Vertical limit
In early May, the European Commission adopted revised competition rules regarding contracts containing supply or distribution arrangements for goods or services. Cormac Little explains.
The new EU regime on ‘vertical agreements’ entered into force on 1 June 2022. This reform represents the culmination of an extensive review process lasting four years, involving engagement with third parties regarding the operation of the relevant EU block-exemption/safe-harbour regime adopted by the commission in 2010.
The purpose of the new rules is to help businesses navigate a commercial environment that has been significantly altered by the growth of e-commerce.
Mindful of these trading developments, coupled with enforcement experience throughout the EU, the new regime brings certain provisions within the safe harbour, but other arrange-ments now fall outside.
The new rules are primarily contained in a new EU block exemption for vertical agreements, namely, Commission Regulation 2022/720 (the 2022 VBER). This law is accompanied by new Guidelines on Vertical Restraints. Both texts were adopted by the commission on 10 May 2022.
The 2022 guidelines provide guidance on the provisions contained in the 2022 VBER, as well as practical examples to help businesses determine whether their vertical agreements are enforceable under EU competition law.
Touching the void
The relevant EU competition rules regarding arrangements between two or more under-takings, such as vertical agreements, are contained in article 101 of the Treaty on the Functioning of the European Union. Article 101(1) prohibits and renders void anti-competitive arrangements between two or more undertakings that affect trade between EU member states.
However, arrangements that infringe article 101(1) may be exempted under article 101(3) if, applying four separate criteria, they are more pro-competitive than anti-competitive. If an agreement benefits from an exemption, it is lawful and enforceable.
To ease the compliance burden on businesses throughout the EU, the commission has adopted various laws (commonly referred to as block exemptions) whose purpose is to define categories of agreements that can be assumed with sufficient certainty to fulfil the four criteria contained in article 101(3), therefore exempting those arrangements from the prohibition contained in article 101(1).
The rationale behind the 2022 VBER (and its predecessors) is that, while vertical agreements may stimulate inter-brand competition, they also carry competition risks by increasing barriers to entry, softening intra-brand competition, and facilitating horizontal (that is, at the same level of the supply chain) collusion.
Businesses operating in the European Economic Area must engage in a three-step process to self-assess whether their vertical agreements comply with article 101:
- Assess whether the relevant contract has the object or effect of restricting competition within the meaning of article 101(1),
- If so, ascertain whether the relevant agreement satisfies the provisions of the 2022 VBER/2022 guidelines,
- If not, consider whether the contract in question is otherwise exempted under article 101(3).
Alive
While the 2022 VBER does, as mentioned above, include some significant reforms, the new law continues to provide for an exemption from article 101(3) for arrangements between suppliers and purchasers, provided certain conditions are met.
Indeed, the 2022 VBER contains the same market-share threshold. Accordingly, contracts between suppliers and buyers may qualify for the safe harbour, provided their respective most recent annual market shares are no more than 30%.
As with its predecessor, the VBER includes a series of hardcore restrictions that lead to the entire agreement falling outside article 101(3). Certain hardcore restrictions remain unchanged – for instance, resale price maintenance is still banned.
The VBER also continues to contain a list of various excluded clauses that require self-assessment as to whether an individual exemption might apply.
For example, the relevant parties should continue to decide themselves whether a non-compete obligation of longer than five years is enforceable.
The Eiger sanction
As stated above, the commission, before adopting the new rules, completed a thorough evaluation of the operation of the 2010 regime. Although this process found that the overall impact of these rules had been positive, the commission decided that it was appropriate to adjust the scope of the safe harbour to ensure that it is neither too generous nor too narrow.
Put another way, the consultation found that certain contracts, which could not be assumed with sufficient certainty to fulfil the quartet of cumulative article 101(3) criteria, were benefiting from the block exemption. These agreements are known as ‘false positives’.
By contrast, the commission learned that certain vertical provisions, falling outside the scope of the safe harbour, could, nevertheless, be assumed with sufficient certainty to fulfil the conditions of article 101(3).
These agreements are known as ‘false negatives’.
The most significant changes in the 2022 VBER thus relate to the following – the first two are seen as false positives, whereas the latter pair are seen as false negatives:
- Dual distribution,
- ‘Most favoured nation’ or MFN clauses,
- Active sales restrictions, and
- Certain indirect measures restricting online sales.
Dual distribution means a situation where a supplier sells goods and services both through independent distributors and directly to customers, making the supplier a competitor of its distributors. While distribution agreements between business rivals are generally excluded from the safe harbour, the 2010 rules did exempt a non-reciprocal vertical agreement where the manufacturer and the distributor only compete at the downstream level, but not at the upstream level.
