LPC: COMMERCIAL LAW & INTELLECTUAL PROPERTY CHAPTER 7

COMMERCIAL LAW & INTELLECTUAL

PROPERTY CHAPTER 7:

Legal Practice Course

DISTRIBUTION AGREEMENTS

Learning Outcomes

After reading this chapter you should be able to:

1. understand the role of distribution agreements and recognise the basic
commercial considerations relevant to distribution agreements;
2. analyse how UK competition law issues arise in the context of a
distribution agreement;
3. identify the CMA’s powers of investigation and the consequences of
prohibited conduct; and

4. apply UK competition law (including, in particular, provisions of the

Competition Act 1998 and the Vertical Agreements Block Exemption
Order) to distribution agreements.

1. Introduction

In this chapter and in SGS 10 you will study distribution agreements. For a
solicitor advising clients on this type of agreement, it is particularly important to
be aware of the applicability of competition law. Competition law regulates,
amongst other matters, the extent to which two or more businesses may come
together and agree on how their goods (or services) are to be marketed. The
consequences of infringing competition law can be very severe and so it is
very important in practice for a commercial lawyer to be sensitive to the risks.

You cannot rely on a client being aware of this before it instructs you in
connection with a distribution agreement. Furthermore, some basic tenets of
competition law may appear counterintuitive to business people (who will be
coming from a purely commercial point of view and with an eye on the ‘bottom
line’) and so you will need to be able to explain the issues clearly. For this
reason, Parts B and C of this chapter are devoted to exploring UK competition
law and how to apply it.

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Before moving on to this topic, however, Part A of the chapter introduces

distribution agreements and addresses the most common provisions of such
an agreement.

PART A: DISTRIBUTION AGREEMENTS

2. Getting products on to the market

So far in the ‘commercial law’ portion of the CLIP module, you have
encountered sale of goods contracts formed between a single buyer and a
single seller. For a manufacturing business, however, a cornerstone of buying
and selling is its ability to get its product ‘out there’ on to the market more
generally. In simple terms, such a business has four choices here.

All businesses who deal in goods need to consider which of these methods
they will use to get their goods on the market. Most will use a combination of
different methods. The question is of particular importance when a business
is breaking into a new market. The four methods are:
1. marketing directly to customers, possibly through a subsidiary and
often online:
although selling directly would generally be seen as the ‘default’ option,
a business might ask itself whether it has sufficient internal resources
and expertise in marketing to make this the sensible choice. A
particularly clear example would be where the business decides to break
into a new market, for example by selling its goods in a different country;
2. appointing an agent to sell goods to customers:
an agent would act on behalf of the manufacturer, its principal. An agent
may find potential customers, negotiate the terms of contracts and even
enter into contracts with customers on behalf of the principal. The key
feature of an agency relationship is that the agent itself never enters into
a contractual relationship with customers on its own account.
agency agreements are governed by the common law of agency so, for
example, principal and agent owe a fiduciary duty to one another. In
addition, agency agreements are quite heavily regulated to ensure that
agents are not exploited by their principals;
3. appointing a distributor to purchase goods for resale to customers:
this is the type of relationship with which this chapter and SGS 10 are
concerned; or
4. licensing its IPRs (e.g. designs or technology):

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the licensee(s) would then be in position to manufacture and sell

products. You encountered IP licences earlier on the module (Chapter 5
/ SGS 6).

2.1 How distribution agreements work

A distributor buys goods from a manufacturer or supplier and sells the goods
on at a profit. There is no direct contractual link between the supplier and the
ultimate customer.

The distributor takes on commercial risks due to its direct contractual link with
the customer (for example, a customer may not pay, or may become
insolvent, or may sue the distributor for breach of contract). However, the
profit margins are normally high enough to justify taking such risks.

A distribution agreement will define the terms of the relationship between the
manufacturer/supplier and the distributor. It will also impose restrictions on the
distributor.

2.2 Types of distribution

You have encountered some of the terminology in this paragraph before,

when considering IP licences in Chapter 5 and SGS 6.

2.2.1 Exclusive

Under this type of distribution agreement, a supplier or manufacturer agrees to

sell its products to just one distributor in a defined territory, not to appoint any
other distributors in that territory and also not itself to sell the same products
directly to customers within that territory.

2.2.2 Sole

This is where a supplier or manufacturer agrees to sell its products to just one
distributor in a defined territory but reserves the right to sell products itself
directly to customers within that territory.

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2.2.3 Non-exclusive

Under this type of distribution agreement, a supplier or manufacturer has

complete freedom to appoint more than one distributor in a defined territory
and also to sell products itself directly to customers within that territory.

2.2.4 Selective

Here the supplier or manufacturer can appoint as many distributors as it wants

in a territory but only if they meet specified criteria such as quality of service.
This method is often used to sell branded goods, for example cosmetics, and
technical goods, where the distributor will need to have specialist expertise. In
the course of the CLIP module, you will not encounter a scenario where your
client is party to such an agreement. But it is important to understand the
expression ‘selective distribution agreement’ since, as you will see, it occurs in
the Vertical Agreements Block Exemption Regulation (see paragraph 6
below).

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3. Main provisions of a distribution agreement

3.1 Appointment

As discussed in paragraph 2.2 above, the basis of the distributor’s

appointment should be made clear.

3.2 Duration

The parties should make provision for the duration of the agreement. This is
often included in the clause dealing with appointment. The distributor is likely
to be keen on an initial fixed term. This will give it an opportunity to establish a
presence and build up relationships with customers. After the expiry of the
initial fixed term the parties may provide for the arrangement to continue
indefinitely until it is terminated by a specified period of notice. Ultimately the
most appropriate duration for each party will depend on commercial factors.

3.3 Products

This term requires careful definition as the supplier may have a broad range of
products and envisage that the distributor will only sell part of that range.
Often it will be sensible to include a schedule to the distribution agreement
where the relevant products can be listed.

The parties also need to make provision for what happens if changes to the
specifications of products are made and new products are launched by the
supplier. What effect will this have upon the arrangement? For example, is
the distributor obliged to accept replacement products or do the parties sit
down and agree to any such changes?

3.4 Territory

It would be common for the agreement to provide that the distributor works
only in a specified territory. On this module, all the distribution agreements
you encounter will award a geographic territory – in practice you may also
come across distribution agreements where the distributor is restricted to
selling to particular types of customer. Care must be taken in drafting all such
provisions because of the risk of infringing competition law.

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When allocating a territory to a distributor, especially if done on an exclusive

basis, a supplier may consider the question of whether or not to ‘reserve’ any
other territory to itself. A ‘reserved’ territory is one which the supplier intends
either to:

 treat as exclusively its own (effectively, acting as its own exclusive

distributor within that territory); or

 perhaps more commonly, allocate in future on an exclusive basis, to one

or more other distributor(s).

3.5 Conditions of sale as between the parties

It is unlikely that the distributor will actually purchase any goods at the same
time as it enters into the distribution agreement itself. Instead the distributor
will place separate orders for goods in order to maintain stock and to meet
orders that it receives from its own customers from time to time. Therefore,
the sale of goods terms set out in the distribution agreement will operate as an
agreed set of standard terms and conditions as between the supplier and
distributor. The supplier will want to ensure these match its own, established
standard conditions of sale. When the distributor places an order for the
supplier’s products, it will already be pre-determined that these are the terms
that will be applicable to that order.

Some examples of such terms include the following:

 The procedure for placing orders and lead times (the distributor is likely to
want the supplier to commit to an agreed lead time for delivery of the
goods to ensure that it can offer delivery times to its own customers).
 Delivery, price and payment.
 Passing of risk and title.
 Warranties/provisions dealing with defects in the goods.
 Termination of orders.

3.6 Product liability

When a distribution agreement is performed there will be

two separate contracts: one between the supplier and the
distributor and a second between the distributor and the Supplier
customer.

If a customer has a claim against the distributor because of

a defect in the products prima facie this will have little to do

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Distributor
LPC: COMMERCIAL LAW & INTELLECTUAL PROPERTY CHAPTER 7

with the supplier. However the Contract (Rights of Third Parties) Act 1999
(unless expressly excluded) and the Consumer Protection Act 1987 may well
mean that a customer could have recourse against the supplier even though
there is no direct contract between them.

The supplier will attempt to minimise and control its liability as far as possible.
Often it will provide a limited product warranty to the distributor for the
distributor to flow down to its customer, and a product liability indemnity. This
exposure will be tempered by imposing a detailed obligation on the distributor
to follow a set procedure in the event of a complaint, for example not to admit
liability, notify the supplier immediately, and allow the supplier to ‘stand in the
distributor’s shoes’ in any litigation claim under which indemnity might be
sought by the distributor from the supplier.

3.7 Duties of the distributor

Duties of the distributor provided for in the agreement might include the
following:
 To purchase products only from the supplier (i.e. not to sell competing
products of other suppliers), subject to competition law (see below) and
the doctrine of restraint of trade.
 To undertake best/reasonable endeavours to promote the products (see
comments above regarding sales/purchase targets).
 To make it clear that they are selling on their own account.
 Not to actively seek customers outside the allocated territory.
 Not to assign the agreement.

