Kneppelhout & Korthals: Exclusive assignment of a territory or block of customers to distributors?11/08/2016
The relationship between a supplier and a distributor can be subject to the cartel prohibition. This is specifically the case when the territory in which or the customers to whom a distributor may sell is restricted in a distribution agreement.
There is European block exemption (Regulation 330/2010) for vertical agreements, such as those between a supplier and distributor. On the basis of this block exemption, vertical agreements are excluded from the cartel prohibition provided that the conditions stipulated in the exemption are complied with. In this way, the regulation provides a safe harbour from which suppliers and distributors can benefit. One of the conditions for benefitting from the block exemption is that a distribution agreement between the supplier and the distributor contains no provision that seriously disrupts competition. These types of restrictive provisions are also known as ‘hardcore restrictions’. Absolute territory protection is such a ‘hardcore restriction’. The assignment of absolute territory protection in an agreement therefore results immediately in the entire agreement not benefitting from the safe harbour. The entire agreement is then subjected to the cartel prohibition test. Generally, the element of the agreement containing a ‘hardcore restriction’ is quickly deemed by the courts and the competition authorities as being in conflict with the cartel prohibition. That element is therefore invalid and cannot be enforced. In addition, high financial penalties can be imposed on the supplier and the distributor and the de facto directors that are involved. The penalties can amount to as much as EUR 900,000 or 10% of group turnover and 80% in the case of reoffending. Claims can also be instigated by third parties against the supplier and the distributor for losses they have suffered as a result of the exclusive territory protection.
Only in the case that the supplier and/or distributor can demonstrate that the territory protection improves production or distribution or contributes towards technological or economic development, that the competition restriction is necessary in order to achieve the improvement, that a reasonable share of the improvement benefits the users and finally that sufficient (residual) competition remains, will the territory protection be permitted (the efficiency defence). This was already briefly discussed with regard to the question “What collaboration agreements are permitted?”. However, the efficiency defence in the case of ‘hardcore restrictions’ is often not accepted by the Commission, national competition authorities and the courts.
Exclusive territory protection is not always a ‘hardcore restriction’: five conditions
The assignment of territory protection in a distribution agreement is not deemed to be a ‘hardcore restriction’ provided that five conditions are met. In that case a benefit can be obtained from the block exemption. The cumulative conditions are:
Both the supplier and the distributor may not have a market share that exceeds 30%;
Active selling may be prohibited, passive selling must be permitted;
A geographic territory or block of customers must be assigned exclusively to a single distributor;
The distributor must be protected against active selling by others (parallel imposition);
There is no restriction on active and passive selling by the customers of the distributor.
The first two conditions arise directly from the text of the block exemption and were briefly discussed with regard to the question “What is exclusive distribution?”. The importance of and the practical consequences of the last three conditions, and in particular the fourth condition (concerning parallel imposition) are often overlooked, as a result of which an assignment of exclusive territory is still in conflict with the cartel prohibition. In addition, in 2015 the Netherlands Authority for Consumers and Markets (ACM) stated that with regard to enforcing the cartel prohibition it was giving priority to vertical agreements that were not covered by the block exemption. This is also in line with the enforcement by other national authorities such as the Bundeskartelamt (Federal Cartel Office) in Germany. As a result, the importance of a consistent and carefully formulated territory assignment and with that the requirement of parallel imposition and the other conditions are emphasised once again. This article shall therefore consider these last three conditions specifically.
The example of a French supplier and a Dutch distributor that also has German customers
In the discussion concerning the five aforementioned conditions, we use below as clarification the example of a distribution agreement between a French supplier that distributes its products directly in France but that wishes to distribute its products in the rest of the EU via distributors, and a Dutch distributor – which also has customers in Germany – that is assigned the Netherlands as an exclusive territory by the French supplier. Although the geographic territory is central in this example, the same basic principles apply to the assignment of blocks of customers to distributors, for example by making a distinction between business and private customers, or retail and wholesale. The assignment of a geographic territory and a block of customers or sales channel (only wholesalers for example) may be combined. A distributor can therefore obtain the exclusive right from the French producer to sell that producer’s products to builders’ merchants, while another distributor acquires the right to sell those same products exclusively to building contractors in the Netherlands.
