Non-compete clauses in cooperation agreements – caution required

Non-compete clauses that require a party to an agreement (or both parties in case of a reciprocal non-compete obligation) not to enter a market where it is currently not present are most common in M&A contracts for the sale of a business, where the seller undertakes not to compete with the sold business for a specific period of time. These type of non-competes are generally accepted under EU competition law as long as their duration, their geographical field of application, their subject matter and the persons subject to them do not exceed what is reasonably necessary. Non-competes in employment contracts have recently attracted the attention of the US FTC and DoJ.

However, non-competes can also be found in cooperation or distribution agreements between businesses. Replying to a preliminary ruling request by the Court of Appeal in Lisbon, the Court of Justice of the EU (CJEU) was asked to clarify its stance on this matter (Case C-331/21). The case contains important statements on the concept of potential competition, the notion of ancillary restraints and the category of by-object restrictions under Article 101 TFEU.

Background to the case

In January 2012 EDP Comercial and Modelo Continente entered into the "EDP Continente Scheme" (the Scheme). The Scheme was essentially a cross discount mechanism, whereby the parties agreed that customers of EDP Comercial and Modelo Continente would benefit from price reductions:

• Modelo Continente is active in the food distribution and consumer products sector in Portugal. Modelo Continente and its shareholder were part of Sonae Group, which is active in retail distribution, telecommunications and audiovisuals, shopping centers, wood products, tourism and energy. Sonae Group developed a business on the market for the supply of electricity between 2002 and 2008 in Portugal by means of an association with Endesa, through a JV (Sodesa), which was 50% owned by each of the participating companies.
• EDP Energias and EDP Comercial (EDP) are part of a Portuguese conglomerate the parent company of which is EDP Energias, active in, inter alia, the production and supply of electricity and natural gas in Portugal.
• The Scheme provided for reductions in electricity prices which were reserved for customers holding a "Continente Card", a discount card issued by Modelo Continente as part of a loyalty programme. Customers wishing to sign up had to conclude a contract for the supply of low-voltage electricity with EDP in addition to holding the Continente Card. Customers then benefited from a 10% reduction on their electricity consumption, which was provided by issuing discount vouchers, which customers could use for the purchases in Modelo Continente stores. Initially, the amount of the reductions was borne entirely by EDP Comercial. Later it was agreed that Modelo Continente would bear part of the reductions.

The Scheme included a reciprocal non-compete obligation on EDP and Modelo Continente. The latter undertook not (i) to engage in the activity of supplying electricity and natural gas in mainland Portugal or (ii) to conclude with any other electricity or natural gas supplier association agreements or other instruments which grant discounts relating to electricity or natural gas. EDP undertook corresponding obligations on the market for the retail distribution of food products in mainland Portugal.

By decision of 4 May 2017, the Portuguese competition authority imposed fines of €34.5 million on EDP and Modelo Continente for breach of the Portuguese equivalent of Article 101 TFEU. The authority took the view that the non-compete obligation amounted to market sharing between EDP and Modelo Continente.

EDP and Modelo Continente challenged the fine and the Lisbon Court of Appeal ended up asking the CJEU for a preliminary ruling on the following aspects:

• Whether Article 101(1) TFEU must be interpreted as meaning that an undertaking managing a network of consumer product retailers may be regarded as being, on the electricity market, a potential competitor of an electricity supplier with which it has concluded a commercial agreement containing a non-compete clause, even where that undertaking is not active on that product market.
• Whether Article 101(3) TFEU, read in conjunction with Article 1(1)(a) of the 2010 Vertical Agreements block exemption Regulation (VABER) must be interpreted as meaning that the Scheme concluded between two undertakings, active on different product markets which are not upstream or downstream of each other, falls within the category of a vertical agreement and an agency agreement.
• Whether Article 101(1) TFEU must be interpreted as meaning that the non-compete clause in the Scheme may be regarded as an ancillary restriction.
• Whether Article 101(1) TFEU must be interpreted as meaning that a non-compete clause, prohibiting one of the parties to that agreement from entering the national market for the supply of electricity on which the other party to that agreement is a major player, at the time of the final stages of the liberalisation of that market, constitutes an agreement which has as its object the restriction of competition, even if consumers derive certain benefits from that agreement and that non-compete clause is limited in time.

The CJEU's reasoning

EDP and Modelo Continente as potential competitors

The Court recalled its case law in the pay-for-delay cases in the pharma sector (in particular its 2020 judgment Generics (UK) and Others, C-307/18, see our summary here). The crucial question was therefore whether there was a real and concrete possibility (as opposed to a mere hypothetical possibility) for Modelo Continente to enter the market for the supply of electricity. Such a possibility must be substantiated by a body of consistent facts taking into account the structure of the market and the economic and legal context within which it operates.

With regard to the specifics of the case before it, the CJEU made the following observations:

