Consultations running on both sets of proposals – divergence will present new legal challenges for multijurisdictional distribution agreements and opportunities for brand owners to take greater control over retail sales
In recent weeks both the EU and the UK competition regulators have published their proposals on how to modify the existing rules on vertical agreements. On 9 July 2021, the European Commission published for consultation a draft of a revised vertical agreements block exemption regulation (VBER) and draft revised guidelines on vertical restraints. Similarly, on 17 June 2021, the UK Competition and Markets Authority (CMA) published a consultation document, which sets out its proposed recommendations to the Secretary of State on the amendments to the retained VBER and accompanying guidelines.
In their respective evaluations both the European Commission and the CMA recognised that the market has changed significantly since the adoption of the VBER and the guidelines in 2010, in particular due to the growth of online sales and emergence of new market players such as large online platforms. However, the proposals put forward by each body differ in approach on a number of established distribution practices, risking new legal challenges for multijurisdictional distribution agreements which fall under both sets of rules governing vertical agreements, while at the same time, particularly in the UK, offering some opportunities for brand owners to take greater control over their distribution networks.
European Commission's draft revised VBER and vertical guidelines
As a result of its review, the Commission has identified various issues regarding the functioning of the current rules on vertical agreements, including difficulties in applying rules that are no longer adapted to the current business environment. These difficulties include applying the current rules to new market participants that do not fit into traditional supply and distribution concepts, as well as to new online sales restrictions.
The growth of online sales and the emergence of new online platforms have led to a number of changes in distribution models, such as increased direct sales by suppliers and a greater use of selective distribution systems, for which the current VBER does not take appropriate account of. Although the new revised VBER will not come into force until the current regulation expires on 31 May 2022, businesses will need to review their existing arrangements in light of the proposals and prepare for the upcoming changes.
Changes to treatment of active sales and distribution systems
In the new draft VBER the Commission proposes to make changes to the rules on active sales restrictions. The draft revised VBER includes new definitions, in particular the possibility of shared exclusivity is introduced, allowing a supplier to appoint more than one exclusive distributor in a specific territory or for a particular customer group. Further, suppliers in exclusive distribution systems will be allowed to demand a "pass on" of the active sales restriction to their customers in a situation where they have entered into a distribution agreement with the supplier or with a party that was given distribution rights by the supplier. In relation to selective distribution, the draft revised VBER grants selective distribution systems enhanced protection from sales by unauthorised distributors located within the selective distribution territory.
The Commission is also proposing to relax treatment of some indirect measures restricting online sales. The draft revised guidelines on vertical restraints provide that suppliers will be able to set different supply prices for online and offline sales by the same distributor/retailer. This will be allowed to the extent that it is intended to incentivise or reward an appropriate level of investments and relates to the costs incurred for each channel. Further, in the context of a selective distribution system, the criteria imposed by suppliers in relation to online sales will no longer have to be overall equivalent to the criteria imposed on brick-and-mortar shops, in recognition that both of these channels are inherently different in nature. Together, these changes present a significant opportunity for brand owners of luxury and high-quality products to incentivise a quality, in-store consumer purchasing experience.
One of the Commission's key objectives in the new draft VBER is to reduce compliance costs for businesses by simplifying complex areas of the current rules and streamlining the existing guidance. The draft revised VBER and guidelines clarify certain provisions perceived as particularly complex and difficult to implement. In particular the provisions on territorial and customer restrictions in Article 4(b) of the current VBER have been replaced with distinct sets of provisions clarifying the scope of the prohibition for each of the main distribution systems, including the exclusive distribution and selective distribution systems.
The new Article 4 proposes a more differentiated approach which allows supplier to restrict its buyers to a varying degree depending on whether the agreement is one for exclusive distribution, selective distribution, or "free" distribution (neither exclusive nor selective). Article 4(b) focuses on exclusive distribution and provides brand owners with more flexibility in designing their distribution systems by allowing the allocation of more than one "exclusive" distributor to which an exclusive territory or customer group has been allocated. Similarly, with regards to selective distribution systems, the new Article 4(c) provides greater protection for members of a selective distribution system against sales from outside the territory. It provides a number of examples of restrictions which would and would not be considered as hardcore restrictions.
Some of the other key changes in the new draft VBER relate to the treatment of dual distribution, which is now both more relaxed (as it includes wholesalers and importers in addition to manufacturers) and at the same time more restrictive (as it introduces a 10% aggregate market share level on the relevant market at retail level). Dual distribution arises where a supplier not only sells its goods or services through independent distributors but also does so directly to end customers in direct competition with its independent distributors. Recently this model has become more popular due to the growth of online sales.
The Commission makes a move towards relaxation of its current rules on dual distribution by extending the current exception to apply not only to manufacturers but also to wholesalers and importers. It explicitly clarifies that the exception applies to all aspects of a dual distribution system, also these that arise as a result of the exchange of information between competitors.
The revised rules introduce a new market share threshold for the dual distribution exception which appears to limit the scope of the exception to agreements where undertakings' combined market share at a retail level does not exceed 10%. If this threshold is exceeded, but remains below the 30% share of the relevant market, the exemption should still apply unless there is any exchange of information between the undertakings which would have to be separately considered under the rules applicable to horizontal agreements.
The draft VBER and guidelines do not provide detail on what sort of information sharing would give rise to competition concerns. It is expected that suppliers may need to communicate with their resellers for a number of essential reasons in a dual distribution situation, such as discussing recommended retail prices, sharing knowledge on the market demand for specific types of products, or assisting with new launches and staff training. While those types of communication could raise competition concerns on a horizontal level, these may very well be legitimate when shared between suppliers and their resellers.
