Episode 3, Vertical Agreements in the EU and UK: Traditional Distribution Issues

Fiona Garside:

Hello, everyone. I'd like to welcome you to the third episode in our podcast series, on the new rules on vertical agreements in the EU and UK. In this series, we're focusing on the impact of the new rules on agency arrangements, dual distribution, traditional and online distribution models, and areas where the EU and UK approaches have now diverged. My name is Fiona Garside and I'm a Senior Expertise Lawyer in the Antitrust, Regulation and Foreign Investment team at Ashurst in London. I'm delighted to be joined today by Donald Slater, a partner in our Brussels office, and Laura Carter, a Senior Associate in our London team. Thank you both for joining me.

Donald Slater:

Hi, Fiona. Good to be here.

Laura Carter:

Hi, Fiona.

Fiona Garside:

As listeners may be aware, on the 1st of June 2022, the revised EU Vertical Block Exemption Regulation, or VBER, entered into force alongside new vertical guidelines. On the same date, the new UK Vertical Agreements Block Exemption Order, also known as the VABEO, entered into force. The block exemptions provide widely applicable safe harbours for vertical agreements, from the EU and UK prohibitions on anti-competitive agreements, provided that the parties have market shares of less than 30% on their respective markets, and that the agreement doesn't contain any hardcore restrictions of competition. Today, we're going to be talking about how the new Vertical Block Exemption Regulation tackles traditional distribution issues, meaning we'll cover issues such as territorial and customer restrictions, resale price maintenance, and non-compete obligations.

Turning first to territorial and customer restrictions. The general principle is that suppliers can, in certain circumstances, prevent their distributors from actively selling to customers in territories or customer groups allocated to other distributors, for example, through targeted advertising. However, generally suppliers cannot prevent distributors from responding to an unsolicited request, that's known as passive selling. Before we dive into the different distribution models, we should highlight that the Commission has provided some updated definitions of active and passive sales. Donald, what clarifications has the Commission provided?

Donald Slater:

Well, the main point is that the new guidelines give us additional clarifications on these concepts of active and passive selling in the online context. So for example, they confirm that setting up an online store should, generally speaking, be considered a form of passive selling. However, that's different in the particular case where you have the seller who sets up an online store with a country specific top level domain and they choose a country other than their home country. For example, a seller based in Germany who sets up an online store with a .es extension for Spain. That kind of case will be considered to be active selling.

Now similarly, if the seller offers a website in a language that's not commonly used in their home country, that will also be considered as active selling. And interestingly, on that language point, the Commission expressly stated that it considers English to be commonly used in all EU Member States. So that's for the online context. Outside the online context, the Vertical Guidelines clarify that participating in tender processes is a form of passive selling. That's the case for both public and private tenders. So that means that any agreement that restricts a buyer from participating in tender processes won't benefit from the block exemption.

Fiona Garside:

Thanks Donald. The new rules provide separate guidance for exclusive, selective, and free distribution models. Looking at exclusive distribution first, Laura, how have the rules changed?

Laura Carter:

So previously, exclusive distribution models involved a supplier appointing a single distributor for a particular territory or customer group, there wasn't a concept of shared exclusivity. But the new rules provide for a more flexible approach, by allowing shared exclusive distribution to benefit from the block exemption in the EU, provided that the supplier appoints no more than five exclusive distributors to share a particular territory or customer group. And in the UK, the VABEO takes a similar approach but doesn't prescribe a maximum number of exclusive distributors. So, instead this needs to be determined by what's proportionate to preserve investment efforts. Another important change to the rules allows suppliers to require distributors to impose exempted restrictions on their own direct customers. This effectively extends the reach of active sales restrictions, providing greater protection for exclusive distributors. However, restrictions on active sales further down the distribution chain won't be covered by the block exemption.

And finally, the block exemption won't apply where a supplier combines exclusive and selective distribution models in the same EU territory. But in the UK, it is permissible under the VABEO to combine exclusive and selective distribution models in the same territory, provided that they operate at different levels in the supply chain. So, this means that, in the UK, a distribution model involving exclusive distribution at the wholesale level combined with selective distribution at the retail level could benefit from the block exemption.

Fiona Garside:

Thanks, Laura. Donald, if we turn now to selective distribution, could you remind us what that entails and how it's treated under the VBER?

Donald Slater:

Sure. So, in a selective distribution system, the supplier sells goods and services to distributors and retailers that are selected on the basis of specified criteria. And that setup is typically used to have greater control over the resale of products because it basically restricts resale to end users and a selected group of distributors that satisfy these specified criteria. Now, previously, the block exemption only covered selective distribution arrangements relating to certain products and those fell into basically two categories.

Firstly, there is complex or technical consumer products that require a high degree of pre-sales advice and post-sale services. So for example, computers, or mobile phones, and so on. And secondly, luxury products where there's a brand image that needs protection or promotion. So for example, perfumes, cosmetics, watches, etc. Now, the revised Vertical Guidelines have expanded the scope of products and services where suppliers can use selective distribution, and under the new rules, it's no longer limited to those two categories of technical and complex, or luxury products. And it's now permissible to use a selective distribution model for all products and services and still benefit from the block exemption.

Fiona Garside:

And as well as expanding the product scope, the Guidelines have also offered us some additional guidance on other conditions relating to selective distribution.

Laura Carter:

Yeah, that's right. So, the Guidelines make clear that the block exemption applies regardless of the nature of selective criteria, i.e. quantitative, or qualitative. So the Guidelines clarify the previous Metro case law, where suppliers use non-discriminatory, qualitative criteria relating to the distributor's technical ability to handle the goods and the suitability of their premises then the arrangement will fall outside the prohibition on anti-competitive agreements. And the Guidelines continue to make clear that where the supplier employs quantitative criteria, such as requirement to order a minimum amount of stock or to achieve a particular level of sales, or qualitative criteria, then an agreement can still benefit from the block exemption, provided the parties' market shares don't exceed 30% and the agreement doesn't contain any hardcore restrictions.

