Irish Competition Authority Decisions

1. Notification was made by Cambridge Business Expansion Fund Ltd (Cambridge) on 30 September 1992 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 grant a certificate, a licence under Section 4(2) in respect of the standard share subscription agreement used by Cambridge for investments in qualifying companies under the BES scheme.

2. The notification concerns the standard share subscription agreement used by Cambridge as manager of a designated investment fund, for the subscription by the fund for new ordinary shares in companies qualifying under the BES scheme.

3. The parties to the standard agreement are as follows:

(i) The investee company i.e., an unquoted company engaged in qualifying trades as defined in the BES scheme. The names of 5 separate investee companies were supplied.

(ii) The existing shareholders in the investee company who are covenantors under the agreement.

(iii) Cambridge Business Expansion Fund Ltd was part of the Cambridge Group plc and was manager of a number of designated investment Funds. Cambridge Corporate Finance Ltd, another company within the Cambridge Group which provided corporate finance services, was also a party to the standard agreement. The Cambridge Group was engaged in corporate finance, leasing and fund management. A Receiver was appointed over the Group and a number of its subsidiary companies in 1993.

4. Under the BES scheme (Relief for Investments in Corporate Trades as introduced in the 1984 Finance Act with subsequent amendments) taxpayers may obtain tax relief in respect of subscription for shares in companies engaged in qualifying trades. The shares must represent new issued ordinary shares in an unquoted company and must be held for a minimum period of 5 years. Similar tax relief is also given where the subscription is made to a designated investment fund (designated by the Revenue Commissioners) where the monies subscribed are invested on the taxpayer's behalf in qualifying companies. The Designated Investment Funds Act 1985 declares that a designated investment fund is not a unit trust and requires that a prospectus should be prepared in respect of each such fund which must be first approved by the Minister for Enterprise and Employment. Approval may not be given unless the Minister is satisfied that satisfactory statements on a number of specified issues are included in the prospectus including details of the manager and of the separate trustee, that the holder of any shares issued to the Fund will be registered as nominee for a particular participant and particulars of the arrangements for transfer of the shares into the participants name after 5 years. In practice each designated investment fund is governed by a trust deed which provides for the holding of the monies subscribed by a trustee, in whose name shares purchased by the Fund are initially registered as nominee for each particular subscriber, and the management of the fund by a manager, who has responsibility for selecting the investee companies and safeguarding the subscribers interests in these companies. There are generally provisions in the trust deed for disposal of the shares after 5 years by the trustee/manager either by way of sale (with each subscriber getting his share of the proceeds) or transfer into the subscriber's name. Mechanisms may be included to facilitate the sale or redemption of the shares including Put and Call options whereby the original shareholders of the investee companies after a period of 5 years could be required to purchase the Fund's shares. If however the shares in an investee company cannot be satisfactorily disposed of, there are provisions for their transfer some time after, into the subscribers name and the trust ends. Unlike an UCIT or investment company, the individual subscriber does not hold units in the Fund but holds the beneficial interest in his proportion of the shares acquired through the fund .

5. (i) The notified standard agreement is made to provide for the conditions under which the manager of the designated investment fund agrees to procure subscription by the fund for shares in the investee company. It provides for the completion arrangements for the subscription, subject to a number of conditions and warranties by the covenantors. Prior to the investment the company will enter into a trust agreement as required by Section 6(1) of the Designated Funds Act 1985 to register the shares in the name of the subscriber to the fund. The company undertakes to maintain its BES status. The company and covenantors covenant to operate the business efficiently and keep the manager fully informed of company progress by way of regular financial and other reports. The agreement lists a number of restricted transactions which the company may not effect without the prior written consent of the manager. These include disposal of a substantial part of the business or a substantial change in its nature, the issue of loans by the company, its entry into onerous contracts, the issue of new shares, the exceeding of borrowing or capital expenditure limits and the payment of dividends.

(ii) The agreement also provides that no change will be made in the company Articles. The manager is entitled to nominate director(s). Cambridge Corporate Finance Ltd is appointed as corporate development consultant to the company for 5 years and for a consideration is given an option to subscribe for shares in the company. The Manager agrees to use reasonable endeavours to procure additional investment in the company. If any covenantor disposes of shares other than to another party to the agreement he will first procure that the transferee will also covenant to comply with the covenants in the agreement.

