Vertical Agreements I
Distribution agreements, Supplier agreements, franchise licensing and agency agreements are vertical agreements under Irish and EU competition law. Horizontal agreements are agreements between participants at the same level in the market. Vertical agreements are those between participants at different distribution levels in the market. Vertical agreements containing restrictions on competition are much less likely to offend competition law, than horizontal agreements which contain restrictions.
Vertical agreements may affect competition by reason of restraints imposed by the use of market power. Selective distribution agreements are commonly used to distribute branded retail products. The arrangements limit both the number of authorised distributors (through the use of objective, qualitative selection criteria related to the product) and the possibilities for resale of the contract goods by the selected distributors.
Vertical Agreements II
Distribution agreements will not breach EU competition law provisions if they do not have a significant effect on trade between the Member States. Domestic competition law may apply where they affect trade within the State. As is the case generally with competition law, it is principally a matter for the parties to determine whether the agreement complies.
Where market share is in excess of 40%, the undertaking may have a dominant position and the arrangements may constitute an abuse of that dominant position. This would be very unusual in practice. See generally the sections on EU and Irish competition law, in relation to practices that constitute the abuse of a dominant position
The EU Commission has identified possible competition concerns with exclusive distribution agreements. They may reduce competition within a brand and cause the partitioning of the market. It may facilitate price discrimination. Where exclusive distribution applies across the market, it may soften competition or facilitate collusion, both at supplier’s level and distributor’s level. It may close out other distributors and reduce competition at that level.
There may be justification for exclusive distribution agreements in terms of economic efficiency. The Commission has sought to balance the restrictions on competition arising from exclusive distribution agreements with features that enhance competition between brands. Distribution agreements typically provide for exclusive distribution in a particular territory. This will be often recognised as necessary for start-up goods entering a new market
The Vertical Agreements Regulation restricts the types of territorial exclusivity which are permissible. Territorial exclusivity may be permissible, but not all territorial restrictions are allowed. Complete obstruction of parallel imports is not usually permitted, even where agreements grant absolute territorial protection which could be justified on the basis of an increase of inter-brand competition. There is a strong presumption that parallel trading should be permitted from outside the relevant territory, subject perhaps to restrictions for a short period, such as the first year, where a significant investment is necessary.
The EU Guidelines on Vertical Restraints take account of the effect of e-commerce. It restricts practices such as dual pricing by which online products are sold at a higher rate.
Exclusive Distribution I
Exclusive distribution agreements may benefit from the block exemption for vertical agreements where market thresholds are below 30 percent for each of the distributor and the supplier. However, below these thresholds, the block exemption will not be available if “hardcore” restrictions apply.
If the exclusive distribution agreement does not benefit from the block exemption, the agreement must be analysed from a competition perspective to determine if it involves within the prohibition. The guidelines on vertical restraints set out the criteria in relation to the analysis of whether the benefit of restrictions outweighs their anti-competitive effect.
The market position between the supplier and its competitors will be relevant. A loss of competition between brands due to the exclusive distribution arrangements is problematic if there is limited competition between different brands. If the market share of the supplier is higher and its market power is more significant, weak competition within the brand is more likely to be anti-competitive overall.
Exclusive Distribution II
Where there are a relatively small number of strong competitors, and each operates an exclusive distribution network, there may be significant anti-competitive effects, if one distributor has exclusive distribution rights in respect of competing products. This may dis-incentivise competition, and the benefit of the block exemptions may not be available, even at thresholds below 30 percent market share.
The higher up the distribution chain, the less likely the exclusive distribution is to affect competition. Restrictions at the retailer level will have more problematical, particularly when they affect larger territory.
On the other hand, exclusive distribution arrangements may generate efficiency; see the above factors in relation to the application of the vertical agreements block exemption. Prohibition on active sales into the territory of another exclusive distributor and restrictions on sales by members who are not authorised distributors are not hardcore restrictions.
Selective Distribution I
Selective distribution agreements restrict distributors and impose restrictions on resale. Distributors are entitled to sell only to other authorised distributors or end users. Branded retail goods are commonly the subject of selective distribution agreements. The goods are usually branded expensive luxury goods, where the method of sale is an important aspect of their market presence.
If the block exemption is not available, a competition analysis is necessary to assess the effects of the arrangement. The market position of the supplier and competitors are important. A reduction in competition between the brand is problematical, only if there is limited competition between brands. If competitors operate similar distribution networks, there may be a cumulative closing of the market so that there is very little price competition.
