This article has been written by Ridhi Jain pursuing a Diploma in Legal English Communication – oratory, writing, listening and accuracy at LawSikho, and edited by Shashwat Kaushik. This article explains what anti-competitive clauses are in vertical agreements with the help of case laws.
It has been published by Rachit Garg.
Table of Contents
Introduction
Competition is for the social good. It ensures the best allocation of scarce resources and the production of good quality goods and services at the most efficient price, ensuring economic liberty and the greatest material progress in a holistic sense. With globalisation, liberalisation, and technological advancement in every sector, the growth prospects in the Indian market have reached endless possibilities. Competition worldwide provokes competitors to develop and protect their business interests from their rivals. Therefore, the need for regulation of competition in the market was felt, and legislation in this aspect was long overdue. In 2002, the country saw the birth of the Competition Act, which was the most celebrated enactment. The objective of this Act is to foster competition and promote consumer welfare by curtailing anti-competitive practises by enterprises. With this purpose in context, this article will assess the need and viability of restrictive clauses in the realm of agreements and the contours of the
Vertical agreements
Competition in a market is required for the sole purpose of a fair market’s existence. A market is an interaction between buyers and sellers for the purpose of consumption of goods or services, leading to the development of the nation. When the equilibrium is broken by the market participants by engaging in restrictive agreements, it leads to frustration with competition, thereby resulting in the exploitation of consumers by enterprises. To combat the enforceability of such agreements, Section 3 of the Competition Act, 2002, was introduced.
Section 3 of the Competition Act of 2002 enumerated both horizontal and vertical agreements. The former is undertaken between enterprises dealing in similar goods and services that intend to distort the market equilibrium through clauses like price fixation, bid rigging, and others. The latter, on the other hand, is an agreement entered into by enterprises of different stages, and such restraints include tie-in arrangements, exclusive agreements, refusal-to-deal arrangements, and others.
Vertical agreements are not per se anti-competitive and have to be tested on an effect-based approach/ rule of reason. Therefore, Section 3(4) of the Competition Act, 2002, undergoes a rule of reason litmus test to conclude the effect of the agreement on competition. The test requires a substantive assertion of the case based on reason and a market survey. The non-exhaustive list in Section 3(4) has the potential to cause Appreciable Adverse Effects on Competition (AAEC). Such an effect is ruled out under Section 19(3) of the Competition Act, 2002, which lists out factors with both negative and positive effects. For the purposes of competition law, vertical agreements should be between members at different levels of the production chain, i.e., having an upstream and downstream market. Exclusive clauses are seen to find seats in both upstream and downstream agreements, and such are recognised by the Act of 2002. Downstream agreements take the form of distribution or dealership agreements. Non-compete obligations in the nature of single branding and purchase quotas would most likely be assessed as exclusive supply, refusal to deal or exclusive dealership agreements under Sections 3(4)(b), (c), and (d) of the Competition Act, respectively.
The Competition Commission of India (CCI) has adjudged the validity of such dealership agreements having exclusive clauses, restraining dealers in various forms/practices from dealing with goods or services of the contracting party’s competitors in numerous cases, as discussed below. The validity of featuring such restrictive/exclusive clauses in agreements, their enforceability, their need, and their de jure/ de facto impact are further assessed through important judicial precedents later in this article.
Explanation of anti-competitive clauses in vertical agreements with case laws
Mr. Ramakant Kini vs. Dr. L.H. Hiranandani Hospital (2012)
In Mr. Ramakant Kini vs. Dr. L.H. Hiranandani Hospital (2012), the agreement is neither horizontal in nature nor vertical, therefore concluding that Section 3(1) is independent of Sections 3(3) or 3(4) of the Act.
The informant alleged violations of Sections 3(4), 4(2)(a)(i), and 4(2)(c) of the Act when Life Cell (a stem cord facility preferred by the informant) was denied access to the stem cord. Instead of treating the agreement between the party and Cryobanks as a vertical agreement, the majority suggested that such an agreement was neither a vertical nor a horizontal arrangement between the parties. The CCI developed its justification to contend that, under Section 3(1) of the Act, horizontal and vertical agreements are merely subspecies of anti-competitive agreements and are in no way exhaustive of the purview of this Section.
The case led to a violation of the above-mentioned sections solely on the basis of the fact that CCI noted that the hospital’s choice of Cryobanks was neither based on a competitive criterion nor a result of quality consideration but oozed out of an understanding of commission. There were no attempts by the CCI to identify market share, relevant markets, or their actual impact on competition. Where it is being studied that the upstream market, which the OP held, was about 62%, the downstream market, which Cryobanks held, was 34.3%, and its competitor, Life Cell, held about 33%, the exclusive agreements entered by the OP with Cryobanks did have the effect of foreclosing competition and creating entry barriers for companies like Life Cell and the remaining 40%. In response to this judgement and the subsequent analogy of opening a third category of agreement having the potential to have anti-competitive effects, the Draft Competition (Amendment) Bill, 2020, proposed an amendment to Section 3(4) that would capture any other agreement and not restrict it to agreements amongst enterprises or persons at different stages of the section of the Act.
