The European Commission's Guidelines on Vertical Restraints
On 24 May 2000, the European Commission adopted, in final form, its Guidelines on Vertical Restraints (the "Guidelines"). The new Block Exemption Regulation on Vertical Agreements (Regulation 2790/1999, hereafter "the Block Exemption Regulation" or the "New Regulation") was adopted in December 1999 and enters into force on 1 June 2000. The Guidelines provide a very detailed explanation of the Commission's approach in applying the Block Exemption Regulation and in applying Article 81(3) of the EC Treaty in individual cases not covered by the Block Exemption Regulation. This memorandum reviews the main contents of the Block Exemption Regulation and explains the most important contents of the Guidelines on the substantive interpretation of the New Regulation which are of practical significance. This memorandum also explains the guidance that the Commission has introduced for assessing agency agreements under Article 81(1).
Scope of the Block Exemption Regulation
Definition of vertical agreements
The Guidelines confirm that vertical agreements are, as defined in Article 2(1) of the Block Exemption Regulation, "agreements or concerted practices entered into between two or more undertakings each of which operates, for the purposes of the agreement, at a different level of the production or distribution chain, and relating to the conditions under which the parties may purchase, sell or resell certain goods or services". This means that where one undertaking produces a raw material which another undertaking uses as an input, or where one undertaking is a manufacturer, the second a wholesaler and the third a retailer, an agreement between them could in each case be covered by the Block Exemption Regulation. Also, the Guidelines state, this does not preclude an undertaking from being active at more than one level of the production or distribution chain. Agreements between undertakings whereby one supplies products to the other for incorporation and supply, can be covered. However, agreements with final consumers not operating as an undertaking are not covered.
Clarification of what is intended by "potential competitors"
As regards vertical agreements between competitors (which, subject to certain exceptions, are not covered by the Block Exemption Regulation), actual or potential suppliers are considered to be competing undertakings. The Guidelines (para. 26) specify that a "potential supplier" of any relevant products is an undertaking that is able to undertake the necessary investments, switch production to the relevant products and to supply the market in response to a small and permanent increase in relative prices (supply-side substitutability) within one year. The Guidelines state that this assessment has to be based on realistic grounds, the mere theoretical possibility to enter a market not being sufficient.
Clarification of when the Block Exemption applies to intellectual property rights provisions
The Guidelines have been amended to include more detailed guidance on the conditions under which agreements containing provisions on intellectual property rights ("IPR") are covered by the Block Exemption Regulation. The Guidelines (para. 30) specify the following conditions: (a) the IPR provisions must be part of a vertical agreement; (b) the IPR provisions must be assigned to or for use by the buyer; (c) the IPR provisions must not constitute the primary object of the agreement; (d) the IPR provisions must be directly related to the use, sale or resale of goods or services by the buyer or its customers; and (e) the IPR provisions must not contain restrictions having the same object or effect as vertical restraints which are not exempted under the Block Exemption Regulation.
According to the Guidelines, most franchise agreements meet such conditions, since the franchisor provides the contract goods or services to the franchisee and the IPR help the franchisee to resell them. The franchisor also usually provides commercial or technical assistance services to the franchisee on a continuous basis (such as procurement services, training and financial planning). The Commission specifies further that franchising agreements containing an IPR licence can be covered by the Block Exemption where the licence does not constitute the primary object of the agreement, and conversely that, although franchise agreements which only concern the licensing of IPR are not covered by the Block Exemption, individual cases will be treated in a similar way.
Hardcore Restrictions under the Block Exemption Regulation
The Commission has, in the final version of the Guidelines, provided a more detailed explanation of the black-listed, hardcore restrictions in Article 4 of the Block Exemption Regulation (paras. 46 to 56).
Resale price maintenance
Agreements or concerted practices having as their direct or indirect object the establishment of a fixed or minimum resale price or price level to be preserved by the buyer are not covered by the Block Exemption Regulation (Article 4(a)). Indirect resale price maintenance is stated to include (para. 47 of the Guidelines) the following: agreements fixing the distribution margin or the level of discount the distributor can grant from a prescribed price level, making the grant of rebate or reimbursement of promotional costs by the supplier subject to the observance of a given price level, linking the prescribed resale price to the resale prices of competitors, threats, intimidation, warnings, penalties, delay or suspension of deliveries or contract terminations in relation to observance of a given price level.
