Steptoe | The UK Competition and Markets Authority’s Vertical Agreement Proposals – Still Anchored to the EU?

The Current Regulatory Moorings

Despite the UK’s final withdrawal from the EU, much of EU competition law continues to regulate commercial activity within the UK. This retained body of law includes the Vertical Agreement Block Exemption Regulation (EU 330/2010) (VABER), a “retained exemption” under UK Brexit-related legislation. VABER provides a ‘safe harbour’ (and its accompanying vertical restraints guidelines offer further shelter) from the prohibition of anti-competitive vertical or supply agreements under Article 101(1) of the Treaty on the Functioning of the EU (TFEU).

As retained EU law, VABER also offers protection in relation to the national equivalent to Article 101(1) TFEU, the UK Competition Act 1998 Chapter I Prohibition (the Chapter I Prohibition). Accordingly, supply agreements affecting the UK market (but which do not have an effect on trade between EU Member States) and falling within VABER have continued to be exempt from the Chapter I Prohibition. It should be noted that, irrespective of future changes to the UK competition law regime, VABER and any successor EU Block Exemption Regulation will continue to apply to vertical agreements that have an effect on intra-EU trade.

The UK Charts a New (but Somewhat Familiar) Course

Now that the UK is no longer an EU Member State, it has the ability to fashion its national competition law in a different manner from that of the EU. Since VABER is due to expire on May 31 2022 and is currently being reviewed by the European Commission, the UK Competition and Markets Authority (CMA) has been considering a replacement measure, the UK Vertical Agreement Block Exemption Order (VBEO). On June 17, 2021, the CMA announced its proposals for the VBEO, which are subject to consultation until July 22, 2021. The CMA is also considering ancillary VBEO Guidance, which will be subject to additional consultation, once released.

In linking its review of supply agreement exemptions to the text of VABER and to those features of distribution that are currently under consideration by the European Commission (as part of its review of VABER), the CMA has maintained a narrow policy remit and the degree of proposed UK divergence from VABER is slight. The CMA has passed up on the chance to set a bolder course by cutting free from the single market imperative that has prohibited certain ‘by object’ or presumptively harmful restrictions of competition. These ‘by object’ restrictions relate to a number of price, customer and territory restraints that are also classified as ‘hardcore’ under VABER and which, if present in a supply agreement, will deny that agreement the benefit of any automatic VABER exemption. However, the CMA has indicated that it will keep some matters under review and, since the VBEO will only have a lifespan of six years, this leaves open the possibility of greater change over time.

This alert analyses the various CMA proposals and identifies possible options the European Commission may adopt with respect to these issues, as part of its review.

Market Share Threshold

The present position: It is a condition of VABER that the market shares of each vertically-related party should not exceed 30%.

The CMA proposal: The CMA does not propose to lower the overall market share threshold of 30%.

Possible EU options: The European Commission is likely to maintain the general market share threshold for the applicability of VABER at 30%.

Dual Distribution

The present position: Under Article 2(4) VABER, where a manufacturer sells directly to end-users, in competition with resellers who are not competing manufacturers and where these arrangements are non-reciprocal, the dual distribution system is exempt from the application of Article 101(1) TFEU and the Chapter I Prohibition. This exemption was created at a time when distribution was typically undertaken through physical outlets and online sales were nascent. Whilst there have always been concerns relating to the possible effects on competition of information exchanges between the personnel involved in direct and indirect sales, the CMA acknowledges that there are mechanisms for dealing with this, such as the use of ‘clean teams’. However, concerns have been heightened by the increase in online sales by manufacturers and their distributors, selling in competition with each other.

The CMA proposal: The CMA has indicated that it will retain the dual distribution exemption and is likely to extend it to wholesalers and importers that sell in competition with their manufacturer supplier. The CMA’s proposed VBEO Guidance may address information flows that take place between the parties, although the parties will be expected to self-assess the risks posed by any such information exchanges, as is currently the case.

This policy proposal is a welcome one. A supplier’s key concern is to sustain and grow sales and to provide the most efficient service for its customers. Using local distributors can free a manufacturer from incurring costly local investments. A neighbourhood reseller may be best placed to serve the needs of smaller or remote end-users, with the manufacturer supporting larger accounts.

