Businesses take note - the introduction of the UK's new 'Vertical' agreements regime is fast approaching

Businesses should now be conducting a competition law review of their supply and distribution contracts as the UK (and EU) rules that apply to such 'vertical agreements' are changing imminently.

The UK's retained EU block exemption, the Vertical Agreements Block Exemption Regulation (VABER) expires on 31 May 2022. It will be replaced on 1 June 2022 by the UK's new Vertical Agreements Block Exemption Order (VABEO).The VABEO simultaneously introduces new prohibitions and greater flexibility for businesses than under VABER. Compliance with the VABEO will:

1. provide businesses with legal certainty that provisions in their distribution and supply agreements do not infringe UK competition law;
2. avoid potential fines; and
3. ensure that the agreements are legally enforceable.

With the implementation date fast approaching, it will be important for businesses to start thinking about how the proposed changes could impact their distribution and supply agreements and indeed, how they can seek to maximise the greater flexibility afforded by the new regime.The purpose of this alert is therefore to summarise the background and explain the key changes in the UK.Note that this alert does not cover the changes to VABER that will be introduced simultaneously in the EU. There are some crucial differences between the two regimes, so if you have any questions or require advice on the proposed EU regime, please contact the Competition team at Freeths.

Background: The Competition Act 1998 prohibits agreements and arrangements between businesses that restrict competition in the UK (unless they meet the conditions for exemption or are otherwise excluded). An agreement is exempt from that prohibition if it creates sufficient benefits to outweigh any anti-competitive effects.VABER is the current block exemption for 'vertical agreements'. It was introduced across the EU in June 2010 and following the end of the Brexit transition period, was one of the seven EU block exemption regulations that were retained under UK law.Vertical agreements are entered into between businesses operating at different levels of the production or distribution chain, such as agreements between manufacturers and wholesalers or retailers. VABER provides a 'safe harbour' and automatically exempts agreements which satisfy its conditions. In other words, vertical agreements that meet the conditions of VABER are presumed to be lawful under UK competition law.More specifically, VABER provides a full exemption for vertical agreements entered into between businesses with market shares of 30% or less where they do not contain any so called 'hardcore' (or 'excluded') restrictions.The Competition (Amendment etc.) (EU Exit) Regulations 2019 enable the Secretary of State to renew or replace block exemptions as they expire. Last November, the Competition and Markets Authority (CMA) recommended that the Secretary of State for Business, Energy and Industrial Strategy (BEIS) replace VABER with new UK legislation, the VABEO.

What will change?The VABEO aims to reflect the significant market developments that have occurred since the introduction of VABER and seeks to ensure that businesses in a 'vertical' relationship with each other are not prevented or disincentivised from entering into agreements that the CMA considers to be overall beneficial and not anti-competitive.While the good news is that the new regime does not involve a total overhaul of the current rules, there are a number of notable changes to be aware of:

1. 'Wide retail parity obligations' will be classed as 'hardcore' restrictions that remove the benefit of the exemption and are presumed to restrict competition

'Wide retail parity obligations' are a type of Most-Favoured Nation clause. They require that a product or service is not offered on better terms on any other sales channel (whether offline or online). This would include both the product supplier's own website and any other indirect channels such as third-party distributors or online platforms.

To date, these obligations have received most attention in relation to vertical agreements involving online platforms (e.g., price comparison websites and online travel agents).

The CMA is concerned that they restrict competition between competitors by reducing their incentives to compete on price, to innovate and to enter markets or expand.

It is important to note, however, that the hardcore restriction:

• does not apply to 'narrow retail parity obligations' such that parties can agree a prohibition on a product supplier offering better terms on its own website; and
• only applies in relation to agreements that relate to the offer, sale or resale to end users and as such, any similar parity obligations agreed as between businesses (wide or narrow) will not be hardcore restrictions and can still benefit from the VABEO.

