Legal Outlook: Vertical Agreements in the EU and UK Episode 4

Legal Outlook Vertical Agreements in the EU & UK: Episode 4 (transcript)

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Transcript



Fiona Garside:

Hello, everyone. I'd like to welcome you to the fourth episode in our podcast series on the new rules on vertical agreements in the EU and UK. In this series, we are focusing on the impact of the new rules on agency arrangements, dual distribution, traditional and online distribution models and areas where the UK and EU 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 Esther Kelly, a partner in our Brussels office, and Hayden Dunnett, an associate in our London team. And today we're going to be talking about the rules on online distribution. Thank you both for joining me.

Esther:

Thank you very much, Fiona, delighted to be here.

Hayden:

Thanks, Fiona. Looking forward to the discussion.

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 day, 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 anticompetitive agreements, if the parties have market shares of less than 30% on their respective markets and the agreement does not contain any so-called hardcore restrictions of competition. Today, we're focusing on how the new rules impact online distribution.

Online shopping was obviously well established by 2010 when the previous versions of the EU block exemption and guidelines were published, but e-commerce has continued to grow since then and in particular, we've seen a significant growth in online marketplaces. Addressing specific issues affecting this type of online distribution has therefore been a long time coming and the European Commission has had to consider a range of relatively complex and sometimes contradictory case law when drafting these new rules. But to reflect this commercial reality, this growth in e-commerce, both the block exemption and the guidelines do now expressly deal with issues relating to online distribution. And this is the area where the revised VBER and guidelines probably innovate the most compared to the previous versions.

Today, we're going to talk about two main aspects of the new rules. First, how the block exemption applies to internet distribution. And second, a new regime for providers of these so-called online intermediation services or OIS. So, for example, that's certain online marketplaces, app stores, price comparison and social media sites.

In the previous episode, Donald and Laura discussed some of the hardcore restrictions, which will prevent an agreement from benefiting from the block exemptions, such as restrictions on passive sales and resale price maintenance. Both the EU and UK have now introduced a new hardcore restriction, which means that suppliers cannot prevent the effective use of the internet. Esther, what does this cover?

Esther:

Thank you, Fiona. That's an excellent question and I think it immediately goes to the heart of some of the challenges that companies and then their advisors may face when trying to apply the new regulation and guidelines. The notion of the effective use of the internet appears multiple times in the documents, without being clearly defined. There are examples of conduct that the European Commission considers to be permissible, and examples of conduct that are so-called hardcore restrictions, that are clearly not okay. But there is some grey space between the two.

If we start with the big picture, the Guidelines accept that there are various legitimate reasons why suppliers might want to impose some restrictions on online sales, just as they may want to impose some restrictions on how brick and mortar sales take place. The reason for this includes to avoid so-called negative externalities, in the economic jargon. The most obvious example of such an externality is one that we may all be familiar with. So, that's where consumers visit a brick and mortar store to have a product shown to them by qualified sales people, so called pre-sale services, but then go online and buy it for a lower price. This is a classic free rider issue. The brick and mortar store has had to invest in qualified sales people, but then that investment cannot be recouped and is instead taken advantage of by an online store that hasn't made the same investments. The difficulty here is that this limits the incentives for brick and mortar stores to provide quality services, and therefore can ultimately lead to lower quality of service for consumers.

So, there are some reasons that we might have legitimate restrictions on online sales. At the same time, the Commission clearly starts from the principle that online commerce is a good thing that overall benefits consumers. So Commissioner Vestager, for example, noted that e-commerce should give customers a wider choice of goods and services, as well as the opportunity to make purchases across borders. And that's a theme that comes back throughout the online discussion in the Guidelines, the importance of not setting up artificial boundaries that could prohibit passive sales.

So, at least one thing is clear. A total prohibition on any type of online sales is a hardcore restriction that will take an entire agreement outside the scope of the exemption. As I say, this is consistent with the overall scheme of the regulation and the precedents in the vertical space, because such an absolute restriction is akin to a passive sales restriction. And we know, of course, that those are problematic, as have been discussed in the previous episodes.

