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Outsourcing and
competition law
Outsourcing can help to simplify businesses in an increasingly global work environment, yet
parties to outsourcing agreements must be aware that their arrangements can have a complex
relationship with competition rules. Adrian Magnus, Eran Tsafrir and Simon Albert investigate

and procurement services being taken

over by Exel were mainly provided to the
Department of Health by in-house armslength bodies, and had extremely limited
turnover from sales of such services to
third parties. However, it was possible to
attribute an open market value to these
in-house services, and this market value
exceeded the 70m turnover threshold for
UK merger control.

CAN AN OUTSOURCING TRANSACTION BE

subject to EU or UK merger control? Can
exclusivity provisions in an outsourcing
agreement infringe competition law?
Outsourcing arrangements can give rise
to competition issues, including merger
control, exchanges of information, and
the enforceability of exclusivity and
non-compete provisions. This article
considers these issues and provides
some practical tips.
MERGER CONTROL
Outsourcing arrangements may
constitute a merger that is subject to UK
or EU merger control. An example is the
Office of Fair Tradings (OFT) Exel Europe
Ltd/NHS Logistics Authority/NHS
Purchasing and Supply Agency decision
of July 2006. Exel Europe Ltd (Exel) is a
UK subsidiary of Deutsche Post AG,
whose core activities in the UK are
contract logistics (including warehousing
and distribution) and freight forwarding.
Exel was to take over the supply of
certain logistics and procurement
services for consumable products that
had been provided to the Department of
Health by the NHS Purchasing and
Supply Agency and NHS Logistics. This
included assets such as IT and office
equipment, contracts and the right to
use certain NHS intellectual property, as
well as up to 1,600 employees.
The OFT held that the transaction was
subject to UK merger control. The logistics

By Adrian Magnus,
partner, and Eran
Tsafrir and Simon
Albert, associates,
Berwin Leighton
Paisner LLP

46 The In-House Lawyer November 2007

EU merger control
A major outsourcing arrangement will be
subject to EU merger control if it involves
a concentration with a Community
dimension. Article 3 of the EC Merger
Regulation (No 139/2004) states that a
concentration includes the acquisition of
direct or indirect control of all or part of
an enterprise or undertaking. So, if an
outsourcing supplier in addition to
taking over a previously internal activity
acquires associated assets which
constitute a business with a market
presence, to which a market turnover can
be clearly attributed, the arrangement
will constitute a concentration
(Commission Consolidated Jurisdictional
Notice (the Notice)). However, there will
not be a concentration if no assets or
employees are transferred to the
supplier, or if that supplier acquires only a
right to direct the customers assets and
employees, which will be used exclusively
to service the customer. A concentration
may also arise where the outsourced

activity has been structured as a fullfunction joint venture on a lasting basis,

operating independently on the market,
that goes beyond one specific function
for its parents and does not rely on them
for its sales and purchases (see for
example, the European Commissions
decisions in IBM Italia/Business
Solutions/JV and EDS/Lufthansa).
The Commission also applied these
principles in its Flextronics/Nortel decision
of October 2004. This case concerned the
acquisition by Flextronics International Ltd
of some of Nortel Network Ltds
manufacturing assets, employees and
related supply-chain activities.
Flextronics is a provider of electronics
manufacturing services to original
equipment manufacturers in the
telecommunications, networking,
consumer electronics, computer and
medical device industries. Electronics
manufacturing services turn out various
types of electronic products on an
outsourced procurement basis. Nortel
Networks Ltd is a supplier of products and
services that support the internet and
other public and private data, voice and
multimedia communication networks. The
Commission decided that the transaction
implied the acquisition by Flextronics of
control of parts of Nortel and as such
amounted to a concentration.
In the Notice, the Commission
provides details of its approach to such
arrangements. The Notice states that

