Vertical Agreements: The New EC Competition Regime

Introduction

After months of procrastination, the European Commission has finally published the new block exemption Regulation for vertical agreements, giving exemption from the Article 81 (ex 85) EC prohibition of restrictive agreements (Regulation 2790/1999, OJ L336/23 hereafter "the Block Exemption regulation" or "the new Regulation). Vertical agreements are defined as agreements between undertakings operating at a different level of the production or distribution chain relating to the purchase, sale or resale of specified goods or services. The Block Exemption Regulation also applies to agreements between an association of undertakings and its suppliers, provided that all the members of the association are retailers of goods, and that no individual member of the association, together with its connected undertakings, has a total turnover exceeding EUR 50 million.

The Commission has also published detailed guidelines (still in draft form) on the application of the new Regulation and the framework of analysis for vertical agreements outside the scope of the regulation. This package is the culmination of a process that commenced with the Commission's Green Paper of 1997 on Vertical Restraints and continued with a follow-up Commission Communication of 30 September 1998. A first draft of the Regulation was published on 24 September 1999, together with a draft of the Guidelines.

The Block Exemption Regulation enters into force on 1 June 2000. It will replace the existing individual block exemptions for exclusive distribution, exclusive purchasing and franchising agreements, all of which were to expire on 31 December 1999, although they have been extended by the new Regulation to 31 May 2000. The Block Exemption Regulation applies to a broader category of vertical agreements (for example agency agreements falling under Article 81(1)), thereby removing the largely arbitrary distinction between which types of vertical agreements could benefit from a block exemption.

The Commission's new approach to the application of EC competition policy to vertical restraints is claimed to be more economically realistic than previously. Vertical agreements can be said not to involve serious competition concerns where little or no foreclosure on the market results, and to this extent a generally more liberal approach is taken in the Block Exemption Regulation. The new Regulation will not apply above a threshold of 30% market share of the supplier or, in exclusive supply situations covering the whole of the EC, the purchaser. (The 30% threshold can be exceeded for a period of two calendar years, provided that either the market share does not exceed 35% or does not do so for more than one calendar year within this two year period.) The market share figure is to be calculated by reference to the previous calendar year and is to include any goods or services supplied to integrated distributors for the purpose of sale.

In any event, the Block Exemption Regulation provides that agreements in existence prior to entry into force of the Regulation on 1 June 2000, which comply with the conditions of the existing exclusive distribution, exclusive purchasing or franchising block exemptions, will continue to be exempt until 31 December 2001.

The shortcomings of the old regime

For some vertical agreements (exclusive distribution, exclusive purchasing and franchising) the old regime was characterised by a variety of block exemption regulations which had the advantage of providing a significant degree of legal certainty. However, quite apart from the fact that they applied only to certain types of agreements but not others of similar economic effect, their formalistic nature had a 'strait-jacket' effect in other respects.

Regulation 1983/83, the old block exemption for exclusive distribution agreements, which will now be replaced by the new Regulation, had the following downsides:

- The 1983 Regulation applies only to sole or exclusive, and not non-exclusive agreements;
- Only agreements between two undertakings are covered, so for example an agreement involving an additional party, say as guarantor or as trade mark licensor, would prevent the block exemption applying;
- The 1983 Regulation did not apply to selective distribution systems;
- Many types of restrictive provisions which businesses frequently want to include in their agreements, though not black-listed, are not white-listed either and so prevented the block exemption applying;
- Agreements other than for resale, for example industrial supply agreements, are not covered.

The content of the Block Exemption Regulation

The Block Exemption Regulation will apply in principle to all vertical agreements, subject to the 30% market share test, including agreements between more than two undertakings, and industrial supply agreements (the supply of goods for incorporation in other products).

This is the first time that either selective distribution agreements or agency agreements will benefit from a block exemption. As explained in the draft guidelines, this will only concern agency agreements falling under Article 81(1), i.e. where the agent bears a financial and commercial risk in relation to the contracts concluded. However since the new Regulation black-lists resale price maintenance, it will not cover agency agreements under which the principal stipulates the price at which the goods must be marketed or sold (as opposed to, say, the amount of commission on each sale).

