Natal Wholesale Chemists and Astra Pharmaceuticals (98/IR/Dec00) [2001] ZACT 7 (12 March 2001)

Ltd (NWC) (‘the claimant’) against Astra Pharmaceuticals (Pty) Ltd (AZ), Merck Pharmaceutical Manufacturers (Pty) Ltd (Merck) and Pharmaceutical Healthcare Distributors (Pty) Ltd (PHD) (respectively referred to as ‘the first respondent’, ‘the ‘second respondent’ and ‘the third respondent’ and collectively as ‘the respondents’).

2. The claimant alleges that the first and second respondents have each entered into an agreement with the third respondent in terms of which the latter is designated as the exclusive provider of distribution services for the products of the two manufacturers, the first and second respondents. The claimant alleges that the effect of these agreements is to prevent it from participating in the distribution of the products of the first and second respondents thereby lessening competition in the market for the distribution of these products. They allege that these agreements violate Section 5(1) of the Competition Act which proscribe vertical agreements that have the effect of lessening competition and that do not generate countervailing pro-competitive gains. The claimant also alleges that the first and second respondents discriminate in respect of prices and terms and conditions of sale as between the third respondent and other wholesalers, including the claimant and, as such, are in violation of Section 9 of the Act that proscribes discrimination by dominant firms.

3. The claimant has asked the Tribunal to find that the distribution of pharmaceutical products through an exclusive distribution system constitutes a prohibited practice in terms of the Act, alternatively, that the first and second respondents discriminate in respect of prices, terms and conditions of sale as between the third respondent and other wholesalers, including the claimant, constitutes a prohibited practice in terms of the Act, and that the Tribunal:

4. Pharmaceutical products, including the ‘ethical’ or patented products manufactured by, inter alia, the two respondents in this matter, have traditionally been distributed to the retail trade, the pharmacies, through the medium of wholesalers, including the claimant - the wholesalers purchase product from the manufacturers and on-sell this to the retailers. The wholesalers cover their costs and earn their profits in the difference between the price at which they purchase the product from the manufacturers and the price at which they on-sell to the retailers. This price differential has taken the form of a discount granted by the manufacturers off their list price. The wholesalers have traditionally received a discount of 17,5% off the list price, a significant part of which has been passed onto the retailers as the wholesalers vie for market share.

5. The most prominent of these wholesalers, including the claimant in this matter, are ‘full-line wholesalers’, that is, they stock the full-range of pharmaceutical products. Certain of the larger purchasers of pharmaceutical products – notably the state but also other bulk purchasers – have traditionally purchased directly from the manufacturers.

6. In recent years pharmaceutical manufacturers have attempted to change the way in which they distribute their products. A raft of pharmaceutical manufacturers – predominantly, though not exclusively, the large multinational ‘majors’ – have designated exclusive distributors of their products. Three such mechanisms of distribution have been established. In two of these arrangements – hitherto referred to as the IHD and Kinesis arrangements – two distribution companies each jointly owned and controlled by separate groupings of manufacturers have been designated as the exclusive distributors of the products of their shareholder/manufacturers. In the instant case the first and second respondents have designated an independently controlled company, namely the third respondent, as their distributor, or, in the terminology employed by the respondents, as their exclusive provider of logistical services.

7. As will be elaborated below, the independent wholesalers allege that, in addition to placing them under severe commercial pressure, these various exclusive distribution arrangements have, collectively and separately, diminished intra-brand competition in the market or markets for pharmaceutical products, that they have not promoted and may have diminished already low levels of inter-brand competition in these markets, that they have raised barriers to new entry in the market(s) for pharmaceutical products, and that they provide the institutional basis for collusion between the various manufacturer groupings who are either the joint owners of their distribution companies (as in the case of the IHD and Kinesis groupings) or, in the instant case, who have entered into distribution contracts with a single agent.

8. The various distribution agencies have been scrutinised by the competition authorities. In 1999 the Competition Board, the predecessor of the Competition Commission, found that a joint exclusive distribution agency for pharmaceutical products – in that instance, the IHD arrangement - constituted a vertical restrictive practice. In August 2000 the Competition Tribunal granted interim relief to nine wholesalers against six pharmaceutical manufacturers and their joint exclusive distribution agency, Druggists Distributors, (the Kinesis arrangement) for contravening section 4(1)(a) of the Act. Section 4(1)(a) proscribes horizontal agreements – agreements between competitors – that lessen competition without generating countervailing pro-competitive gains.

