This article has been written by Shruti Chincholkar, pursuing the Certificate Course in Competition Law, Practice, And Enforcement from LawSikho.
The manner of investment by corporations, persons as well as mutual funds have drastically changed. There has been a reduction in the number when it comes to directly hold corporate stocks. Investors including private equity companies hold more diverse holdings for minimizing the risk. Private equity companies majorly are the minority shareholders of the corporations. Minority shareholdings can be referred to as ownership of shares of less than 50% of the voting rights attached to the equity of the target firm.
The Indian antitrust regime does not have a specific merger control regulation for the private equity firms in regard to common ownership. However, with the allegations against SoftBank Group Corp. investing in Ola, an Indian radio tax service as well as biggest competitor Uber relating to the exchange of information thereby facilitating anti-competitive practices between the two. The Chairman of CCI, Mr. Ashok Kumar Gupta stated that CCI in the near future plans on conducting a market study on private equity and related antitrust concerns.
The concerns with private equity funds arise on the ground of common ownership in the same industry. Furthermore, recent studies conducted by OECD and DoJ affirm the harmful effect of common ownership on market competition. The main issue with common ownership of multiple firms belonging to the same sector is the aspect of control and influence of institutional investors to facilitate the anti-competitive practices. For instance, a company could trade off the revenues with its competitor for the interest of the investor having common ownership of both competitors. Henceforth, such private equity investors should be cautious to negate the detrimental effects on competition due to the common ownership. In foreign jurisdictions, these issues are redressed under the Merger Control Rules.
The legal theories of control by the private equity funds on the portfolio company in the circumstance of the common ownership include firstly, the direct influence with the management, secondly, tacit or passive control over the management of the portfolio company, and lastly, whether such acquisition lessen the market competition or not. Different jurisdictions have different legal theories as stated in the following:
1. Test of decisive influence by EU Merger Review Regime
The definition of control given by the EU Merger Review Regime is the probability of employing ‘decisive influence’ on a corporation. Under the ambit of ‘decisive influence’ include rights of shareholders, contractual obligations, or any other mechanism either singly or in amalgam with the facts and circumstances of the matter are taken into consideration by the EU antitrust watchdog. However, the review is limited to only undertakings which lead to the acquisition of control (OECD, 2008, p.10).
2. Concept of ‘material influence’ applied by the Competition and Markets Authority (“CMA”)
Under this concept applied by UK antitrust watchdog, CMA widens the scope of scrutiny of transactions by reviewing non-controlling minority shareholding having the potential to employ material influence on the portfolio company. There lies a rebuttable presumption on the possibility of employing material influence in the scenario where the private equity fund owns 25% or more of the shares of the portfolio company.
The legal framework in Germany and Austria also devised a similar test of control as acquisitions of less than 25% can also be scrutinized if they have the potential to employ ‘material competitive influence’ by the investor on the portfolio company. However, there is no definition with regards to the term ‘material competitive influence.’ However, in both jurisdictions, the threshold of 25% is only the merger review and does not infer any antitrust harm. The investigation of antitrust concerns comes at the second stage.
3. Concept of no control applied in US Merger Control System
The US antitrust regime tests a transaction on the basis of whether such acquisitions have a probability to mitigate market competition or not. The regulation states that any transaction relating to the 10% or more voting shares of another corporation and forbids such transaction if there’s a possibility of “the effect of such acquisition may substantially lessen competition.”
However, the aforementioned criterion is mitigated to institutional investors for the acquisition for “solely for the purpose of the Investment’ which states that “this section shall not apply to persons purchasing such stock solely for investment and not using the same by voting or otherwise to bring about, or in attempting to bring about the substantive lessening of competition.”