The new Vertical Guidelines also expressly state that there's no requirement for the supplier to publish its selection criteria.

Selective distribution arrangements are also given stronger protection under the new rules. So, suppliers can restrict active or passive sales by exclusive and free distributors and their customers to unauthorised resellers in the territory where the selective distribution model applies, even if those distributors and customers are located outside the territory. Previously restrictions could only be passed on where the distributors were located in the same territory.

Fiona Garside:

Thanks Laura. So, as well as expanding the guidance on selective and exclusive distribution, for the first time, the new VBER provides guidance on situations where the supplier doesn't operate using one of these distribution models. Donald, what restrictions can suppliers impose on their distributors in these so-called free distribution systems?

Donald Slater:

So, as the name suggests in the case of these free distribution systems, the supplier has less scope to impose restrictions than in an exclusive or selective distribution system. That said, as well as restrictions to protect any exclusive or selective distribution systems otherwise in place, there are a number of other restrictions the supplier can potentially impose in free distribution models. So firstly, suppliers can impose a location clause on the buyer, which restricts its place of establishment. That means that a buyer can be required to restrict its distribution outlets and warehouses, to a particular place or territory.

Secondly, suppliers can maintain a separation of the wholesale and retail levels of trade, by restricting active and passive sales by a wholesaler to end users. And here the Vertical Guidelines also clarify that in making that separation, the supplier can distinguish and allow the wholesaler to sell to certain end users (so for example, large customers) while at the same time, prohibiting it from selling to all other end users.

And another way the supplier in a free distribution system can impose restrictions on buyers is where the supplier is selling components to a buyer to incorporate into the supplier's products. And in those types of cases, the supplier can restrict the buyer's ability to actively or passively sell those components to the supplier's competitors, to be used to manufacture the same type of goods as those produced by the supplier.

Fiona Garside:

Thanks Donald. Turning away from territorial and customer restrictions now to look at a different hardcore restriction. The previous guidelines suggested some softening to the Commission's traditionally strict stance on resale price maintenance, also known as RPM, with a recognition that in some circumstances RPM may lead to economic efficiencies. Laura, has there been any further relaxation in the new rules?

Laura Carter:

Yeah, resale price maintenance is still a hardcore restriction, meaning that imposing fixed or minimum resale prices on a buyer is in principle not allowed. And that prohibition covers any commercial strategies or pressure which have the effect of controlling retail prices. And that can include, using threats to coerce a buyer to comply with the suppliers recommended retail prices. In the new Vertical Guidelines the Commission, again, notes that while RPM is a hardcore restriction, and has been found to be an object restriction of competition law by the European Court of Justice, this doesn't mean it's a per se infringement of that prohibition on anti-competitive agreements. It may therefore be possible to justify RPM on a case by case basis, if it gives rise to efficiencies. So that might be where fixed resale prices are imposed in order to organise a short term, low price campaign. But the Guidelines don't really provide significantly new guidance on where RPM might meet those exemption criteria. And so this really remains an area of legal uncertainty where advice is helpful.

So, while RPM is still a hardcore restriction, the Guidelines do provide important additional guidelines. So first, minimum advertised price provisions are assimilated to RPM. So those provisions are the kind that prohibit distributors from advertising prices below an amount set by the supplier. This means that agreements including minimum advertised price provisions will need to be assessed on a case by case basis. Helpfully the Guidelines do suggest that they may meet the criteria to be exempted from the prohibition where they're used to prevent a particular distributor from using the supplier's product as a loss leader, for example.

Secondly, the Commission has clarified that imposing prices in the context of a fulfilment agreement, which is where you've got an agreement between a supplier and a buyer, and the buyer is executing an agreement previously concluded between that supplier and an end customer. So, imposing prices in that context is not considered RPM, where the supplier selects the company that will provide the fulfilment services.

And then finally, the Guidelines make clear that the use of price monitoring software, doesn't on its own constitute RPM, but use of that kind of software can increase price transparency in the market and that can allow manufacturers and resellers to track resale prices more effectively.

Fiona Garside:

And moving on to the last restriction that we're talking about today, non-compete obligations. Donald, how's the treatment changed under the revised rules in the EU and the UK?

Donald Slater:

So, under the previous rules, non-compete obligations that prevented the distributor from selling goods or services that compete with those of the supplier didn't benefit from the block exemption if their duration was more than five years or it was indefinite. Now, that aspect stays the same under the new rules but the revised block exemption takes a more relaxed approach to non-compete obligations that are tacitly renewable beyond five years. So, unlike under the previous rules, that type of tacit renewal clause can now benefit from the block exemption. However, it also has to be possible to renegotiate or terminate the contract with a reasonable notice period and reasonable cost. So in other words, the distributor needs to be able to effectively switch supplier at the end of the five year period. And as a final point here, this approach to tacit renewal is now an area of divergence between the EU and the UK. The UK has not actually adopted this change, so non-compete obligations that are tacitly renewable beyond five years will still need to be assessed on a case by case basis in the UK.

Fiona Garside:

Thank you both for that interesting overview of how the new block exemptions tackle these issues. In particular, it's helpful that the Commission has now provided separate guidance on the types of restrictions that can be imposed, depending on whether the supplier opts for an exclusive, selective, or free distribution model. Similarly, expanding the types of products for which a selective distribution model can be used is a welcome change. If you're interested in learning more about the new EU Vertical Block Exemption Regulation, and the Vertical Agreements Block Exemption Order in the UK, we have a briefing available on our website, and watch out for the next episode in this podcast series.

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