Exclusivity Clause violates Competition Act 2010?

Whether the Collaboration Agreement (CA) and/or Exclusivity provision under Clause 1 of the proposed Supplementary Agreement violates the Malaysia Competition Act 2010 (Act 712) (CA 2010).

1. Pursuant to the Collaboration Agreement between PS and (HC), both Parties had entered into a collaboration to develop and promote the usage of a transportation, entertainment, lifestyle, banking and payments system, known as Mobile Service, previously known as LS App and to make available to consumers in Malaysia a secure, innovative online intergrated lifestyle application that serves the needs of a digital society (“collaboration”).

(B) Supplementary Agreement to the Collaboration Agreement

2. The Parties now propose to enter into a Supplementary Agreement. The proposed Clause 1 reads as follows:

“1. PSD has entered into the CA with HC on an exclusive basis and PSD shall not be permitted to engage with other companies, organisations or entities for similar purposes of the CA.” (emphasis added).

(hereinafter referred to as “the exclusivity clause” or “Clause 1”).

(C) Issues

3. This legal opinion addresses whether the exclusivity clause or Clause 1 is in breach of sections 4 and 10 of the CA 2010. In other words, does the proposed exclusivity clause infringes sections 4 and 10 of the CA 2010?

4. There are two main prohibitions set out in the CA 2010. They are the sections 4 and 10 prohibitions. Section 4(1) of the CA 2010 prohibits a horizontal or vertical agreement between enterprises which 'has the object or effect of significantly preventing, restricting or distorting competition in any market for goods or services.

5. A perusal of the Malaysian Hansard (Parliamentary Debate) of 20 April 2010, states that amongst the main purpose of enacting CA 2010 is to protect the interest of consumers inter alia by having a competitive environment where there are choices in terms of prices and products and services for consumers. CA 2010 promotes competition amongst businesses for the benefit of the consumers.

6. Considering the commercial activities in relation to the collaboration in the development of MS, there is no doubt that both PSD and HC are enterprises within the meaning of ‘enterprise’ under s. 2 of the CA 2010 and hence, CA 2010 applies to both PSD and HC.

(D) Section 4 of the CA 2010

7. The wordings of sub-sections 4(1) and 4(2) CA are plain and clear and as such, it must be given their natural and ordinary meanings.

8. Subsection 4(1) of the CA 2010 reads—

“(1) A horizontal or vertical agreement between enterprises is prohibited insofar as the agreement has the object or effect of significantly preventing, restricting or distorting competition in any market for goods or services.”

9. The word 'market' is defined under s. 2 CA 2010 as follows:

'market' means a market in Malaysia or in any part of Malaysia, and when used in relation to any goods or services, includes a market for those goods or services and other goods or services that are suitable for, or otherwise competitive with, the first-mentioned goods or services.

10. The words 'agreement', 'horizontal agreement’ and ‘vertical agreement' found in s. 4(1) have been defined under s. 2 as follows:

‘agreement’ means any form of contract, arrangement or understanding, whether or not legally enforceable, between enterprises, and includes a decision by an association and concerted practices.

‘horizontal agreement’ means an agreement between enterprises each of which operates at the same level in the production or distribution chain.

‘vertical agreement’ as "an agreement between enterprises each of which operates at a different level in the production or distribution chain."

11. It is therefore first necessary to consider whether the Collaboration Agreement and/or Clause 1 falls within the meaning of horizontal agreement (between enterprises at the same level of production, which normally means competitors in the same market) and vertical agreement (between buyers and sellers at different stages of the production and distribution chain) and are prohibited by s. 4 as they have an anti-competitive object or effect which is significant on the market.

(E) Finding/Analysis

12. It is our considered opinion that the Collaboration Agreement and/or Clause 1 are not anti-competitive arrangement or agreement between the parties and hence, does not infringe s.4 CA 2010 for the following reasons:

(1) Applying the definition of ‘market’ as in s. 2 CA 2010, what can be deduced from the Collaboration Agreement is that the relevant goods and services at issue are the development of the software application (MS), operation and management of MS and, the introduction and integration of MS into the public transportation system by the parties jointly.

(2) Accordingly, the Relevant Market for PSD is the “operation and management of an electronic payment system for users of public transport services in Klang Valley”.

(3) The Relevant Market for HC would be “the development of an electronic payment system (EPS) for use for public transportation in the Klang Valley”.

(4) The Collaboration Agreement and/or the Supplementary Agreement, in particular Clause 1 are not "horizontal agreements" between the parties under the CA 2010. This is because PSD and HC are not enterprises that operate at the same level in the production or distribution chain.

