Reform of German ARC – A paradigm shift?

The German Parliament has passed the 11th reform of the German Act against restraints of competition (ARC). The reform will take effect soon and has three major components:

• The Federal Cartel Office (FCO) is granted the power to implement behavioural or structural measures if a market investigation reveals a "significant and continuous disruption of competition" ("erhebliche und fortwährende Störung des Wettbewerbs") on a market. Breaking with traditional principles of EU and German competition law the imposition of structural or behavioural measures does not require a violation of competition law by the undertakings concerned.
• The FCO already had the power to impose an obligation on undertakings to notify future concentrations below the usual thresholds, if the market investigation shows objective indications that future concentrations will significantly impede effective competition in a branch of the economy. The reform further strengthens the FCO's powers in this regard.
• The reform severely strengthens the FCO's power to order a disgorgement of economic benefits if these benefits are related to a violation of competition law. In particular, the reform introduces an almost irrebuttable presumption that a violation of competition law leads to an economic advantage of at least 1% of the turnover achieved in Germany with the products or services related to the violation.

The reform could have ground-breaking implications. For the first time in its history the FCO will be empowered to order and regulate markets, where market participants have not violated competition rules. This new power raises difficult conceptual problems as it can endanger business models that so far have been viewed as legal and compliant. The new presumptions around the disgorgement of benefits could turn out to be an extremely sharp sword and will raise the stakes for compliance work dramatically.

Behavioural and structural remedies against a significant and continuous disruption of competition

Despite substantial critique from practitioners the German legislator is of the view that there are circumstances under which competition on a market can be significantly and continuously disrupted even where market participants do not abuse market power or violate other rules of competition law. In the eyes of the legislator such disruptions cannot be sufficiently addressed under the current competition law framework. In what has been termed a "paradigm shift" the new ARC therefore empowers the FCO to impose behavioural and structural remedies against undertakings that have not violated competition law if the FCO determines that a significant and continuous disruption of competition exists.

When is competition continuously and significantly disrupted?

The reform bill highlights that it is impossible to provide an exhaustive definition of a disruption of competition. Instead, it enumerates four non-exhaustive indicators for a such a disruption (Sec. 32f (5)):

• unilateral supply or demand power;
• market entry and market exit barriers, barriers to switching suppliers/providers;
• uniform or coordinated behaviour;
• customer or input foreclosure.

In order to be caught by the new powers, the disruption has to occur on (i) at least one nationwide market or (ii) several regional markets or (iii) across markets. The disruption is continuous if it (i) is ongoing for more than three years or has occurred repeatedly over the last three years and (ii) if there is a strong likelihood that the disruption will not disappear within the next two years.

How does the FCO determine a disruption of competition?

Determining a disruption of competition – without looking for actual violations of competition law – appears to be a formidable task. It essentially requires of the FCO to establish what "normal" or "better" competition on a certain market would look like. This seems to come close to what Hayek called the "arrogation of knowledge".

In order to ensure that the FCO makes its determination on a solid factual basis, the new law requires the authority to conduct a thorough market investigation before determining that competition is disrupted. When conducting the market investigation, the FCO has to take account of the following factors:

• number, size, financial strength and sales of the companies, market shares and degree of concentration;
• cross or common ownership of undertakings in the markets concerned;
• prices, quantities, and quality of the products or services in the affected markets (e.g. rigid prices or parallel changes in prices that are not caused by external factors);
• transparency and homogeneity of goods on the markets concerned;
• contracts and agreements between companies in the affected markets;
• degree of dynamism in the affected markets;
• efficiencies benefits, cost savings or innovations with appropriate consumer participation.

However, the legislative material clarifies that these criteria are not conclusive and other factors can be of importance as well.

What measures can be imposed?

In principle, the FCO can impose structural and behavioural remedies. As under Art. 7 of Regulation 1/2003, structural remedies can only be imposed either where there is no equally effective behavioural remedy or where any equally effective behavioural remedy would be more burdensome for the undertaking concerned than the structural remedy.

Behavioural remedies

The law exemplifies different behavioural remedies that the FCO can impose to remedy a significant and continuous disruption of competition. The overarching goal of these measures appears to be lowering market entry barriers to foster competition. These measures include:

• granting access to data, interfaces, networks or other facilities;
• specifications regarding business relationships between companies on the investigated markets and at different market levels,
• obligation to establish transparent, non-discriminatory and open norms and standards;
• requirements for certain forms of contracts or contractual arrangements;
• the prohibition of unilateral disclosure of information that favours a parallel behaviour by companies.

Any undertaking that (i) has made a "significant contribution" to the significant and continuing disruption of competition, which can be any behaviour with an appreciable effect on the market, and (ii) is of importance to the overall market structure can in principle be addressed under the new powers of sec. 32f ARC. While all measures are subject to a proportionality test, the reform notes that the stronger the position of the undertaking on the market in question the more onerous a remedy can be.

