Corporate and M&A

Contact: Prof. Dr. H. Ercument Erdem; Erdem & Erdem (Turkey)

Non-compete agreements are frequently used in merger or acquisition transactions. These agreements are mostly necessary to ensure the attainment of the desired results from the merger or acquisition transaction.

Hence, in acquisitions, in order to ensure that the value of the right or asset acquired is fully transferred to the buyer, the seller might have to be placed under an obligation not to compete with the buyer for a certain period. This requirement may come up particularly in relation to building up a clientele and sufficiently exploiting the know-how acquired. 

Definition of the Prohibition of Competition

Non-compete agreements are ancillary restraints. Ancillary restraints are restraints which are directly related to the concentration and which are necessary to the implementation of the transaction and to fully achieving the objectives envisaged by the merger or acquisition transaction.

Ancillary restraints are actually agreements which aim to prevent or restrict competition as per Article 4 of the Act on the Protection of Competition No. 4054 (the “Competition Act”) and are thus illegal. Nevertheless, non-compete agreements within mergers and acquisitions in compliance with the European Community Regulations are assumed as required ancillary restraints for the fulfillment of the results of said transaction and are thus allowed under certain conditions.

Legal Framework

There is no regulation under the Competition Act regarding ancillary restraints. Nonetheless, the Communiqué Concerning Mergers and Acquisitions Calling for the Authorization of the Competition Board No. 2010/4 (the “Communiqué No. 2010/4”) briefly refers to ancillary restraints. Accordingly, authorizations granted by the Competition Board (the “Board”) to mergers and acquisitions include ancillary restraints as well.

Following the entry into force of the Communiqué No. 2010/4, the Guideline for Undertakings Concerned, Turnover and Ancillary Restraints in Mergers and Acquisitions (the “Guideline”) was published on the official web site of the Competition Authority . The Guide provides information regarding the characteristics and components of ancillary restraints.

Types of Non-Compete Agreements

Non-compete agreements may be foreseen as a prior or accessory agreement, or as a supplementary obligation.

Prior Non-Compete Agreements. These contracts are “agreements” as expressed under the Competition Act, which aim to restrict competition by accepting certain conditions regarding the price, sale, production, distribution and similar areas.

Since the purpose of the prior non-compete agreement is to directly or indirectly prevent, distort or restrict the competition within a product or service market, these kinds of agreements are deemed illegal and prohibited under the Competition Act.

Accessory Non-Compete Agreements. These types of agreements have a tight connection with the main agreement that gives rise to their formation and assist in the performance of this agreement. In other words, these types of agreements are a part of the main agreement and shall have meaning only within the scope of the main agreement.

Unlike prior non-compete agreements, the main point and aim of accessory non-compete agreements is not the direct or indirect prevention, distortion or restriction of competition within a product or service market, even though restriction or prevention of competition is a goal of the agreement. In these agreements, competition is restricted to allow the performance of the main contract and mostly for necessity. Therefore, accessory non-compete agreements cannot be considered as directly against competition.

Supplementary Obligation. Any obligation similar to or complementary with non-compete obligations such as those preventing the seller from employing the workers of the undertaking to be acquired and from disclosing or using the trade secrets of the undertaking to be acquired shall be assessed in a manner similar to non-compete obligations. As such, where confidentiality is related to the know-how, an obligation to prevent the disclosure and utilization of the relevant information as long as it is deemed to be confidential, i.e. retains its know-how characteristics, may be assessed as an essential element of the transaction.

Components of the Non-Compete Agreement

Ancillary restraints, having all of the components below shall not be considered illegal:

Directly Related and Necessary. The Guideline stipulates that ancillary restraints shall be directly related to the merger and acquisition transaction and necessary for the implementation of the operation envisaged from the merger and acquisition transaction, in order to accept such an ancillary restraint.

For an ancillary restraint to be directly related to the acquisition transaction, it is not sufficient for it to be implemented within the same scope or time period with the merger or acquisition transaction. It has to be closely related economically to the main transaction and it has to be necessary to facilitate a smooth transition to the new structure to be formed following the merger or acquisition transaction.

The criterion of necessity demonstrates that the non-existence of the related restraint shall cause the non-implementation of the merger and acquisitions transaction or the implementation within uncertain conditions with higher costs and a low likelihood of success. The Guideline does not express the “necessity criterion” as explained above, but provides a poor translation of the EU Commission Notice on restrictions directly related and necessary to concentrations No. 2005/C - 56/3 (the “Notice”).

