Contractual joint ventures and competition law issues

August 2023  |  SPECIAL REPORT: COMPETITION & ANTITRUST

Financier Worldwide Magazine

August 2023 Issue

Parties have long relied on equity joint ventures to penetrate new markets or share risks in the development or production of new products. Equity joint ventures remain commonplace due to their separate legal personality, providing many benefits including in terms of liability, accounting and tax.

From a competition law perspective the analysis is relatively straightforward, with jointly controlled ventures being seen as a legitimate way to create a new, separate business, operating at arm’s length from its parents.

Despite their benefits, equity joint ventures do not always suit the parties’ objectives. Parties may be prevented from contributing assets that are essential to the joint venture’s operations. This is often the case in the air transport, mining or energy sectors, where rights relating to air traffic, exploration or exploitation are granted to specific legal entities that are prevented from transferring them, on account of nationality restrictions or of preferential tax treatment. In other cases, parties are reluctant to transfer or licence real estate or intellectual property rights to an equity joint venture out of a concern of seeing their control diluted over these key assets.

These constraints often lead parties to conclude contractual joint ventures to achieve their commercial objectives – they would pool resources and share in the economic risks, acting on the market as a single operator and often accept joint and several liability as if they were in an equity joint venture. These arrangements give rise to very complex competition law issues, as they are seen as agreements between independent parties to coordinate their activities.

Such coordination, when it involves key aspects such as production, marketing and pricing, will lead to significant competition law risks, particularly where competing parties are involved, as it may fall foul of the competition law prohibition on restrictive agreements and cartels between competitors.

Legal certainty

Competition authorities and courts would frequently impose very significant sanctions on competitors for agreeing to restrict competition. This often leads parties to carefully consider the respective merits of contractual and equity joint ventures. Equity joint ventures – even when relating to greenfield projects – will often be considered as ‘mergers’ and therefore be subject to prior clearance under the competition law merger control rules, allowing parties to obtain legal certainty for their transaction by seeking clearance from competition authorities.

Unless parties have a significant market position, obtaining clearance is straightforward. Another significant advantage is that the joint venture is seen as a single independent business entity separate from its parents. Provided that it operates at arm’s length from its parents, joint venture activities are not regarded as amounting to coordination between the parents, therefore escaping from the prohibition on restrictive agreements.

On the other hand, contractual joint ventures will most often not be considered as ‘merger’ transactions under competition law, but instead as agreements between independent parties. Where agreements involve joint production, marketing or pricing, risks arise under the competition law prohibition on restrictive agreements. Certain jurisdictions offer procedures allowing parties to seek legal comfort in relation to agreements that are potentially restrictive of competition.

These procedures, however, tend to be heavier and longer than merger control clearance processes, and they usually lead to a time-limited clearance. Contrary to merger control clearances that are typically valid for the lifetime of the joint venture, competition authorities will often authorise contractual joint ventures for a limited period, forcing parties to renew the authorisation on a regular basis. Furthermore, these procedures are only available in a handful of countries, and in many jurisdictions parties to contractual joint ventures have no choice but to conduct their own assessment of the legal risks involved.

Design considerations

A key consideration under competition law for contractual joint ventures is whether a joint venture is needed at all. Where participants to the joint venture are not competitors, and put together their respective complementary skills, it is usually straightforward for them to justify that the pooling of resources and risks under the contractual joint venture allows each of them to achieve something that they would otherwise not achieve on their own. Furthermore, as they do not compete, agreements on joint production and joint pricing are unlikely to fall foul of the prohibition on restrictive agreements.

Contractual joint ventures are more challenging to justify where participants compete among themselves. There are many precedents from authorities in Europe, Australia and Asia recognising that competitors are justified in pooling their resources and risks where this allows them to develop a project faster, to enter new markets, or to improve their services. The threshold for acceptance is, however, particularly high, as parties must show that all of the features of the contractual joint venture including, for example, the sharing of risks and resources, joint production and joint price-setting, are justified, and that a less integrated cooperation model, that would entail less competition restrictions, is not a credible alternative.