Active and passive sales
This distinction is important because some restrictions on active resales (by the buyer) are permitted under the Block Exemption but all restrictions on passive resales by the buyer are black-listed.
The Block Exemption Regulation allows four exceptions to the general prohibition on restrictions on resale by the buyer (Article 4(b)). The first exception allows the supplier to restrict active sales by its direct buyers to a territory or a customer group which has been allocated exclusively to another buyer or which the supplier has reserved to itself. A territory or customer group is stated in the Guidelines (para. 50) to be exclusively allocated when the supplier agrees to sell its product only to one distributor for distribution in a particular territory or to a particular customer group, and the exclusive distributor is protected against active selling into its territory or to its customer group by the supplier and all the other buyers of the supplier inside the EC. The Guidelines also state that the supplier is allowed to combine the allocation of an exclusive territory and an exclusive customer group by, for instance, appointing an exclusive distributor for a particular customer group in a certain territory. This protection of exclusively allocated territories or customer groups must, however, permit passive sales to such territories or customer groups.
"Active sales" are stated in the Guidelines (para. 50) to mean actively approaching customers inside another distributor's exclusive territory or exclusive customer group by direct mail or visits, or through advertisement in media or other promotions specifically targeted at these customers, or creating a warehouse or distribution outlet in another distributor's exclusive territory. "Passive sales" mean responding to unsolicited requests from individual customers. General advertisement or promotion in media or on the Internet can (the Guidelines indicate) be passive sales.
The Guidelines contain a detailed interpretation of the Block Exemption Regulation and the active/passive sales distinction with regard to the use of the Internet (para. 51). The Commission intends advertising or selling products through the Internet to be free for every distributor and accordingly states that the use of the Internet is not generally considered a form of active sales. If a customer visits a web site of a distributor and contacts the distributor and if this contact leads to a sale, this is considered passive selling. The language used on the Internet is not normally relevant. The use of the Internet may be deemed to be active selling only if it is specifically targeted to customers allocated to another distributor (for example through the use of banners or page links specifically available to such customers). It is stated that unsolicited e-mails to specific customers constitute active selling.
According to the Guidelines, the supplier may always require quality standards for the use of the Internet site to resell its goods. This is stated to be particularly relevant for selective distribution. An outright ban on Internet or catalogue selling is stated to be possible only if there is an objective justification, and the Guidelines state that in any case, the supplier cannot reserve to itself sales and/or advertising over the Internet. However, in our view, it should be stressed that these statements by the Commission are very generalised and are based on limited experience so far. One must take account of the fact that in some circumstances yet to be identified or upheld in individual cases, such restrictions on a distributor on promotions or sales via the Internet could be held to fall outside Article 81(1) in the first place so as not to constitute restrictions in an EC competition law sense. The Guidelines, on the other hand, indicate the Commission's general position where such limitations do amount to competition restrictions.
Other restrictions on resales permitted under the Block Exemption Regulation
There are three other exceptions to the black-listed prohibition on restrictions on resales by the buyer in the Block Exemption Regulation (Article 4(b)). All three exceptions allow for the restriction of both active and passive sales. Accordingly, the Guidelines confirm that it is permissible to restrict a wholesaler from selling to final consumers (referred to as "end users" in the Regulation), and to restrict an appointed distributor in a selective distribution system from selling, at any level of trade, to unauthorised distributors, although on the latter point, the Guidelines add the criterion (para. 52) that such a restriction will only be permitted in relation to unauthorised distributors in markets where such a selective distribution system is operated. (It should also be noted that the Block Exemption Regulation black-lists restrictions on sales within a selective distribution system, by retailers to end users or between different distributors whether at the same or different levels of trade, in Article 4(c) and (d).)
The final exception on resale restrictions permitted under Article 4(b) is clarified in the Guidelines (para. 52) to the effect that it is permitted to restrict a buyer of components supplied for incorporation from reselling them to competitors of the supplier. Conversely, the Guidelines also provide helpful clarification of the black-listed restriction set out in Article 4(e) of the Block Exemption Regulation (para 56): this black-listed restriction concerns agreements that prevent or restrict end users, independent repairers and service providers from obtaining spare parts directly from the manufacturer of these spare parts. The Guidelines state that an agreement between a manufacturer of spare parts and a buyer who incorporates these parts into its own products (an original equipment manufacturer), may not, either directly or indirectly, prevent or restrict sales by the manufacturer of the spare parts to end users, independent repairers or service providers. Indirect restrictions, the Guidelines state, may arise in particular when the supplier of the spare parts is restricted in supplying technical information and special equipment which are necessary for the use of spare parts by the users, independent repairers or service providers. However, the Guidelines state that the agreement may restrict the supply of the spare parts to the repairers or service providers entrusted by the original equipment manufacturer with the repair or servicing of its own goods; it is further stated that the original equipment manufacturer may require its own repair and service network to buy the spare parts from it.
