Vertical Agreements in EU Competition Law
1. Concept and function of vertical agreements
The EU competition rules set out in Arts 101 ff TFEU—which together with the merger control legislation under Reg 139/2004 are the core elements of European competition law—aim to provide for the comprehensive protection of competition as an essential condition for a free market economy in the European internal market. Within the system of competition rules, Art 101 TFEU prohibits restraints of competition effected by agreements and concerted practices of undertakings or decisions of associations of undertakings (prohibition of restrictive agreements and exemptions). Horizontal agreements between competitors give particular rise to antitrust concerns because they are capable of directly and seriously restricting or preventing the effectiveness of competition in the relevant market. However, in addition to the dangers posed by collusion among competitors, anti-competitive objects and effects can also be brought about by vertical agreements which are entered into by economic actors functioning at different levels of the supply chain. Pursuant to Article 1(1)(a) of Reg 330/2010 on the application of Art 101(3) of the Treaty on the Functioning of the European Union (TFEU) to categories of vertical agreements and concerted practices, vertical agreements are defined as agreements or concerted practices ‘entered into between two or more undertakings each of which operates, for the purposes of the agreement or the concerted practice, at a different level of the production or distribution chain, and relating to the conditions under which the parties may purchase, sell or resell certain goods or services’.
Vertical agreements covered by this definition are primarily distribution agreements which manufacturers enter into with undertakings operating at the distribution level, such as wholesalers and retailers, whose task is the further marketing of the product along the supply chain. Also qualifying as vertical agreements are procurement contracts concluded by a manufacturer and a supplier whose goods are used by the manufacturer as an input for his own products (industrial supply).
Distribution agreements are of crucial importance for supplying the European internal market with goods because manufacturers make use of distribution intermediaries on a large scale to create marketing channels which extend all the way to the consumer. According to estimates of the European Commission in 2003, the trade sector accounts for 15 per cent of all European employment and comprises 5.5 million undertakings. The overall contribution of the sector is no less than 13 per cent of the GDP of the Union, generating an added value of €880 billion. The Commission regards trade as ‘an essential element for the proper functioning of the internal market’ and has observed that ‘distributors not only build up marketing channels for the distribution of goods and services to end consumers, but also pass on information to the producers on the demand structure and trends in consumer taste’ (European Commission, <http://ec.europa.eu/internal_market/services/brs/distri-trades_en.htm>.
To the extent that contractual stipulations between manufacturers and distributors only determine the price to be paid by a distributor to a manufacturer and the volume of goods or services that the distributor purchases from the manufacturer, vertical agreements do not in most cases cause anti-competitive effects. However, such effects can occur if the agreement imposes restrictions on either the supplier or the purchaser which go beyond the aforementioned arrangement. This is, for instance, the case where a supplier grants a distributor the sole right to distribute the supplier’s goods in a defined territory (exclusive distribution agreement). By such an arrangement, other distributors are prevented from distributing goods of the supplier (ie are prevented from competing) in the territory of the advantaged distributor. Anti-competitive effects may also be caused by agreements which oblige a distributor to purchase specific goods exclusively from a single supplier (exclusive supply agreement). Under these agreements, the distributor is prevented from purchasing the goods from other, possibly cheaper suppliers.
On the other hand, vertical agreements may also cause positive effects. For example, an exclusive distribution agreement might serve to prevent other distributors from free-riding on the promotional efforts of a single distributor (free rider problem) or might help to reduce the potential of either the supplier or the distributor attempting to exploit relationship-specific investments made by the other party to the agreement (hold-up problem). Furthermore, the exclusive position can drive a distributor to concentrate more efficiently on distribution and marketing than would be the case if he were to deal in the same or similar products of several manufacturers.
A vertical agreement is prohibited pursuant to Art 101(1) TFEU if it has as its object or effect the prevention, restriction or distortion of competition within the Common Market and is capable of affecting trade between Member States. In the early years of the European Union, after the coming into force of the competition law provisions, it was disputed whether Art 85(1) EEC (now Art 101(1) TFEU) covered vertical agreements at all. In one of its first decisions with respect to the competition rules, the European Court of Justice (ECJ) decided very clearly that it does: as the Treaty speaks of prevention, restriction or distortion of competition in very general terms and applies indiscriminately to all agreements, the Court concluded that, with regard to the general scope of application of Art 85(1) EEC, it would not be appropriate for the Court to make a distinction between vertical and horizontal agreements where the treaty itself does not (ECJ Joined Cases 56 and 58 – Consten and Grundig  ECR 299, 339;  CMLR 418). The ECJ and the General Court of the European Union (GC) have confirmed this approach in several subsequent judgments.
