The majority of European nations have enacted regulations concerning distribution agreements that are far more restrictive and far more complex than those of most American states. Many of the nations, such as Belgium, have enacted laws that void contrary provisions in the distribution agreements, including provisions incorporating the laws of other jurisdictions. The wise manufacturer or exporter into Europe will take the time to learn the restrictions on agreements in the particular nation subject to the Agreement and not assume that a provision in the agreement using non EU (European Union) law will solve the problem.
One particularly regulated area involves all provisions as to non competition of the distributor or importer. While such provisions are often allowed in the United States and most nations, the EU severely limits the scope and enforceability of such provisions. This article shall discuss some (but not all) of the points to be considered in creating appropriate distribution agreements in the EU. It is vital to get good legal advice in this area of the law and the reader should not merely rely only on a review of this article. This article is to give the basics of the law but the appropriate planning and drafting requires expert advice.
This analysis offers an overview of EU Competition Rules that may affect agreements between U.S. exporters and their EU distributors. U.S. exporters that are seeking distributors in the European Union should be aware of certain EU rules that may limit the restrictions that can legally be included in an agreement. This analysis provides information on special provisions that pertain to small and medium size enterprises, as well as a list of Internet links for gathering more information.
THE BASICS
I. Introduction: Big Is Bad; Small May Be Less Bad.
U.S. companies interested in expanding their business in Europe should be aware of certain EU regulations concerning distribution agreements. Analogous to antitrust laws in the United States, EU competition rules, which apply to both goods and services circulating in countries within the European Union, prohibit certain practices concerning vertical restrictions. Companies are required to make a proactive assessment of the compatibility of their agreements with the regulations.
Over the past several years the EU has adopted a perspective based more on economic effects in enforcing its competition rules. The result has presumably been a less bureaucratic approach that both encourages increased competition while reducing the regulatory burden on companies with little market power. In the case of vertical agreements, the level of scrutiny the EU gives an agreement is proportional to the market share of the firms involved, and the competitive landscape of the sector. This change in approach has enabled EU competition authorities to focus their efforts on inhibiting firms with a large market share from undertaking practices that are most harmful to competition.
II. The EU's view of Vertical Restraints
Vertical restraints are agreements or concerted practices between two or more companies, each of which operates at a different level of the production or distribution chain. Vertical restraints define and limit the conditions under which the parties may purchase, sell or resell certain goods or services. Article 81 of the EC Treaty prohibits agreements between entities that restrict or distort competition in the internal market.[1] However, vertical restraints can also have positive effects, namely in the promotion of non-price competition and improvement in the quality of service received by the consumer. The EU recognizes this, and Article 81 allows for the possibility of agreements that contain vertical restraints that have the effect of improving the production and distribution of goods, or promoting technical or economic progress, with a portion of the benefits accruing to customers.
According to EU regulations, companies involved in economically harmful vertical agreements that stifle competition may be penalized by the imposition of fines of up to 10 percent of a company's global sales.[2] To help companies assess whether their agreements fall within the scope of Article 81(1), the EU has issued regulations and guidance as to what types of vertical restraints are prohibited, and when limited forms of vertical restraints may be allowed.
III. When is a Vertical Restraint Harmful?
The key criterion in evaluating whether a vertical restraint is illegal under EU rules is the effect on trade, particularly between EU Member States. The effect on trade is assessed on two variables - 1) the market power (which is related to market share) of the companies and 2) the nature of the restrictions. Accordingly, as the size of the companies and their market shares increase, the types of vertical restraints allowed become more limited.
The EU has also identified certain provisions that are generally regarded as having negative trade effects, depending on the size and market share of the parties to the agreement, as well as certain provisions that are allowable to foster efficiencies in the market that lead to lower prices for all consumers.
IV. Share of the Relevant Market
The EU allows some restrictive practices where the parties' market shares are below certain thresholds. Market share is typically measured based on the previous year's sales value at the level of trade being considered. If sales value data are unavailable, estimates based on other reliable market information, including market sales volumes, may be used.[3]
EU competition law defines the relevant market as being comprised of any goods or services that are viewed by the buyer as interchangeable or substitutable for one another, by reason of the products' characteristics, their prices and their intended use.[4] In addition, the parties must consider the geographic area in which they are involved in the supply and demand of the specific product or service.