Selective distribution combined with exclusive distribution
In the Guidelines, the Commission states that selective distribution can be combined with exclusive distribution, provided that active and passive selling is not restricted anywhere (para 53). It is, however, specified that the combination of selective and exclusive distribution is likely to infringe Article 81(1) if it is applied by a supplier whose market share exceeds 30 % or in case of cumulative effects (or different selective distribution systems), even though active sales between different parts of the territory remain free. It is also added that such a combination may be individually exempted under Article 81(3) if it is indispensable to protect substantial and relation-specific investments made by the authorised dealers.
Indirect resale restrictions
The Guidelines state that resale restrictions may result from indirect measures such as refusal or reduction of bonuses or discounts or refusal or reduction of supplies. The Commission also considers that a resale restriction can result where the supplier does not provide a Community-wide guarantee service whereby all distributors are obliged to provide the guarantee service and are reimbursed for this service by the supplier, even in relation to products sold by other distributors into their territory.
Clarification of When Non-compete Clauses are Block-exempted
Non-compete clauses for more than five years are not exempted (Article 5(a) of the Regulation). Such non-compete obligations include (Article 1(b)) any obligation on the buyer not to manufacture or sell competing products, or any obligation to buy more than 80% of the buyer's requirements of contract products and equivalent products from the supplier. (Article 5(c) further disapplies the block exemption to brand-specific non-compete obligations in a selective distribution context irrespective of the time period, i.e., obligations preventing members of a selective distribution system from selling the brands of particular competing suppliers). In principle, restrictions described in Article 5 are regarded as less serious than those black-listed in Article 4 and, where the applicable national contract law allows, such restrictions could be severed so as to enable the New Regulation to apply to the rest of the agreement.
The Guidelines specify that non-compete obligations (as referred to in Article 5(a)) are covered by the Block Exemption Regulation even when they are renewable, but where renewal beyond five years requires explicit consent of both parties and no obstacles exist that hinder the buyer to terminate the non-compete obligation at the end of the five year period.
As for vertical agreements already in existence before 1 June 2000 (the date of entry into force of the Block Exemption Regulation), the Guidelines state that, where such agreements comply with the conditions of the existing Regulations 1983/83 (on exclusive distribution), 1984/83 (on exclusive purchasing) or 4087/88 (on franchising), and if the supplier's market share does not exceed 30%, agreements containing non-compete clauses for longer than five years are covered by the Block Exemption when on 1 January 2002 (i.e. from the end of the transitional period for agreements covered by the current Regulations 1983/83, 1984/83 and 4087/88) the non-compete agreements have less than five years to run.
It must be noted that Article 5 (para. (b)) of the Block Exemption Regulation also excludes from the block exemption, the following: post-term restrictions on the buyer not to manufacture, sell or purchase goods or services, unless this (i) relates to goods or services competing with the contract goods or services, (ii) is limited to one year after termination, (iii) is necessary to protect know-how transferred by the buyer, and (iv) is limited to premises from which the buyer has operated during the contract period.
Market Share Calculations
In the section on the market share threshold calculation (paras. 89 to 95), the Commission now clarifies that in case of agreements between an association of retailers and its individual members, the association is the supplier and account needs to be taken of its members' combined market share.
It is specified that it is only in cases of exclusive supply (for the EC as a whole) that the buyer's market share is decisive, and then only the buyer's and not the supplier's market share is to be considered under the Block Exemption Regulation. Where the buyer uses the goods or services supplied in the production of final goods, its market there for such final goods is relevant. It is also provided that in franchising agreements, account needs to be taken of the licensor's market share not only as a supplier of the goods or services, but also as a provider of a distribution concept.
The Guidelines further stipulate that the calculation of the market share is to be based on value figures. If such figures are not available, substantiated estimates based on other reliable market information can be used.