United Kingdom – vertical control taken back?
Although from 1 January 2021 EU competition law is no longer enforced in the UK by the Competition and Markets Authority, the EU VBER remains applicable and enforceable in the UK as part of the body of retained EU law. However, the CMA is currently conducting its own review of VBER and the proposed replacement legislation, Vertical Agreements Block Exemption Order (VABEO), will come into force in May 2022.
On 17 June 2021, the CMA published a consultation document, which sets out its proposed recommendations to the Secretary of State on the proposed VABEO and accompanying guidelines. Although many of the modifications proposed by the CMA seek to replicate existing provisions under the VBER, there are also a number of proposed changes that would contribute to divergence from the EU set of rules and provide brand owners with a larger degree of control over their distribution networks and the way in which they deal with distributors and retailers in the UK.
CMA's proposals to update current VBER
Overall, the CMA recommendations propose a more lenient approach to treatment of vertical agreements. With regards to online sales restrictions, similar to the European Commission's approach, the UK regulator proposes to remove dual pricing (applying different supply prices for products resold instore and online and the requirement for overall equivalence on online and instore quality criteria in selective distribution) from the list of hardcore restrictions.
The CMA considers that existing case law provides sufficient safeguards against outright online sales bans and online distribution and therefore these restrictions would fall under the coverage of the block exemption, subject to undertakings not exceeding the 30% market share thresholds. If adopted, these proposals will bring a significant change for brand owners extending the degree of control that they can exert over their distribution networks and online sales. In particular, brand owners will be better equipped to protect bricks and mortar retailers who invest in a quality consumer purchasing experience from online-only retailers that free-ride on those investments.
Further, the CMA proposes to add three new exceptions that would permit restrictions on active sales These include (i) allowing suppliers to combine exclusive and selective distribution systems in the same or different territories; (ii) allowing shared exclusivity of a single territory making it possible for the suppliers to appoint more than one distributor in a single territory and prohibit other distributors from making active sales there; and (iii) providing greater protection to members of selective distribution systems against sales from outside the designated territory to unauthorised distributors in that territory (although the exact scope of these protections has not yet been outlined by the CMA).
With regards to dual-distribution, in contrast to the European Commission's proposals, the CMA would like to extend the concept of non-reciprocal vertical agreements between competing suppliers so that they can benefit from exemption where only one of the parties also operates upstream as a manufacturer. The new UK Vertical Agreements Block Exemption Order would extend this principle to apply in situations where a party operates upstream as a wholesaler and/or an importer. The CMA is considering providing more guidance in the guidelines on information exchange within vertical integrated businesses.
In addition, the CMA made it clear that resale price maintenance (RPM) should continue to be treated as a hardcore restriction of competition and will therefore constitute a serious infringement of competition law in most cases. This is in line with a number of infringement decisions adopted by the CMA in recent years in which it held that RPM is a "by object" restriction. The CMA is expected to provide further guidance on to when RPM could be justified, particularly in the context of luxury brands.
Finally, the CMA envisages making "wide" most favoured nation (MFN) clauses (or "indirect sales channel parity obligations"), where a supplier agrees not to offer better price or terms to any other buyer, a hardcore restriction. They would be classified as such regardless of the market power of the parties or whether the MFN is used in an online or offline context, and would also apply the prohibition to all levels of the supply chain.
This is a stricter approach than the one taken by the European Commission and could be seen as a result of the CMA's more limited enforcement practice. The "narrow" parity clauses (or "direct sales channel parity obligations"), where the supplier agrees itself not to offer better prices or terms but is free to offer better prices or terms to third parties, will still benefit from the safe harbour, although the CMA has warned that it may investigate such provisions if their use replicates the effects of indirect sales channel parity obligations.
Osborne Clarke comment
Over the past nine years since the rules on vertical arrangements were last updated, the surge in online commerce, further strengthened by the Covid-19 pandemic, has shifted the market in favour of the internet giants at the same time changing the picture for manufacturers who more often than ever sell their goods directly to customers online. For those (and many other) reasons both the Commission's and the CMA's reviews have identified various issues regarding functioning of the current vertical agreements rules, especially in applying them to the existing set of rules to new market participants that do not fit into traditional supply and distribution concepts.
However, to the regret of many commentators, the proposals put forward by each body differ in approach on a number of established distribution practices, presenting new legal challenges for multijurisdictional distribution agreements which fall under both sets of rules governing vertical agreements. Although the new revised UK and EU versions of the VBER will not come into force until the current regulation expires on 31 May 2022, businesses will need to review their existing arrangements in light of the proposals and prepare for the upcoming changes. The likely result of these changes (if retained after consultations) is going to be that, unless amended to cherry pick the more favourable elements of each regime, a large number of distribution agreements will be subjected to both sets of rules forcing the companies to obey the stricter standard, for example, for dual distribution (in the EU) and MFNs (in the UK).
Brand owners would be well-advised to consider whether and how to take advantage of the opportunities to take greater control on their supply chains under the terms of the more favourable UK regime, particularly around dual-pricing, the circumstance in which RPM might be justified in the context of luxury products to protect brand image, and the removal of the principle of equivalence as between online and offline selective distribution criteria.
The Commission invites comments on the draft rules by 17 September 2021. On the basis of received comments the Commission will then finalise the impact assessment and revise the drafts with a view to having new rules in place when the current VBER expires on 31 May 2022. The CMA's deadline for submitting responses to its consultation is 22 July 2021, responses to which will inform the CMA’s final recommendation to the Secretary of State. If you would like to submit your response to these consultations, or to discuss any other issues relating to vertical agreements in more detail, please get in touch with one of our experts or your usual Osborne Clarke contact.