DMU Insight #2: When is fair fair? The DMU’s final offer mechanism for determining tech price disputes

A key element of the SMS regime contained in the Digital Markets, Competition & Consumers (DMCC) Bill, introduced to the UK Parliament last week, is the Digital Markets Unit’s (DMU’s) power to design and enforce firm-specific “Codes of Conduct” for tech firms considered to have “Strategic Market Status” (SMS) (read our summary of the Bill here). While the content of each code will depend on the activities of the firm in question, one requirement likely to appear in many if not all codes of conduct is to “trade on fair and reasonable terms”, an obligation intended – among other things – to prevent SMS firms offering a price that is “unfairly high or low”.

But what is “fair”? And who decides? It’s a fraught issue and under the EU’s DMA, the question of what is a fair and reasonable price for a “gatekeeper” to charge for access to services (e.g. an app store) is shaping up to be a key battleground in implementation. But the DMCC has an in-built solution to avoid litigation: the final offer mechanism, referred to as “FOM”.

What is the FOM?

The FOM sets up a process of arbitration, under which the DMU will act as the arbitrator. Often referred to as “baseball arbitration”, this model of arbitration originated in the United States to resolve salary disputes in the baseball league; its use in the tech sector is relatively novel. Intended as a backstop by the DMU where private negotiations between parties fail, under the FOM, the DMU will invite the SMS firm and the third party to each submit a payment term offer that they regard as fair and reasonable. The DMU is then required to choose one party’s offer only, without any ability to determine alternative offers.

When will the FOM be used?

The DMU can initiate this mechanism in a proposed transaction between a SMS firm and a third party where the following conditions are met:

in the proposed transaction, the SMS firm would be providing goods or services to, or acquiring them from, the third party;

by failing to agree fair and reasonable payment terms, the SMS firm breaches an enforcement order made relating to the breach of a conduct requirement to trade on fair and reasonable terms; and

the DMU cannot satisfactorily address the breach within a reasonable time frame by exercising any of its other digital markets functions.

This means that the FOM will only be invoked where DMU has already found that previous negotiations or offers made by the SMS firm were unfair or unreasonable towards the third party. As part of the FOM, the DMU will invite each party to submit a new “final offer” – in practice, an SMS firm may be expected to propose a new offer that is more favourable to the third party to overcome its initial breach of failing to agree fair payment terms.

Significantly, once the FOM process is underway, the DMU will have powers to gather and share information between the parties, to facilitate each party in submitting a more well-informed payment proposal.

The CMA’s intention behind the FOM

The FOM is intended to address the imbalance in bargaining power between SMS firms and other businesses, by incentivising parties to negotiate sincerely and fairly on payment terms.

Should the DMU find an SMS firm to be in breach of its requirement to offer fair and reasonable terms, this mechanism acts as a backstop to ensure that both parties can be heard through a final offer that they each put forward. As the DMU can only choose between the two offers, parties would be motivated to submit an offer that is closer to a fair split of the joint value. This is because if one party’s offer favours itself too much, it risks the DMU imposing the other party’s proposal.

The CMA considers this will incentivise firms to act fairly, both during the private negotiations process to avoid the FOM being invoked, and if it does proceed, in putting forward a reasonable final offer.

The new arbitration mechanism is also designed to ensure specific transactional disputes involving SMS firms can be resolved more quickly. While – like other decisions of the DMU – appeals will be possible, this will be on judicial review grounds only meaning the threshold for having a FOM determination overturned will be high (and even if successful, would result in the decision being sent back to be made again).

What next?

The application of final offer arbitration like the FOM process in the tech sector is relatively untested. Outside of the UK, this model was first adopted in Australia as a backstop to target bargaining between digital platforms and news media businesses. The regime faced some criticism for being inherently unequal in this context because it assumed that digital platforms owed payment for news content, when platforms may in fact argue that no value should be assigned.

Nevertheless, over 30 voluntary commercial agreements have been made between digital platforms and Australian news businesses, either prior to the regime taking effect or within the first year. These agreements ranged from a global agreement with News Corporation to contracts with smaller regional businesses. No Australian parties have been subject to arbitration yet, but it’s likely that the threat of arbitration itself has in part lead to these agreements being signed.

How precisely the UK’s FOM will operate is as yet unclear. It is likely that the CMA will issue further guidance prior to the DMCC coming into force. In practice however, it will mean that – at a minimum – potential SMS companies will need to consider how they internally value third party transactions and whether they would be comfortable with disclosing the basis for their valuation or calculations used.