How Will The Competition Act's Prohibitions Against Restrictive Vertical And Horizontal Practices Affect South African Business?

29th November 1999

Life for South African business has changed dramatically since the advent of democracy in April 1994. Liberalisation of trade policy and capital account regulation have meant that, for the first time in nearly forty years, South African business has had to compete in the real market place, not simply domestically, but internationally. South Africans accession to the Marrakech agreement in 1994 has meant that tariff protection has been reduced on average by one-third over the past five years and still continues to decline in the so-called sensitive areas of textiles, clothing and motor vehicles. South African companies are, for the first time, allowed to list and raise capital internationally, while South Africa will, in November, become one of the few emerging markets, alongside Egypt and Israel, to sign a free trade agreement with the European Union, which will, over twelve years, free tariffs on 95% of our exports and 86% of our imports.

It is not a coincidence that in this process of reforming an economy characterised by high levels of market concentration, anti-competitive practices and weak competition laws and institutions, government decided to re-write the Maintenance and Promotion of Competition Act, 1979. The 1998 Competition Act ("the Act"), which came into force on 1 September 1999, is designed, amongst other things, to promote economic efficiency and provide consumers with "competitive prices and product choices".

In doing so, the Act, at a formal level, follows mainstream European Union, and, to some extent, United States competition law, by prohibiting restrictive practices, whether vertical (between firm, supplier, or customer) or horizontal (between firms) and abuses of dominance by dominant firms.

Consequently, much of Chapter 2 of the Act, which will be examined in more detail below, is based on Articles 81 and 82 of the 1957 Treaty of Rome ("the EU Treaty"), under which the European Union was established. This is not surprising, as South Africa came under considerable pressure during the EU free trade agreement negotiations to adopt Articles 81 and 82 verbatim.

What is concerning about the Act, however, is its reliance on non-economic standards. The preamble and objects of the Act reveal that it has a social, as much as an economic, objective. Thus, section 2 records that the Act must "promote a greater spread of increase the ownership stakes of historically disadvantaged persons..." while, section 10 (the exemption section), allows the Competition Commission to exempt otherwise prohibited agreements or practices which promote the ability of firms "controlled or owned by historically disadvantaged persons to become competitive".

If the purpose of competition law is the promotion of consumer welfare through economic efficiency, or what Judge Robert Bork calls "improving allocative efficiency without impairing productive efficiency", these social objectives, however laudable, should relocate themselves either to the Employment Equity Act, or the proposed legislation on the restructuring of State-owned enter-prises.

Horizontal restrictive practices: section 4

From a competition lawyer's perspective, the most notorious restrictive practices occur in the horizontal field: between competitors. Section 4(1)(a) of the Act deals with this in some detail, by prohibiting substantially anti-competitive agreements (including concerted practices and decisions) between competitors, unless the parties concerned can prove that a pro-competitive gain outweighs the agreement's anti-competitive effect. Superficially, this looks like US-style rule of reason analysis, under which a horizontal restraint will be deemed unlawful if it adversely affects competition, unless the parties concerned can justify the restraint on efficiency grounds.

What is unfortunate about section 4(1)(a), however, is that, as with its counterpart in the area of vertical restraints (section 5(1)(a)), it reverses the onus of proof. Once the restraint is shown to be anti-competitive, the parties to it are obliged to prove some pro-competitive gain.

In neither the EU nor the US is a defendant firm required to discharge a reverse onus. In both jurisdictions, a firm is required only to put forward evidence, after the complainant has presented its evidence, that the agreement is reasonably necessary to achieve pro-competitive gains. In other words, the defendant's evidence will be weighed against that of the complainant. By contrast, under section 4(1)(a), the outcome of an inquiry will depend on whether the defendant has discharged its onus of proof.Not only does this onus place the defendant at a legal and evidential disadvantage , literally construed it could require every anti-competitive commercial contract between competitors to be justified to the Competition Commission. This can be tested by the following hypothesis: assume that two chemical manufacturers enter into a joint venture agreement to develop a new chemical product because one of them possesses the know-how and the other the capital. While, under US law, the agreement would be tested against its "efficiency enhancing integration of economic activity" and would probably pass muster, under section 4(1)(a), the parties to the agreement would have to prove to the satisfaction of the Competition Commission and the Competition Tribunal that the agreement's pro-competitive gains outweighed its anti-competitive effect. The same reasoning would, of course, apply to collaborative agreements between competitors for research and development, the exchange of information, the supply or purchase of goods or services, or the provision of marketing information.

