Selective distribution: EU law
03 December 2021
03 December 2021
This Quickguide provides an overview of the treatment of selective distribution arrangements under EU competition law.
The UK left the EU on 31 January 2020 and the Brexit Transition Period ended on 31 December 2020. On 1 January 2021, the UK and EU became two fully distinct regulatory, legal and customs territories, whose relationship is governed by the Trade and Cooperation Agreement (TCA).
This Quickguide considers selective distribution in the EU. It does not consider the impact of the TCA on selective distribution agreements between the EU and the UK. Businesses should seek legal advice in relation to selective distribution agreements between the EU and the UK.
A selective distribution arrangement will typically be used by a supplier to maintain greater control over the resale of its products. In such a system, the supplier agrees to supply only those distributors who meet certain minimum criteria. The distributors, in return, agree to supply only other distributors who are within the approved selective distribution system or end-users. The selection criteria used will typically require that the products are sold only through outlets that convey a particular image or that the distributor undertakes specific obligations such as staff training or after-sales services. Selective distribution arrangements are essentially about achieving a consistent standard and quality of service in the outlets where the products are sold.
Selective distribution systems are most often used by suppliers of products in one of two categories:
Since 1 May 2004, parties have been required to draw their own conclusions about the compatibility of their commercial agreements with EU competition law. Although many selective distribution arrangements are considered to be unobjectionable for competition law purposes, there are strict conditions which must be met and the terms and conditions of such arrangements must be individually reviewed on a case-by-case basis.
Since 1 June 2000, selective distribution has been covered by an EU block exemption regulation. On 20 April 2010, the European Commission published its latest version of the block exemption covering distribution agreements, Commission Regulation (EU) 330/2010 and accompanying guidelines.1 This Quickguide provides an overview of how selective distribution agreements are assessed for EU competition law purposes, particularly in light of the block exemption regulation and guidelines, and recent case law.
Article 101(1) of the Treaty on the Functioning of the European Union (TFEU) prohibits agreements, decisions by associations of undertakings and concerted practices that have as their object or effect the prevention, restriction or distortion of competition. Under Article 101(2) TFEU all such anti-competitive restrictions are void. Under Article 101(3) TFEU, prima facie anti-competitive restrictions may be exempted from the prohibition, where it can be shown that, on balance, the consumer benefits and efficiencies flowing from the restriction outweigh the anti-competitive effects. In particular, Article 101(3) will apply where the agreement:
"contributes to improving the production or distribution of goods or to promoting technical or economic progress, while allowing consumers a fair share of the resulting benefit, and which does not:
(a) impose on the undertakings concerned restrictions which are not indispensable to the attainment of those objectives;
(b) afford such undertakings the possibility of eliminating competition in respect of a substantial part of the products in question".
In general, parties are required to make their own analysis of whether their agreements benefit from Article 101(3), but the European Commission has also issued so-called "block exemption regulations" in relation to certain common types of commercial agreement, which set out clear rules as to the conditions which must be met and the terms and conditions which can be included in an agreement for Article 101(3) to apply. The block exemption dealing with distribution (known as the Vertical Agreements Block Exemption (VABER)) is one of the most significant of the EU competition law block exemption regulations in terms of the number of agreements to which it applies (distribution and other supply agreements being commonplace).
A "distribution agreement" may be defined as a contractual arrangement (normally in writing) between two independent parties at different levels of trade under which one party (the "supplier" and typically the manufacturer) contracts to sell goods (or services) to another party (the "distributor" and typically a non-manufacturer/intermediary) with a view to their resale by the distributor. A distribution agreement is an example of a "vertical" agreement, being an agreement between parties operating at different levels of the chain of supply.
Under an exclusive distribution agreement, the distributor will enjoy an exclusive sales territory within which it is protected from competing sales by the supplier and/or distributors appointed in other territories. Slightly less commonly, and either alone or in combination with an exclusive sales territory, the distributor may enjoy the allocation of an exclusive category of customers, again with protection from competing sales by the supplier/other distributors.
A selective distribution agreement typically has no element of territorial exclusivity (or customer exclusivity) but is characterised instead by a restriction on the resale of contract goods to third party resellers who are not party to the selective distribution system. The supplier in practice limits resale to end-users and a "selected" group of distributors who satisfy a set of objective criteria. This group is then free to sell to all end-users, wherever they are situated.
Some selective distribution arrangements fall outside competition law altogether. Case law has confirmed that the Article 101(1) prohibition on anti-competitive agreements will generally not apply to a selective distribution system where four conditions are satisfied:2
Any refusal to approve distributors which meet the qualitative criteria would be likely to be considered an unlawful restriction of competition.
