COMPETITION AUTHORITY

Competition Authority Decision of 2 April 1992 relating to a proceeding under Section 4 of the Competition Act,1991.

Notification No. CA/8/91 - Nallen O'Toole (Belmullet)  relating to a proceeding under Section 4 of the Competition Act, 1991.

Notification No CA/8/91

Decision No. 1

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Competition Authority Decision of 2 April 1992 relating to a proceeding under Section 4 of the Competition Act, 1991.

Notification No. CA/8/91 ‑ Nallen/O'Toole (Belmullet).

Decision No. 1

Introduction

1.	Notification was made with a request for a certificate under Section 4(4) of the Competition Act, 1991 or, in the event of a refusal by the Competition Authority to issue a certificate, a licence under Section 4(2), by Mr. Nallen and Mr. O'Toole, Belmullet, on 21 November 191 in respect of an agreement to transfer a business interest.

2.	Notice of intention to take a favourable decision was published in 'The Irish Times' on 12 March 1992.  There were no submissions from interested parties.

The Facts

(a)	The subject of notification

3.	This notification concerns an agreement between the vendor and the purchaser of an interest in a business in which they had previously been partners.  In the agreement the vendor agrees, as part of the arrangements in selling his share of the business to his partner, to refrain from engaging in the business concerned for a specific period in a defined geographical area.

(b)	The undertakings concerned

4.	The parties to the agreement are Mr. Thomas J. Nallen and Mr. Edward O'Toole who had carried on business in partnership with one another in the town of Belmullet, Co. Mayo.

(c)	The products and services concerned

5.	The business carried on was the sale, repair and provision for rent of televisions, video recorders and hi‑fi equipment, commonly referred to in the electrical trade as 'brown goods'.  They also provided video films for rent and there was particular emphasis on providing televisions, video recorders and video films for rent.  They were engaged in this business for a period of three years.  While in partnership both serviced the business more or less equally, with no staff being employed, and they therefore both knew their customers and dealt with them on a personal basis.  They travelled around the area collecting rents and had a premises in the town of Belmullet where they stored equipment, carried out repair work and provided products for sale and rent.  They dealt with customers who were resident in the town of Belmullet or who lived in the surrounding rural area.
(d)	The market involved

6.	The market can be seen as sub‑dividing into three elements, the sale of brown goods, the provision of the same goods for rent, and the provision of video tapes for rent.  Consumers face a choice between buying and renting certain brown electrical goods such as TVs and video recorders.  The purchase of such goods is a one‑off transaction involving a substantial outlay for most consumers.  Renting may represent a more viable option for those unable to undertake such a large outlay.  The choice between purchasing and renting, however, involves a choice between consuming different types of product.  A rental agreement includes repair and service of the goods.  An individual who purchases a TV or video recorder must purchase such services separately.  Thus the sale and rental of brown electrical goods constitute two separate but related markets.  The rental of video tapes is a third distinct market.

7.	There are three other undertakings carrying on the same business in Belmullet.  The four undertakings are each estimated to have a market share in the range of twenty to thirty per cent.  They deal in the same range of products and engage in the same three function, i.e. sale, repair and rental, except that one undertaking does not provide goods for rent.  The list of licensed video rental outlets in the office of the Film Censorship Board indicates that Mr. Nallen is licensed in respect of two such outlets in Belmullet, Belmullet TV in Upper Barrack Street and Video City in Main Street.  In addition to Nallen/O'Toole, one of the other undertakings is a relatively recent entrant to the market, having replaced another undertaking which left the market.  Consumers in the area also have access to the same products and services in other towns close to the area concerned, in Crossmolina, Ballina and Castlebar which are respectively thirty one, thirty nine and forty seven miles from Belmullet.  Nallen and O'Toole did not have exclusive distribution rights with respect to particular brands and did not confine themselves to dealing in particular brands of products.

(e)	The Agreement

8.	With effect from 1 October, 1991, Mr. Nallen purchased Mr. O'Toole's interest in the business.  As part of the arrangements associated with the transfer of Mr. O'Toole's interest to Mr. Nallen, the parties made the agreement, which is the subject of this notification, on 1 November 1991.

