New Distribution Rules in the EU:
Boiling Down the New Block Exemption
By: RICHARD E. WEINER
On December 22, 1999, the European Commission published Regulation 2790/1999 (the Regulation), which establishes a block exemption for vertical distribution agreements. The new block exemption applies to relationships and agreements between manufacturers and distributors and agents in the European Union. The Regulation, effective on June 1, 2000, replaces previous block exemption regulations applicable to exclusive distribution (regulation 1983/83), exclusive purchasing (regulation 1984/83) and franchise agreements (regulation 4087/88). However, agreements that comply with previous block exemption regulations but fail to comply with the new Regulation are exempt until December 31, 2001, at which point the new Regulation alone will apply.
Intended to liberalize the European Commission's competition policy, the new Regulation places fewer limitations on the types of restrictions that can be placed upon distributors and agents by manufacturing companies than previous regulations. It aims to simplify the rules applicable to vertical agreements and reduce the regulatory burden on manufacturing companies with little or no market power. At the same time, it ensures a more effective control of the relatively few manufacturing companies with significant market power.
The new Regulation is broad in scope and exempts the following from prior notification or examination by government agencies. Agreements that do not contain exclusive restrictions -- such as exclusive purchasing obligations or exclusive sales territory clauses -- are exempt. Also exempt are agreements involving manufacturing companies and exclusive distributors or agents, in which each party has less than 30 percent market share in the relevant geographic area of distribution. Market share is calculated based on market data for the preceding calendar year.
Regardless of the market share held by the parties to the agreement, however, it is not exempt if it contains "hardcore" restrictions. These provisions are called "hardcore" because of their overbearing limitations on the business operations of the distributor or agent. They include the distributor's ability to determine the resale price of the manufacturer's products and the customers to whom or the geographic territory in which the distributor may resell the manufacturer's products. The "hardcore" provisions also restrict a distributor's ability to sell to end-user customers and to any other distributor within the same selective distribution system. In addition, they restrict the manufacturing company's ability to sell its components as spare parts to end-user customers or to companies that repair its products if the distributor usually incorporates the components into the manufacturer's products before selling them to its customers.
Similar to the case of "hardcore" restrictions, no agreement -- regardless of the market share held by the parties to the agreement -- shall be exempt if it contains certain "non-compete" provisions. Those include provisions that restrict the distributor's or agent's ability to sell products competitive with the manufacturer's products or compete against the manufacturing company. Under most circumstances, the new Regulation does not apply to vertical agreements between companies competing for the same customers in the same marketplace. However, it does apply if the agreement is not reciprocal. The Regulation also applies if a competing company acting as a distributor has total annual turnover of 100 million Euros or less, or if the manufacturer is both a manufacturer and a distributor of the products covered by the relevant agreement.
Although generally viewed as beneficial to industry and hailed as a major policy reform of the European Commission, the new Regulation is not without flaws, and it leaves certain issues unresolved. One particularly troubling issue is the calculation of a company's market share for purposes of determining if the new block exemption applies. Under the new Regulation, companies are left to assess for themselves whether they fall above or below the 30 percent market share threshold, allowing opportunity and incentive to manipulate the parameters and the definitions of the relevant industry or relevant market to fit within the new block exemption.
As previously noted, the so-called "hardcore" provisions sometimes allow manufacturers to prohibit a distributor or agent from selling the manufacturer's products to specific groups of customers or in specific geographic territories. However, the provisions do not allow the manufacturer to prohibit the distributor's or agent's customer from doing so. This simply permits the distributor's sub-distributor or the agent's sub-agent to sell to groups of customers or in geographic territories closed to the distributor or agent. This loophole robs the manufacturing company of its ability to secure sales to a particular group of customers or in a particular geographic territory. It also provides the distributor or agent with an incentive, through its sub-distributor or sub-agent, to raid customers in other geographic markets or in other market sectors. According to the original agreement, these customers were to be reserved for the manufacturing company itself or for one of its' other exclusive distributors or agents.
The so-called "hardcore" restriction, which also prohibits a manufacturing company from establishing fixed or minimum resale prices for distributors, is overbroad. Rather than this far-reaching restriction, pricing restrictions should be limited to cases in which fixed or minimum resale would have an anti-competitive effect in the marketplace. This would protect distributors and agents from manufacturing companies with dominant market share that could impose undue price restrictions upon them. At the same time, it would permit manufacturing companies with little or no market share to contract with distributors and agents in the manner they deem best for the distribution and sale of their products. Even the European Court of Justice has long held the view (since its 1969 decision in Volk v. Vervaecke) that cases where little or no market share is involved there is no appreciable anti-competitive effect from the imposition of fixed or minimum resale prices.
Finally, the Regulation's establishment of a market share cap above which the new block exemption does not apply limits manufacturing companies that produce highly innovative products and wish to market them before other companies have the opportunity to introduce competitive products into the marketplace. In such cases, the manufacturing companies with the highly innovative products may have a very high market share in a specific industry within a specific geographic territory because no competing products exist. Yet, because its market share is more than 30 percent, the manufacturing company is not able to take advantage of the new block exemption and would therefore be prohibited from efficiently distributing and selling its innovative product in the marketplace.
The European Commission is scheduled to publish implementation guidelines later this year. Hopefully, these guidelines will shed light upon these and other issues, and will make the Regulation a working document for manufacturing companies, distributors and agents. Only then will the Regulation truly represent major economic reform for companies that distribute their products in the European Union.