Shri Ghanshyam Dass Vij vs. M/S Bajaj Corp. Ltd. & Ors. (2015)
In the case of Shri Ghanshyam Dass Vij vs. M/S Bajaj Corp. Ltd. & Ors. (2015), the commission extrapolated the analogy from the case of Hiranandani Hospital to the present case.
An allegation was levied against the OP, a Fast-moving Consumer Goods (FMCG) company, that it imposed vertical restrictions on the sale of hair oil in gross violation of Sections 3(4)(c), 3(4)(d), and 3(4)(e) of the Act. This case erred on the face of its analogy as it was based on the limited scrutiny of identifying the position of strength of the alleged party with other brands, ignoring the need to find the relevant market and market share of the parties on both the supply and distribution levels. thereby giving a narrowed result on AAEC of the agreement on the actual relevant market of the product of the OP.
Shri Shamsher Kataria vs. Honda Siel Cars India Ltd. & Ors. (2014)
In Shri Shamsher Kataria vs. Honda Siel Cars India Ltd. & Ors. (2014). The informant primarily alleges in this case that the opposite parties have prevented other aftermarket firms, through unfair and anti-competitive agreements, from offering complementary goods or services, thereby abusing their dominant position in the aftermarket. Original Equipment Manufacturer (OEM) enter into three types of agreements: (i) agreements with overseas suppliers; (ii) agreements with Original Equipment Supplier (OES) and local equipment suppliers; and (iii) agreements with authorised dealers. These agreements are being scrutinised for engaging in anti-competitive practises. Such agreements are in contravention of Sections 3(4)(c) and 4(2)(a)(i), 4(2)(a)(ii), 4(2)(c) and 4(2)(e) of the Act.
Analysis of agreements with overseas suppliers- As per US laws and jurisprudence that established the requirement of direct or circumstantial evidence that reasonably proves the unlawful objective, the commission was unable to conclude the existence of agreements between these OEMs and the overseas suppliers, within the meaning of Section 3(4)(c) of the Act, because of insufficiency of evidence.
Analysis of agreements with OEMs and OES
The question to be adjudged was whether the restrictions on the sale of spare parts by the OESs to third parties without the consent of the OEMs amount to AAEC under Section 19(3) of the Act. Thus, whether an agreement restricts the competitive process is always an analysis of the balance between the positive and negative factors listed under Sections 19(a)-(f).
The arguments of the OEMs and their submissions show how the restrictions imposed are to safeguard their legitimate business interests.
- If permitted, the OEMs will be unable to ensure the quality of such spare parts,
- If permitted, the OEMs will be jeopardising the safety and health of their customers,
- If permitted, the OEMs will be jeopardising the goodwill of their brand of automobiles.
- They invoked the defence under Section 3(5)(i) of the Act, and if permitted, the OEMs will be compromising on their IPR.
The Commission appreciates the concern of the OEMs but is unable to conclude that the OEMs cannot achieve their desired objective without imposing the current restrictions upon their OESs. The commission, with respect to the fourth submission, held that IPR can be protected by the OEMs through contractual agreements; therefore, mere selling of the spare parts to a third party will not result in any compromise on the IPR of the OEMs. It is further emphasised on this point that it is not under the obligation to prove the legitimacy of the IPR standing but is obliged with the duty to assess the reasonability of the restrictions imposed by the IPR holder as necessary to protect his rights and interests. The words “reasonable” and “necessary” as enshrined in Section 3(5)(i) of the Act, i.e., allowing an IPR holder to “impose reasonable conditions, as may be necessary for protecting any of his rights,” were stressed upon. However, the CCI has adopted a narrow interpretation of Section 3(5)(i) of the Act; therefore, only restrictions that satisfy the twin limbs of ‘necessity’, as well as ‘reasonability’, are permitted.
Analysis of agreements with authorised dealers by OEMs
In another set of selective distribution agreements, the OEMs restricted the sale and supply of genuine spare parts, diagnostic tools/ equipment, and technical information required to maintain automobiles to only the authorised dealers in the downstream market. As a result, independent repair workshops could not compete with authorised dealers in after sales automobile maintenance services.
Restrictions of such kinds are anti-competitive in nature; such clauses and terms are in violation of Sections 3(4)(b), 3(4)(c), and 3(4)(d) of the Act, as they result in restricting consumer choice and foreclose the aftermarket for repairs/maintenance contracts by independent repairers.
Fx Enterprise Solutions India … vs. Hyundai Motor India Limited … (2017)
This case gives a pragmatic understanding of the contours of enforceability of exclusive clauses in vertical agreements and the CCI approach towards the importance of defining the market, relevant markets, and other factors to be considered while concluding anti/pro-competition effect.
