Promoting competition is a key factor in economic growth. It allows the companies to compete and discover better operating procedures to enhance their economic performance. China has fostered competition even between its own SOE. A properly designed competitive environment attracts private investors from around the world.
Egypt has announced that it will introduce competition to a sector that enjoyed in the past substantial isolation and protectionism.The Industrial Development Authority recently announced that it will introduce competition in the tobacco market in Egypt. It announced that it will grant the first ever private license to manufacture tobacco and tobacco products in a bid to break the historical public monopoly incumbent Eastern Company SAE (“EAST”).
The new license comes with certain conditions.It allows East to become a minority shareholder in the new competitor.Minority shareholders are defined as those who hold less than 50% of the voting rights attached to the equity of the target firm. There are two types of minority holdings: controlling and non-controlling minority holdings. Controlling minority shareholdings is where the minority shareholder has defacto control over the target firm. The non-controlling minority shareholdings do not enjoy control and sometimes does not even have board representation and therefore only has financial interests in the firm. If the non-controlling minority is entitled to board representation, we fall into a hybrid category. Even if the non-controlling shareholder does not have the ultimate decision, he has access to confidential information which is the entitlement of all board members. This note deals exclusively with non-controlling minority shareholdings held by competing firms and the resulting legal and economic risks from the perspective of Competition Law,investment,and free trade.
Legal and Economic Risks of Minority Shareholdings from the Perspective of Competition Law:
In Egypt,the statutes of the companies might provide for proportionate board representation. In such a case, a minority shareholder who has sufficient shareholding can have the right to be on the board. If the board is five members and a minority shareholder has 20% of the target company, he is entitled to a seat on the board.If the statutes of the company do not have proportionate representation on the board, the majority shareholder may appoint 100% of the board. This may be useful to disallow shareholders with conflicting interests.
There are a variety of situations where a relatively small ownership can provide its owner with significant influence over a firm.This is particularly the case due to the lack of participation in the case of fragmented ownership of the remaining shareholders.
The risk of minority shareholdings between competing firms additionally includes price fixing, cartels and exchange of sensitive information. Cartels are a viable risk.Competitors having a minority shareholding in the other party’s company fosters the possibility of colluding with that company going forward.Structural links between competitors facilitate cartels. The competing firms gain the ability to coordinate their products and set prices accordingly.Structural links also facilitate the exchange of confidential information,to be able to dominate the market.The exchange of information does not have to be two-sided in form of collusion.It can also be in form of using the accessible information to predict future business strategies of the target firm. In order to decide whether a specific minority shareholding can be considered anti-competitive, the EU Commission developed two cumulative criteria for determining whether a “competitively significant link” exits between the companies:
1.There is a relationship between the parties (either horizontal or vertical), and
2.the competing party either
a)has a shareholding of around 20 percent, or
b)has a shareholding between 5-20 percent accompanied by additional factors, such as a seat on the board of directors.
If a “significant link” exits between the companies and one company has an influence over its competitor, it is very likely that Article 101 of the Treaty on the Functioning of the European Union (TFUE) is breached. Article 101 of TFUE states that agreements and or concerted practices which cause prevention, restriction or distortion of competition are invalid within the EU. In the context of the tobacco industry, the European Court of Justice (ECJ) decided a case which is of relevance: Philip Morris acquired a non-controlling minority shareholding of 30.8% in Rothmans (from Rembrandt Group Ltd) and held 24.9% of the voting rights. The court held that the structural links resulting from the agreement between the companies “may nevertheless serve as an instrument for influencing the commercial conduct of the companies in question so as to restrict or distort competition on the market which they carry on business”. The possibility of acquiring control of Rothmans International and the fact that the acquisition of the minority holding of shares is not simply a passive investment were sufficient for the ECJ to decide that the structural links resulting from the agreement between the companies are qualified to restrict or distort competition on the market, which infringed with Article 101 of TFUE.
Conditions to Enter the Tobacco Market in Egypt in Light of Competition Law:
Egypt plans to tender a license to produce traditional and electronic cigarettes.The target is to break the monopoly of the East in the multi-billion cigarette industry.It allows a more leveled access to the tobacco market in Egypt.But this level access should conform to Law No.3 for the year 2005 on the Protection of Competition and the Prohibition of Monopolistic Practices (popularly referred to as the Egyptian Competition Law or “ECL”). The controversial terms are as follows:
1.East has the option to participate in the capital of the new company (“Newco”) at a rate of 24% without incurring any part of the cost of the license;
2.The price of Newco’s products is higher than the selling price of the cigarettes produced by the East by at least 50 percent of the lowest product price of the East.