Agency Agreements
For the first time, the Commission's enforcement policy towards such agreements is outlined in both a detailed and practical manner. The Guidelines contain a limitation, however, in that where agency agreements infringe Article 81(1), the Block Exemption Regulation is interpreted to the effect that the principal is not allowed complete freedom to impose sales prices. The Guidelines' chapter on agency agreements replaces the Commission's Notice on agency from 1962, which is now outdated, and the complicated guidelines provided in its 1990 draft Notice which was never adopted.
The Guidelines contain a detailed explanation of what the Commission considers to be a "true agency agreement" (paras. 12-20). According to the new text, an agency agreement falls outside Article 81(1) if the agent does not bear any risks or only bears insignificant risks. It is also necessary that the agent is not the owner of the goods sold or bought or is not itself the supplier of the services. However, it is stated not to be material whether the agent acts for one or for several principals.
The Commission sets out in the Guidelines a detailed explanation of the financial or commercial risks that are relevant in assessing agency agreements. First, there are the risks which are directly related to the contracts concluded or negotiated by the agent on behalf of the principal, such as financing of stocks. Second, there are the risks related to investments which are specifically required for the type of activity for which the agent has been appointed. These costs are usually sunk costs, and therefore involve exit barriers.
According to the Guidelines, where the agent does not bear any or any significant risks in relation to contracts concluded on behalf of the principal, the selling or purchasing function forms an integral part of the principal's activities, despite the fact that the agent is a separate undertaking. In this case, the agent is not independent in relation to the activities for which he has been appointed. By contrast, where the agent bears financial or commercial risks, he is in effect to be treated as an independent dealer who must remain free in determining his marketing strategy in order to be able to recover his contract or market specific investments.
The question of risk must be assessed on a case-by-case basis, and by considering the economic reality of the situation rather than the legal form. The Commission states that Article 81(1) will generally not be applicable where the agent does not become the owner of the goods sold or bought or itself supply the services, and where the agent does not incur the following risks or costs: (a) costs related to the supply/purchase of the contract goods or services, including the costs for the transport of the goods; (b) costs related to sales promotion; (c) costs or risk related to stocks of the contract goods; (d) costs related to after-sales service, repair service or a warranty service unless fully reimbursed by the principal; (e) market-specific investments in equipment, premises or training of personnel (for example, the petrol tanks in the case of petrol retailing); (f) responsibility towards third parties for product liability, unless he is liable for fault; (g) responsibility for customers' non-performance of the contract, with the exception of the loss of the agent's commission, unless the agent is liable for fault in this respect.
If an agency agreement does not fall within Article 81(1), then all obligations imposed on the agent in relation to the contracts concluded or negotiated on behalf of the principal also fall outside Article 81(1). In particular, the following obligations will generally be considered an inherent part of an agency agreement as they relate to the principal's ability to fix the scope of activity of the agent, which is essential if the principal is to take the risks and to determine the commercial strategy: (i) limitations on the goods or services covered by the contract, (ii) limitations on the territory in which the agent may sell these goods or services, (iii) limitations on the customers to whom the agent may sell these goods or services, and (iv) the price at and conditions on which the agent must sell or purchase these goods or services.
In addition, the Commission specified that exclusive agency provisions do not generally lead to anti-competitive effects because they only affect intra-brand competition. However, non-compete provisions (including post-term non-compete provisions) concern inter-brand competition and may violate Article 81(1) if they lead to foreclosure of the relevant market.
Further, according to the Guidelines, an agency agreement may fall within the scope of Article 81(1) EC, even if the principal bears all the financial and commercial risks, where it facilitates collusion between different suppliers. This could be the case if various principals use the same agents while collectively excluding others from using these agents, or use the agents for collusion on marketing strategy or to exchange sensitive market information between the principals.
The Guidelines state that, although the principal normally establishes the sales price, where an agency agreement falls within Article 81(1), an obligation restricting the agent from sharing its commission with the customer would be a black-listed resale price maintenance restriction and the Block Exemption Regulation therefore could not apply to the agreement. Therefore, the agent must be left free to lower the price paid by the customer by up to the amount of his commission, in order for the Block Exemption to apply. The principal is to this extent limited in his freedom to impose sales prices as opposed to insisting on his net return on each unit supplied via the agent.
