European Commission Issues Draft Antitrust Rules on Vertical Supply Chain Agreements
The Background: The European Commission ("Commission") recently unveiled long-awaited draft revisions to its Vertical Block Exemption Regulation ("VBER") and Vertical Guidelines. The VBER includes safe harbors that exempt some agreements in the vertical supply chain from antitrust challenges. To qualify, neither party's market share can exceed 30% and the agreement may not contain a so-called "hardcore restriction."
The Development: Following a long evaluation, the drafts reveal, for the first time, the Commission's specific changes. The current VBER expires in May 2022. The revisions are aimed at adapting the current rules, adopted in 2010, to marketplace developments, including the growth of e-commerce and online platforms and recent EU case law.
Looking Ahead: If implemented as drafted, the VBER will narrow exemptions for most-favored nations clauses and dual distribution systems. While narrower exemptions remain in place for those types of agreements—and they are still lawful if procompetitive—companies should review their supply chain contracts in light of the Commission's proposed changes. The draft VBER also reinforces the Commission's focus on online platforms by excluding them from the benefit of a number of exemptions.
Background on the VBER
Article 101(1) of the Treaty on the Functioning of the European Union ("TFEU") prohibits agreements between companies that significantly restrict competition. The VBER, under Article 101(3) TFEU, provides a safe harbor from antitrust attack for vertical agreements (i.e., agreements between businesses operating at different levels of the vertical supply chain) that meet certain conditions. The VBER assumes that the procompetitive, efficiency-enhancing effects of such agreements outweigh the risk of anticompetitive harm. The VBER is a valuable instrument designed to afford legal certainty to businesses. To benefit from the safe harbor, vertical agreements must not include so-called "hardcore restrictions" and neither party's market share may exceed 30%. In addition, the VBER identifies certain restrictions (e.g., non-compete clauses lasting more than five years) that fall outside the safe harbor, even if the remainder of the agreement qualifies.
The Commission individually analyzes vertical agreements that fall outside of the VBER's scope under Article 101 TFEU. Except for certain "per se" illegal (or "by object") restrictions (e.g., resale price maintenance), the Commission balances anticompetitive effects and procompetitive benefits to determine the net impact on competition, much like the U.S. "rule of reason." The Vertical Guidelines that accompany the VBER provide guidance to interpret the VBER and help companies self-assess vertical agreements that do not qualify for VBER protection.
Narrowing the Safe Harbor
The proposed changes alter the scope of the VBER safe harbor. According to the Commission, the objective is two-fold: first, to cover practices that the Commission considers to generate sufficient efficiency gains to outweigh any anticompetitive effects; second and conversely, to align the new rules with evidence gathered during the evaluation process and to exclude competitively ambiguous practices from the VBER's scope.
In this regard, the Commission's proposals demonstrate a stricter stance towards dual distribution and retail price parity clauses. Those changes are consistent with the Commission's increased scrutiny of practices that have developed along with the growth of e-commerce and online platforms.
Dual distribution refers to the scenario in which a supplier distributes its goods or services both directly to customers and through an independent third-party distributor (and thus competes with its distributor at retail level). Under existing EU law, dual distribution is assessed exclusively under vertical rules and therefore may benefit from the VBER. The Commission's original view was that the vertical aspects (and benefits) of dual distribution took prevalence over any horizontal concerns at retail level. The Commission has observed an increase in the number of suppliers that compete with their distributors, notably through their own online sales channel. In some cases, online intermediation service providers also sell their own products through their platforms, in competition with third-party sellers. Some commentators argue that information exchanges in dual distribution scenarios may enable suppliers, including providers of online intermediation services, to gain a competitive advantage at retail level. To address that perceived issue, the Commission removed the blanket exemption for dual distribution from the draft rules. Under the current proposal:
- Dual distribution is exempt only where there are no "by object" and "hardcore" restrictions (e.g., resale price maintenance) and the parties' aggregate market share in the relevant retail market does not exceed 10% (although that low threshold seems to be still open for discussion);
- Above the 10% threshold, dual distribution remains exempt if the parties' combined market shares do not exceed 30%. Although dual distribution would qualify for the safe harbor, the Commission will additionally evaluate any information exchanges under applicable rules for horizontal agreements; and
- Online intermediation service providers that compete with third-party businesses selling on the intermediary's website do not benefit from the safe harbor. In that scenario, dual distribution will be assessed under the net effect on competition test.