We would like to deal with these restrictions from both a policy point of view and an ECL point of view.From a policy point of view, the question is why do the terms prefer the interests of East to that of the GOE? Why should GOE be denied of 24% of the license fee it collects and save it to East?
The second policy question is why do we continue to favor East interests to that of the Egyptian consumer or worse, our ability to sell internationally?Protection of the Egyptian companies is usually done to allow a domestic company to prosper. It should always be timed. After giving the domestic company the chance to grow, the protection should be withdrawn. This is because protectionism is not an entitlement to the domestic company. It is a limited-time opportunity for it to grow. This protection comes at a high cost. The cost of the Egyptian consumer or the cost of the GOE revenues. It comes at the cost of the Egyptian consumer if the product is not as competitively priced as it could. It comes at the cost of the GOE, if the price is competitively priced, but the company is not as efficient as should be, and therefore reduces the potential additional tax revenues that the GOE could have collected. If the domestic industry is idealisticly competitive even with the lack of competition (which is something that we shall assume but is very unlikely to be the case), then why the continued protection?
From an ECL point of view, and if we are applying the standards the EU Law for guidance, as well as previous precedents of the Egyptian Competition Authority a “competitively significant link” may exit between the companies that since:
- East and Newco are both in a horizontal competitive relationship regarding the production and sale of cigarettes in the Egyptian market.
- East is allowed to participate in 24% of Newco’s shares at a discount, and therefore effectively encouraging the creation of a “significant link” with Newco…something that we need to avoid and not encourage!
- Additionally, Newco is contractually bound to sell cigarettes at a higher price by at least 50 percent of the lowest product price of East, which puts it in a clear disadvantage. This reduces the competitiveness of the offer and therefore the competitiveness of the license value to the GOE.
- The higher price of Newco shall be at the expense of the Egyptian consumer. It shall also be at the cost of the competitiveness of Newco to invade international markets.
Consequently, this may afford East a significant advantage that it should not need after so many years of enjoying the exclusivity in manufacturing.These conditions are an infringement of Article 101 of TFUE if assessed by European standards, but they are also an infringement to sister provision, namely Article 6 ECL. The ECA has previously assessed minority shares owned by one competitor in another context and decided that while the acquisition of a minority share may not always constitute a breach of the ECL, using these shares in order to access a competitor’s confidential information and affect its strategic decisions impacting its competitive position in the market, does breach Article 6 of the ECL. Similar to the facts of the case decided by the ECJ, the minority shareholding does not constitute a passive investment by East but, in light of the super dominance of East, will afford the latter control over Newco, which is not in accordance with ECL, specifically with Article 6 of the ECL. A recent decision by the Competition Market Authority (the UK competition Watchdog) has recently declared in a preliminary decision that the acquisition of Amazon of a minority share in the UK home delivery main market player Deliveroo as infringement to the UK competition rules before clearing the deal after the COVID-19 implications on delivery companies.
Recommendations and Way Forward:
We celebrate the GOE on the step of opening the tobacco market to competition.The terms of the new tobacco manufacturing license are ostensibly restrictive of competition and may therefore inhibit investment in the sector.It is to be applauded that the government finally decided to postpone the bid to revise its terms and conditions and to hopefully make it more competitively neutral. It should not set a price for the license but leave it to competition between the bidders just as was the case in the licenses to produce cement or licenses for the mobile.
The protection of a genuine competitive structure of the market eradicates barriers to entry for new investors. Genuine competition promotes economic efficiency, boosts innovation, and allows consumers to choose among different producers of goods and services. It also encourages businesses to improve the quality of goods and services they sell, and ultimately, benefits society to achieve better standards of living. Moreover, a greater participation of the private sector fosters employment and ultimately creates positive spillovers on the macro-economic performance of the country. Therefore, it is advisable for the terms of the potential bid to maintain a competitively neutral market conditions by enabling a process of genuine and undistorted competition that enables more investment via greater participation of market players that can freely invest in innovation that can lead to the development of health-friendly tobacco products in a way that contributes to achieve more economic efficiency and welfare on the tobacco market in Egypt.The protection of public health can be achieved by less restrictive means that encourages and pushes firm towards healthy and environmentally friendly products.A greater competition in the manufacturing of tobacco is key for greater investment in less harmful products and therefore positively contributes to reducing the costs of providing public healthcare services. Finally, among other less restrictive means, a condition can be imposed on the potential new entrant to grant FRAND license for new smoking healthy-friendly technologies to the incumbent to ensure greater competition in such a new vertical that will hopefully incentives smokers to consider less harmful alternative to traditional cigarettes.
At I&D our Trade & Competition Department holds unique experience in helping business to conduct a compliant and efficient business model by enabling them to consider the best available legal and economic tools that help their business to grow.
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