Where New UK And EU Vertical Agreements Rules Diverge

Law360
July 29, 2022 Publications

Both the U.K. and the EU have now passed new safe harbor legislation exempting certain restrictive vertical agreements from the ambit of U.K. and EU competition rules.

The new rules came into force on June 1, and will have an important effect on how lawyers and companies negotiate and draft certain common types of commercial agreements for use in the U.K. and EU, such as distribution, supply, franchising and agency agreements.

In this article we look at the changes in legislation, and highlight the areas of major difference between the U.K. and EU, and the ramifications for those companies operating on a pan-European basis.

The New Legislation

U.K. Rules

On June 1, the U.K. implemented the Competition Act 1998 (Vertical Agreements Block Exemption) Order 2022, or VABEO, which replaced the retained EU Vertical Agreements Block Exemption, Commission Regulation 2010/330.

On July 12, the Competition and Markets Authority, the U.K.'s principal competition regulator, published the final version of its interpretative guidance, which are issued as an aid to interpretation of the VABEO. The U.K. guidelines replace the 2010 EU Guidelines on Vertical Restraints and the 2004 Office of Fair Trading guidance on Vertical Agreements in the U.K.

The VABEO and the U.K. guidelines set out the U.K.'s safe harbor rules for a range of common vertical agreements, including distribution and supply agreements until 2028. While the new rules came into force on June 1, parties with existing agreements have a grace period of one year to meet the requirements of the new rules.

Agreements that fit within the terms of the VABEO are block-exempted from the prohibition on anti-competitive agreements set out in Chapter I of the Competition Act 1998, and any restrictions of competition are valid and fully enforceable. Therefore, legal advisers and companies should ensure they fit their distribution agreements and other vertical arrangements within the VABEO's terms to take advantage of the legal certainty they bring.

EU Rules

The EU replaced the old block exemption with new vertical agreements block exemption legislation, Commission Regulation 2022/720, or VABE, on June 1. The VABE will continue in force until 2034.

The VABE was accompanied by a set of interpretative guidelines issued by the EU Commission called the Vertical Agreements Guidelines. However, as with the VABEO, parties with existing agreements have a grace period of one year to meet the requirements of the new rules.

Scope and Interpretation

There are now two sets of vertical agreements rules that legal advisers and companies need to consider when drafting distribution and other vertical agreements in Europe.

The U.K. and EU rules are very similar, but there are some crucial differences both in the letter and the interpretation of the legislation, and therefore caution is advised.

The VABEO applies when the agreement is likely to have only an appreciable effect on trade and competition within the U.K., and the VABE applies where the effect is solely within the EU. In cases where an agreement has an effect in both the U.K. and the EU, it is best to ensure compliance with the most stringent requirements to ensure the terms are fully enforceable.

Main Changes in the New EU VABE

Most of the provisions in the VABE stay the same as those set out in the old block exemption, but there are some important changes. The legislation is updated to take account of market developments and in particular the fact that e-commerce is now a well-established method of distribution.

The main changes are as follows:

Restrictions on Online Sales Permitted

At the time of the old block exemption, e-commerce was in its infancy and many of the provisions in the previous legislation were there to ensure equal treatment between brick-and-mortar distributors and e-commerce retailers. However, e-commerce has now become entrenched as a well-established method of distribution at the expense of bricks-and-mortar distributors, which now find themselves struggling to compete.

These offline dealers have overheads and investments sunk in premises, staff and maintaining a physical distribution channel. The VABE recognizes for the first time that it is now appropriate for suppliers to treat online and offline sales differently.

Dual pricing: Suppliers will be able to charge different wholesale prices for online and offline sales made by the same distributor, provided the differences reflect the level of investments made by each channel.

Online sales: Restrictions on using certain online sales channels, such as online marketplaces, are now permitted as will be setting certain quality standards a distributor has to abide by for selling online.

However, restrictions on advertising via price comparison websites will not be allowed, nor will, restrictions on bidding to use a supplier's trademarks or brand names on search engines.

Online platforms: Online platforms will be treated as independent suppliers of online intermediation services and not agents. Therefore, they cannot limit territories or customer groups, or determine resale prices or conditions.

Limitations on Exemption

Price-parity provisions — wide most-favored-nation clauses: All price-parity MFN obligations will be exempted where the parties' market shares fall below 30%, except for wide MFNs imposed on sellers by online platforms — restrictions on selling on better terms on any other retail platforms.

Inclusion of a wide MFN clause will be regarded as an excluded restriction, and the clause will fall outside the protection of the block exemption and will need to be individually assessed by companies to see whether it would merit an individual exemption

Dual Distribution: Dual distribution is where a manufacturer wholesales products to his distributors but also competes with them in the downstream retail market. Under the VABE, dual distribution scenarios can benefit from the protection of the block exemption, but there are limitations.

