monday, 5 may of 2014

Non-compete provisions in M&A transactions in Brazil

Non-compete provisions in M&A transactions in Brazil


Gabriel Rios Corrêa e André Provedel

In a significant number of M&A transactions, just as important as the acquisition of a target company is guaranteeing that the seller will not engage in competition. After all, the seller is often in an advantaged position to snatch businesses and strategic employees from his former company and thus harm the acquirer.


To address this potential risk, M&A agreements customarily contain non-compete provisions prohibiting the seller from managing, developing or owning an interest in any company engaged in a competing business. Such provisions are usually combined with a non-solicitation clause and a confidentiality obligation. The non-solicitation clause prevents the seller from soliciting or hiring one of the target company’s employees or interfering with its suppliers and clients. Under the confidentiality obligation, the seller must refrain from using or disclosing to third parties trade secrets of the target company. M&A agreements oftentimes establish significant penalties for noncompliance with such provisions. Setting up these penalties is advisable considering that, in many cases, it is difficult for the courts to assess the damages caused by noncompliance and thus calculate the indemnification due by the defaulting seller.


Because of the restraints a non-compete provision imposes on the seller, and the overall negative impacts it may have on competition, legislators and antitrust authorities throughout the world have been giving more attention to them. In several countries, if the provision goes beyond certain parameters, it may be considered unenforceable.


In the European Union, an unreasonable non-compete provision is not only void, but also can expose the parties to M&A transactions to significant financial penalties. One example is the decision issued by the European Commission in Telefónica’s acquisition of Portugal Telecom’s interest in Vivo (a Brazilian mobile operator). The EU Commission imposed on the parties a total €80 million fine in reason of a deemed illegal non-compete provision prohibiting both parties from engaging, directly or indirectly, in any competing project related to the telecommunication business within the Iberian market. According to the EU Commission decision, such clause is tantamount to a market sharing agreement, which is considered illegal, because “Instead of competing with each other and behaving as rivals as is expected in an open and competitive market, Telefónica and PT deliberately agreed to exclude or limit competition on each other's home markets”.


In accordance with the guidelines established by the US Federal Trade Commission and the EU Commission, the analysis of the legality of non-compete provisions must involve a balance between (i) the protection of the interests of the purchaser and the value of the acquired business and (ii) its potential anticompetitive harm. Based on such guidelines, antitrust authorities have generally accepted non-compete provisions that are limited to (i) a short term (usually ranging from 2 to 3 years), (ii) the specific geographic area in which the target company sells its products or services, and (iii) the particular sort of products or services then provided by the target.


The Brazilian Administrative Council for Economic Defense (Conselho Administrativo de Defesa Econômica – CADE) has adopted guidelines similar to those of the US Federal Trade Commission and the EU Commission. The limitation of the effects of the clause to the relevant market of the targets included.


However, the CADE has been quite more liberal concerning time limitation. Inspired by article 1,147 of the Brazilian Civil Code (which imposes a 5-year non-compete in the sale of the goodwill of a business), the CADE usually accepts non-compete provisions with a maximum 5-year time limitation1. Notwithstanding, it is noteworthy that some recent decisions have imposed a lower time limitation of 2 or 3 years, in light of the particularities of the relevant markets involved in the transactions and the potential effects on competition.


Additionally, there are other aspects that must be taken into account when negotiating a non-compete provision, such as the possibility of preventing the seller from exercising her/his profession (a situation that would occur, for instance, if a health-care provider sells her/his controlling stake in a medical clinic) or providing consultancy to competitors. There is not yet a developed body of case law to guide the parties as to those issues.


Specially now that the new Brazilian competition law subjects many M&A transactions to pre-merger review by the CADE, non-compete provisions need to be structured with the above parameters in mind. When the restrictive covenants are capable of limiting or otherwise harming free competition, the CADE may not approve them or may subject the approval of the M&A transaction to the adjustment of the non-compete provision.

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1 CADE consolidated such understanding in its Precedent no. 5, published in 2009.

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* Gabriel Rios Corrêa and André Provedel are respectively partner and associate at Lobo & Ibeas Advogados.




 


 

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