3 February 2011
This article first appeared in a slightly different form in Construction News, 3 February 2011.
Competition law compliance is important for all construction firms, large and small. Serious infringements of competition law can result in heavy fines – even for the smallest firms, as a series of competition cases in the UK construction sector demonstrates. In addition, third parties who have suffered loss as a result of competition law infringements can sue the infringer for damages. Further, agreements that breach competition law are unenforceable.
Competition law compliance is also important for all directors and staff. They face personal liability for serious infringements of competition law.
Essential regulation for construction firms
Key legislation and guidelines are as follows:
- UK Competition Act 1998.
- The Treaty on the Functioning of the European Union.
- UK Enterprise Act 2002.
- Company Directors Disqualification Act 1986.
- Guidance issued by the Office of Fair Trading.
- Guidance issued by the European Commission.
- UK Construction Industry Competition Law Code of Conduct.
The Competition Act 1998
The Competition Act 1998 is enforced by the UK Office of Fair Trading (“OFT”). The OFT has substantial powers to investigate and penalise infringements of the Act, including the power to carry out dawn raids at the premises of businesses suspected of infringement and, in some cases, at the homes of senior staff of those businesses.
The Act contains two prohibitions: (a) a prohibition on anti-competitive agreements (in Chapter I of the Act) and (b) a prohibition on abuse of a dominant market position (in Chapter II of the Act). The second prohibition applies only where a firm has significant power in the local, regional or national market for a particular construction activity – as a rule of thumb, a firm is unlikely to be treated as dominant if it has a market share of below 40%.
The first prohibition, on anti-competitive agreements, is relevant to all construction firms. It applies to agreements or arrangements between two or more independent firms – agreements or arrangements between companies in the same corporate group are not caught. The prohibition also catches agreements between competitors (horizontal agreements) and agreements between companies that operate at different levels of the supply chain (vertical agreements) – for example, contractor and sub-contractor. An agreement that is made using a third party as a conduit is caught just as much as a direct agreement between the parties.
The prohibition applies to any type of understanding between firms – formal written agreements of course, but also agreements made orally, “gentlemen’s” agreements and informal understandings reached, for example, in a social context. It also applies to trade association decisions and recommendations - a trade association is treated as an agreement amongst its members. Finally it applies to exchanges of certain types of information. In this chapter, we have used the term “agreement” to refer to all of these types of understanding.
For an agreement to be caught by the prohibition, it must be anti-competitive. There are broadly two levels of anti-competitive agreement: those that contain hardcore restrictions on competition and those that do not.
Hardcore restrictions on competition are the most serious forms of infringement and attract the most serious penalties for firms and their directors and employees. They involve cartel-type conduct:
- Price fixing – this involves competitors agreeing not only the price to charge third parties for their products, but also agreeing the components a price will include, the levels of price increases, discounts or rebates, the timing of price changes and any other price-related matters. Resale price maintenance is vertical price fixing, involving an agreement between e.g., a produce and supplier that the supplier will sell the producer’s goods to third parties at a particular price, or above a minimum price.
- Agreements to limit or withhold supply or production – these involve firms agreeing to restrict the availability of a product or service in order to push prices up.
- Market or customer sharing – this involves competitors agreeing to focus on different product or geographic markets, or different customer groups. This reduces competition for the market or customers concerned and strengthens the firms’ ability to put prices up.
- Bid rigging – this involves competitors agreeing in advance which of them will win a particular contract. Bid rigging takes a variety of forms. The practice of cover pricing was penalised as bid rigging in a number of cases between 2004 and 2009. (See below.)
Collective boycotts are seen in the same light as the above activities. These are agreements among competitors that they will refuse to deal with suppliers, customers and (in some circumstances) other competitors.
Disclosures and exchanges – whether direct or indirect – of competitively sensitive information facilitate cartel conduct and are therefore also treated as very serious infringements of competition law. Competitively sensitive information is information a firm would normally keep confidential and includes information on future prices, costs, target markets, target customers, bid strategies and general market strategy. This is often the area of greatest risk for any business – a single exchange of competitively sensitive information can result in liability. Social events involving competitors create a particular risk of inadvertent disclosure.
