Selective distribution contracts and compliance with competition law

Permitted and prohibited restrictions in selective distribution agreements under competition law

This article aims to analyse the fundamental impact of competition law, within the framework of the European Union, on agreements as common in the market as selective distribution contracts, i.e. those agreements in which a supplier undertakes to sell goods, directly or indirectly, only to distributors selected on the basis of specific criteria, which may be qualitative, quantitative or hybrid; while the distributors undertake not to sell such goods or services to unauthorised distributors in the territory in which the supplier has decided to apply this system.

By its very nature, the selective distribution system already entails an impairment of free competition in the sense that it prohibits the free entry of distributors who do not meet the requirements demanded by the supplier. However, it is considered that it is a system that falls outside the scope of application of article 101.1 TFEU – Treaty on the Functioning of the European Union – , since the improvement of inter-brand competition compensates for the impairment of intra-brand competition caused by the restrictions inherent in the system.

Article 101.1 of the TFEU (its homonym in Spain would be article 1.1 of the Law on the Defence of Competition) prohibits, as a general rule, agreements between undertakings, decisions of associations of undertakings and concerted practices which have as their object or effect the restriction or distortion of competition within the European Union. In this sense, such agreements would lead to their nullity, the imposition of significant fines (up to 10% of turnover) by the European public authorities and/or the public authorities of each Member State (in Spain, the corresponding public authority responsible for ensuring compliance with competition rules is the National Commission for the Competition Market) and/or the claim for damages by those affected by the agreement. However, as it is a selective distribution system, the parties to the contract (supplier and selective distributor) can benefit from the exemption established in article 101.3 of the TFEU and therefore be considered valid agreements in the market; and all this because it is understood that such contracts (i) improve production/distribution; and (ii) allow consumers to participate in its advantages.

In view of the above, in order for such agreements to benefit from the exemption, the requirements set out in Commission Regulation (EU) 330/2010 on the application of Article 101(3) TFEU to categories of vertical agreements and concerted practices (the “Vertical Restraints Regulation”) must be fulfilled. In order for the parties to a selective distribution contract to benefit from the Vertical Restraints Regulation, the following is necessary:

1. The market share of the supplier or buyer does not exceed 30% of the relevant market.
2. The parties are not actual or potential competitors, with the exception of dual distribution (supplier competes with the distributor at the distribution level).
3. The agreement contains any of the hardcore restrictions of Article 4 of the Vertical Restraints Regulation.

At this point, what would be the hardcore restrictions in a selective distribution contract?

a) Selling price restrictions: the supplier may not fix a fixed or minimum selling price by the selective distributor, but may recommend prices or set fixed prices for the introduction of a new product on the market in order to encourage retailers to increase their promotional efforts and build demand for the new product. For example, the UK government fined the watch company CASIO £3.7 million in 2019 for monitoring the prices charged by its distributors and pressuring them to raise prices when they were below the minimum indicated price.

b) Territorial restrictions: In selective distribution systems, it is possible to restrict sales to final consumers or other members of the selective distribution network in the territories where the system is implemented, but cross-selling between dealers cannot be restricted. In order for the supplier to apply territorial restrictions to selective distributors, it is necessary to implement a selection system based on objective, uniform and non-discriminatory criteria.

c) Restrictions on online sales: the supplier may not prohibit the selective distributor from selling the products online, but may impose restrictions on online sales as long as it is based on objective qualitative criteria that are required by the nature of the product and do not directly or indirectly make it impossible for the selective distributor to sell online. Another example of such an infringement and fine in a selective distribution system is the case of the company Guess in 2019. The European Commission imposed a fine of €40,000 on the company Guess as it prohibited members of the selective distribution system from selling online without prior authorisation from Guess, as well as from using the Guess brand for online search.

Online selling is one of the most contentious issues between the various parties to the vertical agreements. In this regard, the main problem that the Court of Justice of the European Union has encountered is when determining whether it is considered an anti-competitive practice to restrict online sales through a third party platform (e.g. Amazon). This issue was resolved in 2017 in the Coty case. In this case, Coty was a German supplier of luxury cosmetic products marketed under a selective distribution system that prohibited the use of third-party platforms/marketplaces. After the German court ruled that a ban on selling through third party platforms is a particularly severe restriction of competition, the case was challenged on appeal by the Frankfurt Higher Regional Court and asked the Court of Justice of the European Union whether such a ban is indeed an anti-competitive practice. The CJEU ruled that there is no infringement of Article 101 (1) TFEU as long as the criteria for the selection of selective distributors are objective, uniform and non-discriminatory.

In addition, another crucial issue to be resolved is the issue of dual pricing between products sold online and products sold offline. Under the current Vertical Restraints Regulation it would be considered a prohibited restriction. However, there is a draft Vertical Block Exemption Regulation, subject to public consultation and expected to be published by 1 June 2022, which would replace the Vertical Restraints Regulation, and would cover supplier conduct where a product is sold at a different price offline than online. Such conduct would be legitimate as long as the differences in investment in the two sales channels have been taken into account and in no case should the prices imposed on products intended to be sold online be aimed at covertly preventing online sales by the distributor. In other words, if the supplier’s sales prices for products to be sold online by the distributor make their sale through this channel financially unprofitable, then this restriction would constitute a serious restriction of competition.

d) Restrictions on the sale of competing products: it is permitted to prohibit the selective distributor from selling competing brands in general, but not to prohibit the brand of a specific competitor.

That said, it should be noted that there are also special rules for vertical agreements in the R & D, technology transfer, specialisation and motor vehicle sectors, which we will not have the opportunity to examine on this occasion, and which we postpone to subsequent circulars.

Finally, as mentioned above, the Draft Vertical Agreements Block Exemption Regulation is expected to be published on 1 June 2022, with the aim of replacing the current Vertical Restraints Regulation, and will remain in force until 31 May 2034. Initially, the Draft Regulation will allow the supplier to impose an obligation on authorised distributors to prohibit the distributors’ customers from reselling to unauthorised operators, as well as to set different prices for products depending on whether they are sold online or offline as discussed above. The draft is also likely to rule on issues that the current Vertical Restraints Regulation does not clearly regulate, such as: In a selective distribution system, do the parties benefit from the block exemption or must it be justified by the nature of the product); Are there efficiency reasons that may justify maintaining a resale price; Is the prohibition to sell through third party platforms a hardcore restriction; Is it justified to require the distributor to have a physical point of sale before being able to sell online; Is it justified to require the distributor to have a physical point of sale before being able to sell online; Is it justified to require the distributor to have a physical point of sale before being able to sell online; Is it justified to require the distributor to have a physical point of sale before being able to sell online; Is it justified to require the distributor to have a physical point of sale before being able to sell online?

AddVANTE will provide information on developments in this area, and we offer our full advice to the parties to vertical agreements in order to ensure that their contractual claims and interests comply with the rules of competition law.