The claims arose because HMIL’s exclusive dealership agreements with dealers restrained them from conducting business with HMIL’s competitor. Such dealership agreements were challenged on the grounds of allegations that Clause 5(iii) of the agreement prohibited the dealer from investing in any other business, particularly in dealerships with competitors of HMIL.
It has been alleged further that Clause 5(iii) of the Dealership Agreement amounts to “refusal to deal” in contravention of the provisions of Section 3(4)(d) of the Act. The CCI’s assessment found that such a clause is not exclusive in nature or does not prevent dealers from dealing with competing businesses, but rather only requires prior written permission to do so. Thereby, it does not qualify as de jure exclusivity; however, if such is not practised in reality, it would amount to de facto exclusivity.
Therefore, after analysing the evidence on records, it was finally concluded by the CCI that Clause 5(iii) of the Dealership Agreement has not restricted, in form or in practise, any dealer in any manner from operating other OEM dealerships. The avowed objective of the clause appears to be to ensure the legitimate interest of the business of the company, i.e., that HMIL dealers do not free-ride on facilities and services provided by HMIL. Further, such a stipulation ensures that HMIL is kept posted on the financial and investment activities of its dealers to ensure that funds meant for the functioning of the dealership business are not diverted elsewhere. In reaching this conclusion, the CCI’s primary focus has been on market power and other factors set out in Section 19(4) of the Act.
Exclusivity in digital markets
Following international trends, the CCI has recently begun to show a growing degree of interest in cases involving businesses engaged in e-commerce. Large e-commerce firms, including Flipkart, Amazon, MakeMyTrip, and OYO, were the subject of probe orders issued by the CCI. The CCI determined that the players in these instances exercised significant market power and dealt with problems particular to digital markets, like platform parity agreements and preferential listing.
In Mr. Umar Javeed and ors. vs. Google LLC and Anr. (2018), a probe against Google was launched for abusing its dominant position in the mobile operating system-related market and was held to be in contravention of Section 4 of the Competition Act, 2002. The informant alleged that Google mandated the OEMs to preinstall GMS, i.e., Google Mobile Services, which contains Google’s proprietary applications like YouTube, Gmail, the Google Play Store, etc., in the Android operating system device. Through the Mobile Application Development Agreement (MADA) and Anti Fragmentation Agreement (AFA), vertical agreements entered into by OEMs and Google consisted of an anti-competitive clause that pre-mandated such OEMs to install GMS in their devices, thereby causing a barrier to entry for rivals in the space.
The CCI found Google to be a dominant player in the relevant market, i.e., the market for licensable Mobile Operating Systems in India, as it accounts for 82% of India’s mobile operating system market as of 2018. The CCI also found that such pre-installation of GMS under the Mobile Application Development Agreement (MADA) and Anti Fragmentation Agreement (AFA) entered between Google and OEMs was considered an unfair condition on the device manufacturers and thereby a gross violation of Section 4(2)(a)(i).
This conduct results in hindering the development and market access of rival mobile applications/services. In October 2022, CCI fined Google to the tune of Rs. 1337 crore for abusing its dominant position and adversely affecting competition in the Indian market.
In Federation of Hotel & Restaurant … vs. Makemytrip India Pvt. Ltd. (Mmt) & … (2019), The Commission found the arrangement between MMT Go and OYO to be in contravention of Section 3(4)(d) read in conjunction with Section 3(1) of the Act. Such commercial agreements were entered into to delist other competitors of OYO like FabHotels and Treebo from the MMT Go online portal in 2018. Based on the information in the dossier, the Commission determined that OYO and MMT-Go had an agreement or understanding that was in the nature of a vertical arrangement subject to Section 3(4)(d) read with Section 3(1) of the Act and that this agreement/understanding had negatively impacted market competition by preventing access to an essential channel of distribution through foreclosure. Thus, the commission, in its order, directed MMTGo to immediately relist such companies to ensure transparency, consumer welfare, choice, and competition in the market.
Conclusion
From a legal and economic perspective, determining the proper welfare assessment of vertical agreements under Competition Law is a challenging task. This article examined some prominent vertical agreement cases in India with the goal of evaluating the CCI’s level of analysis in these cases. It also highlights the CCI’s propensity to promote consumer welfare, choice, and increased market access for businesses while balancing these interests with acknowledging the reasonable restrictions/restraints imposed by businesses to protect their legitimate business interests, trade secrets, and intellectual property. It should be ensured that when exclusive clauses are used, they are justified with respect to scope and duration, well-constructed, targeted, reasonable and offer substitutability/interchangeability to the contracting party or end users.
References
- https://www.jstor.org/stable/26411530
- https://www.cci.gov.in/images/publications_training/en/competition-law-module-for-administrative-and-judicial-training-academies1652179010.pdf
- https://www.cci.gov.in/images/publications_compliance_manual/en/compliance-manual1652179683.pdf
- https://www.oecd.org/regreform/sectors/2376247.pdf
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