2. The exemption will be available to a broader group of 'vertical' relationships

The growth of the UK's digital economy and online sales has led to an increase in businesses choosing to operate 'dual distribution' models. One example would be a business choosing to sell to both retail and wholesale customers. This would result in the business and its wholesale customer competing for the same customers at the retail level.

As is the case under VABER, vertical agreements between competitors will not fall within the scope of the VABEO unless they are non-reciprocal and fall within one of the 'dual distribution' exceptions. One such exception covers agreements between suppliers and distributors where the supplier both manufactures and distributes products and the distributor does not compete at the manufacturing level.

The VABEO extends this list of exceptions to cover 'dual distribution' by wholesalers and importers.

3. There will be more opportunity to treat online and offline sales differently

The growth of online shopping has created increased challenges for the UK high street and retailers providing 'brick-and-mortar' stores. While VABER championed and protected online sales, the VABEO (and the draft Guidance that should be read alongside it) attempts to redress the imbalance that has arisen in recent years by allowing suppliers to benefit from the exemption where they decide to:

1. 1. charge a higher price for products intended to be sold online than for products intended to be sold offline or 'in-store' by the same distributor (also known as dual-pricing); and/or
   2. impose different criteria for online and offline sales on distributors party to a selective distribution system.

The draft Guidance also confirms a previously contentious issue, that businesses can restrict the use of a specific sales channel, such as an online marketplace, regardless of the distribution model adopted, and still benefit from the block exemption provided by the VABEO.

Note, however, that restrictions that aim to prevent the effective use of the internet as a sales channel will remain 'hardcore'. The draft Guidance provides specific examples which reflect recent case law, such as requiring a distributor not to use a supplier trademark or brand name on its website, restricting the use of online advertising channels or banning the use of a supplier's trademarks when bidding for online search advertising.

4. Businesses will have more flexibility in the design of their distribution systems

As is the case under VABER, restrictions on the territories and customers to which a buyer can sell will continue to be 'hardcore' restrictions under the VABEO. That said, the scope of the exceptions to this general rule will be extended to allow:

1. The combination of exclusive and selective distribution in the same or different geographical areas;
2. Shared exclusivity in a geographical area or for a customer group (e.g., allowing the allocation of a geographical area to more than one distributor); and
3. The provision of greater protection for members of a selective distribution system against sales from outside the geographical area to unauthorised distributors inside that geographical area.

 

5. Businesses may have to provide information on their vertical agreements to the CMA

The VABEO provides the CMA with the statutory power to request information in relation to vertical agreements. It requires any party to a vertical agreement to provide the requested information within 10 working days. Failure to comply with this obligation, without reasonable excuse, could lead to the CMA cancelling the application of the VABEO to the agreement concerned.

This power may facilitate more effective enforcement of the rules going forward and as such, should encourage businesses to review their agreements to ensure compliance with the new regime.

When will the changes take effect? The VABEO will enter into force on 1 June 2022.There will be a transition period of one year, providing businesses the opportunity to review their agreements and ensure that they comply with the new rules. During this period, pre-existing agreements that satisfy the conditions for exemption under VABER will continue to fall outside of the competition law rules.Unlike VABER, however, the VABEO will only be in place for 6 years (i.e., until 1 June 2028). This shorter duration should enable the UK to act upon and reflect future market developments more quicky and could signal the possibility of further divergence from the former EU regime in future. Next Steps With the implementation date fast approaching, it will be important for businesses to start thinking about how the proposed changes could impact their distribution and supply agreements.We strongly recommend that clients review their agreements and their upcoming renewal dates. Those that are due to expire or be renewed post transition period (i.e., continue beyond 1 June 2023) should be identified and prioritised for review.The Competition team at Freeths would be happy to advise on how best to maximise the flexibility afforded by the new regime or to discuss any necessary amendments to your current distribution or supply arrangements.

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If you would like any further information in relation to anything covered in this update, please contact a member of our Competition Team.