1. The market threshold of 30% for supplier and distributor
Firstly, the application of the block exemption requires that both the supplier and the distributor do not have a market share that exceeds 30%. If those market shares are exceeded it will not be possible to benefit from the block exemption.
2. Only active selling may be restricted; passive selling must always be permitted
Secondly, the French supplier may impose a prohibition on parties other than the Dutch distributor only with regard to preventing them from actively acquiring customers in the Netherlands, which is also known as ‘active selling’. A ban on active selling means that a German distributor may not actively target Dutch customers. The German distributor may not therefore advertise or undertake promotional activities that target prospects based in the Netherlands, for example by placing advertisements in Dutch monthly magazines, weekly magazines or by sending unsolicited e-mails to Dutch prospects. Specifically, advertising or publicity in the Dutch language shall be regarded as active selling. That does not apply when using the English language because that is considered to be a world language and is not therefore targeted specifically at a certain public. When a German distributor sells products via a website it is also prohibited from placing banners on Dutch websites or paying search engines to display its website when searches are made from the Netherlands. These are targeted forms of advertising and promotion that may be reserved by the supplier for the distributor who has been assigned the exclusive rights to the Netherlands.
However, not every form of advertising is deemed to be active selling. General advertising or promotion that reaches Dutch customers but which is (also) a reasonable way of reaching German customers is not deemed to be active selling but rather passive selling. In that case the Dutch customers are ‘by-catch’. In brief, passive selling boils down to a German distributor responding to a spontaneous request from a Dutch customer. It is, however, necessary that this customer has personally approached the German distributor. The supplier is not permitted to restrict passive selling by the distributor. If the supplier does restrict this then it is deemed to be a ‘hardcore restriction’. This was briefly discussed with regard to the question “What is passive selling?”.
The boundary between active and passive selling is vague, certainly when one considers the use of websites to sell products (online). For a more detailed review of this subject see this article by the undersigned (Esther Glerum-van Aalst) in the Monthly Property Law Journal (Maandblad voor Vermogensrecht).
3. The assignment of a territory or block of customers must be and must remain absolutely exclusive
Thirdly, the restriction with regard to the territory in which or the customers to whom the distributor may sell has to be exclusive. A territory or block of customers is deemed to be exclusively assigned if the supplier undertakes to only supply its products to a single distributor with a view to active selling in that territory or to that block of customers. In the example this means that the French supplier may only assign the territory of the Netherlands to the (in this case Dutch) distributor. This condition is not met if there is a situation of what is known as ‘shared exclusivity’: in this case a supplier assigns the same territory or block of customers to two or more distributors. However, it is possible to subdivide the territory of the Netherlands into smaller, individually exclusive territories. This condition is also not met if the supplier has already assigned a territory or block of customers to a distributor but retains the freedom of appointing other distributors at a later stage. The agreement must then be focussed or formulated in such a way that the distributor acquires an exclusive right for active selling in a specific territory or to a specific block of customers compared to other distributors. Considering the condition discussed above, the exclusive distributor will have to accept the passive selling by other distributors in its territory or to its block of customers, since the supplier is only able to restrict the active selling.
The exclusivity requirement does not, however, restrict the direct selling undertaken by the supplier. A supplier can also decide not to use distributors in a specific territory or for a specific block of customers but to retain that territory or block of customers for itself, even if it is not (yet) active in that territory or with regard to that block of customers. The supplier may do that because it has not (yet) been able to find a suitable distributor or because it already has a suitable distribution system in that territory. This also means that, in addition to a distributor, a supplier can also start selling itself and thus compete directly with a distributor. Please note that in this case there is not only a vertical but also a horizontal relationship between the supplier and the distributor. They become competitors of each other and therefore have to be prudent in particular with regard to the information they exchange within the framework of the distribution system: the exchange of commercially-sensitive information would quickly give rise to a suspicion that the cartel prohibition has been breached.
4. The exclusive distributor is protected against active selling in its territory or to its block of customers by other customers of the supplier (parallel imposition)
Fourthly, the supplier must prohibit the active selling by all other (European) customers in the exclusive territory or to the exclusive block of customers and has to protect an exclusive distributor against active selling by all other (European) customers of the supplier. This requirement of parallel imposition is closely related to the previous condition and is necessary for the operation of an exclusive distribution system.
