The article was published with some editorial changes in digest “Commercial and contractual law” issue 8, 2014

One of the most significant and dangerous harm to competition cases are allocation of markets and customers among undertakings. Along with determination of prices and limiting production and sales, they are considered the so-called “hardcore restriction of competition” – such restrictions of competition, in which no matter how small the market share of the concerned undertakings is, it can never be considered to have minor importance on the market.

This understanding is not accidental. Upon determination of prices the participants in the relevant agreement eliminate the price competition between them. They would not offer the consumers (clients) lower prices in order to attract them. From this the latter suffer direct consequences because they are unable to buy the same goods (product) at a lower price. Upon extreme forms of allocation of markets and/or customers on the other hand, the competition is fully eliminated and each of the involved undertakings receive a particular market (usually geographic) or a specific group of customers.

Principally restrictions of competition (when it doesn’t come to abuse) can be carried out by both undertakings which are competitors (“horizontal restraints”) or by undertakings which operate in different markets i.e. for example, one that supplies raw materials needed to manufacture the products of the other, or one is a manufacturer and the other is a wholesaler, etc. (“Vertical restraints”). There may be vertical restraints with horizontal effects – for example, one participant in the agreement is a manufacturer and he himself is a wholesaler and the other is just a wholesaler.

The subject of this article is vertical restraints and above all those of them related to the allocation of territories and customers, as well as the regulatory approach to them (at European and national level, at the level of “soft law” – voluntary acts, which however reveal how particular behavior is treated, as well on practice level).

Regulations on vertical restraints and philosophy of application of the prohibition and the releasing of it

            EU Regulation – primary law

            In EU law, restrictions of competition that are not associated with unilateral abuses are regulated at the level of primary law in Art. 101 of the Treaty on the Functioning of the EU (ex art. 81 of the Treaty establishing the European Community), concerning both the horizontal and vertical agreements, decisions of associations and concerted practices (hereinafter collectively referred to as “agreements”). Paragraph 1 provides the general prohibition of such anti-competitive agreements and in paragraph 3 is provided the possibility of its dropping out.

To understand the regulation contained in secondary EU law (and also in the Bulgarian national law) shall be briefly examined the philosophy of application of the prohibition of the relevant restrictions and the releasing of it.

Philosophy of application of the prohibition of vertical restraints and the releasing of it. EU law – secondary law and sotf law

            The starting position is that there is a ban on any kind of agreements which have as their object or effect the prevention, restriction or distortion of competition within the internal market (Art. 101 TFEU and Art. 15 of Bulgarian Law on Competition Protection). The Treaty and the law contain a non-exhaustive list of typical such cases, among which are direct or indirect determination of prices or other trading conditions; market allocation or allocation of sources of supply and more.

Possibility of exemption from the prohibition is provided for agreements which contribute to improving the production or distribution of goods or to promoting technical or economic progress, if they meet a few more conditions in the Treaty and the law.

The basic regulation governing anti-competitive practices in the EU is Regulation 1/2003[1]. Among other provisions, it stipulates that in order the exemption from the prohibition to be applied it is not required a prior decision, which is a novelty in 2004 and practically means that undertakings (and their advisers and lawyers) alone assess whether their behavior is exempted from the ban or not. Specifically for the vertical restraints the regulation in the EU is developed in Regulation (EU) № 330/2010, determining which vertical restrictions were previously exempted from the ban. The concept here is that although the formal criteria the agreements to be considered as prohibited are met, in most cases has been proven that there is a preponderance of positive effects of the anti-competitive.

In the sector of motor vehicles is issued Regulation (EU) № 461/2010 of the COMMISSION[2]. In it for the aftermarket are explicitly added several cases where the exemption can not be done. In summary, the regulation of the aftermarket car parts is more rigorous than the common.

However, it should be immediately pointed out that Regulation 1/2003 provides that the Commission may withdraw the exemption when it establishes that in any particular case an agreement has certain anti-competitive effects.

