Vertical agreements under Article 101(1) TFEU and Regulation 330/2010
The economic interpretation of Article 101(1) TFEU relates primarily to vertical agreements. The notion of vertical agreements has been described by the Commission in its Vertical Restrictions Guidelines (hereinafter referred to as the Vertical Guidelines) as’ contracts or concerted procedures concluded between two or more firms, each of which works at a distinct stage of the manufacturing or delivery chain for the purposes of the contract and relating to the circumstances under thereof.
It should be noted that only vertical agreements with significant effect on trade between Member States fall within the scope of Article 101 TFEU. Furthermore, the ECJ held in Case C-260/07 Perdo that vertical agreements pursuant to Article 101(1) TFEU should not be assessed if they meet the requirements of Regulation 330/2010 or fall within the scope of the de minimis rule.
The Vertical Guidelines of the Commission provide the methodology for assessing whether a vertical agreement infringes Article 101(1) TFEU and, if so, whether it can be justified in accordance with Article 101(3) TFEU.2840 Paragraph 110 of the Vertical Guidelines sets out nine factors relevant to the assessment under Article 101(1) TFEU. They are:
- the nature of the agreement;
- the current position of the sides;
- the market position of the rivals;
- the position of the consumers of the contract goods;
- entry obstacles;
- the strength of the market;
- the level of trade impacted by the agreement;
- the nature of the product;
The Vertical Guidelines provide clarification on the implementation of Article 101(1) TFEU to ten kinds of vertical contracts, i.e. single branding, exclusive distribution, exclusive client allocation, selective distribution, franchising, exclusive supply, up-front access payment, category management contracts, limitations on binding and resale. Analyzing them all is outside the scope of this book. However, as is the ECJ’s stance on export bans, the most common kinds of vertical agreements, i.e. selective distribution contracts, franchise agreements and exclusive buying agreements are discussed below.
Direct and indirect export bans in Vertical Agreements Article 101 TFEU
Only in the exceptional circumstances specified in paragraphs 60-4 of the Vertical Guidelines will the direct or indirect export ban imposed on distributors be permitted under Article 101(1) TFEU or benefit from the derogation provided for in Article 101(3) TFEU. The imposition of bans restricts competition by item and is therefore contrary to an integrated market goal as it avoids parallel imports and divisions of the internal market.
Selective distribution agreements in Vertical Agreements Article 101 TFEU
A provider agrees to sell products or services directly or indirectly only to a distributor chosen on the grounds of particular criteria in a selective distribution contract and the distributor undertakes not to sell such products or services to unauthorized retailers.
Manufacturers of high-tech or luxury branded products usually use selective distribution contracts. The very nature of distribution contracts means that such contracts can adversely influence business circumstances by enabling collusive behavior between providers and retailers, by decreasing or eliminating intra-brand competition (this refers to competition between retailers of a specified brand, for instance, between retailers of Rolex watches), by foreclosing access However, selective distribution contracts can also have pro-competitive impacts, such as ensuring higher distribution effectiveness and thus providing advantages to all interested parties, including customers.
In Case 26/76 Metro, the ECJ examined the implementation of Article 101(1) TFEU to selective distribution contracts.
Saba, an electrical and electronic equipment manufacturer, rejected Metro’s application to access its selective distribution network in Germany. The products of Saba outside Germany were marketed directly to single retailers dealing solely with authorized specialist retailers serving the public. The German selective distribution scheme was open to wholesalers who sold goods bought from Saba to authorized specialist retailers whose turnover had to be derived from the sale of electrical and electronic products. Metro served distributors and the public as a money and self-service company based in Germany. This was the primary reason for Saba’s rejection, although Metro did not meet other Saba’s demands in that it was not suitable to manage extremely advanced electronic products with its trading premises, its turnover or its staff’s technical skills. Metro complained to the Commission that the Saba selective distribution scheme in particular did not infringe Article 101(1) TFEU. Saba was entitled to ban direct supplies to customers by wholesalers or sole retailers, although specific provisions such as the prohibition of wholesalers, sole retailers and specialized dealers from exporting to other EU nations or the prohibition of “cross-supplies” (wholesalers to wholesalers or retailers to retailers) were condemned. Metro tried to annul the judgment of the Commission.
The ECJ held that a selective delivery scheme such as that established by Saba did not infringe Article 101 TFEU in so far as resellers were chosen’ on the grounds of objective qualitative criteria pertaining to the technical qualifications of the reseller and his employees and the suitability of his premises and that such terms were evenly laid down for all pots.
This is called the Metro test.