3.8 Distributor’s performance targets

The supplier will want the distributor to make a sufficient effort to sell the
supplier’s products: the more products the distributor sells, the more he will
buy from the supplier, resulting in increased profit for the supplier.

This obligation on the distributor may be expressed as an obligation to use

‘best’ or ‘reasonable’ endeavours or to undertake certain marketing or
advertising activities. In addition, the supplier may require minimum sales or
purchase targets to be drafted into the agreement. This will be particularly
important to the supplier if it is an exclusive or sole distribution agreement. A
‘purchase target’ sets out minimum levels of stock that the distributor must
purchase from the supplier under the distribution agreement. A ‘sales target’
would require a distributor to achieve a certain minimum number of sales to its

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customers. A purchase target is preferable to a supplier as it is easier to

monitor and enforce.

The distribution agreement may also provide that the distributor’s failure to
meet targets has a number of different consequences such as termination of
the agreement or removal of sole/exclusive status. It is probable that the
distributor would try to negotiate some sort of margin for error or ability to
rectify the shortfall.

3.9 Confidential information

The supplier may need to pass confidential product, commercial or customer

information to the distributor. For example, a distributor is likely to need
detailed product specifications to be able to buy and re-sell products. You
have already come across confidentiality obligations on this course. If the
supplier wishes to protect any confidential information, the best way to do so
would be to have an express confidentiality obligation on the distributor in the
distribution agreement (subject, as you have seen, to the law relating to
restraint of trade).

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3.10 Intellectual property (particularly trade marks)

The distributor may need to be granted the right to use the supplier’s
intellectual property rights. For example, the distributor may need a licence to
use the supplier’s trade marks in the process of marketing/advertising the
products. You have already come across IP licences in Chapter 5 and SGS6.

It is likely that the supplier will also wish to protect its intellectual property
rights by placing certain restrictions/obligations on the distributor. For
example, the agreement can clarify that the distributor does not acquire any
intellectual property rights in relation to the goods or any related
advertising/marketing materials. In addition, the supplier may wish to impose
some obligations on the distributor requiring it to protect the supplier’s
intellectual property. For example, the supplier may impose a duty on the
distributor to inform the supplier about any suspected third party infringements
and/or to assist in claims against such third parties.

3.11 Termination provisions

As in all commercial contracts, a distribution agreement should make express

provision as to the circumstances in which it can be terminated by one of the
parties, for example in the event of serious, irremediable breach by the other
party.

Particular attention should be given to what will happen upon termination of

the distribution agreement. What will happen to the stock of products owned
by the distributor? For example, can the distributor sell off the products at a
discount?

The distributor would usually have title to the products and so be free to deal
with them as it wished - but discount selling may lower the brand value of the
supplier’s products. Often a distribution agreement contains a provision
requiring the distributor to sell the products back to the supplier at cost price.

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PART B: INTRODUCTION TO COMPETITION LAW

The Impact of Brexit

The UK exited the EU on 31January 2020 (‘exit day’) followed by a transition

period ending on 31 December 2020 (‘IP Completion Day’).

Prior to Brexit, both UK domestic competition law and EU competition law

were enforceable within the UK. The Competition Act 1998 is closely
modelled on EU sources. The only real difference between EU competition
law and UK competition law was one of territorial scope (with some overlap),
in that the former was concerned with distribution agreements which might
affect trade between member states, whereas UK competition law applies to
agreements which might affect trade within the UK.

Since Brexit, EU competition law is no longer enforceable within the UK.

However many of its sources remain as assimilated law - and assimilated EU
case law remains relevant to the interpretation and application of UK
domestic competition law. See paragraphs 4.3 and 4.4 below.

4. Contexts

The rationale of competition law is to facilitate a trading environment where

there is a high level of competition between market players and no artificial
barriers to prevent this. The degree of competition is thought to influence the
use of resources and affect whether consumers are receiving a good deal. A
high level of competition is also thought to encourage innovation.

4.1 How competition law arises in practice

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Competition law is concerned with regulating five types of scenario. The first
of these is the one we study on the CLIP module.

1. Competition law controls the conditions under which players on a market

can co-operate with one another where they are not competitors and
are at different levels of the supply chain (a ’vertical agreement’). This
includes a distribution agreement between a supplier and a distributor.
Such agreements are controlled under s. 2 of the Competition Act 1998
(‘CA’). This is sometimes referred to as the ‘Chapter I Prohibition’
(because s.2 appears in Chapter I of the CA)

We do not deal further with scenarios 2 - 5 (below) within the CLIP module.
They arise relatively rarely in the day-to-day practice of a commercial lawyer
and should be referred to a specialist competition law practitioner:

2. The Chapter I Prohibition also applies to co-operation between

competitors. For example, under normal conditions competitors can be
expected to try and undercut one another’s prices – but if they behave
as a cartel and cease to compete, consumers have no choice but to pay
artificially high prices. An agreement providing for this type of co-
operation between competitors is known as a ‘horizontal agreement’.

3. Abuse of a dominant position regulates business entities that are so

powerful that they are effectively free of competitive restraints (and
hence are ‘dominant’ within one or more of the markets on which they
operate). The ‘Chapter II prohibition’ prohibits such companies from
engaging in exploitative activities. Often such activities would be
perfectly legal for non-dominant undertakings. For example a dominant
undertaking pricing its products below their cost price may be engaging
in ‘predatory pricing’ (to drive weaker players off the market), whereas
for a non-dominant company this would amount to offering an
unobjectionable ‘loss leader’.

4. Merger control regulates the concentration of market power as a result of

an acquisition, change of control in a company, or the creation of a full-
function joint venture. If you are taking the Private Acquisitions elective
you may come across merger control.

5. State aids are some kind of financial advantage (e.g. subsidies, tax
breaks) paid by a government entity to a private entity. This area is
regulated because such payments could potentially create distortions

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and unfairness between those receiving the aid and those within the
same industry who are not.

Helpful to know in practice

In practice, you are likely to discover that competition law is a large and
complex practice area in its own right. There are numerous points of
competition law of which it is helpful to be aware as background knowledge
for CLIP purposes, albeit they are not directly applicable to the distribution
agreements that we study.

For this reason, in Parts B and C this chapter you will occasionally find
paragraphs of boxed text (like this one) headed ‘helpful to know in practice’.
The contents of such text boxes are good to know, but not examinable for
CLIP purposes.

4.2 Enforcement of competition law - The Competition and Markets

Authority

Competition law is enforced within the United Kingdom by the Competition and
Markets Authority (‘CMA’). The CMA began to function on in 2014; before that,
UK competition law was enforced by the Office for Fair Trading (‘OFT’). You
may come across references, in your reading, to the OFT.

An overview of how the CMA investigates infringements, and the

consequences of a finding of infringement of competition law, is given at
paragraph 5.5 below. The CMA is also an important source of policy and
guidance on how to interpret and apply UK competition law.

4.3 The roots of UK competition law are in EU law

The CA was enacted for the purpose of harmonising national UK competition

law with EU competition law. Until Brexit, UK competition law had to be
interpreted and applied consistently with EU competition law. This is no
longer the case (s.60 CA having been repealed). It remains essential to

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acknowledge the impact of EU law in this area because a significant amount

of EU law is still applicable in the UK, as assimilated law, post-Brexit.

EU competition law came first in time. Therefore the CA was drafted and
brought into force in a world where a panoply of EU legislation and case law
was already directly applicable and enforceable within the UK. Hence the text
of s.2 CA reflects that of Article 101 of the Treaty on the Functioning of the
European Union (‘TFEU’). The CA also imported other sources of EU
competition law wholesale into domestic UK competition law. Such sources
(to the extent they were enforceable within the UK as at IP Completion Day)
remain applicable within the UK competition law framework as assimilated law
See paragraph 4.4.2 below.

4.4 Sources of UK competition law

4.4.1 The Competition Act 1998

This statute prohibits certain types of anti-competitive behaviour (namely the

Chapter I and Chapter II prohibitions described in paragraph 4.1 above) and
provides for the consequences of engaging in prohibited conduct. The CA is
the primary source of competition law on this module and you will find extracts
in the CLIP Handbook. In this chapter, we will be looking closely at s.2 CA,
which establishes the Chapter I prohibition, of particular relevance to
distribution agreements.

4.4.2 Ancillary legislation and official guidance

In order to advise clients in practice on the application of s.2 CA, it is

necessary to refer to the following:

 Block Exemptions

A block exemption is a statutory instrument which clarifies whether or

not a given agreement can be exempted from the Chapter I prohibition
(see paragraph 5.2 below). Block exemptions are secondary legislation,
issued as Orders of the Secretary of State, on the advice of the CMA,
under s. 6 CA. The block exemption which is relevant to this chapter is

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the Competition Act (Vertical Agreements Block Exemption) Order 2022

(‘VABEO’).