(5) PSD is a non-fare revenue generator for PS Malaysia Berhad and it is established to undertake transit oriented development, retail, advertisement and technology projects to further strengthen the performance of PS Malaysia Berhad whereas HC is a mobile e-commerce and technology company that provides business-to-consumer sales and services via mobile applications as well as financial banking, payments services, shopping search engines and data-centric services.

(6) PSD is a company that manage and take charge of technology projects of its parent company ‘PS Berhad’ and it is not an IT company involved in commercial activities similar to HC.

(7) The agreement is a "vertical agreement" between the parties. Simply put, it is an agreement between a transportation oriented development company and a software/payment system development company.

(8) Both parties entered into the agreement to collaborate on the development of the application known as ‘MS’ and the object and/or purpose of Clause 1 is that both parties will collaborate with each other on an exclusive basis for the development, operation and management of MS only during the subsistence of the agreement.

(9) There is no restriction or limitation on PSD in collaborating with other IT Companies for other applications or technology projects because the basis of exclusivity under this Collaboration Agreement is solely in respect of MS and it does no curtail, limit or control technical or technological development competition in the IT industry for technological services.

(10) Other IT companies can still provide technological services to PSD for other projects or developing other mobile/software applications for PSD or to complement MS.

(11) PSD may also enter into other agreements for another software application with a better orientation or functions to replace MS if MS is not built in accordance with the ambition/aspiration of the agreement.

(12) From another point of view, it must be emphasised that basically PSD is the owner of the project and HC is the developer appointed by PSD to develop MS. Considering the fact that the costs in developing MS will be borne by HC and HC will have to contribute its expertise and know-how with respect to the design, specifications and development of MS, PSD agreed to collaborate with HC for MS so that both parties can regulate the nature and scope of their contractual relationship, ownership and control of MS, allocation of responsibilities and division of revenues derived from MS.

(13) Consequently, the division of revenues generated from MS will be the consideration in exchange for the performance or promise of performance by HC.

(14) For this very reason, both parties have to work and/or collaborate exclusively with each other for MS and this is because in the event that PSD is allowed to collaborate with other IT companies on the same software application, HC would suffer losses as HC is the party that invested its expertise, monetary resources and etc at the development stage of the software application to build MS under the Collaboration Agreement.

(15) If PSD is not exclusively committed to the purpose of this agreement, on commercial common sense, it is only fair or it only puts the parties on an equal footing if PSD contributes its monetary resources and expertise at an equal level in developing the software application at the development stage.

(16) In a nutshell, it is manifestly clear that the benefits could not reasonably have been provided by the parties to the agreement without the agreement having been made on an exclusive basis.

(17) In any event it is obvious that both parties do not operate in the same market. PSD’s market is transportation related market whereas HC's market is IT services related market. They are not competitors in the same market. Pursuant to the MyCC Guidelines on Anti-Competitive Agreements, MyCC will consider an anti-competitive agreement to be "significant" if:

(i) the parties to the agreement are competitors in the same market and their combined market share is more than 20%;

(ii) where the parties are not competitors in the same market and their market share individually in the relevant market is 25% or more.

(18) Pursuant to the MyCC Guidelines on Anti-Competitive Agreements, the Collaboration Agreement and/or Clause 1 would not be considered to have a "significant" impact under the CA 2010.

(19) The arrangements between PSD and HC under the Collaboration Agreement and Supplementary Agreement must be regarded as a common practice that takes place between a project owner and its appointed contractor, collaborating to build something on an exclusive basis. This is because, even on a non-exclusive basis form of agreement, the appointment of other contractor by the project owner to do the same job just does not make any commercial sense as this will definitely double the project costs.

(20) It must also be pointed out that if the project owner terminates the contractor just because the project owner wants to appoint another contractor to do the same job, the project owner will be liable for wrongful termination and hence, breach of contract.

(21) Based on the Collaboration Agreement, upon the completion of MS, the IP rights and ownership of MS shall vest in HC and PSD jointly on a 50/50 basis. From this direction and considering that both parties are the joint owners of MS, there is no doubt that the joint ownership of MS only further strengthens the fact that parties are required to work together closely and exclusively in developing, managing, operating, marketing, introducing and integrating MS in the market even without Clause 1 being inserted in the agreement.

(22) By virtue of the Intellectual Property Law, the rights conferred to a registered proprietor of an Intellectual Property are well-settled under the Intellectual Property Acts. Therefore, it is clear that, both parties being the joint owners of MS shall have every right under the Intellectual Property Law to determine the arrangement of their contractual relationship for MS and this does not in any way breach s. 4 of CA 2010 because the arrangement of contractual relationship between registered owners of an Intellectual Property whether on an exclusive and non-exclusive basis has nothing to do with the Competition Law so long as it does not has the object or effect of significantly preventing, restricting or distorting competition in any market for goods or services.

