The Competition Commission recently found a dual distribution restraint to amount to a market allocation agreement between competitors, which is outright unlawful under the Competition Act, 89 of 1998.
The Commission's approach in this matter is contrary to the prevailing international approach to dual distribution restraints and is, with respect, based on an incorrect interpretation of the relevant legal provisions.
On a proper application of the relevant provisions, such restraints should not be treated as outright unlawful and should only be declared unlawful if they are found to have an anti-competitive effect and cannot be justified on pro-competitive grounds. The Commission's approach is worrying since it may undermine firms' optimal commercial decisions on how best to distribute products.
A situation where a supplier simultaneously sells to independent distributors and to those who might be customers of those distributors is referred to in competition law as "dual distribution". Dual distribution arrangements often include restraints on the supplier not to sell goods to certain categories of customers or in certain territories.
Recently, a restraint relating to a dual distribution arrangement involving Sasol Limited (Sasol) and Spring Light Gas (SLG) came under attack by the Competition Commission. The restraint was contained in a supply agreement between Sasol, an upstream supplier of natural gas, and SLG, a downstream trader of natural gas in KwaZulu-Natal.
In terms of the restraint, Sasol agreed not to compete with SLG for the trading of natural gas in KwaZulu-Natal in order to allow SLG to develop its business. The Commission found that the restraint contravened the outright prohibition against competitors allocating markets between themselves and rejected an application by SLG for exemption of the restraint from the provisions in the Competition Act.
The relationship between Sasol and SLG may be viewed as hybrid in nature as it involves both a supply (vertical) dimension and a competitive (horizontal) dimension. On the one hand, Sasol and SLG are in a vertical supply arrangement with each other as Sasol supplies SLG with natural gas which SLG then on-sells to customers. On the other hand, Sasol and SLG may be perceived to be in a potential competitive (horizontal) relationship with each other, to the extent that Sasol is a potential trader of natural gas in KwaZulu-Natal.
The Commission's approach suggests it believes that restraints which flow from a vertical supply arrangement between parties in a hybrid relationship should be assessed under the stricter prohibitions in the Competition Act − these being the prohibitions that apply to market allocation restraints between firms in a horizontal (competitive) relationship rather than under the more permissive prohibitions that apply to such restraints between firms in a vertical relationship.1
This approach is contrary to the approach that has been adopted in leading competition law jurisdictions and is based on an incorrect interpretation of the relevant provisions in the Competition Act.
Very often dual distribution restraints are entered into between suppliers and their customers for legitimate commercial reasons. A supplier may find it unprofitable or not in keeping with its business strategy to distribute in certain areas, where an independent distributor may be better placed to do so. An independent distributor may require comfort that it will not have to compete with their suppliers for customers in a region before they will invest in start-up costs.
Dual distribution restraints in other jurisdictions
There has been some contention over the years as to how to treat dual distribution restraints due to the hybrid nature of dual distribution. However, the prevailing approach in US law and in the guidelines issued by the competition authorities in Europe and Canada, is to characterise such restraints as vertical rather than horizontal. The authorities in these jurisdictions, therefore, take a more permissive approach towards them.
Recent American cases and leading American commentators have acknowledged that where hybrid relationships exist, a so-called rule of reason evaluation should be performed to assess the net impact of the restraints.2 A rule of reason analysis involves determining whether conduct can be justified on the basis that its pro-competitive gains outweigh its anti-competitive effects.
The guidelines issued by the European Commission treat non-reciprocal dual distribution arrangements as vertical agreements, which are not outright unlawful.3
The Canadian Competition Bureau's Competitor Collaboration Guidelines4 (Collaboration Guidelines) state that, "The Bureau does not consider a supplier of a customer to be a competitor of a customer in respect of the product supplied".
The Collaboration Guidelines acknowledge that it may be difficult to distinguish between a horizontal and a vertical restraint in a dual distribution context, but they point out that such agreements can be pro-competitive and are therefore not deserving of condemnation without an enquiry into their actual competitive effects.
