Restrictive Covenants in the Sale of Business Context
Anna V. Putintseva
If you are acquiring a successful Ukrainian business, one of the major concerns is to ensure that the company’s trade secrets, know-how, business connections and practices are preserved and protected after the deal is completed. After all, it is these very assets that made the acquired business successful and you want to make sure that they do not leave the company with the departing seller.
Therefore, it is important to include restrictive covenants in a sale and purchase agreement imposing specific obligations on the seller, thereby preventing him from abusing confidential information about his former business. Examples of the frequently used restrictive covenants include, inter alia: non-competition, non-solicitation, non-disclosure and confidentiality clauses.
Under these covenants a seller of the business agrees not to launch a similar business or trade in competition against the buyer for a certain period of time on a specific territory. The main purpose of such restrictive obligations is to prevent the seller from reentering the same market right after the sale, soliciting key employees, approaching former clients and otherwise competing with the sold business. In the European Union such restrictions are described as ancillary restrictions and are automatically permitted as part of merger clearance to the extend they are directly related, necessary and proportionate to the implementation of the concentration or the agreement concerned.
Such an approach does not work in Ukraine, which does not have any specific rules on the ancillary restrictive covenants and does not provide an answer on the legitimacy of their use in a sale of business situation. Therefore, it is very important to carefully consider each restraint intended by the contracting parties to be included in the agreement to make sure it is in line with the requirements of Ukrainian competition law. It may well be the case that a restraint will be classified by the Antimonopoly Committee of Ukraine (the AMCU) as an anticompetitive concerted action, generally prohibited without prior approval of the AMCU (the AMCU approval), unless it falls within one of the available exemptions.
Which restraints are deemed anticompetitive?
On Protection of Economic Competition Act of Ukraine of 11 January 2001 (the Competition Act) provides for non-exclusive list of anticompetitive concerted actions, among which are: (i) price regulation; (ii) restriction on production, goods’ market activity, technical development, investments or control over them; (iii) sharing of markets or sources of supply by a territory, range of goods, volume of sales, customers, sellers or consumers or other criteria; (iv) distortion of tenders and auctions; (v) removal from or restriction to the market of other market players; (vi) applying varying terms to similar agreements placing business entities into unfavorable competition conditions; (vii) entering into agreements imposing additional commitments on the parties not relating to the subject-matter of the agreement; (viii) significant restriction of competitiveness of other market players without any legitimate reasons. Furthermore, the AMCU may, at its discretion, qualify other similar actions (or omissions) as anticompetitive, if they result in or may lead to the prevention, elimination or restriction of competition.
Thus, if the restrictive covenants constitute any of the actions listed above or other similar actions, the contracting parties may perform them only upon obtaining prior AMCU approval unless the restraints fall within any of the exemptions.
What are the exemptions and do they really help?
General exemptions
The Ukrainian legislator did not envisage any particular exemptions for restrictive covenants imposed by agreements on sale of shares or assets. Therefore, in order to determine whether an AMCU approval is required, it is necessary to analyze the applicability of the general exemptions to concerted actions. Regulation No.27-p On the Standard Requirements to Concerted Actions of Business Entities for General Exemptions from Obtaining the AMCU Approval of 12 February 2002 (the Regulation No.27-p) envisages the following general exemptions (the General Exemptions):
1. De-minimis exemption: where the aggregate market share of the concerted actions’ participants does not exceed 5% on any involved market;
2. Market share exemptions: where the aggregate market share of the participants of horizontal and combined concerted actions is less than 15% and of vertical and conglomerate concerted actions is less than 20% on any involved market, provided, however, the following financial thresholds are not exceeded: (i) EUR 12 million of assets and/or sales by concerted actions’ participants in aggregate worldwide; and (ii) EUR 1 million of assets and sales per at least two participants each worldwide; and (iii) EUR 1 million of assets and sales by at least one participant in Ukraine.
Both de-minimis and market share exemptions are not applicable, however, with respect to the following horizontal or combined concerted actions: (i) price fixing; (ii) restriction, including termination, of production, sale or purchase of goods; (iii) sharing of markets or sources of supply by a territory, range of goods, volume of sales, customers, sellers or consumers or other criteria; (iv) distortion of tenders and auctions. Thus, if a restrictive covenant imposes an obligation not to sell certain goods, it may well be argued that it constitutes a restriction of sale and purchase of goods, which may not be performed without obtaining approval from the AMCU by the parties even with a minimal market share.
Specialization exemption
If the general exemptions are not applicable, the parties to a joint venture agreement containing restrictive covenants may be entitled to avoid obtaining AMCU approval under the exemption for specialized concerted actions1 (the Specialization Exemption), provided certain conditions are met. Specialized concerted actions are defined as horizontal concerted actions of business entities aimed at consolidation of their efforts and resources on production (sale) of certain goods, which results in improvement of production, purchase or sale of goods, provided such actions do not lead to significant restriction of competition on the market or a substantial part of it.
If the latter condition is met, the joint venture participants will not be required to obtain AMCU approval, provided that they undertake only certain obligations (listed in Regulation No.880-p) when engaging in a specialized concerted arrangement. In addition, Regulation No.880-p sets forth a number of exceptions to which the specialized exemption will not apply, including, inter alia, the following: occupying a monopoly position (more than 35% of a certain market); occupying more than a 25% market share by a single business entity; a group consisting of not more than 2 business entities having a market share of more than 50%; and a group consisting of not more than 4 business entities having a market share of more than 70%; and involving a concerted arrangement exceeding a term of 5 years.