As a matter of competition policy, the dangers caused by vertical restraints are generally rated lower than the risks emerging from horizontal restraints of competition (Commission, Guidelines on Vertical Restraints, para 98 f). Anti-competitive agreements between competitors interfere with inter-brand competition (ie competition between substitutable products of different manufacturers), tend to result in higher prices and reduce consumer choice. In contrast, while vertical restraints may reduce competition between distributors of the same brand (intra-brand competition), they do not necessarily produce higher prices. For the parties to vertical agreements, the product of one side is the input of the other. This means that the exercise of market power (abuse of a dominant position) by either the upstream or downstream undertaking, ie setting a higher price for its product, negatively affects the demand for the product of the other undertaking. Consequently, companies involved in a vertical agreement usually have an incentive to prevent an exercise of market power by their counterpart.
However, this incentive should not be overstated. Companies lacking market power which wish to increase their profits will need to improve their manufacturing and distribution methods regardless of whether vertical restraints are employed. Enterprises with market power, however, may enhance their profits at the expense of their competitors by increasing the latter’s costs on the up- and downstream markets and by attempting to appropriate both buyer and consumer surplus.
The negative effects of vertical restraints on the market may be summarized as follows: (1) They can be used for raising barriers to entry leading to the foreclosure of other suppliers or buyers of products from the market. (2) They can contribute to a reduction of inter-brand competition and to an increase in collusion amongst suppliers or buyers. (3) Intra-brand competition may be reduced. (4) Exclusive distribution agreements and exclusive supply agreements can lead to territorial segmentation of markets and preclude the consumer from enjoying the benefits of the internal market.
Nevertheless, an antitrust analysis of vertical restraints under Art 101(1) TFEU needs to be mindful of the potential positive effects of such agreements; where the requirements of Art 101(3) TFEU or a relevant block exemption regulation are met, beneficial effects may justify an exemption from the prohibition of Art 101(1) TFEU. In this fashion, vertical restraints can lead to a strengthening of non-price competition, eg improvement of pre- and post-sales consumer services (advice, instruction and repair services) for technically complex goods like home entertainment appliances and other consumer electronic goods. Vertical agreements with anti-competitive restraints may also be used as an effective tool for opening up new markets for economic actors, as may be the case with regard to exclusive distribution agreements or franchise agreements (franchising).
Art 101(1) TFEU distinguishes between agreements which restrict competition either by their object or by their effect. If an agreement envisions a restraint of competition as its object, it is prohibited pursuant to Art 101(1) TFEU without any actual impact of the restrictive agreement on competition in the relevant market having to be shown. Rather, only the (objective) purpose of the measure and not the (subjective) intentions and motives of the parties to the agreement are taken into account. Moreover, an unwritten requirement of Art 101(1) TFEU is that the agreement must be capable of appreciably restricting competition in the relevant market (‘de minimis’). This requirement is, however, not applicable to hardcore restrictions, ie certain types of agreements which intend to impose anti-competitive restraints. Examples of hardcore restrictions in the sphere of vertical agreements are resale price maintenance or an exclusive territory concession for the purchaser of goods as through this mechanism intra-brand competition is restrained.
As with measures that intend a restraint on competition, Art 101(1) TFEU also prohibits agreements which have (or produce) anti-competitive effects. Here the effects of the measure on the circumstances of the relevant market have to be investigated separately. In this context, it depends in particular on the unwritten definitional element of appreciability: an agreement only falls within the prohibition of Art 101(1) TFEU if it has appreciable effects on the relevant market. In its de minimis notice, the Commission determined that vertical agreements do not appreciably restrict competition if the number of market shares held by each of the participating undertakings does not exceed 15 per cent on any of the affected relevant markets.
For the assessment of vertical agreements under competition law, it is not always enough to take only the effects of a single, isolated agreement into consideration. The effects of the entire contractual network also need to be considered. Accordingly, a single agreement, eg a beer supply contract between a brewery and an innkeeper, may have no noteworthy effects on the relevant market; however, if the agreement is part of an overall system of homogeneous contractual obligations which characterize the entire market, eg beer supply contracts between a multiplicity of breweries and a multiplicity of innkeepers, only an evaluation of the overall system can guarantee appropriate legal scrutiny of the potential market effects for breweries which are not represented on the relevant market. Judicial consideration of homogenous agreements between undertakings as well as agreements with third parties is made possible by the bundle theory of the ECJ. According to that theory the evaluation of a single agreement cannot be distinguished from the overall economic and legal context; rather, the agreement has to be assessed in light of the cumulative effects of the entire contractual network (ECJ Case C‑234/89 – Delimitis v Henninger Brau  ECR 977, 983 ff; ECJ Case 23/67 – Brasserie de Haecht  ECR 407, 414 ff).
