Retales™ Update: New Verticals Block Exemption - impact on franchising

Introduction

The final text of the new Verticals Block Exemption Regulation (the “Block Exemption”) and accompanying Guidelines was published on 20 April 2010 and will come into force on 1 June 2010. 

As previously reported, the current Block Exemption expires on 31 May 2010 and the new text replaces it.  A draft of the replacement text was published by the European Commission for consultation on 28 July 2009.  Comments on the draft were provided by a wide range of stakeholders, including by this firm, but there is little change of substance to the final text.

The new Block Exemption will remain in force for 12 years. There is a one year grace period for agreements currently in force which do not meet the conditions for exemption under the new Block Exemption but which meet the conditions for exemption under the outgoing rules.

A short guide to the new Block Exemption

• Not only the supplier but also the buyer must have a market share of 30% or less on the market on which they respectively sell and buy the product or service in order for an agreement to fall within the Block Exemption.
• Agreements containing hardcore restrictions are still outside the Block Exemption, unless they can be objectively justified or an efficiency defence can be pleaded.  The hardcore restrictions list remains largely the same as under the current rules, but there is more guidance on potential justifications.
• The rule that distributors should be free generally to sell on the Internet remains unchanged.  There is more detailed guidance in the Guidelines on what constitutes passive and active online selling.
• The list of restrictions which fall outside the Block Exemption, now known as “excluded restrictions”, remains unchanged.  A more helpful definition of “know-how” may make it slightly easier to justify post-term non-compete obligations.
• Some clarification work has been carried out by the Commission, including in relation to agency agreements, the de minimis market share threshold and new types of agreements not previously discussed in the Guidelines (category management and upfront access agreements).

The final text – what are the consequences?

30% market share threshold

Under the new Block Exemption, both the buyer and the supplier to an agreement must have a market share of 30% or less in order to fall within the Block Exemption.  Under the current Block Exemption, only the supplier’s market share had to be below 30% but in last year’s draft this requirement was expanded to also apply to the buyer’s market share as a means of dealing with potential buyer power issues.  Concerns raised by stakeholders in the consultation process that this was not the appropriate way to deal with any competition issues arising from buyer power, to the extent that they arise at all, clearly did not sway the Commission from this course.  The Commission’s view is that this change is beneficial for small and medium-sized enterprises which could otherwise be excluded from the distribution market.

Concerns about the uncertainty created by the draft wording – where the market share threshold could not be exceeded on “any of the relevant markets affected by the agreement” – have, however, been addressed by tighter re-drafting of the wording.  The 30% threshold now applies specifically in relation to the market on which the supplier sells the goods or services and the market on which the buyer purchases the goods or services.  This means that in a normal bilateral agreement, the buyer’s market share on the downstream market on which the buyer sells the goods or services is not taken into account.   If an undertaking is both a supplier and buyer in a multi-party agreement, the market share threshold must not be exceeded as both buyer and supplier.

Hardcore restrictions

As in the draft, agreements containing hardcore restrictions remain outside the Block Exemption, although the Guidelines now make it clear that efficiency defences can be pleaded in individual cases.  Examples given in the Guidelines include:

• Where the distributor is the first to sell a new brand, protection against active and passive sales into its territory may be required to protect the distributor’s investment in starting-up.
• Where there is the staggered introduction or testing of a new product, distributors may be prevented from selling outside the test market for the period of testing or introduction.
• In a selective distribution system, restricting active sales by wholesalers to retailers in other wholesalers’ territories may be necessary to prevent free riding off investments in promotional activities.
• Charging higher prices for products sold on-line may be justified where on-line sales lead to higher costs for the manufacturer, e.g. where more customer complaints or warranty claims arise.

