MOST FAVOURED CUSTOMER (“MFC”) AND BENCHMARKING CLAUSE FROM COMPETITION LAW PERSPECTIVE
Most Favoured Customer (“MFC”) and Benchmarking clauses are the most important and critical clauses in any service agreement and the outsourcing contracts. The drafting and negotiation of these clauses are most onerous task requiring dexterity and expertise. MFC clause has virtually similar meaning to the Most Favoured Nation (MFN) treatment under the GATT Agreement and rather used interchangeably in the contracts.
MFC is synonymously called “Pricing Warranty”, “Preferred Pricing” or “Preferred Client”. The effect of an improperly drafted/negotiated MFC may have severe financial consequences to the business. Even if not formally invoked, the MFC’s mere existence in the contract can also be used as leverage by the client to the demand a price negotiation and may call for violation of Anti-Trust Laws.
MFC binds the contracting party to provide its most attractive pricing to the client. Although this can be sheltered under the maxim “Caveat Emptor”, it may trigger the basic soul of the competition laws i.e. promotion of competition in a way, as these provisions directly or indirectly limits the contracting parties to charge the lower price to the new customers. Depending upon how the language is drafted, it can be applied in a way that makes it virtually impossible to accept business from new clients unless the same pricing terms are offered to the existing clients.
Benchmarking is the practice of measuring the price of entity’s services against similarly situated competitors. Benchmarking is a risk management tool designed to overcome the risks of fixed price long-terms contracts. In its simplest format, a benchmarking process compares a contract price to a market price and the contract defines the legal obligations of the parties as a result of that comparison.
The quest for comparable price using benchmarking methodologies leads only to an approximation of a market price. In commercial transactions, approximations may result in legally binding changes in price, provided that the procedures are predictable and objectively verifiable and thus enforceable by the court.
Benchmarking provisions in outsourcing contracts requires a series of decisions, which inter alia includes listing of several issues in the use of benchmarking as a price adjustment technique like.
- Prior determination of a third party that is to conduct the benchmarking process;
- The contents of the data that is used to refer to “market” price;
- The process by which that data base was collected;
- The age of the data that are used for comparison purpose;
- The definition of a comparable transaction;
- The number of comparable transactions between the benchmarker and the parties to the outsourcing transaction;
- The relationship of comparable transactions to the pricing structure of the comparable transaction;
- Whether a change in price will become mandatory, and if non-mandatory, the process by which a non-mandatory change might occur;
- The impact of a miniature or negligible discrepancy between the benchmarking results and the contract price;
- The impact of a price discrepancy; and whether the degree of price discrepancy (miniature, average or outsized) has any binding legal impact upon the parties or their rights to change the agreement’s terms;
- The scope of process (whether for individual SOW or the entire agreement);
- The financial elements or payment, timing and time frames as to which may changes will apply;
- The “due process” or “fairness” elements of the benchmarking overall
Benchmarking provisions are typically used by the clients to exert leverage on the service providers to reduce the cost of its services. Whether or not benchmarking exercise occurs, the mere existence of a benchmarking provision can have far reaching effect of forcing price negotiation.
The question is whether Benchmarking and MFC provisions will trigger the provisions of Anti Trust Laws/Competition Laws or not is required to be examined. The following discussion may throw some light on the same.
Position under Indian Laws:
The (Indian) Competition Act, 2002, provides that any agreement entered into between enterprises or association of enterprises or persons or associations of persons or between persons and enterprises or practice carried on, or decision taken by, any association of enterprises or association of persons, including cartels, engaged in identical or similar trade or goods or provision of services, which – (a) directly or indirectly determine purchase or sale price. Further, any agreement amongst enterprises or persons at different stages or levels or the production chain in different markets, in respect of production, supply, distribution, storage, sale or price of, trade in goods or provisions of services, including inter alia – refusal to deal, shall be an agreement in contravention of sub-section (1) of Section 3. Further, as no enterprise or association of enterprises or persons or association of persons shall enter into any agreement in respect of production, supply, distribution, storage, acquisition or control of goods or provisions of services, which causes or is likely to cause an appreciable adverse effect on competition within India. For the purpose of this Sub-Section, “refusal to deal” include any agreement which restricts, or is likely to restrict, by any method the persons or classes of persons to whom goods are sold or from whom goods are bought; it further provides that the following arrangement shall not be affected by the above provisions i.e. the right of any person to restrain any infringement of or to impose reasonable conditions as may be necessary for protecting any of his rights which have been or may be conferred upon him under –
- The Copyright Act, 1957 (14 of 1957)
- The Patents Act, 1970 (39 of 1970)
- The Trade and Merchandise Marks Act, 1958 (43 of 1958) or the Trade Marks Act, 1999 (47 of 1999)
- The Geographical Indications of Goods (Registration and Protection) Act, 1999 (48 of 1999)
- The Designs Act, 2000 (16 of 2000)
- The Semi-conductor Integrated Circuits Layout-Design Act, 2000 (37 of 2000)
And the right of any person to export goods from India to the extent to which the agreement relates exclusively to the production, supply, distribution or control of goods or provisions of services for such export
The plain reading of Section 3 suggest that the benchmarking provisions and MFC provisions may trigger Competition Act provisions in India if its causes or is likely to cause an appreciable adverse effect on Competition in India and it does not fall within the purview of the exceptions set out in Sub-clause 5 of section 3. Till now no such issue on either the MFC or bench marking has been decided by the CCI. However, the literal interpretation of some terms used in the Act shall be given wide interpretation by the CCI in case any matter is referred to the Competition Commission.