Selective Distribution II
Selective distribution agreements typically involve the restriction of branded products based on criteria related to the products. In order to be eligible to join the network of distributors, resellers must meet certain standards provided by the manufacturer. In contrast to exclusive distribution agreements, the number of distributors is not necessarily limited.
The EU Guidelines on Vertical Restraints outlines some of the possible anti-competitive risks of selective of distribution. The competition risk in selective distribution is that competition within the brand will be reduced by excluding certain type of distributors, who would otherwise have lowered prices. In the case of parallel networks, this may facilitate collusion. It may foreclose certain types of distributors,
On the other hand, selective distribution is recognised as having a potentially pro-competitive effect. It may reward investment and prevent free-riding by others. It may be critical and necessary in establishing brand recognition.
Compliant Selective Distribution I
Selective distribution is permissible in principle provided that it complies with competition law in its terms and in its operation. Selective distribution may be justifiable by reason of the nature of the products. The EU Commission recognises that in some product cases, non-price factors are a significant competitive force. The enhancement of quality through selective networks with provisions which seek to eliminate free riders who damage the brand by lower standards is generally permissible
The 2010 block exemption allows both quantitative and qualitative restrictions. Restrictions on the number of outlets in an area are usually allowed, provided that the market share is below 30% and there are no hard-core restrictions, including in particular restrictions on active selling by distributors to each other and to end-users.
The internet raises difficult questions for selective distribution. There is a risk of free riders who compete unfairly with high-quality retailers who have invested in physical infrastructure. Selective distribution agreements may be justified in imposing proportionate restrictions, requiring minimal infrastructural investment.
Compliant Selective Distribution II
Dealers must be selected on the basis of objective, qualitative criteria. If there are so may systems within the market or it is not based on a justifiable, qualitative and objective reason, the agreement may be breach competition law. The selection criteria must be laid down uniformly for all resellers and not applied in a discriminatory manner.
The criteria must not go beyond what is necessary. A refusal to approve distributors who satisfy the qualitative criteria is likely to infringe competition law.
Qualitative criteria, such as staff training or service quality requirements based on the nature of the product, without restriction on the number of dealers, is regarded as low risk in respect of anticompetitive effect.
Cumulative Selective Distribution
Where there is not significant market power, inter-brand restrictions in selective distribution agreements are generally acceptable on the basis that there is competition from other brands. The Commission seeks to counter the risks of the cumulative effect of selective distribution most of the market is subject to selective distribution.
The exemption may be withdrawn if the different selection distribution systems produce cumulative anti-competitive effects. This is unlikely to arise unless more than half the market operates on the basis of selective distribution.
The risk to competition is deemed excessive if each of the top five suppliers, operate selective distributions and their combined market share exceeds 50 percent. Increased buyer power amongst dealers may increase the risk of collusion. The imposition of criteria regarding selection which could exclude other distributors is also relevant.
Single Branding Agreements
The Vertical Agreement Guidelines refer to single branding agreements as non-compete obligations, the main element of which is that that the buyers are obliged to concentrate their orders for a particular type of product with one supplier. This runs the risk of closing the market to actual or potential competitors.
If the participants have less than 30% market share, and the agreement is for less than five years, then the block exemption applies. The exemption applies to direct and indirect non-compete obligations. This includes exclusive purchasing obligations.
The Commission may withdraw the benefit of the exemption, where the agreement does not fulfil the criteria in Article 101(3). The guidelines indicate that the exemption may be withdrawn where a number of major suppliers enter into single branding agreements with a significant number of buyers in the market, causing a cumulative effect. The Commission may exclude from the exemption, parallel networks of similar vertical agreements where the networks cover more than 50% of the relevant market.
Where the block exemption is not applicable, the guidelines set out considerations for the analysis of whether the single branding agreement is caught by the substantive prohibition. They include the supplier’s market position, the length of non-compete obligations and the likelihood of significant foreclosure of the market.
The guidelines emphasise the possibility of a reduction in inter-brand competition for final products at the retail level. Significant anticompetitive effects may start to arise if 30% or more of the relevant market is tied. Guidance is given in relation to cumulative foreclosure effects.
Resale Prices I
Indirect resales price maintenance will generally be prohibited and unjustifiable. A de facto resale price maintenance clause, although not in express terms, will breach competition law, in a distribution agreement other than in exceptional circumstances.
Resale price maintenance is generally unacceptable even in respect of relatively low market shares, which otherwise fall outside the scope of competition law scope. It may be, however, that where market share is very small, that the resale price maintenance will not have any effect on the competition so as to fall outside the substantive prohibitions.
