The differences between US and EU distribution laws reveal that companies must be vigilant to ensure that their distribution strategies align with both systems of law.
On 20 April 2010, the European Commission adopted a new Regulation which exempts certain distribution agreements from competition law rules prohibiting restrictive agreements, namely Article 101 of the Treaty on the Functioning of the European Union (TFEU). This Regulation, known as the Vertical Restraints Block Exemption Regulation (VBER), replaces the current VBER, which expires on 31 May 2010.
Agreements which benefit from the VBER are automatically exempted from the general prohibition of Article 101(1) TFEU. Agreements that are not covered by the VBER are not presumptively illegal; rather, they must be analysed individually for possible exemption under Article 101(3) TFEU. The new VBER is accompanied by new Guidelines which explain how companies should apply the VBER, and which outline the Commission’s analytical approach to distribution agreements that cannot benefit from the VBER’s exemption from competition rules.
The new VBER maintains the familiar approach that distribution agreements are exempt from competition law scrutiny so long as the supplier’s market share is within the 30 per cent market share safe harbour and the agreement does not contain certain “hardcore” provisions (such as price fixing). However, the new VBER also includes important changes to the market share safe harbour. In addition, the new Guidelines reveal the Commission’s analytical approach to online distribution, and clarify how manufacturers can—and cannot—restrict their distributors’ online sales and still benefit from the VBER. Finally, the Guidelines also suggest a subtle shift in the Commission’s views on resale price maintenance (RPM).
The changes to the VBER and Guidelines affect the way in which companies supplying or distributing in the European Union do business, and awareness of these changes is therefore critical. This article describes these key changes and draws comparisons with US law.
Market Share Safe Harbour
Since the previous VBER took effect in 2000, the market share of the supplier in a distribution agreement has been a key criterion for the application of the VBER’s safe harbour. Under the previous rules, the VBER could apply to a distribution agreement where the supplier had a market share of 30 per cent or less.
The new VBER, however, creates a second market share threshold, which considers the buyer’s market share. Thus, for the VBER safe harbour to apply, a supplier must still have a 30 per cent or less market share in the market in which it sells the contract goods or services. Now, however, the buyer’s market share also must not exceed 30 per cent of the relevant market in which it purchases the contract goods or services.
The Commission contends that this change is beneficial because it accounts for strong buyers which could leverage their market power, resulting in anti-competitive effects. The Commission also asserts that this change will benefit small and medium-sized enterprises (whether supplier or distributor), because they are more likely to benefit from the VBER safe harbour (and therefore are attractive distribution partners).
As a practical matter, however, companies wishing to benefit from the safe harbour offered by the VBER are likely to find the application of the new VBER more complex than the old rules, since both the supplier’s and the buyer’s market shares must now be considered.
As a starting point, the Commission’s approach to online distribution is that, “[i]n principle, every distributor must be allowed to use the internet to sell products.” But this principle is not without limitation. Understanding these new rules is critical, because limitations on online sales that exceed the bounds of the Commission’s approach can disqualify a company from benefiting from the VBER and put its distribution strategy at risk. At the same time, these rules provide companies with clearer guidance on permissible online distribution strategies in Europe.
General Principles: Active versus Passive Sales
The new VBER maintains the rule that a supplier may restrict its distributor from making active sales into a territory or to a customer group reserved to another distributor, but cannot restrict its distributors from making passive sales. Until now, the Commission has presumed that online distribution generally constituted passive sales and therefore could not be restricted by a supplier. As a result, online distribution—and the distinction between active and passive sales—has been one of the most difficult and controversial areas in EU distribution law.
Although the new VBER’s text does not explicitly refer to online distribution, the Guidelines distinguish for the first time between active online distribution (which in principle can be restricted) and passive online distribution (which cannot be restricted).
According to the Commission, a distributor engages in “active” online sales when it actively approaches individual customers or a certain territory, such as by taking the following actions:
- Sending unsolicited e-mails (or other direct mail) to customers
- Conducting internet advertising or other promotions specifically targeted at certain territories or customers
- Placing territory-based banners on third-party websites
- Paying a search engine or online advertisement provider to have an advertisement displayed specifically to users in a particular territory
Suppliers are permitted to restrict this type of active selling and still benefit from the VBER (if other conditions are met).
On the other hand, the Commission has also provided guidance on what constitutes “passive” online selling, which a supplier cannot restrict and still benefit from the VBER. The following are examples of “passive” online selling:
- Responding to unsolicited requests from individual customers (including requests for delivery)
- Hosting a website, even if it creates effects in another territory or in another customer group (in the Commission’s view, such sales are a consequence of easy internet access, not the distributor’s efforts)
- Receiving sales resulting from a customer opting to be kept (automatically) informed by a distributor
In addition to providing examples of passive online sales, the Commission identifies a non-exhaustive list of restrictions that it will consider hardcore restrictions of passive sales (and render the VBER unavailable). These include restrictions that would generally do the following:
- Prevent customers located outside a distributor’s allocated territory from viewing its website, or automatically re-route such customers
- Require a distributor to terminate an online transaction if the customer’s credit card data reveal an address outside the distributor’s allocated territory
- Limit the proportion of overall sales a distributor may make online, or require that a higher price be charged for products resold online than for products intended to be resold off-line
These new rules, while imposing limitations on the supplier’s ability to restrict online sales consistent with VBER coverage, are nevertheless instructive in defining the outer limits of what constitutes a hardcore restriction of passive sales via the internet. In this respect, they provide companies with opportunities to manage online distribution in the European Union with greater legal certainty.