 Guidance The CMA periodically issues guidance on how to apply the

CA and to indicate the CMA’s policy position on certain matters. CMA
guidance is ‘soft law’ and thus not legally binding. However it does
summarise current case law and therefore in practice any relevant CMA
guidance should be taken into account when advising clients. CMA
guidance on the Vertical Agreements Block Exemption can be found
online via .gov.uk.

The EU Commission issues guidance on certain matters of EU

competition law, in the form of Commission Notices. Post-Brexit, the
CMA has indicated that it will ‘have regard’ to certain Commission
Notices. In particular, for the purposes of this chapter, the Commission’s
Notice on Agreements of Minor Importance is relevant (see
paragraph 5.3 below): extracts, of particular relevance to applying s.2
CA, are provided in the CLIP Handbook.

4.4.3 Case law

In practice, case law is an important source of competition law. Prior to Brexit,

this was particularly true of cases decided by the highest European court, the
Court of Justice of the European Union (‘CJEU’): the jurisprudence of the
CJEU when interpreting and applying EU competition law was binding on all
UK courts whem interpreting and applying the CA.

CJEU competition law decisions made before Brexit remain binding on English
courts in the same way as all other assimilated EU case law (as outlined in the
Pre-Module Reading). Bear in mind that no UK Courts is obliged to follow
new CJEU case law (decided post-Brexit) - but practitioners consider it likely
that the courts may regard’ to contemporary CJEU decisions as persuasive.

You do not study any competition case law directly on the CLIP module and
will not be expected to cite competition cases in the assessment. However a
few examples of (CJEU) cases are provided in this chapter, by way of
illustration only and not as authorities that you are expected to cite.

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5. The Chapter I prohibition

This paragraph 5 explains the fundamental principles of the Chapter I

Prohibition by reference to s. 2 CA and relevant ancillary sources.

You need to follow a structured approach to applying competition law. This is

summarised in the flowcharts in the Appendices to this chapter, which provide
a framework for applying s. 2 CA to scenarios involving collusion between two
undertakings. The following text focuses particularly on how to apply them to
a scenario involving a distribution agreement.

In SGS 10 you will refer to the five-step flowchart from Appendix A in SGS 10.
The flowchart from Appendix B shows the same information, but in a different
form taking account of different factual scenarios.

The overall structure to adopt is as follows.

 At step 1 of the flowchart, you diagnose whether or not your client is at

risk of breaching the Chapter 1 prohibition in the first place.

 The next three steps of the flowchart provide ‘escape routes’ from
liability, by exemption or by other means, which you should consider in
turn (although, as we shall see, for a distribution agreement the only
reliable ‘escape route’ is that provided at step 2 of the flow chart).

 Finally, if your client is unable or unlikely to take advantage of any

escape route, at step 5 of the flowchart you must advise it of the
potential consequences of engaging in prohibited conduct, so that it can
make an informed decision as to whether or not to persist with its
conduct.

Each of sub-paragraphs 5.1 – 5.5 below explains one step from the flowchart
and concludes with practical points on applying the law.

5.1 Step 1: General prohibition

S. 2(1) CA sets out the Chapter I Prohibition. For the prohibition to bite, each
of the three criteria listed in s.2 must be met:
1. an agreement between undertakings, a decision by associations of
undertakings or a concerted practice between undertakings; which

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2. may affect trade within the UK; and

3. has as its object or effect the prevention, restriction or distortion of
competition within the UK.

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Examples: infringements of the Chapter I Prohibition in vertical

agreements

Hasbro UK Ltd is a major toy supplier (with classics such as Action

Man, Furby and Subbuteo in its stable) which became subject to two
investigations in quick succession, both relating to vertical agreements:

 In 2001, Hasbro renewed contracts with 10 distributors in the UK

and at the time of renewal sent a letter purportedly clarifying that the
distributors must sell the goods at Hasbro’s listed prices and could
not deviate from these without Hasbro’s prior agreement. This
restricted the ability of the distributors to compete with each other as
they could only sell at the Hasbro list price. In November 2002
following an investigation Hasbro was fined £4.95 million. (The
distributors were not fined because in fact it was Hasbro that had
initiated the activity (OFT Decision CA98/18/2002)).

 In 2003, a further decision of the OFT was published in relation to

Hasbro. This time the decision concerned two agreements entered
into between (i) Hasbro and Argos Ltd and (ii) Hasbro and
Littlewoods Ltd. Those agreements fixed the prices of certain
Hasbro toys and games. On this occasion Hasbro came forward
and co-operated fully with the OFT and as a result it escaped fines.
However, Argos and Littlewoods were fined £15 million and £4.5
million respectively. (OFT Decision CA98/2/2003).

A 2016 decision of the CMA concerns Ultra Finishing Limited, a

manufacturer of bathroom fittings. Ultra’s bricks-and-mortar resellers
(who incurred significant overhead costs of maintaining physical sales
premises not faced by their online competitors), were unable to match
the low prices offered by Ultra’s online resellers. Ultra sought to level
the playing field by issuing ‘trading guidelines’ to online resellers.
Online resellers rely on product photographs, and Ultra normally granted
a royalty-free copyright licence to use theirs: however the trading
guidelines provided that an online reseller would lose such licence if it
discounted its prices by more than a set percentage below Ultra’s
recommended levels. The CMA decided that Ultra’s trading guidelines
infringed the Chapter I Prohibition and imposed a heavy fine on Ultra
(CMA Decision Case CE/9857-14, 10 May 2016).

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5.1.1 Agreement, decision and concerted practice

The three terms, ‘agreement’, ‘decision’ and ‘concerted practice’ in s.2(1) CA

are included to ensure that all types of anti-competitive collusion are caught:
the legislation is drafted to prevent objectionable behaviour from slipping
through the net on a ‘technicality’ such as the absence of explicit agreement.
For CLIP purposes we are concerned with ‘agreements’ between
undertakings because scenarios to which you will apply s.2 CA all relate to
(actual or proposed) distribution agreements.

Helpful to know in practice, to clarify the s. 2 terminology:

 ‘agreement’ includes any commercial contract, along with non-binding

and informal agreements as well. An ‘agreement’ arises if there has
been an expression of a joint intention to behave in a particular way.

 a decision by an association of undertakings would most commonly

be taken by a trade association or professional body, established with at
least some degree of formality, which may seek to co-ordinate the
activities of its members, often by means of its rule-book. Commercial
entities do not form an ‘association’ merely by making a contract or
collaborating on a project.

 a concerted practice is informal co-operation between two or more

entities without a formal agreement. decision or even explicit
understanding. There must be some contact between the undertakings
concerned - falling short of an actual agreement - and then co-operation
in some practical way.

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5.1.2 Effect on trade within the UK (s. 2(1) CA) / implementation in the UK (s.
2(3) CA)

The main significance of this element of the prohibition is jurisdictional. If, as a

matter of fact, an actual or potential effect on trade is, or may be, felt within the
UK- and if the agreement is implemented in the UK (s. 2(3) CA), then the CA
is applicable. This would be the case even if the participants were located
outside the UK.

The drafting of the general prohibition (‘...which may affect trade...’) catches
potential, as well as actual and demonstrable, effects and s.2(3) refers to
intended as well as actual implementation. So it is not necessary, when
applying this criterion, to specify the effect with great particularity. For
example, a given agreement could have a potential effect on trade within the
UK because it might affect sales of particular products, or the structure of the
market or even just the pattern of trade.

5.1.3 Object or effect of preventing, restricting or distorting competition

This element is the crux of s.2. It can be sufficient that the companies have an
‘object’ (i.e. objective) of restricting competition without actually implementing
their plans. Conversely, it can also be sufficient that agreements have as their
‘effect’ the restriction of competition, even if that is not intended, regardless of
the parties’ motivations. ‘Prevention, restriction or distortion’ are
interchangeable terms and, in practice, (and for the purposes of this module)
we use the expression ‘restriction of competition’ as a catch-all term.

The primary purpose of competition law is to protect consumers, not

competitors of the parties to the agreement; however damage to competitors
(and hence reduction of consumer choice) in many circumstances is likely to
have a negative knock-on effect for consumers.
Any distribution agreement will almost invariably be anti-competitive because
it gives the supplier at least some degree of control over the terms on which
the distributor sells the goods on to its customers. For example in respect of a
territory a distribution agreement commonly restricts the persons to whom, or
area in which, the distributor will re-sell the goods. The supplier may also
want to control the terms on which the distributor re-sells goods to its own
customers.

