CCI takes careful look at non-compete agreements

By Adity Chaudhury, Udwadia Udeshi & Argus Partners
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Non-compete agreements (NCAs) have become a standard feature of merger and acquisition deals. Such agreements seek to protect the acquirer of a business by restraining the seller from participating in a similar business or using know-how related to the business and thereby competing with the acquirer. Acquirers often pay a significant amount for the goodwill of the business and for such non-compete obligations.

Adity Chaudhury
Adity Chaudhury

NCAs have been scrutinized in India against the backdrop of section 27 of the Indian Contract Act, 1872, which makes an agreement that restrains anyone from exercising a lawful profession, trade, or business of any kind, void. However, as per various judicial pronouncements, reasonable restraint is permitted under certain circumstances. Further, as an exception to section 27, a seller of goodwill can agree not to carry on a similar business within the specified local limits, so long as the buyer, or any person deriving title to the goodwill from the buyer, carries on a like business there, and provided that such limits appear reasonable to the court.

Courts have held that reasonableness of restraint depends on various factors, and any covenant to prevent divulgence of trade secrets or business connections has to be reasonable to ensure adequate protection to the covenantee. Normally negative covenants operative during the term of a contract have been held to be permissible while those operative after the termination of a contract have been held to be in violation of section 27.

Since the coming into effect of the Competition Act, 2002, NCAs are also subject to the scrutiny of the Competition Commission of India (CCI). Two recent CCI decisions – both relating to acquisitions in the pharmaceutical sector – highlight the competition law concerns that may arise out of NCAs.

Hospira/Orchid

Hospira Healthcare India entered into an agreement to acquire two API businesses from Orchid Chemicals and Pharmaceuticals. The agreement contained a non-compete clause which covered not only the business transferred, but also restricted research, development and testing of penem and penicillin APIs for injectable formulations. While examining the proposed acquisition, the CCI observed that non-compete obligations should be reasonable, particularly in respect of: (a) the duration over which such restraint is enforceable, and (b) the business activities, geographical areas and persons subject to such restraint, so as to ensure that such obligations do not result in an appreciable adverse effect on competition.

The CCI approved the acquisition only after the parties agreed to modify the terms of the non-compete covenant to: (a) reduce the non-compete obligation to four years in India, and (b) allow Orchid to conduct R&D activities for new penem and penicillin APIs.

Mylan/Agila

NCAs again came up during Mylan’s acquisition of the entire share capital of Agila Specialties. Agila was involved in the business of injectable products and, through a subsidiary, was engaged in R&D and manufacturing of oncology-related pharmaceutical products and other preparations. The NCA restrained the selling promoters from developing, manufacturing, distributing, marketing or selling any injectable, parenteral, ophthalmic or oncology pharmaceutical products for human use anywhere in the world for six years.

While examining the proposed acquisition, the CCI referred to its earlier decision in Hospira/Orchid and observed that the non-compete covenant sought to impose a blanket restriction covering products which were not even within the scope of the business activities of the target companies. It said the covenant should cover only those products which were either being manufactured or sold or were under development by Agila and its subsidiary.

The CCI approved the acquisition after the parties proposed modifications, including: (a) reducing the duration of the non-compete obligation to four years; (b) restricting the scope only to products which were being manufactured by the target companies or were in the pipeline; and (c) permitting the promoters to undertake R&D activities for new molecules.

The above decisions demonstrate that any non-compete obligation which causes or is likely to cause an appreciable adverse effect on competition in India would not be valid. However, NCAs are often essential for the success of a combination. To protect the value of the investment the acquirer may require the seller to refrain from competing with the business. If there is a blanket prohibition on such restrictions, then a large part of the economic raison d’être for entering into a deal may be lost.

The CCI has implicitly recognized that business exigencies require the imposition of certain restraints. However, these restrictions should be reasonable and directly related to the combination. Therefore, while drafting NCAs a fine balance must be struck, having regard to the duration and scope of the non-compete obligation.

Udwadia Udeshi & Argus Partners is a full-service law firm with offices in Mumbai, Delhi, Bangalore, Kolkata and Chennai. Adity Chaudhury is a managing associate at the firm. The views expressed by the author are personal and do not reflect the views of the firm.

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