Apart from the pointed out Regulations the vertical restraints are covered in Notices of the Commission – in this case this is a summary of its practice and shows how it would suit the future on an issue. The Notices do not have mandatory binding force, but can be seen as a prominent landmark. Moreover, in its practice Bulgarian Commission on Protection of Competition (CPC) has always strived to comply with specified in such notices.

Relevant to the implementation of the discussed ban are primarily the so-called Commission Notice on agreements of minor importance[3], and the Commission Notice – Guidelines on Vertical Restraints[4]. Of importance is also the Notice concerning markets related to motor vehicles[5].

In summary the concept is as follows:

– There is a prohibition in principle, but there are agreements which because of their insignificant effect did not fall within the scope of this prohibition (rule “de minimis”) – they are described in detail in the Notice on agreements of minor importance.

– There are agreements which, although, are not with minor importance, it is previously clarified that they meet the requirements for exemption – they are included in the Block Exemption Regulation.

– Agreements which are neither with minor importance nor meet the general requirements to be considered as exempted, are subject to individual assessment of whether it should be considered as punishable or released.

– There are certain “hardcore” infringements where it is not possible to apply the rule de minimis, or Block Exemption Regulation. Individual exemption in such cases is generally possible, but practically unlikely.

Regulation in Bulgaria

            Bulgarian Law on Competition Protection approaches in the same way as the European framework. Art. 15 of the LCP establishes a general prohibition on anti-competitive agreements and Art. 16 provides that it shall not apply to agreements with inconsiderable effect on competition and governs when there is such inconsiderable effect, and that it can never be present in the presence of “hardcore restrictions”. Art. 17 provides opportunities for exemption from the prohibition, and, if there is a controversy, the undertaking (or his advisers) must prove that they have met the specified requirements. The law was given the opportunity to the CPC to exempt from the prohibition certain categories of agreements by Commission decision, which is not subject to appeal. It may also decide that for certain behavior does not apply nor its block exemption, nor one that is under the European block exemption regulation.

            Currently into force is Decision № 55/2011 by which certain categories of agreements are exempted from the ban. An interesting approach by the CPC is that vertical agreements with purely national manifestation are considered exempted from the ban on Bulgarian LCP if they meet the conditions of the European Regulation. In practice, thus extends the scope of the Regulation and its texts are equally applicable to purely domestic transactions[6]. Such reference is made also about the concept of “hardcore violations.”

Definition of vertical restraints. Agency agreement. Anti competitiveness in vertical agreements.

“Vertical restraint” is a restriction of the competition in vertical agreement, which falls within the scope of Art. 101 of TFEU (respectively Art. 15 of LCP). “Vertical agreement” is an agreement entered into between two or more undertakings each of which operates at a different level of the production or distribution chain, and relating to the conditions under which the parties may purchase, sell or resell certain goods or services.

It is important to keep in mind that this is an agreement between independent undertakings i.e. if it did not exists, it would be supposed that any of the undertakings woulld determine their commercial behavior by itself. If two undertakings are dependent on each other, it can not be expected each one to decide its competitive behavior by itself and therefore the agreements between them would not fall within the discussed category. Specific exhibition of this idea comes in that the so called “pure agency agreement” is not considered as a vertical agreement.

            It should be emphasized something more. As the Commission has clearly established in its practice, for most vertical restraints, competition concerns can only arise if there is insufficient competition at one or more levels of trade, that is, if there is some degree of market power at the level of the supplier or the buyer or at both levels. It is not only a theoretical concept but the EC has clearly stated in its practice that the vertical restraints are generally less harmful than horizontal restraints. In vertical agreements, they are of minor importance if the market share of each of the parties to the agreement does not exceed 15% on any of the relevant markets. For the horizontal agreements this limit is 10% and it is considered the sum total share of the undertakings involved. In Art. 16 of the LCP have been adopted the same quantitative indicators, though particularly in respect of vertical agreements, the wording of the law is quite non-precision.