Fiona Garside:

And the hardcore restriction also cover restrictions that have that indirect object of preventing effective use of the internet. Could you talk us through some of the examples in the guidance?

Esther:

Yep. So this is where things start to get particularly interesting. So, although the Commission's stated intent, and they've tried hard at this, was to make the VBER easier to use in day-to-day business, this notion of effective use of the internet will require some pretty complex self-assessment in practice.

So, what does the guidance do? It sets out a number of examples of clear hardcore restrictions. The first one that we might think about is restrictions that prohibit the buyer from using an entire online advertising channel. So, what's an online advertising channel? That's something like search engines as a whole, or price comparison sites generally speaking. However, there are some nuances to this. So, prohibiting a distributor from using a specific price comparison site would not generally be considered a hardcore restriction, unless that specific restriction applies to the most widely used advertising service in that particular channel.

Of course in practice determining which set engine or price comparison site is the most widely used may be difficult. So, does this mean that if there are two price comparison sites available for a particular product, we can't prohibit the use of one of them if it has just one more customer? Obviously some common sense is going to be needed in doing self-assessments. In some cases, it's going to be obvious what is the main, most popular site and in other cases, that's going to be challenging. The Guidelines try to clarify this, by saying that essentially, it comes down to the question of whether a distributor would still be able to make effective use of the internet, or whether they are so restricted that it amounts to ban an online distribution in all but name. But as I say, this will be a case-by-case assessment.

Another example of a hardcore restriction is prohibiting a distributor from using the supplier's trademarks or brand names on its website. And this one seems pretty logical. Of course, you can't effectively use the internet to sell a branded good if you're not allowed to use the brand, how will anyone find it to purchase it from you?

A third example that we might cite is one that has clear parallels, I think, with the notion of passive sales restrictions, and that's requirements to seek prior authorisation before making individual online sales transactions, or a requirement to reject, for example, foreign credit cards from customers outside a distributor's allocated territory. So, we have these examples and some more in the guidance, but there will clearly be quite a lot of work to be done in borderline cases and companies and their advisors will have to work through these quite carefully pending guidance from the Commission in terms of their enforcement practice.

Fiona:

Thanks Esther. While the VBER blacklists provisions or conduct whose object is to impede distributors from using the internet, it clearly exempts certain restrictions on the way in which online sales may be carried out. So Hayden, what types of limitations on online selling may benefit from the block exemption?

Hayden:

Thanks Fiona. So, I think this is probably one of the most complicated areas in the VBER and the Guidelines. I think, to some extent, this reflects the history of online sales on the internet and some of the competition issues that have arisen in the past. And so, while the VBER and Guidelines indicate that restrictions may be imposed in relation to the manner in which contract goods or services are sold online, it's also made clear that these restrictions should not indirectly have the object of preventing the effective use of the internet.

Now, the obvious question to ask is what does effective mean in this context? I think it's arguable that and quite difficult to identify any restrictions which would not have such an object. Any sort of restriction on sales through the internet arguably somehow prevents the use of the internet itself. So, I think from our perspective, we think it's very likely to come down to a question of the degree to which a restriction prevents the effective use of the internet.

Now, in this context, the Commission does give some guidance on this particular issue. It says that online sales restrictions generally do not have such an object where the buyer remains free to both operate its own online store and also advertise online. I think this is an important principle that will guide companies in the drafting of their agreements.

However, in relation to advertising, VBER and the Guidelines do provide a bit of a mixed message in terms of how restrictions can play out. As we mentioned earlier, the Guidelines suggests that it's important that the distributor remain free to advertise online, but at the same time the Guidelines also state that online advertising restrictions can benefit from the exemption, provided that they do not have the object of preventing the use of an entire advertising channel by the buyer.

So, under the new rules, I think the question is going to be, when will a supplier prevent the use of an entire advertising channel? And as Esther noted earlier, a prohibition on, say for example, the use of price comparison websites absolutely will be an example of such a restriction. However, less absolute mechanisms, such as qualitative criteria, are going to need to be considered in more detail in order to assess whether they fall foul of the VBER or not.