(23) PSD as the exclusive collaboration partner and one of the joint owners of MS does not in any way have the object of significantly preventing, restricting or distorting competition in any market for goods or services because other software application developers/owners who own a software application with other functionality or the same functionality are not prohibited in dealing with PSD and/or to grant PSD with the licence to use their software application or introducing their software application to PSD.

(24) In contrast, if there exists a software developer who owns a similar software with similar functionality, same coding used, same name as MS and it is tailor-made for PSD, it would not surprising that such software developer would have infringed the Intellectual Property rights of HC/PSD and be sued.

(25) There is no doubt whatsoever that MS would substantially increase the viability and accessibility of public transportation to the general public and benefit the economy. There are significant identifiable technological, efficiency or social benefits directly arising from the Collaboration Agreement including the exclusivity clause because MS is not the only software application/e-payment system available in the market controlled by PS but MS is rightly positioned as another option available to users/riders of public transportation in Klang Valley.

(26) The benefits provided by the Collaboration Agreement significantly outweighs any detrimental effect of the Collaboration Agreement and/or Clause 1 on competition as the agreement does not allow the parties to eliminate competition completely in respect of a substantial part of the services. This is because, the services provided under MS is not restricted to only public transportation e-payment system as it comprised of all sort of payment services which may involve not just PS the parent company of PSD but other companies in banking industry, Food and Beverages, utilities, entertainment and etc. with a sole purpose of providing wider choice of products or services to consumers and users.

(F) Section 10 of the CA 2010

13. Section 10(1) of the CA 2010 states that:

“An enterprise is prohibited from engaging, whether independently or collectively, in any conduct which amounts to an abuse of a dominant position in any market for goods or services.”

14. Section 10(2) provides as follows:

“Without prejudice to the generality of subsection (1), an abuse of a dominant position may include:

(a) directly or indirectly imposing unfair purchase or selling price or other unfair trading condition on any supplier or customer;

(b) limiting or controlling:

(i) production;

(ii) market outlets or market access;

15. ‘Dominant position’ is defined in s. 2 of the CA 2010 as:

‘dominant position’ means a situation in which one or more enterprises possess such significant power in a market to adjust prices or outputs or trading terms, without effective constraint from competitors or potential competitors.

16. The MyCC Guidelines on abuse of Dominant Position state as follows:

1.2. In assessing whether there has been a breach of Chapter 2, the MyCC will proceed in two stages:

(i) firstly, the MyCC will ask whether the enterprise being complained about is dominant in a relevant market in Malaysia; and

(ii) if the enterprise is dominant, then the MyCC will assess whether the enterprise is abusing that dominant position.

2.1. An enterprise shall be dominant (whether as a supplier or a buyer) if it has significant market power in a relevant market in Malaysia. To assess whether an enterprise is dominant, first the relevant market must be defined in accordance with the MyCC's Guidelines on Market Definition. This involves determining both:

(i) the relevant product market; and

(ii) the relevant geographic market.

2.2. In general, the MyCC will consider a market share above 60% to be indicative that an enterprise is dominant. (Refer para 2.9 to para 2.13 in the next few pages.

2.3. Once the relevant market has been defined, the MyCC will determine whether an enterprise has a dominant position.

(G) Finding/Analysis

17. The issues to be addressed are firstly, whether Clause 1 has the object that comes with the effect of putting PSD and HC in a dominant position in the market and secondly, whether PSD and HC abuse that dominant position.

First: Whether PSD and HC are in a dominant position in the relevant market?

18. The relevant goods and services at issue are the software application itself (MS), the development of the software application, operation and management of MS and, introduction and integration of MS into the transit system by the parties jointly whereas the market is the general public or more specifically those users of public transportation in Klang Valley.

19. It is therefore necessary to consider whether the Collaboration Agreement and/or Clause 1 for the purpose of MS and the services provided through MS for the users of public transportation in Klang Valley put PSD and HC in a dominant position within s. 2 of the CA 2010.

20. At the outset it is pertinent to note that MS which is known as MyRapidtap mobile application is still at its infancy stage in the market presently and it is still in the midst of gaining more traction to introduce itself as another alternative e-payment mobile application to the users of public transportation.

21. Consequently, it seems pre-mature to determine the market share controlled or possessed by PSD and HC, captured through the services provided by MS.

22. Be that as it may, what can be confirmed is that, MS or MRP mobile application is still considered very foreign and new to many users in the market, and the dominant party in the market right now is none others than Touch & Go e-Wallet mobile application that possesses more than 60% of market share in terms of e-payment services for public transportation.