(iii) Clause 7(9) of the standard agreement contains the following shareholder covenants viz.

"(a) Each of the Covenantors undertakes to the Manager that:-

(i) for the period of three years from Completion he will not either on his own behalf or in conjunction with or on behalf of any person, firm or company carry on or be engaged concerned or interested in carrying on any business in competition with all or any of the businesses now carried on by the Company or any other member of the Group to which all or any such businesses may be transferred subsequent to Completion or which may with the Manager's consent commence to carry on all or any such businesses subsequent to Completion (other than as a holder of shares or debentures listed on The Stock Exchange or dealt in on the Unlisted Securities Market) within the Republic of Ireland;

(ii) for the period of three years from Completion each Covenantor will not either on his own account or in conjunction with or on behalf of any other person, firm or company solicit or entice away from any member of the Group any officer, manager or servant whether or not such person would commit a breach of his contract or employment by reason of leaving service;

(iii) each Covenantor shall procure that no company owned or controlled by such Covenantor or any one or more of them (and insofar as such Covenantor is able to ensure the same no subsidiary or associated company owned or controlled by him) shall act in such a way as would be a contravention of the obligations contained in this paragraph if such Covenantor were himself to so act."

6. In its submission Cambridge stated as follows:-

"BES enables small companies, which are generally involved in developing new technology or creating and exploiting new markets, to have access to funds which are necessary to enable them to develop and grow. BES investment strengthens and enhances therefore the ability of such companies to compete in their respective markets. As none of the companies are in a position of dominance in markets or enjoy particularly large market shares, BES does not have the effect of copper-fastening an existing dominant position.

BES was initiated by Government to enable companies in the early stages of their development to obtain capital by way of equity investment. Such companies typically find it difficult to raise capital, either from equity investors or through borrowing, in order to facilitate growth given the absence of an established financial track record. BES also enables individuals to obtain tax relief on equity investments made by them into qualifying companies once the statutory criteria are satisfied.

Funds such as those managed by the Applicant provide prospective investors with access to a fund manager with extensive experience in venture capital, who provides the necessary connection between companies seeking investment by way of BES funding and prospective investors.

As indicated above, the restrictions which are the subject matter of this notification are the minimum protection which any prudent investor would require in order to safeguard its investment, an investment which would in most cases not be made without such restrictions, as the companies in which investments are made tend to be controlled and run by a very small number of key individuals whose continuing involvement with the company is crucial for its development. Investment is generally made by the Applicant in investee companies at a valuation which assumes that certain future growth projections are achieved. Because of the early stage of the development of these investee companies and the key roles played by the promoters in the affairs of these companies, achievement of these future growth projections is often dependent on the continued involvement of these parties in the day to day operation of the investee company.

In summary therefore, both BES and the notified restrictions which are imposed as a part of the arrangements whereby the investments are effected, stimulate investment in small developing companies in the State. The investments enable those companies to grow thus enhancing their ability to compete in their respective markets. The consequent effect of the arrangements is thus pro-competitive. It is therefore submitted that the arrangements are not prohibited and void by virtue of Section 4 of the Act."

Arguments were also presented as to why a licence should be granted but these are not reproduced in this decision.

7. Section 4(1) of the Competition Act 1991 prohibits and renders void 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.

8. 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". Cambridge was engaged in the management of funds for gain and was therefore an undertaking. Cambridge Corporate Finance Ltd was engaged in the provision of corporate finance services for gain and was also an undertaking. The investee companies are engaged in qualified trades as defined under the BES scheme and are also undertakings. The covenantors are generally the owners of the investee companies and as such are regarded as undertakings. The notified agreement is an agreement between undertakings. The agreement has effect within the State.

9. The Subscription Agreement constitutes an agreement whereby a designated investment fund managed by Cambridge agrees to make an investment to obtain an equity shareholding in the investee company. This, in effect, involves an investment by a large number of personal investors for a combined stake, generally a minority stake, in the investee company. Such an agreement is not, per se , anti-competitive and does not offend against Section 4(1) of the Competition Act.

