EU Commission Publishes New Regulations and Guidelines on the Application of EU Competition Law to Certain Categories of Commercial Contracts

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1 September 22, 2010 EU Commission Publishes New Regulations and Guidelines on the Application of EU Competition Law to Certain Categories of Commercial Contracts Barry D. Glazer Partner Co-head of London Office +44 (0) On 1 June 2010, Regulation 330/2010 of the European Commission introduced a new vertical agreements block exemption replacing the former block exemption under Regulation 2790/1999. The new block exemption Regulation is accompanied by a new set of guidelines on the application of EU competition law principles under Article 101 of the EU Treaty to vertical agreements. The new Regulation applies to all agreements entered into after 31 May The protection of the old block exemption will continue to apply, however, for a transitional period from 1 June 2010 to 31 May 2011 in relation to vertical agreements already in force on 31 May After this one year grace period, all agreements will be subject to the new rules. Vertical agreements generally include any agreement between parties at different levels of the supply chain. For example, distribution agreements between a manufacturer and a distributor are vertical agreements as are franchise arrangements. Ron Moscona Associate +44 (0) The EU Commission has also published for public consultation two new draft regulations to replace the existing block exemptions on research and development agreements and on specialisation in manufacturing agreements (both of which will expire on 31 December 2010). The Commission has also published new draft guidelines on the application of Article 101 to horizontal co-operation agreements (covering the categories of R&D and manufacturing collaboration agreements as well as other types of horizontal agreements). Background on Block Exemptions Article 101(1) of the Treaty on the Functioning of the European Union (formerly Article 81(1) of the EC Treaty) prohibits agreements and arrangements having as their object or effect the restriction of competition in the EU. Article 101(2) provides that such restrictive agreements are void. The Commission and national regulators in the EU have powers to impose heavy fines on parties to agreements that infringe Article 101. The prohibition under Article 101(1) is broadly stated and can apply in relation to any restrictive agreement or arrangement that potentially has an appreciable effect on trade between Member States in the EU. However, the broad prohibition under Article 101(1) is qualified under Article 101(3) which, together with implementing legislation, authorises the EU Commission to exempt certain agreements on the basis that the restrictive provisions they contain are outweighed by the economic benefits they create, including the benefits for the ultimate consumers. Since 2003, the Commission no longer exercises its former powers to grant individual exemptions, but it continues to issue so-called block exemptions which lay down criteria under which specific categories of agreements can be considered exempt from the application of Article 101(1). Accordingly, subject to the conditions set out

2 in the regulations issued by the Commission, the block exemptions provide a safe harbour for a number of commercial contracts against the risk of falling foul of the prohibition under Article 101. National competition laws across the EU apply the same rules at the national level (including, typically, the protection of the block exemptions issued by the Commission). Agreements that do not meet the criteria of the block exemptions must be independently assessed by the parties against the general principles laid down in Articles 101(1) and 101(3). The guidelines issued by the Commission can provide much needed assistance in this difficult and imprecise assessment and they assist in the interpretation of the block exemption regulations themselves. The conditions for the exemption and the market share thresholds for vertical agreements In most respects, the new block exemption Regulation on vertical agreements and the respective guidelines are similar to the previous Regulation and guidelines. The changes can be characterised as updating and fine tuning rather than an overhaul of the criteria. Still some important changes are notable. As in the old block exemption Regulation, the new regime on vertical agreements is based on the following fundamental rules: All vertical agreements are exempt from the general prohibition against anticompetitive agreements in Article 101(1), provided that: the parties are not actual or potential competitors (except in cases where the seller is a manufacturer/distributor of goods and the buyer is a pure distributor of goods; and equivalent cases in regard to the provision of services) the parties do not exceed the defined market share thresholds; and the agreement does not contain any of the black listed hardcore restrictions. The exemption does not extend to a gray list of certain contractual restrictions (known as excluded restrictions ) which may still be held to infringe Article 101 (1), but - crucially - without tainting the entire agreement as unlawful. The headline changes introduced by the new vertical agreement block exemption Regulation concern the market share thresholds as set out below: Seller s market share threshold Buyer s market share threshold Agreement between competitors are exempt if - Previous New Regulation Regulation 30% 30% 30% but only for exclusive supply agreements Seller is a manufacturer and distributor of goods and buyer is only a distributor; or Buyer s annual turnover is up to Euro 100m 30% Seller is a manufacturer and distributor of goods and buyer is only a distributor