S. 2(2) CA provides a non-exhaustive list of common types of activity that

prima facie fall within the general prohibition. Some examples of restrictions

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most likely to be attempted under the terms of a distribution agreement are

discussed in tabular form below, adopting the framework of s.2(2) CA.

s. 2(2) restriction Explanation / Example

(a) directly or A supplier supplies its products to distributors on
indirectly fix purchase condition that all distributors agree to abide by the
or selling prices or supplier’s predetermined price list when selling the
any other trading products on (this is known as ‘resale price
conditions; maintenance’ or ‘price fixing’).
This leads to higher prices for the ultimate
consumer. A price fixing agreement removes a key
means of competition between distributors.
(b) limit or control A supplier sells its products to a distributor on
production, markets, condition that the distributor does not sell to any
technical development customer outside a certain territory.
or investment; As a result, distributor could be obliged to turn
away customers for an arbitrary reason such as
their geographic location. This can have the effect
of limiting the market by preventing the ultimate
consumer from ‘shopping around’ to choose from
whom it wishes to purchase.
(c) share markets or A supplier and its distributors collectively share out
sources of supply; a market, e.g. one distributor will sell goods in the
North of England, and another in the South of
England.
Alternatively, a supplier and its distributors might
carve up a market amongst themselves such that
within the UK, for example, Distributor A agrees to
take no more than 40% of sales of a given product,
Distributor B 25% and Distributor C 35%.
Either of these scenarios would create unfairness
for consumers who could end up with a limited
choice of sources of supply.
(d) apply dissimilar A supplier and its distributors decide together they
conditions to will not supply to party C (a ‘collective boycott’).
equivalent The effect on consumers here is less direct: a
transactions with consequence of cutting out C from the supply chain
other trading parties, in this way is to create an artificial disadvantage for
thereby placing them C as against its competitors. It is likely to be better
at a competitive for the ultimate consumer if C is able to compete
disadvantage; on a ‘level playing field’ with all other market
players.
(e) make the A supplier sells Product A to distributors on

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conclusion of condition that distributors also purchase Product B

contracts subject to from the supplier, whether the two products are
acceptance by other related or not (‘bundling’).
parties of Ultimately, consumers are likely to suffer because
supplementary competitors (and hence consumer choice) are
obligations which, by squeezed out of the market for Product B. This
their nature or scenario has been seen in practice in respect of
according to computer software, for example: the bundling of
commercial usage, Internet browsing software with a computer
have no connection operating system disincentivises consumers to
with the subject of the shop around for browser software from rival
contracts. suppliers. Initially this works to the detriment of the
rival suppliers (who may be driven out of business)
but ultimately the consumer loses out as alternative
(possibly better) products are lost to the market.

5.1.4 Step 1 application tips

Ensure you address all three elements of the Chapter I Prohibition and apply
them to the facts.

It is advisable to avoid allowing your analysis to become too complicated. The

Chapter I Prohibition is broad in scope, and it is tempting to waste effort trying
to argue your client out of it. Remember that this is just the start of your
analysis and the task in hand is simply to diagnose whether or not prima facie
the prohibition bites – in which case, the remainder of the flow chart may
operate to rescue your client from liability.

If there is no infringement of the Prohibition then advise your client

accordingly. If there is a prima facie infringement, then you will turn your mind
to the escape routes at steps 2, 3 and 4 of the flow chart.

5.2 Step 2: Block exemptions

5.2.1 The principle of exemption

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The Chapter I Prohibition is broad and catches behaviour which may, in

practice, be innocuous - for example, most distribution agreements prima facie
contain restrictions on competition: but such agreements have a sound
economic rationale and can work to the ultimate advantage of consumers.

The CA provides an exemption to the Chapter I Prohibition. In essence,

exempt agreements are those which are desirable from a commercial or
policy point of view, albeit they may have some anti-competitive side-effects.
Exempt agreements do not breach the Chapter I Prohibition (s.2(1) CA). The
full criteria for exemption are set out in s. 9 CA (see paragraph 5.4 below).

At step 2 of the analysis, we apply the principle of exemption without applying

s. 9 directly to the facts. This is because, for distribution agreements
(amongst other common categories of commercial agreement), there exists an
easier means of deciding whether or not a given agreement is exempt.

5.2.2 Block Exemptions

A ‘block exemption’ is a piece of legislation which translates the broad s.9

criteria into a detailed rule-book for agreements of a particular kind (i.e. a
category, or ‘block’ of agreements). Examples of existing blocks, for which
exemptions have been drafted, include research and development
agreements; technology transfer agreements (which relate to the exploitation
of patents and know-how); and, of particular relevance to this chapter, vertical
agreements (including distribution agreements).

Blocks of agreements are defined by their commercial function. To simplify

somewhat, when a particular category of exempt agreement is sufficiently
common in practice to warrant the effort of creating a special rule-book for that
category, then a block exemption is likely to be drafted and issued.

At Step 2 of the flowchart, we consider whether a given agreement appears to

belong to a block and, if so, we turn to the text of the relevant block exemption
and apply its provisions.

Key elements of a block exemption are: (i) scoping provisions, including

definitions, allowing us to conclude whether or not any given agreement
belongs to the block in question; and (ii) lists of forbidden clauses, the

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exemption of any given agreement being conditional upon its not including
any such clauses. We return to this stage of the analysis in detail in Part
C of this chapter.

Any agreement to which a block exemption applies is, as a matter of law,

exempt from the Chapter I prohibition (s. 6(3) CA), provided that its terms
comply fully with the rules set out in the block exemption. It is much easier in
practice to apply a block exemption to an (actual or proposed) agreement
than it is to apply s.9 CA directly.

5.2.3 Source of block exemptions

S. 6 CA authorises the CMA to initiate the issue of block exemptions, which

are made in the form of Orders of the Secretary of State (a type of statutory
instrument).

The Competition Act (Vertical Agreements Block Exemption) Order 2022 (SI
2022 no.516) (‘VABEO’) is the block exemption relevant to distribution
agreements. The provisions of VABEO are discussed more fully in Part C of
this chapter and its text is provided in the CLIP Handbook. You will apply the
VABEO in a scenario in SGS10.

Other BEOs currently in force relate to other types of agreement under which
businesses commonly co-operate, for example the Research & Development
BEO or the ‘Specialisation’ BEO.

Helpful to know in practice

For EU competition law purposes, the EU Commission issues Block

Exemption Regulations (‘BERs’) which are block exemptions from the EU
equivalent of the Chapter I prohibition. EU Regulations have direct effect in

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EU Member States so that, pre-Brexit, BERs applied where parties in the UK

were at risk of breaching EU competition law.

CA makes provision for BERs to provide exemption from the Chapter I

prohibition, as if they had been issued as block exemption orders under s. 6
CA, by virtue of a mechanism known as ‘assimilated exemption *’ (see s.10
CA). This allows BERs to be imported into the UK competition law framework
as if they had been issued under s. 6 CA. S. 10 CA remains in force post-
Brexit in an amended form, so assimilated exemptions are still applicable
within the UK domestic competition law framework (as assimilated law).

However the UK appears to have adopted a practice of diverging from BERs

at the earliest convenient opportunity. BERs have a limited duration and are
regularly renewed, commonly on a ten-year cycle; since Brexit, as BERs have
fallen due for renewal the Government has issued equivalent BEOs under s. 6
instead of adopting new BERs as assimilated exemptions.

You do not need to read s. 10 CA, or know about assimilated exemptions and
BERs, for CLIP purposes but you may encounter them in practice.

5.2.4 Step 2 application tips

Full discussion of how to apply Step 2 of the flowchart to a distribution

agreement comes in Part C of this chapter. To summarise, in the meantime:
the over-arching question at step 2 is ‘can the agreement claim to be exempt
by means of a block exemption?’

If the agreement does comply fully with the VABEO, then you can conclude
that it is exempt from the Chapter I prohibition and you can leave the
flowchart.

*
You may find that this same concept referred to in practice as ‘parallel exemption’ or ‘retained
exemption’.

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If the agreement does not comply fully with the VABEO then your advice to the
client will depend upon whether (i) the parties are still negotiating a proposed
agreement; or (ii) the parties have already entered into the agreement.

 A proposed distribution agreement which is still subject to negotiation

should be drafted to comply with the VABEO, as the only sure way to
avoid the risk of infringing the Chapter I Prohibition.

 If you are advising a client in relation to a distribution agreement which

has already been made, then the parties are at risk of having already
breached the Chapter 1 Prohibition. In that case, you need to proceed
to step 3 of the flowchart to explore the extent to which they may have
any chance of an alternative ‘escape route’.

See Appendix B for a visual expression of the content of this paragraph 5.2.4.

5.3 Step 3: Is the effect on competition appreciable?

5.3.1 The de minimis principle

According to case law, the Chapter I prohibition is subject to a ‘de minimis’

rule. Some undertakings (who would otherwise breach the prohibition) are too
small in scale for their activities to make a real impact on competition in the
actual marketplace. Agreements between such undertakings are said not to
have an ‘appreciable effect on competition’ and the prohibition does not bite
on such agreements.

The ‘appreciable effect’ principle is not truly an exemption to the Chapter I

Prohibition: rather, it sets a limit on the applicability of the relevant criterion of
s. 2 CA.