Possible EU options: The European Commission may retain the existing exemption and could mirror the approach taken by the CMA in expanding its application to importers and wholesalers. A further option could be to lower the safe harbour threshold to a level below 30% for dual distribution, particularly given the Commission’s concern about manufacturer and reseller overlapping online sales. However, given its apprehension regarding the growth in dual distribution online, the Commission could abolish this exemption altogether. Parties engaged in any dual distribution arrangements outside the reformed VABER would be subject to a burdensome self-assessment obligation. It is to be hoped that the Commission will provide enhanced guidance regarding the horizontal aspects of any such arrangements.

Resale Price Maintenance

The present position: Resale price maintenance (the setting of minimum or fixed resale prices by a supplier ‘RPM’) has been accepted by the U.S. Supreme Court as a restriction that can induce reseller investment in a given brand, the anti-competitive effects of which should be subject to a ‘rule of reason’ or effects-based analysis under section 1 Sherman Act. Under EU competition law, RPM is regarded as a ‘by object’ restriction and as a hardcore restriction under Article 4(a) of VABER. In theory, RPM, may be subject to an individual exemption under Article 101(3) TFEU or section 9 of the Competition Act 1998. In practice, this is an extremely rare occurrence. The European Commission and EU Member State national competition authorities (NCAs) usually regard the efficiencies said to be attainable through RPM as being ones that can be delivered through less restrictive means, such as the imposition of enhanced service obligations on a selective distributor.

The CMA proposal: The position that RPM is merely another intra-brand, investment-inducing restraint, the economic effects of which depend on the parties’ market power, may continue to have its advocates, but in the UK and EU regulatory arenas, the argument has achieved no traction. The CMA proposes to continue to categorise RPM as a ‘hardcore’ restriction that would render the VBEO inapplicable, where imposed in a supply agreement.

Possible EU options: The European Commission will continue to classify RPM as a ‘hardcore’ restriction, given existing EU jurisprudence relating to this form of price restraint. There is the possibility of greater European Commission guidance being provided. However, given the lack of regulatory appetite to confer an individual exemption under Article 101(3) TFEU in relation to RPM arrangements, businesses would be well advised to approach any such price restraints with extreme caution.

Territorial and Customer Restrictions

The present position: Vertical agreements that restrict the territory into which or the customers to whom a distributor can sell are generally prohibited under Article 4(b) VABER. These prohibitions are subject to certain exceptions relating to the conferral of exclusive territories or exclusive customer groups and the implementation of selective distribution systems. Under EU jurisprudence, the conferral of absolute territorial protection is a ‘by object’ restriction under Article 101(1) TFEU. Under VABER, selective distributors can be required not to sell to unauthorized dealers and a prohibition of sales to end-users by a wholesaler is permitted. It is also possible to prohibit active sales that exceed the scope of exclusively conferred territories and customer groups, but passive sales to customers must be allowed. Sales via the internet are generally seen as passive (apart from certain forms of extra-territorial sales outreach) and an outright prohibition (whether de facto or de iure) regarding the use of the internet is treated as a ‘by object’ restriction under Article 101(1) TFEU and as hardcore under VABER.

The CMA proposal: The CMA has rejected the argument that the EU’s treatment of territorial and customer restrictions is solely driven by the EU single market imperative and has emphasized the need to preserve intra-brand competition and consumer choice. The CMA has also stressed the importance of maintaining a degree of integration between Northern Ireland and the EU under the Northern Ireland Protocol and its desire to avoid “inadvertently compromising the integrity of the UK internal market or harming consumers in the UK.”  It believes that the structure of VABER “strikes a fair balance” between conferring a degree of dealer protection and ensuring a level of consumer choice. It, therefore, intends to maintain the distinction between active and passive sales, whilst providing a fuller explanation of the difference in its proposed VBEO Guidance. It is considering permitting the combination of exclusive and selective distribution in the same or different territories, the conferral of shared exclusivity by more than one distributor with respect to a given territory or customer group and also allowing greater protection for members of a selective distribution system from sales outside a territory to unauthorized distributors within it.

