UK: New Rules for Supply Agreements Finally Published

The European Commission has published the final text of the block exemption for "vertical agreements", i.e. distribution and other supply agreements. It has also published extensive guidelines to explain the principles it will apply in assessing vertical agreements under the new rules. The block exemption and the guidelines can be found here . The text of the guidelines is subject to subsequent linguistic amendment.

The new rules, which replace the current block exemption and guidelines on 1 June 2010, follow a lengthy and detailed process of consultation and revision. The importance of the vertical agreements regime to companies in all sectors cannot be overstated: for the last ten years, the outgoing rules have proved an indispensable source for the analysis of a wide variety of supply arrangements; and, equally, the new rules are likely to prove essential for an assessment of the compliance position of many commercial agreements.

It is significant that the Commission is retaining the basic elements of the old regime. This is in contrast to the radical changes it is making to the block exemption rules for specific sectors (e.g. automotive and insurance). The Commission clearly feels the outgoing regime has worked well. The Commission has, however, made significant amendments to the verticals regime in order to reflect both market developments and its enforcement experience over the last decade. As expected, the main changes have particular regard to the increased buyer power of big retailers and the evolution of online trade.

The remainder of this Law-Now highlights in greater detail the main areas of development relevant to suppliers and, increasingly, purchasers.

("Purchaser" and "distributor" are used interchangeably below to refer to the entity purchasing from a supplier under a vertical agreement.)

What is the structure of the verticals regime (old and new)?

The new block exemption is the second block exemption to cover vertical agreements generally. The original block exemption, implemented in 2000, introduced a regime based upon automatic exemption for restrictive agreements where (i) market share thresholds were not exceeded and (ii) a limited black list of restrictions were not infringed (price-fixing/export bans etc).

Agreements which exceed market share thresholds, but do not contain black-listed restrictions, are not automatically prohibited. They simply fail to obtain automatic or "block" exemption and require analysis on an individual basis to see if they remain exemptible. The 2000 regime also set out, in detailed guidelines which have proved useful for the analysis of supply agreements, a flexible approach to assess restrictions for companies which fell outside the market share thresholds, but did not infringe the black list.

Again, the structure of this regime is retained, but with a significant number of key changes and refinements.

The main change: general threshold for purchaser's market share

The main change is to the market share thresholds. For an agreement to benefit from automatic exemption, not only the supplier's but also the purchaser's market share must not exceed 30%.

  • The exact wording of the new provision is that the purchaser's market share must "not exceed 30% of the relevant market on which it purchases the contract goods or services".
  • The Commission has stated that this change is motivated by the market power of larger retailers and distributors.
  • This contrasts with the outgoing regime, where the relevant market share threshold (also 30%) was the supplier's, the purchaser's share being relevant only to provisions restricting the supplier from selling to other EU-located purchasers. Reference to this type of restriction has now been removed from the block exemption (although it is still assessed in the guidelines).
  • In many cases, this new market share threshold will result in increased and onerous economic/legal analysis for the parties to a supply agreement. Over the last decade, it has proved difficult enough to establish market shares for suppliers. It may be harder to assess purchase markets for contractual products, since purchasers may be less likely (than suppliers) to have appropriate information available.

More permissive approach to passive selling restrictions

The block exemption itself is unchanged in relation to its provisions on restricting active and passive selling, and the general rule remains that a supplier must not prevent a distributor from responding to unsolicited business opportunities outside its designated territory or customer group, i.e. "passive" selling.

However, the point likely to be of most interest to businesses generally is the carve-out in the guidelines which allows a restriction of passive sales in certain circumstances. The carve-out permits a restriction of passive sales for two years to a territory or customer group reserved for a distributor selling a new brand, or into a new market, where that new distributor has significant start-up costs in making investments and/or in developing the new market.

It is interesting that this carve-out is found in the guidelines and not within the text of the block exemption, since an equivalent provision for technology licences is found in the text of the technology transfer block exemption itself.

Even though this point is not found in the block exemption text, it is likely to be of considerable practical importance to suppliers with a cross-border network of distributors.

Fine-tuning of passive/active distinction for online sales

The guidelines are clear that in general having a website will be considered passive selling only, and so restricting sales via a website will generally be unlawful. Passive selling via a website includes customers visiting the website and contacting the distributor with a view to a purchase, and customers opting to be kept automatically informed via a distributor's website. The choice of website language options will be considered part of passive selling, and in their own right will not amount to active selling into regions with a particular language.

Online advertisement specifically addressed to certain customers will, on the other hand, be considered a form of active selling to those customers. For example, territory-based banners on third party websites are a form of active sales into the territory where these banners are shown, and paying a search engine or online advertisement provider to have advertisements displayed specifically to users in a particular territory will be active selling into that territory.

