14 Vertical Agreements in US and EU

Dr.Ritu Gupta

15.1 Introduction

Vertical agreements are agreements between undertakings at different levels of the production or distribution chain and relate to the conditions under which the parties may purchase, sell or resell certain goods or services. For most vertical restraints, competition concerns can arise only if there is insufficient competition at one or more levels of trade i.e. if there is some degree of market power at the level of the supplier or the buyer or at both levels. The provisions of the anti-trust legislations both in US and EU prohibit such agreements if such agreements act as a clog on the free play of market forces or restrict or distort competition.

The common law doctrine of restraint of trade and its relationship with Sherman’s Act as well as with EC competition law has been explained by the Courts at both the places respectively. Although, in common law, the courts have focused more on the effects of the restraint between the parties while competition law focuses more on the effects on the market, the public interest remains a touchstone to determine restraint of trade in both the jurisdictions. Usually, similar terminologies have been adopted.

Position in US:

In the US, parallel federal and state anti-trust legislations exist. The US competition law is very easy but hard at the same time. Statutory principles are simple but challenging while applying to complex set of facts. Following legislations are applicable to vertical restraints:

1. Sherman Act, 1890 – Section 1 prohibits agreements that constitute restraints of trade if they are on balance anti-competitive. The agreement can also be challenged under section 2 if the party allegedly indulging in anti-competitive practice has monopoly power and if the agreement helps obtain or maintain such monopoly power.

2. Federal Trade Commission Act, 1914 – Section 5 of the FTC Act prohibits entities from engaging in unfair or deceptive acts or practices in interstate commerce.

3. Clayton Act, 1914 – Under Section 3 of this Act it is unlawful for any person to lease or make asale of goods made so as to substantially lessen competition or tend to create a monopoly in any line of commerce.

4. Robinson-Patman Act, 1936- This US federal law is an amendment to the Clayton antitrust Act that prohibits anti-competitive practices by producers especially price-discrimination.

The Federal Courts like EC apply market power screen in most respects. In tune with EC’s BFR, these Courts donot make an inquiry into the competitive effects of a restraint unless a manufacturer has economic power in a relevant market, either at the manufacturing level or downstream at the distribution or dealer level.

Position in EU:

The European Economic Community (EEC) was established by Treaty of Rome in 1957. It has been known as EC. In EC, vertical agreements fall within Article 81 (1) of the Treaty. Art. 81 prohibits agreements that have, either as their object or as their effect, the prevention, restriction or distortion of the competition in the market. Article 81 of the EC Treaty also identifies certain acts which it deems as restrictive of competition which are as follows:-

a. directly or indirectly fix purchase or selling prices or any other trading conditions;

b. limit or control production, markets, technical development, or investment;

c. share markets or sources of supply;

d. apply dissimilar conditions to equivalent transactions with other trading parties, thereby placing them at a competitive disadvantage;

e. make the conclusion of contracts subject to acceptance by the other parties of supplementary obligations which, by their nature or according to commercial usage, have no connection with the subject of such contracts.

Article 81(2) provides that such agreements are void unless and until exemption is granted by the European Commission under Art. 81(3). Further, Art. 81(3) exempts all 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 benefit. These exemptions may be categorized as below:

a) where the practice is beneficial to consumers, e.g., by facilitating technological advances (efficiencies), but does not restrict all competition in the area.

b) ‘Agreements of minor importance’ (except those fixing sale prices) wherein small companies, together holding no more than15% each in the case of vertical agreements (the de minimis condition) are exempted.

c) block exemptions that include a list of permitted contract terms, and a list of those banned in these exemptions (the hardcore restrictions)

Other than EC Treaty, there are Guidelines on vertical restraints. These Guidelines set out the principles for the assessment of vertical restraints under Article 101 of the Treaty on the functioning of the European Union (TFEU). Art. 101(1) of TFEU prohibits agreements that may affect trade between European Union (EU) countries and which prevent, restrict or distort competition. Agreements which create sufficient benefits to outweigh the anti -competitive effects are exempt from this prohibition under Article 101(3) TFEU. By issuing these Guidelines, the Commission aims to help companies to make their own assessment of vertical agreements under the EU competition rules.

15.2 Evolution of Law in US

In the US, vertical agreements fall within Sec. 1 of the Sherman’s Act which prohibits generally any agreement that is in restraint of trade. In Business Electronics v Sharp Electronics, the Court explained the meaning of the term ‘restraint of trade’ as follows:

“The term ‘restraint of trade’ refers not to a particular list of agreements but to a particular economic consequence, which may be produced by quite different sorts of agreements in varying terms and circumstances. The changing content of the term ‘restraint of trade’ was well recognized at the time the Sherman’s Act was enacted.”