9.	In the agreement, Mr. O'Toole undertook not to engage in the relevant business within a radius of twenty miles of the town of Belmullet for a period of three years commencing on 1 October, 1991.  He would not directly or indirectly solicit any such business from the public on his own behalf or on behalf of any other party.  Clause 3a of the Agreement states:‑

	"Mr. O'Toole hereby undertakes and covenants with Mr. Nallen, that he will not, for a period commencing on the 1st October, 1991, and terminating three years thereafter, be engaged in the relevant business in any capacity whatsoever, and without prejudice to the generality of the foregoing, that he shall not be engaged, either as principal, partner, agent, servant, employee, director (including shadow director) or otherwise howsoever, whether directly or indirectly carry on, help, or assist in carrying on or be associated with the relevant business within a radius of 20 (twenty) miles, of the town of Belmullet, in the County of Mayo, and that during the same period, within the same area, Mr. O'Toole shall not directly or indirectly solicit from the public, any business connected with the relevant business, nor shall he solicit or endeavour to obtain business for any other party, carrying on the same or similar business in the same area, during the same period."

Mr. O'Toole also agreed to pay, by way of damages, specified sums of money to Mr. Nallen in the event of any breach of the agreement by Mr. O'Toole.

10.	Mr. O'Toole is now engaged in the repair and sale of general and specialist radio and audio equipment, especially in connection with the fishing industry in the Belmullet area, ship to shore radio, sonar, depth finders and the like.  Mr. Nallen and Mr. O'Toole consider that this does not compete with the relevant business as defined in the agreement.

Assessment

(a)	Section 4(1)

11.	Section 4(1) of the Competition Act states that 'all agreements between undertakings, decisions by associations of undertakings and concerted practices which have as their object or effect the prevention, restriction or distortion of competition in trade in any goods or services in the State or in any part of the State are prohibited and void'.

12.	As this is the first notification on which the Authority has taken a decision some general outline of the Authority's views on Section 4(1) might be appropriate at this stage.  Both the European Commission and the Court of Justice have decided against interpreting Article 85(1) literally.  If Section 4(1) were to be interpreted literally then virtually every form of business agreement could be argued to prevent, restrict or distort competition because any agreement effectively prohibits others from concluding the very same contract with the original parties.  Such an interpretation would render it virtually impossible for business to operate.

13.	The present notification concerns arrangements whereby an individual has bought out his former partner's interest in a business and is seeking to impose restrictions designed to prevent his former partner setting up business in competition with him for a period of time, by means of what may be best described as a 'non‑competition clause'.  In deciding whether the agreement is in breach of Section 4(1) of the Competition Act, the Authority first of all examines its overall economic impact and then considers the specific question of the non‑competition clause.

(b)	The Undertakings and the Agreement

14.	Section 3(1) of the Competition Act defines an undertaking as 'a person being an individual, a body corporate or an unincorporated body of persons engaged for gain in the production, supply or distribution of goods or the provision of a service'.  The Section explicitly states that individuals may come within the definition of undertakings if they are 'engaged for gain in the production, supply or distribution of goods or the provision of a service.'

15.	Prior to the conclusion of this agreement Mr. Nallen and Mr. O'Toole as business partners were engaged for gain in the supply and distribution of goods, namely televisions, videos and hi‑fi equipment, and in the provision of a service, namely the rental and repair of televisions and rental of video films in the town of Belmullet and its environs.  Having bought out Mr. O'Toole, Mr. Nallen has continued to trade in the same business.  Mr. O'Toole has continued in business in his own right repairing and servicing radio, radar and navigation equipment on fishing vessels.

16.	The European Commission has ruled on the definition of an undertaking in a number of cases under Article 85(1) of the Treaty of Rome on which Section 4(1) is based.

	'The word "undertaking" is a wide term which extends to almost any legal or natural person carrying on activities of an economic or commercial nature including, for example, limited companies, partnerships, trade associations, agricultural co‑operatives, sole traders and State Corporations.  Whether the undertaking is profit‑making is immaterial, provided it carries out economic or commercial activities.