In the example of the French supplier and the exclusive Dutch distributor this means, on the one hand, that when for example the French supplier prohibits the active selling in the Netherlands by German distributors while that ban is not imposed on distributors from other (European) Member States, the competition between the German and all other (European) distributors is restricted. German distributors are the only party specifically refused access to the Dutch market. Because in this case the French supplier fails to restrict the active selling by all (European) distributors, the condition of parallel imposition is not complied with. A German distributor can invoke the invalidity of the active selling prohibition and claim damages from the French supplier for the loss it has suffered as a result of the ban.
On the other hand, in the example, the condition of parallel imposition means that if the French supplier fails to prohibit active selling in the Netherlands by its other (European) distributors, the Dutch distributor is not protected against active selling in the Netherlands and the other distributors can simply acquire customers in the Netherlands. In effect and from a legal perspective, the Dutch distributor therefore has no exclusive territory, while this is what was agreed between the French supplier and the Dutch distributor. By not providing the Dutch distributor with any protection against active selling by other distributors, the French supplier is acting in conflict with the distribution agreement. Protection against active selling by other distributors can be necessary in order to protect the investments of the Dutch distributor. The French distributor will therefore do well to ensure that all agreements with distributors contain a parallel imposition or a prohibition on active selling in the Netherlands. If not, it runs the risk of being faced with a claim for compensation from the Dutch distributor, because the French supplier has not fulfilled what it should have done on the basis of the block exemption and the agreement: protect the Dutch distributor.
5. The presence of active and passive selling restrictions on customers of the distributor
Finally, the active selling may only be restricted with regard to the distributor that is a party to the distribution agreement. This means that when the distributor in turn uses sub-dealers or enters into agreements with independent resellers, the supplier may not demand of the distributor with whom it has concluded an agreement that that distributor also restricts the active and passive selling by the sub-dealers or resellers in respect of a specific territory or block of customers. The reason for this is because the sub-dealers or resellers are not direct parties to the distribution agreement between the supplier and the exclusive distributor. This could imply that the establishment of an exclusive distribution system can be pointless because sub-dealers and resellers can undermine that system.
With regard to the sub-dealers, this problem can be easily resolved: the supplier can become a party to the agreements between the exclusive distributor and the sub-dealers, so that in these agreements the active selling can also be restricted. With regard to independent resellers, the problem is more difficult to resolve: after all, they do not form part of the supplier’s distribution system. An exclusive distributor would be able to bypass the active selling restriction imposed on it by utilising independent resellers, without the supplier being able to impose any restrictions on these resellers. On the basis of the mutual trust associated with the agreement, the supplier can of course object to the (intentional) use of independent resellers to bypass the active selling restriction and for the future, at the end of the agreement, the supplier can of course decide not to extend the agreement and proceed to appoint a different distributor. The (threat of) unilateral (early) termination of an agreement by the supplier based on the reason that a distributor is intentionally attempting to bypass the active selling restriction by using independent resellers can, however, also result in a breach of the cartel prohibition. It does need to be noted here that the exclusive distributor can also impose selling restrictions on resellers on its own initiative. These can be both active and passive selling restrictions and the distributor may do this in order to make itself attractive to certain suppliers.
An efficient and/or high-quality distribution system generates many benefits. For example, the supplier is assured that its products are supplied to (end) users in the required manner, for example with a high level of service, a short delivery time and/or at a low price. A distributor that is protected to a certain degree by the supplier is able to invest in its service, as a result of which its operation becomes more efficient or the service to the (end) user is improved. It is often the (end) user that ultimately benefits most from this. For this reason, many distribution agreements based on European legislation are exempt from the cartel prohibition in advance. Despite this, there are still a number of competition law risks. For example, this is the case when a supplier exclusively assigns geographic territories or blocks of customers to distributors and these distributors are protected against other distributors to a(n) (excessively) far-reaching extent. This limits competition between distributors and the freedom of choice of the consumer, which ultimately will result in more negative than positive effects. Absolute customer or territory protection by the supplier is not exempt from the cartel prohibition in advance and will therefore quickly conflict with it.
However, when an exclusive customer or territory assignment complies with the five cumulative conditions referred to in this article, it is still possible to benefit from the European exemption.
Esther van Glerum wrote this article together with her colleague Flip van der Kraan