European Union: CJEU Judgment Provides Guidance On Non-Compete Clauses

The Court of Justice of the European Union (CJEU) handed down a judgment concerning co-promotion agreements between potential competitors in a preliminary ruling to the Lisbon Court of Appeal.

The ruling (C-331/21) offers some direction to stakeholders on how European agencies and the courts may treat non-compete restrictions, including a reminder to closely consider the economic and legal context in which such restrictions are agreed.

Background

The Portuguese Autoridade da Concorrência (AdC) imposed a €38.3 million fine on electricity and gas supplier Energias de Portugal (EDP), and food retailer Model Continente (MC), for agreeing to share markets for the supply of electricity and natural gas, and the retail distribution of food.

Under the agreement, EDP offered price rebates for the supply of low-voltage electricity in Portugal to customers holding an MC-issued loyalty card. Those customers benefited from a 10% reduction on electricity spending in the form of discount vouchers loaded onto the MC card. The agreement contained a two-year non-compete clause preventing EDP and MC from entering each other's markets in Portugal, and negotiating similar agreements with third parties.

The parties appealed the AdC's decision to the Lisbon Court of Appeal, which sought a preliminary ruling from the CJEU.

Preliminary ruling

The CJEU ruled on four overarching questions:

1. When can two parties, who are not currently active on the same markets, be considered "potential competitors"?

The CJEU ruled that two parties can be considered "potential competitors" where, absent the agreement, there are "real and concrete possibilities" of one party joining the other's market and competing with it. This is settled law, but the CJEU raised some interesting points:

• An agreement containing a non-compete clause is an indication that there is potential competition. The CJEU considered that if the parties did not perceive themselves as potential competitors, they would, in principle, have no reason to agree to a non-compete. The CJEU acknowledged that this subjective consideration cannot constitute independent, decisive, or indispensable evidence of potential competition, but it can be taken into account to support consistent objective evidence of an infringement.
• The parties' economic activities pre-dating the agreement are relevant in an assessment of potential competition. Between 2002 and 2008, MC was active in the supply of electricity through a joint venture with Endesa, the incumbent electricity supplier in Portugal. Prior activity by one party in the other party's market, whether independently or through association with third parties, including on a temporary basis, may influence the assessment of potential competition. It can demonstrate a viable strategy for entering, particularly where the potential competitor holds useful licenses and/or know-how.
• A party's existing infrastructure may enable expansion into new product markets, including by collaboration. A party with an established sales and marketing infrastructure in the relevant country may find it easier to partner with companies which are already active in the relevant product market, and enter by collaboration.
• Preparatory steps taken to enter a market are indicative, but not conclusive (or necessary) to a finding of potential competition. The probative value of preparatory steps to establish market entry depends, among other things, on the structure of the relevant market and the economic and legal context. Preparatory steps may have greater bearing in industries characterised by long-run barriers to entry (e.g., pharmaceuticals; see C‑307/18 Generics (UK) and Others and C‑591/16 P, Lundbeck v Commission).
• Competition authorities are not required to demonstrate potential competition with certainty, but a finding must be substantiated with consistent facts, considering "the structure of the market and the economic and legal context within which it operates". In this case, the agreement coincided with a crucial phase in the liberalisation of the Portuguese low-voltage electricity market, which improved MC's prospect of entering as a rival of EDP.

2. Can a co-promotion agreement concluded between two parties active on different product markets be categorised as a 'vertical agreement' and an 'agency agreement'?

The categorisation of an agreement as horizontal or vertical can impact the validity (and enforceability) of non-compete provisions. For instance, agency arrangements – which are vertical in nature – do not generally fall within the scope of the EU prohibition against anti-competitive agreements.

In this case, the CJEU ruled that an agreement promoting the development of the parties' product sales through a promotion and cross-discount mechanism could not be considered a vertical agreement. While the parties were active on separate markets (the supply of electricity on the one hand, and food retail on the other), those markets were not upstream or downstream of each other. The Court also found that this was not an agency arrangement, as each party bore a part of the costs and risk associated with the implementation of the agreement.