• Subjective evidence: Evidence of a subjective nature, such as the mere wish or desire of the undertaking which is not present on the market concerned to enter that market, cannot constitute independent, decisive or indispensable evidence demonstrating potential competition. However, such a subjective element can be taken into account in order to support consistent objective evidence and thereby strengthening the demonstration that there are real and concrete possibilities of entering the market concerned.
• Perception: The conclusion of the non-compete itself is a strong indication that there is potential competition. If the parties to a non-compete agreement did not perceive themselves as potential competitors, they would, in principle, have no reason to conclude such an agreement. An indication of that type may therefore usefully substantiate objective evidence seeking to demonstrate the real and concrete possibilities for the undertaking which is not present on the market to enter it.
• Activities at group level: The activities of the entities of the group of which the undertaking concluding the non-compete forms part, and the activities of that undertaking itself on the relevant market (and on upstream and related markets) prior to signature of the agreement in question, may also be taken into account to identify potential competition. While the existence of real and concrete possibilities of entering the market concerned must be assessed at the moment of the conclusion of the non-compete, meaning that subsequent circumstances are excluded, earlier economic activities on the relevant market (or on the upstream or related markets) of entities within the group or the relevant undertaking itself can be relevant. Such activities may, inter alia, prove to be relevant for determining possible barriers to entry or the structure of the market, or even constitute evidence of a potential viable economic strategy for entry of the market concerned. The Court therefore took the view that the activities of the Sonae Group can be particularly relevant here – irrespective of the question whether Sonae and Modelo Continente formed one undertaking under competition law. Evidence from such activities can hint at the transfer of know-how, which is useful for entering the market concerned, or can be relevant to assess whether the undertaking concerned would have a viable economic strategy for entering the market.
• Preparatory steps: Preparatory steps cannot constitute an autonomous requirement for the purpose of demonstrating whether potential competition exists. Such steps are relevant only in so far as they may be appropriate for demonstrating that the undertaking concerned had real and concrete possibilities of entering the market concerned, which in turn depends on the specific barriers to entry. They can prove to be significant where, as in the medical sector, there are numerous barriers to entry. In the Court's view it is therefore not necessary to establish that the undertaking concerned took preparatory steps in order to be regarded as a potential competitor.

Definition of vertical agreement/agency agreement

As regards the scope of application of the 2010 VABER the Court is quite clear. By definition a vertical agreement is an agreement entered into between two or more undertakings each of which operates at a different level of the production or distribution chain, and which relates to the conditions under which the parties may purchase, sell or resell certain goods or services. Parties not operating on different levels of the supply chain – as in the case at hand – do therefore not conclude vertical agreements within the meaning of that definition.

The applicants in the main proceedings had additionally argued that the Scheme should be regarded as being two cross-agency agreements, with each of the contracting parties being responsible for promoting sales by the other contracting party. However, given that EDP and Modelo Continente shared the risks associated with the Scheme, their arrangement could not be characterised as an agency agreement. Additionally, the court held that where the contracting parties do not operate, for the purposes of the agreement, within the same production or distribution chain, a characterisation as an agency agreement is not possible.

Ancillary restriction

The Court essentially repeats its case law from Mastercard and others v Commission (C-382/12P). If a given operation or activity is not caught under Article 101(1) TFEU owing to its neutrality, the restriction of the commercial autonomy of the participants in that operation does not breach Article 101(1) TFEU if it is objectively necessary to the implementation of that operation and is proportionate to its objectives. The test of necessity is interpreted strictly by the Court. The question is whether it would be impossible to carry out the neutral operation/activity in the absence of the restriction in question. The fact that that operation is simply more difficult to implement or even less profitable without the restriction concerned does not suffice.

With a view to the case at hand the Court makes two observations:

• The non-compete exceeded the term of the Scheme by a year and was not limited solely to the supply of low-voltage electricity as was the Scheme, but also covered the supply of medium- and high-voltage electricity to industrial customers. While the Court does not reach a definitive conclusion in this regard, it highlights that the national court will have to assess whether the scope of the non-compete can be viewed as necessary, taking into account the specific facts and circumstances of the case.
• With a view to the argument that the non-compete was necessary to protect business secrets of the other party (in particular electricity consumption patterns) the Court is at least sceptical and invites the referring court to assess whether there were less restrictive solutions available to the parties. The Court mentions in particular the confidentiality provision and a clause protecting intellectual property (both were part of the arrangement) in that context.

By-object restriction

The Court notes that in line with its previous case law the concept of a by-object restriction must be interpreted narrowly. However, market sharing agreements can be viewed as being so harmful to competition that they fall within this category. The Court then draws an analogy and states that same is true of market-exclusion agreements, which have as their object the elimination of potential competition and the prevention of competition by keeping a potential competitor outside the market concerned.

If parties want to rely on pro-competitive effects to argue that a market-exclusion agreement does not count as a by-object restriction the hurdles will be high:

• The mere fact that there are procompetitive effects is not sufficient to rule out such a classification. The threshold will only be met if those effects are demonstrated, relevant, specifically related to the agreement concerned, and sufficiently significant to justify a reasonable doubt as to whether that agreement caused a sufficient degree of harm to competition.
• In the case at hand the referring court will need to take account the fact that the non-compete clause coincided with the final phase of liberalisation of the market for the supply of electricity in Portugal. It will also need to assess whether the pro-competitive effects were in fact specific to that non-compete clause itself and not simply connected with that agreement as such.

Practical Implications

The judgement is important for various reasons:

• The Court spells out how it interprets the notion of potential competition outside of the pharmaceutical sector (the case law to date is mainly focused on pay-for-delay cases in the pharma sector). Undertakings must be aware that in liberalised sectors with lower market entry barriers it is much more likely that they might be viewed as potential competitors. In particular, it is not necessary that they have taken preparatory steps for a market entry.
• The court indicates that where parties agree on a non-compete clause they may be deemed to be competitors and may then have to rebut that presumption – even if they operate in unrelated industry sectors. Undertakings should therefore consider carefully whether a non-compete is really necessary in their case or could cause more harm than good.
• If the parties consider a non-compete to be necessary they must be aware that it can be categorised as a market exclusion agreement and may qualify as a restriction of competition by object in the eyes of a competition authority. While the Court acknowledges that a non-compete can potentially be necessary to protect know-how and business secrets, undertakings need to assess thoroughly whether there might be less restrictive means to protect their know-how.
• Additionally, parties using a non-compete should be aware that they will likely be viewed as potential competitors and should therefore take appropriate measures when exchanging competitively sensitive information (e.g. internal clean teams or Chinese Walls).