European competition law: the new vertical block exemption

On 1 June the European Commission’s new vertical agreements block exemption (VABE), and revised guidelines on vertical agreements, came into force. VABE and the guidelines are relevant to agreements between companies operating at different levels of the supply chain, including supply agreements, distributorships or reseller agreements, franchise agreements and agency agreements.

VABE provides an automatic safe harbour from the prohibition on restrictive agreements in article 101 (1) of the Treaty for the Functioning of the European Union (TFEU) for all vertical agreements that fall within its scope and comply with its provisions. If businesses can draft their agreements so as to fall within VABE, they can have peace of mind that those agreements will be enforceable and that they will not be exposed to enforcement sanctions.

Criteria for the safe harbour

For an agreement to benefit from the exemption provided by VABE, the market share of both the buyer (on the market in which it purchases the goods) and the supplier (on the market in which it supplies the goods) must not exceed 30%.

The agreement must also not contain any “hard core” restrictions. Hard core restrictions include restrictions on the buyer’s ability to determine its own pricing (although certain exceptions exist in the context of agency agreements); conferring absolute territorial protection on the buyer (or total exclusivity in relation to a customer group); territorial and customer restrictions on sales within a “selective distribution system”; and restrictions on sales of components. If an agreement contains any hard core restrictions, it will be unable to benefit from VABE in any respect (even if some of its provisions are drafted in line with what is permitted).

Changes from the previous regime

The new VABE and the revised guidelines are largely based on the regime which has applied to vertical agreements in Europe for the last 10 years. However, there are a number of key changes to note:

1. The major change to the safe harbour is that (as outlined above) an agreement will now only benefit from the safe harbour if the market shares of both the buyer and the supplier do not exceed 30% on the markets in which they operate. If the market share of either party exceeds 30%, VABE will not apply.
2. The guidelines expand on the rules relating to internet sales and provide that restrictions on internet sales will amount to a hard core restriction of competition. Therefore, any terms in an agreement which prohibit selling via the internet or require a buyer to pay more for items sold through the internet will take an agreement outside of the safe harbour provided by VABE and would create a presumption of illegality.
3. The guidelines contain provisions that are favourable to a brand-owner when its products are sold via the internet. Suppliers are, among other things, now able to require that buyers conform to appropriate quality standards for their websites and online advertising; have one or more “bricks & mortar” shops before engaging in internet selling; and sell a certain absolute amount (in value or volume) through their “bricks & mortar” shop.

The impact of these changes will ultimately depend on the type of vertical agreement that companies are operating.

Outside the safe harbour?

If an agreement falls outside the safe harbour and restricts or distorts competition contrary to the article 101(1) prohibition, it may still be exempt if it meets the general criteria for individual exemption under article 101(3) of the TFEU:

• the agreement brings about efficiencies;
• it only imposes restrictions that are indispensable for achieving those efficiencies;
• it allows consumers a fair share of the resulting benefit; and
• it falls short of substantially eliminating competition.

If the agreement does not meet the requirements of VABE or meet the criteria for general exemption, then it is prohibited under the TFEU.

Prohibited agreements may face enforcement action by the European Commission, or a national competition authority, which may impose fines of up to 10% of a company’s worldwide turnover, give directions to take steps to bring an infringement to an end and, in some cases, apply for individuals to be disqualified from acting as company directors. Parties to a prohibited agreement can also be sued for damages by anyone who has suffered losses as a result of the agreement.

Effect on Chinese companies

One of the major concerns for Chinese companies that supply EU markets is the change in the market share threshold that must be met in order to qualify for exemption under VABE. Chinese companies may not know whether their distributors have a market share exceeding the 30% threshold. Previously the distributor’s market share was not relevant to the question of exemption.

Chinese companies should also ensure that their distributor agreements do not prevent their European distributors from making sales through the internet. The revised guidelines state that “every distributor must be allowed to use the internet to sell products”. Any restriction of a company’s ability to make internet sales is a hard core restriction of competition.

Chinese companies should check their European distribution agreements to ensure that they comply with the terms of the new VABE. Failure to do this could result in the agreement falling foul of the prohibition, the agreement (or parts of it) being unenforceable, and (in some cases) the risk of enforcement sanctions.

Under the terms of the safe harbour there is a one year transitional period for agreements which were in place as at 31 May (and which complied with the previous regime). The transitional period gives businesses until 1 June 2011 to ensure their agreements comply with the new VABE.

Charlie Markillie is a solicitor at Eversheds. He specializes in competition law