Non-compete agreements are common features in many contracts that can help incentivize one party to enter an agreement that is, overall, beneficial to consumers. For instance, one baker in a town might want to exit the business by selling her productive assets to a competitor who can more effectively use them. The selling baker might be willing to promise not to re-enter the business in that town for a reasonable period of time. In such situations, the agreement should pass muster under the competition laws because the more effective use of the assets is a bigger benefit to consumers than any loss from the agreement not to compete.

Two recent actions on both sides of the Atlantic, however, make clear that such agreements must be carefully crafted and related to actions that are otherwise good for consumers. If not, heavy fines and other costly penalties are possible under the competition laws of the U.S., EU and individual states and countries.

The FTC Action

The Federal Trade Commission (FTC) recently challenged a non-compete agreement between two once-competing bleach producers. Bulk bleach is primarily used in water treatment plants to disinfect water. One producer (Oltrin) agreed to pay the other (JCI) $5.5 million over four years in exchange for JCI's list of North Carolina bleach customers and an agreement that JCI would not sell bulk bleach in North Carolina or South Carolina for six years.

The consent agreement entered into by the FTC and the bleach producers requires Oltrin to "release JCI from all provisions of the [agreement between the parties] that prevent JCI from competing in the sale of bleach to customers." Oltrin also must assign some of its bleach contracts to JCI, manufacture and deliver bleach to JCI for up to six months, and forward all solicitation bids it receives to JCI, among other obligations. For its part, JCI is required to re-open its plant in Charlotte, North Carolina, which it closed in the wake of the agreement with Oltrin. Finally, Oltrin must pay for an Interim Monitor — selected by the FTC — who will ensure compliance with the consent agreement.

The EC Action

In Europe, the European Commission fined two telecommunications firms a combined €79 million ($107 million) for agreeing not to compete with each other in their respective home geographical markets, in violation of Article 101. The two firms, Telefónica and Portugal Telecom, had jointly owned a Brazilian mobile operator, Vivo. When Telefónica bought Portugal Telecom's stake for complete control of Vivo, Telefónica and Portugal Telecom inserted a clause in the agreement by which they agreed not to compete with each other in Spain and Portugal. This agreement was to last about fifteen months but was suspended four months later when the firms were notified that the Commission had opened an investigation. While the Commission did consider the short duration a mitigating factor in setting the fine, it still saw such non-compete agreements as "one of the most serious violations of EU competition rules" because of their negative effect on competition and the creation of a single market in important industries like telecommunications.

After the EC imposed the fines, Telefónica immediately emphasized its intention to appeal the fine before the European Court of Justice, claiming that the non-compete "was never applied." Furthermore, Telefónica pointed out that the agreement was immediately made public, evidencing the parties' lack of intent to violate competition laws. Portugal Telecom, in announcing that it too was considering bringing an action before the Court of Justice, similarly clarified that the agreement was not intended to and did not actually restrict competition.

Lessons Learned

Non-compete agreements, by definition, reduce competition between the contracting parties; therefore, the parties must be able to articulate how that reduction in competition is necessary to generate some other, greater benefit to consumers. Based on the publicly-available facts, it is unclear in both cases how the parties could articulate such a countervailing benefit to competition. In the bleach case, the payments seem designed to do no more than pay one competitor to leave the market and promise not to return. In the telecommunications case, it is unclear how a non-compete provision regarding Spain and Portugal was related to the sale of an interest in a mobile operator in Brazil.

Also, in both cases, the companies involved were two large competitors in industries with high barriers to entry and few other competitors. Under such conditions, the need is even greater for a convincing explanation for why the non-compete clause is necessary to achieve some effect beneficial to consumers. As both cases show, the inability to provide such an explanation can be very costly.

Non-compete provisions are common elements of many agreements and often pose no competition law issues; however, parties to such agreements must tailor them narrowly and be able to articulate why they are necessary to achieve an overall increase in competition.

(Tal Chaiken, an associate in our Chicago office, contributed to this report.)