This note sets out the structure of the new competition law regime for vertical supply chain agreements in the UK. Following the publication of the draft VABEO, the CMA has now also published the accompanying guidance ('the Guidance'). The full text is available here. Both documents work together in tandem. The VABEO is not an overhaul of the existing rules. It retains a similar structure whilst modernising the approach. Overall, our view is that both the VABEO and Guidance are clearer and better articulated documents than the retained VBER.

At the time of writing, the Guidance is still under consultation and may be subject to change. However, given the tight timetable until the new regime comes into force (31 May 2022), it is highly unlikely that the below will be substantially amended.

What is the VABEO?

Chapter 1 of the Competition Act 1998 ('CA98') prohibits agreements which restrict competition. Section 9 CA98 sets out the exception to this prohibition for agreements, which contribute to improving the production or distribution of goods or to promoting technical or economic progress, while allowing consumers a fair share of the resulting benefits.

Agreements between entities active at different levels of the supply chain, (a manufacturer and distributor for example) are referred to as vertical agreements. Competition law has long established that vertical agreements may be able to benefit from the section 9 CA98 exemption. In order to give businesses legal certainty, the Vertical Agreement Block Exemption Order ('VABEO') automatically exempts through a safe harbour,  vertical agreements which comply with a set of criteria, namely:

  • the parties each have a market share below 30%; and
  • the agreement does not contain any hardcore restrictions (e.g. fixing resale prices).

The VABEO comes with detailed guidance which provides crucial insight into its interpretation in relation to the main types of vertical agreement and distribution structure. The Guidance also sets out the CMA's position in relation to vertical agreements falling outside the safe harbour. This is invaluable guidance for the self-assessment that businesses and their legal advisors are expected to undertake to ensure distribution agreements comply with competition law.

The VABEO is strongly influenced by the equivalent EU regime under the VBER which had been in force in the UK since 2010. In parallel with the UK, the EU has also upgraded its regime to reflect new commercial realities brought in by the growth of e-commerce. You can read our full update on the new EU regime  here. The EU's new regime will also come into force on 1 June 2022.

1. The updated list of hardcore restrictions

The inclusion of hardcore restrictions within a vertical supply chain agreement will bring the entire agreement outside of the safe harbour created by the block exemption. Art 8(2)(a) to (f) VABEO sets out the updated list of restrictions which the CMA considers to be hardcore.

Such restrictions carry a presumption of anti-competitive harm and are generally treated as restrictions of competition by object. Hardcore restrictions are, nevertheless, still capable of fulfilling the conditions for individual exemption under s. 9(1) of the Competition Act if sufficient pro-competitive effects can be established. The Guidance sets out examples of how the conditions may be satisfied, for e.g. in the case of genuine new market entry. However, in our experience, satisfying the individual exemption criteria can be an uphill struggle.

The concept of 'objective necessity' can also be an important consideration in any competition law assessment. However, the guidance confirms that this is a narrow exception reserved, for e.g., ensuring compliance with a public ban on selling dangerous substances to certain customers.

  • Resale Price Maintenance (RPM) – Art 8(2)(a)

As expected, the VABEO retains the existing legal position on RPM. In the context of a distribution arrangement, imposing a fixed or minimum resale price will be a hardcore restriction. Imposing a maximum or recommended resale price will remain acceptable as long as in practice such measures do not amount to a minimum or fixed resale price as a result of pressure or incentives.

This hardcore restriction is about the buyer's ability to determine the onward resale price of a product or service. The CMA provides a limited example of when RPM can meet the conditions for individual exemption under section 9(1), namely, when a new product is introduced to the market by a manufacturer or a short-term low-price campaign is introduced in the context of a franchise network.

  • Territorial and Customer restrictions – Art 8(2)(b) – (d)

The VABEO applies to vertical agreements that have an effect on trade within the whole of the UK. This means territorial restrictions will be those which affect the single market within the UK. The general rule is that a buyer should be allowed to approach individual customers actively (active sales) and to respond to unsolicited requests from customers (passive sales). The VABEO sets out 4 exceptions to this rule for selective and exclusive distribution networks:

i. Active sales can be restricted to an exclusive territory or customer group

ii. The restriction of active or passive sales to end users by wholesalers

iii. Active and passive sales to unauthorised distributors can be restricted within a selective distribution system

iv. A supplier can restrict an authorised buyer of components from reselling them to competitors of the supplier who would use them to manufacture the same type of goods as those produced by the supplier

The VABEO confirms that exclusive and selective distribution networks can be combined in the same or different geographical areas. It also introduces the new concept of 'shared exclusivity', which allows for the appointment of more than one 'exclusive distributor' in a geographical area or customer group. Both of these developments are in line with the EU's new regime.

