By Aurélien Condomines
Avocat à la Cour

This article aims at describing in a succinct manner the European rules applicable to distribution agreements since the entry into force of the new “block exemption regulation” in 2000 (See Regulation 2790/99 exempting certain categories of vertical agreements and Guidelines on Vertical restraint issued in 2000). This recent reform has introduced significant changes in the Commission’s approach of antitrust issues in the context of distribution agreements: (i) there is now only one exemption regulation for most types of vertical agreements, (ii) that regulation contains a list of contractual provisions which are considered not acceptable, other types of clauses being deemed acceptable (the “straightjacket” approach of the previous system has been abandoned), and (iii) the new system provides a “safe harbor” for agreements which do not exceed a 30% market share threshold, and requires a case-by-case assessment of the economic impact of vertical agreements which do meet that threshold. One difficulty, which is not addressed in this article, is that distribution agreements must also comply with applicable national competition laws.

1.  Why is competition law important in the distribution context?

Article 81-1 of the Rome Treaty prohibits anticompetitive agreements or concerted practices. Agreements infringing article 81-1 are void and may expose the parties involved to fines and/or damages before national courts and/or competition authorities. This is particularly important in the context of distribution agreements, given that – as a matter of fact - this area is one where private parties are often the most likely to go to court. For example, one of the parties to the contract may want to get rid of burdensome contractual obligations (e.g. a non-compete obligation), or a third party may want to contest a selective or exclusive distribution system in order to be allowed to resell the suppliers products.

A distribution agreement likely to have anticompetitive effects may nevertheless be exempted under article 81-3 of the Rome Treaty, which allows certain restrictive contractual provisions to be enforced, provided that they contribute to consumer welfare and “economic progress” (inter alia by improving the distribution of goods). An individual exemption can be sought from and granted by the European Commission - and only by the European Commission – by way of a cumbersome notification process and regulatory approval procedure. However, the easier way is to comply with the “block exemption” regulation (Regulation 2790/99), which provides safe harbor for certain agreements and does not require any notification or administrative procedure. An ongoing reform will probably change this system by allowing national courts and competition authorities to grant an individual exemption whenever they are reviewing the competitive impact of a given agreement or concerted practice. However, before this reform is adopted the in-house lawyer or external counsel must make sure that his company’s or client’s contracts comply with the Commission’s views as expressed in the regulation 2790/99 (and in the explanatory Guidelines on Vertical Restraints) and, in case of doubt and serious risks, contemplate the notification of the agreement to the Commission.

Regulation 2790/99 (hereafter “the Regulation”) applies to any type of agreement entered into companies, which do not operate – for the purpose of the agreement - at the same level of the production or distribution chain (i.e. so-called “vertical agreements”). This includes in particular: traditional distribution (i.e. resale) agreements, franchising, selective distribution, agency, etc. It does not include agreements which have as their primary object the licensing of intellectual property rights, nor automobile distribution agreements (which are subject to special rules), nor agreements between competitors (with certain exceptions). The assessment of agreements under the Regulation is complex, both from a procedural point of view (interaction with other regulations, possibility for the Commission to withdraw the “automatic” exemption under the regulation, etc.) and from a substantial point of view (the Commission’s views are expressed in a 40-page document called “guidelines” involving complex case-by-case economic analysis). This general article is not detailed enough to cover all the complex issues involved, especially if the market shares of the parties are high.

2. The primary factor of analysis: market shares

The new regime is supposed to be based on a case-by-case analysis of distribution agreements’ economic impact. The primary criterion chosen by the Commission to measure this economic impact is the market share of the parties involved.

First, under the Commission’s new “de minimis” notice (issued in 2002), a vertical agreement is deemed not to have any anti-competitive impact on the market if the market shares of each of the parties to the agreement do not exceed 15% (10% if the vertical agreement is concluded between competitors), except if the agreement contains so-called “hardcore restrictions”. Such an agreement does not infringe article 81-1 of the Rome Treaty.

