COMPETITION AUTHORITY

Competition Authority Decision of 13 March 1997 relating to a proceeding under Section 4 of the Competition Act, 1991.

Notification No CA/786/92E - Development Capital Corporation Ltd/Direct Marketing Technologies Group Ltd/Shareholder Agreement

Decision No. 479

									Price 	£0.80
										£1.30 incl. postage

Competition Authority Decision No. 479 of 13 March 1997 relating to a proceeding under Section 4 of the Competition Act, 1991.
                            
Notification No. CA/786/92E ‑ Development Capital Corporation Ltd /Direct Marketing Technologies Group Ltd./Shareholder agreement.

Decision No. 479

Introduction

1.   Notification was made by Development Capital Corporation (DCC) on 30 September 1992 with a request for a certificate under Section 4(4) of the Competition Act, 1991 in respect of a Share Subscription Agreement in relation to shares in Direct Marketing Technologies Group Ltd (Direct Marketing).  Following the issue of a Statement of Objections on 7 November 1995, amendments were made to the notified arrangements to meet the concerns expressed by the Authority.

The Facts

(a) Subject of the notification

2.  The notification relates to the Share Subscription Agreement dated 24 October 1988 between DCC, as subscriber, Matthew McNamara and Anthony O'Donovan Johnstone as covenantors and Cartagena Ltd (now named Direct Marketing Technologies Ltd) in relation to the subscription by DCC for shares in Direct Marketing. By way of supplemental agreement dated 30 May 1989 James McGuirk was added as a covenantor to the notified agreement.

(b) The parties involved

3.(i)   DCC was engaged in the provision of venture and development capital. It is now a publicly quoted industrial  holding company with a broad range of investments including a number of subsidiary companies in the healthcare, oil distribution, and office automation sectors as well as investments in a number of publicly quoted companies and other unquoted companies. 

(ii)    Direct Marketing, formerly named Cartagena Ltd, was incorporated in the State on 6 May 1988 and is engaged in the provision, on a consultancy basis, of software and marketing expertise to a company engaged in direct marketing of insurance. At the date of the agreement it had an issued share capital of £2 represented by 2 shares of £1 each which was beneficially owned as to 1 share each by Matthew Mc Namara and Anthony O'Donovan Johnstone.

(iii)   At the date of the agreement Matthew Mc Namara and Anthony O'Donovan Johnstone were sole directors and owners of Direct Marketing. They are covenantors under the notified agreement. James McGuirk, who was added as a covenantor to the agreement, is now a director of Direct Marketing.  

(c) The Notified Agreement

Share Subscription Agreement

4. (i) The notified share subscription agreement was made on 24 October, 1988 to provide for the subscription by DCC and the covenantors for shares as set out below and to provide for the future regulation of the conduct of the business of the company and the relationship between the shareholders. The agreement, as amended by the supplemental agreement dated 30 May 1989, provided for the subscription for and issue of shares in tranches as follows to the shareholders

                                           		Ordinary £1 shares
Matthew McNamara                                     23,912
Anthony O'Donovan Johnstone                    23,912
James Mc Guirk                                              2,174
DCC ‑ 1st tranche                                         14,767
           2nd tranche                                         22,191
                                           Total :                 86,956.
The shares issued to DCC were at a substantial premium. In February 1997 DCC sold its entire shareholding in Direct Marketing Technologies Group Ltd. to Nightshade Ltd. The only remaining shareholdings are Matthew Mc Namara and Anthony O’ Donovan Johnstone.

(ii) The agreement provides for phasing of the subscriptions and the completion arrangements. It provides for warranties by the original shareholders and that on completion the covenantors shall each enter into employment agreements, in the agreed form, with the company which the company covenants to fully enforce. The covenantors will on or before completion assign any agencies, licences etc held by them to the company. Provision is made for an executive share option scheme subject to a maximum of 5% of issued share capital. DCC is appointed business development adviser.

(iii) The agreement provides that the company shall carry on the relevant business in an efficient manner and no material alteration will be made to the scope or nature of the businesses. Provision is made for the appointment of 2 directors by DCC and for the information requirements to keep DCC advised on progress of the business. Restrictions are imposed on the company in relation to the disposal of shares in its subsidiaries, and borrowings and capital expenditure above fixed parameters. There are further restrictions on the company including the issue of shares without the consent of DCC, creation of charges, onerous contracts, substantial disposal of assets, issue of loans above set limits or the acquisition of subsidiaries. 

(iv)  The agreement also contains the following non competition clauses

" 4.01  (a) ...each of the Covenantors hereby covenants with the Subscriber and with the Company that during the period commencing on the date hereof and terminating two years after the date upon which he shall cease to be a shareholder in or employed by any 

of the Companies (whichever is the later) he will not directly or indirectly use his expertise knowledge or experience of the Restricted Businesses to compete with the Companies in the Prohibited Area nor be interested or engaged in any business competing with the Companies in the Prohibited Area in any of the Restricted Businesses.