3. Can a non-compete clause in a co-promotion agreement, the objective of which is not anti-competitive, be justified as an "ancillary restraint"?

The Ancillary Restraint Notice states that a non-compete (contained in an otherwise lawful agreement) can be justified where it is "objectively necessary" to the implementation of the main agreement and "proportionate" to its objectives. In this case, the CJEU noted the following:

• The duration of the non-compete exceeded the term of the co-promotion agreement by one year;
• The scope of the non-compete was not limited to the subject matter of the agreement (i.e. the supply of low-voltage electricity and food retail), but also covered adjacent markets (i.e. the supply of medium- and high-voltage electricity to industrial customers, and the supply of natural gas); and
• The non-compete prohibited MC from entering into an agreement with another electricity supplier to grant discounts or other monetary benefits to end customers.

Subject to its finding on the fourth question below, the referring courts have the responsibility to determine whether the non-compete in this case was objectively necessary and proportionate.

4. Can a non-compete preventing a party to enter the other's market(s) restrict competition by object?

The CJEU acknowledged that the concept of 'restriction of competition by object' must be interpreted restrictively. It applies only to certain types of coordination between companies which are, by their very nature, so harmful to competition that there is no need to examine their effects.

The CJEU ruled that an agreement containing a non-compete preventing the parties from entering each others' markets can constitute market sharing or market-exclusion – and thus a restriction of competition by object. The CJEU asked the referring court to make its determination on this point taking into account the clause's economic and legal context, including:

• EDP's position as a major player on the electricity supply market;
• The commercial nature of the co-promotion agreement;
• The duration of the non-compete (which exceeded the term of the agreement by one year);
• The scope of the non-compete (which was wider than the object of the agreement); and
• The occurrence of the restriction in the particular context of market liberalisation, which is akin to the dismantling of significant barriers to entry.

Our takeaways

Competition authorities continue to focus on potential competition.

• The European Commission (EC) and the UK Competition and Markets Authority (CMA) have adopted revised Horizontal Guidelines, which more clearly define the concept of "potential competitor" in line with recent case law. According to the revised guidelines, the assessment of potential competition may include factors such as (i) the potential competitor's intention and ability to enter the relevant market within a short period of time; (ii) the existence of entry barriers; (iii) the existence of concrete/realistic evidence of potential entry (iv) whether the relevant firm took preparatory steps to enter; (v) the structure of the market and the economic and legal context within which it operates; and (vi) the perception of firms already stablished on the market regarding the potential entrant;
• Potential competition remains an area of focus also in the context of merger control (see for example the EC and CMA's ongoing investigations in Adobe/Figma, where the agencies are scrutinising Figma's likelihood of entering Adobe's markets, and its ability to exert a significant constraining influence even as a potential competitor).

The concept of potential competition remains broadly interpreted.

• Courts and competition authorities are expected to thoroughly assess market conditions (including barriers to entry), and the parties' historical activities (and entry attempts) to inform an analysis of whether a firm is a potential rival;
• The mere existence of non-competition clauses may be relied on as evidence of potential competition.

The economic and legal context in which a non-compete is agreed remains fundamental to the analysis.

• Courts and competition authorities must assess the objectives of non-compete restrictions in light of their economic and legal context. They must take account of the nature of the goods or services affected, as well as their functioning and structure of the market in question (see T-374/94, European Night Services);
• Non-compete restrictions which contravene or hinder a specific policy objective (such as market liberalisation) are more likely to attract scrutiny; and
• The existence of market power may heighten potential competition concerns.

Parties should carefully consider the scope and duration of non-competes.

• The scope of the non-compete should align with the objective of the lawful agreement, and the clause should not restrict the parties' activities on unrelated markets;
• Parties should assess whether the aim(s) of the non-compete can be achieved through less restrictive means (e.g., confidentiality restriction, exclusive licenses, etc.); and
• Non-competes with a short duration are not immune from scrutiny. In horizontal agreements, parties should consider additional justifications prior to agreeing to a non-compete that exceeds the duration of the agreement.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.