Second, a distribution agreement which may infringe article 81-1 because it contains potentially anti-competitive provisions (exclusivity, selection of distributors, non-compete clauses, territorial restrictions, provisions concerning the resale price, etc.) and the above-mentioned 15% market threshold is met, may be exempt under article 81-3 if it does not meet the 30% threshold set forth by the Regulation. Under the Regulation, a vertical agreement is exempted if the market share of the supplier on the relevant market does not exceed 30%, except – again – if the agreement contains so-called “hardcore restrictions”. If the vertical agreement contains an exclusive supply obligation, the market share to be taken into account is that of the buyer/distributor, not that of the supplier.

Three remarks must be made at this point:

- The market share thresholds require a definition of the relevant product market and geographical market. However, while the relevant market under the “de minimis” threshold of 15% is to be defined in a “traditional” way (i.e. the market share of the supplier in the downstream market for the products supplied and the market share of the distributor as a distributor), the relevant market under the second threshold of 30% is defined as the market between the supplier and the buyer/distributor (i.e. the market share of the supplier as a supplier of products to distributors and the market share of the distributor as a buyer of such products).

- The market shares are calculated, in principle, on the basis of sales value. Only if data on sales value is not available should other factors, such as sales volume, be taken into account.

- The so-called “hardcore restrictions” are the same for the implementation of both the 15% de minimis threshold and the 30% exemption threshold (except for the case of vertical agreements entered into by competitors, where additional “hardcore restrictions” apply with respect to the 15% threshold). The “hardcore restrictions” are described below.

More specific rules concerning the fluctuation of market shares and the market impact of the accumulation of similar vertical agreements on the same market (“network effects”) can be found in the Regulation and the Guidelines published by the Commission, but are not addressed here.

If it is clear that an agreement does not exceed the 15% threshold or the 30% threshold, and does not contain any “hardcore restrictions” as described below, then no further analysis should be required – the agreement should not entail any substantial risk of nullity, damages or fines. Otherwise, its must be assessed whether the agreement falls under the prohibition of article 81-1 and could benefit from an individual exemption under article 81-3 by the European Commission. To this effect, the Guidelines on Vertical Restraints issued by the Commission in 2000 usually provide helpful guidance.

Finally, if the market share of any or both of the parties (distributor and/or supplier) is higher than 50-60% (depending on the market structure this figure may be higher or lower), and the agreement contains any type of exclusivity provision, there is a genuine risk of nullity, fines and damages. Indeed, under European law, a company enjoying a dominant position on any relevant market should in principle not be bound by exclusivity or impose such exclusivity on others. Thus, there are in fact three market share thresholds to remember (15%, 30% and 50%-60%).

3. Contractual provisions regarding resale prices

Any contractual provisions or concerted practices having the direct or indirect effect or object to fix the resale price or a minimum resale price to be observed by the buyer/distributor are considered to be “hardcore restrictions”. Such restrictions exclude any exemption of the agreement under the Regulation, as well as the granting of an individual exemption by the European Commission. This rule concerns clear-cut price-fixing provisions, but also more indirect ways of fixing prices or minimum prices such as the fixing of minimum distribution margins or the forceful implementation of pseudo-recommended prices. In particular, recommended resale prices are often on the borderline between acceptable recommendations and prohibited fixed prices, because the distributors may not have – for various practical reasons – a real choice as to resale prices.

An exception is made with respect to agency agreements, where the resale price is set by the principal, who remains at all times the owner of the products sold. However, the Commission considers that only “genuine” agency agreements can benefit from this exception, i.e. agency agreements where the principal bears all or almost all the financial and commercial risks related to the transactions concluded on his account by the agent, and the agent does not exercise an independent economic activity in relation to the activities for which he has been appointed.

As concerns provisions merely recommending resale prices or fixing a maximum resale price, they may be deemed innoxious or exempted under the Regulation if the agreement does not meet the 15% or 30% market share thresholds described above. Otherwise, the Commission may grant an exemption if it finds that the practice will not lead to a uniform price level. To this effect, the Commission may take into account various market factors. For instance, the stronger the market position of the supplier, the more likely it is that recommended prices or maximum prices will lead to uniform resale prices. Furthermore, the Commission is also wary that, when a supplier is active in an oligopoly market, “recommended” resale prices may facilitate collusion between competing suppliers.