10. The agreement contains continuing contractual commitments arising from the agreement including the warranties given by the original shareholders to the new investors and the option given to Cambridge to purchase new shares. These do not raise issues under the Competition Act. The agreement also provides for a number of obligations on each of the parties which will govern how the companies will be managed including the information requirements to keep Cambridge as manager of the Fund informed of the companies' progress. These are matters internal to the management of the companies which are designed to protect the minority shareholding position of the new investors and also do not raise issues under the Competition Act.

11. The agreement also contains a list of restricted transactions which the company may not undertake without the prior written consent of Cambridge. These include such actions as a change in the nature of the business carried on, the acquisition or disposal of shares, entering into onerous contracts, capital expenditure above specified limits, disposal of substantial assets and excessive borrowing. Cambridge was engaged in the management of a form of a venture capital fund, albeit a tax driven designated investment fund, and was acting on behalf of many personal BES investors who hold the beneficial interest in the Fund's shares in the companies. Cambridge was engaged as Fund manager and had a duty to safeguard the interests of the BES subscribers for whom the shares in the investee companies are held in trust. With no particular expertise in the business concerned, Cambridge was dependent on the majority shareholders for the day to day management and supervision of the businesses. As indicated in their decision on Cambridge - ACT/Imari1 the Authority takes the view that providers of venture or development capital are entitled to take steps to protect their investment. The restrictions on transactions imposed on the operation of the investee companies are designed to protect that investment by ensuring that the assets of the company are not substantially (or even artificially) diluted without their knowledge. They may be regarded as prudent protection of the non-active shareholder interest and no more than is necessary to achieve the object of protecting the investment. In any event the restrictions are more related to the internal running of the company rather than its trading activities. The Authority does not therefore regard these restrictions as offending against Section 4(1) of the Competition Act.

12. Clause 7(9)(a) of the standard agreement imposes non-compete restrictions on the covenantors, who are the existing shareholders in the investee company, from engaging in a business which would be in competition with the business carried on by their companies. This restriction applies within the State for a period of 3 years from completion of subscription for shares. There is also a similar non-solicit clause, for 3 years from completion, under which a covenantor may not solicit or entice away employees of the company.

13. In its decision on Cambridge-ACT/Imari, the Authority indicated that, in general, a restriction on parties in a business competing with it for so long as they remain part of the business, does not offend against Section 4(1). Insofar as the non compete restrictions apply to the period when the covenantors effectively remain as shareholders in the company these provisions do not offend against Section 4(1) of the Competition Act.

14. The non-compete and non-solicit restrictions apply for a period of 3 years from completion. Taking into account the particular nature of the BES investment involved, the Authority considers that where the duration of the non-compete or non-solicit clause equates with or is less than the estimated duration of the Fund's subscription to the company, this does not offend against Section 4(1). Considering the particular vulnerability of the small investor's position as a minority shareholder in an unquoted company, the Authority accepts that safeguards are necessary to ensure the continuing commitment of the original owner to his business for the period of a temporary investment and to prevent him competing directly with it to the detriment of the minority investor. Without safeguards over this period it is unlikely that the BES investment would proceed. In this instance the non-compete and non-solicit restrictions apply for a period of only 3 years from the date of completion of the subscription and accordingly this clause does not offend against Section 4(1).

15. In the Authority's opinion, the investee companies, the covenantors in the investee companies and Cambridge Business Expansion Fund Ltd and Cambridge Corporate Finance Ltd were undertakings within the meaning of the Section 3(1) of the Competition Act, 1991 and the notified standard subscription agreement is an agreement between undertakings. In the Authority's opinion, the notified standard agreement does not offend against Section 4(1) of the Competition Act, 1991.

16. 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 standard subscription agreement between Cambridge Business Expansion Fund Ltd, Cambridge Corporate Finance Ltd , the investee company and its shareholders, as covenantors, notified under Section 7(2) on 30 September 1992 (notification no. CA /1108/92E) does not offend against Section 4(1) of the Competition Act, 1991.

For the Competition Authority

Des Wall

Member

22 June 1995.

1.Decision No. 24, 21 June 1993