UK: Are You Concentrating? A Guide To The Merger Regulation For Outsourcing Lawyers

Last Updated: 14 May 2008
Article by Julia Jones

By Mark Henley and Julia Jones

Until recently, competition law issues in outsourcing projects were very much on the periphery. That may no longer be the case as the European Commission now tells us that the EU Merger Regulation can apply to outsourcing deals. In this article Julia Jones and Mark Henley look at what outsourcing lawyers need to know about the Merger Regulation and when they should consult with their competition colleagues.

Competition Law and Outsourcing Transactions

Until recently competition lawyers have had only a marginal part to play when considering outsourcing transactions. Some advice may have been needed on exclusivity arrangements and on the impact of Article 81 (concerning agreements which restrict competition) but besides these areas there has been little to worry about. However, all this seems about to change. Always with an eye for a snappy and memorable title, the European Commission issued "Commission Consolidated Jurisdictional Notice under Council Regulation (EC) No. 139/2004 on the control of concentrations between undertakings1" (the "Notice") which states that the Merger Regulation2 can apply to outsourcing deals.

Mergers are regulated by competition law because they can impede effective competition. Whilst Article 82 of the Treaty establishing the European Community is concerned with preventing the abuse of a dominant position, the Merger Regulation is intended to prevent competition from being restricted in the first place.

Under the Merger Regulation the Commission can examine significant multi-jurisdictional mergers, acquisitions and joint ventures and oppose them if they are incompatible with the common market. If the various criteria set out in the Merger Regulation are fulfilled then the parties to the affected transaction will be obliged to notify the Commissions Competition Directorate General for approval prior to implementation. The Notice now makes clear the Commissions view that in some situations this could apply to outsourcing transactions too.

Community Dimension

The Merger Regulation sets out various highly complex turnover tests designed to assess whether the transaction will be significant enough to have an impact on the Community (whether it has a "community dimension"). The details of these tests are beyond the scope of this article but it is worth remembering too even if a transaction is deemed not to have a "community dimension" it may still be examined by national competition authorities. In the UK, for example, section 23 of the Enterprise Act states that a "relevant merger situation" will arise where two or more enterprises cease to be distinct and certain turnover or "share of supply" thresholds are exceeded. This could apply to certain outsourcing transactions.

Moreover, even where the Merger Regulation does apply, national authorities may retain a parallel jurisdiction if the merger threatens to create or strengthen a dominant position within a distinct local market.

Are you concentrating?

The Merger Regulation applies where the proposed transaction forms a "concentration" of undertakings. It establishes that a concentration will be deemed to arise where a change of control on a lasting basis results from either: (a) the merger of two or more previously independent undertakings or parts of undertakings; or (b) the acquisition of direct or indirect control of the whole or parts of one or more other undertakings.

The intention of the parties must be for the concentration of undertakings to operate on a lasting basis. Typically there is no direct guidance on how much time will constitute a "lasting basis." The only, rather cryptic, clue in the Notice is that it will be long enough to bring about a lasting change in the relevant market structure.

A business with access to the market

In many outsourcing contracts, the contractor provides a service which the customer originally carried out in-house and related assets and employees are transferred to the contractor. In these circumstances the Notice makes clear that a concentration may arise if the transaction is said to have created "a business with access to the market." This will occur if the contractor is able to use the transferred assets and employees to provide services to third parties, either immediately following the transfer or within a short period afterwards.

In order to create a "business with access to the market" that manufactures a product, it may be necessary to transfer production facilities. However, to create a "business with access to the market" in the services sector, the contractor might need only relevant know-how (from transferred employees and intellectual property) and the means for developing market access quickly (for example, from marketing facilities).

The Commission anticipates that the time taken for the contractor to develop market access ought not to exceed 3 years in duration, depending on specific market conditions. If the assets transferred do not enable the contractor to build up a market presence in that time, then they will not be viewed as having created a business with access to the market.

Full-function Joint Ventures

On some occasions a service may be outsourced through the creation of a joint venture company between the customer and the contractor. In these circumstances, the Notice points out that under the Merger Regulation3 a concentration will arise if a joint venture is created that performs all the functions of an autonomous economic entity ("full-function") on a lasting basis.

The Commission indicates that a joint venture is unlikely to be considered full-function if it provides services solely to its parent companies, is reliant on input from its parents and/or if sales to third parties will remain ancillary to the principal provision of services to the parents.

The Notice states that the joint venture must also have management dedicated to its day-to-day operations and access to sufficient resources including finance, staff, and assets (tangible and intangible). It does not matter if the joint venture is not autonomous in terms of decision making, so long as it is "economically autonomous from an operational viewpoint." Matters to be considered in deciding whether a joint venture is full-function include:

Staff

A joint venture need not have its own employees to be autonomous. Employees of third parties can be used under an operational agreement or they may be acquired from an employment agency. Secondments from either parent company may also suffice during a start-up period. However, an autonomous joint venture must be able to choose for itself the source of its staff.

Activities

The joint venture will not be full-function if it takes over only a specific function of the parents business without its own access to or presence in a market. So a joint venture which takes over, for example, only the Research & Development or production activities of its parents will not be full-function.

Sales

If more than 50% of the joint ventures turnover comes from third parties, the joint venture will usually be classified as full-function. If the turnover from third parties is less than 50%, the Commission will undertake a case-by-case analysis. The Commissions main interest is in whether the joint venture deals with its parents at arms length on the basis of normal commercial conditions.

Conclusion

By claiming that the Merger Regulation can apply to outsourcing transactions, the Commissions Notice will surprise and dismay many. In recent years, customers have come to expect their outsourcing providers to use transferred assets to enter the market and pursue third party revenue opportunities against which they can defray some of the service charges. With the added complexity and uncertainty that the Merger Regulation brings, parties to outsourcing transactions may be inclined to agree that third party revenue opportunities offer more hazards than benefits.

Footnotes

1 Adopted on 10 July 2007

2 Council Regulation (EC) No. 139/2004, OJ L 24, 29.1.2003

3 At Article 3(4).

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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.

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