The Metro test is restated by the Vertical Guidelines. They distinguish between purely qualitative selective contracts and quantitative ones. Purely qualitative selective contracts are outside the prohibition of Article 101(1) TFEU given that three requirements are met:
- the nature of the item concerned requires a selective distribution scheme (but this is no longer needed by Regulation 330/2010).
- Resellers shall be selected on the grounds of objective qualitative criteria.
- Objective criteria must not go beyond what is required.
With respect to the first condition, the ECJ indicated in Metro that selective distribution contracts were justified in “the industry covering high-quality manufacturing and technically sophisticated consumer durables.” The ECJ verified in subsequent instances that other kinds of products such as luxury or branded products and newspapers (due to their exceptionally brief lives) justified selective distribution apart from technically advanced products. It is essential to note that Regulation 330/2010 removed the requirement for a selective distribution scheme to be established for the item concerned.
With regard to the second situation, it needs dealers to be chosen on the grounds of objective qualitative critics that are consistently established for all prospective distributors and implemented in a non-discriminatory way. He should be prepared to become a dealer when a prospective dealer meets the qualitative requirements. It is not always simple to distinguish between qualitative and quantitative requirements. Nonetheless, quantitative restrictions ‘ more directly restrict the prospective amount of dealers by, for example, requiring minimum or maximum sales, setting the amount of dealers, etc.’ In Metro, the ECJ discovered that constraints on the reseller’s and his staff’s technical skills and the suitability of the reseller’s premises were qualitative.
With regard to quantitative restrictions, the following clauses were considered as such and were therefore in breach of Article 101(1) TFEU: in Metro, a clause requiring dealers to keep particular inventory quantities, to support the product of the manufacturer and to store a whole variety of products; in Case 31/80 L’Oréal and in Givenchy, a requirement that the distributor ensure a minimum quantity of products
Regarding the third condition, the ECJ made it clear in Metro that “qualitative criteria” should not go beyond what is necessary to preserve the quality of the goods or to ensure that they are sold under proper conditions. What is needed relies on the product’s nature. This is demonstrated in Case T-19/91 Vichy, where the requirement that Vichy’s cosmetics be sold in retail pharmacies where a skilled pharmacist was present in all EU nations except France (where this was not needed) was deemed disproportionate, taking into consideration the goals that Vichy wished to accomplish outside France (i.e. enhancing the quality of both of its goals). In Ideal-Standard, conditions imposed on wholesalers specialising in the sale of plumbing fittings and sanitary ware, and having a specialised department for their sale, were regarded unjustified on the floor of the product’s nature, i.e., plumbing fitting systems were not technically adequately sophisticated. In Case C-439/09 Pierre Fabre the ECJ ruled that in the context of the selective distribution of its cosmetic and personal care products, the de facto ban of internet sales enforced by a producer of dermo-cosmetic products could not be justified by the need to provide individual guidance to clients or by the protection of the brand image. Indeed, for the sale of its products, the producer needed a skilled pharmacist’s physical presence and thus de facto forbidden the sale of Internet.
Selective distribution contracts that fail the Metro test may be exempted under Regulation 330/2010 if they meet their market share requirements and do not contain the’ hard-core constraints’ laid down in Article 4 or the limitations laid down in Article 5. Regulation 330/2010 relates to these contracts irrespective of the nature of the products and the selection criteria. Furthermore, under Article 101(3) TFEU, a selective distribution contract not covered by Regulation 330/2010 may be justified.
The essence of franchising contracts is that they contain licenses for trademarks, symbols or know-how of IPRs for the use and distribution of products and services, and that the franchisor provides the franchisee with technical and commercial help during the existence of the contract. The franchisee shall practice the privileges in question and the franchisee shall pay a franchise fee in return for the use of the business method in question. Franchising contracts generally involve a mixture of distinct vertical restrictions on how to distribute the goods.
The leading case for franchise contracts is Case 161/84 Pronuptia.
THE FACTS WERE:
Pronuptia de Paris, specializing in the sale of wedding clothes and other wedding access-ories, concluded a franchise agreement with Mrs Schillgalis. In exchange for the exclusive right to use the trademark “Pronuptia de Paris” in three areas of Germany–Hamburg, Olden-burg and Hanover–Mrs Schillgalis was obliged to purchase 80% of the clothes she intended to sell directly from Pronuptia and a certain percentage of other clothes from sup-pliers approved by the franchisor in order to make the sale of wedding clothes her main business act Pronuptia pledged to refrain from opening any other Pronuptia store in the land covered by the contract and give its help from personnel training to marketing in all aspects of the company.
