Not all restraints of trade fall foul of the Competition Act

October 1st, 2018

Dawn Consolidated Holdings (Pty) Ltd and Others v Competition Commission (CAC) (unreported case no 155/CACOct2017, 4-5-2018) (Rogers JA) (Davis JP and Boqwana JA concurring)

By Unathi Jukuda

Restraints of trade have been a contentious issue for competition law. For example, the significant concern about restraints of trade, is the possibility that such arrangements can lead to the creation of a cartel and attract liability for all those involved. In a recent Competition Appeal Court case, the matter of restraints was once again considered with interesting implications for competition law.

In Dawn Consolidated Holdings (Pty) Ltd and Others v Competition Commission (CAC) (unreported case no 155/CACOct2017, 4-5-2018) (Rogers JA) (Davis JP and Boqwana JA concurring) the case dealt with a merger transaction where Dawn, which held 49% in a joint-venture company called Sangio, wished to increase its shareholding to 100%. The Competition Commission (the Commission) initially approved the transaction without conditions, however, on investigation, the Commission found that the shareholders’ agreement between Dawn and Sangio contained a ‘non-compete clause’. The non-compete clause provided that Dawn and its subsidiaries would not manufacture high density polyethylene piping (HDPE) in South Africa (SA) in competition with Sangio, and that the restriction would prevail for as long as Dawn continued to hold shares in Sangio.

The Commission alleged that the clause sought to allocate the market as contemplated in s 4(1)(b)(ii) of the Competition Act 89 of 1998 (the Competition Act) by preventing Dawn from entering the relevant market. In essence s 4(1)(b)(ii) provides that:

‘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 and if –

(b) …

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

Section 4(1)(b), provides for a per se prohibition against agreements between competitors to fix prices, divide markets or engage in collusive tendering. Dawn advanced that, if properly characterised, the non-compete clause did not amount to a per se prohibition but was rather a restraint in the normal course of a business transaction, intended to protect its underlying investment in Sangio.

The Competition Tribunal (the Tribunal) in considering whether the restraint of trade was reasonable, decided that the restraint was not one of commercial necessity. Other factors that the Tribunal considered when making its decision was the extent of the duration of the non-compete clause, which the Tribunal concluded was too lengthy and that the restraint operated against the buyer (Dawn) as opposed to the seller.

There has been uncertainty in South African competition law as to whether restraints of trade constitute a contravention of the Competition Act. On the one hand, in Nedschroef Johannesburg (Pty) Ltd v Teamcor Ltd/Waco International Ltd/CBC Fasteners (Pty) Ltd/Avlock International (Pty) Ltd (CT) (unreported case no 95/IR/Oct05, 1-2-2006) (N Maniom) the Tribunal found the restraint of trade to be disproportionate, in that it operated against the purchaser in favour of a party that was not a party to the transaction and in addition the restraint was for an extensive duration. On the other hand, in Replication Technology Group (Pty) Ltd v Gallo Africa Limited (CT) (unreported case no 92/IR/Sep07, 10-12-2007) (D Lewis) at para 32, the Competition Tribunal found the restraint to be proportionate due to its limited nature.

The Competition Appeal Court in considering the appeal from the Tribunal in the Dawn case noted that, in principle, when dealing with cases where the parties to the agreement are potential competitors, the only legal basis on which non-compete clauses can be held not to contravene s 4(1)(b)(ii), is if regard is had to the principle of characterisation (at para 28). This principle was succinctly defined in the case of American Natural Soda Ash Corporation and Another v Competition Commission and Others 2005 (6) SA 158 (SCA) at para 47, wherein the court held that the essential inquiry for characterisation is about establishing ‘whether the character of the conduct complained of coincides with the character of the prohibited conduct’. The court went further and noted that the process embodies two elements, one being the scope of prohibition, which is a matter of statutory construction and the other being the nature of the conduct complained of, which is a factual inquiry (American Natural Soda at para 47).

One of the issues that the Competition Appeal Court had to grapple with was whether the Tribunal was correct in finding that the restraint of trade was not a clause inserted in the ordinary cause of commercial necessity, because it did not follow on a joint venture. The shareholders’ agreement unequivocally stated that the agreement between parties was not a joint venture. The Competition Appeal Court took a distinct view from that of the Tribunal. The Competition Appeal Court went further than just solely basing its finding on what the relationship was called in the shareholders agreement (literal interpretation), but rather focused on what the true nature of the relationship was (purposive interpretation). The Competition Appeal Court applied the principle of characterisation and arrived at a different conclusion to that of the Tribunal. The Competition Appeal Court found that a restraint, which is commercially reasonable in the context of the transaction is not characterised as violating s 4(1)(b)(ii) (Dawn at para 28).

The second issue that the Competition Appeal Court had to decide was the length or duration of the restraint. The Tribunal previously expressed its concern about the fact that the restraint of trade was for a long period of time and not the usual short period. Again, the Competition Appeal Court disagreed with this proposition adopted by the Tribunal. The Competition Appeal Court found the duration of the restraint to be reasonable and necessary to protect the underlying investment. Dawn was only restrained insofar as it continued to hold shares in Sangio.

The Competition Appeal Court delineated an appropriate test for assessing ancillary conduct, holding that the character of a non-compete clause is not to be assessed as if it stood on its own. It must be viewed in the context of the transaction as a whole and the circumstances of the parties when they concluded the agreement. The court went on further and stated that the requirement that the restraint should be objectively necessary may, however, be too strict. The appropriate test, according to the court, was the following:

  • Is the main agreement (ie, disregarding the impugned restraint) unobjectionable from a competition law perspective?
  • If so, is a restraint of the kind in question reasonably required for the conclusion and implementation of the main agreement?
  • If so, is the particular restraint reasonable proportionate to the requirement served? (Dawn at para 32).

Ultimately, since the Commission did not suggest that the shareholders agreement in itself was objectionable, the Competition Appeal Court concluded that the restraint was in the ordinary course of business, as it was necessary to protect proprietary confidential information of Sangio, as Dawn would have access to information and know-how of the business of Sangio. The ancillary restraint was found to be proportionate as it operated as long as Dawn was a shareholder in Sangio.

The Competition Appeal Court judgment is welcomed for bringing much needed clarity on some of the issues surrounding restraints of trade in competition law. This judgment underscores that not all agreements, which on the face appear to violate s 4(1)(b) of the Competition Act will per se amount to a prohibited conduct. The test for ancillary conduct developed in this case is significant as it is one of the first cases that sets out how one ought to apply it within the context of characterisation. It flows from this judgment that restraint of trade clauses contained in a sale of business or shareholders agreement will not necessarily be considered anti-
competitive, provided that it is designed to protect the value of the investment and not designed to limit competition.

Unathi Jukuda LLB (UWC) ND: Marketing (CPUT) is a candidate attorney at Werksmans Attorneys in Cape Town.

This article was first published in De Rebus in 2018 (Oct) DR 45.