17.	The Commission ruled in the Reuter/BASF case that an individual could be regarded as an undertaking by virtue of engaging in economic activity through firms which were under his control, by exploiting the results of his own research and as commercial adviser to third parties.  Similarly in the Nutricia case the Commission decided that individuals were undertakings by virtue of their being the future proprietors of a business.

18.	There is a difference between Irish and EC legislation in that the Irish Act defines an undertaking as being "engaged for gain".  In practice, this appears to differ very little from the EC view that an undertaking carries out economic or commercial activities.
19.	Mr. Nallen and Mr. O'Toole were and are engaged for gain in the provision of services and are therefore, undertakings within the meaning of Section 3 of the Act.  The arrangements notified to the Authority in this case are concerned with the acquisition by Mr. Nallen of Mr. O'Toole's share in what had been a jointly owned business and various undertakings given by Mr. O'Toole.  The arrangements constitute an agreement between undertakings which applies to a part of the State.

(c)	Economic Effects of the Agreement

20.	The present notifications involves an agreement between two quite small undertakings.  Following the Court of Justice decision in the Volk v. Vervaecke case, the European Commission has taken the view that undertakings below a certain size are not subject to the competition rules on the grounds that they cannot, by virtue of their small size, be regarded as having any significant impact on competition.  This 'de‑minimis' provision was an administrative response to the Court's decision in the Volk case that
	'an agreement falls outside the scope of Article 85 when it has only an insignificant effect on the markets, taking into account the weak position which the persons have on the market of the product in question.'

21.	There is no provision in the Competition Act which would exclude small undertakings from the provisions of the Act.  Section 4(1) of the Act prohibits agreements, decisions and concerted practices 'which have as their object or effect the prevention, restriction or distortion of competition in trade in any goods or services in the State or in any part of the State'.  Given the size and distribution of population in Ireland it is possible that a number of relatively small undertakings could, by acting together, prevent, restrict or distort competition in a part of the State.  The exclusion of small undertakings from the provisions of the Act could deny consumers in parts of the State the protection against  anti‑competitive activities which the Act provides.  The present agreement cannot, therefore, be regarded a outside the scope of the Act on the grounds that it concerns undertakings which are so small that they cannot have any significant effect on competition.

22.	There are currently four undertakings engaged in the retailing and rental of brown electrical goods in Belmullet.  One of these, the ESB is a large State company which, inter alia, has a nationwide chain of stores retailing white and brown electrical goods.  Apart from the ESB, the undertakings concerned are also engaged in the rental of brown electrical goods and of video films.  Mr. Nallen operates a separate video rental business in Belmullet.  In many areas garages, grocers and various other outlets compete in the market for video film rentals.  The number of competitors and the level of competition in the brown electrical goods market in Belmullet will remain unchanged as a result of this agreement.

23.	The partnership arrangement between Mr. Nallen and Mr. O'Toole, which had ceased to operate prior to the coming into force of the Competition Act, may itself have reduced the number of competitors in the market.  The Authority was not concerned with examining the partnership agreement in this case and, to date no partnership agreements have been notified to it.  The Authority does not regard partnerships per se as being in contravention of the Act.  In certain circumstances, however, partnership agreements may be in breach of Section 4(1) by virtue of certain restrictive clauses contained in them.

24.	While the Authority is primarily concerned in this case with the market in the town of Belmullet and its environs, competition is not confined to this area.  Traders based in Belmullet cannot prevent consumers from purchasing such goods elsewhere.  There are undertakings engaged in this business in a number of nearby towns, namely; Crossmolina, Ballina and Castlebar.  Many electrical discount stores based in Dublin advertise the prices of such appliances extensively in the national newspapers, so that there is no reason to suppose that consumers would be ignorant of the prices pertaining elsewhere.

Similarly, as pointed out, one of the undertakings located in Belmullet operates on a nationwide basis.  There is anecdotal evidence that consumers were in the past prepared to travel long distances to avail of cheaper prices for such items in Northern Ireland.  An important consideration here is the fact that most of these items are relatively expensive and constitute 'one‑off' purchases for households.  It could not, for example, be reasonably argued that consumers in Belmullet have the option of going to Dublin or elsewhere to purchase bread.

