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9 September 2013

Competition Law Twists and Turns in the Agricultural Sector

Author: Anastasia Usova, Volodymyr Solohub
Source: The Ukrainian Journal of Business Law. – 2013. – September. – p. 18-20

Most large Ukrainian agricultural holdings have undergone substantial group restructuring and/or consolidations in the past 5 years. Many small and medium-size companies were integrated into large agricultural holdings with significant market power. This has led to an appreciable concentration on agricultural markets and, consequently, increased control for competition compliance by agricultural groups on the part of the Anti-monopoly Committee of Ukraine (the AMCU).

The need for consolidation of the agricultural assets under a single holding company (or its several layers) exposes such agricultural groups to a number of merger control issues. These issues gain particular importance when the agricultural groups prepare for public transactions (such as IPOs, debt offerings, etc.) or deals to attract financing from large international banks or intergovernmental institutions.

Restructuring of agricultural holdings traditionally involves the incorporation of a holding company abroad (or several layers of holding and sub-holding companies) and transfer of Ukrainian assets to such a holding company. Contrary to the popular (and often misleading) belief, the transfer of agricultural assets which were de facto controlled by a single ultimate beneficial owner (the UBO) or a number of UBOs to a holding company which is legally and beneficially owned by the same individual(s), in most cases cannot benefit from an "intragroup" transfer exemption (a rule allowing the parties not to file for merger control clearance in Ukraine for transactions made within one single group of companies). This is because such exemption can only be applied in cases when there has been no omission to obtain clearance for any prior transaction involving the UBO(s) and the subsidiaries, which resulted in or was instrumental to achieving the current structure of the group. The reality of the Ukrainian agricultural sector is such that in most cases the groups were formed with some or many violations of Ukrainian merger control rules.

Therefore, prior to transferring a multitude of companies under a single offshore umbrella, a merger control due diligence exercise needs to be carried out. Once all the "wrongful" or "defective" acquisitions and/ or share transfers have been identified, these will need to be cleared by the AMCU retrospectively. On top of that, the group will pay fine for each violation separately. Importantly, as under Ukrainian competition law the fine is imposed on the entire group of companies and is calculated based on such group's annual turnover for the year immediately preceding the year when the fine is imposed, the parties should start "clearing" the group as early in the restructuring process as possible. Another peculiarity of competition law is the statute of limitations. Unlike in other areas of civil law, the statute of limitation for failing to obtain merger control clearance for a transaction which required such clearance is 5 years. Moreover, if a company which was "defectively" acquired by the group and subsequently transferred within the group, then the 5-year period of limitation will start from the moment the last transfer was completed.

Another factor to consider is disclosure requirements. Sometimes the groups file merger control applications to the AMCU without disclosing their real UBOs. During the group restructuring to incorporate a transparent vertically integrated structure, such non-disclosure of real owners is not advisable due to these two reasons: (i) any such omission to disclose the actual UBO is potentially subject to a fine for providing false or incomplete information (in the amount up to 1% of the annual group-wide turnover for the year immediately preceding the year when the fine is imposed); and (ii) in case of the public transactions, the real UBOs will be in any case disclosed in the offering documentation, which is publicly available.

One of the final but still a very important consideration is timing. Depending on the group size and the number of "defective" acquisitions, the clearance of the group's past violations and obtaining clearance to consolidate the group under an off-shore structure may take from 3 to 12 months. This should be taken into account when planning the overall transaction timing.

However, agricultural holdings should mind competition law not only in cases of restructuring or new acquisitions. Apparently, even a routine activity of agricultural enterprises traditionally enjoys particular attention from the AMCU due to the social significance of some of their product markets.

Furthermore, there are some peculiarities in the AMCU's approaches to the agro sector that should be considered by agricultural holdings in the course of everyday operations. In particular, when analyzing certain agricultural markets the AMCU tends to find dominance on the buyer/customer end, which is not specific to the AMCU and thus turns its typical approach upside down. In particular, the AMCU defines agricultural enterprises that lease agricultural land plots from individuals as "suppliers on rental services of land plots (allotments)." When calculating the respective market shares of such leaseholders, the AMCU limits the relevant geographic market to the territory of village councils of a district where the land is leased by the leaseholder. Given such narrow geographical limits, many agricultural enterprises are regarded by the AMCU as dominant since they lease more than 35% of agricultural land plots within a given part of a district.