The exemption of dual distribution will not apply to the exchange of information between the supplier and the buyer that is either not directly related to the implementation of the vertical agreement or is not necessary to improve the production or distribution of the contract goods or services.

In addition, an agreement between an online marketplace and a third-party supplier will not be exempted where the parties compete for sales via the online marketplace.

Greater Flexibility

The commission has responded to comments from stakeholders for more flexibility in the block exemption's design of manufacturers' distribution networks to better align with market needs.

Shared exclusivity: The VABE introduces the concept of shared exclusivity, whereby a supplier will be able to appoint up to five distributors within a particular territory or customer group to share an exclusive appointment and still prevent each of those suppliers from actively selling outside their territory.

There is also greater freedom to mix selective and exclusive distribution systems as well as enhanced protection to prevent active or passive sales by an exclusive distributor or his customers into a territory where the supplier operates a selective distribution system.

Free distribution: A new category of free distribution — neither exclusive nor selective — will be exempted and can include certain restrictions on active sales by the distributor.

Sales by buyer's customers: In exclusive distribution systems, suppliers will be able to oblige buyers to impose active sales restrictions on their own customers to protect investment incentives.

Noncompete restrictions: The limit of five years for noncompete clauses of fixed or indefinite duration is retained in the VABE. The position under the old block exemption was that to be exempted a noncompete clause had to come to an end after five years and the parties would then have to reenter the noncompete clause for it to remain enforceable.

However, under the VABE, there is now flexibility. The EU guidelines, at paragraph 248, state that noncompete obligations that are tacitly renewable beyond a period of five years can benefit from the block exemption, provided that the buyer can effectively renegotiate or terminate the vertical agreement containing the obligation with a reasonable period of notice and at a reasonable cost.

How Does the VABEO Differ From VABE?

The VABEO largely keeps the provisions of the old block exemption. However, it does introduce some important amendments to improve and update the current legal framework. Most of these are similar to those set out above in the VABE, but there are several changes that do differ from the VABE and create divergence in legislation on vertical agreements for the first time since Brexit.

Dual Distribution

Under the VABEO, dual distribution will continue to be exempted. The scope of the VABEO is also extended to include dual distribution by wholesalers and importers.

In contrast to the VABE, there is no limit to the exemption applying in relation to exchange of information provisions.

Wide Retail MFN Clauses

The VABEO takes a much tougher stance on MFN clauses than the EU. Wide retail MFN clauses become hardcore restrictions under the VABEO. However, this does not include all wide MFN clauses. Clauses in business-to-business agreements are not caught.

Hardcore wide MFN clauses are only those which relate to retail. The U.K. guidelines at paragraph 8.74 explain that "retail parity obligation" means restrictions that apply in the retail context and involve an undertaking offering, selling or reselling goods or services to end users.

The inclusion of a hardcore restriction as in Article 8(2)(f) in an agreement will have the effect of canceling the block exemption provided by the VABEO. To prevent circumvention of this obligation, the hardcore restriction will also apply to measures that have the same effect as a wide MFNs contained in a contractual provision.

Noncompete Obligations

There is no new flexibility in respect of noncompete obligations as in the VABE. Noncompete obligations that are tacitly renewable and could extend beyond five years need to terminate on their fifth anniversary to remain fully valid and enforceable and within the block exemption. The parties then have the option of renegotiating the clause if they wish to do so.

Territorial and Customer Restrictions

Restrictions on territories into which a buyer can sell continue to be a hardcore restriction, and the current exception allowing the restriction of active but not passive sales is also continued.

However, a ban on passive sales is allowed to territories where a supplier operates a selective distribution network.

Impact of the Reforms

The lack of alignment between the EU and U.K. rules on vertical agreements is likely to present challenges to multinational businesses, which will be required to comply with rules that are not always consistent.

The divergence is not major, but it is enough to present an issue. That divergence may increase over time when bearing in mind that the current U.K. rules will expire in 2028 and the EU rules not until 2034. So, we are likely to see a second set of U.K. rules before the EU rules change again.

Legal advisers and companies that try to ensure they fit their distribution agreements and other vertical arrangements within the terms of the appropriate block exemption legislation take advantage of the legal certainty it brings.

However, they now run the risk that agreements drafted to cover the EU and the U.K. may lose the protection of the VABEO where those agreements have a U.K. effect. This could render certain obligations or indeed the whole agreement void and unenforceable.

Therefore, it is prudent to draft any vertical agreement with the most stringent obligations under both the VABE and the VABEO in mind.

It is highly advisable for companies with EU or U.K. distribution operations to review their agreements in light of the new obligations under the VABE and VABEO.

This is beneficial not only to ensure their validity and enforceability, but also to take advantage of the new flexibility which both sets of rules now afford.

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