5.3.2 What does ‘appreciable effect’ mean? NAOMI

The CMA has announced that, in determining whether an agreement has an

‘appreciable effect on competition’ for the purposes of the Chapter I

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prohibition, it will have regard to the EU Commission’s approach to the same

issue. The Commission’s approach is set out in its Notice on Agreements of
Minor Importance (‘NAOMI’), extracts from which are provided in the CLIP
Handbook.

NAOMI indicates a ‘safe harbour’ for agreements which do not have an

appreciable effect on competition. An agreement will generally be considered
not to have an appreciable effect on competition:
 unless the agreement has the object of restricting competition, and
 if the market share held by each party is at or below a specified
threshold.

Thus if NAOMI does apply to a given agreement we can (in most cases)
conclude that the agreement does not breach the Chapter I prohibition.

Taking these elements in turn:

(a) Object of restricting competition

Paragraph 2 of NAOMI states that (notwithstanding the parties’ market

shares) no safe harbour is available to agreements which have as their
object the prevention, restriction or distortion of competition.

The word ‘object’ can be read synonymously with ‘objective’, so it follows that
no intentional attempt to restrict competition can benefit from NAOMI.
However this is not the end of the matter.

According to paragraph 13 of NAOMI, certain provisions are so anti-

competitive by nature that the act of agreeing to them is deemed to have no
other function than to restrict competition. In particular, according to
paragraph 13, NAOMI does not apply to agreements containing any of the
terms that are listed as hardcore restrictions in any block exemption (see
paragraph 7.4.1 in Part C below) Paragraph 14 of NAOMI goes on to clarify
that a distribution agreement which loses the benefit of a block exemption only
to the extent it contains excluded restrictions (see paragraph 7.4.2 in Part C
below) can still benefit from the NAOMI safe harbour.

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(b) Market share threshold

Paragraph 8 of NAOMI sets out applicable market share thresholds, which

are set at different levels for (usually horizontal) agreements between
competitors and (usually vertical) agreements between non-competitors. The
appropriate threshold for distribution agreements (which can be taken to fall
into the latter category) is as follows: the market share of each party - taken
separately - must not exceed 15%.†

Measuring a given party’s market share is a complex exercise in practice,

because it is necessary first to determine, as a matter of fact in any given
scenario, what are the ‘relevant markets affected by the agreement’. In
practice, the CMA’s answer to this question relies on investigation into how
buyers and sellers behave in the real world, along with application of
economics-based analysis and does not necessarily correspond to the parties’
conception of ‘the market’ as used in everyday parlance. On the CLIP module
we do not explore this issue in any depth and, where relevant, a ‘relevant
market affected’ by any agreement will be identified in the scenario or given as
an explicit assumption.

5.3.3 Step 3 application tip

NAOMI is likely to be of limited relevance to a distribution agreement. NAOMI

paragraph 14 clarifies that the safe harbour it establishes is primarily intended
to provide leeway for agreements which - unlike a distribution agreement - are
not covered by any block exemption.

Therefore:
 it is better for the parties to a proposed distribution agreement to ensure
its terms comply with the VABEO than to look for a safe harbour under
NAOMI; and
 when advising a party to an agreement which has already been made,
consider why that agreement was not able to take advantage of VABEO.

†
This is something of a simplification because the expressions ‘distribution agreement’, ‘vertical
agreement’ and ‘agreement between non-competitors’ are not strictly synonymous. However in practice it
would be unusual for a distribution agreement of the type discussed in part A of this chapter (and in SGS
10) not to qualify as all three.

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If this is because the agreement contains hardcore restrictions (see

paragraph 7.4.1) then NAOMI is unlikely to offer an escape from liability
for breaching the Chapter I Prohibition.

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5.4 Step 4: self-assessment?

The final line of protection against liability for infringing the Chapter I
Prohibition, where neither a BER nor NAOMI provides an ‘escape route’ for an
agreement that has already been made, is to return to s. 9 CA and attempt to
argue that the agreement is exempt on its own merits.

At this stage, the parties carry out their own analysis of the issues and balance
the competition concerns with the potential benefits of the agreement. We
refer to this exercise as ‘self-assessment’ because unless and until the case is
decided by the CMA or a court the parties cannot be certain that their analysis
is correct: the agreement may, or may not, be exempt.

5.4.1 Exemption by application of s.9 CA

As mentioned in para. 5.2.1 above, the principle underlying s.9 CA is to render

exempt from the Chapter I Prohibition agreements which are fundamentally
desirable from a commercial or policy point of view, albeit they may have
minor anti-competitive side-effects.

To this end, s.9 CA sets out four stringent conditions all of which must
satisfied. To paraphrase these, the agreement must:
1. have a positive effect, i.e. contribute to improvement of production or
distribution, or promote technical or economic progress; and
2. allow consumers to receive a fair share of the benefit; and
3. not impose restrictions on the undertakings concerned that are beyond
those strictly necessary to help to achieve the previous two objectives;
and
4. not act as a tool to effectively eliminate competition in relation to a
substantial part of the affected products.

5.4.2 Step 4 application tips

In a scenario where a distribution agreement prima facie breaches the

Chapter I prohibition, self-assessment under s.9 CA is, in practice, the least

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promising of the available escape routes. This is why we apply the text of s. 9
as a last line of defence (as step 4 of the flow chart).

The reasons why s. 9 is not commonly relied on by competition lawyers in

practice include the following.

 A block exemption is much better as it offers certainty for parties (s. 6(3)
CA). Where a block exemption is available, compliance with its detailed
provisions will, as a matter of law, amount to compliance with the above
four conditions of s.9 so that the agreement in question is exempt from
the Chapter I Prohibition.

 Relying on self-assessment is generally a risky strategy for the parties

which leaves them exposed: advising a client to rely on an individual
exemption can be seen as analogous to advising a client accused of
copyright infringement to act in reliance on a ‘fair dealing’ defence. Even
if you can make out an argument for individual exemption, there is, in
reality, nowhere to look for reassurance that your argument will prevail
unless and until the matter is decided in court.

 The CMA can, in exceptional cases, give individual guidance, for

example where a particular scenario raises ‘novel and unresolved
questions’ and it would be useful to a wider audience to resolve the
issue. But such guidance is not binding on the competition authorities or
the courts. Such cases, of necessity, are very rare in practice.

 Once in this fall-back position of relying on self-assessment, you would

assess the agreement in question by reference to case-law, which is
difficult to apply in practice since each case tends to turn on its own
(highly complex) facts. Much of the case-law ultimately finds its way into
the relevant CMA guidelines, to which you would also refer in practice.

 An agreement which contains hardcore restrictions, or otherwise has as

its object a restriction of competition, cannot benefit from a block
exemption so it is difficult to see how it could benefit from self-
assessment. Such an agreement would fall foul of at least conditions 3
and 4 above, if not all 4 conditions.

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You are most likely to apply s. 9 CA in circumstances where your client is

already being investigated by the CMA or is defending a third-party claim for
breach of its statutory duty under s. 2 CA.

When advising a client who has not yet engaged in prohibited conduct, it
would be better advised to desist from such conduct.

In either event, your client must be made aware of the potential consequences
of infringing the Chapter I prohibition and so you should proceed to Step 5 of
the flowchart.

5.5 Step 5: Infringement consequences

5.5.1 Investigations of infringement

In the UK the CMA has authority to investigate under the CA.

If the CMA has reasonable grounds for suspecting that a party is infringing
competition law there are certain powers available to assist with the
investigation. These range from sending onerous information requests or
requiring documents to be produced, copied (and explained) to actually
searching business and domestic premises often via unannounced
inspections known as ‘dawn raids’. Business premises can be searched either
with or without a warrant (a warrant is always necessary in relation to
domestic premises).

The CMA also has powers to compel individuals to answer questions in the
course of its investigations, to require senior representatives to remain with
the inspectors during searches and to seal filing cabinets. It is a distinct
possibility that parties being investigated for competition law infringements
may otherwise seek to destroy evidence and warn other participants.

A party under investigation is unlikely to welcome inspectors from the CMA,

but there are serious consequences for failing to co-operate, including
potential criminal sanctions. It is crucial for the party subject to a CMA dawn

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raid or in receipt of a CMA request for information alleging infringement of s.2

CA, to call in legal advisers immediately. Not only can lawyers provide advice
in relation to competition law but also they can monitor that the investigation
does not breach any human rights or other procedural requirements.
Companies are advised to have in place detailed dawn raid procedures and
policies. Some firms carry out mock dawn raids for their clients to test their
employees and internal policies.

5.5.2 Consequences of infringement of the CA

The CMA has extensive powers to impose sanctions on parties who infringe
competition law. These include:

 Imposing fines. This is usually the biggest risk of an infringement. The

CMA has adopted guidance on the appropriate amount of penalties,
originally issued by the OFT in September 2012. The CMA adopts a
starting-point figure of up to 30% of turnover to which the infringement
relates (the precise level being set with regard to the seriousness of the
infringement). That figure can be adjusted in light of aggravating and
mitigating factors, subject to the overall maximum 10% of the
undertaking’s total worldwide turnover. Aggravating factors include
being the ringleader or being a recidivist (repeat offender). Mitigating
factors include a reduction for having a very limited role in an
infringement although in practice mitigating circumstances are applied
sparingly and in a narrow, limited way.