3 These changes demonstrate that there is more focus now on the distributor side then previously. Distributors are becoming very powerful in the marketplace and so, at least in the Commission s view, there is an increased risk that they might use their market power to impose restrictive anti-competitive terms on suppliers. Accordingly, the exemption does not apply if the buyer s market share exceeds 30% (whereas previously that threshold applied only if the agreement contained exclusive supply obligations). The Vice President of the European Commission explained in a speech of 20 April 2010 that the 30% market share threshold now applies to distributors as well as to suppliers in order to prevent big distributors from using their buying power to impose anti-competitive contractual clauses on suppliers, to the detriment of competition and consumers. This change is, therefore, fully justified, and is beneficial for SMEs, whether manufacturers or retailers, which could otherwise be excluded from the distribution market. If the parties exceed the market share requirement, the agreement has to be independently assessed by the parties. In these situations the risk of violating Article 101 is significant, precisely because of the high market share. Parties in that position must satisfy themselves that the restrictive provisions in their agreement can be justified by the overriding benefits to consumers to be achieved by the restrictions by applying the analysis set forth in the Commissions Guidelines on Vertical Restraints. Hardcore and gray restrictions The new block exemption Regulation on vertical agreements introduces few changes to the black list of hardcore restrictions or to the gray listed excluded restrictions. The hardcore restrictions (which the Commission considers as almost always infringing Article 101) remain, essentially, the following: price fixing; restrictions on the buyer s right to sell contract goods into territories or to customer groups outside his own (except for restrictions on active sales to territories or customer groups reserved to the supplier or to its other exclusive distributors); restrictions on sales to end-users by members of a selective distribution system; restrictions on cross supplies between members of a selective distribution system; restriction imposed on the supplier of components from selling the components as spare parts to end-users or to independent repairers. The excluded restrictions (which are neither hardcore nor exempt) also remain effectively unchanged. These are, in summary: non-compete obligations during the agreement exceeding a 5 year period; post-termination restriction on the buyer in relation to the manufacture, purchase or sale of goods or services (except, in very limited circumstances such as franchising, a 1 year restriction); restrictions on members of a selective distribution system from selling specific competing brands. The Commission s Guidelines on Vertical Restraints expand on the distinction between passive and active sales, which is a key distinction in connection with the hardcore restrictions on cross-border sales or on sales to excluded customer groups. In general, active sales are targeted promotions such as actively approaching

4 individual customers by for instance direct , including the sending of unsolicited s, or visits; or actively approaching customer group or customers in a specific territory though advertisement in media, on the internet or other promotions specifically targeted at that customer group or targeted customer in that territory. Distributors can be lawfully restricted by contract from making active sales. By contrast, a passive sale is where the distributor responds to unsolicited requests from customers including delivery of goods or services to such customers. As mentioned above, the block exemption Regulation treats restrictions on distributors relating to passive sales as hardcore restrictions which are likely to be unlawful and which take the contract outside the protection of the block exemption. General advertising which is not targeted directly at excluded territories or customers is treated as an essential element of passive sales. A contractual restriction on the distributor s right to advertise, therefore, may amount to a hardcore restriction. A focus on the use of the internet by distributors The new Guidelines on Vertical Restraints provide greater details on restrictions or obligations on the use of the internet by distributors to promote and sell goods. The guidelines emphasise that in principle, every distributor must be allowed to use the internet to sell products. In general having a website is considered a form of passive selling, since it is a reasonable way to allow customers to reach the distributor. The guidelines draw a distinction, though, between, on the one hand, general internet advertising and the use of a general website for online sales and, on the other hand, using the internet to target customers in an excluded territory directly or to target excluded customer groups. The guidelines explain that the targeted approach falls into the category of active sales and accordingly the agreement can restrict the distributor from such activities. In addition to prohibiting restrictions in a distribution agreement on the distributor s right to use the internet as a channel for sales of goods and as an advertising media, the Guidelines on Vertical Restraints explain that various ancillary obligations designed to curb cross-border sales or sales to excluded customer groups through the internet are also regarded as hardcore restrictions. This includes the obligation on the distributor to block access to its website to customers from excluded territories, or the requirement to divert such customers to the supplier s or its relevant distributor s website in the excluded territory, or the requirement to refuse to make online sales to customers whose contact or credit card details indicate they are based in excluded territories. New draft regulations on R&D and specialisation in manufacturing agreements R&D and specialisation in manufacturing agreements are two categories of so-called horizontal co-operation agreements (agreements between companies at the same level of activity). The two block exemption Regulations applying to these two categories will expire on 31 December The Commission published new draft Regulations and new draft guidelines on horizontal and co-operation agreements which, once in final form, will eventually replace the existing block exemption Regulations and guidelines. The R&D block exemption The block exemption Regulation on R&D agreements (both in its current form and as proposed under the amended draft Regulation) provides a fairly limited safe harbour. For instance, many R&D collaboration agreements do not benefit from the existing R&D block exemption because they do not meet the conditions that all parties must have access to the joint research and development for the purpose of further research and exploitation and that (unless an element of joint exploitation or supply is included in the contract) each party must be free independently to exploit the