What are the legal implications of such approach for leaseholders? While dominance itself is not prohibited in Ukraine, abuse of dominance constitutes a serious violation of competition law and is prohibited irrespective of its object, reasons or effect.

This means that dominant leaseholders should refrain from any actions that may amount to abuse of such dominance. The behavior is regarded as abusive of dominance if it results or may result in prevention, elimination or restriction of competition or impairment of the interests of other undertakings, which would have been impossible in a competitive market environment. In particular, the On Protection of Economic Competition Act (the Competition Act) provides for a non-exhaustive list of different forms of abuse, such as illegitimate pricing, price discrimination, refusal to deal, etc. The AMCU is particularly concerned about illegitimate pricing, which involves a dominant entity setting prices that would be impossible on a competitive market.

For example, in December 2011 the AMCU imposed a UAH 68,000 fine on Private Agricultural Enterprise "Molniya-1" for abuse of dominance in the rental market of agricultural land1. In particular, the entity did not adjust the existing lease rates up to 3% of the monetary value of the land plots, pursuant to amendments introduced to the legislation in 2008. In the meantime, even when complying with state regulations on minimum lease rates, the dominant leaseholders are not discharged from obligation to establish economically justified prices in their lease land contracts. In many instances the AMCU emphasized that when setting the price a dominant leaseholder should duly consider the quality of land and should not apply similar lease rates to land plots of different quality and value. In case of any changes to the lease rate, especially its decrease, a leaseholder should be ready to provide the respective justification of a change if requested by the AMCU. Otherwise, in the absence of justifiable reasons this may also be qualified by the AMCU as abuse of dominance.

A similar approach is applied by the AMCU to some other agricultural markets. For instance, the AMCU regularly fines milk processing undertakings for abuse of dominance through setting unjustified purchase prices for non-skimmed milk. Such companies are often considered as holding dominant position given a narrow definition of the relevant market limited to a single village or town where only one or a couple of milk processing plants are active. For example, the AMCU found abusive the behavior by LLC Moloko which decreased its purchase price from January till May 2008 by 33.3%. Although it was a seasonal trend in the region where many companies decreased their prices, the abusive nature of pricing was evidenced by the fact that while the price decrease of other entities was insignificant the decreased price of LLC Moloko was 8.18% lower than the average price in the region. Such conclusion of the AMCU was confirmed by the ruling of the Higher Commercial Court of Ukraine.

In other cases abuse of dominance on the part of milk processing undertakings was found due to facts of applying similar prices to non-skimmed milk of different quality or, contrariwise, setting dissimilar prices for milk of equivalent quality. Therefore, the dominant purchasers should duly consider a product quality and other distinguishing product features to avoid the risks of allegations of unjustified pricing.

In addition to the above, holding a dominant position in any market imposes an additional merger clearance burden on agricultural companies in case of mergers, acquisitions or other concentrations in this or adjacent market. Under the Competition Act, exceeding a 35% market share by parties to the concentration (individually or jointly) in the market concerned or the adjacent market constitutes a separate ground for the obligation to obtain AMCU merger clearance. The Competition Act allows for quite a wide interpretation by the AMCU of the notion of "concerned or adjacent market". Thus, dominant undertakings, even within one regional market, should not ignore the risk of liability for implementation of concentration without the AMCU clearance irrespective of the value of their assets and sales.

Therefore, given the social importance and specific patterns of certain product markets, agribusiness is subject to significant compliance standards, including the requirement to comply with competition regulations and merger control regime. Both the formation and subsequent operation of agricultural groups, especially those holding significant land banks, force them to carefully and thoroughly adhere to competition law restrictions.

1 Kharkov region territorial division vs Private Agricultural Enterprise "Molniya-1", Decision No 137-k of 8 December 2011, case No.2/02-144-1; Ruling of the Higher Commercial Court of Ukraine of 10 October 2012, case No.5023/10690/11.

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