There is a New Vertical Exemption on the Block

Summary

The European Commission published the new Vertical Block Exemption Regulation and related guidelines on May 10, 2022. The purpose of the block exemption is to generally exempt agreements between market players at different levels of the supply chain from the EU’s prohibition on anticompetitive agreements if certain market share thresholds are met and provided the agreement does not contain certain prohibited restrictions. This client alert describes the five main changes in the new block exemption relating to dual distribution, most favored nation clauses, sales restrictions in distribution systems, restrictions of online sales, and non-compete clauses. It also highlights a few key areas of divergence with the proposed UK regime.

In further detail: 

The EU’s new Vertical Block Exemption Regulation No. 2022/720 (“New VBER”) and related guidelines (“New Vertical Guidelines”) were published on May 10, 2022 following an evaluation process started in 2018. This process involved the European Commission (“EC”) updating the old Vertical Block Exemption Regulation No. 330/2010 (“Old VBER”) enacted in 2010, with a particular focus on developments in modern digital business models and prevalence of internet sales.

The purpose of the block exemption is to recognize that agreements between market players at different levels of the supply chain are generally efficiency enhancing and of benefit to consumers, unless they contain certain hardcore restrictions of competition and as long as neither party has significant market power.

The VBER therefore provides a block exemption (“safe harbor”) from the EU’s prohibition on anticompetitive agreements (Art. 101 TFEU and its national equivalents) for vertical (distribution) agreements if certain market share thresholds are met and provided the agreement does not contain certain prohibited restrictions (“blacklisted clauses” or “hardcore restrictions”) or excluded restrictions. If an agreement falls within the scope of the VBER, Art. 101 TFEU (and its national equivalents) will not apply. This regime is intended to reduce burden on business by giving them legal certainty around the compliance of certain categories of agreement with antitrust laws.

The New VBER retains many of the provisions found in the Old VBER. For example, while there are some new clarifications on resale price maintenance, the EC continues to treat it as a hardcore restriction – consistent with recent enforcement action in this area. However, there are some significant changes that companies need to understand to ensure that their distribution arrangements in the EU benefit from the exemption. And the updated regulation and guidance bring much needed clarity around the application of these rules to digital markets, following several years of debate as to how to make them fit for purpose in the modern age.

In parallel, the UK Competition and Markets Authority is consulting on its own amended guidance to accompany the UK equivalent of the New VBER, which will replace the Old VBER that was retained in the UK post-Brexit and which is due to expire in May 2022. Helpfully, the UK’s proposed Vertical Agreements Block order (“VABEO”) largely mirrors the EC proposals, but a few important distinctions will need to be navigated.

This client alert describes the five main changes in the New VBER and highlights a few key areas of divergence with the proposed UK regime. 

1. Dual Distribution – New Rules for Information Exchange and No Exemption For Online Marketplaces

A major change concerns dual distribution, namely where a supplier sells goods or services both directly to its own customers as well as through distributors/retailers, thereby competing with its independent distributors/retailers. For example, consumer goods manufacturers may sell their products direct to consumers through online stores as well as via retailers. Rising online sales have of course increased the prevalence of dual distribution.

The Old VBER exempted dual distribution agreements in general if the market shares of both the manufacturer and retailer did not exceed 30%. Dual distribution will continue to benefit from the general protection of the VBER covering now more levels of the supply chain (importers and wholesalers in addition to manufacturers). However, information exchange between the supplier and the retailer (Art. 2(5)) is only exempted if it “is either directly related to the implementation of the vertical agreement or is necessary to improve the production or distribution of the contract goods or services.”

The New Vertical Guidelines explain how the EC interprets information exchange in dual distribution scenarios. The parties can share (i) current prices including recommended or maximum prices, (ii) technical information (e.g., certification, registration, etc.), (iii) aggregated information linked to customer purchases, preferences and feedback, (iv) supply related information (e.g., sales volume, inventory, returns), (v) performance-related information, and (vi) marketing related information.

However, the following exchanges are unlikely to be exempted: (i) future prices, (ii) customer-specific sales data and (iii) information relating to goods sold by a buyer under its own brand name with a manufacturer of competing branded goods.

The new rules on dual distribution will have potentially important consequences for branded suppliers that sell their products on their own websites in addition to supplying through distributors or retailers. Notably, the EC dropped its proposal to subject information exchanges in dual distribution to a market share cap of 10%, which should make self-assessment easier.

Online marketplaces no longer benefit from the exemption if they sell products in competition with the businesses to which they provide online intermediation services (Art. 2(6)). This applies regardless of any market shares of the involved parties. These agreements have to be assessed under Art. 101 TFEU (and the related horizontal guidelines).  

In contrast, the UK CMA does not propose to exclude online marketplaces from the benefit of the exemption.

