Importance of contractual control in merger review

Overview
When franchising agreements confer control
Consequences for practitioners
Comment

This article discusses a recent Administrative Council for Economic Defence (CADE) decision on the definition of 'de facto control' for the purposes of Brazilian competition law and its consequences for practitioners.

Overview

In most jurisdictions, the definition of 'control' plays a decisive role in determining whether a transaction is subject to mandatory review and which companies are relevant for the competitive assessment of a deal. Brazil is no exception.

According to Brazilian competition law and regulations, a transaction is reportable only if (among other criteria):

• one economic group has a turnover or volume of business that exceeds R750 million in the last fiscal year before the transaction; and
• another economic group has a turnover or volume of business in Brazil that exceeds R75 million in the last fiscal year before the transaction.

However, the definition of 'economic group' is not always clear.

In a recent decision (Gavea/Chilli Beans), CADE consolidated the understanding that the concept of economic group includes not only companies in which the parties and their group own a controlling shareholding or a relevant minority interest (equal to or above 20% of the total or voting stock), but also all entities that are de facto controlled by the group – even if no stock is held in said entities.

While this decision does not materially change CADE's decisional practice, it highlights the uncertainty that practitioners face on a daily basis: there is no statutory definition of what constitutes 'control' under Brazilian competition law (least of all external control) and no guidelines on the topic other than those addressed in CADE's decisional practice.

When franchising agreements confer control

Franchising agreements do not typically confer control over the franchisee; however, exceptions exist. In Brazil, CADE recently indicated that some types of franchising structure may create de facto economic dependence between the franchisee and the franchisor.

In Gavea/Chilli Beans, CADE indicated that the business format franchising model in question granted the franchisor decisive influence (control) over how the franchisee managed and conducted its business, which could have led the market to believe that all franchisees operated as a single economic entity. CADE further determined that Chilli Beans' franchisees could not influence the way in which their products were sold; instead, franchisees had to abide by the commercial guidelines established by the franchisor.

According to CADE, this type of arrangement would give the franchisor contractual control over all franchisees, even if they had full autonomy on other matters, such as investment decisions and costs and expenses (eg, the acquisition of inputs, the hiring of personnel and rent).

Consequences for practitioners

The decision confirms CADE's decisional practice,(1) which provides that control may exist even when there are no structural links and no capital holdings between two companies.

In particular, it lists certain criteria that practitioners should consider when assessing whether contractual arrangements (eg, distribution models) that involve some level of influence of one company over another create control between them – namely:

• the level of integration between the companies' activities resulting from the agreement (ie, whether the agreement creates economic dependence between the parties);
• the freedom of the parties to determine their own commercial policies and strategy (eg, to set their prices);
• whether the parties present themselves as a single economic enterprise to the market (eg, by using the same brand); and
• whether the members of the network created by the agreements (if any) compete.

Comment

As described above, CADE has established in its decisional practice certain criteria that companies should consider when determining whether their contractual relationships with close partners (eg, franchisees and distributors) may confer de facto control. In short, the higher the level of such partners' independence, the lower the chances that the authority will consider them to be part of the same group.

However, the criteria above are somewhat unclear and do not allow companies to assess, with sufficient certainty, whether an agreement creates de facto control. Moreover, there is limited case law on the topic, which do not establish general standards on how to determine the meaning of 'de facto control' under Brazilian competition law.

CADE has already taken a positive step in listing the criteria that it considered when defining de facto control in recent decisions. A welcome next step would be to consolidate the standards used in concrete cases in order to prepare clear guidelines and a more general framework that could reduce uncertainty for companies seeking to do business in Brazil.

For further information on this topic please contact José Inácio Ferraz De Alemeida Prado Filho or Guilherme Morgulis at Barbosa, Müssnich & Aragão Advogados by telephone (+55 11 2179 4600) or email (jip@bmalaw.com.br or ghf@bmalaw.com.br). The Barbosa, Müssnich & Aragão Advogados website can be accessed at www.bmalaw.com.br.

Endnotes