Competition law issues can arise at various levels of the production, supply and distribution chain. But the point at which they arise may affect the likelihood or severity of any anti-competitive provisions. Here, we discuss how competition law deals with both vertical agreements and, to a lesser extent, horizontal agreements.
Jump to:
- Competition Act: Chapter I and Article 101 prohibitions
- What are vertical agreements?
- What are horizontal agreements?
- What is the difference between vertical agreements and horizontal agreements?
- Common types of vertical agreement
- How are vertical agreements assessed?
- Vertical agreement block exemption
- Other EU block exemptions
- What are hardcore restrictions?
- What is the market share threshold?
- Vertical restrictions
- Intellectual property provisions
- EU Guidelines on vertical restraints
- What happens if the vertical agreement block exemption does not apply?
- How does the Chapter II or Article 102 prohibitions (abuse of a dominant position) affect vertical agreements?
- How does the Chapter I or Article 101 prohibitions affect horizontal agreements?
- Considerations in the case of horizontal agreements
Competition Act: Chapter I and Article 101 prohibitions
Under Chapter I of the Competition Act 1998, English law prohibits anti-competitive arrangements within the UK. This closely aligns with the position under EU law which prohibits anti-competitive arrangements within the EU pursuant to Article 101 of the Treaty on the Functioning of the European Union (TFEU).
EU competition law incorporates various block exemptions which excludes certain arrangements from the Article 101 prohibition. These block exemptions also apply in respect of agreements that may fall within the Chapter I prohibition.
The competition law regime, its exemptions and detailed provisions are complex and commercial legal advice should be sought if there is any risk of competition issues arising, whether at a domestic or European level. Carefully considering the commercial relationship between the relevant parties and specific drafting can significantly reduce the chances of an arrangement being deemed to be in breach of the competition regulations.
What are vertical agreements?
Vertical agreements are agreements made between two or more parties which are operating at different levels of the production, supply and distribution chain for the purposes of that agreement. For example, between a manufacturer and a supplier or between a supplier and a retailer.
The parties only need to be operating at different levels of the chain for the purposes of the specific agreement, that is, the parties could ordinarily be competitors. But provided that they are acting at different levels in respect of the arrangement in question (for example, a manufacturer agreeing to supply the goods made by another manufacturer), it will be deemed a vertical agreement.
For the purposes of vertical agreements, the main applicable EU block exemption is the vertical agreement block exemption, which exempts many vertical arrangements from the Chapter I and the Article 101 prohibitions (see Vertical agreement block exemption).
What are horizontal agreements?
Horizontal agreements are agreements made between two or more parties which are operating at the same level of the production, supply and distribution chain, for example, between two suppliers or two retailers. Examples include, joint selling agreements, joint buying agreements, specialisation agreements and R&D agreements made between competing enterprises.
There are several EU block exemptions which may apply to horizontal agreements (see How does the Chapter I or Article 101 prohibitions affect horizontal agreements?).
What is the difference between vertical agreements and horizontal agreements?
Vertical agreements operate on an upstream/downstream level, whereas horizontal agreements operate on the same level.
Vertical agreements are therefore considered by the competition authorities to be less likely to result in anti-competitive practices. Although competition issues may arise if one party to the agreement has significant market power or if there are a number of similar agreements in place which together, could have an effect on the market.
Any horizontal or vertical agreement which does not benefit from a block exemption needs to be considered by the parties themselves to determine whether the agreement is anti-competitive. To assist with this the European Commission has issued guidance (see Vertical restraints guidance) on the main factors to be considered.
Common types of vertical agreement
Common types of vertical agreements include:
- Distribution agreements – where one party appoints another (the distributor) to purchase the goods and market them under its own name.
- Supply agreements – where one party agrees to purchase the goods solely from the other party (the supplier).
- Franchising agreements – where one party (the franchisor) permits the other party (the franchisee) to use the franchise name, branding and know-how in return for an agreed sum. The franchisor often has some control over how the franchisee conducts the business but also provides assistance and support.
- Selective distribution agreements – where a supplier allows a group of specified enterprises to market its goods, with each member of the group having to meet certain criteria and possibly being subject to certain restrictions, for example, where it can market the goods.