Typical types of vertical agreements that may affect competition are agency agreementss and such for subcontract.

EC defines the “agent” for the purposes of antitrust law as a legal entity or a natural  person vested with the power to negotiate and/or conclude contracts on behalf of another person (the principal), either in the agent’s own name or in the name of the principal, for the purchase of goods or services by the principal, or sale of goods or services supplied by the principal. As mentioned above, if the contract is a pure “agency contract”, then it will not ever be able to fall into the hypotheses of the prohibition. Determining factor in this regard is the financial or commercial risk borne by the agent in connection with the activities for which he was appointed as an agent. It is assumed that the agreement is for pure agency, if the agent does not bear any, or bears only insignificant risks associated with contracts concluded and / or negotiated on behalf of the principal. It comes to risks related to market-specific investments and other activities in the same product market. Risks that are related to the activity of providing agency services in general, such as the risk of the agent’s income being dependent upon its success as an agent, are not material to this assessment.            Of course, the assessment of whether a contract is purely agency is complex and is made specifically for each case. It is assumed that in such a contract the function of the agent is part of the activities of the principal. The latter assumes the significant risks and therefore the obligations imposed on the agent fall outside the scope of the prohibition. Figuratively speaking, it is assumed that in these cases the agent is a kind of division in the structure of the principal. So this do not constitute a violation of antitrust law, if in these cases the principal determines that the agent will act only in a specific territory or in respect of certain clients. That would be a violation only if the agent alone has risks of its activity.

Another typical type of vertical agreements is the subcontract. However, the same do not present an interest for the purposes of this article.

Allocation of markets and customer groups through vertical agreements as a restriction of competition.

According to LCP the allocation of markets and customers is a hardcore restriction, for which the rule for minor importance do not apply. European legislation, however, contains a more detailed description of the hardcore restrictions. And since CPC has excluded the application of the block exemption in cases where there are “hardcore restrictions” under European law, the latter are of matter for the law enforcement in the country.

Where such a hardcore restriction is included in an agreement, that agreement is presumed to be prohibited. It is also presumed that the agreement is unlikely to fulfill the conditions of exemption, but the undertakings have the opportunities to prove that there are pro competitive effects and for which reason the individual exemption does not apply.

It is categorically adopted that the block exemption can never be present when there is a restriction on sales by a buyer party to the agreement or its customers far as those restrictions relate to the territory or the customers to whom the buyer or its customers may sell the contract goods or services. This hardcore restriction relates precisely to market partitioning by territory or by customer groups. Any other agreements that somehow lead to the allocation of territories or customers, but do not include such restrictions do not exclude from application the block exemption, although according to the text of Art. 16 of the LCP are not such with inconsiderable effect.

Most typically looks allocation of markets or customers to be made as a result of the assumption of direct obligations. For example, the distributor can be directly undertook not to sell to certain customers or to customers in certain areas. Also typical example would be a commitment to direct orders from such “forbidden” customers or territories to other distributors. It is possible, however, the result of an agreement not to be so direct. Restrictions are also cases where the supplier indirectly restricts the possibilities and / or distributor’s stimulus to work to specific territories or customers. For example with a refusal or reduction of bonuses or discounts, termination of the supply, hindering of supplied quantities to the demanded searching size within the specified distributor territory or customer group, limiting the share of sales that can be exported, etc. There are also other, more indirect ways to get to such a partition.

It is important to recognize that in the European practice as a serious infringement is considered banning the distributor to sell in certain areas / customers. Prohibition for the supplier is however permissible. If the distributor is free to sell where it sees fit, but his supplier is forbidden to sell in a given area, it will not be evaluated as such a hardcore restriction of competition.

