This blog offers a quick guide on selective distribution agreements and what you should look out for when considering one. Our lead lawyer for selective distribution agreements is Neil Williamson. Please get in touch if you have any questions.
What is a distribution agreement?
A distribution agreement is a legal agreement between a supplier and a distributor of goods. There are various types of distribution agreement including exclusive distributorship, sole distributorship, non-exclusive distributorship and selective distributorship.
What is a selective distribution agreement?
A selective distribution agreement allows suppliers to appoint particular distributors according to their specific needs. The suppliers agree to supply only to approved distributors who meet specified minimum criteria and the distributors agree only to supply end users or other distributors or dealers within the approved network. These minimum specific criteria are often set out in a schedule at the end of the agreement. Such criteria may include having suitable premises, having adequate training of sales personnel and providing sufficient after-sales services.
Is selective distribution appropriate for my business?
There is no definitive list of products for which selective distribution has been found to be necessary. Past decisions of the Commission and the European Courts have however indicated that selective distribution is likely to be justified in the case of luxury goods such as perfumes and cosmetics, technically complex products such as photographic equipment, and products that combine the two such as high-quality watches.
Selective distribution is therefore not appropriate for all businesses. If the characteristics of the product do not require selective distribution or do not require certain minimum criteria, such a system would not be efficient. EU competition law also comes into play here. If a selective distribution agreement is found to prevent, restrict or distort competition within the internal market, the businesses involved may be liable to pay large fines. Individuals involved may even find themselves facing director disqualification or criminal sanctions for the most serious breaches.
How do I know if my selective distribution agreement is in breach of EU competition law?
Under Article 101(1) of the Treaty on the Functioning of the European Union (TFEU), an agreement will be in breach of EU competition law if it prevents, restricts or distorts competition within the internal market. However, it is generally accepted that selective distribution agreements will not be caught by this restriction provided that three conditions are met. These conditions are set out in the case of Metro I. Firstly, selective distribution must be necessary for the products in question. Secondly, distributors must be chosen on the basis of objective, qualitative criteria. And thirdly, the conditions must be laid down uniformly and applied in a non-discriminatory manner. If these conditions are satisfied then Article 101(1) probably won’t apply and your agreement will not be in breach of EU competition law. If you think that your agreement is, or may still be, caught under Article 101(1) then the next step is to consider whether your agreement qualifies for an individual exemption under Article 101(3).
Under Article 101(3) of the TFEU, a selective distribution agreement caught by Article 101(1) may still be valid and legally enforceable if it satisfies the individual exemption criteria. The criteria are as follows:
• The agreement improves the production or distribution of goods or services or promotes technical or economic progress;
• The agreement allows consumers a fair share of the resulting benefit;
• The agreement does not impose any restraints on competition other than those absolutely necessary to attain the above objectives; and
• The agreement does not substantially eliminate competition.
If you can satisfy all four criteria then your agreement will qualify for an individual exemption and will not be in breach of EU competition law. If your agreement does not satisfy all four criteria then all is not lost. Your agreement may still be caught by something called the “vertical agreements block exemption.”
Vertical agreements block exemption
For the purposes of EU competition law, a selective distribution agreement is a “vertical agreement”. A “vertical agreement” is an agreement entered into by two or more parties which operate at different levels of the production or distribution chain, relating to the conditions under which the parties may purchase, sell or resell certain goods or services. The “vertical agreements block exemption” (VABE) creates a general presumption of legality for “vertical agreements”, provided that the supplier’s market share is below 30% and that the agreements do not contain specific hardcore restrictions. Hardcore restrictions include:
A supplier cannot impose fixed or minimum prices at which distributors must resell the goods that have been supplied. Providing a list of recommended selling prices or imposing maximum selling prices may be acceptable provided that they do not amount to a fixed or minimum selling price as a result of pressure from or incentives offered by the supplier.
Certain territorial/customer sales restrictions
A supplier cannot apply any direct or indirect restrictions on the territories to which, or customers to whom, the distributor may sell the contract goods or services.
Cross supplying between distributors
A supplier cannot restrict authorised distributors from selling or purchasing the supplied goods to or from other authorised distributors in the network. This means that appointed distributors cannot be forced to purchase the goods exclusively from the supplier.
When assessing whether your selective distribution agreement falls under the VABE you also need to look out for certain “excluded restrictions”. If your agreement contains certain “excluded restrictions”, the VABE will not apply to that specific restriction. However, the rest of the agreement may still benefit from the VABE exclusion if the above conditions are satisfied and the “excluded restriction” is severed from the agreement. Hardcore restrictions cannot be severed from an agreement in this way. The “excluded restrictions” are:
Buyer non-compete obligations if these extend beyond five years
A supplier cannot directly or indirectly restrict the distributor from manufacturing, purchasing or reselling any goods or services that compete with the supplied goods or services. A supplier also cannot insist that the distributor purchases more than 80% of their total purchases of that product from them.
Post-termination buyer non-compete obligations
A supplier cannot directly or indirectly restrict the distributor, after termination of the agreement, from manufacturing, purchasing or selling competing goods or services unless the obligation is limited to a maximum period of one year, it is necessary for the protection of know-how and the obligation is limited to the same point of sale from which the distributor has operated during the agreement.
Restrictions on sales of particular competing products
A supplier cannot directly or indirectly restrict an authorised distributor in a selective distribution network from selling the brands of particular competing suppliers.
Agreements of minor importance
Some selective distribution agreements may also be able to benefit from the Commission’s 2014 Notice on agreements of minor importance. The De Minimis Notice states that the Commission will not normally initiate proceedings against agreements between Small to Medium Enterprises. The Notice also states that larger companies should not face investigation where their market shares in the relevant markets do not exceed 15% for agreements between non-competitors and 10% for agreements between competitors. Where competition is restricted by the cumulative effect of the agreements, this threshold is lowered to 5%. An agreement can only benefit from the De Minimis Notice if it does not have as its object the prevention, restriction or distortion of competition. Agreements containing one or more of the hardcore restrictions are also unlikely to benefit from an individual exemption or the De Minimis Notice.
If you’ve been keeping up-to-date with EU competition law then you’ve probably heard of the Coty case. In 2017 the Court of Justice of the European Union confirmed that luxury brands may restrict distributors in a selective distribution network from selling their goods through third-party online platforms such as Amazon and eBay, if:
• Distributors are chosen on the basis of objective, qualitative criteria;
• The criteria are applied uniformly and in a non-discriminatory fashion;
• The criteria do not go beyond what is necessary; and
• The restriction in proportionate in the light of preserving the luxury image of the goods.
In 2018 the commission expressly indicated that the Coty principles applied irrespective of the product category concerned and were equally applicable to non-luxury products.
This principle, however, should be followed with caution. In 2018 the Competition Appeal Tribunal confirmed the decision of the Competition and Markets Authority (CMA) against Ping Europe Limited. The CMA found that Ping, a manufacturer of golf clubs, had infringed competition law by entering into agreements with two UK retailers with clauses prohibiting them from selling the Ping golf clubs online. The CMA found that Ping’s commercial aim of promoting in-store custom fitting could have been achieved through less restrictive means. This landmark case sends an important signal that attempts by manufacturers to impose absolute bans on selling their products online are not permitted by law.
Selective distribution is an exciting and ever- developing system in the distribution and marketing world. Before entering into a selective distribution agreement you should carry out extensive research and consider your options carefully. If you have any questions concerning selective distribution agreements please contact Neil Williamson.