers

• IHD had been formed in similar fashion by pharmaceutical manufacturers

• the critical question was whether it was an association of firms who were in a horizontal relationship; and

• who used the association for purposes of restricting competition in contravention of section 4

Horizontal Restrictive Practices Section 4

• once a restraint is shown to be anti-competitive, the parties to it are legally obliged to prove some pro-competitive gain

• in neither the EU nor the US is a defendant firm required to discharge a reverse onus

• under section 4(1)(a), the outcome of an inquiry will depend on whether the defendant has discharged its onus of proof (see the Pharmaceutical case)

• this could require every anti-competitive commercial contract between competitors to be justified to the Competition Commission

Possible defences under section 4(1)(a)

- economies of scale

- economies of scope

- economies of distribution and marketing

- network effects

Horizontal Restrictive Practices Section 4 : Per se Horizontal Restraints

• Section 4(1)(b) prohibits outright, without any scope for justification, price fixing, market division or collusive tendering

• while this is per se prohibition borrowed from US anti-trust law and Article 81(1) of the Treaty of Rome, in neither jurisdiction is such a restraint prohibited outright

Section 4(1)(b)

“(1) An agreement between, or concerted practice by firms, is prohibited if it is between parties in a horizontal relationship [i.e a relationship between competitors] and if-

(a)…; or

(b) it involves any of the following restrictive horizontal practices:

(i) directly or indirectly fixing a purchase or selling price or any other trading condition

(ii) dividing markets by allocating customers, suppliers, territories, or specific types of goods or

services, or

(iii) collusive tendering.”

Essential features of section 4(1)(b)

• agreement or concerted practice

• between firms or association of firms

• in a horizontal relationship (between competitors)

• that involves price fixing market division; and collusive tendering

Per se prohibitions

- price fixing involves directly or indirectly fixing a purchase price, or selling price or any other trading condition

- market division involves dividing markets by allocating customers , suppliers, territories , or specific types of goods or services

- collusive tendering occurs where competitors take turns in winning tenders through coordinated conduct

Price fixing

• price fixing is that prohibition where competitors agree to “fix” or agree on prices

• this can take place through any kind of arrangement or understanding that has the effect of fixing, controlling or maintaining prices, discounts, allowances rebates or credits in relation to goods or services bought or sold by any party in competition with another.

Examples of price fixing

• Association of Pretoria Attorneys / Competition Commission

the APA set tariffs that attorneys in Pretoria should charge their clients

• Healthcare cases

the Board of Healthcare Funders (BHF) the Hospital Association of South Africa (HASA); and SAMA

Examples of international price fixing cases

• Lysine Cartel fined $110 million for operating a world-wide Lysine

Cartel between July 1990 and June 1995

• Soda Ash - Solvay / ICI Commission imposed fines on Solvay and the ICI for

geographical market sharing

• F Hoffmann-La Roche AG Vitamin suppliers participated in 8 distinct secret

market-sharing and price fixing practices fixed prices, allocated sales quotas, agreed on and

implemented price increases and issued price announcements in accordance with their agreements

fined EUR 462 million

Trading Conditions

• a trading condition under the Act include a firm’s credit terms , delivery charges, minimum quantities, interest charges or anything which affects the economics of the transaction

- Patensie Sitrus Beherend Bpk Competition Commission & Others Case 37 / CR/Jun01;

- The view held by the Tribunal in this case was that a trading condition must relate to the price-quantity nexus and would certainly not cover delivery schedules

- the use of a common distributor by competitors would only constitute the fixing of a trading condition on the basis of the particular features of such an arrangement and how the distributorship is set up.

• market division and reciprocity occur when two competitors will agree to only sell specific products, work in specific regions, and sell to only specific customers (also known as customer allocation)

• Nedschroef Johannesburg (Pty) Ltd (Nedschroef) / Teamcor Ltd and Others Case 95/IR/Oct05

- the applicant applied to the Tribunal to interdict and restrain the respondents from enforcing a restraint of trade clause in its sale of business agreement with the respondents.

Market division and reciprocity

Some legal clarifications

Per se / Absolute prohibition

• outright prohibition

• cannot raise pro-competitive justifications

• blacklist

• e.g. s4(1)(b)

Rule of reason prohibitions

• anti-competitive effect may be justified on the basis of technological, efficiency or other pro-competitive gains

• which outweighs the anti-competitive effect s4(1)(a)

Horizontal Restrictive Practices Section 4 : Per se Horizontal Restraints

• in the US, the courts have developed a two-stage test for determining whether an agreement is to be prohibited first, the court will inquire whether it is a ‘naked

restraint of trade with no purpose except stifling of competition”;

if it is a naked restraint, it will be declared unlawful (in other words, given per se treatment);

Horizontal Restrictive Practices Section 4 : Per se Horizontal Restraints

if it is not, but does adversely affect competition, the court will ask whether “the restraint can reasonably be expected to contribute to an efficiency enhancing integration of economic activity”;

