The final version of the Vertical Block Exemption Regulation and Vertical Guidelines: a fairly positive text, favorable to the protection of distribution networks and their proper functioning, despite some imperfections

On 10 May 2022 the European Commission published the final version of its regulation and guidelines on vertical restraints applicable in particular to distribution agreements.

The regulation is the result of genuine consultation by the Commission with stakeholders throughout the Union. The Commission is to be commended for its cooperation in taking into account the many comments from third parties, in particular from businesses, professional organizations and their counsel which aided in the improvement of initial drafts.

Overall, the texts resulting from the Commission’s consultations are rather positive for distribution networks: they are favorable to the protection of networks and their proper functioning, even if they still contain some imperfections.

I. Better protection of distribution networks

A. The positive points

First of all, we welcome the preservation of a block exemption that is simple to apply, depends on the supplier’s market share not exceeding 30% on the market for the sale of the contractual goods or services and the buyer’s market share also being below 30% – but is calculated in a reasonable manner not on its local market but on the upstream market for its purchases – and the absence of black or red clauses i.e. hardcore or excluded restrictions of competition. The retaining of this traditional block exemption rule is accompanied by a number of positive innovations which go some way towards taking better account of and protecting distribution networks.

1) Better consideration and protection of exclusive distribution

The exclusive distribution regime was no longer taking into account certain necessary developments in this type of distribution and, above all, had become insufficiently protective of the exclusivity granted to distributors, which in practice had been reduced significantly to a minimum. The Commission took note of the complaints of the network heads on these two points.

a) Recognition of a shared exclusive distribution option

This has been a long-standing demand of the tractor accessory distribution networks. Tractor catchment areas are fairly large whereas it can be necessary to have the option to appoint several distributors of complementary agricultural equipment in a larger catchment area. The Commission had accepted the idea in its first drafts by allowing the appointment of a limited number of exclusive distributors for the same exclusive area or customer base. However, it made shared exclusivity conditional on a pro rata determination of the territory or customer group allocated so as to guarantee a certain volume of business that would preserve the distributors’ investment efforts. This condition was a source of legal uncertainty and undoubtedly a breeding ground for future litigation. In the final version of the text, the Commission has been receptive to those criticisms and now allows for a maximum number of five buyers to be eligible for exemption (Article 1(1)(h) of the regulation. This is a very positive innovation and allows the needs of a sector which has traditionally relied on exclusive distribution to be taken into account.

b) Better protection for exclusive distributors against active sales from other territories

The definition of active sales has been broadened and now better takes into account active targeting of customers via the internet, in particular by operating a website with a top-level domain corresponding to particular territories, or by offering on a website languages that are commonly used in particular territories, where such languages are different from those commonly used in the territory in which the buyer is established (Article 1(1)(l)). It was therefore fitting to give  little more weight to the content of exclusivity arrangements, undermined by the development of the internet.

c) An option to extend the restriction on active sales to the exclusive distributor’s direct customers (the so-called pass-on clause)

It will be possible to restrict not only the active sales of the exclusive distributor in another exclusive territory but also those of the distributor’s direct customers (Article 4(b)(i) of the regulation). This possibility will make it possible to avoid certain circumventions of the ban on active sales outside the exclusive territory.

d) The possibility, if different systems are adopted in different countries, of protecting exclusive distributors against active sales by selective (or free) distributors and their direct customers into exclusive territories or customer bases

The regulation recognizes the possibility of using different distribution systems between the various Member States, whether selective, exclusive, or free, and in this case to prevent the exclusivity granted in the States under exclusive distribution from being undermined by active sales the countries in which selective or unrestricted distribution is in place

2) Better protection for selective distribution

a) An option to extend the ban on out-of-network resales to the selective distributor’s direct customers (so-called pass-on clause)

It will be possible to restrict not only the selective distributor’s out-of-network sales to non-authorized distributors located in the territory in which the selective distribution system operates, but also those of the selective distributor’s customers (Article 4(c)(i)(2) of the regulation). This option will make it possible to avoid certain circumventions of the prohibition on out-of-network resales. This is particularly true of sales by selective distributors to large customers or renters who might be tempted to resell the selective products instead of using them for their own needs. These clauses could be very relevant in the automotive or satellite sectors.

b) The possibility, if different systems are adopted in different countries, of protecting selective distributors against sales by exclusive (or free) distributors and their customers into selective territories

The regulation recognizes the possibility of using different distribution systems in the various Member States, whether selective, exclusive or free, and in this case to prevent the prohibition on out-of-network resale in force in selective countries from being undermined by active or passive sales to out-of-network resellers from exclusive distributors and their customers in countries where exclusive distribution has been established (Article 4(b)(ii) of the regulation). A similar rule has been laid down for free distributors in relation to selective countries (Article 4(d)(i)).

3) Clarification of the restrictions authorized in the case of free distribution (neither exclusive nor selective)

For the first time, a body of rules specifies the conditions under which non-exclusive and non-selective free distribution can be exempted while at the same time enjoying the benefit of the block exemption (Article 4(d)).

4) Wider recognition of the legitimacy of dual distribution compared to the Commission’s original plans

Dual distribution is a system of distribution to final customers, on the one hand by the supplier’s distributors, and on the other by the supplier itself in the form of direct sales (through its branches or subsidiaries, to key accounts or via the internet). The Commission’s initial drafts would have deprived almost all distribution networks of the benefit of the block exemption. They subjected dual distribution to a straitjacket of conditions that were impossible or very difficult to meet: total exemption of the agreement only in the event of a combined market share on the downstream, local market of less than 10%, which is exceeded in the case of most networks and is often impossible to calculate; exemption subject to the absence of any restriction by object, which is not defined, etc. In view of the avalanche of criticism that this project has provoked, the Commission has accepted to exempt dual distribution in a more flexible and reasonable way.