25.	Undertakings located in Belmullet may face less competition from suppliers outside the area in the rental market as it may not be possible to rent brown electrical goods from suppliers outside the area.  While the ESB is not involved in the rental of such goods it does sell them on attractive credit terms.  It is claimed that the purchase of electrical goods on such terms from the ESB represents an alternative to renting for low income households and that there is some overlap between the retail and rental market as a result.
26.	The European Commission has interpreted the term 'competition' to refer not only to actual competition but also to potential competition.  In the case of joint ventures the Commission has stated that 'the degree of potential competition depends largely on the nature of the product manufactured or the services offered by the joint venture.  In general a restriction of competition arises if, in the absence of the restriction, there would have been a real likelihood of the restricted party engaging in the activity in question.  The restraint placed on Mr. O'Toole by this agreement may be viewed as preventing a new competitor from entering the market.

27.	The Commission view is in accord with modern economic theories of competition which stress the importance of potential as opposed to actual competition in a particular market.  The main conclusion of such theories is that, provided it is relatively easy for new competitors to enter and leave a market, this will be sufficient to produce competitive behaviour within that market.  As the US Federal Trade Commission pointed out:
	'the threat of new entry can be as potent a procompetitive force as its realisation.

28.	The threat of potential competition does not apply in all cases.  Experience has shown that some markets where such considerations were thought to apply and which were thought to be 'contestable' are not in fact.  The main advocates of 'contestability theory', as it is known in the economics literature, have themselves indicated that 'before anyone can legitimately use the analysis to infer that virtue reigns in some economic sector and that interference is therefore unwarranted, that person must first provide evidence that the arena in question is, in fact, highly contestable.

29.	If incumbent firms perceive that new entry is unlikely and act with disregard for potential competitors, then it is not to the point that new entry is feasible.  It follows that if the threat of potential entry is sufficiently strong to deter anti‑competitive behaviour by undertakings in a particular market, the existence of restrictive practices such as price fixing or market sharing is, a priori, an indication that the threat of entry is unlikely or perceived to be unlikely by existing firms, and that the market is therefore not a contestable one.

30.	Economic research has indicated that the prospect of entry is considerably reduced if entry costs are high and it is believed that such costs will not be recovered if a new entrant is forced to leave the market.

31.	Contestability arguments would not apply were:
(a)	impediments imposed by law or convention limited the scope for potential entry;
(b)	arrangements existed which would prevent a potential new entrant from obtaining supplies required by them in order to enter the market.

(c)	the costs of entry and the risk of losses entailed in having to withdraw from the market effectively deterred potential new entrants;

(d)	the behaviour of undertakings within the market indicated that they regarded the threat of entry as unlikely.

32.	In the case of this agreement the Authority is concerned with the market for the sale and rental of brown electrical goods and video films in the Belmullet area.  This is a market where there appear to be few if any barriers to entry.  There are no legal impediments which would prevent new competitors from entering the market.  Mr. Nallen has indicated that he does not have any exclusive distribution rights over particular brands.  The costs of entry would appear to be relatively low.  An undertaking need only rent relatively small premises and purchase a limited number of appliances for sale or rental. The bulk of such costs could be recouped relatively easily by selling the appliances somewhere else, so that the risk of suffering a major loss through having to withdraw from the market is slight.

33.	It would appear therefore that anyone who wants to could enter this market relatively easily.  Such a view of the business is supported by frequent references in trade journals complaining about the constant inflow of new entrants who are alleged to undermine the position of incumbent undertakings  The only apparent reason why additional competitors have not entered the market in Belmullet is that it is already regarded as operating competitively, and there is perceived to be no scope for a new competitor to enter the market by undercutting those already there.  One undertaking has ceased to operate in Belmullet within the past three years, but it has been replaced by a new entrant.