Three main grounds have been identified as the rationale behind the decision to use a selective distribution system; and these grounds underlie the conditions for finding that a selective distribution system is compatible with EU competition law. The three broad grounds are as follows:
The VABER automatically exempts from the general Article 101 prohibition, vertical agreements:
Where possible, market shares should be calculated on the basis of value rather than volume of sales, based on the preceding calendar year.
A vertical agreement may fall outside, and therefore not benefit from, the block exemption because, for example:
In such cases, the parties will need to assess for themselves whether the agreement falls within Article 101(1) and, if so, whether it meets the criteria for exemption under Article 101(3).
The benefit of the VABER is not generally available to distribution arrangements entered into by actual or potential competitors. A potential competitor in this instance is a party that could, and would be likely to, enter the market quickly (within around 12 months) in response to a small but permanent price rise. There is one important qualification to the exclusion of competing parties under the block exemption. The block exemption will apply where competitors enter into a non-reciprocal distribution arrangement (i.e. only one party distributes for the other) and:
The VABER contains a list of serious (so-called "hardcore") restrictions of competition which, if included, will remove the benefit of the block exemption from the agreement in its entirety. This does not necessarily mean that the agreement or the relevant restrictions will be unenforceable under Article 101(2). There are two sets of circumstances where this will not be the case, but both are, in practice, difficult to apply:
The hardcore restrictions most relevant to a selective distribution arrangement include:
Each is considered in turn below.
In the context of a selective distribution arrangement, it is essential to note that whilst the supplier can impose high standards of quality and service, it cannot seek to control the retail prices charged by its distributors.
Imposing a fixed or minimum resale price upon a buyer is (in principle) not allowed. A recommended or a maximum price is, in principle, allowable. However, there is always a danger that a "price recommendation" or a "maximum price" becomes a de facto minimum or fixed resale price which will be prohibited. Resale price maintenance also covers any commercial strategies or pressure which has the effect of controlling retail prices. The following would therefore also be likely to be found to constitute resale price maintenance:
The European Commission's 2010 guidelines (at paragraph 225) show some softening of the traditional strict stance on this subject, recognising that resale price maintenance may, in some circumstances, lead to economic efficiencies and therefore meet the test for exemption under Article 101(3). The guidelines comment that resale price maintenance may be justifiable during an initial product launch period, or for short-run co-ordinated promotions across a franchise or distribution network. Of particular interest in the selective distribution context, given the "free-riding" concern discussed above, are comments that resale price maintenance may be justifiable to eliminate free-riding, on the basis that retailers which invest in additional customer services may cut back on such services if they are undercut on price by retailers which do not provide such services. However, there will be a high burden of proof to justify these tentative exceptions under Article 101(3) and caution is essential.
Selective distribution agreements which aim to restrict distributors from entering into cross-border sales will not be permitted. The VABER contains two territorial hardcore restrictions specific to selective distribution.
Within a selective distribution system, authorised distributors must be free to sell to all end-users, and cannot be restricted in terms of either active or passive sales. Accordingly, a provision limiting or otherwise acting as a disincentive to a distributor's use of the internet for resale will amount to a restriction of active or passive sales, and therefore a hardcore restriction of competition.
"Active" sales are where the seller takes steps to attract customers, for example through advertising or sales promotions; "passive" sales are where the seller has not taken any such steps but the purchaser has found the seller and requested the products.
In the context of selective distribution, the VABER (at Article 4(c)) states that the following amounts to a hardcore restriction:
"the restriction of active or passive sales to end users by members of a selective distribution system operating at the retail level of trade, without prejudice to the possibility of prohibiting a member of the system from operating out of an unauthorised place of establishment".
This means that members of a selective distribution system cannot be restricted in the customers to whom they sell. The guidelines (at paragraph 52) elaborate on this in the context of e-commerce, stating that any requirement on a distributor to prevent customers located in another territory from viewing its website and purchasing its goods will be considered a hardcore restriction. Case law has also established that a ban on selling via the internet is not equivalent to a prohibition on "operating out of an unauthorised place of establishment".7
Examples of such hardcore restrictions of passive selling, identified in the guidelines, are as follows:
The European Commission also indicates that any criteria imposed on an authorised distributor in relation to online sales which are not equivalent to the criteria imposed on sales through a "bricks and mortar" shop, constitute a hardcore restriction, as they are likely to prevent dealers from using the internet to reach more customers.11 Internet sales are considered further in Section 6 below.