9. Natal Wholesale Chemists have now brought an application for interim relief against PHD and the manufacturers who utilise this distribution company, allegedly the third of the exclusive arrangements active in the distribution of ethical pharmaceutical products.

10. The claimant is a full-line wholesaler trading as Alpha Pharm-Durban. Alpha Pharm is a joint venture formed by the four co-operative wholesalers in South Africa. It has nine distribution centres that distribute products from manufacturers to doctors, hospitals and other health care suppliers.

11. Both the first and second respondents, AstraZeneca Pharmaceuticals (Pty) Ltd and Merck (Pty) Ltd, are subsidiaries of multinational foreign-based pharmaceutical manufacturers. The third respondent, Pharmaceutical Health Distributors (Pty) Ltd is a logistics company.

12. As of the 25 November 2000 AZ, the first respondent, appointed PHD, the third respondent, as its distribution agent. PHD is a third party logistics provider operating on a fee-for-service basis. In terms of the agreement AZ outsourced its warehousing and distribution functions, as well as its order generation, credit control and debt management operations to PHD until 31 December 2002. AZ retains ownership of its stock until it is sold to a third party.

13. Before this arrangement came into affect AZ distributed its products to its direct purchasers, i.e. clinics, hospitals, dispensing doctors, mines, mail order retailers, the State and wholesalers through the agency of Railit Total Transportation (RTT). Wholesalers then on-sold the stock they had purchased to their retail customers at prices determined by them. AZ sold its products to its direct customers at various discounts off list price, depending, inter alia, on the nature and volume of products purchased by such customers. Wholesalers received the traditional uniform minimum discount of 17,5% off list price.

14. However, AZ decided to phase out its manufacturing function and to outsource its warehousing, distribution, order-generation, debt management and credit control functions. AZ avers that the decision to outsource these activities was taken because they did not form part of its core business, namely the sale and the marketing of its products, because its Alrode distribution facilities were outdated and required considerable investment and because there were significant economies of scale to be reaped from using a single agent/distributor.

15. According to AZ all its clients now have the choice of buying either directly from it, with PHD doing the physical distribution, or buying from the wholesalers but who now also receive the product that they purchase via the third respondent’s network of distribution services.

16. The second respondent, Merck, has been dealing with PHD, its exclusive distribution agent, since 27 March 2000. Although the service fees paid to PHD differ it has exactly the same logistics services arrangement with PHD as the one between AZ and PHD. Merck decided to appoint PHD as its agent as part of its strategy to outsource non-core business activities to enable it to concentrate on the manufacture, marketing and sales of pharmaceutical products. The arrangement expires in March 2002.

17. According to Merck it has had an established working relationship with RTT who provided a transport and delivery service to it prior to the arrangement with PHD. PHD has outsourced the transport of Merck’s products to RTT.

18. According to Merck 60% of its sales continue to be made to the traditional wholesalers including the applicant, who, as in the arrangement between the first and third respondents, are now also required to utilise the distribution and other services of the third respondent.

19. The third respondent has been granted the exclusive rights to act as the logistics service provider to the first and second respondents. It may expand its services to other pharmaceutical companies – indeed, avowedly because of the positive impact of scale economies on the cost of the distribution services, all three respondents commit themselves in their various agreements to encourage others to use the services of the third respondent. At present PHD also distributes products of Sekunjalo (Pty) Ltd, a manufacturer of generic pharmaceutical products.

20. PHD provides the services of warehousing, distribution, debt collecting, batch tracking, order processing, picking, packing, credit control and debt management to its principals, the first and second respondents. These services are provided through PHD’s association with the following companies:

21. PHD and Recall are wholly owned subsidiaries of Fuel Logistics Holding Company Limited (“Fuel Logistics”). Fuel Logistics and International Health Distributors (IHD) each own 50% of the shares of Kite. IHD, referred to above, is a joint exclusive distribution agency controlled by several other pharmaceutical manufacturers.

22. The applicant applied for interim relief under section 59 of the Competition Act of 1998 on 1 December 2000. The Act has since been amended by the Competition Second Amendment Act, No. 39 of 2000 with effect from 1 February 2001. Section 59 was replaced by Section 49C.

Any proceedings that were pending before the Competition Commission, Competition Tribunal or Competition Appeal Court before the date of commencement of this Act must be proceeded with in terms of the principal Act as amended, except to the extent that a regulation under section 21(4) or 27(2) of the principal Act as amended, or a rule of the Competition Appeal Court, provides otherwise.