In addition, a fine of up to 1% may be imposed on parties who fail to co-

operate with an investigation.

 Restraining the parties from activities while the investigation takes

place and/or issuing directions to act in a particular way, for example to
cease to engage in particular abusive conduct.
 Termination or modification of an agreement. Note that any agreement
which falls within the s. 2 prohibition is void anyway (s. 2(4) CA).
 Obtaining a binding commitment (given by the undertaking under
investigation) to cease infringing behaviour. This allows the investigation
to conclude without a definitive decision as to infringement having been
made.

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A third party who has been affected by an undertaking’s anti-competitive

behaviour can pursue an action for damages against the undertaking (based
on a claim for breach of statutory duty). This would typically involve
damages claims by customers who have suffered loss e.g. by being
overcharged a fixed price for a number of years. There has not been major
take up of damages claims by aggrieved third parties probably because there
is a commercial incentive for the parties to continue to do business.

A director engaged in anti-competitive activity can also be disqualified.

5.5.3 Provisions and policies allowing leniency and settlement

There are three ways in which an undertaking can avoid or reduce any
potential fines that it may face.

Limited immunity

Small businesses can avoid fines on the basis that they are too small for their
actions to have a significant impact on trade within the UK (s. 39 CA). In
practice the provision for limited immunity is not of much significance because:
(i) it is not available if the agreement involves price-fixing; and (ii) it provides
no protection against any other consequences of infringement enumerated
above.

Immunity for whistleblowers

This is the key way in which a party who has been involved in an infringement
of competition law can seek to reduce its fine. The CMA has a well-
established leniency programme, under which a party who comes forward with
information about a cartel can receive total immunity (i.e. a 100% reduction) or
a partial reduction in the fines that would otherwise have been levied against
them.

The Enterprise Act 2002 allows the CMA to issue a ‘no action’ letter to
someone who would otherwise be prosecuted for a competition law

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infringement, which provides immunity from prosecution. It is also possible to

avoid disqualification as a director by this means. This is to encourage
whistleblowers who have participated in prohibited activity to then come
forward.

The immunity does not extend to other consequences such as avoiding

agreements or third party damages actions.

Settlement

Under the CA a competition law infringement case can be brought to a close

by the settlement process. This involves the party under investigation
admitting its liability in return for a discount on the fine (which is capped at
20% for settling the case pre the CMA issuing the statement of objections and
10% for settling the case post the CMA issuing the statement of objections).
Settlement is distinct from leniency but discounts can be obtained for both
leniency applications and for settlement.

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PART C APPLYING COMPETITION LAW TO DISTRIBUTION

AGREEMENTS

6. Part C introduction

We have seen so far in this chapter that:

 a distribution agreement is said to be ‘vertical’ because it forms part of a

chain of contractual relationships under which goods flow downwards
from their source (e.g.manufacturer) at the top, via one or more
intermediaries, to the end-user (who may or may not be a consumer) at
the bottom;

 distribution agreements are common in practice and have a sound

economic rationale;

 when advising a client on the Chapter I Prohibition in relation to a

distribution agreement, you should follow the five-step structure as
summarised in Appendices A & B to this chapter;

 any given distribution agreement is more likely than not to fall within the
scope of the Chapter I Prohibition under s.2 Competition Act 1998
(‘CA’). For example, to award a territory to a distributor is likely to ‘limit or
control’ the market;

 the CA provides an exemption to the general prohibition (under s.9), and

to assist the application of s. 9 it authorises (under s. 6) the making of
block exemption orders. Block exemptions provide a means for
agreements to qualify as exempt; and

 the Competition Act (Vertical Agreements Block Exemption) Order 2022

(‘VABEO’) is the block exemption available to distribution agreements.

This part of Chapter 7 covers two issues in more detail.

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Paragraph 7 provides details of the VABEO and how to apply it – this

paragraph functions as a guide to applying step 2 of the flowchart.

Paragraph 8 summarises the ‘big picture’ of how practitioners typically put

competition law advice into a commercial context: we take account of the
different points of view of parties to distribution agreements in differing
scenarios.

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7. The VABEO

7.1 Block Exemptions recap

We have seen in Part B paragraph 5.2 of this chapter that:

 a block exemption is a piece of secondary legislation, which translates

the exemption to the Chapter I Prohibition (from s. 9 CA) into a detailed
set of rules applicable to all agreements of a particular category (a
‘block’ of agreements). A block exemption can be regarded as a
‘worked example’ of how the broad principles of s.9 play out in relation to
agreements in its respective block;
 s. 6 CA, authorises the Secretary of State to make block exemption
orders specifying particular blocks of agreements;
 any agreement belonging to the block to which a block exemption order
refers is, as a matter of law, exempt from the general prohibition (s.6(3)
CA) – if its terms comply with the detailed provisions of the respective
block exemption; and
 the block exemption relevant to distribution agreements is the VABEO.

7.2 Applying the VABEO: overall structure

In order to establish whether or not a given distribution agreement is exempt

from the Chapter I Prohibition, we need to establish (i) that the agreement in
question belongs in the block of agreements to which VABEO applies and also
(ii) that the terms of the agreement comply with the provisions of the VABEO.
Each of these issues can be broken down in turn into two stages, as follows:

Does the agreement belong in the VABEO block?

 Is the agreement a vertical agreement as defined by the VABEO? and

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 Do the parties satisfy the market share thresholds set out in the
VABEO?

Do the terms of the agreement comply with the VABEO?

 Does the agreement contain any hardcore restrictions? and

 Does the agreement contain any excluded restrictions?

The remainder of this paragraph 7 adopts this structure.

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7.3 Applying VABEO: Does the agreement belong in the VABEO

block?

7.3.1 Vertical Agreement

According to article 3(1) VABEO, the category of ‘vertical agreements’ is a

specified category for the purposes of s. 6 CA. This matters because an
agreement which falls within a specified category is exempt from the Chapter I
prohibition (s. 6(3) CA).

The VABEO definition of ‘vertical agreements’ is as follows (article 3(2)):

‘agreements […] 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’.

A note on terminology: such goods and services are referred to in VABEO

as ‘the contract goods or services’. This chapter uses the expression ‘the
contract goods’ as shorthand, because the distribution agreements we explore
on CLIP relate to the purchase, sale and resale of goods, not services.

7.3.2 Market Share Thresholds

According to article 6(1) VABEO, the block exemption applies to a vertical

agreement only on condition that:

 the market share of the supplier does not exceed 30% of the relevant
market on which it sells the contract goods - article 6(1)(a); and

 the market share of the distributor does not exceed 30% of the relevant
market on which it purchases the contract goods - article 6(1)(b).

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A note on terminology: the VABEO uses the word ‘buyer’ to refer to the
distributor under a distribution agreement. This chapter uses the word
‘distributor’ to avoid confusion between the distributor and its own customers.

Article 7 VABEO makes provision as to how parties’ market shares are to be

calculated in practice. On the CLIP module we do not explore that issue. The
parties’ shares of the relevant market in any scenario will, if relevant, be
identified in the scenario.

7.4 Applying VABEO: Do the terms of the agreement comply?

Having concluded that the agreement under consideration falls within the
block of agreements to which VABEO applies, we turn to the question of
whether or not the terms of the agreement comply fully with the VABEO.
Does the agreement contain any hardcore restrictions or excluded
restrictions as specified in Articles 8 and 10 respectively?

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7.4.1 Hardcore Restrictions – Article 8 VABEO

In order to benefit from the automatic exemption in the VABEO, the agreement
must not contain any of the provisions identified as ‘hardcore restrictions’.
These are specified in article 8.

Meaning of ‘Hardcore restriction’

If any hardcore restriction is included in a distribution agreement, the block

exemption is cancelled in respect of the whole agreement - article 9
VABEO. We have seen in Part B above that a distribution agreement which is
not exempt under VABEO is not likely to benefit from any alternative ‘escape
route’ from liability.

Thus a hardcore restriction is a contractual term which renders void the whole
agreement in which it appears - even if all the other terms are innocuous. The
parties to such agreement will face all other potential consequences of
breaching the Chapter I Prohibition. It is essential that a distribution
agreement does not contain any hardcore restrictions.

This paragraph discusses only those hardcore restrictions to be found in

VABEO which are most commonly encountered in respect of distribution
agreements.

Helpful to know in practice

Additional hardcore restrictions, outside the scope of this module, which you
may encounter if you advise on competition law in practice include:

 Certain restrictions found in selective distribution agreements (see

paragraph 2.2.4 above);

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 Restrictions which prevent manufacturers of components from supplying

them as spare parts to end-users or repairers of the types of goods into
which the components are incorporated; and

 Wide retail parity clauses (also known as wide ‘most favoured nation’
clauses) under which contract goods must be sold to consumers via one
channel on terms which are no worse than on another channel. An example
might be where a supplier promises one buyer that it will not supply its
goods to any other buyer at lower prices. The relevant provisions of
VABEO are not applicable to B2B sales platforms.

