On 9 July 2021, the EU Commission released a draft version of the EU Vertical Agreements Block Exemption (“VABE”) for consultation, together with the accompanying vertical agreements guidelines. The proposed changes are significant for businesses.
Vertical agreements are those which relate to the supply of goods and services between parties at different levels of the supply chain. Examples include manufacturers and distributors, wholesalers and retailers and franchisees and franchises, as well as certain agreements between contractors and sub-contractors.
The most obvious examples may occur in retail (for example, the supplier of luxury fashion items and a chain of high street stores) but the concept goes wider. In the construction context, examples of vertical arrangements would include an agreement between a manufacturer of materials and its wholesaler or between a supplier of raw materials and a manufacturer which integrates those into its own goods
Fines may be issued where anti-competitive conduct arises within a vertical relationship. For example, suppliers have been fined for imposing resale prices on distributors and restraining them completely from selling online. There are severe penalties for infringing competition law: parties to anti-competitive agreements may be fined up to 10% of the global turnover as well as suffering the possible non-enforceability of their agreement itself.
Most vertical relationships however do not give rise to competition concerns. The VABE provides a safe harbour from competition law for vertical agreements between parties whose market shares fall below 30% where the agreement avoids inclusion of certain “hardcore” anti-competitive clauses (e.g. RPM and online sales bans). The VABE therefore effectively operates as a code of what is acceptable for agreements of this nature.
The existing block exemption will expire on 31 May 2022. The consultation process is therefore being conducted with a view to having a successor regulation in place to replace the existing one on its expiry.
Proposed changes: Dual distribution
Dual distribution describes distribution systems in which the supplier / manufacturer reaches customers through both independent resellers and their own retail level outlets or websites (sometimes using “monobrand” stores). In the construction context, an example of dual distribution could be a manufacturer of materials which had its own outlets, while also selling through an independent wholesaler.
The existing block exemption does not extend the safe harbour to distribution agreements between direct competitors. However, it does allow agreements between businesses which compete only at the retail level of trade (but not, say, the manufacturing level). In the example above, if the independent retailer did not make its own competing brand of goods (but only sold goods produced by other entities), the safe harbour would still apply.
Going forward, the safe harbour will only automatically apply where the parties to the dual distribution system have a share of the retail market which does not exceed 10%. This is obviously lower than the general 30% threshold which currently benefits those agreements.
Where the parties have between 10% and 30% of the market share, their agreements will generally be safe. However, that immunity will not apply to the exchange of information between the parties. In other words, they will need to ensure that they do not share information in a way which is capable of distorting competition.
This is something of a headache. Suppliers and retailers may find it helpful to exchange information about, say, sales volumes. That may assist both of them to match supply with demand for the most popular products. Going forward, they may be concerned that sharing such information could be considered anti-competitive and be sanctioned by competition authorities.
Parity or “most favoured nation” clauses
Changes are also proposed around the use of parity clauses or “most favoured nation” clauses in vertical agreements. Parity clauses prohibit the supplier from offering its goods or services to competitors of the purchaser on better terms.
While parity clauses are permitted under the current regulation, they are controversial. In the past decade, they have been scrutinised in a series of investigations involving agreements between suppliers of travel and hospitality services and online travel agents (“OTAs”). OTAs have imposed parity clauses on airlines and hotel chains. That has led to standardised offers across platforms and objections that customers are prevented from shopping around between platforms to get better deals.
There are generally two types of parity clause; those which prevent the supplier from offering better terms itself to any reseller (“narrow parity clauses”) and those which prohibit the supplier from offering a better deal either on its own sales channel or to any other platform or reseller (“wide parity clauses”).
Under the EU’s proposed reforms, the block exemption will no longer extend to wide parity clauses.
Bans on active selling
Active selling is characterised as a transaction instigated by the seller itself (e.g. through marketing or contacting customers) as opposed to one where it is the customer that has taken the initiative to bring about the sale (which is termed “passive selling”).
Under the existing block exemption, suppliers may restrain distributors from actively selling into other territories or customer groups where those have either been reserved for the supplier or for an exclusive distributor.
Active sales restrictions are important to preserve the integrity of complex distribution systems, especially of an international nature. Resellers may feel more reluctant in investing in the promotion of goods or services in their designated territory knowing that their efforts may benefit sellers outside the territory who are targeting the same customer group with the same goods or services.
The current rules limit the supplier’s freedom to structure its supply chain. The supplier will not be able to restrain active selling into a territory or customer group where, for example, it has appointed two resellers (rather than one) to service that territory or group.
The reforms go some way to address this. The supplier will be able to protect territories where there are a limited number of re-sellers, provided that it can show that there is a link between the shared exclusivity and the efficiency of the system. The supplier will need to justify that the number of distributors chosen has been set in such a way as to allow distributors to recoup their investments on selling in the territory.
Dual pricing for online and offline sales
The existing block exemption was drafted when e-commerce was in its infancy and therefore seeks to encourage sales through online channels. It does not benefit systems under which online and offline sellers are charged different wholesale prices (known as “dual pricing”).
The Commission has accepted the position of the significant number of consultees arguing for dual pricing. They have pointed out that bricks and mortar stores face higher costs than online outlets. Physical stores have also faced significant setbacks as a result of the COVID-19 crisis, forcing many to close for extended periods. Conversely, online selling is now so popular that it no longer requires regulatory protection to the same extent. Under the proposed rules, dual pricing would be permitted provided its real purpose was not to stop customers buying online.
Under the current rules, where suppliers operate a selective distribution system, they may only lay down requirements for online sales by resellers where those requirements are equivalent to edicts for physical sales. The Commission proposes to remove this requirement of equivalency, accepting that both types of channel are inherently difficult, making it unduly onerous to demonstrate true equivalence for these requirements.
Comments: will the U.K. follow suit?
The consultation on the draft regulation and guidelines closed on 17 September. The Commission will consider the final round of stakeholder input, make any final changes to the draft before the new Block Exemption takes effect on 1 June 2022.
Although the U.K. has now left the EU, the VABE forms part of the U.K. legal system as retained legislation. The U.K. Competition and Markets Authority (“U.K. CMA”) is also consulting on a new instrument to replace the existing block exemption. One of the priorities of the current reform is to keep pace with the explosive growth of e-commerce, which has changed trading practices and presented new challenges for competition policy.
These developments will impact those businesses which sell through distributors or operate at different levels of the sales chain. They will need to assess whether their existing vertical agreements will be affected by the Commission’s reforms or indeed those contemplated by the U.K. CMA. If that is the case, they should put in place a strategy for heading off this risk and avoiding the possibility of fines, damages or the agreement not standing up in court. Businesses will need to review their distribution agreements and ensure they will continue to be effective after the new Block Exemption takes effect.