- Online sales bans

Similarly in line with the EU's position, restrictions which prevent the effective use of the internet as a sales channel will be deemed hardcore. The Guidance provides concrete examples of such restrictions, including the requirement for a distributor not to use a supplier trademark or brand name on its website. Likewise, a restriction on the use of online advertising channels or a ban on using a supplier's trademarks for bidding to be referenced in search engines such as Google Adwords, will be treated as hardcore. The CMA recognises that access to search engines, such as Google, is crucial to the use of the internet as an effective sales channel and the Guidance therefore reflects that commercial reality.

The general prohibition is, however, softened by the fact the CMA clarifies that suppliers can give instructions to their distributors on how their products should be sold, such as through the use of quality requirements/criteria, irrespective of the distribution model applied, so long as such requirements do not have as their object the prevention of the use of the internet as an effective sales channel. Importantly, the Guidance also confirms that a direct or indirect ban on sales through online marketplaces (described as 'online intermediation services') are block exempted. This builds on and extends the Coty jurisprudence.

- Dual pricing

Requiring a distributor to pay a different price for products intended to be resold online to the price payable for products to be resold offline (dual pricing) was previously a hardcore restriction. However, the commercial landscape has drastically changed in the last 10 years and has been further exacerbated by the COVID-19 pandemic. It is now the case that maintaining a physical store requires more investment than setting up an online-only presence.

Given this shift, the CMA looks set to fundamentally change its focus and the Guidance provides that dual pricing can be block exempted. The wholesale price difference should take into account the different investments and costs incurred. The CMA also makes clear that the price difference should not prevent the use of the internet as an effective sales channel. This would be the case if the price difference makes the effective use of the internet for the purposes of selling online unprofitable or financially unsustainable.

- More guidance on the active and passive sales distinction

The concepts of active and passive sales have long been a source of confusion. In the age of online sales and targeted advertising on social media platforms the distinction has been increasingly blurred. It was clear from the CMA's consultation preceding the launch of the VABEO, that one of the CMA's aim was to clarify the distinction. Art 8(5) of the VABEO along with the Guidance does exactly this.

Not all forms of advertising will constitute active sales. General advertising or promotion that reaches customers in other distributors' geographical areas or customer group, but which is a reasonable way to reach customers outside those geographical areas or customer groups (for instance in one's own geographical area), will qualify as passive selling.

  • Active Sales: actively targeting customers by direct means of communication including calls, e-mails, letters or visits. It also includes targeted advertising and promotion, offering language options on a website different to the ones commonly used in the geographical area, and using a domain name corresponding to a geographical area other than the one in which the distributor is established.
  • Passive Sales:  Sales in response to unsolicited requests from individual customers, including delivery of products to such customers. It also includes setting up a website and participating in a public procurement exercise.
  • Restrictions of cross-supplies within a selective distribution system – Art 8.2(c)

Within a selective distribution network, a supplier cannot prohibit active or passive sales between its authorised distributors. Doing so will continue to amount to a hardcore restriction. Selective distributors should be free to purchase the contract products from other authorised distributors within the network, operating either at the same or at a different level of trade. Consequently, selective distribution should not be combined with vertical restraints aimed at forcing distributors to purchase the contract products exclusively from a given source. Within a selective distribution network, no restrictions can be imposed on authorised wholesalers as regards their sales to authorised distributors.

  • Restriction of the sales of spare parts – Art 8(2)(e)

Restricting end users, independent repairers, wholesalers and service providers from obtaining spare parts directly from the manufacturers of such spare parts, will continue to be a hardcore restriction.

  • Wide Retail Parity Obligations – Art 8(2)(f)

Parity obligations are provisions that require one party to an agreement to offer the other party goods or services on terms (price, inventory, availability etc) that are no worse than those offered to its own customers or to third parties. A wide retail parity obligation restricts by reference to any of the supplier's indirect sales channels (for example online platforms), which ensures that the prices or other terms and conditions at which a supplier's products are offered to end users on a sales channel are no worse than those offered by the supplier on another sales channel. In contrast, narrow retail parity obligations restrict only by reference to the supplier's own direct sales channels.