• the EU follows a similar approach : restrictive practices listed in Article 81(1) (which are largely reflected in section 4(1)(b)) are not automatically prohibited, although they would normally be regarded as anti-competitive

Horizontal Restrictive Practices Section 4 : Per se Horizontal Restraints

• two companies that have a significant interest in each other will be presumed to have entered into a proscribed agreement, of the type described in section 4(1)(b), if they engage in such a practice, unless they can establish, under section 4(3), a “reasonable basis” for concluding that this was a “normal commercial response to conditions prevailing in that market”

Horizontal Restrictive Practices Section 4 : Per se Horizontal Restraints

• section 4(5) excludes the operation of section 4(1) if the agreement or practice is either engaged in by a company within a group of companies, with the same shareholders, or by the “constituent firms within a single economic entity similar in structure” to such a group of companies

• in the EU, the operation of Article 81(1) is excluded where management or control of a company, or similar economic entity, is vested in one party, where that party exercises a decisive influence over the affairs of the joint undertaking

Alternative argument: Supreme Court of Appeal’s decision (Ansac)

• the competition authorities initial view was that section 4(1)(b) created per se prohibitions

• accordingly, no defence was possible to a per se

• parties accused of violating this sub-section were precluded from considering any efficiency justifications for the conduct in question

The Ansac decision

• confirmed that section 4(1)(b) prohibitions are per se

• however, SCA held that competition authorities must still review any relevant evidence that seeks to characterise the conduct in question as falling within the ambit of per se prohibitions

• “It does not follow that price-fixing has necessarily occurred whenever there is an arrangement between competitors that results in their goods reaching a market at a uniform price.”

Observations from the Ansac decision • competitors may embark upon a legitimate joint

venture without transgressing the section 4(1)(b) prohibitions

• to determine whether the kind of price-fixing proscribed by the Act has occurred, it is necessary to enquire beyond the mere terms of the competitors’ arrangement

• the competition authorities must distinguish, in particular, between those price-fixing arrangements that are designed to avoid competition and indirect price-fixing arrangements which do not

The role of US jurisprudence in the Ansac decision

• SCA’s decision seems to support the consideration of the efficiency defence in what it calls the purpose and effect analysis of the agreement in question, a distinctly US way of looking at the issue

• This line of reasoning is clearly drawn from a long line of US cases on the subject of joint ventures

• The analysis of US case law in respect of joint venture type arrangements is particularly useful

Broadcast Music Inc v Colombia Broadcasting System Inc (1979)

• CBS challenged blanket licences issued by the American Society of Composers, Authors and Publishers (“ASCAP”) and BMI as per se price-fixing

• both respondents served as clearing houses for copyright owners

• the fee for the blanket licence was calculated as a percentage of total revenues, or a flat fee

• however, the members of ASCAP and BMI retained the right to license the exploitation of their work individually

US Supreme Court’s decision in BMI

• the court held that a purposive, rather than a literal, interpretation of the Sherman Act was required to characterise the conduct

• the court held further that the blanket licences were neither “plainly anti-competitive”, nor did they “lack… any redeeming virtue”, nor were they a “naked restraint of trade with no purpose except stifling of competition”

• the court accordingly accepted a rule of reason analysis in view of the difficulties inherent in negotiating individual sales transactions in the industry

BMI contd...

● the court accepted that a blanket licence was not a naked restraint but a “necessary consequence of the integration necessary to achieve these efficiencies, and a necessary consequence of an aggregate license is that its price must be established”

● the court also considered that the US Department of Justice had reviewed ASCAP’s blanket licences previously and concluded that they were not per se violations of the Sherman Act

● the Court accordingly concluded that:

“Not all arrangements among actual or potential competitors that have an impact on price are per se violations of the Sherman Act or even unreasonable restraints… Joint ventures and other cooperative arrangements are also not usually unlawful, at least not as price-fixing schemes, where the agreement on price is necessary to market the product at all”

Characterisation under BMI

The following factors, at least, are relevant to characterisation under BMI:

●is the conduct or agreement necessary to market the product in order to achieve the efficiencies generated by the conduct?

●does the conduct or agreement set a mandatory or a default price?

●has a government agency investigated and sanctioned the particular conduct or agreement?

Penalties for contravening the horizontal agreement provisions

• the competition authorities may impose an administrative fine

• a first offender in respect of section 4(1)(b) may face an administrative fine (a repeat offence is required for a section 4(1)(a) violation

• the administrative penalty may not exceed 10 % of the firms annual turnover in South Africa during the preceding financial year

• the competition authorities may declare the whole or any part of an agreement in contravention of section 4 void

• the parties may face civil action in the High Court as a result of prohibited conduct

Conclusion

• competition authorities are very concerned about horizontal arrangements between competitors

• these arrangements are normally very harmful to competition and the welfare of consumers

• result in the misallocation of resources

• lead to market failures