34.	This agreement will have no effect on the actual level of competition within the market as the number of competitors in Belmullet and adjacent towns will not be affected.  The exclusion of Mr. O'Toole may appear to involve some reduction of potential competition but only for a limited period.  Indeed the longer term effect may be to increase the level of competition in the market if Mr. O'Toole decides to re‑enter the business in his own right at the end of three years.  In the absence of barriers to other new entrants the agreement cannot be regarded as having any real effect on competition in this market.

(d)	The Non‑Competition Clause

35.	The Authority now turns to the specific issue of the 
non‑competition clause which is a key element of the present agreement.  There are a series of EC cases dealing with similar agreements under Article 85(1). The Commission view, which has been confirmed by the European Court of Justice, is that arrangements of this type are essential to secure the transfer of the goodwill of a business to a new owner.  They are regarded as not involving any restriction on competition but as essential to allow the full transfer of ownership, provided their duration and extent is only that which is necessary to secure the full transfer of the goodwill.  If an agreement satisfies these criteria it has been found not to be in breach of Article 85(1).

36.	In the Nutricia and Reuter/BASF cases the Commission ruled that the agreements were in breach of Article 85(1) of the Treaty of Rome.  The Commission decision was, however, based on the view that the duration of the non‑competition clause was longer than was necessary for the proper transfer of the goodwill of the business to the new owner.  It is clear from both decisions that a shorter non‑competition clause would have been acceptable.  Indeed in the Nutricia case, although the agreements had operated since 1979, the Commission ruled that the infringement only dated from 1983, four years after the agreement came into effect.  The Commission decision in this case was upheld by the Court of Justice.  In the Mecaniver‑PPG case the Commission granted a negative clearance to the agreement for a specified period of time.

37.	It is clear from the Commission's decisions that the length of time necessary for the full transfer of the goodwill of a business will vary from industry to industry.

	'In general, the assessment under Article 85(1) of the non‑competition obligations imposed on sellers of businesses will depend on the particular circumstances of each individual case and no universal rule can therefore be established as to the permissible duration of such clauses.'

38.	Thus what may be regarded as a reasonable length of time for a non‑competition clause in one case may be regarded as excessive in another.  In the former case such a clause would not be regarded as a breach of Article 85(1) whereas in the latter it would.

	'In the absence of circumstances which deviate greatly from those in the Reuter/BASF or Nutricia cases, these decisions, however, indicate as [a] general guide that where the transfer of a business also involves the transfer of good‑will and know‑how, a period of approximately five years will normally be acceptable, whereas a period of approximately two years will normally apply if the sale involves only the transfer of good‑will.

39.	In the Nutricia case the Commission indicated that among the factors to be taken into account in evaluating the duration of such clauses were:

(i)	how frequently consumers in the relevant market change brands and type (in relation to the degree of brand loyalty shown by them),
(ii)	for how long, after the sale of the business, the seller, without a restrictive clause, would be able to make a successful comeback to the market and regain his old customers.

40.	The European Commission also decided in the Nutricia case that:

	'The geographical scope of a non‑competition clause also has to be limited to the extend which is objectively necessary to achieve the aforementioned goal.  As a rule, it should therefore only cover the markets where the products concerned were manufacture or sold at the time of the agreements.'

41.	The view that such arrangements are essential in order to secure the transfer of the goodwill of a business and that they do not, therefore, involve a restriction of competition, appears to be well established under both US competition law and common law in the UK and Ireland.  Such a view has prevailed in the US for almost one hundred years, following the decision of Judge Taft in the Addyston Pipe case which stated that:
	'It was equally for the good of the public and trade, when partners dissolved, and one took the business, or they divided the business, that each partner might bind himself not to do anything in trade thereafter which would derogate from his grant of the interest conveyed to his former partner.  Again, when two men became partners in a business, although their union might reduce competition, this effect was only an incident to the main purpose of a union of their capital, enterprise, and energy to carry on a successful business, and one useful to the community ....... For the reasons given, then, covenants in partial restraint of trade are generally upheld as valid.'

42.	The EC competition rules are themselves based on US antitrust legislation.

43.	The courts in Ireland and the UK have tended to take a favourable view of restraint clauses of this nature in the past.  Such views were based on common law rather than competition legislation.