Now, the Guidelines also indicate that dual pricing, which is where the distributor is charged more for a sale made online than say, for example, in a bricks and mortar stores, is in principle admissible and allowed under VBER. However, there needs to be an economically justifiable reason for the difference in price.

Fiona Garside:

Thanks Hayden. A complicated area that we'll definitely wait for further guidance as the Commission starts to apply the new guidelines in practice. Esther, now if we turn to some of the other restrictions that look to be more straightforward to apply?

Esther:

Yes. So, I think one that is a little bit more straightforward relates to online marketplaces. So, this builds on the Coty precedent, but it extends the principle of that judgment to all forms of distribution of goods and services. So, previously it was thought that this only related to selective distribution and luxury products.

Two important points here, we've got the eternal requirement that it cannot prevent effective use of the internet. And then secondly, we need to remember the distinction between online marketplaces, which can be prohibited in a general manner, and advertising channels, which cannot. And so, what's the difference between the two? The key distinction is whether a site offers direct online purchasing functionality. If it doesn't do so then it's likely to be an advertising channel, and so we couldn't ban them wholesale. So that would be like our price comparison sites.

Others that may be easier to interpret relate to requirements that a distributor operate one or more brick and mortar shops or showrooms. That's happened under the previous case law. And similarly, there are some possibilities to require a distributor to sell a minimum amount of goods or services offline, but that must be an absolute value or volume requirement and not as a percentage of the distributor's total sales.

And then finally, the revised VBER and the Guidelines no longer require compliance with what we typically call the equivalence principle when it comes to selective distribution. So, that means that we can have different criteria that might apply to online and offline sales, which obviously reflect the difference in those marketing channels.

Fiona Garside:

Thanks Esther. As we move into the second part of our discussion, I just want to remind listeners of how agency is considered in the online context for competition law. So, as we touched on in episode one, companies active in the online platform economy are often considered to be agents under contract or commercial law, but for the purposes of the VBER and the VABEO, a company will only be considered to be an agent where it meets the conditions set out in the Guidelines, and these are more restrictive. So, the guidance makes it clear that it's unlikely that companies active in the online platform economy will be considered to be genuine agents for the purposes of assessing their vertical agreements. And this is for three main reasons.

First, the online platforms typically serve a very large number of sellers. So, that means they don't effectively become part of any one seller's undertaking, as we say, so, not part of the same entity.

Second, there are strong network effects and other features of the online platform economy that can result in a power imbalance in the size and bargaining power of the parties. And again, that means that the platform rather than the seller might actually determine the conditions for selling the goods or services, and therefore the commercial strategy.

And finally, just to note that online platforms typically make significant market-specific investments: for example, in software or advertising, after sales services. And as we talked about in episode one, this can be an issue in terms of agency because these companies will bear significant financial or commercial risks associated with the transactions that they intermediate. If you want a recap in more detail then I'd encourage you to go back and listen to episode one but that's just a high level reminder as we start to think about these online intermediation services providers, or OIS providers, because not being treated as an agent is likely to be particularly problematic for these providers. Before we go into the guidance in more detail, Hayden, can you remind listeners how the Commission has defined OIS providers please?

Hayden:

Sure. So, OIS providers allow companies to offer goods or services to other companies or consumers online, and they effectively do this with a view to facilitating direct transactions between those parties, or in a sense, effectively an intermediary. The Vertical Guidelines provide a few examples of OIS providers and these include e-commerce marketplaces, app stores, price comparison tools and social media services. I think that the key is that an OIS provider facilitates two parties contracting with each other directly.

Now, to add a level of complication to an OIS provider, a number of these providers offer additional services or intermediation services, but under the VBER, this does not mean that they're not considered to be an OIS provider. So, for example, where an OIS provider also takes payment for transactions that it intermediates, or provides services such as advertising, ratings, insurance, or guarantees against damage, these types of services would not prevent them from being considered to be an OIS provider.

Now, the concept of an OIS is actually derived from other EU regulation, known as the P2B regulation. And there's also been quite development of some complicated case law around what an OIS provider actually is. I think it's going to be seen to what extent that case law, which was not in a competition law context, is transposed into the competition law world. I think we're going to have to wait and see how that is applied in the VBER world and whether there'll be further clarity in this respect, which is probably not much comfort for companies who are working out how to self-assess under these provisions at the moment.

