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Cambridge Business Expansion Fund Ltd/Standard Subscription Agreement with Investee Companies [1995] IECA 404 (22nd June, 1995)
Competition
Authority Decision no. 404 of 22 June, 1995 relating to a proceeding under
Section 4 of the Competition Act, 1991.
Notification
No. CA/1108/92E - Cambridge Business Expansion Fund Ltd/Standard Subscription
Agreement with Investee Companies
Decision
No: 404
Introduction
1. Notification
was made by Cambridge Business Expansion Fund Ltd (Cambridge) on 30 September
1992 with a request for a certificate under
Section 4(4) of the
Competition
Act, 1991 or, in the event of a refusal by the Competition Authority to grant a
certificate, a licence under
Section 4(2) in respect of the standard share
subscription agreement used by Cambridge for investments in qualifying
companies under the BES scheme.
(a) The
Subject of the Notification
2. The
notification concerns the standard share subscription agreement used by
Cambridge as manager of a designated investment fund, for the subscription by
the fund for new ordinary shares in companies qualifying under the BES scheme.
(b)
The
Parties Involved
3. The
parties to the standard agreement are as follows:
(i) The investee company i.e., an unquoted company engaged in qualifying
trades as defined in the BES scheme. The names of 5 separate investee companies
were supplied.
(ii) The existing shareholders in the investee company who are covenantors
under the agreement.
(iii) Cambridge Business Expansion Fund Ltd was part of the Cambridge Group
plc and was manager of a number of designated investment Funds. Cambridge
Corporate Finance Ltd, another company within the Cambridge Group which
provided corporate finance services, was also a party to the standard
agreement. The Cambridge Group was engaged in corporate finance, leasing and
fund management. A Receiver was appointed over the Group and a number of its
subsidiary companies in 1993.
(c) Designated
Investment Funds
4. Under
the BES scheme (Relief for Investments in Corporate Trades as introduced in the
1984 Finance Act with subsequent amendments) taxpayers may obtain tax relief in
respect of subscription for shares in companies engaged in qualifying trades.
The shares must represent new issued ordinary shares in an unquoted company and
must be held for a minimum period of 5 years. Similar tax relief is also given
where the subscription is made to a designated investment fund (designated by
the Revenue Commissioners) where the monies subscribed are invested on the
taxpayer's behalf in qualifying companies. The
Designated Investment Funds Act
1985 declares that a designated investment fund is not a unit trust and
requires that a prospectus should be prepared in respect of each such fund
which must be first approved by the Minister for Enterprise and Employment.
Approval may not be given unless the Minister is satisfied that satisfactory
statements on a number of specified issues are included in the prospectus
including details of the manager and of the separate trustee, that the holder
of any shares issued to the Fund will be registered as nominee for a particular
participant and particulars of the arrangements for transfer of the shares into
the participants name after 5 years. In practice each designated investment
fund is governed by a trust deed which provides for the holding of the monies
subscribed by a trustee, in whose name shares purchased by the Fund are
initially registered as nominee for each particular subscriber, and the
management of the fund by a
manager,
who has responsibility for selecting the investee companies and safeguarding
the subscribers interests in these companies. There are generally provisions in
the trust deed for disposal of the shares after 5 years by the trustee/manager
either by way of sale (with each subscriber getting his share of the proceeds)
or transfer into the subscriber's name. Mechanisms may be included to
facilitate the sale or redemption of the shares including Put and Call options
whereby the original shareholders of the investee companies after a period of 5
years could be required to purchase the Fund's shares. If however the shares in
an investee company cannot be satisfactorily disposed of, there are provisions
for their transfer some time after, into the subscribers name and the trust
ends. Unlike an UCIT or investment company, the individual subscriber does not
hold units in the Fund but holds the beneficial interest in his proportion of
the shares acquired through the fund
.
(d) The
Notified Arrangements
5.
(i)
The
notified standard agreement is made to provide for the conditions under which
the manager of the designated investment fund agrees to procure subscription by
the fund for shares in the investee company. It provides for the completion
arrangements for the subscription, subject to a number of conditions and
warranties by the covenantors. Prior to the investment the company will enter
into a trust agreement as required by Section 6(1) of the Designated Funds Act
1985 to register the shares in the name of the subscriber to the fund. The
company undertakes to maintain its BES status. The company and covenantors
covenant to operate the business efficiently and keep the manager fully
informed of company progress by way of regular financial and other reports. The
agreement lists a number of restricted transactions which the company may not
effect without the prior written consent of the manager. These include disposal
of a substantial part of the business or a substantial change in its nature,
the issue of loans by the company, its entry into onerous contracts, the issue
of new shares, the exceeding of borrowing or capital expenditure limits and the
payment of dividends.
(ii)
The
agreement also provides that no change will be made in the company Articles.
