UK Vertical Agreement Block Exemption Order (VABEO): A cautious refresher

This article summarises the CMA’s current proposals on the content of the VABEO and their significance for distribution agreements in the UK. The VABEO will mostly replicate the bulk of the retained VBER. However, the proposals to removal the dual pricing and equivalence rules from the current list of hardcore restrictions are quite significant and will be welcomed by manufacturers and brand owners. It is still too early to tell whether the EU Commission will follow the same approach as the CMA when it publishes its own draft block exemption regulation in the next few months, or if this is the beginning of divergence between the two regimes.

Background

Since 1967, a series of EU block exemption Regulations have exempted many distribution, resale and other vertical agreements from the prohibition in Article 101 TFEU. In preparation for Brexit, the UK had retained the current Vertical Agreement Block Exemption Regulation into UK law. The retained VBER, (like its EU counterpart) will remain applicable until May 2022. In parallel with the EU Commission’s consultation on the future of the regulation, the CMA launched a consultation kicked off by a series of round tables attended by Bird & Bird. The draft consultation document, published on 17 June 2021 (the “Consultation”), sets out the CMA’s current thinking and likely recommendations to the Secretary of State.

What are the proposed new rules?

1. Dual Distribution exception to be extended

Although the retained VBER is aimed at agreements between non competitors, the dual distribution exception reflects the fact that the line between competitors and non-competitors is increasingly blurred. Manufacturers often sell directly through their own websites, whilst also entering into agreements with distributors to resell their products. Art 2(4) of the retained VBER grants the benefit of the safe harbour to non-reciprocal agreements between competitors, where for instance the supplier is manufacturer and a distributor of goods, while the buyer is a distributor and not a competing manufacturer.

In the Consultation, the CMA acknowledges that the dual distribution exception is increasingly relied upon. It is welcome news that the VABEO will retain an exception for dual distribution in the same form as the retained VABER. The exception is also likely to be extended to dual distribution by wholesalers and importers. A growing concern for competition policy makers, however, has been the issue of information flows between the supplier and the buyer, which may give rise to horizontal competition concerns where the parties are competitors. We expect the CMA to provide more clarity on this point in the VABEO Guidance.

2. RPM to remain a hardcore restriction

Unsurprisingly, the CMA is minded to retain the status of hardcore restriction for Resale Price Maintenance ("RPM"). The long-established prohibition of RPM and the volume of enforcement and resulting jurisprudence would have made any shift away from this position seismic. Nonetheless, it is worth noting that more guidance is expected on the potential efficiency arguments which could justify RPM. In the Consultation, the CMA reiterates that it remains open to such arguments, which it will consider carefully.

3. Active and Passive sales

The CMA proposes that territorial restrictions (including the related distinction between active and passive sales) should be retained in their current form and continue to be treated as hardcore. The Consultation does, however, reflect on whether the growth of e-commerce in the last few years has called into question the extent to which certain online sales should be still treated as passive sales. The CMA recognises that the boundary between active and passive sales may need to be re-drawn. We are eagerly anticipating more details on this in the VABEO Guidance. The CMA will be drawing on its work in digital markets to feed into the updated Guidance.

4. Changes to the list of hardcore restrictions

Among the most notable proposals of the Consultation are the changes to the list of hardcore restrictions. Back in 2010, when the retained VBER was drafted, online sales were much less developed than today, and in need of protection. This justified (i) the equivalence principle (the prohibition of imposing criteria for online sales which are not overall equivalent to the criteria imposed in brick-and-mortar stores in the context of selective distribution) and (ii) the prohibition of dual pricing (charging a higher price for products intended to be resold online than for products intended to be sold offline).

Ten years on, the position has drastically changed. Indeed, there are now many challenges to the viability of many brick and mortar retailers due to the growth in online sales. A greater concern is now how to save the high street from a downward spiral? Physical shops have significantly higher running costs than pure online retailers (for example employment costs are 2 to 5 times lower for online distribution than traditional retail channels). The CMA concludes that this results in a lack of economic justification for retaining the current approach.

