A number of recent developments have highlighted the potential exposure of private equity firms to competition law risks as a result of the activities of their portfolio companies.
In this briefing, we look at what private equity firms need to watch out for and how they can minimize the risks that they face.
Why worry?
Serious breaches of competition law by companies active in the EU are likely to result in enforcement action by the European Commission or EU member state competition authorities, such as the Office of Fair Trading (OFT) in the UK (see notes below: “EU and UK competition law: key points”).
The most obvious competition law risk for private equity firms is the potential value impact on a portfolio company. The portfolio company may face significant fines if involved in a breach of EU or UK competition law and may also face damages actions from harmed third parties.
Competition law investigations can also result in a substantial diversion of management time and have reputational consequences.
However, there are a number of less obvious risks faced by private equity firms which should also be borne in mind.
Direct liability for fines above the portfolio company level
Liability for fines may not stop with the portfolio company; it can attach to parent entities as well. Under EU and UK competition rules, liability for a competition law breach by a particular company attaches to the entire “economic unit” of which that company forms part.
As a result the European Commission and OFT are able to hold a parent liable for the competition law infringement of a subsidiary if the parent exercises “decisive influence” over the subsidiary, even if there was no involvement in or knowledge of the competition law breach. Indeed, there is a (rebuttable) presumption of such influence where the parent owns all, or nearly all, of the shares of a subsidiary.
On the same basis, private equity firms which exercise decisive influence over their portfolio companies may be in the frame for fines for a competition law breach by a portfolio company. Further, such liability can even potentially arise after the portfolio company has been sold (see the recent Goldman Sachs example noted below: “Recent cases involving private equity firms”).
Disputes with fund investors
Typically, private equity fund investors give an indemnity to the private equity firm, acting as fund manager, which may cover losses such as fines for breach of competition law imposed on the private equity firm.
However, fund investors may well be reluctant to bear these costs. Depending on the wording of the indemnity, they may be able to resist payment by arguing that the private equity firm has been negligent in failing to take sufficient steps to ensure that the portfolio company complied with competition law.
Director disqualification
The OFT has recently signalled its intent to make wider use of its powers to apply for disqualification of directors who are implicated in breaches of EU or UK competition law. Depending on the circumstances of the particular case, investor directors could potentially also face proceedings for disqualification.
Recent cases involving private equity firms
Several recent cases have highlighted the scope for private equity firms to be drawn into investigations of the activities of their portfolio companies by competition authorities:
- Goldman Sachs is reported to have received a “Statement of Objections” from the European Commission in relation to an alleged competition law infringement by Prysmian, a supplier of power cables, which was owned by certain GS Capital Partners funds for some of the relevant period, but had been sold in the intervening period.
- AXA and Cube: In January this year, the European Commission opened an inquiry into alleged price fixing involving several French water companies including SAUR, in which AXA Private Equity and Cube Infrastructure have significant stakes.
- There are a number of other cases where competition authorities have investigated and subsequently fined private equity portfolio companies for competition law infringements. We are aware of at least one other case where the European Commission fined a private equity firm based on an infringement by its portfolio company.
In this regard, it is worth noting that the OFT does not have to prove that a director actually contributed to the breach; a court may order disqualification where the director either:
- had reasonable grounds to suspect a breach of competition law (and took no steps to prevent it); or
- did not know that the conduct amounted to an infringement but ought to have known.
Minimizing competition law risks: due diligence and compliance measures
Private equity firms should consider first whether their due diligence processes are sufficient to cover potential competition law breaches by prospective portfolio companies and that appropriate warranties and indemnities are secured on the purchase.
In relation to their existing portfolio companies, private equity firms should consider whether they have asked the right questions about compliance with competition law and whether an appropriate compliance programme is in place.
In their respective guidance documents, both the European Commission and OFT accept that there is no “one-size-fits-all” policy when it comes to compliance; measures which are entirely appropriate in one sector or for one company may not be suitable for another.
When it comes to implementation of compliance measures, both the European Commission and the OFT stress that board support is essential – and needs to be clearly communicated to the rest of the business. Both advocate the appointment of a senior executive to take charge of compliance (who will be expected to have a greater understanding of competition law than, say, non-executive directors – see below).
They also emphasize that regular staff training is unlikely to be sufficient; consideration needs to be given to other measures, such as appropriate procedures for management oversight of sensitive areas (e.g. the activities of staff whose roles bring them into contact with competitors) and clear reporting mechanisms.
Private equity firms may also wish to consider making the implementation of compliance measures on an ongoing basis the subject of post-completion covenants in the relevant investment documentation.
Minimizing competition law risks: what is expected of investor directors?
It is important to ensure that management teams and investor directors understand, in broad terms, what types of behavior may infringe competition law and what the consequences are likely to be. Investor directors do not need to become experts in competition law.
However, in recent guidance, the OFT has indicated that it expects all directors (including non-executives) to be aware that arrangements with competitors to fix prices, engage in bid-rigging, limit production or share customers or markets are likely to constitute serious infringements of competition law, as are exchanges of commercially sensitive information with competitors (e.g. about future pricing intentions).
The OFT also expects all directors to know that businesses which occupy a position of market dominance may be prohibited from engaging in the following practices:
- charging excessively high prices;
- refusing to supply an existing customer without good reason;
- granting rebates or discounts that do not relate to objective criteria such as the volume of purchases made;
- tying or bundling (requiring or incentivising customers to buy two products together);
- charging prices which are so low that they do not cover costs; and
- refusing to grant access to facilities which are essential to other businesses.
In addition, the OFT expects non-executive directors involved in approving key commercial decisions (such as a joint venture with an actual or potential competitor) to satisfy themselves that, where necessary, appropriate competition law advice has been sought.
See “Questions all directors should ask”.
EU and UK competition law: key points
EU and UK competition law prohibits:
- Anti-competitive agreements: serious infringements include price-fixing, bid-rigging and market-sharing arrangements.
- Abuse of dominance: businesses which enjoy substantial market power may be prohibited from e.g. charging excessively high prices or refusing to supply a customer without good reason.
The consequences of infringement include:
- Fines up to 10% of worldwide turnover for the most serious infringements.
- Unenforceability of agreements.
- Third party damages claims.
- Director disqualification (UK only).
- Criminal prosecution of individuals implicated in cartel activity (UK only).
Questions all directors should ask
- The OFT suggests a number of questions that all directors (including non-executives) should ask:
- What are our competition law risks at present?
- Which are the high, medium and low risks?
- What measures are we taking to mitigate those risks?
- When are we next reviewing the risks to check they have not changed?
- When are we next reviewing the effectiveness of our risk mitigation activities?
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