The new regulation will also apply to vertical agreements containing ancillary provisions on the transfer or use of intellectual property rights for the purpose of using or reselling the goods or services supplied, provided there are no further competition restrictions of a type not exempted under the Regulation. On this basis, by reference to the draft guidelines, a trade mark licence granted to a distributor could be covered, as could software supply agreements where the reseller, without acquiring any licensed rights himself, acts as a conduit for a use licence between the supplier and the end user of the software, for example "shrink wrap" licences.

In line with current limitations on the scope of Regulations 1983/83 and 1984/83, the Regulation will not apply to vertical agreements between competitors where these are concluded on a reciprocal basis. It will also not apply to non-reciprocal agreements between competitors where the buyer is a competing manufacturer or has an annual turnover of more than EUR 100 million.

Where non-reciprocal vertical agreements for services are entered into by competing undertakings, they can be block exempted where the supplier is a provider of services at several levels of trade, while the buyer does not provide competing services at the level of trade where it purchases the contract services (even where the buyer's annual turnover exceeds EUR 100 million).

The Block Exeption Regulation does not contain a white list, meaning that any vertical agreement complying with the market share and other general criteria will be covered by the block exemption provided that the agreement does not contain any black-listed provisions. These prohibited clauses are listed in Article 4 and include resale price restrictions on the buyer.

As a result of the black list, the Block Exemption under the new Regulation will not apply to vertical agreements which restrict the customers to whom or territories to which the buyer may sell. However, as exceptions to this general rule, the new Regulation will apply in the following cases:

(a) Restrictions of active sales into the exclusive territory or to an exclusive customer group reserved to the supplier or allocated by the supplier to another buyer, where such a restriction does not limit sales by the customers of the buyer.

(b) Restrictions of sale to end users by a buyer operating at the wholesale level of trade, including a wholesale level dealer in a selective distribution system. This last minute amendment of the Regulation brings it in line with the Commission's and the Court's settled case law in this field. Restrictions on sales to end users by members of a selective distribution system are prohibited (black-listed) where the members are operating at the retail (as opposed to wholesale) level.

(c) Restrictions on sales to unauthorised distributors by the members of a selective distribution system.

(d) Restriction of the buyer's ability to sell components for the purpose of incorporation, where the customers "would use them to manufacture the same type of goods as those produced by the supplier".

Restrictions on cross-supplies between any distributors (at whatever level) in a selective distribution system and restrictions on sales to end users by retail-level dealers in a selective distribution system are now expressly classified as "hard-core", i.e. black-listed.

Article 5 lists those prohibited restrictions which, although not themselves covered by the block exemption, do not take the whole agreement outside the scope of the block exemption. This is the case for the following restrictions:

(a) Any direct or indirect non-compete obligation which includes obligations to purchase more than 80% requirements from the supplier, which are of indefinite duration or for longer than five years. When a non-compete obligation is tacitly renewable beyond a period of five years, it will be deemed to have been concluded for an indefinite duration.

(b) Any direct or indirect obligation causing the buyer, after termination of the agreement, not to manufacture, purchase, sell or resell goods or services will only be covered by the block exemption if:

- it relates to goods or services which compete with the contract goods or services, and
- it is indispensable to protect know-how transferred by the supplier to the buyer, and
- it is limited to the premises and land from which the buyer has operated during the contract period.

(c) Such a non-compete obligation must be limited to a period of one year after the termination of the agreement, without prejudice to the possibility of imposing a restriction unlimited in time on the use and disclosure of know how which has not yet entered the public domain.

(d) Any direct or indirect obligation causing the members of a selective distribution system not to sell the brands of particular competing suppliers.

In situations where parallel networks of similar vertical restraints cover more than 50% of the relevant market, the Commission may adopt a further regulation disapplying the new block exemption to vertical agreements containing specific restraints relating to that market. Even more interestingly, by way of a new departure under the new Regulation, the competent authority of a Member State is given the power to withdraw the benefit of the new Regulation in respect of its national territory, where that has all the characteristics of a distinct geographic market and the agreement in question has effects there which are incompatible with Article 81(3) (ex 85(3)) EC.