25. The claimant argues that by virtue of Section 23(5), the Competition Second Amendment Act retrospectively applies to pending legal proceedings, including the applicant’s section 59 application. This means that the Section 59 application filed prior to the commencement date of the Competition Second Amendment Act must now be proceeded with in terms of the new section 49C, which replaces it.

26. The respondents on the other hand argue that section 23(5) only applies to procedural amendments and not to amendments affecting parties’ substantive rights and obligations. They submit that the changes to section 59 as reflected in section 49C of the Competition Second Amendment Act are matters of substantive law, hence, the substantive legislation applicable to these proceedings is that set out in section 59 of the original Act.

31. Firstly, Section 49C(2)(c) provides that the standard of proof in interim relief proceedings under the Act is the same as in a High Court common law application for an interim interdict. The standard of proof for an interim interdict at common law was laid down in the case of Webster v Mitchell where it was held that:

32. An applicant under Section 49C(2)(b) therefore has only to establish his case on a prima facie basis; this is a departure from the approach in the old Section 59(1) where as we have seen a claimant had to prove its case on a balance of probabilities.

33. Secondly, under Section 59 a claimant had to show that the interim relief order was necessary to prevent serious irreparable harm to itself or to prevent the purposes of the Act being frustrated. The amendments have done away with the alternative requirement (the necessity to prevent the purposes of the Act being frustrated); Section 49C(2) requires evidence that the order is necessary to prevent serious or irreparable harm.

34. Thirdly, in terms of Section 49C(2), the Tribunal no longer has to consider whether each of the requirements has been established in isolation, but rather looks at all the factors listed in Section 49(2)C as a whole to see whether a case for interim relief has been established. This feature of Section 49C(2) distinguishes it from the old Section 59 where interim relief could only be granted where each of the listed requirements had been satisfied. Section 49C(2) follows the approach at common law as applied by Appellate Division in the case of Eriksen Motors (Welkom) Ltd v Protea Motors, Warrenton 1973 (3) 685 (A). The court held that in deciding whether to exercise its discretion to grant interim relief the court should not look at the prerequisites in isolation but should consider all of them in conjunction with each other. The court went to state that these prerequisites

“… are not individually decisive, but are interrelated, for example, the stronger the applicant’s prospects for success the less the need to rely on prejudice to himself. Conversely, the more the element of “some doubt”, the greater the need for the other factors to favour him.”

35. It has not, however, been necessary for us to decide which section should be applied to this matter. Even on the lower burden of proof required under the amended Act, the claimant has not succeeded in proving the existence of a restrictive practice. Accordingly, we have not had to consider the other elements necessary for sustaining a claim for interim relief – the question of irreparable harm and the balance of convenience. Accordingly, the legal dispute regarding the retrospectivity or otherwise of the amended Act has no bearing on the outcome of this matter.

36. Although not formally withdrawn, neither the papers filed by the claimant, nor its written heads of argument, nor its oral arguments persist in the claim – contained in its notice of motion – that all or any of the respondents are in violation of Section 9 of the Act. Accordingly, this claim is dismissed without further comment.

An agreement between parties in a vertical relationship is prohibited if it has the effect of substantially preventing or lessening competition in a market, unless a party to the agreement can prove any technological, efficiency or other pro-competitive gain resulting from that agreement outweighs that effect.

38. The claimant alleges that the respondents have, by entering into agreements whereby the third respondent is vested with the exclusive right to distribute the products of the first and second respondent, lessened competition and, absent countervailing technological, efficiency or other pro-competitive gains, are accordingly in violation of the Act.

39. Anti-trust scholarship and jurisprudence conventionally adopts a sceptical attitude to claims of anti-trust harm arising from all species of vertical agreement. In particular it is widely recognised that the diminution of intra-brand competition consequent upon exclusive distribution arrangements is frequently compensated for by pro-competitive benefits that enhance the ability of the producer to compete against its competitors, that is, by the strengthening of inter-brand competition. This general approach, which we follow, is recognised by the claimants in the present matter.

40. We stress that this does not mean that we propose following the influential scholarship that argues for treating vertical agreements as legal per se. It simply serves to underline the requirement, even under the less rigorous evidentiary burden that attaches to an application for interim relief under the amended Act, to provide concrete evidence in support of a claim that purports to identify anti-competitive consequences flowing from a vertical agreement. As will be elaborated below, we have concluded that the applicants in this matter have failed to complement hypotheses and speculation with the necessary supportive evidence.

South Africa: Competition Tribunal

Natal Wholesale Chemists and Astra Pharmaceuticals (98/IR/Dec00) [2001] ZACT 7 (12 March 2001)