Dual distribution restraints in South African law
In terms of South Africa's Competition Act, if a market allocation restraint is considered to be a horizontal agreement, it will probably be characterised as outright unlawful cartel conduct in terms of section 4(1)(b) of the Act.5 In other words, it will be considered unlawful regardless of whether it has an actual anti-competitive effect or if it could be justified on the basis of pro-competitive gains.
In contrast, if it is considered a vertical agreement it will be assessed in terms of section 5(1) of the Act. In this case, the agreement will only be unlawful if it results in anti-competitive effects which cannot be justified on the basis of pro-competitive gains.
This distinction is important in that, if a restraint is found to contravene the outright prohibition in section 4(1)(b), a penalty of up to 10% of turnover can be imposed for a first time contravention. By comparison, if the restraint is found to contravene the prohibition applicable to vertical restraints (section 5(1)), it will only attract a penalty for a repeat contravention.
There is no South African case law dealing with the question of whether the relationship between parties in a dual distribution relationship should be treated as horizontal or vertical. However, the guidance that has been provided by the courts to date as well as the principles of legislative interpretation support the view that dual distribution relationships should be treated as vertical rather than as horizontal.
Firstly, in the ANSAC6 case, the Supreme Court of Appeal indicated that conduct should be characterised taking into account the intention of the parties. It found that only conduct which is designed to avoid competition, rather than conduct which merely has that incidental effect, should be prohibited outright in terms of section 4(1)(b).
In the Nedschroef7 case, the Tribunal held that the absence of reciprocity in a restraint may indicate that the relationship between the firms concerned should not be characterised as horizontal.
Secondly, in terms of the principles of legislative interpretation, because of the potentially large administrative penalties that can be imposed for contravening the outright prohibition in section 4(1)(b), this provision should be restrictively interpreted so that only naked forms of cartel behaviour fall within its scope.
Furthermore, too broad an interpretation of section 4 (which applies to horizontal restraints) would render section 5 (which applies to vertical restraints) unnecessary as all vertical relationships would be viewed as horizontal, given that all suppliers are also potential competitors to their distributors.
In our view, the Commission has incorrectly assessed Sasol and SLG's dual distribution arrangement as outright prohibited conduct. A consequence of this is that firms may in future be deterred from entering into such arrangements for legitimate pro-competitive reasons. A rule of reason treatment of dual distribution restraints is therefore preferable.
1. In contrast to this approach, in 2007 the Commission considered a similar relationship to be vertical in nature; The Competition Commission and Zip Heaters (Australia) Pty Ltd, case no. 17/CR/Feb07
2. Antitrust Law: An Analysis of Antitrust Principles and their Application, P. Areeda and H Hovenkamp, at para 1605a
3.The European Commission Guidelines on the applicability of Article 101 of the Treaty on the Functioning of the European Union to Horizontal Co-operation Agreements (2011/C 11/01) specify that the Block Exemption Regulation on Vertical Restraints (Commission Regulation (EU) No 330/2010 of April 2010) and Guidelines on Vertical Restraints (OJ C 130, 19.5.2010) cover non-reciprocal dual distribution arrangements
4. Enforcement Guidelines, December 23, 2009
5. However, it is worth noting that if the competition authorities were mindful of the vertical dimensions of the "horizontal" restraint, they might consider the conduct under section 4(1)(a), which involves a balancing of the pro-competitive gains and the anti-competitive effects of the restraint. This would be equivalent to assessing the restraint as a vertical restraint, which we submit is the appropriate approach to assessing such restraints
6. American Natural Soda Ash Corporation and another v Competition Commission and others 2005 6 SA 158 (SCA)
7. Nedschroef Johannesburg (Pty) Ltd v Teamcor Limited and others, Case No. 95/IR/Oct05
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