	'The purchaser of a business can restrict the seller from engaging in similar enterprises in the future.  The need to impose such a restriction is accepted by the courts because the proprietary interest in the goodwill of the business may be worthy of protection.  But such restrictions will not be upheld should they be deemed to be wider than are reasonably necessary for that protection.'

44.	In deciding whether the restraint imposed is reasonable, the courts have regarded two factors as particularly relevant.  Firstly the buyer must establish a proprietary interest which the clause is seeking to protect.  Secondly the clause must be reasonable in the light of all the circumstances of the case.  In this respect the restraint must not go further than reasonably necessary for the protection of the purchaser's interest in point of space, time or subject‑matter.

45.	It is therefore widely recognised in competition law in other countries and in our common law that some restraint on a party disposing of all or part of his interest in a business is essential for the proper transfer of the goodwill of the business to take place, and that without the transfer of such goodwill, the transfer of ownership would be incomplete.  Without such a restraint no proper transfer of goodwill could take place.  The Authority agrees with this view.  The restraint must, however, be limited in terms of its duration, geographical coverage and subject matter to that which is necessary to secure the adequate transfer of the goodwill.  Provided this is the case, then clearly the intention of such a restraint is not to restrict competition in the market in question.

46.	The restraint on Mr. O'Toole in this agreement is for a period of three years, although the agreement involves a transfer of goodwill only.  While the Authority would tend to agree at this stage with the EC view that a period of two years would generally be sufficient for the complete transfer of the goodwill of a business, it believes that a longer period is justified in this case.  Consumers tend to purchase the products in question infrequently.  In addition, in this case, close personal contact with customers was a major factor in the business.  This is a small rural community where most consumers would know, or at least know of, Mr. O'Toole as someone engaged in the particular business.  In addition, Mr. O'Toole is still active in business within the area.  For these reasons it would appear that the period specified in the agreement is no more than is required to secure the complete transfer of the goodwill.

47.	In this case the restraint applies to an area with a radius of 20 miles from the town of Belmullet and appears to correspond to the area within which Mr. Nallen and Mr. O'Toole previously carried on their business.  Finally the restriction applies only to the lines of business in which Mr. O'Toole was previously engaged in a partnership with Mr. Nallen.  The restrictions involved are no more than are necessary to ensure the adequate transfer of the goodwill of the business to Mr. Nallen and on those grounds are not in breach of Section 4(1) of the Competition Act.

The Decision

48.	Mr. Nallen and Mr. O'Toole are undertakings within the meaning of Section 3 of the Competition Act and the arrangements in question constitute an agreement which applies within a part of the State.

49.	The Authority believes that in this case the agreement cannot be said to prevent, restrict or distort competition as it involves no reduction in the number of actual competitors in the market in question, and does not reduce the threat of potential competition within this market.

50.	In any case, on the specific issue of the non‑competition clause, which is at the heart of this agreement, the Authority believes that such a clause is essential in the event of the sale of a business for the transfer of the goodwill of the business to the purchaser.  Without such a restraint the purchaser could not be sure of obtaining all of the goodwill of the business for which he had paid and the seller would be unable to benefit by disposing of his share in a business which he had helped to build up.  In the Authority's view therefore, such a clause is not in breach of Section 4(1) of the Competition Act provided that the restrictions contained in such a clause or clauses are limited in terms of time, geographical coverage and subject matter to those which are necessary to secure the adequate transfer of the goodwill.  The Authority believes that the present agreement between Mr. Nallen and Mr. O'Toole satisfies these criteria and that it does not offend against Section 4(1) of the Competition Act, 1991.

The Certificate

51.	The Competition Authority has issued the following certificate:

The Competition Authority certifies that in its opinion, on the basis of the facts in its possession, the agreement for the transfer of a business interest between Mr. Nallen and Mr. O'Toole of Belmullet, notified under Section 7, does not offend against Section 4(1) of the Competition Act, 1991.

For the Competition Authority

Patrick Massey,
Member,
2 April 1991