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for an outsourcing arrangement to

constitute a concentration, the assets
previously dedicated to the in-house
activities of the customer must enable
the supplier to provide services, not only
to the outsourcing customer, but also to
third parties. This may be either
immediately or within a short period
after the transfer (normally up to three
years, but depending on the specific
conditions of the market in question).
This will be the case if the transfer
relates to an internal business unit or a
subsidiary that already provides services
to third parties.
If third parties are not yet supplied,
the assets transferred should (in the case
of manufacturing) contain production
facilities, the product know-how and the
means for the purchaser to develop
market access within a short period (eg
including existing contracts or brands).
Where services are concerned, the
assets transferred should include the
required know-how (eg relevant
personnel and intellectual property) and
facilities that allow market access (eg
marketing facilities). To be a
concentration, the assets transferred
therefore have to include at least those
core elements that would allow a market
presence. Many transfers of in-house
facilities to an outsourced supplier will
not meet these criteria.
An outsourcing arrangement
constituting a concentration will only be
subject to EU merger control if it has a
Community dimension, ie if the turnover
of the relevant parties satisfies certain
turnover thresholds. Satisfying these
thresholds requires, in particular, that
the combined worldwide turnover of the
parties exceeds 2.5bn, each of them
has an EU turnover exceeding 100m
and they must not both achieve more
than two-thirds of their EU turnover in
one and the same EU member state. In
relation to outsourcing transactions,
turnover of the relevant parties means
the turnover in the preceding financial
year of the whole of the suppliers group
and the part of the customers business
that is being outsourced. Where EU
merger control applies, UK merger
control will usually not apply.
Turnover is usually calculated from
the most recent financial years audited
accounts. However, the Notice states

that, where an outsourcing transaction

involves a business unit which only had
internal revenues in the past:

UK merger control applies to outsourcing

transactions which cause two or more

the turnover should normally be

calculated on the basis of the
previously internal turnover or of
publicly quoted prices, where such
prices exist.

enterprises to cease to be distinct, if one

of two jurisdictional tests is satisfied.

Where this does not appear to

correspond to a market valuation or the
expected future turnover, the Notice adds:
the forecast revenues to be
received on the basis of an agreement
with the former parent may be a
suitable proxy.
Subject to limited exceptions, the
Commission has exclusive jurisdiction
over concentrations with a Community
dimension. Notification of such
transactions to the Commission is
mandatory and the parties cannot
complete the transaction before EU
merger clearance has been obtained.
According to the EC Merger
Regulation, the Commission will assess
whether the arrangement in question:
significantly impedes effective
competition, in the Common Market or
in a substantial part thereof, in
particular as a result of the creation or
strengthening of a dominant position.

issue. In that decision, the OFT concluded

that the transaction did involve
enterprises ceasing to be distinct.
The outcome was different in the
OFTs University College London
Hospitals NHS Foundation/HCA
International Ltd decision (October
2006). Here, the OFT held that the
relevant outsourcing transaction did not
involve enterprises ceasing to be
distinct, because:

At the time of writing, no outsourcing

transactions have been blocked under EU
merger control.
UK merger control
UK merger control applies to outsourcing
transactions that cause two or more
enterprises to cease to be distinct, if
one of the two jurisdictional tests
considered below is satisfied.
An enterprise as defined by the
Enterprise Act 2002 means the
activities or part of the activities of a
business; typically the assets and
records needed to carry on the business,
together with the benefit of existing
contracts and/or goodwill. The transfer
of customer records is likely to be
important in assessing whether an
enterprise has been transferred.
Exel illustrates the OFTs approach to the

The transaction concerned the

commercial leasing by University
College London Hospital Trust (UCLH)
to HCA International Limited (HCA) of
premises, which were vacant (except
for very limited outpatients visits), for
an initial period of five years for use
as a private patient unit.
HCA could access and use a linear
accelerator and MRI scanner for an
initial period of five years, but the
equipment was not in working order
and no title to this equipment was to
pass from UCLH to HCA.
UCLH had agreed to allow HCA to use
certain UCLH facilities (including two
bunkers and a scanner room) and
support services relating to the
operation and administration of a
private patient unit (eg pathology,
facilities management, IT and

IBM
Italia/Business
Solutions/JV
(Case
COMP/M2478)
[2001] OJ C278/3
EDS/Lufthansa
(Case IV/M560)
[1995]
Flextronics/Nortel
(Case
COMP/M3583)
Commission
Decision
2004/322/04
[2004] OJ C322/8
Hewlett
Packard/Synstar
(Case
COMP/M3555)
[2004] OJ C249/4 >

November 2007 The In-House Lawyer 47

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telecommunication services) for an

initial period of five years.