Agreements that do not contain hardcore restrictions, but that restrict competition because, for example, they involve co-operation among competitors (e.g., joint bidding for a contract where the client is made aware of the co-operation on the face of the bid), or exclusive sub-contracting arrangements, need to be assessed to determine their effect on competition. If the effect of an agreement is insignificant, the prohibition will not apply at all. If its effect is significant, but the benefits that flow from it outweigh any anti-competitive effect, it may benefit from exemption. The rules that apply in determining whether an agreement has a significant effect on competition and whether it may qualify for exemption are complex and legal advice should always be taken. There is useful guidance on these matters in a number of guidelines issued by the OFT and European Commission.
UK Construction Industry Competition Law Code of Conduct
The UK Construction Industry Competition Law Code of Conduct, adopted as a result of the OFT's most recent investigation of cover pricing in the construction industry (see below), sets out basic principles for construction firms to follow to enable them to comply with the UK and EU prohibitions on anti-competitive agreements.
Treaty on the Functioning of the European Union
The Treaty on the Functioning of the European Union (“TFEU”) also contains prohibitions on (a) anti-competitive agreements (in Article 101 TFEU) and (b) abuse of market dominance (in Article 102 TFEU). The principles that apply under the Competition Act are virtually the same as those that apply under the TFEU. However, the Competition Act prohibitions apply wherever the activities of a business have an impact on competition and trade in the UK, whereas the TFEU prohibitions apply wherever the activities of a business have an impact on competition and trade in the wider EU. If the activities of a business impact on competition and trade both in the UK and elsewhere in the EU, that business will be subject to both the Competition Act and the TFEU. However, only one penalty will apply – there is no double jeopardy (see below). The TFEU is enforced by the European Commission throughout the EU. It is enforced in the UK either by the European Commission or by the OFT. The powers of the OFT to investigate and penalise infringements of the EU prohibitions are identical to its powers in relation to infringements of the UK prohibitions. The powers of the European Commission in relation to infringements of the EU prohibitions are very similar, but not identical, to those of the OFT.
Enterprise Act 2002
The Enterprise Act 2002 has a number of competition-law related provisions. It exposes directors to personal liability for breaches of competition law by their companies. The Act amends the Company Directors Disqualification Act 1986 to enable the OFT to apply to the High Court for individuals to be disqualified as directors of any company for up to fifteen years where (a) the company of which the individuals are directors breaches either of the UK or EU competition law prohibitions referred to above and (b) the individuals’ conduct makes them unfit to be directors. As a result of a recent change on the OFT’s policy, a director’s conduct will make him or her unfit to be a director not just where he or she was directly involved in the infringement, but also (i) where he or she had reasonable grounds to suspect the infringement and took no steps to stop it and (ii) where he or she did not know, but ought to have known, of the infringement. This puts a significant burden on directors – executive and non-executive alike – and those who act as directors to ensure that they have adequate measures in place to ensure compliance and identify non-compliance. Up until the end of 2010, the OFT had not made any application to disqualify a director. The position is likely to change in light of the OFT’s new policy.
The Enterprise Act also exposes directors and employees to personal liability for the cartel offence. The offence is committed where an individual dishonestly agrees to make or implement an agreement between two or more competitors that involves price fixing, or limitation or withholding of production or supply, or market or customer sharing, or bid rigging. The Enterprise Act expressly states that bid rigging does not include joint bidding, i.e., where the person requesting the bids is made aware of the joint nature of the bid in advance. Individuals suspected of committing the cartel offence can be prosecuted and if found guilty face up to five years’ imprisonment and unlimited fines. There is a two-step test for dishonesty: (i) was the individual’s conduct dishonest according to the ordinary standards of reasonable and honest people and if so (ii) did the defendant realise that what he or she was doing was by those standards dishonest? Key to determining dishonesty will be evidence that the individual has tried to conceal his or her activities. A number of individuals are currently being investigated by the OFT and the Serious Fraud Office under the cartel offence provisions.
Further competition law related provisions in the Enterprise Act govern the powers of the UK competition authorities to block or clear mergers and acquisitions of businesses and to conduct market inquiries and remedy any anti-competitive features identified as a result of such inquiries.
Finally, construction firms may be affected by the EU rules on state aid, in Article 107 TFEU, where they are involved in contracts with state bodies or contracts that involve some form of state support. These rules prohibit states from granting assistance from state resources on a selective basis, to individual firms, where the assistance distorts competition. Examples include a contract under which the public body pays more than market rate, loans from a public body for less than market rate and transfer by a public body of assets at under value. Most contracts with public bodies are awarded following procurement processes conducted in compliance with EU and UK procurement legislation. As one of the aims of the legislation is to ensure that public bodies obtain best value, state aid issues should not arise in this context.