2. Most Favored Nation (“MFN”) Clauses – Special Rules for Online Marketplaces

MFN clauses (or also price parity clauses) require a seller of goods or services to offer the goods or services to another party on conditions that are no less favorable than the conditions offered by the seller to certain other parties or via certain other channels. The Old VBER generally exempted MFN clauses if both the supplier and buyer do not exceed a market share of 30%.

Due to concerns about the potentially negative effects for price competition of using MFNs in the platform context, the New VBER introduces a special rule for online marketplaces. MFN clauses prohibiting the retailer from offering more favorable conditions on competing online marketplaces (so-called “wide MFNs”) will be excluded from the benefit of the exemption.  Instead, these clauses will need to be assessed individually under Art. 101 TFEU including the Horizontal Guidelines, cf. Art. 5(1)(d).  

By contrast, MFN clauses of market players not operating an online marketplace will continue to benefit from the block exemption if both the supplier and buyer do not exceed a market share of 30%. The same applies to MFN clauses imposed by online marketplaces which only restrict the retailer’s ability to offer more favorable conditions on its own website (so-called “narrow MFNs”). Notably, the CMA proposals go further than the EC, by categorizing wide MFNs as “hardcore restrictions,” meaning that the presence of such a clause in an agreement will cause the whole agreement to fall outside the exemption.

3. Sales Restrictions in Distribution Systems

The New VBER provides for a clear distinction between exclusive distribution, selective distribution and free distribution. Overall, the rules for distribution systems have been extended and made more flexible.

There is more freedom to restrict active sales in exclusive and other distribution systems. While the Old VBER required that certain territories or customer groups needed to be allocated exclusively to one other distributor, active sales restrictions are now exempted if there are up to five other distributors active in a certain territory or responsible for a certain customer group (Art. 4(b)(i)). The New Vertical Guidelines now clarify that a supplier can also require its distributors to pass on these active sales restrictions to its direct customers (unlike under the Old VBER).

The New VBER allows suppliers who operate a selective distribution system (i.e. where the supplier appoints a limited number of distributors based on specified criteria) to impose broad sales restrictions. For instance, suppliers can restrict active and passive sales by distributors (including their direct customers) in a selective distribution system to unauthorized distributors located in any territory where the supplier operates a selective distribution system.

4. Restriction of Online Sales

The New Vertical Guidelines relax the approach towards online sales restrictions in line with EC case law.

• Dual pricing strategies, i.e. where the supplier sets a different wholesale price for products sold online compared to products sold offline are no longer viewed as per-se hardcore restrictions. The New Vertical Guidelines provide for a nuanced approach and highlight that dual pricing is permitted if the price difference takes into account investments or costs related to a certain type of distribution.
• Restrictions on sales in online marketplaces has been a much-debated topic. While some national competition authorities (particularly the German Federal Cartel Office) viewed these as anticompetitive, the European Court of Justice ruled in the Coty judgment that they could be exempted under the Old VBER. The Coty judgment left room for interpretation as regards whether only certain (trademark or high-quality) products would fall under the Old VBER. The New Vertical Guidelines now provide that restrictions of sales on online marketplaces generally benefit from the block exemption in all distribution systems and regardless of the goods or services concerned, provided that the reseller is entitled to sell through its own website.
• Certain online advertising restrictions may also benefit from the New VBER. However, these restrictions need to be carefully designed not to have the effect of preventing the use of an entire advertising channel, which is a hardcore restriction. For example, the New Vertical Guidelines provide that a complete ban on the use of search engines, the use of price comparison websites or search engine marketing restrictions (e.g. preventing the use of brand names for bidding in search engines) would not be exempted, as such restrictions could prevent the effective use of the internet by resellers. By contrast, the exclusion of certain search engines or price comparison websites may be possible.

5. Non-Compete (or Exclusivity) Clauses

The New VBER no longer provides that automatic renewals of non-compete (or exclusivity) clauses fall outside the block exemption. The Old VBER limits this to provisions not exceeding five years.  Under the New Vertical Guidelines, an implied or automatic renewal of the non-compete clause (taking the duration beyond five years) may be exempted if the customer can effectively renegotiate or terminate the vertical agreement containing the non-compete agreement within a reasonable time after the expiration of the period and at a reasonable cost. The EC mentions that loans or equipment provided must not hinder customers from terminating the non-compete. The UK proposals have retained the Old VBER position, meaning tacitly renewable non-competes will not be exempt.

Timing – do we have to make any changes to our contracts immediately?

The New VBER enters into force on June 1, 2022 and will apply to all new agreements from that date.  Existing contracts do not need to be adjusted immediately. A transitional rule provides that agreements in effect on May 31, 2022, will continue to be exempted under the Old VBER until May 31, 2023. This may sound like plenty of time, but given the time it takes to review all distribution agreements to identify potential compliance issues including the often complex and lengthy negotiations that often occur, we recommend acting sooner rather than later. And, as noted above, those active also in the UK should be aware that the UK equivalent rules (yet to be finalized) will not be completely aligned with those of the EU.