The US Supreme Court earlier applied per se rule to such agreements. It was in 1970’s when GTE Sylvania placed non-price vertical restraints under rule of reason. Khan judgment also did the same to Maximum Retail Price Maintenance agreements in 1997. In 2007, the Leegin casefollowed the suit for Minimum Retail Price Maintenance agreements where US changed its stand on Resale Price Maintenance (RPM) by striking down 96 year old rule that RPM were automatic violations of Sherman’s Act. But despite Leegin holding, Rule of reason treatment for minimum RPM has not been universally embraced.

The California Attorney General has repudiated Leegin and insisted that minimum RPM remains per se illegal under the state’s antitrust statute, the Cartwright Act.Maryland amended its antitrust statute in April 2009 to continue per se illegal treatment for minimum RPM.The New York Attorney General has taken the position that New York’s antitrust statute, the Donnelly Act, makes minimum RPM per se illegal, but courts have so far rejected the argument.

Now, the Courts have frequently refused to apply the per se rule and have declared rule of reason analysis to be applicable. In US v Microsoft Corporation, the Court held that the per se rule was poorly designed to address newly integrated products in the markets for innovative technology. Therefore, the court applied rule of reason.

The position of Tie-in cases have been explained by US Supreme Court in the following words:“…the essential characteristics of an invalid tying arrangement lies in the seller’s exploitation of its control over the tying product to force the buyer into the purchase of a tied product that the buyer either did not want at all, or might have preferred to purchase elsewhere on different terms. When such ‘forcing’ is present, competition on te merits in the market for the tied item is restrained and the Sherman’s Act is violated.”

The SC explained further that a tying arrangement could be considered to be illegal per seonly when it is shown that the seller has sufficient market power in relation to the tying product. In Standard Oil Co.’s case the US SC held that the requirement in the agreement violated Section 3 of the Clayton Act as it restricted access for its retailers of other channels of procuring petrol and petroleum products. Therefore, competition may be said to be foreclosed in a substantial share of the line of commerce. In Tampa Electric Co’s case the Supreme Court explained substantiality in the following words:

“To determine substantiality in a given case, it is necessary to weigh the probable effects of the contract on the relevant area of effective competition, taking into account the relative strengths of the parties, the proportionate volume of commerce involved in relation to the total volume of commerce in the relevant market area, and the probable immediate and future effects which pre-emption of that share of the market might have on effective competition therein.”

In State Oil v Khan, the US Supreme Court overruled Albrechtand held that vertical maximum price fixing, like the majority of commercial arrangements subject to the anti-trust laws, shouls be evaluated under the rule of reason. As in its view ‘rule of reason analysis will effectively identify those situations in which vertical maximum price fixing amounts to anti-competitive conduct.’

In EU, Articles 81(1) (a)-(e) set out some of the classes of restrictions to which the article is intended to apply. The article applies to both inter-brand as well as intra-brand competition. The Commission held in European Night Services that in assessing an agreement under Article [81(1)] of the Treaty, account should be taken of the following:

actual conditions in which it functions

the product or services covered by the agreement actual structure of the market concerned.

From the outset, the primary objective of European competition policy has been that of market unification i.e. creation of a single market. Vertical restraints may result in partition of market and exclude new entrants. Where vertical restraints obstruct such integration, e.g. by allocating particular national or regional markets and territories to particular distributors, they are prohibited.

The key decision in Consten and Grundig delivered by ECJ in 1966 remains the most important case to be considered under Art.81 and one that demonstrates the application of most aspects of that article. The ECJ while examining the collusive distribution agreement concluded that Art. 81 applied not only to horizontal agreements but to vertical agreements as well. The ECJ held that

“Although competition between producers is generally more noticeable than that between distributors of the same mark, it does not thereby follow that an agreement tending to restrict the latter kind of competition should escape the prohibition of article [81(1)] merely because it might increase the former.”

In Metro-SB-Grossmarkete GmbH & Co. Kg v Commission case, the Court held:

…although price competition is so important that it can never be eliminated, it does not constitute the only effective form of competition or that to which absolute priority must in all circumstances be accorded…”

Thus, the court and the Commission both recognized that there could be situations in which some restriction on price competition would be acceptable if that restriction fostered other types of competition.

After that, large demand for exemptions emerged on individual basis. In 1980 ’s, the ECJ began issuing Block Exemption Regulations (BER) to exempt a class of similar agreements where positive effects outweighed negative effects. In Windsurfing case, the Commission and ECJ found agreements in contravention of the prohibitions on anti-competitive agreements.