While determining whether a non-compete agreement is necessary, the Board thoroughly evaluates for an extended period of time whether the relevant restraint is directly related to the merger and acquisition transaction and necessary for the implementation of the operation .

Objective. The objectivity of a competition restraint means that this prohibition must be objectively necessary pursuant to the concrete conditions of acquisition or merger in the concrete case. The purpose in this situation is not to prohibit the transferor from competing or restrict his commercial and entrepreneurial freedom. This restraint must be objectively necessary with regards to the specific conditions of the concrete case. In other words, for a restriction to be objective, a transferor other than transferor concerned must envisage a competition restriction like this one within the circumstances of the concrete case.

The Guideline does not explain the objectivity principle as described above, rather it purports that the “direct relation” and “necessity” criteria must be assessed objectively in accordance with the specifics of the case. However, this issue is clearly stated in the Notice.

Reasonable. The Guideline states that in order for a prohibition of competition contract to be recognized as reasonable, it’s scope with respect to subject, geographic area and person shall not exceed the reasonable level that is required for the implementation of the merger and acquisition transaction. In other words, the competition restriction should only cover the competition concerns that the purchaser may have as a consequence of the merger operation and should not go beyond these concerns.

• In terms of Subject. As a rule, non-compete obligations must be limited to those goods and services comprising the area of operation of the economic unit to be acquired before the transaction. Goods and services that have mostly completed development phase but not yet entered marketing phase may be included within this framework.
• In terms of Geographic Area. Non-compete obligations must be limited geographically to the area of operation of the seller before the transaction. However, in exceptional circumstances, such as when the seller has made investments to enter into new regions, restraints concerning these regions may also be accepted as necessary and reasonable.
• In terms of Person. Restraints concerning the seller itself and those economic units and agencies which constitute an economic unit with the seller may be accepted as reasonable while any non-compete obligations beyond them, especially those concerning the dealers of the seller or users, shall not be accepted as necessary and related restraints.

For an extended period the Board, on one hand, audits whether the scope of the ancillary restraint is reasonable or not, and on the other hand it especially investigates the persons to whom the restraint is related, subjects of the restricted activities and geographic area where the restriction is applied .

Reasonable Period. The Guideline provides that non-compete agreements that do not exceed three years in duration are generally accepted as reasonable. Nevertheless, it may be possible to accept under the framework of ancillary restraints a non-compete obligation with a duration longer than three years where a customer tie-in lasts longer or it is required by the nature of the know-how transferred, provided that the scale required by the concrete case is not exceeded.

While examining the Board decisions, it can be observed that the Board analyzes each case separately as required and accepts non-compete agreements concluded for more than three years .

The Guideline sets forth that in joint ventures, long-term or indefinite non-compete obligations preventing the parent undertakings from competing with the joint venture may be accepted as ancillary restraints.

Evaluation of the Non-Compete Agreement

In the event the merger and acquisition transaction exceeds the thresholds set forth in the Communiqué No. 2010/4 , the Board examines the transaction and authorizes the transaction if it complies with the competition rules. In such cases, the authorization granted by the Board also covers ancillary restraints. Therefore, a separate application is not necessary in order to apply to the Board with regards to ancillary restraints.

In the event that the merger and acquisition transaction does not exceed the thresholds set forth in the Communiqué No. 2010/4, the parties to the transaction should determine whether the restraints introduced by the merger or acquisition exceed this framework. Within the scope of the Guideline, the parties determine whether the non-compete agreement is an ancillary restraint or not; in other words they determine whether such restraint is illegal.

Upon request by the parties, in its decision concerning the merger or acquisition, the Board shall assess any restraints with a novel aspect that have not been addressed in the Guidelines or in its previous decisions.

Conclusion

Non-compete agreements play a key role in merger and acquisition transactions. When a non-compete obligation is not regulated in such transactions, the investment made becomes meaningless and no contribution is made to the economy. In other words, the purpose of competition law cannot be realized.

Within this scope, it was appropriate to set forth ancillary restraints initially in the Communiqué No. 2010/4 and then lay them out in the Guideline, in compliance with European Union law.

Furthermore, the section of the Guideline on ancillary restraints is but a brief summary and references to the Board decisions are very few. In fact, pursuant to the Guideline, the transacting parties are essentially entitled to evaluate whether non-compete agreements may be considered as ancillary restraints or not. In this way, the Guideline does not actually guide the transacting parties and does not facilitate their work. In addition, some parts of the Guideline are directly taken from the Notice of the European Union and translated badly. For this reason, I am of the opinion that the Guideline needs to be revised once again.