Recommended resale prices are not so-called hardcore restrictions under competition law. They do not necessarily and automatically breach competition law. Provided there is no concerted practice between the parties (e.g. franchisor and the franchisee) and there are sufficient competition in the market, the recommendation may not necessarily breach competition law.
Resale Prices II
Recommended resale prices can readily be found to be part of a concerted practice. The obvious risk is that the retail prices will be used as a method of conveying information between participants of the market, resulting in effective price fixing. The market power of the supplier is important. The stronger the supplier’s position, the more likely the recommendation will be implemented.
Certain recommended or maximum resale prices can benefit from the block exemption for vertical agreements if the market share is below 30 percent. Above that level, the anti-competitive effects may have to be analysed. It may be possible in some exceptional circumstances to show positive effects which maximum price helps to uphold.
In certain circumstances, such clauses may have a pro-competition effect, by allowing buyers to benefit from lower prices and increased competition between suppliers. In other cases, they may have anti-competitive effects, due to effective price alignment and fixing.
Most Favoured Clauses
A “most favoured” clause provides that the supplier will provide the buyer with the same terms, as it provides to others. It often gives the supplier a right of first refusal to meet other offers, which the purchaser obtained. Such clauses are not necessarily inconsistent with competition law but must be analysed.
A right of first refusal may be accompanied by the above provisions. It may alleviate the negative effects of the exclusive purchasing obligation. However, they may also have negative effects, in that they facilitate collusion between suppliers in that the buyer is obliged to reveal the competing offers received.
The first type of clause is usually found in the agreements between suppliers and distributors. It typically provides that the supplier will offer the distributor the same price that it offers other distributors. A most favoured clause could equally provide that the distributor promises the supplier that it will give terms at least as favourable or prices that are at least as high, as it gives to similar suppliers.
Under the second type of clause, the buyer must inform the supplier of better offers it receives and in some cases the sources of the offer for similar goods. The buyer may only proceed with the better offer if the supplier does not match it. Such clauses are commonly found in exclusive purchasing agreements.
Clauses which restrict passive sales into excluded EU territories or customer groups are excluded from the exemption. This is based on the EU requirements for an integrated market and the long-standing objection to compartmentalisation of the single market.
The Commission has published guidelines on the distinction between active and passive sales. The use of the internet in itself does not comprise an active sale if it is a reasonable means of marketing. Provided the website is not aimed at specific customers, primarily located in another state, it does not comprise an active sale. The language on the website is not determinative. Apart from e-commerce marketing, passive selling would include catalogue selling and responding to unsolicited orders.
The guidelines allow for a restriction of passive sales in limited circumstances. Where the distributor is first in the market selling a new brand or first to bring an established brand into a new market, the significant investment may justify a restriction on passive sales for up to two years.
Active Outside Territory
In exclusive distribution agreements, the supplier usually agrees to appoint a single distributor to sell its products in particular areas or to a particular type of customers. Commonly, the distributor is restricted from making active sales outside of its territory.
In another form of selective distribution, distributors are restricted from selling to unauthorised distributors, so that appointed dealers and final customers are the buyers. They are not given exclusive territories or customer groups.
The restriction of active or passive sales to end users, by a member of a selective distribution system operating at a retail level of trade, is prohibited. This is without prejudice to the possibility of prohibiting a member of the system from operating out of an unauthorised place of establishment
The restriction of cross supplies between distributors within a selective distribution system, including between distributors operating at a different level, is prohibited.
A restriction between a supplier of components and a buyer who incorporates those components, of the supplier’s ability to sell the components or spare parts to end users, repairers or other service providers, not entrusted by the buyer with the repair or servicing of the goods, is prohibited.
References and Sources
Comercial Law Fidelma White 2nd Ed 2012 Ch 4
Enclylopaedia of Forms and Precedents Vol. 16 (4)
International Commercial Agency and Distribution Agreements: Case Law and Contract Clauses (AIJA Series) (2011) H
Distribution Agreements under EC Comptetition Law: Viktoria Robertson (2008)
International Agency, Distribution and Licensing Agreements (Commercial) Christou
Distribution Agreements Under the EC Competition Rules 2002 Korah O’Sullivan
- Vertical Agreements I
- Vertical Agreements II
- Exclusive Distribution I
- Exclusive Distribution II
- Selective Distribution I
- Selective Distribution II
- Compliant Selective Distribution I
- Compliant Selective Distribution II
- Cumulative Selective Distribution
- Single Branding Agreements
- Resale Prices I
- Resale Prices II
- Most Favoured Clauses
- Passive Sales
- Active Outside Territory
- References and Sources