Position under the United States Laws:
In U. S., Sherman Antitrust Act, 1890 regulates the restraint of trade or commerce among the several States or with foreign nations, is declared to be illegal. Every person who shall monopolize or attempt to monopolize or combine or monopolize any part of the trade or commerce among several States or with foreign nations, shall be deemed to be guilty of felony and on conviction shall be liable for heavy fines. The MFC and benchmarking provisions can be used to monopolize the trade.
Jonathann B. Baker, Director, Bureau of Economics, FTC (U.S.), before Business Development, Inc. Antitrust 1996 conference observed that “Analyzing vertical restraints is complicated by the variety of forms they take. The most-favored-customer clause is a good example because it is familiar and common and it has frequently been subject to antitrust attention.
In applying rule of reason antitrust analysis to vertical restraints such as a most-favored-customer clause, the anticompetitive effects must be identified and compared with efficiencies. I will describe three anticompetitive mechanisms by which a most-favored-customer clause in vertical contracts could harm competition, one corresponding to each of the general vertical theories I have noted: practices facilitating coordination, raising rivals’ costs, or dampening competition. My broader purpose “of highlighting the many ways vertical practices can harm competition” is, in one respect, not well served by focusing upon most-favored-customer provisions: the distinction between the facilitating practices and dampening competition theories could be made more apparent by choosing some other vertical practice for study. On the other hand, my goal of encouraging careful analysis of individual practices rather than careless application of slogans is well served: I will explain why some, though not all, of the commonly-supposed efficiency benefits of most-favored-customer provisions are illusory”.
Whereas MFC clause is not completely banned under the USlaws, the courts have held that the MFC clauses should be examined on merits of individual cases and in the light of the unique factual circumstances surrounding the parties and its effect on the competition. (The U.S.court in UnitedStateof Americaand the State of Michigan V Blue Cross Shield of Michigan and United States V Delta Dental of Rhode Island)
Position under German Laws:
The new German Act against Unfair Competition (UWG) prohibits certain trade practices which are considered unfair, excluding cartel laws and merger control which are governed by a separate Act (GWB). Under the old Act i.e. German Act against Restraints of Competition (“ARC”) has provided that the clauses like MFC to be problematic and specifically provided that “Agreement between undertaking which concerns goods and commercial services and which relates to markets within the area of application of this Act, shall be prohibited insofar as they restrict a party in its freedom to determine prices of terms of business in agreement which includes with third parties on the goods supplied, on other goods, or on commercial services”.
Position under U.K. and European Union Laws:
In U.K., the Competition Act, 1998 regulates the Agreements, practices and conducts that may have a damaging impact on competition. Chapter I of the Competition Act, 1998 provides that the Anti-competitive Agreements and concerted practices that have the object or effect of preventing, restricting or distorting competition in U.K.However in case if the effect of the anti-competitive agreement or the concerned practices agreement, the European Union has competence to deal with the problems, and exclusively EU laws would apply. The Office of Fair Trade (OFT) is the UK’s consumer and competition authority. Presently there are no recent OFT decisions regarding MFN largely determined by VBER and accompanying guidelines. The European Commission has concluded in the number of case (such as gas pipelines, Opodo, Hollywood film distribution and copyright societies) that MFN clause can give rise to competition concerns such as those referred to above i.e. Resale Price Maintenance and information exchange. However, in practice it has been observed, MFN clause when investigated at European Commission Level, have not given rise to fines but the parties have removed MFN clauses from their agreements so that the Commission can then close the case.
Largely, across the countries, MFC clause and the benchmarking clause should be used with great caution and diligence so that the provisions of anti-trust laws should not get attracted.
 Section 3 (1) of Competition Act, 2002;
 Section 3 (4) of Competition Act, 2002;
 Section 3(5)(i) of Competition Act, 2002
 Section 3(5)(i) of Competition Act, 2002
 Article 1 ofSherman Antitrust Act
 Article 2 ofSherman Antitrust Act. Both these articles provides for fine upto US$ 100 Million for corporate and US$ 1 Million for individuals.
 2:10-cv-15155-DPH-MKM, E.D. Mich. (Complaint filed on 18th October, 2010) also available at www.justice.gov/atr/cases/f266900/266327
 Citation: 943 F. Supp. 172 (D.R.I. 1996)
 Gesetz gegen den unlauteren Wattbewerb
 Gesetz gegen Wettbewerbsbeschrankungen
 Article 14 of ARC
 EU Verticals Block Exemption Regulation and Guidelines
 Available at http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:52001XC1120(02):EN:NOT
 Available at http://europa.eu/rapid/pressReleasesAction.do?reference=IP/06/1311&format=HTML&aged=0&language=EN&guiLanguage=en