Loyalty or fidelity rebates conditioned on the percentage of requirements of customers can have an effect of restricting or excluding competition in the market.

It can sometimes be unlawful for a supplier with a strong market position to offer its customers long-term supply terms with volume rebates which are conditional on the customer purchasing 90% or more of its requirements from the supplier.

A recent US case, ZF Meritor v Eaton Corporation, has demonstrated the legal risks associated with exclusivity rebates, even if the net prices offered to customers were above the costs of supply.

The major supplier and its loyalty rebate

Eaton is a supplier of heavy-duty truck transmissions used in heavy-duty vehicles in the United States. It had a dominant market share for these products. Eaton offered its customers, the manufacturers of heavy-duty vehicles, five-year supply agreements on favourable terms subject to a number of restrictive conditions:

  • rebates conditional on the customer purchasing up to 90% or more of its total requirements from Eaton;
  • requiring each vehicle manufacturer exclusively to list only Eaton's transmissions in its vehicle catalogues used by purchasers of heavy vehicles to select their components, and not to list any competing brands in the catalogues;
  • requiring vehicle manufacturers to "preferentially price" the Eaton transmissions when resupplying these to customers and vehicles, so as to ensure that competing brands of transmissions were always priced higher to downstream customers; and
  • a "meeting competition" clause, which allowed vehicle manufacturers to source competing transmissions, if offered at a lower price, provided that Eaton was first given a right to match or beat that competing price.

A 2-to-1 majority in the Third Circuit Court of Appeals upheld a jury verdict that these exclusive dealing conditions were likely to seriously harm competition and therefore contravened US law. Last month the United States Supreme Court declined Eaton's application to appeal the decision.

The Court of Appeals finds Eaton's loyalty rebate unlawful

The Court of Appeals majority noted Eaton's high (>80%) market share in the supply of transmission units, and the fact that the plaintiff rival had sought to enter the market but exited after seven years, failing to win significant market share in the face of the exclusive dealing conditions. The Court noted the rebates were not tied to volumes supplied but to percentages of the customers' requirements.

Much of the majority decision considered whether exclusive dealing or "loyalty" rebates could contravene US law, if the net prices charged by Eaton were still above its cost of supply. There are a number of decisions of the United States Supreme Court which required proof that prices must be below cost to be found to be "predatory".

The Court of Appeals majority did note, however, that "if price is the clearly predominant mechanism of exclusion, the price/cost test tells us that so long as the price is above cost", it will be presumed to be pro-competitive.

However, where, as in this case, exclusive dealing conduct rested not on price but on various contractual conditions of the kind noted above, the Court held that the jury was entitled to find that the conduct contravened US law and the plaintiff was entitled to recover damages.

Loyalty rebates under Australian competition law

In Australia, the Competition and Consumer Act prohibits offering exclusive dealing conditions if they involve either a purpose, or a likely effect, of substantially reducing or hindering competition in a market.

These issues were most recently considered in the Australian context in the ACCC's case against Baxter Healthcare, where a number of rebates and discounts were found to contravene the Act and large penalties were imposed.

Under Australian law, amendments in recent years have made it clear that prices could be "predatory" and unlawful, even if they were set above cost, provided they met the other requirements of a "misuse of market power" or "substantial market share" under section 46.

Under Australian law, like the approach taken in the Eaton case, there is a separate examination of whether exclusive dealing conditions are unlawful, which considers both the purpose and the likely effect of the exclusive dealing restrictions on competition in the market.

Applying Australian principles to the facts in this case, we expect that a similar conclusion would have been reached by an Australian court.

Key lessons from the Eaton case

The Eaton case is an important reminder that so-called loyalty rebates or fidelity rebates, which are conditioned not on the volume of purchases but the percentage of requirements of customers, can have an effect of restricting or excluding competition in the market.

These rebates and the other restrictions of the kind in this case can raise serious questions under section 47 of the Competition and Consumer Act.

Businesses with significant market positions offering exclusivity conditions and rebates broadly across a market will need to carefully consider how they do this to avoid breaching competition laws.