When Pronuptia sued Mrs Schillgalis for failing to pay “royalties,” she asserted that the franchise agreement was null and void contrary to Article 101(1) TFEU. A preliminary issue on the implementation of Article 101(1) TFEU to franchising contracts was referred to the ECJ by the German Supreme Court.
The ECJ held that the limitations enforced by the franchisor are outside the reach of Article 101(1) TFEU if they fulfil two circumstances: firstly, the lawful interests of the franchisor should be protected under EU law, that is, the franchisor should be shielded from the danger of using the know-how and the aid it provides to the franchisees to benefit their competitors. As a result, there was no breach of Article 101(1) TFEU of a clause preventing the franchisee from opening a shop selling the same or similar items outside its territory during and after the termination of the agreement and the requirement for the franchisor to approve a proposed transfer of the shop to another party.
Secondly, the franchisor has the right to safeguard its network’s reputation and identity and therefore maintain some control in this regard. Specifically, the shop’s location specifications, the shop’s layout and decoration, the proportion of clothes bought and supply sources were valid.
Price suggestions were not in violation of Article 101(1) TFEU if the franchisee was able to set its own rates and therefore there was no concerted practice on rates between the parties.
A clause limiting the franchisee from opening a second store in its exclusive land without the franchisor’s approval was in violation of Article 101(1) TFEU, having regard to the possibility of dividing the land of a Member State into a number of closed regions. Furthermore, this limitation would stop the franchisee from benefiting from its investment, bearing in mind that “a potential franchisor would not risk becoming part of a chain, investing his own cash, paying a comparatively large entry fee and having to pay a significant annual royalty, unless he could hope, thanks to a degree of competition protection on the part of the franchisee.
Such a clause should therefore be examined in accordance with Article 101(3) TFEU.
The EU organizations have taken a liberal attitude to constraints enforced by franchise contracts by considering their general positive impact on trade and the benefits offered to both the franchisee and the franchisee. Even a clause condemned in Consten and Grundig to ensure utter terrible protection may fall outside the prohibition of Article 101(1) TFEU if it is deemed necessary to cause the franchisee to conclude the contract.
Exclusive supply and buy contracts
As they enhance inter-brand competition, exclusive contracts between producers and distributors or between producers and distributors are usually legal. Potentially both sides profit from them. Manufacturers can calculate the demand for their product for the length of the contract and adjust their output accordingly; manufacturers and distributors receive advantageous rates, technical aid, supply preferences and so on in return for their commitment. However, if one party to an exclusive contract is in a dominant place on the relevant market, the arrangement can foreclose the market and discourage development of tiny undertakings, thereby harming customers. For instance, with regard to exclusive purchase contracts, i.e. contracts requiring multiple separate distributors each to buy all their individual demands from one supplier, a fresh supplier will not be able to get its products into sufficient stores with the consequence that customers will not be able to benefit from wider product selection and better prices. For this purpose, when evaluating exclusive contracts, the Commission takes into account whether the contract in question is part of a network of comparable agreements and, if so, assesses its cumulative impact on trade between Member States, i.e. assesses whether the cumulative impact of foreclosing the relevant market has. This is illustrated in Brasserie de Haecht (No. 1) Case 23/67.
The owners of a café in Esneux, Belgium, promised to purchase all their beer, lemonade and other beverages from that brewery for the length of the loan and two more years in return for a loan produced by a brewery in Belgium. When the brewery sued the café owners for violation of the contract, they asserted that the arrangement infringed Article 101(1) TFEU as it limited trade between Member States by restricting the stores for breweries from other Member States in Belgium.
The ECJ held that, in its financial and legal context, the agreement should be evaluated, in specific whether there was only one agreement or whether the agreement was component of a network of comparable contracts. Its impact on trade between Member States was insignificant if it was a distinct arrangement. However, if it was part of a network of contracts, its general effect could lead in the opening of fresh stores making it hard or even impossible for new undertakings to join the market.
Exclusive purchase contracts shall not fall within the range of Article 101(1) TFEU if the impact of such an arrangement has no “blocking” impact on prospective rivals, either separately or as part of a network of several comparable contracts.
It should be observed that the market share of the parties is not the only factor to be taken into consideration when evaluating an employee exclusive supply / purchase contract. Indeed, regardless of whether or not an individual contract contributes substantially to the cumulative foreclosing impact and therefore infringes Article 101(1) TFEU, its length may in itself be in violation of Article 101(1) TFEU if it is excessive compared to the average length of the contracts reached on the relevant market.