From the analysis of different tests applied by different foreign jurisdictions, it is evident that the legal theories on the control as well as transactions relating to the non-controlling minority shareholdings lie outside the ambit of the merger rules. However, some other jurisdictions go beyond the concept of control but assess the potential of the firm to influence the acquired company’s strategic decision-making process
In the case of the Dow/Dupont merger involving the merger of two large chemical producers, the EU Commission went to analyse the stake of common ownership among the competitors in the relevant market. Therefore, the Commission held that “the decision taken by one firm, today, to increase innovation competition has a downward impact on its current profits and is also likely to have a downward impact on the (expected future) profits of its competitors. This, in turn, will negatively affect the value of the portfolio of shareholders who hold positions in this firm and in its competitors. Therefore, as for current price competition, the presence of significant common shareholding is likely to negatively affect the benefits of innovation competition for firms subject to this common shareholding.” Therefore, it is observed that the Commission analysed the negative effect on the competition due to the common ownership due to the exercise of control and influence on the strategic decisions of the acquired firm.
It is pertinent to note that antitrust concerns with regard to private equity are not limited to the merger control regulations. There are a few instances where the acquisition of minority shareholding in a corporation amounts to contravention in the form of facilitating or forming anti-competitive agreements or abuse of dominance.
Judicial precedent by EU Commission
In the case of British American Tobacco Co Ltd v. Commission of the European Communities, the EU Commission observed that mere minority shareholding by PE firms is not sufficient ground to prove the limitation of market competition. However, the same can act as a mechanism to influence the conduct of a player in the market, resulting in distorting competition in the relevant market by commercial cooperation between the competitors.
With regards to the abuse of dominance, the European Court (case decided prior to the adoption of European Commission Merger Regulation) held that minority ownership in a competitor could only amount to the abuse of dominance when there is an effective control in the acquired firm commercial policy.
Judicial precedents in the USA
There have been various instances where private equity firms were held liable for involving or facilitating the antitrust practices. One of the recent cases of City of Greensboro v. Am. Sec., LLC a private equity firm had a shareholding in the portfolio companies engaged in running a water chemical business, and two of its employee were named as Managing Directors (“MD”)of the portfolio companies were alleged to indulge in collusion to allocate customers and/ or fix the price of a water treatment chemical, liquid aluminium sulfate, known as “Alum.” The PE firm and its two managing directors (the “PE defendants”) filed motions to dismiss in the district court, which the court denied on February 1, 2018. In 2019, the PE firm agreed to pay $13 million to settle the antitrust claims against it.
The defendant PE firm in its motion to dismiss argued that the existence of ownership is insufficient ground for subjecting it to the liability arising out of the anti-trust issues. However, the court rejected the arguments. However, the court rejected the arguments and held that the incidence of direct involvement of the PE firm in the anti-competitive practices of its portfolio companies is sufficient to make a case of antitrust litigation against such a firm.
Although in another case of Re Packaged Seafood Products Antitrust Litigation, the U.S. District Court for the Southern District of California, dealing with allegations of tuna price-fixing, considered motions to dismiss by a British PE firm, its U.S. subsidiary, and a related holding company that was invested in the Bumble Bee tuna company. There, the court found that the alleged facts failed to show two of the PE entities’ direct involvement in the alleged price-fixing which contravenes Section 1 of the Sherman Act. The court went on to reject the plaintiffs’ “alter ego theory”— that attempted, among other things, to impute acts of the portfolio company to the PE investors—for failure to allege a “unity of interest.” The court also rejected the plaintiffs’ “agency theory”8 and “vicarious liability theory” (involving dual officers) when the plaintiffs failed to overcome a presumption that “the directors are wearing their ‘subsidiary hats’ and not their ‘parent hats’ when acting for the subsidiary.” The aforementioned precedents reflect that the courts in the United States assess the antitrust concerns alleged on the PE equity firms on the basis of whether PE firms have direct involvement in the anti-competitive practices of their portfolio companies.
In nutshell, antitrust issues in the private equity sector have different approaches in the different jurisdictions across the globe. The main concept of common ownership causing anti-competitive practices is assessed by its control on the basis of its voting rights or other aspects in the portfolio firms. There are various Merger Control Regulations with regards to the scrutiny of mergers falling beyond a certain threshold. However, there are a few instances where private equity firms are liable for anti-competitive conduct of their portfolio company even when the firm has minority shareholding on the basis of its control in the management of the strategic decisions of the portfolio firm. PE firms have to be a little more cautious while making transactions keeping in mind that the transactions would not lessen the market competition and refrain from any meetings which can be construed as the formation of an agreement that is anti-competitive in nature.
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