4.01 (f) Each of the Covenantors will not during the period commencing on the date hereof and terminating two years after the date upon which he shall cease to be a Shareholder in or employed by any of the Companies (whichever is the latter) within the Prohibited Area either on his own behalf or on behalf of any other person firm or company solicit in competition with the companies or any of them in relation to the Restricted Business the custom of any person firm or company who at any time during the last three years up to the termination of his employment with the Company or his ceasing to be a shareholder was a customer of or in the habit of dealing with the Companies or any of them or represent himself as being in any way connected with or interested in the business of the Companies."

"Prohibited Area" is defined as being the Republic of Ireland and the United Kingdom and "Restricted Businesses" as being the business of the provision of insurance broking services both life and non‑life.

Supplemental Agreement

5.  The supplemental agreement was made on 3 May 1989 to provide for the transfer of 2,174 shares from Messrs. Mc Namara and Johnstone to Mr. McGuirk.  The agreement also provides that the earlier agreement will be construed as if Mr. Guirk had been named as one of the covenantors.

Employment Agreements  

6.  Copies of employment agreements furnished provide details of the conditions and terms of employment of Mr. Mc Namara and Mr. O'Donovan Johnstone. Clause 5.01 in each agreement contains the following protective covenant:

“5.01  Trade Secrets. The Director shall not except as authorised or required by his duties reveal to any person persons or company any of the trade secrets secret or confidential  operations processes or dealings or any information concerning the organisation business finances transactions or affairs of the Company or of any Member of the Group which may come to his knowledge during the period of his employment hereunder and shall keep with complete secrecy all confidential information entrusted to him and shall not use or attempt to use any such information in any manner which may injure or cause loss either directly or indirectly to the Company or any Member of the Group or its or their business or businesses or may be likely so to do. This restriction shall continue to apply after the termination of this Agreement without limit in point of time but shall cease to apply to information or knowledge which may reasonably be said to have come into the public domain.”

(d) Submissions of the parties

7.(i)  DCC submitted that the arrangements did not have the object or effect of preventing, restricting or distorting competition in the State. The arrangements created a strong business partnership between DCC and the investee company ‑ Direct Marketing Technologies Group Ltd  ‑ which brought together capital and financial acumen with proven entrepreneurial and operational ability to the business. DCC further submitted that the long term nature of the arrangements was guaranteed by the equity stake, in a highly illiquid investment, which DCC had in the company and by the commitment of the management of the company. The arrangements by which DCC contributed considerable capital and financial resources to Direct Marketing Technologies Group Ltd resulted in that company being a more effective competitor in the market place. Since DCC does not invest in more than one company in the same market, no restriction on competition takes place at the shareholder level.
 
(ii)  DCC also submitted that the restrictions on the freedom of the parties to take independent commercial decisions did not simply restrict competition but were absolutely essential to create a powerful business partnership between diverse parties bringing different skills and resources to this venture. They were necessary for both parties to obtain their respective and mutual commercial objectives. The restrictions were necessary for Direct Marketing Technologies Group Ltd because they ensured the full and active participation of key senior managerial staff with proven expertise and experience in the development of the company. They also ensured that the company would have the back‑up of the financial expertise and experience of DCC. The restrictions were necessary for DCC because they allowed DCC some measure of control over the activities of Direct Marketing Technologies Group Ltd and thereby also over the value of its substantial investment in the company.

(iii)  DCC further submitted that it expected to be a full partner in the venture and to contribute to all major strategic decisions taken by the company. They considered the minority protection provisions relating to DCC's shareholding to be essential to achieve this objective. Since DCC expected to enhance the value of its investment by providing financial advice, they considered it appropriate to set out the nature of the advice to be given by them to the company. DCC submitted that the restrictions on the actions of the company in clause 5.14 from undertaking certain activities which DCC did not consider to be consistent with the original reason for making the investment and which they did not consider to be in the company's best interests.

(e) Subsequent Developments

8.   Following the issue of a Statement of Objections on 7 November 1995 in which the Authority objected to the duration of the non-competition clause 4.01(a) and the non-solicit clause 4.01(f) DCC agreed to amend it by way of letters of waiver, which were executed on 11 December 1995 and transmitted to the covenantors. As the benefit of the covenants also enured to Direct Marketing similar waivers in favour of the covenantors were executed by that company on 8 February 1996.

Assessment

(a)  Section 4(1)

9.   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.

(b)   The Undertakings.

10.   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".

11.   The parties to the notified arrangements are Direct Marketing, Matthew Mc Namara and Anthony O'Donovan Johnstone, James Mc Guirk and DCC. Direct Marketing is engaged for gain in the provision of software and consultancy advice in relation to insurance broking and is therefore an undertaking. Messrs Mc Namara and Johnstone were the owners of Direct Marketing at the date of the share subscription agreement and in line with previous Authority decisions are each therefore regarded as an undertaking.  DCC was engaged in the business of venture and development capital and is now a broadly based industrial holding company. It is therefore an undertaking.   The notified agreement is an agreement between undertakings. The agreement has effect within the State.