The CMA believes that the status quo is no longer appropriate and recommends the following changes:

a) Dual pricing should no longer be regarded as a hardcore restriction of competition; and

b) The imposition of criteria for online sales that are not overall equivalent to the criteria imposed on brick and mortar shops in a selective distribution system should no longer be regarded as a hardcore restriction.

5. Wide parity obligations to be added to the list of hardcore restrictions

Parity obligations typically require one party to an agreement to offer the other party goods or services on terms (usually price) that are no worse than those offered to third parties. The retained VBER does not refer to parity obligations and the current guidelines only do so as an example of a measure that may make RPM more effective. However, parity obligations have been the subject of intense scrutiny by competition authorities in the EU and UK in the last ten years, particularly in the context of online platforms. Competition concerns tend to arise in relation to ‘wide’ parity obligations, which specify that a product or service may not be offered on better terms on any other channels. By contrast, ‘narrow’ parity obligations require only that better terms will not be offered on a party’s own sales channel, without stipulating conditions for sales via other channels.

The CMA is proposing to adopt definitions to reflect the notions of narrow and wide parity obligations by differentiating between (i) parity obligations that affect ‘direct’ sales channels and (ii) parity obligations that affect ‘indirect’ sales channels. Indirect sales channel parity obligations (and equivalent measures) would be treated as a hardcore restriction under the UK VABEO.

It’s worth noting that the CMA is still reserving its position in relation to ‘direct’ sales channels parity obligations which may be investigated if there is evidence that their use replicates the effect of ‘indirect’ sales channels parity obligation

6. Excluded restrictions will remain

The CMA considered during the roundtable process whether the five-year limit on non-compete restrictions was still adequate. In its recommendations, it concludes that the current position in relation to non-compete restriction should be retained in the VABEO. Although the five-year limit is somewhat arbitrary, any other limit would be exposed to the same criticism. The CMA is also considering whether to provide further guidance in relation to the assessment of non-compete obligations in the context of franchise agreements.

7. More guidance on agency and sustainability

A large number of participants at the CMA roundtable were of the view that more guidance should be provided in relation to agency. In particular, guidance would be welcome on (i) the application of agency principles to arrangements with online platforms and (ii) the application of agency when a company active on a downstream market acts both as an agent and as an independent distributor for different products of the same supplier (dual role agents). The CMA is proposing to provide guidance covering these issues within the VABEO Guidance and will refer back to its own enforcement practice.

Given that the transition to ‘net zero’ carbon emissions is one of the strategic priorities for the CMA, it was determined to explore whether any uncertainties in the interpretation of retained VBER had led to the abandonment of sustainability initiatives by some businesses. In the Consultation, the CMA proposes to provide guidance in the context of the VABEO Guidance in particular in relation to the criteria for admission to selective distribution systems.

8. Shorter life span of six years

The CMA considers that it would be appropriate for the next review of the UK VBAEO to take place six years after its current review of the retained VBER. Given the current fast pace of market development, the block exemption should be reviewed sooner than the 10 years provided for in the VBER, to ensure that it remains relevant to changing circumstances.

9. New features: a transition period and a right for the CMA to cancel the benefit of the VBAO

The CMA is proposing a one-year transition period for the UK VABEO. This is a welcome announcement and would give businesses time to review their existing agreements and if appropriate bring them in line with the new order in order to benefit from the exemption. It is particularly important given the possibility of emerging divergence from the new EU regime.

The CMA has the power to withdraw the benefit of the block exemption to an agreement which does not satisfy the conditions of exemption. In the Consultation, the CMA recommends that the VBAEO sets out clearly the basis on which the CMA could action such a withdrawal. In practice this will only be used in exceptional circumstances and notice would need to be given to the Parties in writing.

Next steps

Interested parties have until 22 July 2021 to respond to the consultation document. You can access the full document here. Assuming that the Secretary of State will accept the recommendation, the responses to the questions will be used to inform the preparation of an impact assessment of the CMA’s final recommendation and ultimately a new set of rules of vertical agreements in the UK before May 2022.