There are several cases in which, although there is such a restriction in the activity of the distributor, the Commission accepts that hardcore restriction does not exist:

– If there are territories or customers for which a distributor is the exclusive distributor or which are reserved for the supplier itself, then it is permissible for other distributors to be prohibited  working with these areas / customers. Exclusive distribution means that under the contract between the parties, the supplier is committed only exclusive distributor to work in the area in the question. It is important to note that in these cases it is unacceptable the so called passive sales to the retention groups or territories to be restricted. While the sale is active when individual customers is actively approached or is actively advertised a territory, passive sales mean responding to unsolicited requests from individual customers including delivery of goods or services to such customers. Standard general advertising or promotions, customary for advertising in territory outside someone’s exceptional, even when they reach customers in (exclusive) territories of other distributors are considered passive selling. It is unacceptable for them to be restricted with a vertical agreement. Even though with some uncertainty, the use of a website is considered passive selling and any restriction on the distributor to use its website to advertise a territory or to serve customers, reached his website, is generally illegal. It is also prohibited to be limited the quantity of goods that can be sold online. It is permissible, however, for the supplier to sets certain standards to the distributor for example to possess separate stores.

– It is permissible under certain conditions a wholesaler to be restricted from selling to end users.

– There is no hardcore restriction if the provider restricts the distributors in a selective distribution system from selling to unauthorized distributors.

– It is permissible a buyer of components to whom they are supplied for incorporation into a product, to be restricted from reselling them to competitors of the supplier

Typical clauses in vertical agreements related to market allocation

In the practice of the European Commission and the CPC can be found some typical cases where there could be effects associated with the allocation of the market. Of course, such effects do not always occur, and on the other hand, market allocation can occur also in other cases.

Under Regulation 330 is assumed that in general vertical agreements are not prohibited if the market share of each participant in its market is up to 30%. The Regulation (for Bulgaria – Decision 55/2011) regulates also the conditions under which as exempted are considered decisions of associations of undertakings having an effect as agreements between undertakings. However, even if market shares in question are higher than 30% this does not mean that there is no possibility of individual exemption. Also, even if there are hardcore restrictions under the Regulation, an individual exemption can happen, although it is less likely. In each case an individual assessment should be made. Key criteria to be considered are the nature of the agreement, market shares, market shares of competitors, opportunities for access to the market, buyer power of the customers, the nature of the product, degree of maturity of the market and others. Main competition risks of market partitioning are restricting access to the market, easing price discrimination, easing the opportunities for collusive agreements, obstruction market integration and more. In the assessment  should be evaluated also possible positive effects such as easing the development of new products and markets, overcoming the “market parasitism”, stimulating the investments, economies of scale, building the image of the brand and others.

It is very important to keep in mind the overall context in which is concluded a vertical agreement. If there is only one of this, and the relevant commitments are made between a supplier and a distributor. It is obvious that this situation can not lead to allocation of territories or customers among several distributors as far such several distributors do not exist. Quite the opposite – in a system of agreements under which a provider concludes a many vertical agreements (eg. Exclusive distribution) with many (exclusive) distributors, then it leads to the real allocation. Here, however, must be recognized that no one should be held responsible for more than an agreement in which he participates. Otherwise would be contrary to the personal nature of liability under the LCP.

Selective distribution system

In Selective distribution agreements there is a limited number of authorized distributors with limited possibilities for resale. They are based on the selection criteria related primarily to the nature of the product. Selective distribution is almost always used to distribute branded final products.

EC in its practice allowed under this type of agreement to be provided resale restrictions in respect of all sales to unauthorized distributors i.e. not only restriction of active sales.

Any presence of selective distribution in one degree or another, represents allocation of market, but it is acceptable because the criteria are related to the characteristics of the product. However EC does not allow to be prohibited to a member of a selective distribution network to distribute the product to a group of end customers. I.e. any prohibitions to sell to unauthorized distributor are eligible, but any bans on sales to group customers (whether professional or not) are inadmissible. There is no obstacle however each member of a selective distribution network to obtain a certain area and may not sell off. However, if there is such an allocation of territory, it would be illegal the so allocated network of selective distribution to be combined with clauses of exclusive distribution. When there is a selective distribution, its members should be able to purchase products from one another.