Possible EU options: The European Commission may adopt similar policy choices to those indicated by the CMA, allowing shared exclusivity and greater impermeability with respect to selective distribution networks. The overall effect of these reforms, if adopted, will be to continue to require suppliers to create a patchwork quilt of restrictions and a need to plan the overall channel structure in advance, albeit with slightly greater latitude regarding its design.

Indirect Measures Restricting Online Sales

The present position: Indirect measures restricting online sales are regarded as ‘hardcore’ restrictions under VABER, including:

• charging a higher price to a distributor for products destined to be resold online than for products intended to be sold offline by that distributor (dual pricing); and
• imposing online sales criteria that are not overall equivalent to the criteria imposed in brick-and-mortar stores in the context of selective distribution (the ‘equivalence principle’).

The CMA proposal: The CMA considers that the equivalence principle and the prohibition of dual pricing are no longer warranted. Online sales have grown exponentially and there is general recognition that brick-and-mortar retailers are obliged to make large investments and face a significant cost disparity, compared with pure online resellers. The CMA recognises that offline distributors require incentives to invest in promoting products and pre-sales services and should be protected from free-riding by online distributors that focus mainly on price, without offering comparable services or support. These findings echo those of the European Commission’s e-commerce sector inquiry, which acknowledged the need for a level playing field between offline and online resellers. The CMA’s Guidance should inform businesses of any degree of proportionality that might be required with respect to dissimilar pricing and selective criteria, as applied between online and offline channels.

Possible EU options: Paragraph 64 of the EU Vertical Guidelines acknowledges that dual pricing, although hardcore under VABER, can meet the requirements for an individual exemption under Article 101(3) TFEU. This can be the case where selling online leads to manufacturers shouldering substantially higher costs (e.g. installation, customer support or warranty claims) than with respect to offline sales. The European Commission may amend VABER to allow the application of different criteria for online and offline sales in selective distribution agreements, whilst providing guidance relating to those dissimilar restrictions likely to limit internet sales and hinder customer choice.

Price Parity Clauses

The present position: Parity clauses are contractual obligations that require one party to offer the other goods or services on terms no worse than those offered to third parties, often referred as ‘most-favoured nation’ (MFN) clauses. VABER does not address these and the EU Vertical Guidelines merely note that they are measures that can support RPM. The CMA has conducted past investigations into the use of MFNs in context of the private motor insurance market and the ComparetheMarket price comparison website (PCW). The CMA has previously found significant competition concerns arising from the use of ‘wide’ parity obligations. It has drawn a distinction between:

• ‘Narrow’ MFNs, which specify that a supplier must set a price on the intermediary’s PCW which is no higher than the price offered through its own website, but which do not specify conditions for sales by the supplier through other channels; and
• ‘Wide’ MFNs, which require suppliers to set a price on the intermediary’s PCW that is no higher than the price offered through its own website or through any other sales channel.

In these two investigations, the CMA banned the use of wide MFNs, whilst taking the view that reducing the risk of free-riding by suppliers on PCW services is a plausible efficiency justification for narrow MFNs.

The CMA proposal: As part of its review, the CMA has maintained the distinction between narrow and wide MFNs. For the purposes of the VBEO, the CMA intends to reclassify MFNs as ‘sales channel parity obligations’ and to use the terms ‘direct sales channel parity obligation’ and ‘indirect sales channel parity obligation’ (broadly equivalent to narrow and wide MFNs) respectively. It will classify a parity clause applied to an indirect sales channel as a hardcore restriction that would deny the relevant agreement the sanctuary offered by the VBEO. Since the competitive effects of sales channel parity obligations are often ambivalent and require careful case-by-case analysis, the CMA has reserved the right to investigate those that are applied to direct sales channels where there are indications that their use creates effects similar to price parity obligations as applied to indirect sales channels.