Penalties for breach and other risks
Businesses face the following risks if they breach the UK or EU prohibitions on anti-competitive agreements or abuse of market dominance:
- fines of up to 10% of the global turnover of the group to which the infringing business belongs – the way in which fines are calculated is described in Section 4 below.
- actions brought by third parties to recover damages for losses suffered as a result of the breach.
- unenforceable agreements.
- orders to change business terms or business structure.
- reputational risks.
- loss of management time in dealing with inspection visits, information requests and formal proceedings.
- substantial legal costs.
Individual directors whose companies infringe either of the two prohibitions risk:
- up to fifteen years’ disqualification as a director of any company – not just of the company whose infringement has resulted in their disqualification – and they may not be involved in the setting up or management of any business.
- serious career and reputational risks; and
- substantial legal costs.
Individual employees and company directors face the following risks if they are dishonestly involved in cartel activities:
- prosecution for the cartel offence and up to five years’ imprisonment and unlimited fines.
- serious career and reputational risks.
- substantial legal costs; and
- the possibility of being sued by their employer to recover any fines imposed on the company, together with legal costs incurred as a result of the cartel investigation (see Section 4).
Competition case law in the UK construction sector to date has focused largely on cover pricing and on breaches of UK competition law alone – the OFT has found no cross-border effect justifying the application of EU competition law alongside UK competition law.
There have been six OFT decisions on cover pricing, between 2004 and 2009. In each case, the OFT imposed significant fines on firms operating in England and Scotland. These decisions involved findings that cover pricing constituted bid rigging and was therefore a serious infringement of competition law. The cover pricing generally arose when a pre-qualified firm – Firm A – received a request to submit a tender for a particular contract and did not wish to win the contract. Based on a concern that a decision not to bid would result in Firm A being omitted from the list of firms invited to bid in future, a decision was made to seek a cover price from another firm known to have received an invitation to bid for the same contract. A representative of Firm A contacted Firm B, asking Firm B to disclose either the price at which Firm B intended to bid, or a price above which Firm A could bid without winning the contract. Firm B would also sometimes provide Firm A with a breakdown of its bid so that Firm A could submit a bid that was sufficiently detailed to be credible.
The OFT’s view of cover pricing as a serious infringement was endorsed by the UK Competition Appeal Tribunal (“CAT”) in appeals against two of the earlier decisions.
The latest decision, adopted by the OFT in September 2009, is currently under appeal before the CAT. In this decision, the OFT imposed fines totalling £129.2 million on 103 construction firms operating in England, following its largest investigation to date. The investigation began as a result of a complaint from a customer. As a result, the OFT carried out dawn raids on a number of firms in the East Midlands. This led to some firms applying for leniency (i.e. immunity from fines) in exchange for providing the OFT with information on cover pricing activities. The information provided resulted in the investigation expanding to other parts of England. Twenty-five of the firms concerned appealed to the CAT, mainly in relation to the OFT’s calculation of their fines.
The OFT’s five-step method of calculating fines is set out in one of its guidance notes. The first two steps are based on the turnover generated by the infringing business in the market affected by the infringement and reflect the seriousness and the duration of the infringement. The third step involves the OFT applying a “minimum deterrence threshold” – if the fine at the end of step two does not exceed a specified percentage of the global turnover of the group to which the infringing firm belongs, the OFT will increase the fine. This resulted in many of the fines being increased very substantially and in turnover from non-construction businesses and turnover outside the UK being used in the calculation. A decision on these appeals is expected in early 2011.
More generally case law in the UK and EU demonstrates that fines for breaches of competition law are increasing year on year. In 2010, fines levied by the OFT exceeded £263 million; fines levied by the European Commission exceeded €4 billion.
On a separate note, the Safeway case has raised the possibility that an individual employee who has been involved in a breach of competition law might be sued by his or her employer to recover any fines imposed on the company for breach of competition law, together with legal costs incurred as a result of the cartel investigation. In 2008, Safeway began proceedings in the High Court against employees whose involvement in a cartel in relation to dairy products had resulted in Safeway being investigated by the OFT and agreeing to pay the OFT a £5.6 million fine in exchange for early resolution of the investigation.