While UCLH was to second some

support staff to the private patient
unit, no employees would be
transferred to HCA. They would
remain employees of UCLH. No
medical staff would be transferred
to HCA.

No goodwill, customer details or

other business assets had been or
would be transferred to HCA.

Case C-234/89
Stergios Delimitis
v Henninger Bru
AG [1991]
ECR I-00935
Case C-214/99
Neste
Markkinointi Oy v
Ytuuli Ky and
others [2000] ECR
I-11121
BP Kemi/DDSF
(Case IV/29.021)
Commission
Decision
79/934/EEC
[1979] OJ L286/32
Esso Petroleum v
Harpers Garage
[1967] UKHL 1
Panayiotou (aka
George Michael) v
Sony Music [1994]
EMLR 229

No liabilities had been or would be

transferred.

There are two alternative

jurisdictional tests under UK merger
control. The first is a turnover test. This
is satisfied in relation to outsourcing
arrangements if the UK turnover of the
part of the customers business being
outsourced exceeds 70m. The second
is the share of supply test. This is
satisfied in relation to outsourcing
arrangements if, as a result of the
transaction, the supplier and the part of
the customers business that is being
outsourced together supply 25% or more
of all the goods or services of a
particular description supplied in the UK
(or in a substantial part of it). The share
of supply test is much less clear-cut
than the turnover test and narrow
descriptions of services can make it
fairly easy to satisfy.
Whether there is a substantive
merger control issue will depend on the
position of the parties in the relevant
product or service and geographic
markets. Subject to limited exceptions,
the OFT has a duty to refer mergers that
satisfy either of the above jurisdictional
tests to the Competition Commission
(CC) for further investigation where the
relevant merger has resulted (or may be
expected to result) in what the
Enterprise Act refers to as a substantial
lessening of competition within any
market(s) for goods or services in
the UK. The CC can block the merger,
clear it, or clear it subject to conditions,
eg divestment.
It is not compulsory to notify a
qualifying merger to the OFT, but it is
risky to complete a transaction that

48 The In-House Lawyer November 2007

qualifies for UK merger control without

obtaining merger clearance from the
OFT. The buyer could be forced to sell all
or part of the business acquired. The
authorities may also impose severe
restrictions on the buyers ability to deal
with the acquired business while a
competition investigation is carried out.
For an outsourcing transaction, this
could prevent the transfer of the
relevant people and assets to the
supplier and frustrate both parties
commercial objectives, by preventing the
supplier from performing its obligations
to the customer.
Merger decisions in outsourcing
cases to date have not required the
authorities to reach a conclusive view on
the relevant market, as the transactions
investigated did not give rise to
competition concerns, regardless of the
way the relevant market was defined.
See, for example, the OFTs decisions
in Exel, Vertex/Marlborough Sterling
and Northgate/Systems Solutions. This
may change over time if relevant
markets become more concentrated.
However, several of these merger
decisions concern (and include useful
guidance on) market definition in IT
service markets, a major outsourcing
market. See, for example, the
Commissions decisions in Hewlett
Packard/Synstar and IBM Italia/Business
Solutions/JV.
PROHIBITED ANTI-COMPETITIVE
AGREEMENTS
Article 81(1) of the EC Treaty and
Chapter 1 of the Competition Act 1998
prohibit agreements that have the object
or effect of preventing, restricting or
distorting competition and which may
affect trade between EU member states
or within the UK, respectively (the socalled Prohibitions). Breaches of those
Prohibitions are punishable with heavy
fines (up to 10% of turnover). Infringing
agreements are unenforceable and the
parties to them may be sued for
damages. Under the Enterprise Act,
individuals who are involved in a breach
of competition law may be disqualified
as directors for up to 15 years and, in the
case of serious infringements (involving
price fixing, market sharing and bidrigging) may be subject to unlimited fines
and up to five years imprisonment.