Past cases have determined that short-haul holiday packages are not substitutable for long-haul packages,[5] and ruled that the market for bananas "is sufficiently distinct from the other fresh fruit markets" after examining the propensity of consumers to substitute peaches and table grapes for bananas.[6] Determining the relevant market can be especially complex when dealing with high technology products where interchangeability and substitutability may be subject to a variety of conditions.
V. Small and Medium-Sized Enterprises
The EU has deemed that agreements between small and medium-sized enterprises (SMEs) are rarely capable of appreciably impacting intra-Community trade or competition. Accordingly, the EU has indicated that it generally will not institute proceedings either upon application or on its own initiative concerning agreements between SMEs.[7] However, if an agreement between two SMEs contains a provision that has a clearly negative effect on cross-border trade, e.g., by prohibiting a party from cross-border sales, then Article 81 would still apply.
SMEs should also be aware of Member States' national laws that may apply even where EU rules do not.
The EU defines a small enterprise as employing fewer than 50 personsand having either an annual turnover not exceeding 7 million euros or an annual balance sheet total not exceeding 5 million euros. The EU defines a medium enterprise as employing fewer than 250 persons and having either an annual turnover not exceeding 40 million euros or an annual balance sheet total not exceeding 27 million euros.[8] The monetary thresholds defining SMEs within the EU will change beginning January 1, 2005. Small enterprises will be defined as having either an annual turnover not exceeding 10 million euros or an annual balance sheet total not exceeding 10 million euros. Medium-sized enterprises will be defined as having either an annual turnover not exceeding 50 million euros or an annual balance sheet total not exceeding 43 million euros. The number of employees in the EU definition of both small- and medium-sized enterprises will remain unchanged.[9]
VI. "De Minimis" Threshold
Under the EU's "de minimis" notice, the effect on competition is considered negligible when each of the parties to a vertical agreement has a market share below 15 percent (10 percent if the vertical agreement is between competitors).[10] Such an agreement, provided it does not include any prohibited "hardcore restrictions" discussed later in section X, is automatically permissible unless the market is characterized by multiple parallel vertical agreements.
VII. Block Exemption Regulation
Where the share of the relevant market between the supplier and the buyer or distributor does not exceed 30 percent, EC Regulation 2790/1999, often referred to as the "Block Exemption Regulation" (or "BER"), provides a "safe harbor" for many vertical agreements. Hardcore restrictions are still prohibited, as are certain other provisions described below.
The BER allows for vertical agreements between competitors only when the agreement is "non-reciprocal and the buyer has a turnover not exceeding EUR 100 million or the buyer is not a competing manufacturer but only a competitor of the supplier at the distribution level (i.e., a manufacturer that sells its products both directly and via distributors)."[11] The BER does not apply to competitors involved in exclusive distribution and importation agreements. For example, "two brewers active in different countries cannot become the exclusive importer and distributor of the other brewer's beer in his home market."[12]
But note that the following provisions in an agreement are prohibited regardless of the economic criteria above:
Three provisions that are not allowed, or are allowed only if they meet certain conditions, are:
a. Non-Compete obligations in effect during the contract, that require the buyer to purchase all or more than 80 percent of the buyer's total requirements from the supplier or from an undertaking designated by the supplier, are allowed only if they are of a defined duration that is not greater than five years. Such obligations prevent the buyer from purchasing and selling competing goods or services or substantially limit such purchases or sales. Non-compete obligations are allowed if the supplier provides the premises from which the buyer trades in the goods or services.
b. Non-Compete obligations effective after the contract that restrict the buyer from dealing in another brand are only allowable if they are limited to one year after the termination of the contract, are indispensable to protect know-how transferred from the supplier to the buyer, and are limited to the point of sale from which the buyer has operated during the contract period.
c. Exclusion of specific brands in a selective distribution system, e.g., where a supplier prevents its appointed dealers from selling a competitor's product, is not allowed.
