Distribution Agreements and UK / EC Competition Law
A distribution agreement is a legal agreement between a supplier of goods and a distributor of goods. The supplier may be a manufacturer, or may itself be a distributor reselling another’s goods. Distribution agreements can fall foul of both UK and EC competition law and care should therefore be taken with their drafting. This briefing note summarises some of the key considerations which need to be addressed when preparing a distribution agreement.
TYPES OF DISTRIBUTORSHIP ARRANGEMENT
There are several different types of distribution agreement. The following are some of the more common examples:
- Exclusive distributorship
The supplier agrees to sell the contract goods only to the distributor within a certain defined territory, and agrees not to appoint other distributors or sell the goods directly to other customers within the territory.
- Sole distributorship
The supplier appoints a distributor as his only or sole distributor within a territory, but the supplier reserves the right to supply the goods directly to end users.
- Non-exclusive distributorship
The supplier has complete freedom both to sell directly and to appoint other distributors within the territory.
- Selective distributorship
The supplier, in appointing a distributor as part of a selective distribution system, agrees to appoint additional distributors only if they meet certain criteria.
UK AND EC COMPETITION LAW – KEY PRINCIPLES
In the UK two sets of competition rules apply. Anti-competitive behaviour which may affect trade within the UK is specifically prohibited by the Competition Act 1998 and the Enterprise Act 2002 and where the effect of the anti-competitive behaviour extends beyond the UK to other EU member states, it is prohibited by Articles 81 and 82 of the EC Treaty.
There are two main types of anti-competitive activity which are prohibited by UK and EC competition law. These are:
1 Anti-Competitive Agreements
Anti-competitive agreements are defined as agreements between businesses that prevent, restrict or distort competition (or are intended to do so) and which affect trade in the UK and/or EU.
Agreements likely to be prohibited include those which:
• fix the prices to be charged for goods or services;
• limit production;
• carve up markets; or
• discriminate, e.g. between customers (e.g. charge different prices or impose different terms where there is no difference in what is being supplied).
2 Abuse of Dominant Market Position
A dominant position in a market essentially means that a business is generally able to behave independently of competitive pressures, such as other competitors, in that market.
Conduct which may be considered an abuse by a business in a dominant position includes:
• charging excessively high prices;
• limiting production;
• refusing to supply an existing long standing customer without good reason;
• charging different prices to different customers where there is no difference in what is being supplied; or
• making a contract conditional on factors that have nothing to do with the subject of the contract.
VERTICAL AGREEMENTS BLOCK EXEMPTION
Whether a distribution agreement actually restricts competition and whether in that case the benefits outweigh the anti-competitive effects will often depend on the market structure. In principle, this requires an individual assessment in each particular case. However, under EC competition rules, most distribution agreements will benefit from an exemption afforded to vertical agreements (often referred to as the “vertical agreements block exemption”) which creates a general presumption of legality for vertical agreements, provided that the supplier’s market share is below 30% and that the agreements do not contain specified hard core restrictions.
A vertical agreement is one that is entered into between businesses operating at different levels of the economic supply chain, and includes, for example, agency and franchising arrangements as well as distribution agreements.
The majority of distribution agreements should not give rise to competition concerns provided that the supplier’s market share is below 30% and the parties ensure that they steer clear of the hardcore restrictions (see below for more details).
In general, if a distribution agreement includes a “hardcore” restriction, it will usually not benefit from any of the safe harbors created under EU competition law, including the vertical agreements block exemption.
Hardcore restrictions include:
1 Price-fixing or resale price maintenance
A supplier is not allowed to impose a fixed or minimum price at which distributors can resell the goods. However, the imposition of a maximum resale price or a recommended resale price is normally not prohibited provided that such provisions do not have the effect of a fixed or minimum resale price as a result of pressure from or incentives offered by the party imposing the restriction.
2 Restrictions concerning the territory into which, or the customers to whom, the buyer may sell
This restriction relates to market partitioning by territory or by customer. Distributors must remain free to decide where and to whom they sell. However, restrictions on “active sales” into a territory reserved by the supplier or in respect of which another buyer has been granted exclusivity are permitted. These restrictions are only allowed where there is an exclusive arrangement and the supplier is not permitted to restrict “passive sales”.
For these purposes:
“Active sales” means actively approaching customers inside another distributor’s exclusive territory or exclusive customer group by for instance direct mail, personal visits, advertising in media or other promotions specifically targeted at the customer group or customers within that territory or establishing a warehouse or distribution outlet in other distributor’s exclusive territory; and
“Passive sales” means responding to unsolicited requests from customers including delivery of goods or services to such customers. General advertising or promotion in media or on the internet that reaches customers in other distributor’s exclusive territories or customer groups but which is a reasonable way to reach customers outside those territories or customer groups, for instance to reach customers in non-exclusive territories or in the distributor’s own territory, are passive sales.
Important Note: it is commonly assumed that the supplier can prohibit all “active sales” outside the territory allotted to the distributor. That was the position under a previous block exemption. However, the current block exemption is narrower (and more complicated): the supplier can only prohibit “active sales” into territories which have been reserved exclusively to itself or another buyer. If a supplier has non-exclusive distribution arrangements in any country, it cannot prevent its distributors in other countries from making active sales into that country.
3 Territorial/customer sales restrictions in a selective distribution system
A supplier is not permitted to restrict the end-users to whom the authorised distributors may sell. Save that territorial exclusivity is permitted, i.e. the supplier may commit itself to supply only one distributor in a given territory and can require the distributor to sell only from a given location provided that “active sales” and “passive sales” are not restricted.
4 Cross supplies between distributors within a selective distribution system
Authorised distributors must remain free to sell or purchase the goods to or from other authorised distributors within the network. This means that appointed distributors cannot be forced to purchase the goods exclusively from the supplier. However, authorised distributors can be restricted from reselling to unauthorised distributors.
5 Spare parts
Agreements that prevent or restrict end users, service providers and independent repairers from obtaining spare parts directly from the manufacturer of the spare parts are not permitted.
FAILURE TO COMPLY
Businesses involved in anti-competitive behaviour may find their agreements to be unenforceable and risk being fined up to 10% of their global turnover for particularly damaging behaviour as well as exposing themselves to possible damages actions from customers. Furthermore, individuals involved with the business could find themselves facing director disqualification orders or even criminal sanctions for serious breaches of competition law.
Being aware of competition law provisions will enable a business to meet its obligations, and in doing so, avoid the penalties set out above, and will also enable the business to assert its own rights with regard to completing businesses and protect its position in the marketplace.