MCA examines relationship between credit period and commission: minority shareholders of Searle getting a raw deal-I
Order: The undertaking, M/s. Searle Pakistan Ltd, engaged in the manufacture of pharmaceutical products and low calorie sweeteners, sale of food and consumer items and manufacture of pharmaceutical items for other companies in Pakistan, (hereinafter referred to as "SEARLE") is an undertaking, as defined under Section 2(1)(m) of the Monopolies and Restrictive Trade Practices (Control & Prevention) Ordinance, 1970 (hereinafter referred to as the "Ordinance").
SEARLE is among the leading pharmaceutical companies in Pakistan. M/s International Brands (Pvt) Limited (hereinafter referred to as "IBL") is an associated undertaking of SEARLE in terms of section 2(1)(b) of the Ordinance. It is also the sole distributor of SEARLE. IBL is a leading distribution company in Pakistan.
SEARLE provided its annual audited accounts for the year ended June 30, 2005 and the information required under the Monopoly Control Authority (Supply of Information) Rules, 1995 (hereinafter referred to as the "Rules"). The information supplied by SEARLE was examined and it was found that during the year ended June 30, 2005 its total sales to IBL, made at trade price less discounts of 10% to 12%, amounted to Rs 1,757.396 million.
The commission/discount allowed amounted to rupees 63.650 million (Note 13-other receivables, to the accounts refers). The rates of commission/discount allowed by SEARLE to its associated undertaking, IBL, were observed to be higher as compared with the rates of commission/discount allowed by other companies of SEARLE's size and standing in the pharmaceutical industry.
During the year ending June 30, 2005, IBL also claimed Rs 23.928 million from SEARLE on account of miscellaneous expenses, (carriage and duties, warehouse rent, mark-up expenses, communication expenses, corporate service and vehicle hiring charges), which was a deviation from usual business norms/practice.
Before the Monopoly Control Authority in the matter of M/s. Searle Pakistan Ltd & International Brands (Pvt) Limited (File No 8(588)/INV/DD-R&I/MCA/94)
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Present Mr Khalid A. Mirza
Chairman
Raja Raza Arshad
Member
Mr Abdul Ghaffar
Member
Dates of hearing: 05-03-2007, 19-03-2007 & 20-04-2007
Present for Respondents: Mr Abdul Rehman Memon &
Mr S.M. Nasir Raza Directors
Mahmood Idrees Qamar & Company
Chartered Accountants
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Section 4(b) of the Ordinance prohibits any dealings between associated undertakings, which have or likely to have the effect of "unfairly benefiting the owners or shareholders of one such undertaking to the prejudice of the owners or share-holders of any other of its associated undertakings." The dealings of SEARLE with IBL were, therefore, found to be, prima facie, in violation of Section 4(b) of the Ordinance.
Show Cause Notices No 30 & 31 of 2006-07 dated 07-02-2007 were, therefore, served, on SEARLE and IBL respectively under section 11 read with section 12(1)(a)(iii) of the Ordinance. Both undertakings were required to respond to these Show Cause Notices by February 22, 2007. They were also given an opportunity of being heard on March 05, 2007, at Karachi, in the same Notices.
In response to the Show Cause Notice, IBL, vide its letter dated February 21, 2007 submitted that the Show Cause Notice was received by it on February 20, 2007 and requested that they be allowed further time until April 15, 2007 to give their reply and represent before the Authority.
IBL was advised vide letter dated February 21, 2007 to appear before the Authority on March 05, 2007 at Karachi and make its submissions to the Authority for disposal of the Show Cause Notice as the matter had already been fixed for hearing on that date.
Both the undertakings failed to appear before the Authority on March 05, 2007, fixed for hearing at Karachi.
The matter was fixed for hearing on March 19, 2007 at Islamabad. Mr Abdul Rehman Memon, Director, Mahmood Idrees Qamar & Company, Chartered Accountants, appeared before the Authority, as authorised representative for both undertakings, and further amplified upon the written replies already submitted and provided necessary clarifications in response to queries put to him. He was directed to provide documents and information in respect of both undertakings, by March 26, 2007.
At the next hearing which was held on April 20, 2007 at Karachi, Mr S.M. Nasir Raza, Director, Mahmood Idrees Qamar & Company, Chartered Accountants, appeared as authorised representative for both the undertakings, and responded to the Authority's queries. He was also directed to supply further information with respect to both undertakings by May 5, 2007.
There are several inaccuracies and inconsistencies in the submissions received from SEARLE and IBL. We feel that little purpose will be served by dwelling on these matters since the analysis in the following paras necessarily brings out the essential facts for consideration.
We may begin by reiterating that the Show Cause Notices to SEARLE and IBL were issued on the following grounds:
(i). SEARLE had been allowing 10%-12% commission/discount to its associated undertaking as a distributor, which was comparatively higher than the rate of commission/discount allowed to distributors by pharmaceutical companies of comparable size and standing in the market; and
(ii).SEARLE was ostensibly reimbursing IBL on account of expenses, like carriage, duties, warehouse rent, mark-up expenses, communication expenses, corporate service charges and vehicle hiring charges to IBL, which was at variance with the norm for such business situations and which clearly represented an undue favour to the associated undertaking.