VIII. Technology Transfer Agreements
The Technology Transfer Block Exemption Regulation[13] (TTBE) is similar to the BER, but with applicability to licensing of intellectual property such as patents. Many of the provisions, such as the hardcore restrictions and market share thresholds, mirror the BER. The TTBE addresses issues of particular concern when licensing technology, such as field of use and captive use restrictions, royalties, and non-compete obligations.
The EU is in the process of updating the TTBE, and on October 1, 2003, invited comments on a new draft regulation concerning the application of the competition rules relating to technology transfer agreements.[14]
IX. Assessment of Agreements
Agreements that are ineligible for BER, de minimis, or SME treatment need to be assessed for their anti-competitive effects, and whether the agreements may actually benefit consumers through improved efficiency in production or distribution of the goods or services. Companies need to consider the negative effects of their agreements on inter- and intra-brand competition, whether competition is potentially foreclosed through barriers to entry, and if limits on market integration may result. They should also evaluate their agreements for possible positive effects that can benefit consumers, such as investments in training and technology for distributors, free-rider problems, economies of scale, and uniformity and quality standardization, among others.
As an aid to parties and their counsel in the assessment process, the European Union has issued guidelines to be used in evaluating competitive effects of agreements.[15] If after reviewing the guidelines, parties are uncertain if the novel terms of an agreement may be viewed by EU competition authorities as having harmful effects on competition, the Commission is drafting a notice that provides a procedure for requesting non-binding "guidance letters" from the Commission to help the parties assess the effects on competition from the terms of agreements. Under new enforcement provisions that take effect on May 1, 2004, the Commission no longer will issue comfort letters and exemption decisions on the legality of agreements and practices.
X. Hardcore Restrictions
The BER lists five "hardcore restrictions" that are regarded as generally harmful and almost never are allowed. These types of restrictions are not eligible for BER or de minimis exemption. In the case of SME's, the EU will only take action if there is a negative effect on trade, although Member State rules may still apply.
1. Resale Price Maintenance - "A supplier is not allowed to fix the price at which distributors can resell their products."[16] This provision prohibits setting minimum resale prices. For purposes of the BER, imposing maximum resale prices or providing recommended resale prices normally is not considered a hardcore restriction. However, where the maximum or recommended resale price becomes a focal point for the distributors, it may have the effect of facilitating horizontal collusion between suppliers. [17] Accordingly, dominant companies and companies in oligopolistic markets should be aware of how recommended or maximum resale prices may affect the market.
2. Restrictions Concerning the Territory into which or the Customers to whom the Buyer May Sell - EU regulations prohibit "the restriction of the territory into which, or of the customers to whom, the buyer may sell the contract goods or services."[18] However, exclusive territory arrangements for active sales efforts, as well as exclusive customer groups are allowable under the BER. Additionally, a seller may restrict buyers to dealing at the wholesale level of trade only, and from selling components to competitor manufacturers. "However, passive sales, i.e., sales in response to unsolicited orders including general advertising and sales over the Internet, must always remain free."[19] The BER for exclusive territories may be withdrawn when the market is oligopolistic and characterized by parallel agreements. Exclusive territory restrictions may limit inter- and intra-brand competition and would need to demonstrate consumer benefits if practiced by dominant firms.
3. Selective Distribution - Selective distribution agreements restrict the number of distributors by applying selection criteria for admission as an authorized distributor. While selective distribution is not prohibited, EU competition rules impose two hardcore restrictions on such systems:
a) Selected distributors cannot be restricted in the end-users to whom they may sell.[20]
b) Selected distributors cannot be forced to purchase the contract goods exclusively from the supplier; they must remain free to sell or purchase the contract goods to or from other selected distributors within the network.[21]
Two criteria can come into consideration when employing a selective distribution system: qualitative and quantitative. Use of qualitative selection criteria (such as training, range of products offered, service at the point of sale) generally is regarded by the EU as an objective, non-discriminatory method if applied uniformly. Conversely, use of quantitative selection criteria, where suppliers are chosen with the intent of limiting the number of distributors in a market, are more likely to reduce intra-brand competition and be subjected to close EU scrutiny. BER treatment may be withdrawn if the anti-competitive effects of a selective distribution system are appreciable and the nature of the product does not require selective distribution.[22] Exclusive distribution is usually allowed if companies can demonstrate that the practice leads to higher levels of distribution efficiency that produce a net benefit for consumers.