23. The exclusive collaboration of PSD and HC for MS therefore neither put PSD and HC in a dominant position in the market nor does it restrict any competition in the market by allowing PSD and HC to acquire significant market power to control the e-payment market for public transportation. The first issue must therefore be answered in the negative.

Second: Whether there is an abuse of the dominant position?

24. Considering the first issue is in the negative, the need to determine the second issue with regards to abuse of dominant position will effectively become irrelevant.

25. For completeness and based on the assumption that the collaboration between PSD and HC is on an exclusive basis for the purpose of MS and therefore put them in a dominant position in the market, is there an abuse of the dominant position?

26. It is our opinion that it remains strenuously challenging to decide that there is an abuse of its dominant position by PSD and HC for the following reasons:

(1) The collaboration between PSD and HC and the insertion of Clause 1 in the Supplementary Agreement do not directly or indirectly impose unfair ticket price or fare or other unfair trading condition, surcharge on any service provider or user as the fares and/or ticket prices for public transportation are heavily regulated and determined by the GM.

(2) PS has a farebox recovery ratio roughly at around 75%. This means that for every ringgit of operational costs, only around 75 cents is met by passenger fares. Despite GM’s grants and stimulus packages given to set off its expenses, PS still incurs operational loss on the back of flattish revenue.

(3) PSD and HC also do not have the significant power to adjust the ticket price or fare, fare fixing, fare/price recommendation, imposition of condition on any user or limit/restrict other competitors from entering into the market as there are already several competitors in the market presently, namely, Boost, Fave, Setel, Touch & Go, Grabpay and the list goes on.

(4) MS is just another alternative e-payment mobile application collaborated between the parties for the purpose of creating another available option to benefit the users in the market and it does not harm competition/consumers;

(5) The exclusive collaboration between the parties for MS also does not put PSD and HC in a dominant position even in the upstream market because the exclusive collaboration for MS does not constraint or limit other competitors from entering into the market. Other competitors are free to introduce their e-payment mobile application to PS subject to both commercials and data sharing arrangements in order for it to be used as one of the e-payment options available for users of public transportation. In other words, any new e-payment must complement MS and subject to both commercials and data sharing arrangements.

(6) Even if the exclusive collaboration between PSD and HC is dominant, it should not be stopped them from engaging in competitive conduct and lawful arrangement that benefits consumers/users even while the inefficient competitors are harmed.

(7) The exclusive arrangement between the parties in actual fact helps to further strengthen the idea of open competition in the market and supports the competition that is currently dominated by Touch & Go and Grabpay.

(8) It also helps to instil confidence in the local competitors to challenge the giant competitor such as Touch & Go/Grabpay and increase local participation in domestic e-payment industry because currently the market is largely controlled by foreign e-payment mobile applications owned by foreign companies/owners.

(9) PSD and HC’s collaboration despite exclusive to each other only opening up more market access not just to the local IT Industry but also banking, e-payment, insurance and transportation industries.

(10) Finally, there is already a platform equally available to all in the market, and that there is no abuse in the downstream market.

(H) Conclusion

27. In conclusion we are of the opinion that the Collaboration Agreement and/or Clause 1 under the Supplementary Agreement does not breach sections 4 and 10 of the CA 2010 on the following reasons:

(1) Collaboration of the parties on exclusive basis via clause 1 does not ipso facto infringe sections 4 and 10 CA 2010 as the purpose of the Collaboration Agreement and the exclusivity clause are not premised on an anti-competitive object or having anti-competitive effect.

(2) The object of the Collaboration Agreement and exclusivity clause also fall outside an activity deemed under s. 4(2) of the CA 2010 as it does not have 'the object and effect of significantly preventing, restricting, or distorting competition in any market for goods or services’ as the agreement and clause 1 are unlikely to be considered to have a 'significant' impact under the CA 2010.

(3) PSD and HC are neither in a dominant position nor engaging independently or collectively in any conduct which may amount to an abuse of dominant position in the market for MS.

(4) MS is still new to the market and more importantly it is made in Malaysia, a product of Malaysia. The exclusive collaboration between PSD and HC represents a reasonable commercial response to the market entry in terms of e-commerce payments industry in Malaysia and hence, the exclusivity clause is not in contravention with s. 10(3) CA 2010 because the Competition Act does not prohibit an enterprise in any position from taking any step which has reasonable commercial justification.

(5) The exclusivity clause does not directly or indirectly impose or adjust ticket price or other unfair trading condition on any supplier or customer or limit or control production, market outlets, market access, technical or technological development or investment or having any predatory behaviour towards competitors to the prejudice of consumers.

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