The jurisprudence of the ECJ and the administrative practice of the Commission have restricted the application of Art 101 TFEU to certain kinds of vertical agreements. For instance, so-called genuine agency agreements, where the agent (commercial agents) sells or purchases goods or services for the principal without assuming commercial risk in excess of the agent’s commission (eg market specific investment or the adoption of storage costs), do not fall under the scope of application of Art 101(1) TFEU. Furthermore, the ECJ has excluded selective distribution systems in the form of specialized trade from the application of Art 101(1) TFEU. This exemption is subject to the condition that (i) the selective distribution system is necessary due to the nature of the product; (ii) the selection of the reseller takes place according to strictly qualitative criteria and is non-discriminatory; (iii) the system strengthens competition and is in the interest of the consumers and, finally, (iv) the anti-competitive restraint does not exceed what is necessary to reach these goals (ECJ Case 26/76 – Metro/Commission I  ECR 1875, 1906 ff).
2. Types of vertical agreements
The various forms of vertical agreements reflect the divergent economic and legal needs of the companies involved and their attempt to meet these needs by arranging a single distribution channel extending from the manufacturer to the consumer. In more than 50 years of experience in applying Art 101(1) TFEU (ex 81(1) EC, 85 EEC), certain types of agreements have proven to be particularly significant and frequent in practice.
a) Exclusive distribution agreements
Exclusive distribution agreements refer to agreements in which a manufacturer, with respect to a particular territory, undertakes to deliver certain goods to only a single distributor for the purpose of resale in that territory. Usually, the distributor promises at the same time not to sell to customers in a specific territory. Often, the manufacturer also undertakes to refrain from direct sales to customers in the territory of the distributor. A threat to competition arises mainly from the reduction of intra-brand competition and market partitioning. Price discrimination is also possible. Furthermore, in the case of wide application of exclusive distribution systems, there is a high risk of collusion among manufacturers and distributors. However, exclusive distribution agreements that entail anti-competitive restraints may also have positive effects: they can reduce transaction costs if the supplier limits his marketing activity to few distributors. Moreover, the sole distributor frequently markets the goods in his own territory in an especially intensive way.
b) Exclusive supply agreements
In an exclusive supply agreement, a purchaser binds himself to purchase a product solely or to a predominant degree from a particular supplier. This makes market entry for competing suppliers more difficult. Additionally, it creates potential for collusion between different suppliers. Furthermore, inter-brand competition at the point of sale by the purchaser may be limited if the supplier only delivers certain—and not all—brands. Possible positive effects include the reduction of distribution costs through the long-term planning of a marketing scheme, stabilization of distribution channels, restriction of risks in the event of market fluctuations plus an incentive for the purchaser to support the marketing of the goods in question.
c) Selective distribution systems
A selective distribution system is a scheme whereby a manufacturer restricts his distribution by corresponding contractual clauses to certain distributors and prevents them from delivering goods purchased under the contract to other distributors who are not members of the distribution system. Generally, selective distribution systems are not permissible for the marketing of all products; it is permissible only for goods which require such systems—eg to preserve their quality or to ensure their proper use. Examples include long-lasting, high-quality and technically complicated products or certain luxury goods which require consumer advice, information and service. Over time, different types of selective distribution have developed through the legal practice which affects competition to varying degrees. The ECJ has held that a simple selective distribution system under which resellers are chosen according to objective criteria of a qualitative nature with regard to the technical qualifications of the reseller and his staff and in which those criteria are laid down uniformly for all potential resellers and are applied indiscriminately to all such resellers (‘qualitative selective distribution system’), does not fall within the ambit of the prohibition of Art 101(1) TFEU (ECJ, Case 75/84 – Metro II,  ECR 3021, paras 37, 40). However, selective distribution systems in which the reseller is charged with obligations going beyond the ‘objective criteria of a qualitative nature’ or through which from the outset the number of resellers to be admitted to the system is restricted (‘quantitative distribution systems’) are subject to the prohibition of Art 101(1) TFEU, but they might be exempted from the prohibition if they comply with the requirements of Art 101(3) TFEU or a block exemption regulation.
