Beware – Your restraint of trade clause may be anti-competitive

By Lee Mendelsohn, director and head of the Competition Law Team, Edward Nathan

Businesses are bought and sold every day in South Africa, as elsewhere in the world. A common clause included in sale of business agreements is an undertaking by the seller of the business that it will not, for a specified period of time, compete with the purchaser in the production, marketing and sale of particular products, either in a specified area or at all.

The commercial rationale for the inclusion of restraint clauses in sale of business agreements is clear – the buyer seeks to protect the value of the business acquired from the erosion that may well result if the seller (with all its know-how and experience) were to commence operation in competition with the sold business within a short period after the sale.

Despite the above commercial rationale, parties should be aware that they are not free to craft restraint clauses of the nature contemplated with impunity. They are restricted in their freedom to contract by the provisions of the Competition Act.

The Competition Act’s impact upon clauses of the nature referred to recently came under scrutiny in the matter of Nedschroef Johannesburg (Proprietary) Limited and Teamcor Limited 05/IR/Oct05.

The facts of the case were as follows. In September 2000, Nedschroef purchased an automotive fastener manufacturing business from Teamcor. That transaction was preceded by a sale by Teamcor to CBC Fasteners (Pty) Ltd (CBC) of Teamcor’s national bolts business. The sale to CBC was effected at a premium, apparently on the basis of an undertaking by Teamcor to CBC that it would not sell its remaining business (comprising its automotive fastener manufacturing division) to any competitor of CBC. Conversely, the sale to Nedschroef was effected at a discount to value, allegedly on the basis that Nedschroef undertook, in favour of both Teamcor and CBC, not to conduct any businesses other than those specified in the agreement for a period of ten years.

Some five years after the giving of the restraint undertaking, Nedschroef became interested in entering the market for the manufacture of short lock bolt fasteners, a market outside the permitted activities of Nedschroef, according to the contract. In its attempt to extricate itself from the restraint undertaking, Nedschroef approached the Competition Authorities for relief – claiming that the restraint undertaking was an unlawful division of markets by competitors.

Nedschroef alleged that the restraint contravened section 4(1)(b)(ii) of the Competition Act and sought from the Competition Tribunal an interim suspension (pending a final determination of a complaint lodged by it with the Commission) of the operation of the restraint clause and an interdict against CBC implementing the restraint, on the basis that the restraint divided the market by allocating specific goods between competitors.

After unsuccessfully arguing that Nedschroef was not entitled, five years after the entering into by it of the agreement, to seek interim relief, CBC raised two substantive defences to Nedschroef’s application for interim relief.

Firstly, it alleged that, as Nedschroef (which conducted no business whatsoever at the time of entering into the agreement containing the restraint provision) was not, at the relevant time, a competitor of CBC, the provisions of section 4 of the Competition Act did not apply. In essence, this compelling argument is as follows: section 4 proscribes competitors from dividing markets between them – parties who are not competitors are not similarly constrained. The Tribunal, however, rejected this argument and held that “market division does not require that both firms be competitors prior to the act of division. If they are potential competitors this will suffice”.

Secondly, CBC argued that a division of markets requires reciprocity (that is, an agreement between competitors to divvy up a market such that competitor “A” has an exclusive right to market product “X” whilst competitor “B” has exclusive domain over marketing product “Y”). As the restraint in question was a unidirectional one (in that only Nedschroef undertook to restrain itself from certain business activities), CBC’s submission was that no market division had occurred.

The Tribunal again found against CBC and ruled that “market division has occurred and competition in that market is lessened as a result…that is the test in ‘characterising’ the agreement, and an absence of reciprocity does not detract from that”.

As part of the legal requirements for the granting of interim relief, Nedschroef was required to demonstrate that the balance of convenience favoured the granting to it of the order sought. In order to tip the balance in its favour, Nedschroef undertook to retain all revenue derived from the operations in question in a ring-fenced account and to pay, in due course, to CBC any damages that CBC may prove that it suffered, should the restraint ultimately be found to be lawful.

The Tribunal thus rejected CBC’s bases of opposition (including lateness in bringing the application, that CBC and Nedschroef were not competitors at the relevant time and lack of reciprocity of the restraint), found that the balance of convenience favoured Nedschroef and held that the restraint was causing harm to competition. It thus granted the relief sought by releasing Nedschroef, on an interim basis, from the restraint and interdicting CBC from enforcing it.

The Tribunal was not swayed by the principle of freedom of contract. Notwithstanding Nedschroef’s voluntary conclusion of the agreement, it was nonetheless afforded protection under the Competition Act for clauses that it subsequently found to be onerous or unexpectedly harsh.

Contracting parties must be aware that the entering into of a contract is no bar from seeking relief in terms of the Competition Act. Indeed, the Tribunal has stated that it would be unreasonable and unjust to hold a party to a bad bargain if it would do a major disservice to competition enforcement.