In addition, the assessment takes account of the parties’ respective market positions – parties with a significant market share will face a very high hurdle in showing that their joint venture is not only justified, but also does not lead to significant restrictions of competition. Finally, where competition restrictions are to be expected, for example on account of the extent of the cooperation or of the parties’ high market shares, parties must demonstrate that the joint venture will generate significant redeeming benefits. Different legal tests apply in this respect, from a consumer-centric approach in the European Union (EU) and many parts of Asia, to a broader ‘net economic benefit’ test in Australia or Singapore.

Under both tests, parties must be able to demonstrate that their joint venture will create benefits not only for themselves but also for third parties – for example, cost savings arising from economies of scale must be likely to be passed on to customers (a key consideration under the EU approach), or an increase in production must be shown to benefit the economy at large (under a broader test).

The magnitude of these benefits must be sufficient to outweigh competition concerns. This requires a balancing analysis between the benefits of the joint venture and its restrictive effects, and a detailed review of economic incentives for the parties to create these benefits. Creating these incentives often requires the sharing of financial and commercial risks among parties.

These competition law constraints play a significant role in the design of contractual joint ventures and even sometimes affect their feasibility, with parties being attentive to choose a business model that leads to the creation of significant efficiencies. Despite the many hurdles, contractual joint ventures are regularly authorised by competition authorities in various sectors of the economy.

A recent example comes from the energy sector. Earlier in 2023, the Australian Competition and Consumer Commission authorised plans by three energy companies to jointly market and sell (through gas supply contracts of up to 15 years) natural gas produced from a prospective gas field in southern Australia. The competition authority considered that the joint marketing venture is likely to result in a net public benefit as it enables the earlier development and availability of the gas supply and leads to a reduction in transaction costs in commercial negotiations between the parties, while it would unlikely lead to any significant impact on market dynamics as the volume of gas involved represents only a very small share of the demand.

In the air transport sector, many so-called ‘metal-neutral’ joint ventures have been authorised by competition authorities across the world, although authorities would sometimes subject their approval to conditions. For example, in a 2013 decision concerning the joint venture between Air Canada, United Airlines and Lufthansa regarding their transatlantic passenger flights, the EC considered that the venture led to the elimination of competition between the airlines on key parameters such as pricing and capacity.

The EC, however, recognised that this coordination was indispensable in providing the common incentives for the parties to achieve the benefits of the joint venture. Furthermore, the authority remained concerned with the joint venture’s effect on competition on account of the parties’ high market shares, and considered that the benefits arising from the joint venture were not sufficient to outweigh its restrictive impact. The authority accordingly required commitments from the parties (with a view to facilitate entry by other airlines) in return for its authorisation.

In the maritime shipping sector, the Hong Kong Competition Commission considered, in a decision made in 2020, that the contractual joint venture between members of the Hong Kong Seaport Alliance entailed a high degree of coordination of parties’ production, commercial policies (including a joint approach on pricing and marketing) and profit-sharing. In reviewing the transaction, the authority acknowledged that such integrated coordination provides the required common incentive for parties to bring about the benefits of the Alliance, and approved the transaction despite its concerns over the parties’ high market shares on account of the commitments offered by the parties in respect of their future pricing.

Conclusion

The above examples show that contractual joint ventures are feasible. However, legal uncertainties and compliance costs are significant when compared to equity joint ventures, which from a competition law perspective remain the more straightforward choice for parties.

 

Marc Waha is a partner and Joe Lee is an associate at Norton Rose Fulbright. Mr Waha can be contacted on +852 3405 2508 or by email: marc.waha@nortonrosefulbright.com. Mr Lee can be contacted on +852 3405 2310 or by email: joe.lee@nortonrosefulbright.com.

© Financier Worldwide

BY

Marc Waha and Joe Lee

Norton Rose Fulbright

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