Updated analysis of online selling restrictions

The guidelines update and amplify the guidance on a supplier's ability to restrict on-sales by its purchasers, and in particular on-sales via the internet. In general the aim appears to be maximising use of the internet as a distribution channel, and recognising technological advances in online sales and marketing. The Commission sets out, for example, that the following will be hardcore restrictions of competition:

  • Agreeing that an exclusive distributor will stop customers from another exclusively allocated territory from viewing its website, or will re-route customers automatically to a website in another territory (although this does not exclude an agreement that the distributor's website offers links to the websites of other distributors and/or the supplier).
  • Agreeing that an exclusive distributor shall terminate consumers' transactions over the internet if their credit card data reveal that they are outside that distributor's territory.
  • Agreeing that a distributor shall limit its proportion of overall sales made over the internet (although a supplier may require, without limiting online sales, that a distributor sells a certain absolute amount of the products off-line to ensure efficient operation of its brick-and-mortar shop, and the supplier may also ensure that a distributor's online activity remains consistent with the supplier's distribution model).
  • Agreeing that a distributor shall pay more for products intended to be sold online rather than off-line (although this does not exclude the supplier agreeing with the buyer a fixed fee, i.e. not increasing with realised off-line turnover, in order to support the buyer's off-line or online sales efforts).

The guidelines specifically state, however, that in some limited circumstances a manufacturer may be able to charge more for products intended to be resold online than those to be resold off-line. In particular, this may be permissible where sales online lead to substantially higher costs for the manufacturer than off-line sales e.g. where these are likely to lead to more customer complaints and warranty claims due to the nature of the product and the lack of off-line support.

A supplier is also able to require quality standards for the use of an internet site (as it could for a shop). In a selective distribution system, a supplier may require that a distributor have one or more brick-and-mortar shops as a condition of membership of the distribution system. A supplier may also require that its distributors use third party platforms to distribute the contract products only in accordance with the standards and conditions agreed between the supplier and its distributors for online sales, e.g. a supplier may require that customers do not visit a distributor's website through a site carrying the name or logo of the third party platform hosting that site.

Suppliers must not discourage distributors from selling online by imposing more onerous criteria than those for off-line sales. Criteria need not be identical, but they must be equivalent overall, and any differences must reflect differences between those two forms of selling.

New analysis of upfront access payments and category payments

New sections in the guidelines indicate how the Commission will apply the law to two specific types of vertical restraint that were not expressly analysed in the old guidelines. These are upfront access payments (i.e. various fees that suppliers pay in order to get access to a distribution network and remunerate services provided to the suppliers by the purchasing retailers) and category management agreements (where a supplier is entrusted with marketing a whole category of products, rather than just its own products in that category). Although there is nothing novel in the law set out in these sections, the mere fact that the Commission has clarified its thinking in these areas has generally been welcomed. Their inclusion also emphasises that the Commission is concerned about such practices, whilst recognising their potential positive effects.

The Commission notes that both upfront access payments and category management are covered by the block exemption where both parties' market shares do not exceed 30% and that both can lead to efficiencies. It also gives guidance on the likely situation where the market share is above 30%.

  • For upfront access payments, the Commission will be concerned, for instance, by situations where payments are high and their use is widespread as this could increase market entry barriers at the supply level or facilitate collusion between purchasers in concentrated retail markets.
  • For category management, the Commission is concerned this could lead to collusion between retailers (e.g. where the same supplier is category manager for all/most competing retailers) or between suppliers (e.g. increased opportunities to exchange sensitive commercial data). Other brands (whether competing with the category leader's brands or with the retailer's own-label products) could be disadvantaged.

Resale price restrictions – hint at a more flexible approach

There is a new section in the guidelines analysing how the law should be applied to resale price maintenance (RPM), i.e. the supplier in some way imposing on a distributor a resale price which is not a maximum or recommended price. In this new section, which supplements the existing (and retained) section on RPM from the old guidelines, the existing rules on RPM are reiterated and its anti-competitive effects clearly enumerated. As with the old guidelines, the new guidelines leave no room for doubt as to the hardcore nature of RPM.

In addition, however, the guidelines now set out various economic benefits (efficiencies) that could potentially apply to the use of RPM for new products or promotions, but only in defined circumstances. It seems that these kinds of efficiencies will not be easy to demonstrate, but this change in the guidelines indicates that such arguments can be made. This is again a clarification of the current situation, but it is significant that the guidelines even hint at more flexibility for a form of restriction which has always been perceived as hardcore.

How will the new rules be phased in?

The new block exemption comes into force on 1 June 2010 and will be valid until 31 May 2022.

Agreements already implemented before 1 June 2010 will benefit from a one-year transitional period. In other words, if an existing agreement already satisfies the conditions of the old rules, its parties do not need to worry about the new rules until 1 June 2011.

The transitional period is, above all, relevant to agreements which could lose automatic exemption because (under the new rules) they do not satisfy the threshold for the purchaser's market share.

Conclusion

Despite the similarities with the old regime, there are significant changes and developments in the new rules for vertical agreements. Companies need to decide whether existing arrangements need auditing to ensure compliance with the new rules on (above all) the purchaser's market share and online trade. For new arrangements, i.e. which will be implemented after 1 June 2010, suppliers and purchasers will have to assess information on the purchaser's market position, as well as online trade issues and compliance with the core and unchanged rules on verticals.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 21/04/2010.

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