Acceptable Limitations of Online Sales in Selective Distribution Systems
Selective distribution in the European Union refers to a strategy in which a supplier distributes through authorised dealers that are chosen based on satisfaction of certain criteria linked to the product. Selective distribution systems are typically used in connection with the distribution of branded, final products—in particular, luxury products or goods with special characteristics.
The text of the new VBER does not refer to online sales, but the Commission’s Guidelines make clear how suppliers using a selective distribution system may—and may not—restrict online distribution and still benefit from the VBER.
Espousing the principle that every distributor must be free to sell on its website as it does in its traditional shops and physical points of sale, the Commission generally proscribes suppliers from the following, for example:
- Limiting the quantities that its distributors sell online
- Requiring a distributor to charge higher prices for products to be sold online
At the same time, the Commission also outlines possibilities for suppliers to control online distribution in a selective distribution system. Under the existing VBER and Guidelines, a supplier is entitled to require its distributor to maintain an efficient operation of its “bricks and mortar” shops, in compliance with the supplier’s distribution model. A supplier is also entitled to select distributors on the basis of certain quality standards. As a result, a supplier may regulate online sales by taking the following actions, for example:
- Requiring the distributor to sell at least a certain absolute amount (in value or volume) of products off-line
- Selling only to distributors that have one or more brick-and-mortar shops, so that consumers can physically see and test products (in effect, requiring an online seller to have a physical location)
- Charging more for online sales if such sales lead to substantially higher costs for the supplier than sales made off-line (for instance, if off-line sales normally include home installation by the distributor and online sales do not, the manufacturer may face higher costs as a result of customer complaints and warranty claims)
- Using third-party platforms to distribute products only if the standards agreed upon with the supplier are met for the distributor’s use of the internet
Resale Price Maintenance
Consistent with the previous VBER, an agreement to fix resale prices continues to be treated as a hardcore restriction under the new VBER. However, the accompanying Guidelines make clear that it may nevertheless be possible for companies to establish an efficiency defence under Article 101(3) TFEU in individual cases.
The Guidelines suggest that RPM may lead to efficiencies in cases where a manufacturer introduces a new product, particularly during the introductory period. This may provide the distributors with the means to increase sales efforts and expand overall demand for the product so that the launch of the product is successful. Similarly, fixed resale prices may be necessary to organise a coordinated short-term low price campaign (two to six weeks in most cases) in a franchise system (or similar distribution system), activities which the Commission acknowledges could benefit consumers in certain circumstances.
The new VBER enters into force on 1 June 2010 and will be valid until 31 May 2022. However, the new VBER grandfathers agreements that satisfy the old VBER for a transitional period. In other words, agreements that are in force on 31 May 2010 and satisfy the criteria of the old VBER will continue to be exempt from competition law until 31 May 2011—even if the agreement does not satisfy the new VBER.
The New VBER Compared with US Law
Under US law, distribution agreements are analysed under Section 1 of the Sherman Act, which prohibits “unreasonable” restraints of trade and is analogous to Article 101 TFEU.
US law contains no direct analogue to the VBER. Rather, agreements must be analysed under Section 1 of the Sherman Act. Most vertical agreements are analysed under the so-called “rule of reason”, which involves a balancing of pro-competitive benefits versus anticompetitive effects.
As a practical matter, the analysis of distribution agreements under US antitrust and EU competition law will often result in similar outcomes. There are important differences, however, particularly if a distribution agreement threatens the integration of the single market—one of the fundamental bases of the European Union.
For example, if a supplier wants to benefit from a competition law exemption under the VBER, passive sales cannot be restricted, since this would reduce intra-brand competition and be unhelpful for market integration. On the other hand, such a restriction is unlikely to raise questions under US law if the benefits in inter-brand competition are not outweighed by a reduction in intra-brand competition between dealers.
Moreover, the new VBER and Guidelines may be beginning to converge with US antitrust law in respect of RPM. Under US law, RPM was presumptively illegal until the Supreme Court of the United States ruled in Leegin that it should be subject to the rule of reason. The Commission maintains its position that RPM is a hardcore restriction, but recognises that in some cases balancing may be appropriate.
The differences between US and EU law concerning distribution reveal that companies must be vigilant to ensure that their distribution strategies align with both systems of law. As these examples show, the analysis can differ, with significant impact on a firm’s distribution strategy.