EXCLUSIVITY AND
NON-COMPETE CLAUSES
Outsourcing arrangements commonly
contain exclusivity and non-compete
provisions. These may restrict
competition and must therefore be
considered in the light of the Prohibitions.
The competition law analysis of such
provisions depends on whether the
transaction is a concentration for
competition law purposes (see above).
Ancillary restraints
Obligations that are directly related and
necessary to the implementation of a
concentration (or ancillary restraints)
are deemed not to fall within the scope
of the Prohibitions. They will be
automatically covered by any
Commission merger clearance decision
authorising a transaction. It is up to the
parties to assess whether a restriction is
directly related and necessary.
The Commissions Notice on
restrictions directly related and
necessary to concentrations, from which
the above definitions are taken, sets out
the Commissions practice in relation to
ancillary restraints. The OFTs approach,
as outlined in its Mergers: Substantive
Assessment Guide, follows the
Commissions Notice on restrictions
(whether or not the merger is notified to
the OFT).
Covenants by the vendor not to
compete with the business being sold or
transferred are generally permissible,
provided they are limited both in scope
(as to the product and geographic area
covered) and in duration. In an
outsourcing transaction, these would
prevent the customer from resuming
in-house provision of the services.
The Notice on restrictions states
that when the transfer includes both
goodwill and know-how, a vendor noncompete covenant for up to three years
is permissible. When only goodwill is
included (ie no know-how is transferred),
a vendor non-compete covenant can
only be justified for up to two years. If
the transfer is limited to physical assets
(eg land, buildings or machinery) or to
exclusive intellectual property rights, a
vendor non-compete covenant will not
be permissible as an ancillary restraint.
Purchase or supply obligations (and
service agreements) between vendor and

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purchaser which are aimed at

guaranteeing the quantities previously
supplied can be justified for up to five
years. Obligations providing for fixed
quantities, possibly with a variation
clause, are permissible as ancillary
restraints, but obligations providing for
unlimited quantities, exclusivity or
conferring preferred-supplier or preferredpurchase status are not treated as
ancillary restraints. They therefore have
to be considered separately (see below).
Arrangements that are not
concentrations and contain exclusivity or
non-compete provisions may infringe the
Prohibitions, which, as mentioned above,
will affect the enforceability of the
arrangements and have other potentially
serious consequences. It is therefore
necessary to consider whether those
agreements have an appreciable effect
on competition and/or are exempted
from the Prohibitions.
Agreements of minor importance
Arrangements are only prohibited under
competition law if they have an
appreciable impact on competition. The
Commissions Notice on agreements of
minor importance (the de minimis Notice)
provides that agreements will generally
not appreciably restrict competition if:

the parties aggregate market share

on any relevant affected market does
not exceed 10% in the case of actual
or potential competitors, or 15% in the
case of non-competitors; and
the agreement does not contain any
hard-core restrictions (eg price-fixing
or market-sharing arrangements, or
those allocating markets or
customers). In determining whether
an agreement has an appreciable
effect on competition, the OFT will
refer to the Commissions approach,
set out in the de minimis Notice.

Many outsourcing arrangements will

therefore be treated as of minor
importance for competition law
purposes and therefore do not infringe
the Prohibitions. However, market
definition is crucial to this. A supplier
operating in a narrowly defined service
market may have a market share of more
than 15%. Exclusive agreements

between that supplier and its customers

may therefore have an appreciable
effect on competition and require further
competition law analysis to determine
whether, for example, exclusivity
provisions are enforceable.
Arrangements that are not covered
by the de minimis Notice, but contain
restrictions on competition, may still be
exempted from the Prohibitions by virtue
of an individual or block exemption.

Where the parties market shares are

too high for the de minimis Notice to
apply, an exclusivity obligation lasting
over five years may be prohibited under
Article 81(1) of the EC Treaty.

Individual exemptions
To benefit from an individual exemption,
an arrangement must satisfy several
conditions, set out in Article 81(3) of the
EC Treaty, designed to ensure that the
economic benefits provided by the
arrangement outweigh its negative
effects on competition. These require
that the agreement in question:

contributes to improving production

or distribution, or to promoting
technical or economic progress, while
allowing consumers a fair share of
the resulting benefit; and
does not impose restrictions that are
not indispensable to the attainment
of those objectives, or give the
parties the possibility of eliminating
competition in respect of a
substantial part of the products or
services in question.

