EU Competition Rules for Distribution Agreements #5: Non-compete obligations

Why is competition law important in the distribution context?

Article 101(1) of the Treaty on the Functioning of the European Union prohibits anticompetitive agreements or concerted practices. Agreements infringing Article 101(1) are void and may expose your company to fines and/or damages before national courts and/or competition authorities. This is particularly important in the context of distribution agreements where private parties (i.e. your companies’ customers and competitors) are often the most likely to go to court or file complaints with competition authorities.

This note is part of a blog series in which we seek to provide guidance on the most relevant topics of EU competition law for distribution agreements. In this fifth blog we discuss non-compete obligations.

What is it?

A non-compete obligation is defined in the Vertical Block Exemption Regulation (‘VBER’) as:

“any direct or indirect obligation causing the buyer not to manufacture, purchase, sell or resell goods or services which compete with the contract goods or services, or any direct or indirect obligation on the buyer to purchase from the supplier or from another undertaking designated by the supplier more than 80% of the buyer’s total purchases of the contract goods or services and their substitutes on the relevant market, calculated on the basis of the value or, where such is standard industry practice, the volume of its purchases in the preceding calendar year.”

It follows from this definition that a non-compete clause can apply to three situations:

1. the supplier prohibits its distributor from selling competing goods or services;
2. the supplier prohibits its distributor from starting a competing business in a certain area; and/or
3. the supplier obliges its distributor to purchase more than 80% of the supplier’s products or services.

Non-compete clauses: when are they permissible?

Non-competition clauses have their own regime in the VBER, which is laid down in Article 5. A non-competition clause that meets the conditions of Article 5 falls under the safe harbour of the group exemption, provided that the market shares held by the supplier and the buyer on the relevant markets do not exceed 30% (Article 3) and the agreement does not include any of the hardcore restrictions set out in Article 4 of the VBER.

Pursuant to Article 5 of the VBER, when assessing non-compete obligations, a distinction must be made between non-compete obligation that apply during the term of the agreement and non-compete obligations that apply after termination of the agreement,

Non-compete obligations during the agreement
Non-compete obligations cannot benefit from the block exemption if their duration is indefinite or exceeds five years. Non-compete obligations that are tacitly renewable beyond a period of five years can however benefit from the block exemption, provided that the buyer can effectively renegotiate or terminate the vertical agreement containing the obligation with a reasonable period of notice and at a reasonable cost. It must be possible for the buyer to effectively switch its supplier after the expiry of the 5-year period.

The limitation of non-compete obligations to a duration of 5 years does not apply where the contract goods or services are resold by the buyer from premises and land owned by the supplier or leased by the supplier from third parties not connected with the buyer. In such cases, the non-compete obligation may be imposed for a longer duration, provided this does not exceed the period of occupancy of the point of sale by the buyer. The reasoning behind this is that it is considered unreasonable to expect a supplier to allow competing products to be sold from premises and land that it owns without its permission.

Where the term of a non-compete exceeds five years or is indefinite, it cannot benefit from the safe harbour under the VBER. Such clauses require an individual assessment under Article 101 TFEU. Unlike the case with hardcore restrictions, the inclusion of a non-compete clause that is formulated too broadly does not mean that the rest of the vertical agreement cannot benefit from the VBER.

Post-term non-compete obligations
Post-term non-compete obligations imposed on the buyer are excluded from the benefit of the block exemption, unless all of the following conditions are fulfilled:

1. the obligation is indispensable to protect know-how transferred by the supplier to the buyer;
2. it is limited to the point of sale from which the buyer has operated during the contract period;
3. it is limited to a maximum period of 1 year.

The know-how concerned must be secret and substantial. In particular it must include information that is significant and useful to be buyer for the use, sale or resale of the contract goods or services.

Key rules non-compete restrictions

• Non-compete obligations must be limited to five years in order to benefit from the block exemption.
• Non-compete obligations may be tacitly renewable beyond five years on the condition that the distributor can effectively switch to a competing supplier after the expiry of the five-year period.
• Post-term non-compete obligations must fulfil a set of stringent criteria and may last no longer than one year in order to benefit from an exemption under the VBER.

FAQ’s

Can non-compete obligations that are tacitly renewable beyond a period of five years benefit from the safe harbour under the VBER?
It depends. Non-compete obligations that are tacitly renewable beyond a period of five years can benefit from the block exemption, provided that the buyer can effectively renegotiate or terminate the agreement with a reasonable period of notice and at a reasonable cost.

For example, if the supplier has granted a loan to the buyer, the repayment of this loan should not be arranged in such a way that it prevents the buyer from being released from the non-compete obligation at the end of the five-year period. Similarly, in cases where the supplier has supplied certain equipment to the buyer, the buyer should have the option to acquire such equipment at its market value at the end of the five-year period.

Is there a different regime for non-compete obligations in franchise agreements?
In view of the specific characteristics of franchising (such as the use of a uniform business name, uniform business methods (including the licensing of IPRs) and the payment of royalties in return for the benefits granted), provisions that are strictly necessary for the functioning of franchising systems can be considered as falling outside the scope of Article 101(1) TFEU altogether.

This includes non-compete obligations relating to the goods or services purchased by the franchisee that are necessary to maintain the common identity and reputation of the franchise network.

For such non-compete obligations in a franchise relationship the duration is irrelevant, provided that it does not exceed the duration of the franchise agreement.

If you have any questions about the contents of this note, please contact Minos van Joolingen, Martijn Jongmans or Sophia Wittkämper of Banning’s Competition & Regulatory Team, telephone number +31 73 692 77 52.