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Construction industry & cover pricing

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04 Feb 2013

It has recently been reported in the media that the Competition Commission’s head of advocacy and stakeholder relations, Trudi Makhaya, says they expected to reach settlements with most applicants who partook in the fast-track settlement project for the construction industry by the end of this year.

Simple cover pricing should be distinguished from cover pricing practices involving money (or sub-contracting agreements) changing hands as compensation to the “losing” bidder who submitted the cover price by agreement, thereby ruling itself out of the running - this practice constitutes hard-core collusive conduct.

According to Irma-Dalene Gouws, director at Werksmans, if this objective is reached, the fast track process, launched in February 2011, would have taken almost three years – leaving scores more industry players who did not participate in the fast track process to settle with the Commission or battle it out before the Competition Tribunal.

The objective of the fast track settlement process was to elicit confessions of involvement in bid-rigging relating to major infrastructure projects in South Africa, but in the process many instances of simple cover pricing was exposed as being prevalent in the construction industry.

What is Simple Cover Pricing?

Simple over pricing takes place in the context of tender preparation and submissions and involves firms bidding for contracts they did not want to win in order to avoid showing the client there was a lack of interest.

By talking with some or all of the competing bidders, the firms established what prices they could bid without actually winning the contract.

Simple cover pricing should be distinguished from cover pricing practices involving money (or sub-contracting agreements) changing hands as compensation to the “losing” bidder who submitted the cover price by agreement, thereby ruling itself out of the running - this practice constitutes hard-core collusive conduct.

Is it illegal?

The practice of simple cover pricing has historically been regarded as widely acceptable behaviour in the construction industry - not only in South Africa but around the world.

To many industry participants who were involved in simple cover pricing, the fact that competition authorities regard it as a contravention, which came as a surprise as they had no collusive intent when they submitted such cover price bids.

In September 2009, after a five and a half year investigation, the OFT in the United Kingdom fined 103 construction companies £129.5 million over allegations of collusion on tenders between 2000 and 2006. 

Subsequently, many of the fines were dramatically reduced by the Competition Appeal Tribunal (“CAT”), where it specifically related to simple cover pricing. 

In reducing the fines, the CAT considered the fact that the industry had viewed the practice of cover pricing as acceptable and, although the nature of cover pricing was still regarded as illegal, the harm caused by simple cover pricing is much less than is the case with “hard core” cartel conduct.

However, the practice was considered serious enough for the CAT to still impose a base penalty of 3.5 percent on the affected turnover of the firms involved in cover pricing, which penalty was then adjusted upwards for aggravating factors such as the length and frequency of involvement, and downwards in mitigation, for factors such co-operation with the investigation, and the implementation of a competition law compliance programme.

Will simple cover pricing really be equated to hard-core cartel behaviour?

To date there are no South African precedents available to set a guideline as to how our competition authorities are likely to evaluate the practice of simple cover pricing.

 It is anticipated that the Commission’s approach will be to view cover pricing arrangements as a hybrid practice which amounts to both collusive tendering and a form of price fixing. 

As such, cover pricing in South Africa will be regarded as conduct falling within the ambit of section 4(1) (b) (i) and (iii) of the Act, which are per se prohibited.

These types of contraventions may result in a penalty of up to 10 percent of annual turnover, even for a first-time offence.   

Firms in the construction sector must therefore at all times steer clear of requesting or providing cover prices to their competitors and remain vigilant that they do not fall foul of the Competition Act when preparing their bids.

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