The manager is entitled to nominate director(s). Cambridge Corporate Finance
Ltd is appointed as corporate development consultant to the company for 5 years
and for a consideration is given an option to subscribe for shares in the
company. The Manager agrees to use reasonable endeavours to procure additional
investment in the company. If any covenantor disposes of shares other than to
another party to the agreement he will first procure that the transferee will
also covenant to comply with the covenants in the agreement.
(iii)
Clause
7(9) of the standard agreement contains the following shareholder covenants viz.
"(a) Each of the Covenantors undertakes to the Manager that:-
(i) for the period of three years from Completion he will not either on
his own behalf or in conjunction with or on behalf of any person, firm or
company carry on or be engaged concerned or interested in carrying on any
business in competition with all or any of the businesses now carried on by the
Company or any other member of the Group to which all or any such businesses
may be transferred subsequent to Completion or which may with the Manager's
consent commence to carry on all or any such businesses subsequent to
Completion (other than as a holder of shares or debentures listed on The Stock
Exchange or dealt in on the Unlisted Securities Market) within the Republic of
Ireland;
(ii) for the period of three years from Completion each Covenantor will
not either on his own account or in conjunction with or on behalf of any other
person, firm or company solicit or entice away from any member of the Group any
officer, manager or servant whether or not such person would commit a breach of
his contract or employment by reason of leaving service;
(iii) each Covenantor shall procure that no company owned or controlled
by such Covenantor or any one or more of them (and insofar as such Covenantor
is able to ensure the same no subsidiary or associated company owned or
controlled by him) shall act in such a way as would be a contravention of the
obligations contained in this paragraph if such Covenantor were himself to so
act."
(e) Submission
of the Parties
6. In
its submission Cambridge stated as follows:-
"BES
enables small companies, which are generally involved in developing new
technology or creating and exploiting new markets, to have access to funds
which are necessary to enable them to develop and grow. BES investment
strengthens and enhances therefore the ability of such companies to compete in
their respective markets. As none of the companies are in a position of
dominance in markets or enjoy particularly large market shares, BES does not
have the effect of copper-fastening an existing dominant position.
BES
was initiated by Government to enable companies in the early stages of their
development to obtain capital by way of equity investment. Such companies
typically find it difficult to raise capital, either from equity investors or
through borrowing, in order to facilitate growth given the absence of an
established financial track record. BES also enables individuals to obtain tax
relief on equity investments made by them into qualifying companies once the
statutory criteria are satisfied.
Funds
such as those managed by the Applicant provide prospective investors with
access to a fund manager with extensive experience in venture capital, who
provides the necessary connection between companies seeking investment by way
of BES funding and prospective investors.
As
indicated above, the restrictions which are the subject matter of this
notification are the minimum protection which any prudent investor would
require in order to safeguard its investment, an investment which would in most
cases not be made without such restrictions, as the companies in which
investments are made tend to be controlled and run by a very small number of
key individuals whose continuing involvement with the company is crucial for
its development. Investment is generally made by the Applicant in investee
companies at a valuation which assumes that certain future growth projections
are achieved. Because of the early stage of the development of these investee
companies and the key roles played by the promoters in the affairs of these
companies, achievement of these future growth projections is often dependent on
the continued involvement of these parties in the day to day operation of the
investee company.
In
summary therefore, both BES and the notified restrictions which are imposed as
a part of the arrangements whereby the investments are effected, stimulate
investment in small developing companies in the State. The investments enable
those companies to grow thus enhancing their ability to compete in their
respective markets. The consequent effect of the arrangements is thus
pro-competitive. It is therefore submitted that the arrangements are not
prohibited and void by virtue of Section 4 of the Act."
Arguments
were also presented as to why a licence should be granted but these are not
reproduced in this decision.
Assessment
(a) Section
4(1)
7.
Section
4(1) of the
Competition Act 1991 prohibits and renders void all agreements
between undertakings, decisions by associations of undertakings and concerted
practices which have as their object or effect the prevention, restriction or
distortion of competition in trade in any goods or services in the State, or in
any part of the State.
(b) The
Undertakings
8.
Section
3(1) of the
Competition Act defines an undertaking as "a person being an
individual, a body corporate or an unincorporated body of persons engaged for
gain in the production, supply or distribution of goods or the provision of a
service". Cambridge was engaged in the management of funds for gain and was
therefore an undertaking. Cambridge Corporate Finance Ltd was engaged in the
provision of corporate finance services for gain and was also an undertaking.
The investee companies are engaged in qualified trades as defined under the BES
scheme and are also undertakings. The covenantors are generally the owners of
the investee companies and as such are regarded as undertakings. The notified
agreement is an agreement between undertakings. The agreement has effect
within the State.
