News and developments
On the legal and economic risks of Minority Shareholdings in Tobacco Industry
Egypt has announced that it will introduce competition to a sector that enjoyed in the past substantial isolation and benefited from wide protectionism policies. 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 (“EASTERN COMAPNY”).
The new license comes with certain conditions. Primarily, it allows Eastern Company 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.[1] There are two types of minority holdings: controlling and non-controlling minority holdings. Controlling minority shareholdings is where the minority shareholder has de-facto 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.
[1] Organization for Economic Co-operation and Development (OECD), December 2017, Background Note by the Secretariat, Common Ownership by Institutional Investors and its Impact on Competition, paragraph 9. [2] European Commission: Economic Literature on Non-Controlling Minority Shareholdings ("Structural links") (Brussels, 25.6.2013). [3] Treaty on the Functioning of the European Union (TFUE). [4] Joined Cases 142/85 and 156/84 British American Tobacco Company Limited and RJ Reynolds Industries Inc v European Commission, 1987 ECR 4487 (Philip Morris, paras 37-38). [5] The Egyptian Competition Authority - Press Release: http://www.eca.org.eg/ECA/Upload/News/Attachment_E/8285/Glovo’s%20exit%20from%20the%20Egyptian%20market.pdf
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 of fragmented ownership of the remaining shareholders.[2] 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:- There is a competitive relationship between the parties (either horizontal or vertical), and
- the competing party either
- has a shareholding of around 20 percent, or
- has a shareholding between 5-20 percent accompanied by additional factors, such as a seat on the board of directors.
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 hope is to break the monopoly of Eastern Company 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:- Eastern Company 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;
- The price of Newco’s products is higher than the selling price of the cigarettes produced by Eastern Company by at least 50 percent of the lowest product price of the Eastern Company.
- Production quota to be imposed on the Newco
- Eastern Company and Newco are both in a horizontal competitive relationship regarding the production and sale of cigarettes in the Egyptian market.
- Eastern Company is allowed to participate in 24% of Newco’s shares at a discount, and therefore effectively encouraging the creation of a “competitively significant link” with Newco
- Additionally, Newco is contractually bound to sell cigarettes at a higher price by at least 50 percent of the lowest product price of Eastern Company, which puts it in a clear disadvantage. This reduces the competitiveness of the offer and therefore the competitiveness of the license value to the government.
- 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 penetrate international markets.
Recommendations and Way Forward:
The Egyptian government step of opening the tobacco market to competition is ought to be celebrated. 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. 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.[1] Organization for Economic Co-operation and Development (OECD), December 2017, Background Note by the Secretariat, Common Ownership by Institutional Investors and its Impact on Competition, paragraph 9. [2] European Commission: Economic Literature on Non-Controlling Minority Shareholdings ("Structural links") (Brussels, 25.6.2013). [3] Treaty on the Functioning of the European Union (TFUE). [4] Joined Cases 142/85 and 156/84 British American Tobacco Company Limited and RJ Reynolds Industries Inc v European Commission, 1987 ECR 4487 (Philip Morris, paras 37-38). [5] The Egyptian Competition Authority - Press Release: http://www.eca.org.eg/ECA/Upload/News/Attachment_E/8285/Glovo’s%20exit%20from%20the%20Egyptian%20market.pdf