In contrast to the EU's position, the VABEO introduces the inclusion of a wide retail parity obligation as a new hardcore restriction. This is, however, not a surprise and codifies existing UK case law. It is nonetheless noteworthy as it represents a significant divergence from EU law and one where the UK position is stricter. The Guidance, in parallel, clarifies that the block exemption applies to all other types of parity obligation in vertical agreements as long as the parties' market shares do not exceed 30%.

2. Excluded Restrictions – Art 10 VABEO

Unlike the inclusion of hardcore restrictions, the inclusion of an excluded restriction will not bring the entire agreement outside of the safe harbour. Instead, only the excluded restriction itself will be subject to a self-assessment under Section 9(1) CA98. There are now 3 such restrictions within the UK regime:

  • Non-compete obligations

The VABEO has retained the existing position that non-compete obligations with a duration longer than five years or which are indefinite will not benefit from the safe harbour. The five-year period, whilst seemingly arbitrary, is a helpful reference point at which parties to a distribution arrangement should assess whether their contractual terms still meet the requirements which allow them to benefit from the safe harbour.

  • Post term non-compete obligations

Similarly, non-compete which extend beyond the term of the agreement do not benefit from the safe harbour unless the restriction is deemed indispensable to protect know-how transferred (e.g., in the context of a franchise). Even in this instance it should be limited: i) to the point of sale (e.g the physical store) from which the buyer has operated, and ii) to a maximum period of 1 year post term.

  • Sales of competing goods in a selective distribution system

This excluded restriction concerns the sale of competing goods in a selective distribution system. It aims to prevent the foreclosure of competing suppliers. If a selective supplier restricts its appointed dealers from buying products for resale from specific competing suppliers, such a restriction will not automatically benefit from the safe harbour. Instead it will be subject to an individual assessment.

3. Agency

The Chapter I prohibition does not apply to undertakings which form part of a 'single economic unit'. In competition law terms, the relationship between an agent and its principal is characterised as one in which the agent no longer acts as an independent economic operator. The fundamentals of the agency analysis have not changed in the VABEO, however the Guidance provides an updated and helpful structure to assist with this sometimes highly complex analysis along with more practical examples.

There are still 3 types of financial or commercial risk material to the assessment:

i. Contract specific risks

ii. Risks related to market specific investments, and

iii. Risks related to other activities undertaken on the same product market by the agent

An agreement will be categorised as an agency agreement if the agent bears no, or only insignificant, risks of the three types set out above.

In line with the EU position, undertakings providing online intermediation services will be treated as 'suppliers' under the VABEO. This means that they cannot qualify as agents for the purpose of the Chapter I prohibition. This is a logical position as online intermediation service providers typically make considerable market specific investments, such as into software and infrastructure. They also usually work with a number of sellers in parallel which prevents them from effectively forming part of the seller's economic unit.

The Guidance also addresses the concept of dual role agency, whereby an independent distributor of a supplier is also considered to act as an agent for other products of that same supplier. The CMA hints at its own scepticism around dual role agency as the Guidance admits that the assessment of whether an agency relationship meets the relevant conditions can be complex and that it is more likely that a dual agent would take on financial or commercial risk than a stand-alone agent.

4. Obligation to provide information to the CMA – Art 12 VABEO

Interestingly, the CMA is sharpening its enforcement tools in the context of vertical agreements. The VABEO now explicitly requires any party to a vertical agreement to provide to the CMA any information that it requests concerning that agreement. If the requested information is not provided within 10 working days, the CMA reserves the right to cancel the block exemption. This is an extraordinary development. For instance, it could strengthen the CMA's hand when it comes to investigating complaints by third parties. Even where the parties consider that they fall within the block exemption, they could nonetheless be forced to undertake an individual assessment of the entire agreement.

5. Duration of the VABEO

The VABEO will be in force until 1 June 2028. This gives it a five-year life span from the end of the one-year transitional period. The shortened scope of the VABEO is a welcome improvement as this gives the CMA an opportunity to adapt the rules where appropriate if the commercial landscape undergoes further changes in the coming years.

Conclusion

The Guidance is subject to consultation until 5th May 2022. Given the late publication of the document, it is highly unlikely that the final text will contain any significant amendments. Stakeholders should expect the new regime as proposed in the draft document to enter into force on 31st May 2022.

A one-year implementation period will give distributors a window of opportunity to bring their distribution agreement in line with the new rules. Given the changes are not dramatic this should not pose too much of a challenge to businesses. Rather the new regime offers new opportunities and flexibility for distributors of all kinds. The CMA has made a good attempt at addressing the evolution of online sales, giving greater flexibility for brand owners to support physical stores, which is reflected in the end of the absolute protection of online sales.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.