4. Spare Parts - Agreements are not allowed to prevent or restrict end-users, independent repairers and service providers from obtaining spare parts directly from the manufacturer of the spare parts.[23] An agreement between a manufacturer of component parts and an original equipment manufacturer buyer "may not prevent or restrict sales by the manufacturer of these spare parts to end users, independent repairers or service providers."[24]
XI. Other Common Vertical Restraints
The EU's "Guidelines on Vertical Restraints" provides several examples that can help United States businesses get a better sense of what is and is not allowed under EU competition rules. Below are a few of the more common vertical restraints that are mentioned in the guidelines.
1. Single Branding - Often called `ties,' single branding induces a buyer to concentrate their purchases of a particular type of product on the brand of one supplier. As mentioned earlier, the BER limits this type of non-compete agreement to a maximum of five years. Single branding by dominant companies is regarded as limiting the ability for new-entrants to appear in the market and enabling the seller to force buyers to accept higher prices.[25]
2. Exclusive Customer Allocation- Some vertical agreements may seek to appoint only one distributor for a specific category of customers. Exemptions are justified if companies can demonstrate "the need to invest in specific equipment, skills or know-how to adapt to the requirements of their customers."[26]
3. Franchising - Franchising agreements often include licensing of intellectual property rights, in particular trademarks and know-how, for the use and distribution of goods or services. In addition to the license, the franchiser usually provides the franchisee with ongoing commercial or technical assistance. Vertical restraints involving franchising often involve a combination of other agreements, such as selective distribution or exclusive distribution. The EU assessment process takes the efficiencies that result from the franchising business model into consideration when assessing the anti-competitive effects of the vertical restraints included in the franchising agreement.[27]
4. New Products - Vertical restraints to open new product or geographic markets generally are not regarded as restricting competition during the first two years of a new product being put on the market. This rule only applies to non-hardcore vertical restraints, however, in recognition of the need to recover expenses associated with launching a new product, territorial restrictions on both passive and active selling may be allowed under certain circumstances.[28]
5. Exclusive Supply - These agreements oblige or induce the supplier to sell a particular good or service to only one buyer for the purposes of a specific use or for resale. Such agreements are eligible for BER treatment when the relevant market shares are less than 30 percent. Because of the possibility of foreclosure effects, the buyer's share of the downstream product market is important for evaluating anti-competitive effects. Where market shares are above the BER threshold, these types of agreements are generally permissible where there is significant investment by a non-dominant EU distributor (e.g., the EU distributor assists the supplier in designing the product).[29]
6. Bundling or Tying - In this type of vertical agreement a supplier makes the sale of one product conditional upon the purchase of another distinct product from the supplier or another party designated by the supplier. The first product is referred to as the `tying' product and the second as the `tied' product. The BER exempts this practice when the tying supplier has numerous competitors. However, collusion of multiple competitors is prohibited due to the rise of a cumulative effect, which erodes competition in the market.[30]
XII. Conclusion
Many commentators have concluded that the enforcement of “Anti Trust” laws in the EU is far more aggressive than in the current United States thus American companies, long used to a relatively free hand in their structural creations and contractual commitments, are often nonplussed to discover the restrictions imposed upon them by EU law.
Companies entering into agreements for the distribution of their products or services in the European Union should be aware of the EU competition rules and restrictions on vertical restraints. Although small and medium-sized businesses are generally exempt from the provisions of Article 81, SMEs should take care to avoid including restrictions that directly restrict trade. Larger companies should review the hardcore restrictions and published guidance when assessing their agreements to ensure compliance with EU law. Companies entering into distribution agreements should consider seeking legal counsel if they need assistance evaluating their agreements.