4. Territorial and customer restrictions

Contractual provisions, which have the purpose or effect of partitioning a distribution network by customer or by territory are also considered “hardcore restrictions”, which excludes any exemption of the agreement under the Regulation or the granting of an individual exemption. There are four exceptions to that rule:

(i) It is possible to restrict “active” sales by a distributor to a territory or customer group that has been allocated exclusively to another distributor or to the supplier himself (“active sales” are sales made by actively approaching individual customers, for instance by direct mail or visits).
 
(ii) It is possible to restrict a wholesaler from selling to end-users.

(iii) It is possible, in a selective distribution system, to restrict an authorized distributor from selling to unauthorized distributors.

(iv) It is possible to restrict a buyer of components supplied for incorporation into another product from reselling them to customers who would use them to manufacture the same types of goods as those produced by the supplier.

A distribution agreement containing one or several of these four provisions is exempted under the Regulation if the above-mentioned market share threshold of 30% is not met. In cases where the market share threshold is met (i.e. the supplier’s or distributor’s market share exceeds 30%), an individual exemption by the Commission may be required.

The Commission has indicated in the Guidelines on vertical Restraints that it would grant an individual exemption in certain cases:

- Exclusive distribution (there is only one appointed distributor for a contractually defined territory): the stronger the market position of the supplier, the more competition between distributors will be reduced. Furthermore, when a supplier is active in an oligopoly market or if the same company is the exclusive distributor of several suppliers, exclusive distribution may facilitate collusion between competing suppliers. Moreover, the combination of exclusive distribution with exclusive purchasing obligations may have serious anti-competitive effects. Various other factors may come into consideration in the Commission’s assessment, and the more restrictive effects the agreement has, the more it will be necessary to demonstrate that the distribution system will carry strong efficiencies (economies of scale, better quality of service, better distribution of complex or new products, etc.).

- Customer allocation (only one distributor is appointed for a specific category of customers):  the same remarks as stated regarding exclusive distribution apply, with the exception that the Commission is more reluctant to exempt customer allocation. It appears that such practices are only likely to be exempted on an individual basis if they are justified by substantial efficiency effects. As a general rule, the case is strongest for new or complex products where customers have specific needs and the distributors are required to make specific investments to meet customer requirements. In addition, exemption is unlikely if the customers allocated are at the consumer level.

5. Non-compete provisions/exclusive purchase obligations imposed on the distributor

The Regulation provides for a specific type of “hardcore restrictions” concerning non-compete provisions and exclusive purchase obligations: such “hardcore restrictions” do not exclude exemption of the whole agreement, but merely cause the contractual provisions concerned to be excluded from exemption under the Regulation:

- Non-compete: A contractual provision causing the distributor not to sell / manufacture / purchase competing products is not exempted under the Regulation if its duration is indefinite or exceeds 5 years (obligations which are tacitly renewable after a 5 years period are deemed to be indefinite). If the distributor sells the products from premises owned or leased by the supplier, such contractual provisions are exempted under the regulation even if they exceed 5 years, provided that they do not exceed the duration of occupancy of said premises by the distributor.

- Purchase obligations: A contractual provision causing the distributor to purchase more than 80% (in value) of his total purchases of the products concerned from the supplier or from a third party designated by the supplier is not exempted under the Regulation if its duration is indefinite or exceeds 5 years (obligations which are tacitly renewable after a 5 years period are deemed to be indefinite). Again, if the distributor sells the products from premises owned or leased by the supplier, such contractual provisions are exempted under the regulation even if they exceed 5 years, provided that they do not exceed the duration of occupancy of said premises by the distributor.