In 1990s, a process of reforms was initiated that resulted in the adoption of Regulation 2790/1999. It was a general BER for vertical agreements which would prevent them from being prohibited under Art. 81(1) if certain conditions were fulfilled. Art. 4 of the Regulation provides for ‘black clauses’ or ‘hard core’ restrictions on competition e.g. price-fixing, setting fixed or minimum prices, directly or indirectly creation of territorial restrictions, limiting on delivery to certain customers or restrictions imposed on authorized dealers within selective distribution systems on selling to end-users etc. Arrangements that provide for such restrictions are void in their entirety.

The Commission’s Guidelines on Vertical Restraints deal with Agency agreements at paras 12-21. The determining factor in defining an agency agreement for the application of Article 101(1) is the financial or commercial risk borne by the agent in relation to the activities for which he has been appointed as an agent by the principal. Genuine agency agreements do not fall within art. 81(1). Genuinity of the agency agreement depends on the question of allocation of risk.

Recently, the Commission has adopted Regulation (EU) No 330/2010 which replaced Regulation2790/1999. This BER also provides a safe harbor for most vertical agreements and renders, by block exemption, the prohibition of Article 101(1) TFEU inapplicable to vertical agreements that fulfill certain requirements. In Pierre Fabre case, the Court of Justice of European Union (CJEU) adopted a strict approach towards internet sale of products through selective agreements. It was held that an absolute ban on internet sales to end users in the context of a selective distribution network constitutes a restriction of competition ‘by object’, unless justified objectively.

On 14th March, 2013, the ECJ ruled in Allianz Hungariacase that to determine whether an agreement restricted competition by its object, regard must be had to the contents of its provisions, its objectives and the economic and legal context of which it forms part, as well as nature of goods or services affected and the real conditions of the functioning and structure of the market(s) in question.

15.4 Pro-Competitiveness of Vertical Restraints

More often than not, it has been observed that vertical restraints do not harm competition in any manner. Rather, these improve economic efficiency within a chain of production or distribution in the following ways:

i. By facilitating better coordination between the participating undertakings or enterprises

ii. By reducing transaction and distribution costs of the parties

iii. By optimizing sales and investment levels

iv. By allowing consumers a fair share of the benefit.

The EC has granted a block exemption to certain vertical restraints. These are referred to as ‘vertical agreements provided they fulfill the conditions set out in the regulations. Moreover, the exemptions will be applicable only if such agreements fall within the scope of Article 81(1).

15.5 Problems before courts while evaluating vertical agreements:

After adopting rule of reason to cases of vertical agreements, the Courts have to determine the effects of such agreements in every individual case which is a daunting task. Also, the burden of proof in the rule of reason approach is on the plaintiff to prove that the practices being challenged are prohibited by the law. Once it is proved facially that the agreement in question is anti competitive, then the burden shifts on the other party, the defendant. Since, every contract includes some sort of restraints of trade, it is challenging to establish that the intended results could not have been achieved by using restrictions that were far more pro-competitive.

Learning Outcomes:

Summary:

In this module, the legal framework on vertical restraints in both EU and US has been discussed. The relevant provisions of Sherman’s Act, Clayton’s Act, and Federal Trade Commission Act in US have been discussed. Art. 81 of the Treaty and the Guidelines on Vertical Agreements under Article 101(1) of TFEU have been analyzed. The positive effects like promotion of non-price competition and improvement in quality of service are also dealt with. The adoption of rule of reason approach in the place of per se rule is described. The evolution of the regulatory provisions has been done with the help of case laws.

References:-

1) Guidelines on Vertical restraints [SEC(2010) 411]

2) Business Electronics v Sharp Electronics

3) Consten and Grunding 1966[ECR] 299

4) European Night Services v Commission [1998] ECR II-3141

5) Leegin Creative Leather Products, Inc. v PSK Inc 551 US 2007

6) Pierre Fabre v Autorite de la Concurrence, Case C-439/09, Decided on Oct.31, 2011

7) Eastman Kodak Co v Image Tech Services 504 US 451 (1992)

8) www.eur-lex.ec.eu.europa.en

9) Socony 310 US at 224

10) Chicago Board of Trade v US 246 US 231

11) Texaco Inc. v Dagher 126 S. Ct. 1276 (200)

12) GTE Sylvania Inc. 433 US 36 (1977)

13) Windsurfing International v Commission Case 193/83 [1986]ECR 611

14) EstablissementsConsten SARL and Grundig-Verkaufs-GmbH v Commission cases 56, 58/64 [1996] 1 CMLR 418