Vertical Agreements: The New Reality

Introduction

For those operating in the retail sector (amongst others), 1st June 2022 saw changes to the UK and EU competition law rules and the "safe harbour" or exemption from the application of competition law for certain types of vertical agreements, i.e. for contractual parties operating at different levels of the supply chain. Agreements, already in place between suppliers and retailers and benefitting from the old EU vertical restraints block exemption before its expiry, benefit from a year's transitional period in which to be brought into compliance with the new rules going forward. Any new agreements entered into must fall within the parameters of the new rules in order to benefit from the safe harbour offered.

Whilst the UK, on its departure from the EU, had retained the previous EU vertical restraints block exemption and, thus, the benefit of its safe harbour until its expiry, it has now introduced its own rules in the form of the Vertical Agreements Block Exemption Order¹  (the "UK Order") rather than adopting the EU's new Vertical Restraints Block Exemption²  (the "EU Regulation"). There are also extensive UK and EU Guidance  accompanying the new legislation. The new rules provide greater flexibility in some areas and take account of the changing e-commerce landscape.

For those doing business in both the UK and the EU, it is important to note that there are now two separate regimes. Although there are many similarities between them (for example, both continue to list hardcore restrictions (whose inclusion precludes the agreement from benefitting from the safe harbour), there are the beginnings of divergences between them. We set out below common types of vertical agreements/clauses typically found in vertical agreements and highlight how the new regimes apply to them.

Different Types/ Aspects of Vertical Arrangements

Dual Distribution

Expansion of Scope: Although the main utility of the safe harbour is for arrangements between parties at different levels of the supply chain and not competitors, the scope of the previous EU vertical restraints block exemption had also included agreements between a manufacturer/supplier and retailers where the former was also active downstream at the retail level.  Brands are increasingly providing their own direct to consumer offerings and, thus, competing with the retailers that they supply. The new regimes not only specifically cover this form of dual distribution, but have expanded the scope to cover wholesalers and importers at the upstream level.

Information Exchange: As brands and retailers increasingly compete with each other downstream, the nature and extent of the exchange of commercially sensitive information between them has become a very salient consideration. Both regimes make clear the importance of any information exchanged being directly related to/necessary for the implementation of the vertical agreement and, in relation to the EU Regulation, "is necessary to improve the production or distribution of the contract goods or services". Both sets of Guidance provide further details on what may, or may not, be exchanged.

Online Intermediation Services ("OIS") Providers: OIS services include e-commerce marketplaces and price comparison tools allowing businesses to offer goods and service to other businesses or to final consumers 'with a view to facilitating direct transactions being initiated between them'. Under the EU Regulation, if the OIS provider also sells goods/services in competition with those businesses to whom it provides such services, the safe harbour does not apply. The UK Order, however, does not differentiate between OIS providers.

Exclusive Distribution

Under the previous EU vertical restraints block exemption, a supplier could allocate an exclusive territory or customer group to one distributor (or reserve it for itself). Under the EU Regulation, a supplier can now select up to five distributors and, under the UK Order, the supplier can select a 'limited number' of distributors (the number being proportionate to the allocated territory/customer group in order to preserve the investment incentives for the distributors). Customer groups can be defined using criteria or by means of a list of identified customers.

Sales restrictions can be placed on exclusive distributors prohibiting them from selling to unauthorised resellers where the supplier operates a selective distribution system. These restrictions can also be passed down to their customers.

The UK Guidance (but not the EU Guidance) also confirms that a supplier can combine both exclusive and selective distribution within the same territory if these systems operate at different levels of the distribution chain (so that the supplier can appoint an exclusive wholesaler and also selective distributors).  

Selective Distribution

Clarification of Scope: Over a number of years, there has been a divergence across the EU regarding the application of competition law to aspects of selective distribution systems. The new EU and UK Guidance make clear that the safe harbour may apply to selective distribution arrangements, irrespective of the nature of the products concerned (i.e. they do not need to be luxury or hi-tech) and whether the selection criteria are qualitative and/or quantitative in nature.

In addition, there has been a relaxation of the 'equivalence' requirement so that different qualitative criteria can be imposed on authorised distributors depending upon whether they are operating physical stores or online. Requirements for authorised distributors to operate at least one brick-and-mortar store have been the subject of debate in recent years, but the new regimes still permit this.