- Post-term ban: A contractual provision restraining the distributor from selling / manufacturing / purchasing competing products after the termination of the distribution agreement is not exempted under the Regulation. There is one exception - such a provision is exempted if (i) it relates to products which compete with the products concerned by the agreement, (ii) it is limited to the premises from which the distributor has operated during the contractual period, (iii) it is indispensable to protect substantial know-how transferred to the distributor, and (iv) it is limited to a duration of one year after termination of the contract (without prejudice to the possibility of prohibiting the use and disclosure of know-how for an unlimited time).

If the 30% exemption threshold provided for in the Regulation is met and the agreement contains non-compete / exclusive purchase provisions, the parties may want to obtain an individual exemption from the Commission. Such exemption will be granted depending on various factors. In particular, the higher the supplier’s market share, the more the agreement will have anti-competitive effects. Also, the longer the duration of the non-compete / exclusive purchase provision, the more the agreement will have anti-competitive effects (a duration exceeding 5 years will rarely be considered acceptable). Finally, the combination with other restrictive provisions (e.g. a selective distribution system) may not be acceptable because it would entail a too strong foreclosure effect.

6. Sale of spare parts

Under the Regulation, a contractual provision which restrains the supplier from selling spare parts directly to end-users or to repairers or other service providers outside the distributor’s network is a “hardcore restriction”. A distribution agreement containing such provision would thus not be exempted under the Regulation (note that, on the contrary, in a “sub-contracting” agreement such a provision would not even be considered anti-competitive).

7. The particular case of selective distribution (including franchising agreements)

In a selective distribution system, the supplier sells the products only to authorized distributors selected on the basis of specific criteria and these distributors undertake not to sell the products to unauthorized distributors. Under the new European regime, selective distribution systems in which the selection criteria are qualitative (e.g. quality of service and personnel), but also where the selection criteria are quantitative (i.e. limitation in the number of distributors) may be exempted under the Regulation if the 30% exemption threshold is not met. In addition, franchising agreements seem to be subject to the same rules as selective distribution agreements (although they are not explicitly mentioned in the Regulation).

A selective distribution system may even not be considered anti-competitive at all under article 81-1 of the Rome Treaty if (i) the selection criteria are strictly necessary, qualitative (i.e. not quantitative) and applied in a non-discriminatory manner, and (ii) the nature of the products concerned justifies the selective approach (e.g. complex/new products or luxury products).

There are two “hardcore restrictions” which, if they are provided for in a selective distribution agreement, infringe article 81 of the Rome Treaty and exclude the exemption of the agreement under the Regulation (in addition to other “hardcore restrictions” as described in this article, such as minimum resale price requirements or certain types of exclusive dealing, etc.):

- It is considered a “hardcore restriction” to restrict a selective distributor at the retail level from selling (actively or passively) to end-users. This is without prejudice to the possibility of requiring such distributor to operate only from an authorized place of establishment. It also does not restrain the supplier from committing to supply only one distributor on a specific territory (exclusive distribution), provided that the distributors can sell the products to whomever they want at the retail level.

-  It is considered a “hardcore restriction” to restrict cross-supplies between selective distributors within the same network, even if they are not at the same level of trade.

It is further provided in the Regulation that contractual provisions causing the members of a selective distribution system not to sell the brands of one ore more designated competing suppliers shall not be exempted. This rule differs from the “hardcore restrictions” described above, because it does not exclude the exemption of the whole agreement, but merely that of the particular contractual provision.

If the agreement containing restrictive (but not “hardcore”) provisions is not exempted under the Regulation because the 30% market share threshold is met, an individual exemption may be sought from the Commission. The Commission takes into account several factors for granting such exemptions, and in particular: the market share of the supplier (the stronger it is, the more the agreement may affect competition), the existence of other selective networks in the same market (several selective networks reduce intra-brand competition and increase the risks of collusion between suppliers), the combination of the selective system with non-compete obligations imposed on the distributor (which increases foreclosure effects), etc. Finally, as concerns franchise agreements, the Commission has pointed out certain specific criteria in its Guidelines on Vertical Restraints, which are not addressed in this article.
 

(April 2002)

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