Resurgence of MFN clauses in contracts and treaties

Resurgence of MFN clauses in contracts and treaties
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Most favored nation clauses have been around for centuries. Perhaps because of their increasing popularity, however, governments and the public are starting to question how well they work. 

What do U.S. District Judge Denise Cote, Michigan Governor Rick Snyder, the Automotive Service Association (ASA), the head of a prominent Ghanaian business lobby, South Africa’s Department of Trade, and investment negotiators from the European Commission have in common?

They have all, in their varied capacities and across multiple industries, come down hard on Most Favored Nation (MFN) clauses in the past year.

Once resigned to the domain of legal experts and obscure policy analysts, these treaty and contractual tools are increasingly used to even the playing field between trading nations, as well as between parties to a commercial or insurance contract. However, their use has not been without pushback, especially recently.

MFN clauses have traditionally been used in the context of international trade agreements, where they stipulate that the trading benefits given by one state to another must be at least as favorable as those extended to a third state, thereby “equalizing” the terms. Indeed, their precursors were used as early as the 11th century between feudal lords and foreign merchants.

The principle is now a bedrock of the multilateral trading system, not to mention a key factor behind the liberalization of the international investment regime.

MFN under increased scrutiny

However, in a period of growing protectionist sentiment owing to the still-sluggish global economy, MFN is now, more than ever, being vilified. In Ghana, James Asare-Adjei cites MFN as one of reasons why Accra must take a “resolute stance” against the proposed Economic Partnership Agreement with the EU, which is currently being negotiated.

He was perhaps emboldened by his Southern African counterparts, who managed to eliminate such a clause in the Southern African Development Community’s own ongoing EPA negotiations.

Nevertheless, lest one believes that such concerns are restricted to the realm of stakeholders in emerging countries, the European Commission itself was forced to respond to public outcry and rethink its inclusion of MFN in a proposed Canada-EU trade and investment deal.

What makes this particularly controversial in investment treaties is the very real possibility of a limited agreement being undermined by an MFN clause, which can be subsequently used to “import” more pro-investor substantive and often procedural provisions. The latter includes contentious investor-state dispute settlement.

But the MFN turnaround has also spread to the private sector and the government regulators.

Its most recent application has been in the landmark Apple e-books verdict (presently under appeal), which found that the electronics giant conspired with publishers to fix prices of e-books.

Central to Judge Cote’s July 2013 ruling was the variant of MFN, which Apple incorporated into its contracts with five major publishing companies. In this case, the clauses guaranteed that iBookstore would receive the best available e-book retail price and shift publishers to an “agency model,” which the Department of Justice (DOJ) alleged would compel them into renegotiating their competitor e-book contracts (namely with Amazon and Barnes & Noble) into agency models as well.

This ruling may have marked a turning point for MFN with respect to private contracts.

Anti-MFN efforts underway

A former DOJ antitrust lawyer emphasized this is the first time a court has found an MFN clause to be anticompetitive. His warning may equally apply to the judgment of lawmakers, as Governor Snyder demonstrated last year when he joined twenty or so other states and banned MFN clauses from health insurance contracts for similar reasons, a development seen as a clear snub to Blue Cross and other insurance titans.

The underlying complexity of MFN clauses and how they can somewhat counter-intuitively lead to higher prices explains why, until recently, their role in expanding the scope of treaties and contracts has gone under the radar, shielded from much public scrutiny.

But that is beginning to change. The partial curbing of MFN in Michigan immediately prompted a Senate subcommittee hearing. Such renewed focus on the clause has galvanized the ASA’s efforts to ban MFN from auto insurers’ contracts with repair shops.

It is not difficult to foresee similar attempts at aggressive public sector oversight of MFN in other sectors, as the clause is also popular with cable companies, record labels, and online travel booking sites, all of which have dealt with litigation over their use of the clauses in the last few years.

MFN is not inherently anticompetitive. In fact, it usually leads to lower prices, more rights, and reduced transaction costs for consumers and companies alike.

But there are certain “red flags” that investors should heed when employing MFN clauses. Firms with large market shares will invariably attract regulatory attention. Accusations of collusion will more likely occur when companies and the majority of their competitors enter into such articles.

De facto barriers to entry that emerge due to MFN also serve as a signal to supervisory bodies. “MFN-plus” and “airtight MFN” clauses, predictably, raise similar antitrust concerns. Just as governments across the globe have been pressed to reconsider their infatuation with MFN and the liberal assumptions underpinning it, the private sector must adapt as well.

Categories: Economics, International

About Author

Kevin Amirehsani

Kevin is a Denver-based policy and public engagement consultant. He was previously the head of operations for a solar energy startup in Lagos, researcher for the US Commercial Service in Cape Town and the Institute for Democratic Governance in Accra, and Peace Corps volunteer in Cameroon. He holds an MSc. in International Political Economy from LSE along with a B.S. and B.A. in Industrial Engineering and Political Science from UC Berkeley.