Article 5 of the VABER lists some less serious (or non-hardcore) offending restrictions of competition. The inclusion of these restrictions will not generally disapply the application of the block exemption to the rest of the agreement, but the specific provision will not be exempted and will therefore be unenforceable (unless, as discussed above, it can be individually justified under Article 101(3)). The VABER lists the following such restrictions:
Clearly, the last of these restrictions is particularly relevant to selective distribution. Under the VABER, it is possible to prohibit authorised distributors from reselling any competing brands at all, but any obligation to boycott the products of a specific supplier will not benefit from the exemption. This provision is designed to prevent a situation whereby a number of suppliers using the same selective distributors are able to prevent specific competitors from using these distributors, thereby potentially foreclosing the market to those suppliers.
The current guidelines state that: "In principle, every distributor must be allowed to use the internet to sell products".12
Internet sales have been the subject of much discussion in relation to distribution agreements, as they threaten the notion of exclusive territories and allow for the possibility of "free-riding". Furthermore, in the context of luxury goods in particular, there is a fear amongst suppliers that the prestige of the brand may be lost if it is not accompanied by personal customer service and care in an appropriate environment, which add to the aura of luxury, prestige and exclusivity.
The VABER itself does not refer specifically to internet sales; however, the associated guidelines do attempt to provide some clarification on the European Commission's approach to internet sales with specific reference to selective distribution systems.
The guidelines sought to update the definitions of active and passive selling in the light of the growth of e-commerce. They state that the use of the internet is generally considered to constitute passive selling. More specifically, the guidelines state that the use of a website is considered passive selling so long as it is not targeted at certain customers through the use, for example, of online advertising banners and unsolicited emails to customers. These practices will be considered to be active selling.13 This distinction is less relevant in the context of selective distribution systems, as both active and passive selling to end customers (and other authorised distributors) must be permitted.
While, as noted above, many restrictions on the use of the internet will constitute hardcore restrictions, a distributor may impose quality standards:
The guidelines also recognise that certain quality requirements may need to be tailored specifically to reflect the characteristics of distribution over the internet. This is illustrated by reference to the possibility of a requirement upon an authorised distributor to limit the quantity of goods sold to each end-user in order to prevent sales to unauthorised distributors. If internet platforms make it easier for unauthorised distributors to obtain large quantities of products, the quality standards for online sales may need to be stricter to take this into account.
The European Court of Justice (ECJ) found in Pierre Fabre16 that a clause in a selective distribution agreement which effectively prohibited distributors from selling its products via the internet amounted to a restriction of competition "by object". Whilst not expressly prohibiting sales via the internet, the agreement stipulated that sales be made exclusively from a physical space in which a qualified pharmacist was present. The ECJ found that the clause had as its object at the very least the restriction of passive sales to end-users wishing to purchase online, and it could not therefore benefit from the VABER.
However, the ECJ has also confirmed17 that a clause, which prohibits authorised distributors in a selective distribution system from using "in a discernible manner" third party platforms for internet sales of the relevant goods, may be compatible with the VABER, provided that certain criteria are met, and in particular that the clause:
In this case, the authorised distributors were permitted under the agreement to engage in online sales through their own electronic shop windows, or through third-party platforms provided that the use of such platforms was "not discernible to the consumer".
A provision in an agreement which infringes Article 101(1) and cannot be exempted automatically under the VABER or individually under Article 101(3) is void and unenforceable. The entire agreement will fail if the particular infringing provision cannot be severed. The European Commission is able to impose fines for breaches of Article 101(1) and third parties may sue for civil damages in national courts for losses arising out of the infringing provision/agreement. Third parties may also use infringements as a "sword" or a "shield", in order to seek to avoid obligations under a distribution arrangement or as a defence against a breach of contract claim.
It is true that there has been relatively little enforcement relating to selective distribution or other vertical agreements in recent years by the European Commission, and activity has tended to focus on horizontal cartels between competitors. However, there have been recent cases relating to territorial restrictions, online customers and resale price maintenance.
Moreover, enforcement at the national (Member State) level (employing Article 101 and/or national law equivalents) has in many instances been greater. For example, levels of regulatory activity in relation to distribution are relatively high in France and Germany. In addition, many national court cases in relation to competition law concern vertical arrangements (including selective distribution arrangements). Further, there has been a particular focus in recent years on the role of the internet as an effective distribution medium, and regulators have actively pursued cases where suppliers have sought to limit the role of the internet in distribution.
Thus, although selective distribution has been less of a priority for the European Commission in recent years, it is the subject of national level scrutiny and generally it is strongly recommended that compliance with the VABER, in particular in relation to hardcore restrictions and restrictions on the use of the internet, is taken very seriously. This is an area of law, given its long history and the extensive precedents and guidance which are available, which all companies will be expected to get right, and any serious infraction that does come to light can expect to be dealt with firmly.
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The information provided is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to.
Readers should take legal advice before applying it to specific issues or transactions.