Price parity clauses, sometimes called most-favored nation clauses ("MFNs"), require a supplier to offer its goods or services on conditions that are no less favorable than those terms the supplier offers other customers or other sales channels. Although MFNs can be procompetitive, scrutiny from EU Member State antitrust authorities has led to divergent decisions in the online booking sector at the national level. In an attempt to harmonize the approach to MFNs, the Commission proposes to:
- Exclude from the VBER's safe harbor "across-platform" MFNs imposed by online intermediation service providers that prevent suppliers from offering better terms on other platforms (also known as "wide" parity clauses). Such clauses may still be lawful, and their net impact on competition will still be evaluated under Article 101 TFEU;
- Exempt all other types of MFNs, including so-called "narrow" parity clauses relating only to the supplier's direct sales or marketing channels; and
- Provide guidance on the individual assessment of different types of MFNs in which the parties' market shares exceeds certain thresholds.
Expanding the Safe Harbor in Exclusive Distribution
The draft VBER provides suppliers with more clarity and flexibility to design exclusive or selective distribution systems. Suppliers may appoint more than one exclusive distributor in a given territory or for a particular customer group. However, the draft Vertical Guidelines clarify that such "shared exclusivity" should not be used to shield a large number of distributors from competition located outside the exclusive territory nor to partition the internal market. As a consequence, the number of appointed distributors should be determined in proportion to the allocated territory or customer group in such a way as to secure a certain volume of business that preserves their investment efforts.
The draft rules also would allow suppliers to restrict sales by the customers of their exclusive or selective distributors into another exclusive territory or to unauthorized distributors, respectively.
Guidance on Online Sales Restrictions
The draft VBER and Vertical Guidelines clarify how the Commission will evaluate various types of online practices that have emerged with the growth of e-commerce, reflecting the principles established in recent EU and national case law.
The draft VBER defines online sales "restrictions" that qualify as a "hardcore restriction" in Article 1(1)(n) as restrictions that, directly or indirectly, in isolation or combination with other factors, have as their object to prevent the buyers or their customers from effectively using the internet for the purposes of selling their goods or services online or from effectively using one or more online advertising channels. The new definition includes restrictions "capable of significantly diminishing the overall amount of online sales in the market."
The draft Vertical Guidelines provide examples of practices falling within that definition, following the EU and national recent enforcement practice in Pierre Fabre, Guess, and Asics. Besides a direct prohibition to use the internet as a sales channel, prohibited restrictions include, among others:
- Requirements to sell only in a physical space or in the physical presence of specialized personnel;
- Requirements to seek a supplier's prior authorization for selling online; and
- A direct or indirect prohibition to use a specific online advertising channel, such as a restriction on the use of price comparison tools (although quality standards may be applied) or the use of suppliers' brand names and trademarks for paid referencing in search engines.
The proposed rules also implement the European Court of Justice ("CJEU") ruling in Coty (detailed in our December 2017 Commentary), which exempted a supplier's direct or indirect ban on sales on online marketplaces from Commission scrutiny.
The Commission's proposals also recognize that e-commerce is a well-established sales channel that does not necessarily require the level of protection envisaged by the current rules. As a result, the Commission proposes to soften its approach to so-called "dual pricing," a practice in which a supplier charges a distributor a higher wholesale price for products intended for sale online compared to the price for products sold offline. While the Commission currently regards that practice as a "hardcore restriction," condemned without an inquiry into the net competitive impact, the draft VBER would permit suppliers to set different wholesale prices for online and offline sales by the same distributor, provided that the supplier intends the dual pricing to incentivize or reward an appropriate level of investments and the price difference relates to the costs incurred for each channel.