Structural remedies

Sec. 32f introduces two types of structural remedies:

• The organizational separation of company or business units (sec. 32f (3) No 6 ARC. The organizational separation leaves the ownership of the units untouched, e.g. the FCO can demand of undertaking X to keep its business units A and B separate (including the appointment of separate management teams and the introduction of information barriers). Yet, ownership for both units would remain with X under an operational separation scheme.
• Obligation to divest parts of an undertaking to third parties (sec. 32 f (4) ARC. Given the ultima ratio characters of this remedy, the law foresees substantial hurdles for its imposition:

• • Addressee of a divestment order has to be a dominant undertaking or an undertaking which is of paramount significance for competition across markets within the meaning of sec 19a ARC (currently only Alphabet, Meta, Apple and Amazon have been determined by the FCO to be of paramount significance).
  • A divestment order must always be the ultima ratio, i.e. it has to be demonstrated by the FCO that other measures are not as efficient.
  • A divestment order must not include business units, the acquisition of which the FCO or the EU Commission has been cleared under merger control proceedings within the last ten years.
  • A divestment order must only be implemented if the price for the divested entity amounts to at least 50% of the value that an auditor (appointed by the FCO) has determined for the divestment business; if the price remains below 100% of the audited value (but above 50%) the state will pay 50 per cent of the delta between the value and the purchase price.

The addressee of the divestment order has to be compensated by the FCO if the price that it can achieve in the divestment process is below 50% of the value that an auditor (appointed by the FCO) has determined for the divestment business.

Besides imposing structural or behavioural remedies the FCO can also accept commitments from the undertakings concerned that eliminate the significant and continuing disruption of competition.

Gazing into the crystal ball – what are potential candidate markets?

The President of the FCO, Andreas Mundt has mused publicly that he can think of "interesting markets" for the application of the FCO's new powers – of course without going into details. Given that the criteria to determine a significant and continuous disruption of competition are extremely broad it is almost impossible to exclude any market just based on these criteria.

While some of the statements in the legislative material might at least offer an initial clue as to what markets might be of interest for the FCO, the overall picture remains blurry:

• The legislative material explicitly mentions that buying alliances in the retail sector are an example of buying power.
• The legislator also mentions several times that oligopolistic markets with homogenous goods and high transparency can lead to higher prices – even where competitors comply with competition law.
• On the other hand, the legislator clarifies that if start-ups experience lower competitive pressure for a short period of time as a result of innovation and are hence able to realize temporary first mover advantages (usually in the form of high profits) these advantages are usually not an expression of a continuous disruption of competition. Rather they are the result of the usual cycle of innovation.

It remains to be seen what markets will become an enforcement priority for the authority.

Request to file mergers below thresholds (sec 32f (2)):

Under the previous version of the ARC, the FCO could already (following a market investigation) request undertakings to notify every concentration in a specific sector if the market investigation reveals sufficient indication that future concentrations will significantly impede competition.

The new sec. 32f (2) essentially only lowers the thresholds that need to be met for such a notification requirement. The FCO can now request a notification for all concentration if

• the acquirer achieves a turnover of 50m EUR in Germany and
• the target has a turnover of 1m EUR in Germany

Additionally, the new ARC clarifies that the stand still obligation applies to deals that have to be notified under a request by the FCO.

Disgorgement of benefits

For years, the FCO could order the disgorgement of the economic benefits that undertakings gained by a violation of German or EU Competition law. However, the provision has hardly achieved any significance in the last decades mostly because it is very difficult for the FCO to demonstrate the amount of the economic benefit resulting from the violation.

To mitigate these difficulties, the reform substantially lowers the hurdle for ordering a disgorgement:

• It shall be presumed that a violation of competition law has caused an economic advantage. The amount of the economic advantage can then be estimated by the FCO, whereby a preponderance of probability for the estimated amount shall suffice.
• Additionally, the reform introduces a second presumption according to which it shall be presumed that the economic advantage amounts to at least 1% of the turnover achieved in Germany with the products or services related to the violation.

• • This presumption can only be rebutted if the undertaking proves that it has not generated any profit (in general and unrelated to the violation) during the disgorgement period. When determining the profit of undertaking the worldwide profit of all persons and entities forming a single economic unit shall be taken as a basis.
  • In particular, the undertaking cannot argue that no economic advantage or an advantage less than 1% has actually accrued.
• As an exception, the presumption shall not apply if due to the special nature of the violation it is impossible that the violation has led to an economic advantage. The legislative material mentions a one-off bid rigging cartel as an example, if none of the undertakings concerned has actually won a contract.
• The disgorgement order must not exceed 10% of the total worldwide turnover of the undertaking (defined as a single economic unit) achieved in the business year preceding the decision.

The reform has the potential to turn the disgorgement order into an extremely powerful tool for the FCO, as it can now force undertakings to pay a considerable amount for every violation of competition law.

• The scope of application is very broad: The FCO can impose a disgorgement for all types of violations including in particular restrictions of competition by effect that normally do not count as "hard-core" and accordingly do not trigger a fine.
• The amount can easily be very considerable: 1% of all sales in Germany achieved with the products related to the violation, potentially over a period of five years (the disgorgement period) will often amount to a formidable figure.
• A rebuttal of the presumption will not be possible in most cases. Given that the law looks at world-wide turnover an undertaking will only be able to escape the disgorgement if it can demonstrate that it has operated at a loss on a world-wide level throughout the total disgorgement period.

It remains to be seen how cautious the FCO will handle this very sharp sword. In any event undertakings need to be even more vigilant now when it comes to competition law compliance: Even minor violations (e.g. a excessive non-compete obligation in a supply agreement) might now have very severe financial consequences.