5 results of the joint research and development and any pre-existing know-how necessary for the purpose of such exploitation. The new draft Regulation repeats these conditions in similar language and adds a new requirement, according to which, in order to have the benefit of the block exemption the R&D agreement must provide that prior to starting the research and development all the parties will disclose all their existing and pending intellectual property rights in as far as they are relevant for the exploitation of the results by the other parties. Such broad disclosures are by no means standard practice in R&D collaborations which means that (assuming the final version includes this condition) many such collaborations will not have the benefit of the block exemption. The new draft Regulation on R&D agreements, as does the current one, includes a list of hardcore restrictions covering issues such as price fixing, allocation of territories and customers, output and sale limitations, restrictions on a party's right to carry out R&D activities, alone or in collaboration with third parties, in an unrelated field (or, after the collaboration is completed, in the same field), and the requirement to enforce IP rights, or to take other measures, in order to prevent third parties from commercialising contract products obtained from a different source. Non-challenge clauses and restrictions on the right to grant licences, which were formerly treated as hardcore restrictions, are converted under the new draft to excluded restrictions. In terms of the parties market share, the new draft Regulation repeats the rules as in the existing block exemption: no ceiling is imposed on the application of the block exemption if the agreement is between non-competitors whilst a ceiling of a combined market share of 25% applies if the agreement is between competitors. There are detailed definitions as to the term competitors and as to the application of the market share threshold. The underlying principle, as explained in the guidelines on horizontal co-operation agreements, is that joint R&D projects should not be encouraged where the joint agreement is likely to prevent competing R&D projects which may result in competing products and technologies being introduced into the market. Where the parties have a significant combined market share, the Commission assumes that but for the R&D collaboration each of the parties would invest in developing its own product. This would generally be to the advantage of consumers and to the development of technology. The Commission also asserts that R&D collaborations could slow down innovation, hinder competition between the parties outside the scope of the collaboration and have a foreclosure effect. Therefore, the exemption for R&D collaborations is limited to a relatively modest combined market share where the parties are competitors. The new (draft) guidelines on horizontal co-operation agreements include a number of expanded sections that provide more details and clarity than the existing guidelines. One example is the chapter on standardisation agreements (where parties define technical standards and quality requirements to be met by future products or services) which now also covers the issue of industry wide standard terms and conditions where several competitors agree to use the same standard terms with their respective customers (for example standard Ts&Cs in the banking and insurance sectors). The guidelines recognise that such standardisation of terms can offer efficiency gains in terms of increased comparability of the offers on the market and lower transaction costs. But the guidelines state that it is impossible to provide a safe harbour for such standardisation practices and that each case will have to be assessed on its own merits, taking into account, among other things, the market shares of the participating parties and the extent to which the standard terms are used.

6 Specialisation in manufacturing block exemption The specialisation block exemption also applies in fairly specific circumstances and the new draft Regulation does not introduce material changes to the existing block exemption. It applies to agreements where (either unilaterally or on a reciprocal basis) one party agrees to refrain from or to cease manufacture of a product and to purchase that product from the other party and where the other party is obliged to supply the product to the first party. It also applies to joint manufacturing agreements. The exemption applies subject to a combined market share ceiling of 20% between the parties. The exemption applies on condition that the agreement does not include certain hardcore restrictions (including price fixing, limitations on output and any allocation of markets or customers). Self assessment An agreement could breach Article 101(1) if its object or effect is to restrict competition in the EU. If there are no block exemptions that apply the agreement may be still be lawful but it is left for the parties to self-assess its legality on basic EU competition law principles. The Commission guidelines (including the Guidelines on Vertical Restraints and the guidelines on horizontal co-operation agreements) can assist parties in self assessing their agreements. The Commission guidelines generally distinguish between two basic categories of agreements. Agreements which have as their object the restriction of competition are essentially cartels disguised as collaboration agreements of various types. The Commission treats horizontal agreements that include some of the main hardcore restrictions as falling into this category. These would always be in breach of Article 101. Many other agreements might fall into the second category of agreements that have an anti-competitive effect. In these latter cases self assessment is key. The assessment is not a simple task but two basic rules of thumb can be helpful. First, if the agreement falls outside a block exemption purely because the parties exceed the market share thresholds, the risk that the agreement might be in breach of Article if it contains restrictive covenants or otherwise has an anticompetitive effect - will increase the greater the market position of the parties. Secondly, if the agreement does not have the benefit of the block exemption because it contains hardcore or excluded restrictions, there is a significant risk that it is in fact in breach of Article 101, even if the parties market share is modest. In such cases, the necessity of such restrictions should be carefully weighed and insofar as they are considered essential, the parties should carefully assess whether or not the restrictive provisions would nevertheless be considered as benefiting from individual exemptions under Article 101(3) of the Treaty. Disclaimer 2010 Dorsey & Whitney LLP. This article is intended for general information purposes only and should not be construed as legal advice or legal opinions on any specific facts or circumstances. An attorneyclient relationship is not created or continued by reading this article. Members of the Dorsey & Whitney LLP group issuing this communication will be pleased to provide further information regarding the matters discussed therein.