Restrictions on Internet selling

The new Block Exemption maintains the position that distributors should be free generally to sell online. Restrictions on sales over the Internet are regarded as “passive sales restrictions” meaning that they are hardcore and prima facie prohibited.  This reflects the Commission’s long-held view that the Internet is a very good means to foster inter-state trade.  However, when the Guidelines were originally written in 1999/2000, the Internet as a sales tool was in its infancy and the Commission (as well as many businesses) had little or no experience of how, commercially, suppliers of goods and services might seek to control Internet sales by their distributors.  The current Guidelines are therefore vague about the kinds of online selling practices that might amount to impermissible passive sales restrictions.  The new Guidelines draw on 10 years’ experience of Internet selling to provide much more specific guidance on what suppliers can and cannot restrict in relation to Internet sales.

What is the difference between “passive” and “active” Internet selling?

Having a website is a form of passive selling.  Therefore, distributors cannot be prevented from setting up a website to sell the products.  Nor can the supplier impose indirect restrictions such as requiring that customers from outside the distributor’s territory are routed via the distributor’s website to their own website, restricting the proportion of overall sales over the Internet or imposing a higher price for products intended to be sold over the Internet.

Nor do the language options on a website of themselves convert a “passive selling” website to an “active selling” one.  So, for example, a supplier cannot restrict its UK distributor from having a German language version of its website, even where Germany has been allocated to another distributor.  However, online advertisements specifically addressed to customers outside the distributor’s territory do constitute active selling and can be restricted. Examples include territory-based banners and paying a search engine to specifically display advertisements to users in a particular territory.

Can quality requirements be imposed?

Quality requirements can be imposed on Internet selling, just as they can be for shop or catalogue selling.  One example provided is that where the distributor’s website is hosted by a third party, the supplier can require that customers do not enter the website via a site carrying the third party’s name or logo.
In relation to selective distribution, the new Guidelines make it clear, whilst online sales to end users within the selective distributor’s territory must be permitted, quality criteria may be imposed on online sales provided that they are “overall equivalent” to the offline sales criteria.  In what can be seen as a rebuff to online-only retailers, the Commission effectively permits suppliers to extend the concept of selective distribution to the Internet, although suppliers will need to consider carefully whether the criteria they impose for Internet sales are “equivalent” to their quality requirements for bricks-and-mortar shops.

Resale price maintenance

Resale price maintenance (RPM) remains a hardcore restriction which gives rise to the presumption that the agreement restricts competition and falls within Article 101(1).  However, the Guidelines also state that undertakings have the possibility of pleading an efficiency defence under Article 101(3). 
None of the concerns raised in the consultation about the uncertainty as to the enforceability of RPM obligations have been addressed in the final text. The most prudent  approach would be to continue to treat RPM obligations as problematic.

What else does the new Block Exemption cover?

Other changes to the current Block Exemption (some of which were already included in the draft) include:

• The Block Exemption and Guidelines now reflects the new terminology of the Lisbon Treaty adopted at the end of last year.
• Recitals 8 and 9 of the Block Exemption specifically state that above the 30% threshold, there is no presumption that vertical agreements are caught by Article 101(1) or fail to satisfy the conditions of Article 101(3).
• Article 5 of the Block Exemption on “excluded restrictions” has been restructured but there is no change at all to the substance of the Article.
• The definition of “substantial” know-how has been changed from “information that is indispensable” to “significant and useful”.  This represents a slightly lower hurdle for undertakings wishing to rely on the transfer of know-how to justify a post-term non-compete obligation and is a very useful change for many franchisors.
• There is additional guidance in the Guidelines on the difference between unilateral conduct and acquiescence.
• There are new sections in the Guidelines on upfront access payments and category management agreements.
• In relation to the assessment of whether an agreement is a genuine agency agreement, parties should consider whether the agent undertakes other activities in the same product market as the principal which are not reimbursed by the principal.  This has changed from the draft text, which included the assessment of risk in relation to after-sales and repair services.
• The de minimis market share threshold to determine whether Article 101(1) applies to an agreement between undertakings has been raised from 10% to 15%.

Next steps

The Commission has not invited comments on the final text, which will enter into force on 1 June 2010.  As noted above, parties have until 31 May 2011 to ensure that vertical agreements covered by the current Block Exemption comply with the new provisions.

For further information, please contact Chris Wormald or Nick Pimlott.