The 10% threshold has been dropped as well as the condition of no restriction by object. Exchanges of information between suppliers and competing distributors in the case of dual distribution are subject to a more realistic regime (Article 2(5)). The exemption does not apply to exchanges of information between the supplier and the buyer which are either not directly related to the implementation of the vertical agreement or are not necessary to improve the production or distribution of the contract goods or services or which do not fulfil either of these conditions. Unfortunately, the non-application of the block exemption in the case of a platform with a hybrid function has not been repealed or framed by the regulation, which is a major flaw in the text.

B. Negative points

1) The abnormal exclusion from block exemption of dual distribution with the provision of online intermediation services

The benefit of the Block Exemption Regulation does not apply to vertical agreements relating to the provision of online intermediation services where the provider of the online intermediation services is an undertaking competing on the relevant market for the sale of the goods or services which are the subject of the intermediation (Article 2(6) of the regulation).

The Commission has been informed of the perverse effects of non-eligibility for the exemption in the context of dual distribution to suppliers who offer their distributors the possibility of making sales on a website made available to them by the supplier. This possibility turns them into suppliers of online intermediation services and deprives them of the benefit of the block exemption even though they are providing a support service to their distributors.

The Commission has taken these criticisms on board, but in a very unsatisfactory way. The new Vertical Guidelines state in section 4.4.4 that the Commission is unlikely to prioritize enforcement against vertical agreements entered into by hybrid platforms where the agreement does not contain restrictions by object and the platform does not have significant market power.

This statement does not solve the problem. Many selective networks will be deprived of the benefit of the block exemption because of the continued exclusion of all hybrid platforms. It is immaterial that the Commission does not make this a key issue of its competition policy. In order to act against non-networked resellers, a head of  network must prove the lawfulness of its network. The burden of proof is on the network head. In principle, the regulation is supposed to make this easier whereas inapplicability of the block exemption will make it much more difficult for network heads to defend selective networks in court, which is paradoxical to say the least.

2) Excessive limits to the recognition of the concept of agent

The guidelines (points 23 to 45) make the recognition of the status of agent under competition law conditional on the agent not having to bear all the risks specific to the contracts concluded and/or negotiated by the agent, the risks relating to market-specific investments and the risks relating to other activities carried out on the same product market, where this independent activity is required by the supplier (or, if it is borne, that it remains absolutely insignificant). The wealth of detail relating to the assumption of these risks by the supplier and the evidential rigor required of the supplier may make the use of agents extremely complex and discourage it, whereas it is a marketing method which should be encouraged, and commercial law already makes the use of commercial agents very costly.

II. Better operating rules for distribution networks

In addition to clarifying the parity obligations (excluding from the block exemption extended parity obligations including conditions offered on other platforms but exempting parity obligations restricted to direct sales channels), the new regulation and especially the guidelines bring improvements in the functioning of the networks even if there are still some unsatisfactory points.

 A. The good points

 1) A reduction in the favorable regime for internet sales

While the previous guidelines had set up a regime to favor online over physical sales, the new guidelines rectify this and strive for more neutrality. The Commission has realized that it is certainly no longer necessary to favor digital sales over physical sales.

The Commission abandons two rules of principle, the prohibition of dual wholesale prices to the same distributor depending on whether it resells in physical stores or online and the principle of equivalence of terms. It will now be possible to charge different wholesale prices to the same distributor depending on whether it resells via the internet or in a physical store, provided that the price difference is linked to differences in costs or investment between physical and online sales. Similarly, in a selective distribution system, the criteria for online sales will no longer have to be broadly equivalent to the criteria required for physical stores in order to take account of the inherent differences between the two sales channels, provided that the purpose is not to prevent internet sales.

2) Greater flexibility with respect to tacitly renewable non-competition obligations

Until now, in order to benefit from the block exemption, the duration of non-compete obligations could not be indefinite or exceed 5 years or be tacitly renewable beyond 5 years. Now, contractual non-compete obligations tacitly renewable beyond 5 years may be agreed provided that the buyer can effectively renegotiate or terminate the contract so as to be able to effectively exit the contract and change supplier at the end of the 5 years. The Commission has listened to the complaints of suppliers who complained that this constraint obliges the parties to terminate the relationship and renegotiate the contractual conditions at the end of every five years.

 B. Negative points

1) A persistent distrust of any form of RPM

The regulation and the guidelines continue to espouse a general mistrust of retail price maintenance whereas economic analysis has shown that its effects are not necessarily anticompetitive. While the guidelines do allow for a number of RPM practices, the burden of proof of their legality seems to preclude any practical application. If we add to this the fact that French law seems to have moved from a so-called triple test to a tow pronged test of the referral to fixed or minimum prices and the acceptance thereof , the substantive law seems to be increasingly out of touch with the lessons of economic analysis in this area.

2) Very limited recognition of fulfillment contracts

The only real innovation with regard to fixed prices is that fulfillment contracts are no longer considered as RPM provided that the contract concluded by the supplier is entrusted by the latter to a distributor for its fulfillment, without any possible choice on the part of the buyer. This is a very cautious acknowledgement of this type of contract which does not correspond to the needs of the market, as customers generally wish to have the choice between several distributors for reasons of security of supply.

To sum up, the reform of the regulation has led to significant improvements in terms of legal certainty and network efficiency, but there are still a number of imperfections in the current regime that should be remedied. Of course, the benefit of the options opened up by the regulation is not automatic and requires work to adapt contracts in order to be eligible .