Possible EU options: The European Commission could leave VABER unchanged, with parity clauses being exempt where the parties’ market shares do not exceed 30% or could classify them as hardcore, requiring self-assessment in every case. Either of these options would do little to clear up the present confusion surrounding the treatment of MFNs within the EU. NCAs appear to disagree on how MFNs should be analysed under EU competition law. This disagreement is best illustrated in the Booking.com case, where the German Bundeskartellamt took a radically different approach to narrow MFNs than other NCAs by applying a general prohibition. In its recent judgment, the German Federal Supreme Court confirmed that VABER was inapplicable to the price parity clause, since the market share threshold of 30% was exceeded. It was not an ancillary restraint, no individual exemption was available on efficiency grounds and accordingly, it was prohibited by Article 101(1) TFEU. From a procedural perspective, most investigations have resulted in the adoption of commitment decisions that, due to their brevity, provide very little guidance relating to price parity clauses, whose effects can be economically ambiguous. A more useful option would be for the European Commission to follow the CMA’s approach in permitting narrow MFNs and categorising wide MFNs as hardcore non-exempt provisions, thereby creating greater legal certainty.

Non-Compete Obligations

The present position: Under Article 5(1)(a) VABER, the following obligations do not benefit from VABER’s exemption and require self-assessment as to whether they satisfy the requirements of Article 101(3) TFEU:

• exclusive purchase obligations (whereby a purchaser must acquire more than 80% of its requirements for contract goods or services from the supplier) that exceed five years, are indefinite or are tacitly renewable beyond five years, unless the goods or services are resold from premises owned or leased by the supplier (when the restriction can endure for term of the lease or rights of occupation);
• post-termination non-compete obligations unless they relate to the contract goods or services, do not exceed a year, are limited to the land or premises from which the reseller operated during the contract period and are necessary to protect the supplier’s know-how;
• an obligation on a selective distributor not to sell specified competing brands.

It is possible for post-termination provisions to be for longer than one year, if necessary to protect know-how that continues to remain confidential.

The CMA proposal: The CMA intends to maintain the current position. Although it has been argued that the exclusions from VABER for these obligations are arbitrary, it is open to the parties to justify the restrictions. Even though there might be provisions in an agreement that allow a tacitly renewed obligation to be terminated subsequently, Article 5 is designed to ensure that channels are automatically opened up at least every five years, to ensure greater supplier access and consumer choice. The VBEO Guidance will address post-termination provisions that are necessary to protect know-how and also with respect to the application of the VBEO non-compete provisions in the context of franchise agreements.

Possible EU options: It is probable that the European Commission will maintain the status quo regarding Article 5 VABER, although it may also provide greater guidance.

Agency

The present position: Paragraphs 12 to 21 of the VABER Guidelines indicate whether a reseller is an independent undertaking (to which Article 101(1) TFEU applies), or whether it is operating at the direction of the supplier in circumstances where it does not accept contract-specific or general risk with respect to products acquired and their resale and so is not an undertaking regulated by Article 101(1) TFEU.

The CMA proposal: The CMA does not intend to effect any changes in relation to agency in the VBEO. It will instead address any issues (for instance whether to move away from a determination of an agency relationship based on how risks have been allocated and the provision of greater advice regarding platform-based relationships) in the VABEO Guidance, on which it intends to consult later in 2021 or early in 2022.

Possible EU options: It is probable that the European Commission will also provide greater guidance on this topic in its VABER Guidelines.

Sustainability

The present position: Neither VABER nor the VABER Guidelines contain provisions regarding sustainability considerations.

The CMA proposal:  The CMA does not intend to accommodate sustainability considerations in the VBEO. It will offer further information regarding how sustainability might be utilized as a criterion in selective distribution networks in the VABEO Guidance.

Possible EU options: It is not known whether the European Commission will provide greater guidance regarding sustainability in its future VABER Guidelines. It has already indicated that this issue will be addressed in its proposed horizontal guidelines and it may be that it will regard the latter as being the appropriate place for that guidance.

Keeping a Steady Course

Despite the UK’s departure from the EU, the CMA has clearly indicated that it does not see a need to steer competition policy in a radically different direction. The CMA has chosen to hug a normatively familiar shoreline, keeping an eye on UK internal market developments and those across the Channel. Deeper waters may beckon, in due course.

Authors:

• Paul Hughes
• Charles Whiddington
• Simon Hirsbrunner

Compliments of Steptoe & Johnson – a member of the EACCNY.