To add another level of complication, we also have what are known as hybrid OIS providers. And these are providers that not only intermediate the sale and purchase of goods between parties, but they're also active in the sale of goods themselves. Now, where an OIS provider also sells these goods and services in competition, the block exemption does not apply to these hybrid providers. However, the Commission has set out in guidance that it's unlikely to prioritise enforcement action against these types of agreements, where they don't have object restrictions and where an OIS provider does not have significant market power. However, hybrid OIS providers will still need to self-assess under Article 101 in particular.

In an interesting distinction, however, this sort of hybrid OS model is considered differently under the UK Vertical Agreements Block Exemption Order. So, it'll be interesting to see going forward what the differences are in practise, in the enforcement in the different regimes.

Fiona Garside:

Thanks Hayden, certainly potential for some divergence on this between the EU and the UK. Taking it back to higher level, Esther, what are the implications of being an OIS provider?

Esther:

So, in addition to the important point that Hayden mentions about the exclusion of hybrid OIS from the EU rules, I'll mention a few points. First of all, it impacts how an OIS provider should calculate their shares for the purpose of applying the 30% safe harbour. So, the relevant market for a non-hybrid OIS is that for the supply of online intermediation services so not the market for the products that are eventually being sold via that service.

Second, it implies certain obligations in relation to MFNs or parity clauses, that will be discussed in more detail in the next episode.

And third, it raises a number of interesting questions in relation to the hardcore restrictions. So, the Guidelines make clear that OIS providers are considered to be suppliers for the purposes of Article 4, because they are supplying OIS services to those that want to distribute goods via their website. So, it's pretty clear in that case, then an OIS supplier clearly cannot impose minimum prices on those buying online intermediation services from them. So, an OIS supplier cannot require those wanting to sell via their site to apply minimum prices, for example, that's RPM.

So this raises a question in terms of what happens if the reverse scenario occurs. So, imagine that we have a manufacturer of branded goods, and let's say this is a very high profile branded good. They use the OIS to reach customers, fair enough. The branded supplier wants to impose minimum prices at which the OIS can offer their branded goods. Are we talking about RPM or are we not? Here we reach an interesting definitional question and encounter some of the challenges that are presented by potentially two-sided markets.

Suppliers of OIS should also note the warning in Article 6 of the VBER. This specifically refers to potential withdrawal of the benefit of the block exemption, even if the other criteria are normally met, in cases where the market for the supply of online intermediation services is a) highly concentrated and b) there are parallel networks of similar agreements.

So, this is another challenge for self-assessment, since if you're an OIS, you may not know if there are networks of parallel agreements, because you wouldn't know what your competitors are doing or you really ought not to. So, it's an additional point where the OIS providers are going to need to be careful and are going to need to really think through the terms that they have put in their contract carefully with their advisors, I think.

So, there are other questions related to OIS that will also take careful thought, but I think overall, the headline item is that those who fall into this category are going to need to think these things through very carefully. And I think we'll all be waiting eagerly for additional guidance from the Commission.

Fiona Garside:

Thank you both for that very interesting overview of how the rules on vertical agreements have changed in relation to online distribution. The revised Guidelines have clearly made significant changes to the rules regarding selling by digital channels. And while it's welcome in some respects, that the new rules offer greater clarity and flexibility for online selling, at the same time, the concrete application of these rules, particularly the rules relating to online intermediation services, could benefit from further clarification and they may well add to the complexity of this area of the law. So, as Esther said, we'll be eagerly awaiting further guidance from both the Commission and the CMA as well.

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, then we have a briefing available on our website, and watch out for the next episode in this podcast series. That episode's going to cover the key differences between the new EU and UK rules and, as Esther mentioned, we'll highlight there the different approaches to parity obligations, also known as most favoured nation courses. So, do please check that out.

To ensure you don't miss any future episodes, do subscribe now on Apple Podcasts, Spotify, or your favourite podcast platform. And while you're there, please feel free to keep the conversation going and leave us a rating or review. Until then, thanks for listening.


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