(a) Pricing restrictions: may a distributor set its own sale prices?
Article 8(2)(a) VABEO
Article 8(2)(a) addresses provisions in distribution agreements which can be
referred to as ‘price fixing’ or ‘resale price maintenance’.
The essence of article 8(2)(a) is that distributors must be free to set their own
onward sale prices. Any restriction on the distributor’s ability to determine its
onward sale price is a hardcore restriction.
This rule is ‘without prejudice to the possibility of the supplier imposing a
maximum sale price or recommending a sale price, provided that such
provisions do not amount to a fixed or minimum sale price […]’.
Any ‘recommended retail price’ or the like should not amount to a covert or
indirect means of controlling the distributor’s prices. As a general rule (unless
the parties wish to agree maximum resale prices) it is prudent for a distribution
agreement to say nothing at all about the distributor’s onward sale price.

(b) Territorial restrictions: where / to whom may a distributor sell the

contract goods?

Articles 8(2)(b) and 8(3) VABEO - or - Articles 8(2)(d) and 8(5) VABEO

The VABEO sets out specific rules about territorial restrictions applicable to
particular scenarios. The scenarios we consider in this chapter are: (i) where
the supplier ‘operates an exclusive distribution system’; and (ii) where the
supplier ‘operates neither an exclusive distribution system nor a selective
distribution system’.

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A note on terminology: the expression ‘exclusive distribution system’ is

defined in Article 8(7). This VABEO-specific definition is wider than the
traditional definition of exclusive distribution agreements (paragraph 2.2.1
above) because it includes arrangements where a supplier gives ‘shared
exclusivity’ to two or more distributors in a single territory. On this module we
do not consider scenarios involving shared exclusivity.

Whether or not the supplier operates an exclusive distribution system, the full
picture of what VABEO has to say (as to the extent to which territorial
restrictions can be permitted) is set out in a pair of articles. The rules are
substantially the same for both scenarios so we will consider them together
here, to avoid repetition. In SGS 10 and the assessment, if relevant, the facts
of a scenario will tell you whether or not the supplier operates an exclusive
distribution system so taht you can apply the correct article references.

Each pair of articles must be read together, in the following relationship:

 articles 8(2)(b) and 8(2)(d) set out hardcore restrictions, i.e. what is
not permitted in a distribution agreement, subject to exceptions; and
 articles 8(3) and 8(5) set out excepted restrictions, i.e. what is
permitted in a distribution agreement, by way of exception to article 8(2)
(b) or 8(2)(d) respectively.

The hardcore restrictions are broad; and the excepted restrictions are narrow.
A summary of how these articles work together these articles is provided below
in tabular format. First of all we will consider what they provide.

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Helpful to know in practice

Articles 8(3) and 8(5) each set out five excepted restrictions. Of these, only one
is applicable to distribution agreements in general on the CLIP module. You
may find, in practice, that it is permissible under VABEO for a distribution
agreement to make provision restricting a distributor’s place of establishment –
articles 8(3)(c) and 8(5)(c). The other excepted restrictions are only relevant in
very specific circumstances, not generally applicable to the type of distribution
agreement we study in CLIP.

What the rules say

General rule: Articles 8(2)(b) and 8(2)(c) prohibit any restriction, in the
terms of a distribution agreement, of the geographical area into which (or of
the customer groups to whom) the distributor may actively sell or passively
sell the contract goods or services. Respectively, we refer to such restrictions
as an ‘active sales ban’ and a ‘passive sales ban’. The types of ‘restriction’
amounting to an ‘active sales ban’ or a ‘passive sales’ ban include terms
preventing a distributor from: selling via the internet; using online advertising
channels; selling into (or outside) a specified geographical area; and/or selling
(or not selling) to specified market sectors (see Article 8(6)).

To understand the rules fully, we need to appreciate the meaning of the terms
‘active sales’ and ‘passive sales’. They are defined in Article 8(7) VABEO.

Active sales are targeted sales and occur as a consequence of positive

action on the part of the distributor to reach particular customers. Examples of
active selling into a particular area include: approaching customers there in
person; sending direct mail (including email); targeted advertising to
customers in that area (including on the internet /via social media); and paying
a search engine to advertise to users located in a particular territory.

Passive sales occur as a consequence of an unsolicited request to buy,

made by a customer. Passive sales generally occur when customers ‘shop
around’ to choose from whom they wish to buy. Examples of passive selling in
a particular area include: responding to unsolicited customer orders; general

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advertising (which targets the distributor’s territory and also happens to reach
customers in another distributor’s territory); and, generally, using a website to
sell products.

Rule applicable to passive sales bans.

VABEO prohibits all passive sales bans. There is no excepted restriction

available to any passive sales ban.

This recognises that customers must be free to shop around. For example, a
ban on passive sales outside a distributor’s territory would compel the
distributor to turn away certain customers, simply because they come from the
wrong place. Furthermore, distributors should, as a general rule, be free to
advertise and promote their goods however and wherever they choose. To
prevent a distributor from undertaking passive selling activities (of which
examples are given above) would be too onerous.

Rules applicable to active sales bans

VABEO prohibits active sales bans generally (articles 8(2)(b) and 8(2)(d).
But some active sales bans are permitted in distribution agreements, as
excepted restrictions.

Articles 8(3)(a) and 8(5)(a) permit ‘the restriction of active sales’ by a

distributor into a geographical area - or to a customer group - which has been
reserved to the supplier or allocated by the supplier exclusively to another
distributor. (For a reminder of what it means for a supplier to ‘reserve’ a
territory to itself, see paragraph 3.4 above.)

The excepted restriction acknowledges that exclusive distribution agreements

exist in practice, and have a justification. A distributor invests time and money
to secure sales and to develop the supplier’s brand, and this benefits the
supplier. In turn, the supplier may help its distributor secure enough volume of
sales to justify such investment by awarding territory to the distributor on an
exclusive basis. To preserve the exclusivity of one distributor’s territory, a

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supplier must be able to prevent other distributors from actively soliciting sales
in that territory. Otherwise the territory would no longer be exclusive.

Helpful to know in practice

The excepted restrictions in articles 8(3)(a) and 8(5)(a) are drafted to permit
‘flow down’ of an excepted active sales ban to the next level on the distribution
chain. So it is permissible for a terms of a distribution agreement to require a
distributor to ban its own customers (i.e. businesses on the next level down
the distribution chain) from actively selling into the territory of the supplier’s
other exclusive distributors. This point will not be relevant to the scenarios we
study on the CLIP module.

Territorial restrictions: Summary Type of Scenario

where S. where S. does not

operates an operate an
exclusive exclusive
distribution distribution
system system

Hardcore restrictions -

 All passive sales bans are prohibited.

Article 8(2)(b) Article 8(2)(d)
 Any active sales ban not permitted below
is prohibited.

Excepted restrictions -

Active sales bans are permitted into:

 another distributor’s exclusive territory; or Article 8(3)(a) Article 8(5)(a)

 the supplier’s reserved territory

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The self-assessment exercise on the following pages gives you an opportunity

to test your understanding of the VABEO rules on territorial restrictions and to
practise applying them.

Hardcore restrictions: consequences

For all practical purposes, if your client enters into a distribution agreement
which contains any one or more hardcore restrictions, it will face the
consequences of breaching the Chapter I Prohibition:
 as we have seen in paragraph 5.3.2 above, inclusion of any hardcore
restriction will prevent the parties from accessing the de minimis ‘safe
harbour’ under NAOMI; and
 it is difficult to conceive of a sound argument for exempting a distribution
agreement on its own merits, under s. 9 CA, in circumstances where its
provisions are expressly forbidden by the relevant block exemption
rules.

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Territorial Restrictions Exercise

A supplier in the UK does not operate an exclusive distribution system. It has

appointed one exclusive distributor (‘B’) for East Anglia and one non-exclusive
distributor (‘C’) in London. There are no other distributors appointed and the supplier
has not reserved any territory to itself.

The supplier intends to appoint a non-exclusive distributor (‘A’) for the whole of
Yorkshire.

Four diagrams follow, each showing a territorial restriction which the supplier may wish
to include its distribution agreement with A. Decide whether each example is either
prohibited as a hardcore restriction under Article 8(2)(d) VABEO or permitted as an
excepted restriction under Article 8(5)(a) VABEO.

A solution to this exercise is provided on the Hub

1. Is it prohibited or permitted for the supplier to ban A from making active sales
into East Anglia?

‘A must not target

YORKSHIRE
marketing on
Non-exclusive
Distributor, A

EAST ANGLIA

Exclusive
Distributor, B

LONDON

Non-exclusive
Distributor, C

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2. Is it prohibited or permitted for the supplier to ban A from making passive

sales into East Anglia?