During the course of the proceedings, it was noted that since July 2003 SEARLE had been allowing 120 days interest-free credit to IBL and was charging IBL 7.5% mark up per annum (revised in April, 2006 to KIBOR + 2 1/2 %) on payments received after 120 days.
It may also be mentioned that the IBL Group (ie IBL, Karachi Investment Company (Pvt) Limited, First IBL Modarba, First UDL Modarba and the family of Mr Rashid Abdullah) holds 52.79% shares in SEARLE, whereas 47.21% shares are held by the general public, including public sector corporations, companies, banks, development finance institutions, non-bank finance institutions, insurance companies, modarbas, mutual funds, foreign investors, and individuals.
The information provided shows that SEARLE signed a distribution agreement with IBL on July 01, 2000 for a period of 10 years renewable for a further 10 years on the following terms and conditions:
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i). Commission: 10% on pharmaceuticals
12% on items other than pharmaceuticals
ii). Freight and Octroi: To be borne by SEARLE
iii). Credit period: 75 days
iv). Mark up: 15% per annum on delayed payments
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Through an amendment, effective from July 01, 2003 the following changes were incorporated in the above agreement:
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i). Credit period 120 days
ii). Mark up 7.5% per annum on delayed payments
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A new distribution agreement executed on July 01, 2005 retained the commission of 10% for pharmaceutical products, the credit period of 120 days and the mark-up of 7.5% per annum on delayed payments. Through another amendment that took effect from April 01, 2006 the mark-up on delayed payments was revised to 6 months KIBOR plus 2.5%.
It is noteworthy that the two distribution agreements did not say anything about re-imbursement of expenses and also that the distribution agreement of July 01, 2000 did not mention payment of mark-up in respect of outstandings with institutional sub-distributors (primarily government institutions).
We have examined several distribution agreements involving various premium pharmaceutical companies like SEARLE in order to objectively determine industry practice with respect to the terms of distribution agreements. These distribution agreements reflect the following terms:
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Name of the Company Name of the distributor Commission/Discount % Credit Period Reimbursement of Expenses.
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Parke Davis & UDL Distribution 7% 15 days advance payment No
Company Limited (Pvt) Ltd
Pfizer Laboratories Ltd UDL Distribution (Pvt) Ltd 7% 15 days advance payment. No
Brookes Pharmaceutical
Laboratories (Pakistan) Ltd Pharma Logistic (Pvt) Limited. 8.5% Advance payment No
Cyanamid (Pakistan) Ltd Millat Agencies 7.5% - local 7 days credit. Transportation,
5.0 % -Imported 2.5% penalty on insurance, octroi and
monthly basis on interbranch transfers.
delayed payment
Aventis Limited S. Amin Trading Company. 4.5% Advance payment plus Octroi charges.
interest free security of
Rs 100,000
Highnoon Laboratories Limited. United Medical Hall. 9% - Local Advance payment. Transportation expenses.
5% - Imported
Merck Sharp & Dohme Muller & Phipps 5% 120 days No
of Pakistan Ltd Pakistan (Pvt) Ltd
Roche Pakistan Limited Muller & Phipps Pakistan (Pvt) Ltd On purchases of: 21 days 1.5% of the trade
Less than Rs 1 billion = 8.00% price as transportation.
Exceeding Rs 1 billion = 7.50%
Exceeding Rs 1.5 billion. = 7.00%
Bristol Myers Squibb Muller & Phipps 10% 40 days 2.5% of the trade price
Pakistan (Pvt) Ltd Pakistan (Pvt) Ltd as freight charges.
Pharmatec Pakistan (Pvt) Ltd Muller & Phipps 9% - Local 40 days 2% freight and forwarding.
Pakistan (Pvt) Ltd 7% - Imported
Getz Pharma Pakistan Muller & Phipps Pakistan (Pvt) Ltd 9% 30 days 1.5% as freight charges.
Becton Dickinson Pakistan Muller & Phipps 8 1/4 % 30 days No
(Pvt) Ltd Pakistan (Pvt) Ltd
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From the table above, it is difficult to discern any established or standard industry norm with regard to terms of distribution contracts. However, it is observed that commission/discount rates vary from 4 1/2% to 9% with only one instance when the commission charged by the distributor is as high as 10%.
Also, while there are several instances when advance payment by the distributor has been stipulated, and credit periods, if allowed, have generally not exceeded 40 days, there is one example in the table above where the credit period allowed is as much as 120 days.
It is noteworthy, however, that this extended 120 day credit period appears to have been balanced by a low 5% commission. On the other hand, the one instance in the above table where the commission charged is as high as 10%, the credit period allowed is only 40 days.
While there must be other considerations that get factored in (eg, the inventory turnover ratio, negotiating strength of the parties, their preferences etc), it is obvious that generally speaking there tends to be an inverse relationship between the commission paid and the credit period allowed to the distributor.
Clearly distinguished from this is one instance where the commission paid is only 4 1/2% but advance payment is stipulated instead of allowing credit period of suitable tenor as one would ordinarily expect in a case like this - it seems, prima facie, that the distributor has got a rough deal at both ends of the stick.
(To be concluded)
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