The commission was con-cerned that this provision might allow for the exchange of competitively sensitive information between compet-itors. Therefore, under the 2022 VBER, any information exchange in a dual-distribution scenario between a supplier and a buyer now falls outside the safe harbour where it:
- Is not directly related to the implementation of the vertical agreement, or
- Is not necessary to improve the production or distribution of the contract goods or services.
MFN clauses, also known as parity obligations, require a seller to offer goods/services to a buyer on conditions no less favourable than those the same seller offers to another buyer through other sales/marketing channels (such as this supplier’s own website). As the 2010 regime did not specifically address parity obligations, all types of such clauses were block exempted.
That said, in the intervening period, MFN clauses, parti-cularly regarding online travel bookings by consumers, became the subject of various competition investigations/enforcement action throughout the EU (including in Ireland). This led to the distinction between wide retail/cross-platform MFNs and narrow MFNs.
The former category restricts suppliers from offering more favourable terms on all of their sales channels plus any rival online platforms, whereas the latter prevents a supplier from offering better terms on its own website but does allow it to offer more favourable conditions on rival channels (including third party websites).
Under the 2022 VBER, all MFNs benefit from the safe harbour, with the exception of cross-platform parity obligations.
Active sales restrictions are limitations on a buyer’s ability to approach individual customers directly. Such clauses were identified by the commission as an example of false negatives that should be covered by the safe harbour.
The 2010 regime contained narrow exceptions, whereby only active sales restrictions imposed by a supplier on the buyer fell within the safe harbour (and not on customers of the buyer).
The evidence gathered during the review of the 2010 rules also indicated that certain aspects of the rules on active sales restrictions limited suppliers in designing their distribution systems according to their business needs.
The 2022 guidelines thus provide a clearer definition of so-called ‘active sales’ and ‘active sales restrictions’, thus extending the scope of the safe harbour.
Active sales include targeting customers via direct communication, price comparison services, or advertising on search engines targeting customers in particular territories, etc. In addition, a supplier, under the 2022 VBER, may now compel its distributors to pass on active sales limitations to their respective customers.
Certain indirect measures restricting online sales: another potential false negative addressed by the commission related to e-commerce. The review of the 2010 VBER showed that the development of online sales has been such that they no longer require special protection relative to offline sales.
Under the 2022 VBER, dual pricing (that is, charging the distributor a higher wholesale price for products to be sold offline than for those to be marketed on the internet) is no longer a hardcore restriction. Accordingly, suppliers may apply different wholesale prices to online and offline sales to encourage or reward investment.
Although there is no requirement for suppliers to perform comprehensive cost calculations or share detailed cost information, the different wholesale rates must be reasonably related to cost or investment disparities between the online and offline sales channels.
That said, certain conditions apply to dual pricing or else the safe harbour does not apply. Specifically, the difference in wholesale prices for online and offline sales should not be used to limit cross-border trade or inhibit the buyer from making proper use of the internet.
While the parties are allowed to create a system that allows them to execute dual pricing efficiently, any such mechanism should not limit the number of products the buyer can offer online.
Separately, the imposition by suppliers of other varying criteria for online and offline sales is also no longer treated as a hardcore restriction.
The climb
The 2022 VBER aims to harmonise the approach to online restrictions across the EU. The new rules provide that any restrictions on online sales constitute a hardcore restriction where they prevent buyers or their customers from effectively using the internet to sell the relevant goods or services, including any attempt to prevent the general use of one or more online advertising channels (such as a search engine or price-comparison website).
The 2022 guidelines expand on the 2022 VBER, providing that arrangements such as requiring the buyer to sell the relevant products in a ‘bricks-and-mortar’ store only, obliging the buyer to seek the supplier’s permission before making an online sale, and prohibiting the buyer from establishing/operating an online store are all hardcore restrictions.
The 2022 guidelines also seek to address the distinction between online passive and active sales. For example, a sales website is an example for the former. However, translating that website into a language not commonly used in the territory of the distributor is a form of the latter.
For example, if a French distributor had an English-language website, this would be seen as a form of active selling.
Free solo
The 2022 VBER and 2022 guidelines largely achieve their joint aim of providing entities doing business in the European Economic Area with simpler, clearer, more up-to-date rules, thereby enhancing legal certainty and making it easier for them (and their legal advisors) to decide whether their respective proposed cross-border contracts are likely to be enforceable.
It remains to be seen whether the Competition and Consumer Protection Commission will follow the approach of the European Commission, given that the Irish regime on vertical agreements is currently due to expire at end of this year.
That said, EU law has primacy over national law so, if necessary, businesses would be well-advised to adapt their vertical agreements to the new EU rules prior to the end of the transitional period on 31 May 2023.
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Cormac Little
Cormac Little is head of competition and regulation at William Fry