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Exclusive distribution: new rules, risks and opportunities

Source: Amatin 2022

While drafting, negotiating and implementing agreements, business entities have to make sure that such agreements comply with a number of legal requirements, inter alia with applicable antitrust and competition regulations. While dealing with foreign companies, it is very important to take into account restrictions imposed by imperative rules of respective jurisdictions.

Any rule may have a number of exceptions

One should remember that regulations of most countries prohibit business practices and agreements which could prevent, restrict or distort competition on the market. Such violation may entail a considerable amount of fine (of up to 10 % of the annual worldwide turnover of the offending company or group of companies) in major part of the countries, including the EU member states.

Besides some special rules and exclusions may apply if particular restrictive agreements could generate objective economic benefits that outweigh the negative effects of the restriction of competition.

For instance, the EU legislation (i.e. Article 101(3) of the Treaty on the Functioning of the European Union) exempts some restrictive agreements from the prohibition, if they meet a number of criteria:

  • such agreements must contribute to improving the production or distribution of goods or to promoting technical or economic progress;
  • consumers must receive a fair share of the resulting benefits;
  • such restrictions must be essential to achieving the abovementioned objectives;
  • such restrictive agreements must not give the parties any possibility of eliminating competition in respect of a substantial part of the products in question.

Thus, each agreement and business practice should be assessed individually taking into account peculiarities of each particular case.

What is new in the EU?

On 1 June 2022 new rules, which regulate a number of antitrust and competition issues (including exclusive distribution) came into force in the European Union, namely:

  • a new version of so called Vertical Block Exemption Regulation (“VBER”), i.e. the Commission Regulation (EU) 2022/720 of 10 May 2022 on the application of Article 101(3) of the Treaty on the Functioning of the European Union to categories of vertical agreements and concerted practices, as well as
  • a new version of Guidelines on vertical restraints (i.e. so called Vertical Guidelines) issued by the European Commission on 10 May 2022.

The abovementioned new Regulation and Guidelines are of high importance not only for the EU, but also for other countries.

What does “exclusive distribution” mean?

“Exclusive distribution system” means a distribution system where the supplier allocates a territory or group of customers exclusively to itself or to a maximum of five buyers and restricts all its other buyers from actively selling into the exclusive territory or to the exclusive customer group. Such definition has been recently provided in the abovementioned Commission Regulation (EU) 2022/720 of 10 May 2022.

In practice, the main reason why manufacturers and other suppliers intend to use exclusive distribution systems is to incentivise distributors:

  • to make the financial and non-financial investments needed in order to develop the supplier’s brand in a territory where the brand is not well known, or sell a new product in a particular territory or to a particular customer group, or
  • to focus their selling and promotional activities on a particular product.

As for distributors, they may prefer an exclusive distribution because it can enable them to secure a certain volume of business and a margin that justifies their investment efforts.

Risks which may be entailed by exclusive distribution

Exclusive distribution may entail a number of competition risks, in particular:

  • the foreclosure of other distributors and, thus, reducing both: intra-brand competition at the distributor level (i.e. competition among distributors of the same branded product, either on price or non-price terms), and inter-brand competition (competition among distributors of products manufactured by companies under different brands);
  • market partitioning, which may facilitate price discrimination, and reduced intra-brand competition, if the supplier allocates a territory or customer group exclusively to one or more buyers;
  • risk of collusion and/or softening inter-brand competition, at both the supplier and the distributor levels, if multiple suppliers appoint the same one or several distributors in a given territory.

There is a number of factors which should be taken into account while assessing competition risks which may be entailed by exclusive distribution agreements, inter alia:

  • the supplier’s and the buyer’s market shares;
  • market position of the supplier and its competitors;
  • the number of distributors appointed per exclusive territory or customer group;
  • the dynamics of the market (for instance, the growing demand, changing market positions and changing technologies may make the negative effects of exclusive distribution systems less likely than in mature markets);
  • the nature of the product (for instance, anti-competitive effects of exclusive distribution will be less acute in sectors where online sales are more prevalent, as online sales may facilitate purchases from distributors beyond the exclusive territory or customer group), etc.

Possible ways to establish an exclusive distribution in compliance with the law

Suppliers may establish an exclusive distribution if it meets a number of criteria envisaged by the EU regulations, inter alia, if:

  • the supplier’s and the buyer’s market share do not exceed 30 %;
  • the supplier appoints no more than 5 distributors per exclusive territory or customer group;
  • the exclusive distribution agreement does not contain any of so called “hardcore restrictions” (i.e. serious restrictions of competition, for example, resale price maintenance etc.).

As a rule, foreclosure of other distributors does not constitute competition violation if the supplier applying the exclusive distribution system appoints a large number of exclusive distributors on the same relevant market and those exclusive distributors are not restricted in selling to other non-appointed distributors. However, foreclosure of other distributors may entail competition risk if an exclusive distributor becomes the exclusive buyer for a whole market.

An exclusive distribution agreement may be objectively justified if it meets a number of criteria, for instance:

  • if exclusivity is necessary to incentivise distributors to invest in: (a) developing the supplier’s brand, or (b) providing demand-enhancing services, or (c) specific equipment, skills or know-how to meet the needs of a particular category of customers;
  • in case such an exclusive distribution agreement concerns new products, complex products or products whose qualities are difficult to judge before consumption (so-called experience products) or even after consumption (so-called credence products);
  • if an exclusive distribution leads to savings in logistic costs due to economies of scale in transport and distribution;
  • if the exclusivity is of limited duration and is aimed at ensuring that the exclusive distributors may recoup their investments.

Our recommendations

Each exclusive distribution agreement should be assessed individually in order to identify all risks taking into account both applicable legislation as well as recent law-enforcement practice of relevant jurisdictions.

We would recommend drafting and negotiating distribution agreements carefully, while implementing a number of risk mitigation tools (inter alia, proper wording of risk mitigation clauses, respective substantiation in company’s internal documents etc.).

AMATIN AG  Rechtsanwälte / Rechtsberatung  │  Attorneys at Law / Counselors  │  Conseiller Juridiques / Avocats

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