XIII. Competition Links
EU Directorate General for Competition website, with links to legislation, publications, Member State competition authorities, and related news releases:
http://europa.eu.int/comm/competition/index_en.html
Publication by DG Competition: Competition Policy in Europe, The competition rules for supply and distribution agreements, European Communities, 2002, an basic guide to EU competition laws related to agency and distribution agreements:
http://europa.eu.int/comm/competition/publications/rules_en.pdf
U.S. Department of Justice, Antitrust Division, International Documents, links to documents related to international antitrust agreements and antitrust guidelines for international agreements:
https://www.justice.gov/atr/public/international/intdocs.htm
International Competition Network, an inter-governmental organization focused on improving global cooperation and convergence of competition enforcement:
http://www.internationalcompetitionnetwork.org
OECD Competition Committee, with useful links and reports on competition practices by competition authorities:
http://www.oecd.org/competition/
An excellent source for advice for United States companies first encountering the complex world of European distribution is The U.S. Commercial Service, U.S. Mission to the European Union, Boulevard du Regent 27 Brussels B-1000, Belgium
Tel: +32 2 508 2222
Fax: +32 2 513 1228
e-mail: brussels.ec.office.box@mail.doc.gov;
Website: http://www.buyusa.gov/europeanunion.
American Antitrust Institute, a public interest group based in Washington, D.C., that provides government officials, researchers, and other interested parties, including the general public, with information on competition law:
http://www.antitrustinstitute.org
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[1] Article 81 of the EC Treaty (ex Article 85)
[2] Regulation (EC) 17/62, Article 15 (2). In practice 10 percent serves as a ceiling, for further detail see "Guidelines on the method of setting fines imposed pursuant to Article 15(2) of Regulation No 17 and Article 65(5) of the ECSC Treaty"
[3] Commission Regulation (EC) No 2790/1999 on the application of Article 81(3) of the Treaty to categories of vertical agreements and concerted practices, Article 9(1)
[4] Commission Regulation (EC) No 2790/1999, Article 1(a)
[5] Judgment of the Court of First Instance (Fifth Chamber, extended composition), Airtours plc v Commission of the European Communities, June 6, 2002.
[6] European Court of Justice Case 27/76, United Brands Company and United Brands Continentaal BV v Commission of the European Communities, February 14, 1978.
[7] Commission Notice 2001/C 368/07 on agreements of minor importance which do not appreciably restrict competition under Article 81(1) of the Treaty establishing the European Community (de minimis)
[8] Commission Recommendation 96/280/EC concerning the definition of small and medium-sized enterprises.
[9] Commission Recommendation 2003/361/EC concerning the definition of micro, small and medium-sized enterprises.
[10] Commission Notice 2001/C 368/07
[11] ibid.
[12] Competition Policy in Europe, The competition rules for supply and distribution agreements, European Communities, 2002, p. 10 ("Competition Policy Booklet")
[13] Commission Regulation (EC) No 240/96 of 31 January 1996 on the application of Article 85 (3) of the Treaty to certain categories of technology transfer agreements
[14] Competition rules relating to technology transfer agreements, Communication pursuant to Article 5 of Council Regulation No 19/65/EEC of 2 March 1965 on the application of Article 81(3) of the EC Treaty to certain categories of agreements and concerted practices, as last amended by Regulation (EC) No 1/2003, OJ C 235, October 1, 2003, p. 10-54
[15] Commission Notice Guidelines on Vertical Restraints, OJ 91/1-44, October 13, 2000, para. 184-198 "Guidelines Notice"
[16] Commission Regulation EC No 2790/1999, Article 4 (a)
[17] Guidelines Notice, para. 111-112, 225-228
[18] Commission Regulation EC No 2790/1999, Article 4(b)
[19] Competition Policy Booklet, p.11-12.
[20] Commission Regulation EC No 2790/1999, Article 4(c)
[21] Commission Regulation EC No 2790/1999, Article 4(d)
[22] Guidelines Notice, para. 184-198
[23] Commission Regulation EC No 2790/1999, Article 4(e)
[24] Competition Policy Booklet, p.12.
[25] Guidelines Notice, para. 106-018, 138-160
[26] Guidelines Notice, para. 178-183
[27] Guidelines Notice, para. 42-43, 199-201
[28] Guidelines Notice, para. 119 (10)
[29] Guidelines Notice, para. 202-214
[30] Guidelines Notice, para. 215-224