In summing up, Ukrainian competition rules provide for a number of exemptions from obtaining AMCU approval, most of which are unclear and can be ambiguously interpreted. Besides, the rules establish different exceptions from the exemptions and the burden lies on the parties to determine whether their actions require or may require approval from the AMCU or clearly fall within an exemption.
Alternatively, the contracting parties may apply to the AMCU requesting its preliminary conclusion regarding the qualification of the proposed restrictive covenants as concerted actions. Such application is not mandatory, but may be helpful in guiding the parties regarding the necessity of obtaining AMCU approval before engaging in concerted behavior. To obtain a preliminary conclusion from the AMCU, the contracting parties must file substantially the same package of documents which is filed for obtaining AMCU approval. Preliminary conclusions are issued within 1 month, and the state processing fee is EUR 124. If the AMCU, however, comes to a conclusion that AMCU approval is required to permit the proposed restrictive covenants, the contracting parties must file an application (with a reference to already submitted documents) requesting the issuance of the AMCU approval and wait up to 3 months for its issuance. In practice, if the parties in an M&A deal make two simultaneous applications: (i) to obtain an approval for concentration taking the AMCU 45 days to issue; and (ii) to obtain an approval for concerted actions taking up to 3 months to issue, the AMCU may, in its discretion, issue both approvals simultaneously within a 45-day term.
Applying for AMCU approval
If it is concluded that the restraints constitute anticompetitive concerted actions for which none of the exemptions are available, the only possibility to legitimise the concerted arrangement is to obtain prior AMCU approval. For the purpose of obtaining AMCU approval, the contracting parties must prepare and file with the AMCU a joint application accompanied by various documents.
In the application the contracting parties will need to describe the intended concerted actions, their impact on the relevant market(s), including on actual and potential competitors, consumers, market sharing, etc. In addition, arguments must be provided supporting the fact that the concerted actions will contribute to (i) improvement of production, purchase and sale of goods; (ii) technological and economic development; (iii) development of small or medium-sized business; (iv) optimization of export or import of goods; (v) development and application of uniform technical terms or standards for goods; (vi) efficiency of production, etc.
Pursuant to the Competition Act, the AMCU may authorize anticompetitive concerted actions if the participants of concerted actions provide sufficient evidence of the above listed positive effects. If the contracting parties fail to provide strong arguments in favor of the intended concerted actions, the AMCU is required to deny issuance of its approval. The AMCU, however, before issuing a denial, may notify respective applicants and allow them to submit additional supporting information and/or documentation proving that benefits of the concerted actions will offset the negative effects thereof.
The overall review procedure for obtaining AMCU approval is up to 3 months, and the state processing fee is EUR 230. As a general rule, the AMCU approval is valid for one year. The applicants, however, may request for a longer period (e.g., the term of a contract), in which case it will be at the discretion of the AMCU to issue its approval either for a requested period or for another period determined upon the results of the review.
Liability
According to the Competition Act, failure by the participants of concerted arrangement to obtain prior AMCU approval (if required) will constitute a violation of Ukrainian antimonopoly legislation, which is punishable by a fine in the amount of up to 10% of the combined annual revenue of the breaching entity’s group for a recent reporting year. If the profit resulting from the concerted behavior exceeds 10% of the combined group’s revenue, an additional fine may be applied in the amount not exceeding a triple amount of unlawfully earned profit.
The Competition Act also establishes a fine in the amount of up to 1% of the combined revenue of the breaching party’s group for provision of untrue information to the AMCU.
The statute of limitation for concerted conduct constitutes five years from the date of the violation, and in the event of a continuing violation — five years from the date of the termination of the violation.
The violation is generally deemed to have been committed starting from the date of a relevant contract or from the date of the actual commencement of the concerted conduct, as the case may be.
Besides, parties whose rights were infringed as a result of a concerted arrangement, are entitled to file a court claim seeking compensation in an amount double the harm caused by the breaching parties.
Review of AMCU decisions
The Competition Act provides that during five years from the date of its decision to grant AMCU approval the AMCU may reconsider its decision if:
(i) the AMCU was not and could not have been aware of material circumstances prior to the adoption of an unlawful and unjustifiable decision; or
(ii) the decision was made on the basis of untrue information which resulted in adopting of an unlawful and unjustifiable decision. The AMCU may also reconsider its decision during the term of the validity of AMCU approval if: (i) parties to concerted actions failed to comply with the terms envisaged by AMCU approval; or (ii) the circumstances on the basis of which AMCU approval was granted, ceased to exist. As a result of such reconsideration, the AMCU may (i) confirm its decision on the issuance of the AMCU approval; or (ii) recall its decision in whole or in part; or (iii) make a new decision with respect to a concerted arrangement.
Conclusion
Although various types of restrictive covenants commonly used in sale of business contracts may constitute anti-competitive concerted actions under Ukrainian law, they do not always have a negative impact on competition. Instead, frequently, concerted arrangements lead to facilitation of competition by improvement of production and sale techniques, optimization of trade practices, development of uniform technical terms and standards for goods.
However, in order to ensure that each particular restrictive covenant is carried out in line with Ukrainian law, one has to correctly classify it, apply available exemptions and, if necessary, validate it by obtaining AMCU approval.
1 Specialized concerted actions are governed by Regulation No. 880-p On the Standard Requirements to Concerted Actions of Business Entities on Specialization of Production Permitting such Concerted Actions without Obtaining AMCU Approval of 11 December 2008 (the Regulation No.880-p).