How are vertical agreements assessed?
To determine whether a vertical agreement is anti-competitive, various questions need to be considered. The answers to these may determine whether the vertical agreement falls within the UK and EU competition regime and if so, whether the vertical agreement block exemption will apply:
- Does the arrangement fall within the Chapter I or Article 101 prohibitions? If not, then further consideration of the arrangement may not be required.
- Is the arrangement a vertical agreement? If not, the vertical agreement block exemption will not apply.
- If the arrangement is a vertical agreement, does it fall within an EU block exemption, other than the vertical agreement block exemption? If so, the vertical agreement block exemption will not apply. (Other EU block exemptions).
- Does the agreement include hardcore restrictions? If so, the vertical agreement block exemption will not apply. (What are hardcore restrictions?)
- What is each party’s market share? The vertical agreement block exemption will not apply if either of the parties’ market shares are above a certain threshold. (What is the market share threshold?)
- Does the agreement include any specific vertical restrictions? If so, can these be severed from the agreement to allow the rest of the agreement to apply? (Vertical restrictions).
- Does the agreement contain provisions relating to intellectual property? If so, and these provisions are the primary purpose of the agreement, the vertical agreement block exemption may not apply. (Intellectual property provisions).
Vertical agreement block exemption
The EU vertical agreement block exemption releases certain vertical agreements from falling within the Chapter I or Article 101 prohibitions. If the vertical agreement block exemption applies to the arrangement in question, no further consideration of the arrangement from a competition perspective is required. But if the block exemption does not apply, further consideration of the arrangement under Chapter I or Article 101 will need to be undertaken to determine whether the arrangement may give rise to anti-competitive concerns.
To be covered by the vertical agreement block exemption, the arrangement must be a vertical agreement or concerted practice between at least two undertakings, which deals with the conditions for buying, selling or reselling services or goods. The parties must be operating at different levels of the production, supply and distribution chain for the purposes of the specific agreement. The block exemption will not apply if the arrangement is between competing undertakings, unless the competition only arises as a result of activities which are not covered by the agreement.
Broadly speaking, provided that hardcore restrictions are not included in the agreement and the parties to it do not exceed the market share threshold, a vertical agreement is highly likely to benefit from the vertical agreement block exemption.
The UK’s competition authority, the Competition and Markets Authority, has the power to withdraw the benefit of the vertical agreement block exemption in respect of specific agreements. Although the likelihood of it exercising this right is low. The European Commission also has the power to withdraw the benefit of the vertical agreement block exemption in certain situations.
The current vertical agreement block exemption will expire at the end of May 2022 and is under review.
Other EU block exemptions
If the agreement in question may come within another EU block exemption, the vertical agreement block exemption will not apply. Other common block exemptions include the motor vehicles block exemption, the technology transfer block exemption, the R&D block exemption and the specialisation agreement block exemption.
What are hardcore restrictions?
If the agreement includes any of the following hardcore restrictions, the benefit of the vertical agreement block exemption will be lost in respect of the entire agreement:
- Any resale restrictions relating to customers or territory, subject to some limited exceptions.
- The enforcement of a fixed or minimum resale price, although a maximum or recommended resale price are both permitted.
- Any restrictions on the end users to whom participants in a selective distribution system can sell.
- Preventing participants in a selective distribution system from supplying other members of the system.
- Prohibiting the sale of spare parts by a supplier to a customer, unless the customer already uses the buyer for repair and servicing purposes.
On the whole, hardcore restrictions result in the loss of the vertical agreement block exemption, although on occasion certain hardcore restrictions may be acceptable. For example, if the restriction is necessary in order to comply with a prohibition on selling dangerous goods, set up a new market or test a new product.
What is the market share threshold?
For the vertical agreement block exemption to apply, the market share of each party to the agreement must be less than 30% on the relevant market(s) covered by the agreement. If the market share of either party or both of them is above this, the vertical agreement block exemption will not apply and the parties themselves must decide whether the agreement falls foul of the Chapter I or Article 101 prohibitions (whichever is relevant).
If the market share of either party changes during the period of the agreement, different rules, which are outside the scope of this note, apply.