Per se horizontal restraints

Things do not become better with section 4(1)(b), which absolutely prohibits, without any scope for justification, and whether or not in the form of an agreement between competitors, price fixing, market division or collusive tendering. Again, superficially, while this is a per se prohibition borrowed from US anti-trust law and Article 81(1) of the EU Treaty, in neither jurisdiction is such a restraint prohibited outright.

In the US, the courts have developed a two-stage test for determining whether an agreement is to be prohibited. First, the court will inquire whether it is a "naked restraint of trade with no purpose except stifling of competition" . If it is a naked restraint, it will be declared unlawful (in other words, given per se treatment). If it is not, but does adversely affect competition, the court will ask whether "the restraint can reasonably be expected to contribute to an efficiency enhancing integration of economic activity" . The EU follows a similar approach: restrictive practices listed in Article 81(1) (which are largely reflected in section 4(1)(b)) are not automatically prohibited, although they would normally be regarded as anti-competitive.

Unlike the EU or the US, section 4(1)(b) prohibits three, or possibly four, horizontal restraints outright , without any possibility of justification. Again this can be tested against a commonplace example. Assume that an accounting firm, as part of its partnership agreement, restrains its partners from competing with one another for three years in Gauteng and its surrounding provinces, on pain of not being paid a partner's pro rata share of the partnership capital account, when leaving the partnership. Although there may be a good economic justification for this, in relation to the retention of the firm's clients, such a restraint could in future be prohibited outright.

Matters do not end there, as section 4(2) presumes the existence of a prohibited agreement under section 4(1)(b), if the firms in question either have a common substantial shareholder, or one of more common director, and they engage in the proscribed practice. Although the worst aspects of section 4(2) were removed during the Parliamentary hearings on the Bill last year, two companies with cross-directorships or substantial cross-shareholdings will be presumed to have entered into a proscribed agreement, of the type described in section 4(1)(b), if they engage in such a practice, unless they can establish, under section 4(3), a "reasonable basis" for concluding that this was a "normal commercial response to conditions prevailing in that market".

This presumption has no counterpart in either EU or US law. More importantly, the provision does not make sense. As section 4(1)(b) does not require an agreement between competitors in order to operate, presuming such an agreement does not tell one what the terms of that agreement are.

A final aspect of section 4 is that section 4(5) excludes the operation of section 4(1) if the agreement or practice is either engaged in by a company within a group of companies, with the same shareholders, or by the "constituent firms within a single economic entity similar in structure" to such a group of companies. In the EU, the operation of Article 81(1) is excluded where management or control of a company, or similar economic entity, is vested in one party, where that party exercises a decisive influence over the affairs of the joint undertaking.

The question which must be asked domestically is whether the competition authorities will construe section 4(5) literally in accordance with the parent-subsidiary company test under the Companies Act, 1973, or whether it will follow the broader EU single economic entity test. Again, this is not without economic significance, as a narrower approach will almost certainly discourage joint ventures by firms which are not constituted in a parent-subsidiary company relationship, but where one party controls the joint venture.

Vertical restrictive practices: section 5

Unlike Article 81(1) of the EU Treaty, the Act distinguishes between horizontal and vertical restraints, although it subjects the latter, in section 5(1)(a), to rule of reason treatment, in a manner similar to section 4(1)(a). In other words, a substantially anti-competitive agreement between a firm and its suppliers or customers will be prohibited, unless the firm can prove pro-competitive gains. As with section 4(1)(a), section 5(1)(a) shifts the onus of proving the pro-competitive advantages of a vertical restraint on to the defendant firm. For reasons previously discussed, this is invidious and without precedent in comparative competition law.

What makes applying the reasoning of horizontal restraints to the vertical sphere worse is that this covers much of normal commercial life. South African business probably does not realise that as of 1 September 1999, all exclusive distribution, purchasing, licensing, franchising or know-how agreements, as well as all long-term exclusive supply agreements, will have to be justified under section 5(1) (if such agreements foreclose market access by other firms) and, unless so justified, will be prohibited.