Block exemptions
Where an arrangement is covered by a
block exemption, these conditions are
presumed to be met. An outsourcing
agreement will fall within the scope of
the Commissions Vertical Agreements
Block Exemption (VABE) where the
suppliers share of the relevant market
does not exceed 30% and the
arrangement does not contain certain
specified hard-core restrictions. The
VABE does not normally apply to
vertical agreements between
competitors, but can apply where the
buyer does not provide services
competing with those it purchases from
the supplier for example because the
buyer has outsourced all those services
to the supplier.
For the purposes of the VABE, a noncompete obligation in an outsourcing
arrangement means any obligation on the

customer not to compete with the

contract services, or any obligation on the
customer to purchase from the supplier
more than 80% of the customers total
purchases of the contract services (or
substitutes for them). An obligation on the
customer to buy specified services only
from the supplier ie an exclusive
purchasing obligation will therefore be a
non-compete provision. Such a noncompete provision will only benefit from
the VABE if its duration does not exceed
five years. An indefinite obligation - such
as one which will automatically be
renewed after five years will not benefit
from the VABE. The VABE is due to expire
on 31 May 2010.
Where the parties market shares
are too high for the de minimis Notice
to apply, an exclusivity obligation
lasting over five years may be
prohibited under Article 81(1). EU case
law shows that if the duration is
manifestly excessive in relation to the
average duration of contracts
concluded in the relevant market, the
Article 81(1) prohibition will apply (see
for instance Stergios Delimitis v
Henninger Bru AG, Neste Markkinointi
Oy v Ytuuli Ky and others, and BP
Kemi/DDSF). Within the UK the common
law principle of restraint of trade may
also apply, for instance where the
duration and/or geographic scope of a
restriction goes further than necessary

November 2007 The In-House Lawyer 49

>

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to protect the legitimate interests of

the parties and/or where the restriction
is contrary to the public interest. See
for example Esso Petroleum v Harpers
Garage and Panayiotou (aka George
Michael) v Sony Music.
Where the outsourced supplier needs
to use the customers technology or
equipment to provide services to that
customer, certain provisions in the
agreement may benefit from the
Commission Notice of 18 December 1978
concerning its assessment of certain
subcontracting agreements. This applies
where a contractor (customer) entrusts
a sub-contractor (supplier) with the
supply of services, manufacture of
goods, or performance of work under the
contractors instructions, to be provided
to the contractor.
The 1978 Notice states that the
Prohibitions do not apply to clauses
whereby technology or equipment
provided by the contractor may not be
used except for the purposes of the
subcontracting agreement, or may not be
made available to third parties, or whereby
services resulting from the use of that
equipment or technology may be supplied
only to the contractor. In each case, this
applies only where the technology or
equipment is necessary to enable the
sub-contractor to supply the services,
not when the sub-contractor already has
them at its disposal, or could obtain
access to them under reasonable
conditions. However, many outsourced
suppliers will be selected precisely
because of their technology or equipment.
Exclusive purchasing and/or supply
obligations can be valid for more than
five years under the Commissions
Specialisation Block Exemption, which is
due to expire at the end of 2010. In an
outsourcing context, this can apply to
unilateral specialisation agreements,
when two competitors agree that one
will stop producing (or not produce)
certain products or services and will buy
them from the other. It can also apply to
reciprocal specialisation agreements,
when two competitors agree that each
will stop producing (or not produce)
different products or services and will
buy them from one another. In each
case, the block exemption applies only if
the parties combined market share does
not exceed 20% and the arrangement

50 The In-House Lawyer November 2007

COMPETITION ISSUES IN OUTSOURCING: PRACTICAL TIPS

Consider the structure of the arrangement and whether it would constitute a

concentration or merger.

Consider the potential application of merger control as early as possible.

Carefully consider the allocation of regulatory risks, including whether the

transaction is to be conditional on merger clearance.

If merger control is relevant, allow time to resolve jurisdictional issues, gather

market information and for pre-notification contacts with the competition
authorities.