Vertical restrictions
Although not classified as hardcore restrictions, certain other provisions also fall outside of the vertical agreement block exemption. However, unlike hardcore restrictions, these restricted provisions may, where possible, be severed from the agreement. As a result, the block exemption will still apply to the remainder of the agreement. Careful drafting is therefore required to avoid falling within one of the restricted provisions in the first place and to ensure that, as an alternative, severance is possible.
Broadly, the restricted provisions are:
- Direct or indirect non-compete provisions lasting for more than five years or indefinitely.
- Non-compete provisions which apply following termination of the agreement.
- Preventing participants in a selective distribution system from selling goods from a specific competitor supplier.
Certain limited exceptions may apply to the above.
Intellectual property provisions
An intellectual property agreement cannot benefit from the vertical agreement block exemption. Although if the agreement’s primary purpose is not related to intellectual property, then the vertical agreement block exemption can be utilised. Otherwise, a block exemption such as the technology transfer block exemption may apply. Intellectual property provisions in a vertical agreement are a tricky subject in what is already a complex area and professional legal advice should be sought.
EU Guidelines on vertical restraints
The EU Commission has issued guidelines on vertical restraints to help with determining when an agreement should be excluded from the Chapter I or Article 101 prohibitions. Generally, vertical restraints are less likely to be anti-competitive than horizontal restraints.
What happens if the vertical agreement block exemption does not apply?
If the vertical agreement block exemption does not apply to an arrangement, it may still be permitted notwithstanding the Chapter I or Article 101 prohibitions, if the benefits of the arrangement exceed the anti-competitive effects.
How does the Chapter II or Article 102 prohibitions (abuse of a dominant position) affect vertical agreements?
The UK’s Chapter II prohibition and the EU’s Article 102 (of the TFEU) prohibition prevent businesses, which are dominant in the market, from abusing their position, if doing so may affect trade in the UK or the EU, respectively.
Actions which could fall within these prohibitions in respect of vertical agreements include:
- extremely low pricing
- an unjustified refusal to supply
- tying
- insisting on non-compete provisions
- and/or discriminatory pricing
It is vital to remember that the vertical agreement block exemption does not apply to the Chapter II or Article 102 prohibitions. Therefore, any entity which is dominant in the market, should bear in mind the potential for falling foul of these provisions. That said, where a practice is covered by the vertical agreement block exemption, the parties must have satisfied the market share threshold test and so are less likely to be considered ‘dominant’ for the purposes of Chapter II or Article 102.
How does the Chapter I or Article 101 prohibitions affect horizontal agreements?
Horizontal agreements are, because of their very nature, more likely to fall within the Chapter I or Article 101 prohibitions than vertical agreements. They are, essentially, agreements between competitors and as such, considerable care should be taken to ensure that such agreements do not give rise to anti-competitive effects. In some cases, they can be considered a cartel, which can result in criminal sanctions.
Some horizontal agreements may be covered by certain block exemptions, such as the specialisation agreement block exemption, the technology transfer block exemption and the R&D block exemption, provided that the agreement falls within the relevant block exemption’s criteria. In addition, the European Commission has provided guidance in relation to horizontal agreements.
Considerations in the case of horizontal agreements
It is imperative that parties focus on the potential anti-competitive effects of any horizontal agreement and ensure that legal and genuine cooperation arrangements between two or more enterprises do not stray into Chapter I or Article 101 territory.
Factors which should be considered when entering into these type of arrangements are:
- The parties’ market positions
- The parties’ positions absent any agreement between them (i.e. could one party have undertaken the scheme on its own?)
- Whether the arrangement will result in customer cost savings
- The necessity for any restrictions or obligations and so on
Practical actions which may assist in reducing the risk of an arrangement being deemed anti-competitive include:
- Retaining written evidence of discussions and arrangements, such as meeting minutes
- Ensuring that staff members receive training about competition law and the potential risks
- Putting in place guidance and checks to ensure that actions ostensibly made under the cooperation agreement do not go further than agreed and that only the agreed information is passed between the parties
Competition law, both at the domestic and EU level is a complex topic but can lead to severe repercussions. Any arrangement, particularly those with a competitor, should be thoroughly assessed and legal advice obtained as soon as possible to ensure that it does not give rise to any anti-competitive effects.
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