Also, in the context of selective distribution systems, the draft Vertical Guidelines indicate that a supplier may impose conditions for online sales (e.g., to cover costs of customer product returns) that are not identical to the conditions for sales in brick-and-mortar shops.
The Commission's draft guidance also attempts to enhance legal certainty by simplifying and clarifying certain rules.
- General sales terms and conditions, even if imposed by one party and accepted tacitly by the other, amount to an agreement that may be subject to Article 101 TFEU;
- Article 101 TFEU will not apply to an agent if the agent, for a very brief period of time, acquires title to contracted goods while selling them on behalf of the principal, provided that the agent does not incur any costs or risks related to the transfer of property;
- The exemption for agents in the paragraph above would not apply to providers of online intermediation services;
- The Commission retained its harsh treatment of resale price maintenance ("RPM") as a hardcore restriction. RPM, also known as vertical price fixing, is an agreement between a manufacturer and a distributor to set the price at which a distributor will resell the manufacturer's products to retailers. Therefore, for the foreseeable future, EU law will diverge from U.S. federal law, which analyzes RPM under the rule of reason following a Supreme Court ruling in 2007 that overturned nearly 100 years of precedent during which RPM was per se unlawful. In limited circumstances, RPM may be exempt, for example, to organize a coordinated short-term low price campaign. The draft guidelines also provide that online intermediation service providers cannot fix the sales price for the transactions that they facilitate; and
- Non-compete clauses of less than five years, but that are tacitly renewable beyond a period of five years, are now exempt under the VBER, provided that the buyer can effectively renegotiate or terminate the agreement within a reasonable notice and at reasonable cost.
The Commission has invited submission of public comments by September 17, 2021. If adopted on their current proposed schedule, the revised rules take effect on June 1, 2022, with a transitional period until May 31, 2023, to adapt agreements that were already in place at the time of adoption.
Similar Initiative in the UK
The Commission's proposals mirror a similar initiative in the UK, where the VBER was incorporated into UK law following Brexit. Similar to the EU, the current version of the VBER also expires in the UK in May 2022, but as the Commission's revised rules will not have effect under UK law, this development is one of the first opportunities for material divergence between EU and UK antitrust laws.
To replace the VBER in the UK, the Competition and Markets Authority ("CMA") is consulting on a proposed Vertical Agreements Block Exemption Order ("VABEO") that is likely to be similar to the existing VBER rules and incorporate some of the reforms contemplated in the Commission's proposals. However, material differences with the Commission, so far, include a broader exemption for dual distribution arrangements not to be limited by a specific market share threshold and with no rules specific to online intermediation service providers.
The CMA expects to publish the final version of the proposed VABEO in the latter part of 2021, which will then be subject to approval by the UK Government. Once greater clarity is available regarding the final version of the VABEO it will be important for businesses to assess whether their current practices will continue to benefit from the revised UK exemption and whether there might be greater flexibility available with respect to their UK operations that might not be available in the EU.
Five Key Takeaways
- The European Commission has proposed new rules on agreements in the vertical supply chain. The new rules reflect increased scrutiny of new practices and distribution systems (including dual distribution), which have developed with the growth of e-commerce and online platforms.
- The draft rules narrow the VBER safe harbor related to dual distribution and MFNs. In particular, certain information exchanges in dual distribution would be specifically carved-out from the block exemption as well as an online intermediation service provider's use of "wide" MFNs.
- The draft rules would expand the list of prohibited "hardcore restrictions," narrowing the extent to which a supplier could influence a reseller's online sales.
- Although the draft rules largely narrow the exemptions, the draft VBER would increase the ability of suppliers to design distribution systems.
- Unlike under U.S. federal law, RPM would remain a "hardcore restriction" in the EU, condemned in most instances without any consideration of its potential benefit to competition.
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