This is undesirable for two reasons. First, it gives rise to uncertainty and, second, it does not make a great deal of economic sense. In the US, most vertical non-price restraints are treated as legal, because Americans believe that economic efficiency is enhanced by leaving manufacturers to develop their own distribution systems. In the EU, on which section 5(1)(a) is based, bloc exemptions have had to be granted for exclusive distribution and purchasing agreements and the trend is very much towards liberalising, rather than controlling, restrictions on vertical practices.

The problem with section 5(1)(a) is that it may, in practice, prove unworkable. Not only is the Competition Commission in danger of being overwhelmed by a flood of applications to exempt vertical restraints, but the Commission has no mechanism, on its own, under the Act, to issue bloc exemptions, unless an application is made by a firm to do so. In this event, there could be serious questions about the firm's locus standi to do so on behalf of an industry, as opposed to itself.

Exemptions: section 10

Section 10 of the Act allows the Competition Commission to exempt an otherwise prohibited agreement or practice from the Act's proscriptions under a limited range of circumstances specified in section 10(3)(b). These include the promotion of exports, the ability of small businesses, or firms owned or controlled by historically disadvantaged persons, to become competitive and the economic stability of any industry designated by the Minister of Trade and Industry.

The first point to note about these grounds of exemption are that they are far more narrowly drawn than the equivalent provision, Article 81(3), in the EU. This permits a more balanced assessment of the merits or demerits of the individual restriction by providing for:

"improving the production or distribution of goods or to promoting technical or economic progress, while allowing consumers a fair share of the resulting benefit...."

The point that the Commission may as a rule not of its own accord grant a bloc exemption to an industry is highlighted by section 10(4), which allows it, exceptionally, to exempt intellectual property agreements both individually and by category.

The Act, however, contains two major changes to the Bill as introduced to Parliament last year. First, section 3(1)(d) now excludes "acts subject to or authorised by public regulation", in other words conduct which is the subject of some other statutory regime, such as a cellular telephone licence granted by the SA Telecommunications Regulatory Authority. Second, section 65(1) makes it clear that a contractual provision remains valid, until declared void or prohibited by the Competition Tribunal or the Competition Appeal Court. This may happen only after an investigation by the Competition Commission and a positive finding, following a hearing, by the Competition Tribunal. This is very much to be welcomed in the interests of both commercial and legal certainty.

Penalties: sections 61 and 62

Although business may derive some comfort from section 65(1), it could be short-lived. Sections 60 and 61 of the Act provide that the Competition Tribunal may not only declare a firm's conduct to be a prohibited practice, following an investigation and a hearing, but it may fine such firm up to 10% of its annual turnover in the preceding financial year in the event of a breach of a per se prohibition or a repeated breach of a rule of reason prohibition . In an EU context, this can be seen from last year's case involving Volkswagen and the European Commission, where the Commission fined Volkswagen 102 million dollars for preventing its Italian dealers, on pain of dismissal, from selling motor cars to Austrian customers, who would pay substantially more for these vehicles across the border.

While this broadly follows EU law , it does not o so consistently. This is because an appeal from the Competition Tribunal lies only to the Competition Appeal Court and no further, whereas in EU it would lie all the way to the European Court of Justice in Luxembourg. Moreover, while the EU provides for periodic penalty payment for non-compliance with a Commission decision, the Act simply criminalises this conduct with penalties of up to ten years' imprisonment or a fine of R500 000, or both.

In conclusion, while the treatment of horizontal and vertical restrictive practices under the Act is a considerable improvement not only on its scanty treatment under the Act's predecessor, but also on the Bill as introduced to Parliament, the Act's:

  • reversal of normal standards of proof
  • creation of outright prohibitions in the horizontal sphere
  • outlawing of anti-competitive vertical restraints
  • narrowness of exemptions
  • failure to provide for bloc exemptions,

means that, in practice, all third party agreements entered into by business in South Africa will, in future, require the closest legal examination and may well require exemption proceedings before the Competition Commission.

Peter Leon, MPL

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