Supply with a product of only one brand

This is a vertical restraint that restricts the competitive behavior of the distributor, but not on the markets / customers, to which he sells but the opposite – he is obligated or induced to purchase a certain type of product only when it is produced by one manufacturer. It is assumed that when the purpose or effect is more than 80% of the relevant products to be of the producer, there is such a restriction. In its purest form, it does not mean that the buyer can only buy directly from the supplier (that would be “exclusive supply” described below) but that the buyer will not buy and resell or incorporate in his product goods or services by competitors of the relevant producer. A so-called ‘English clause’, requiring the buyer to report any better offer and allowing him only to accept such an offer when the supplier does not match it, can be expected to have the same effect as a single branding obligation. The allocation of the market in this case is in favor of the supplier, as he guarantees namely his product to reach customers of the distributor. In itself this restriction is not hardcore.

Exclusive distribution

The exclusive distribution looks classic form of market allocation. With it the supplier agrees to sell his products only to one distributor for resale in a particular territory. At the same time the distributor is usually limited in his active selling into other (defined as exclusive) territories. The main problems for competition posed by this type of agreements are related to non-allowing other distributors as competitors in the wholesale market, and facilitating the possibilities for collusive agreements. The exclusive distribution is exempted by the Block Exemption Regulation when the supplier’s market share does not exceed 30%, even if combined with other vertical restraints, of course if the same are not hardcore restrictions.

A combination of exclusive and selective distribution is exempted by the Block Exemption only if the active selling in other territories are not limited.

Although the exclusive distribution to look like a typical allocation of the market, it must be borne in mind that it is not always with anti-competitive effects. For example, there will be no real limitation to the access to the market if the exclusive distribution is not related to the obligation for working with only one brand. Although in a given territory (group of customers) to work only one distributor, if that distributor sells goods with different brands, then each manufacturer (supplier) will practically have access to the reserved area or group of customers, and customers will have access to all these brands.

If the exclusive distribution occurs in the market for retail trade is assumed that risks of competition are higher than in wholesale. Also, if it is combined with the so- called “exclusive supply” (with it the distributor is required to purchase goods only from certain parties without the opportunity to use alternative suppliers), the manifestation of the anticompetitive effects increases.

Possible pro-competitive effects of the exclusive distribution are associated with provoking investments by distributors about protecting or building up the brand image and saving logistic costs due to economies of scale in transport and distribution. Pro-competitive effects can be expected for new products, for complex products and for products whose qualities are difficult to judge before consumption.

Exclusive customer allocation

            In an exclusive customer allocation agreement, the supplier agrees to sell its products to only one distributor for resale to a particular group of customers. At the same time, the distributor is usually limited in its active selling to other (exclusively allocated) groups of customers. The ways an exclusive customer group to be defined are different – for example by their occupation but also through a list of specific customers selected on the basis of one or more objective criteria. The main competition risk is the price discrimination to be facilitated. Where most or all of the suppliers apply exclusive customer allocation, collusion, both at the suppliers’ and the distributors’ level, may be facilitated. Lastly, exclusive customer allocation may lead to market foreclosure for other distributors. Itself exclusive customer allocation is not a hardcore restriction and may benefit from a block exemption. Its combination with selective distribution, however, generally constitutes a hardcore restriction.

Certain effects of market allocation may also have other typical vertical agreements such as franchise systems; exclusive supply (when the supplier is obliged or induced to supply the contract products only or mainly to one buyer), upfront access payments, agreements about category management and others.

In conclusion, it can be concluded that the vertical restraints of competition are generally less harmful than the horizontal and in many cases they are exempted from prohibition to restrict competition. However, when they lead to serious consequences such as the market allocation, they are inherently punishable. For each agreement to determine whether it is punishable or is considered exempted from the prohibition should be made specific and comprehensive examination of all relevant criteria and factors as the assessment is made by the undertaking itself as in the event of a dispute, it must justify why it is have considered that the agreement is not illegal.