As selective distribution systems affect competition to varying degrees of intensity, they need to be considered in a differentiated manner under competition law. Selective distribution systems can lead to a reduction of intra-brand competition and—if such systems are used by all important manufacturers—to a foreclosure of certain types of distributors. Such systems also facilitate collusion between distributors and manufacturers. But these systems can also have positive effects by ensuring the supply of certain services (eg post-sales service to consumers), reducing free rider problems between distributors (eg in the sphere of advertisement and advice), securing a particular brand image and protecting relationship-specific investments of contract distributors.
d) Franchising agreements
The concept of (goods or services) franchising relates to a form of distribution where the franchisor permits the franchisee to use the name, brand, equipment and know-how of the franchisor in producing or marketing his products and/or services. Franchise agreements normally provide that the franchisee obtains the contracted goods exclusively from the franchisor. Additionally, such agreements often contain further anti-competitive elements, eg an obligation on the part of the franchisee to distribute the contracted goods only in a certain salesroom. This serves to protect franchisees from competition by other franchisees. The same aim is followed by the so-called municipal area rules where the franchisor is obliged not to license any other franchisees in a certain geographical area surrounding the salesroom of a franchisee. Besides anti-competitive effects, such agreements can also have positive effects. They enable manufacturers to establish themselves on new markets without high investment. Franchise contracts can generate cost savings due to the unification of business methods. Also, inter-brand competition may potentially be improved when distribution through franchise contracts increases the competition faced by the large-scale, highly networked distribution chains otherwise dominant in the market.
Article 101(3) TFEU provides the conditions and the forms under which a vertical agreement with an anti-competitive element is exempted from Art 101(1) TFEU. Article 101(3) TFEU includes two different possibilities for exemption: block exemptions and direct exemptions.
As concerns the exemption of vertical agreements, the European Commission has adopted two block exemption regulations which are of extraordinary practical importance. These are Regulation 330/2010 of 20 April 2010 on the application of Art 101(3) of the Treaty on the Functioning of the European Union to categories of vertical agreements and concerted practices and Regulation 461/2010 of 27 May 2010 on the application of Art 101(3) of the Treaty on the Functioning of the European Union to categories of vertical agreements and concerted practices in the motor vehicle sector. The regulations add specificity to the otherwise vague and undefined conditions for exemptions outlined in Art 101(3) TFEU, especially for the sector of vertical agreements. In so doing, they relieve companies, competition authorities of the Member States and courts from a complicated examination of the lawfulness of such agreements.
If the conditions for one of the above-mentioned block exemption regulations are not fulfilled, eg if the 30 per cent thresholds established in Art 3(1) Reg 330/2010 are exceeded, a single agreement among two or more parties can nonetheless be exempted by direct application of Art 101(3) TFEU. For this exemption to apply, four cumulative conditions must be satisfied: the agreement must contribute to improving production or distribution or to promoting economic or technical progress; it must allow consumers a fair share of the accrued benefits; the restraints must be indispensable to the attainment of these benefits in question; and competition for a substantial part of the concerned products must not be eliminated. Agreements which contain the above-noted hardcore restrictions can normally not be exempted under Art 101(3) TFEU.
4. Legal consequences of a violation of Art 101 TFEU
If a vertical agreement falls under Art 101(1) TFEU because it pursues anti-competitive aims or contains anti-competitive elements and is exempt neither on the basis of a block exemption regulation nor directly under Art 101(3) TFEU, the agreement is null and void in accordance with Art 101(2) TFEU and does not generate any estoppel effect (prohibition of restrictive agreements and exemptions).
DG Goyder, EC Competition Law (3rd edn, 1998) 177–260; Ernst-Joachim Mestmäcker and Heike Schweitzer, Europäisches Wettbewerbsrecht (2nd edn, 2004) §§ 12 and 14; Volker Emmerich, Kartellrecht (10th edn, 2006) § 5 II; Thorsten Mäger, ‘§ 16: Kartellrecht’ in Reiner Schulze and Manfred Zuleeg (eds), Europarecht. Handbuch für die deutsche Rechtspraxis (2006); Markus Buchner, EG-Kartellrecht und Vertriebssysteme, insbesondere der KFZ-Vertrieb (2006); Jonathan Faull and Ali Nikpay, The EC Law of Competition (2nd edn, 2007) 9.01–9.359; Peter Roth and Vivien Rose (eds), European Community Law of Competition (6th edn, 2008) 6.001–6.196.