The employees challenged Safeway's ability to bring the proceedings, and when the High Court decided that the case could go to trial, they appealed to the Court of Appeal. The Court of Appeal decided in late 2010 that as a matter of public policy Safeway should not be able to recover the fine from its employees, as this would undermine the deterrent purpose of competition law. The fine had been imposed on Safeway alone and Safeway alone was responsible for paying it.
In early 2011, Safeway indicated that it intended to seek permission to appeal to the Supreme Court.
What construction firms and their staff need to do to comply with competition law
Increased fines mean increased risks for construction firms. Those risks can best be managed by adopting a firm compliance policy, endorsed at board level and based on the four-step approach advocated by the OFT in draft guidelines published for consultation in October 2010:
- Identify the exact competition risks the firm faces in each of the markets in which it operates. For most construction firms, this will involve assessing:
- whether they are subject to cartel or information exchange risks, for example, through contacts with competitors in various fora, including trade associations, and;
- whether there is a risk that their contracts may not comply with the rules on anti-competitive agreements – for example, because they confer exclusivity or contain non-competes or other restrictions on competition.
- For construction companies with a strong market position in specific product or geographic areas, this will also involve an assessment of the extent to which they may be subject to the additional competition law obligations on dominant businesses. This involves an assessment of the scope of the market concerned and the power of the firm within that market. This risk does not generally arise where a firm has a market share of below 40%.
- Assess the level of those risks. This involves a review of a number of factors. For example, in relation to cartel risk, a firm will need to review the frequency of contacts between its staff and the staff of competitors.
- Put in place measures to mitigate those risks – these need to be appropriate to the firm’s operations, but can include:
- providing training that is relevant to the firm’s activities, targeted appropriately at staff with different risk profiles and refreshed regularly;
- requiring competition law compliance as part of the firm’s business code of conduct;
- making non-compliance a disciplinary offence under employees’ contracts of employment;
- ensuring contacts with competitors, in trade associations or otherwise, are controlled;
- putting in place measures that enable suspected infringements to be reported – for example, a hotline – and placing an obligation on all employees to report any suspicions;
- providing adequate opportunities for employees to discuss concerns;
- ensuring certain contractual provisions are subject to legal review before being agreed; and
- making at least one person responsible for competition law compliance within each business unit or division.
- Review the above steps to ensure that risks have not changed and that the measures put in place remain appropriate.
The OFT has said that, although there are no automatic discounts to financial penalties where a firm has undertaken compliance activities, it may reduce a fine where the above steps have been taken – this will be a question of fact in each case.
Risks for individual company directors – executive and non-executive – have also increased. Along with the draft guidelines for companies, referred to above, the OFT issued draft guidelines for directors in October 2010. These stress the importance of directors in securing a culture of compliance within companies. They also set out the competition law knowledge that directors are expected to have. At a minimum, all directors are expected to understand the importance of competition law compliance and to know that the following infringe competition law: price fixing, bid rigging, market and customer sharing, exchanges of competitively sensitive information and resale price maintenance. They are also expected to understand competition law principles sufficiently to be able to recognise other risks and know when to seek further advice and put additional preventive measures in place. The extent to which directors are expected to have a greater understanding of competition law will depend on the size of the business and their role.
Adoption of the two guidelines referred to above will not only make it clear how far firms and their directors need to go in ensuring compliance – they will also reduce the likelihood of lenient treatment where firms and individual directors have failed to follow those guidelines.
Cartel offence risks for individual employees and directors are on the increase as regulators gain experience in this area. If government proposals to transfer responsibility for prosecuting the cartel offence to a new UK economic crime agency are implemented, this may also result in an increase in prosecutions.
No changes to the basic principles of UK competition law are expected. However, there are likely to be procedural changes, with the proposed merger of the OFT and the Competition Commission, as well as the transfer of responsibility for prosecuting the cartel offence to a new UK economic crime agency. In addition, the OFT’s guidelines on competition law compliance for companies and directors are due to be adopted in early 2011. The CAT’s decision on the appeals against fines imposed by the OFT in its September 2009 decision on cover pricing is expected in early to mid 2011 and will shed light on the validity of the OFT’s approach to calculating fines. Finally, the decision of the Supreme Court in the Safeway case will determine whether employees may be sued by their employer to recover fines and investigation costs payable as a result of those employees' involvement in activities that breach competition law.