short lines

European Distribution - a checklist for competition law compliance

April 2005

Distribution models come in a number of guises, including agency, franchising, selective distribution, exclusive distribution, fully open models, and so on. Whatever the model however, suppliers need to be aware of the application of EU (and each Member State 's own) competition law rules relating to distribution, as these will to a greater or lesser extent, usually apply. In this Short Lines we summarise these applicable rules, and conclude with a short checklist for European distribution.

"Genuine Agency" v Distribution

The agency and distribution distinction is crucial in the application of European competition law rules, as the rules don't apply where a supplier uses a "genuine agent", which unsurprisingly, is not as simple as labelling the arrangements an agency. Broadly, to be considered a "genuine agency" for the purposes of European competition law rules, the agent must bear very little or no financial or commercial risk in relation to the activities for which it has been appointed[i] . In other words, the agent must truly be acting on the principal's behalf and must not for example, be exposed to contractual risks with customers, or be required to purchase stock from the supplier for resale to customers. With every silver lining however, there comes a cloud. If the arrangements are a genuine agency, the principal faces the uncomfortable application of the Commercial Agents Directive[ii] , the usual downside of which is the requirement to compensate the agent on termination of the arrangements.

Article 81 EC

Other distribution arrangements, whatever their label, frequently attract unwelcome attention because of Article 81 EC (and its Member States' national law equivalents such as Chapter I of the Competition Act in the UK ). Article 81(1) prohibits agreements which affect trade between EU Member States and that have an anti-competitive object or effect. Particular displeasure is reserved for agreements that fix prices or other trading conditions, limit production, or share markets. It is easy therefore, to see how Article 81(1) can apply to distribution, if a supplier wishes to set the resale prices for its products, or to grant exclusivity in particular countries or markets. However, Article 81(1) will often not apply, if there is an insufficient effect on competition.[iii]

Exemptions

Article 81(3) exempts agreements caught by Article 81(1) that nonetheless have pro-competitive effects. In distribution terms, one would seek to argue that an exclusive distribution agreement (which shares markets and is therefore potentially anticompetitive) is pro-competitive because it opens up new markets that the supplier would not otherwise enter, for varying adverse commercial reasons (for example, market knowledge, licensing requirements, etc).

The European competition authorities have long recognised the pro-competitive gains from distribution, and the need to offset the commercial risks for the distributor with some commercial advantage through exclusivity and similar incentives. In 1999 the Commission adopted the Vertical Agreements Block Exemption Regulation [iv] and published accompanying Guidelines[v] , which elaborate, and have become the definitive rules upon, the application of Article 81 to distribution arrangements.

Vertical Agreements Block Exemption Regulation

Our May 2001 Short Lines[vi] discussed the Vertical Agreements Block Exemption Regulation ("VABER"). In summary, distribution agreements will be exempted under VABER where they contain no "black listed" terms (e.g. that fix resale prices or share markets or customers), provided the supplier's market share is less than 30% [vii]. However, it is possible to restrict active selling by one distributor into the exclusive market of another distributor, and to restrict retail sales by wholesalers, but broadly speaking, where an agreement fixes resale prices or shares markets or customers it is likely to fail. Conversely, if the supplier's market share exceeds 30% the agreement won't be automatically void, but the VABER exemption won't be available.

Lengthy non-compete obligations (that are indefinite or exceed 5 years) are usually unenforceable, but will not of themselves void the whole distribution agreement in the same way as price-fixing and market-sharing.

Distribution Checklist

To determine the probable impact of EU (and equivalent Member State national) competition laws to distribution arrangements consider asking the following questions:

Is the 'distributor' actually an agent ? Where 'distributors' take no commercial risk in the contractual arrangements with end users, and for example, hold no stock, they are likely to be agents and therefore outside Article 81. However, the Commercial Agents Directive will probably apply instead.
If no, are the parties' market shares both less than 15%? This usually requires some detailed economic analysis, but broadly speaking, (and subject always to question 3 below) if neither party holds in excess of 15% of a relevant market, Article 81 will not apply.
Does the distribution agreement contain any 'black listed' provisions? If any of the restrictions listed in Article 4 of VABER are included, the arrangements most likely infringe Article 81 and are therefore void as a whole.
If no, is the supplier's market share less than 30%? If the supplier's market share is less than 30% VABER will often exempt the distribution arrangements from Article 81.
Finally, are there any prohibited conditions? Lengthy non-competes are prohibited by Article 5 of VABER and cannot be enforced.

Conclusion

Competition law analysis of distribution agreements can be difficult but is by no means impossible. The trick is as much to be able to recognise when the issues don't arise, as when they do. The introduction of VABER partially eased this exercise (by presenting only two clear hurdles - black listing and market share thresholds - after which exemption is usually available), but in other ways made the exercise more difficult (by often requiring detailed economic analysis to determine market share). Whilst there are Commission Guidelines to aid in any such analysis, both on market share [viii] and specifically on the application of Article 81 to distribution agreements,[ix] these are often difficult to apply in practice. The key is, therefore, to sort the wheat from the chaff. The above 5 questions should hopefully make this easier.

David Meredith

Useful URLs

http://europa.eu.int/eur-lex/lex/LexUriServ/LexUriServ.do?uri=CELEX:31986L0653:EN:HTML
Commercial Agents Directive

[1]Section 2, Commission Guidelines on Vertical Restraints, OJ 2000 C291/1

[2] Directive 86/653

[3] Commission Notice on Agreements of Minor Importance, OJ C368, 22/12/2001

[4] Regulation 2790/99

[5] See note 1

[6]"Vertical Restraints - Less Form More Effect"

[7]The distributor's market share is instead relevant when considering exclusive supply

[8]Commission Notice on the Definition of the Relevant Market OJ 1997 C372/5

[9] see note 3 above