Dual Pricing

Both new regimes provide a more flexible approach to dual pricing, i.e. a supplier charging a distributor different wholesale prices depending upon whether the products are to be sold in physical stores or online, whereas it was previously treated as a hardcore restriction, despite the concerns raised about free-riding. This does not mean that suppliers can now charge differentiated prices at will and care needs to be taken in relation to a supplier's pricing practices.  The price differential should reflect the differences in the retailer's investment and costs associated with the different sales channels. A supplier must not use dual pricing for the purpose of restricting sales to a particular territory or customer group or to prevent the retailer's effective use of the internet (see below for more details).

Online Sales and Advertising Restrictions

Under both regimes, a new hardcore restriction has been introduced, namely the prevention by the supplier of 'effective use' of the internet by its buyer to sell the goods or services. 

This hardcore restriction does not preclude the possibility of the vertical agreement containing some online restrictions. A prohibition on selling via online marketplaces is not a hardcore restriction as the distributor will still be able to use the internet effectively by selling on its own online store and by advertising online. However, suppliers must not impose (and retailers must not accept) restrictions on the use of entire online advertising channels, such as a total ban on price comparison tools or search engines. Care needs to be taken in relation to imposing or accepting restrictions on the use of a particular price comparison tool or search engine, where this is very popular or widely used, as this could impact on the retailer's ability to attract customers to its own online store and could amount to a hardcore restriction. A retailer must not be precluded from establishing or using its own online store.

Wide Parity Clauses

These are often referred to as wide Most Favoured Nation clauses or MFNs and have been the focus of some EU and UK regulatory scrutiny in recent years. Wide MFNs require a supplier to offer the goods or services on no less favourable terms than those offered to anyone else through any other sales channel, whilst a narrow MFN only requires the supplier not to offer more favourable terms via its own sales channel. Both regimes have reduced the scope of the safe harbour in relation to MFNs at the retail level. 

Under the EU Regulation, a restriction on the buyer of OIS services offering its products to end users on competing platforms (e.g. on online marketplaces or price comparison websites) at a lower price or on other more favourable terms is excluded from the automatic benefit of the safe harbour and the provision (not the agreement as a whole) requires individual self-assessment. However, the UK takes a stricter approach as the UK Order lists wide retail MFNs as hardcore restrictions so that the whole agreement would not benefit from the safe harbour. Under the UK regime, this hardcore restriction not only applies where online platforms are used, but also where the intermediary is an offline sales channel (e.g. a traditional broker).

The UK's approach does not sit particularly comfortably in light of the recent judgment by the UK's Competition Appeal Tribunal overturning the CMA's decision that Compare the Market had infringed competition law through the use of wide MFNs and its finding that the wide MFNs in question had not been shown to be anti-competitive. 

Resale Price Maintenance or RPM

The imposition (directly or indirectly) by a supplier of minimum or fixed resale prices on its distributors remains a hardcore restriction under both regimes. The respective EU and UK Guidance also make clear that the imposition of minimum advertised prices or MAPs will be treated as an indirect means of applying RPM, although both set out a possible exception where the supplier's imposition of MAPs (or of a minimum resale price) is to protect against brand damage through loss leadership. They also set out certain, very limited circumstances where RPM may lead to efficiencies and be 'on balance pro-competitive'. 

In relation to fulfilment contracts, where the supplier enters into a vertical agreement with the buyer to fulfil a supply agreement concluded by the supplier with a specific customer, both sets of Guidance make clear that the imposition by the supplier of resale prices does not constitute RPM where the provider of the fulfilment services has been selected by it and not by the customer. 

Non-Compete Obligations and the Five-Year Duration

Under both regimes, and as per previous practice, the safe harbour does not extend to non-compete or exclusivity obligations (where the buyer is prohibited from manufacturing, purchasing or selling competing goods or required to purchase more than 80% of their total purchases of the relevant goods from the supplier) which exceed five years' duration or are of indefinite duration. However, there has been some relaxation under the EU regime as the safe harbour does extend to tacitly renewable non-competes beyond five years, provided that the buyer can 'effectively' renegotiate or terminate the arrangement with reasonable notice and at reasonable cost. Under the UK regime, a tacitly renewable obligation beyond five years is treated as being of indefinite duration and, thus, outside of the safe harbour. 

¹The Competition Act 1998 (Vertical Agreements Block Exemption) Order 2022
²Regulation 2022/770/EU
³CMA Guidance on Vertical Agreements Block Exemption Order of July 2022 and Commission Notice: Guidelines on vertical restraints