(b) Applicability
of Section 4(1)
9. The
Subscription Agreement constitutes an agreement whereby a designated investment
fund managed by Cambridge agrees to make an investment to obtain an equity
shareholding in the investee company. This, in effect, involves an investment
by a large number of personal investors for a combined stake, generally a
minority stake, in the investee company. Such an agreement is not,
per
se
,
anti-competitive and does not offend against
Section 4(1) of the
Competition
Act.
10. The
agreement contains continuing contractual commitments arising from the
agreement including the warranties given by the original shareholders to the
new investors and the option given to Cambridge to purchase new shares. These
do not raise issues under the
Competition Act. The agreement also provides for
a number of obligations on each of the parties which will govern how the
companies will be managed including the information requirements to keep
Cambridge as manager of the Fund informed of the companies' progress. These
are matters internal to the management of the companies which are designed to
protect the minority shareholding position of the new investors and also do not
raise issues under the
Competition Act.
11. The
agreement also contains a list of restricted transactions which the company may
not undertake without the prior written consent of Cambridge. These include
such actions as a change in the nature of the business carried on, the
acquisition or disposal of shares, entering into onerous contracts, capital
expenditure above specified limits, disposal of substantial assets and
excessive borrowing. Cambridge was engaged in the management of a form of a
venture capital fund, albeit a tax driven designated investment fund, and was
acting on behalf of many personal BES investors who hold the beneficial
interest in the Fund's shares in the companies. Cambridge was engaged as Fund
manager and had a duty to safeguard the interests of the BES subscribers for
whom the shares in the investee companies are held in trust. With no particular
expertise in the business concerned, Cambridge was dependent on the majority
shareholders for the day to day management and supervision of the businesses.
As indicated in their decision on Cambridge - ACT/Imari1 the Authority takes
the view that providers of venture or development capital are entitled to take
steps to protect their investment. The restrictions on transactions imposed on
the operation of the investee companies are designed to protect that investment
by ensuring that the assets of the company are not substantially (or even
artificially) diluted without their knowledge. They may be regarded as prudent
protection of the non-active shareholder interest and no more than is necessary
to achieve the object of protecting the investment. In any event the
restrictions are more related to the internal running of the company rather
than its trading activities. The Authority does not therefore regard these
restrictions as offending against
Section 4(1) of the
Competition Act.
12. Clause
7(9)(a) of the standard agreement imposes non-compete restrictions on the
covenantors, who are the existing shareholders in the investee company, from
engaging in a business which would be in competition with the business carried
on by their companies. This restriction applies within the State for a period
of 3 years from completion of subscription for shares. There is also a similar
non-solicit clause, for 3 years from completion, under which a covenantor may
not solicit or entice away employees of the company.
13. In
its decision on Cambridge-ACT/Imari, the Authority indicated that, in general,
a restriction on parties in a business competing with it for so long as they
remain part of the business, does not offend against
Section 4(1). Insofar as
the non compete restrictions apply to the period when the covenantors
effectively remain as shareholders in the company these provisions do not
offend against
Section 4(1) of the
Competition Act.
14. The
non-compete and non-solicit restrictions apply for a period of 3 years from
completion. Taking into account the particular nature of the BES investment
involved, the Authority considers that where the duration of the non-compete or
non-solicit clause equates with or is less than the estimated duration of the
Fund's subscription to the company, this does not offend against
Section 4(1).
Considering the particular vulnerability of the small investor's position as a
minority shareholder in an unquoted company, the Authority accepts that
safeguards are necessary to ensure the continuing commitment of the original
owner to his business for the period of a temporary investment and to prevent
him competing directly with it to the detriment of the minority investor.
Without safeguards over this period it is unlikely that the BES investment
would proceed. In this instance the non-compete and non-solicit restrictions
apply for a period of only 3 years from the date of completion of the
subscription and accordingly this clause does not offend against
Section 4(1).
The
Decision
15. In
the Authority's opinion, the investee companies, the covenantors in the
investee companies and Cambridge Business Expansion Fund Ltd and Cambridge
Corporate Finance Ltd were undertakings within the meaning of the
Section 3(1)
of the
Competition Act, 1991 and the notified standard subscription agreement
is an agreement between undertakings. In the Authority's opinion, the notified
standard agreement does not offend against
Section 4(1) of the
Competition Act,
1991.
The
Certificate
16. The
Competition Authority has issued the following certificate.
The
Competition Authority certifies, that in its opinion, on the basis of the facts
in its possession, the standard subscription agreement between Cambridge
Business Expansion Fund Ltd, Cambridge Corporate Finance Ltd , the investee
company and its shareholders, as covenantors, notified under
Section 7(2) on 30
September 1992 (notification no. CA /1108/92E) does not offend against
Section
4(1) of the
Competition Act, 1991.
For
the Competition Authority
Des
Wall
Member
22
June 1995.
Notes
1.Decision
No. 24, 21 June 1993
© 1995 Irish Competition Authority
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