(c)   Applicability of Section 4(1)

Share Subscription Agreement  

12.   The Share Subscription Agreement constitutes an agreement whereby DCC agreed to make a venture capital type investment by way of subscription for a minority equity shareholding in Direct Marketing. The Authority considers that the investment of venture capital to obtain a minority shareholding in a company is not, per se, anti-competitive and does not offend against Section 4(1) of the Competition Act.  The agreement also contains standard provisions relating to the future internal management and operation of the company designed to protect the minority shareholding position of the new investor. The Authority has decided in a number of decisions that such standard provisions do not offend against Section 4(1). 
     
13.   Clause 4.01 of the agreement imposes a number of non-compete and non-solicit restrictions on the three covenantors which effectively prevent any of them from engaging in the business of the provision of insurance broking services in competition with Direct Marketing (clause 4.01(a)) or soliciting the custom for such services from any person or company who had been a customer of Direct Marketing in the 3 years up to a covenantor's termination with Direct Marketing (clause 4.01(f)). The restrictions apply for the period from the date of the agreement and terminating 2 years after a covenantor ceases to be a shareholder in or employed by Direct Marketing, whichever is the later. 

14.   In their 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, therefore, as the non-compete and non-solicit restrictions apply to the period when the covenantors remain as shareholders in, or employed by the company these provisions do not offend against Section 4(1) of the Competition Act.

15.   A similar view is taken in relation to non-compete and non-solicit restrictions which apply for a period after a disposal of shares provided that the restrictions do not exceed what is necessary to enable the purchaser to secure the goodwill of the business which would, effectively, be sold by the disposal of shares. In considering these restrictions the Authority has regard both to the duration of the restriction, and its scope, including its geographic scope. Under the notified agreement the non-compete and non-solicit restrictions apply for a period of 2 years after disposal of shares which is the period which the Authority generally finds acceptable. The scope of the restriction covers the whole of the State, as well as the UK, but in the light of the country wide business covered by Direct Marketing's activities the Authority does not consider that the scope of the restriction offends against Section 4(1). Restrictions in relation to the UK do not come within the scope of the Competition Act.

16.   Under the agreement the non-compete restriction under clause 4.01(a) also applied for a period of 2 years after the date a covenantor ceased to be an employee of the company if this was later than the date he ceased to be a shareholder. The Authority has consistently taken the view that such a provision could have the effect of extending the non-compete period far beyond the period necessary for the transfer of the business and that it therefore offended against Section 4(1). DCC and Direct Marketing have now agreed not to enforce this non-compete clause for a period in excess of 2 years after a covenantor ceases to be a shareholder in the company and have executed waivers to this effect on 11 December 1995 and 8 February 1996 respectively. As this reduces the period of non-competition to the period which the Authority generally finds acceptable, the provision no longer offends against Section 4(1) of the Competition Act. 

17.    Under clause 4.01(f) each covenantor was also restricted from soliciting customers of Direct Marketing  for a period of 2 years after the date he ceased to be an employee of the company if this is later than the date he ceases to be a shareholder. In its Decision No. 20, the Authority has accepted that some restriction on the soliciting of customers, after termination of employment, could be necessary to protect the legitimate interests of the company. In this instance the restriction applied for a period of 2 years after the date of termination of employment and, as no justification had been provided for a non-solicit period of such a long duration, the Authority considered that it therefore offended against Section 4(1).  DCC and Direct Marketing have now agreed not to enforce this non-solicit clause for a period in excess of 1 year after cessation of employment, if this is later than the date of cessation as a shareholder, and executed waivers to this effect. As this reduces the duration of 

the non-solicit clause to the period which the Authority generally finds acceptable, the provision no longer offends against Section 4(1) of the Competition Act. 
 
Employment Agreement

18.   Under clause 5.01 of the employment agreements each director is prevented from revealing to any person any of the company’s trade secrets, secret or confidential operations, processes or dealings. The restriction continues to apply after termination of the agreement without limit in point of time but does not apply to information that has come into the public domain. The Authority takes the view that trade secrets and information involved is the company’s property, that the company is entitled to protect its property and that the clause does not therefore offend against Section 4 (1).

 (d)  The Decision

19.   In the Authority's opinion Direct Marketing Technologies Group Ltd, Matthew McNamara, Anthony O'Donovan Johnstone, and Development Capital Corporation plc, are undertakings within the meaning of Section 3(1) of the Competition Act, 1991 and the notified share subscription agreement dated 24 October 1988 is an agreement between undertakings.  In the Authority's opinion  the notified arrangements, as amended by way of waivers dated 11 December 1995 and 8 February 1996, do not offend against Section 4(1) of the Competition Act, 1991.

The Certificate

20.     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 Share Subscription Agreement dated 24 October 1988 between Direct Marketing Technologies Group Ltd, Matthew McNamara, Anthony O'Donovan Johnstone, James Mc Guirk and Development Capital Corporation plc, notified under Section 7 on 30 September 1992 (notification no. CA/786/92E), and as amended by way of the waivers dated 11 December 1995 and 8 February 1996, does not offend against Section 4(1) of the Competition Act, 1991.

For the Competition Authority.

Isolde Goggin
Member.
13 March 1997