08 Sep Interest in several links of the production chain; look before you leap
There are countless products and services whose “production chain” consists of several links. It may appear attractive for a manufacturer or producer to take a participating interest in another link in the production chain, for instance in the case of a manufacturer of clay that takes an interest in the share capital and management of its customer, a producer of bricks. That might seem like a good marriage with advantages all around, but it can also be a recipe for disaster. That was demonstrated by a recent ruling of the Enterprise Court of 28 April 2022.
The case before the Enterprise Court centred on shareholders and directors who were involved in various companies in the strawberry production chain. Three sub-activities could be distinguished in that chain: the breeding, propagation and cultivation of strawberries. Breeders develop new strawberry varieties, propagators grow strawberry plants on the basis of licences granted by breeders, and farmers produce strawberries that they place on the market. The parties in the case before the Enterprise Court were joint shareholders and directors of a breeding company, and one of the parties was the owner of a propagation company. The companies were each other’s supplier and customer, and furthermore supplied other, non-affiliated companies. Due to deadlocks and conflicting interests on the board of the breeding company, the decision-making process came to a standstill and a conflict arose. The Enterprise Court ruled that the parties were guilty of mismanagement and therefore appointed an extra director to put things in order.
Causes of the conflict
The judgment passed by the Enterprise Court demonstrates that the conflict between the parties was largely due to the following facts:
(i) the interests of the various companies in the production chain do not always run parallel;
(ii) one of the directors of the breeding company was a major shareholder in the propagation company, as a result of which that director had a conflict of interest in decisions that affected the propagation company; and
(iii) no clear regulations or other checks and balances regarding conflicts of interest were in place.
But there were also other reasons why the parties should have stayed in their own link in the chain. Unaffiliated parties were more reluctant to do business with their companies, for fear of unfair competition and disclosure of confidential information. The directors of the breeding company were also unsure at some point whether information provided by the other director would not be used in the propagation company. It was also suggested during the proceedings that the relationships between the parties and their companies were at odds with competition law. That is conceivable, but was not addressed by the Enterprise Court.
Lessons in practice
What lessons does this judgment offer in practice? Be aware that participating in the share capital and management of different companies in the same production chain may give rise to various challenges. Important points to consider are the following:
- A company’s board must be guided solely by that company’s interest, taking into account the interests of all the parties involved in the company. If a director has a direct or indirect conflict of interest in a decision (for instance because the decision has implications for the other company in the production chain in which that director is involved), the director must abstain from the consultation and decision-making. Having a participating interest in several companies in the same production chain may give rise to a conflict of interest. It is therefore advisable to agree on a clear conflict of interest arrangement that covers not only the decision-making process but also the information that is shared with the conflicted director.
- Commercially, a participating interest in several links in a production chain can have consequences for the relationship with external buyers and suppliers. They may be concerned about unfair competition and disclosure of information. To obviate these concerns, it could be opted to participate in several links in the chain only as a shareholder, not also as a director. Contractual restrictions could also be included regarding the information that the board shares with shareholders.
- Finally, be aware that agreements between links in a production chain may constitute cartel agreements under competition law. If competition law rules are breached, any interested party may invoke the nullity of those agreements, regardless of enforcement by ACM (the Netherlands Authority for Consumers and Markets).
For more information on this subject, please contact Sander Pieroelie (+31-6-222 878 65) or Lusine Shahbazyan (+31-6-128 715 76).
This article was published in the Newsletter Vestius of September 2022