Further reform: the timing of notification

Agreements which are outside the scope of the new Regulation, as for all block exemptions, can only be exempted under Article 81(3) pursuant to individual notification. However, the Commission is actively seeking to reduce the number of individual notifications of vertical agreements, to enable it to concentrate resources on more serious competition matters. Accordingly, in 1999 it proposed and the European Council adopted, Regulation 1216/99 amending Article 4(2) of the main EC competition procedural regulation, Regulation 17/1962. Under this amendment, all vertical agreements, individually notified, can benefit retrospectively from exemption as from the date of their entry into force, rather than, as previously, the subsequent date of their notification. This makes it much more reasonable in many cases for companies whose vertical agreements fall outside the new block exemption to defer notification until such time as a genuine dispute or problem of enforceability arises in connection with the agreement, because a notification can be made then so as to obtain retrospective exemption. Prior to this reform, parties to vertical agreements, as for almost all other agreements, were exposed to the risk of invalidity (and possibly also the risk of Commission fines) in respect of the period between the date of the agreement and the date of any subsequent notification.

This reform was an important counterbalance to offset the limitation on the scope of the new block exemption resulting from the market share test. It is likely that this amendment to Regulation 17/1962 will assist in reducing precautionary notifications made at the outset mainly with a view to safeguarding the validity of the restrictive provisions. The Commission states in its draft guidelines that it will not give priority to dealing with notifications of vertical agreements in the absence of litigation in national courts or complaints.

Will the new regime, on balance, benefit businesses?

There are a number of advantages and some disadvantages of the new system to businesses, some of which can be summarised as follows:

Advantages:

(a) The new block exemption will apply to a much wider range of vertical agreements than those which have hitherto benefited from block exemptions, in that the following will all now be capable of being covered: non-exclusive as well as exclusive distribution agreements, supply agreements of goods for incorporation (and not just agreements on exclusive purchasing for resale), agency agreements (but not where the supply or sale price is stipulated by the principal to the agent), co-promotion agreements and agreements for the supply (with a licence to the end user) of computer software.

(b) Selective distribution arrangements now will be capable of coming within a block exemption.

(c) Below the market share thresholds, the block exemption will be more permissive than the current régime in the sense that any restrictions relating to the purchase, sale or resale of contract products will be permitted if they are not black-listed or expressly prohibited by the block exemption, i.e. they do not need to be included in a white list.

(d) Where agreements are not clearly within the new block exemption, the amended Article 4(2) of Regulation 17/1962 (Regulation 1216/99) enables the view reasonably to be taken by businesses that notification can be deferred until such time as an enforceability problem arises in respect of the agreement, reducing the need for precautionary notifications to the Commission at the outset.

(e) The black-list only approach will, from an EC competition law perspective, give parties greater contractual freedom below the 30% market share threshold.

Disadvantages:

(a) The application of the market share threshold will significantly limit the scope of the block exemption.

(b) The black-list is relatively complex and contains a significant erosion of the supplier's ability to prohibit all active sales efforts by a distributor outside his allocated territory, which has been a fundamental principle of the current Regulation 1983/83. Under the new block exemption, restrictions on active sales by a buyer may only be prevented in relation to an exclusive territory or customer group allocated by the supplier to another buyer, but restrictions on resales in relation to territories in the EC (or EEA) which have not been so allocated, will be black-listed. This includes (it appears) restrictions on resales in the supplier's home territory, where no resellers have been appointed for it.

(c) It will no longer be permitted under the new Regulation to require a purchaser to buy all of his requirements of the contract products (or of equivalent products) from the supplier (or any other designated party) (or even to apply such obligations to more than 80% of the buyer's requirements), or to impose any direct or indirect non-compete obligations on the buyer, of more than five years' duration.

It is important to note that agreements outside the block exemption, will not automatically be deemed ineligible for exemption, but they will require individual notification and examination under Article 81(3).

Overall, businesses and their lawyers will now be able to make a realistic assessment as to whether any individual notification of a vertical agreement outside the block exemption can sensibly be deferred until such time as a genuine enforceability issue arises, without unreasonably jeopardising the validity of the competition restrictions The amendment to the date on which any subsequent exemption can take effect will facilitate a more logical approach and a more rational risk management assessment on the question of individual EC notification of vertical agreements not clearly within the block exemption.

Richard Eccles and Yaël Ginzburg
CMS Cameron McKenna,
Brussels