Check the legitimacy of the relevant transaction under competition law before
any information exchange takes place relating to it, especially when outsourcing
to a competitor.

Agreements by the customer not to compete with a business transferred to the

supplier are justifiable for up to three years if know-how is transferred, or two
years if goodwill alone is transferred, if the transfer amounts to a concentration.

Exclusive purchasing obligations on the customer may benefit from the Vertical
Agreements Block Exemption where they do not last for more than five years
and the suppliers market share is not over 30%.

Exclusive purchasing and supply obligations may be imposed for more than
five years under the Specialisation Block Exemption if the parties combined
market share is not over 20%. If market shares are higher than 20% and the
duration is excessive compared with the market average, exclusivity may infringe
competition law.

Outsourcing arrangements may be of minor importance for competition law

purposes if the parties market shares are low enough and no hard-core
restrictions are included.

Information exchanged between competitors should be kept to the minimum

required to negotiate, conclude or give effect to the relevant transaction, with
appropriate information barriers established to restrict information to those who
need to know it for those purposes.

Where information has to be exchanged to enable a successor supplier to take

over from an incumbent supplier, ensure this happens via the customer (or with
the customers express knowledge and consent) and that the exchange of
information is confined to what is necessary to serve that customer.

does not contain any hard-core

restrictions on competition.
Where an outsourcing arrangement
involves one competitor outsourcing to
another, the Commissions Notice on
horizontal co-operation agreements
(the HCA Notice) may well be relevant,
provided that the arrangement may
generate efficiency gains which
adequately benefit consumers.

Outsourcing the production of goods or

services is considered in detail in the
HCA Notice, for instance as unilateral
specialisation agreements (where one
party agrees to purchase the relevant
products from the other, while the other
party is obliged to produce and supply
those products).
The HCA Notice allows the parties to
an outsourced production agreement to

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agree on the output directly concerned

by the production agreement (such as
the agreed amount of outsourced
products) despite the normal prohibition
on agreements which limit output or
share markets or customer groups. The
HCA Notice states that where the
outsourced element represents only a
small proportion of the parties total
costs, or only a small proportion of the
costs of the final product, it is unlikely to
lead to co-ordination of their competitive
behaviour or to infringe the Prohibitions,
although the position of the parties in the
markets concerned is still an important
issue. Market concentration and market
shares are also relevant factors.
INFORMATION EXCHANGE
Competition law requires businesses to
act independently and not to co-ordinate
their behaviour with their competitors.
Exchanges of information between
actual or potential competitors may
therefore breach the Prohibitions
where the object or effect of the
information exchange is to influence
competitors competitive conduct, or to

disclose a competitors plans or

intentions, thereby making that market
artificially transparent.
This will be particularly relevant where
a customer outsources services to a
competitor, or on a transfer of outsourced
services from one supplier to a competing
successor supplier. In the former case,
the customer and its prospective supplier
or suppliers will be discussing many
details of the customers business,
including its required services, service
levels and costs, which would not normally
be disclosed by one competitor to
another. In the latter case, negotiations
leading to the transfer of services from
the incumbent supplier to the successor
supplier (who are likely to be competitors),
will involve a degree of information
exchange (perhaps via the customer)
concerning the outsourced business.
It is not always easy to distinguish
legitimate exchanges of information from
prohibited ones. The analysis should be
carried out on a case-by-case basis,
taking into account the nature and type
of the information exchanged, the level
and aggregation of the information, the

period to which the information relates

and the structural characteristics of the
market on which the exchange takes
place. In the context of outsourcing,
various tips are set out in the box
opposite. In general, however:

commercially sensitive information

that may influence the competitive
conduct of actual or potential
competitors (such as information
regarding pricing policies, investment
plans or capacity), or that discloses a
competitors unpublished competitive
intentions, should not be exchanged;
and

information that is historical,

anonymous, aggregated,
independently compiled and publicly
available may be exchanged.

By Adrian Magnus, partner, and

Eran Tsafrir and Simon Albert,
associates, Berwin Leighton Paisner LLP.
E-mail: adrian.magnus@blplaw.com,
eran.tsafrir@blplaw.com,
simon.albert@blplaw.com.

November 2007 The In-House Lawyer 51