YORKSHIRE
If customer from East
Non-exclusive Anglia places an order...
Distributor, A

EAST ANGLIA

Exclusive
‘A must not fulfil
Distributor, B
customer’s order’

LONDON

Non-exclusive
Distributor, C

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3. Is it prohibited or permitted for the supplier to ban A from making active sales
into London?

YORKSHIRE

Non-exclusive EAST ANGLIA

Distributor, A
Exclusive
Distributor, B

‘A must not target

marketing on London’

LONDON

Non-exclusive
Distributor, C

4. Is it prohibited or permitted for the supplier to ban A from making passive

sales into London?

YORKSHIRE

non-exclusive
Distributor, A

EAST
ANGLIA

If customer
from London

asks to buy...
‘A must not sell
to customer’

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LONDON

Non-exclusive
Distributor, C

7.4.2 Excluded Restrictions – Article 10 VABE

Excluded restrictions (like hardcore restrictions) are prohibited by VABEO

and therefore void. The difference between an excluded restriction and a
hardcore restriction is the consequences of including an excluded restriction
amongst the terms of a distribution agreement can be less severe. Unlike
hardcore restrictions, excluded restrictions can, in principle, be severed from
the agreement in which they are contained – article 11. See below for more
details of this.

All excluded restrictions are varieties of non-compete clause.

A note on terminology: in this chapter, we use the expression ‘non-compete

clause’ loosely, to refer to a clause’s function in commercial terms. The
expression ‘non-compete clause’ in this context might include any clause
under which a distributor is restrained from certain commercial activities, to
which the supplier may object).

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You may recall the common law doctrine of ‘restraint of trade’ (which you have
encountered previously in Chapter 4 / SGS 5 in relation to confidentiality
agreements; and, in BLP, in the context of a director’s service contract). A
non-compete clause is, generally, likely to operate as a restraint of trade and
at common law is prima facie void; but it can be ‘rescued’ to the extent that it
(i) protects a legitimate business interest of the party imposing it and (ii) is
reasonable in scope to protect that interest. The provisions of VABEO have
no effect on the applicability of the common law doctrine of restraint of trade.

It should be obvious that non-compete clauses, by their nature, prevent or

restrict competition. However VABEO does acknowledge that, whilst they are
anti-competitive, such provisions also have a clear commercial rationale and
are not unusual in practice. The effect of VABEO is to impose clear and hard
limits on the extent to which non-compete clauses in distribution agreements
can be justified and upheld from a competition law point of view.

To what extent are non-compete clauses prohibited by VABEO?

Article 10(1) provides that the block exemption applies to an agreement on

condition that it does not contain an excluded restriction.

Excluded restrictions are as follows:

 a non-compete obligation is an excluded restriction if its duration is
either (i) indefinite, or (ii) exceeds five years - article 10(2)(a); and
 a non-compete clause is an excluded restriction if it survives the
termination of the agreement in which it is contained (known in practice
as a ‘post-termination non-compete clause’) - article 10(2)(b).

To summarise the overall effect of Article 10 in terms of what is permitted:

VABEO permits a supplier to impose a non-compete clause on a distributor,
but only for a fixed period (of max. 5 years overall) and only whilst the
agreement as a whole is in force.

Helpful to know in practice

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Articles 10(3) and 10(4) provide limited exceptions to these rules. We do not
consider the exceptions in this chapter because they are so narrow as to apply
only to types of vertical agreement which are not distribution agreements.
Article 10(3) is of particular relevance to agreements concerning the operation
of business models such as are commonly found in respect of petrol stations
and ‘tied’ pubs; Article 10(4) applies to franchise agreements (see note in
Chapter 5).

Excluded restrictions: consequences

The excluded restrictions specified in Article 10(2) are not ‘hardcore’.

Including one of them in a distribution agreement does not automatically result
in loss of the benefit of the block exemption and avoidance of the whole
agreement.

Article 11 VABEO provides that the consequence of including an excluded

restriction amongst the terms of an agreement depends on the extent to which
it is possible to sever the excluded restriction from the remainder of the
agreement in which it is contained.

In a ‘worst-case’ scenario, where an excluded restriction is not severable

from the agreement as a whole, the consequence of its inclusion is effectively
the same as if it had been a hardcore restriction. Article 11(a) provides that in
those circumstances the block exemption is cancelled in respect of the whole
agreement, (which will therefore infringe the Chapter I prohibition and be void).

However, article 11(b) provides that if an excluded restriction is severable

from the agreement, then that restriction can be severed, effectively leaving
the remainder of the terms of the agreement valid and enforceable with the
benefit of the block exemption - provided, of course, that none of its other
terms amounts to a hardcore or excluded restriction.

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The VABEO has nothing to say on the question of whether or not a

restriction can be severed. That is a question of common law for the court to
answer case-by-case. You may recall that
 the court must take account not only of whether the remainder of the
agreement makes sense once the offending clause is removed (the ‘blue
pencil’ test) but also of the commercial effect of deleting the clause; and
 a severability clause in a contract can indicate that the parties wish
unenforceable clauses to be severed where possible; but inclusion of a
severability clause does not, as a matter of law, of itself render any given
clause severable.

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Example: a non-compete clause which was not severable

The following is an example of a case where the court considered whether or

not a clause was severable. At the time of that case the forerunner of the
VABEO (known as the VABER) was in force. It contained provisions
substantially identical in effect to Article 10 VABEO.

Days Medical Aids v Pihsiang (29 January 2004) concerned a distribution

agreement for mobility scooters which included a 10 year non-compete
clause, preventing the distributor from selling any other make of mobility
scooter.

On the facts the agreement was held not to be anti-competitive in the first
place. The judge went on, however, to consider (if he was wrong on his
conclusions) whether the VABER would apply to the agreement. The
applicable market threshold was met, but the non-compete clause took the
agreement outside the VABER because it was for more than five years.

The judge acknowledged that this was not a hardcore restriction and so turned
his mind to the question of whether the remainder of the agreement could be
rescued by severing the non-compete clause. On the facts, it was held that
the non-compete clause was essential to the commercial deal and therefore
not severable. The agreement would have made no sense without it. The
distributor had paid a lump sum to the supplier in return for exclusivity, and the
long period of ‘lock-out’ was the core of the commercial deal between them.
To strike it out would ‘change the nature of the contract’.

8. Summary: advising on competition law aspects of a

distribution agreement

How do practitioners apply competition law to distribution agreements? The

starting point is to establish precisely why your client has instructed you.

8.1 Where a distribution agreement is proposed

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Your client may be instructing you in connection with a proposed distribution

agreement, the commercial heads of terms of which have been agreed, and
your job is to spot the competition law implications and ensure the agreement
is properly drafted. Your objective in this type of matter is to advise your client
how to stay out of trouble.

Using the flowchart, in Step 1 you need to identify any prohibited conduct
caught by s.2 CA. Assuming there is such prohibited conduct then the next
step (Step 2) is to ensure that the VABEO is the applicable block exemption
and, if so, then advise the client that the agreement should be drafted to
comply with the terms of the VABEO, with no hardcore or excluded
restrictions. If necessary suggest appropriate amendments to an existing
defective draft, because otherwise the parties to the agreement risk the
consequences of engaging in prohibited conduct.

If your client refuses so to amend the proposed agreement, then you must
advise it of the potential consequences of infringement – Step 5. Neither
NAOMI nor self-assessment offers robust protection against liability.

8.2 Where a distribution agreement is already in force

If you are being instructed in connection with a distribution agreement which is

already in force and to which your client is a party, your objective now is to
advise your client as to steps it can take to get out of trouble and, if need be,
how to defend legal action brought against it (by the CMA or by a third party
bringing a claim for breach of statutory duty).

Step 1 is to identify whether there is prohibited conduct. If so, apply the

VABEO (Step 2) and check to see whether the agreement complies. If the
agreement complies with VABEO then it is exempt and there is no breach of
the Chapter I Prohibition. If the agreement does not comply then you need to
go on to apply NAOMI (Step 3) and finally self-assess under s.9 (Step 4)
(neither of which can normally be expected to offer much comfort to your
client). Then advise the client of the CMA’s powers of investigation and the
consequences of infringement (Step 5).

As NAOMI and self-assessment offer protection only in limited circumstances

you need to advise your client as to how it could minimise its exposure to loss:

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 it should stop any prohibited activity and co-operate with any CMA
investigation; and
 it could avoid fines altogether by reporting the agreement to the CMA
(‘whistleblowing’) (paragraph. 5.5.3 above).

8.3 Where client is the victim of prohibited conduct by others

A third type of scenario is where you are being instructed by a client who is
suffering because of anti-competitive activity by other parties. For example,
your client may be paying an inflated price for particular goods as a result of
price fixing further up the supply chain; or experiencing difficulties in
purchasing them locally, because all distributors are subject to a passive sales
ban or collective boycott.

In this case, your objective is to advise your client as to whether or not there is
a prima facie case for infringement of s. 2 CA and, if so, advise the client what
it should do.

When applying the steps of the flowchart you will need to adjust your
perspective to that of a potential claimant (rather than defendant). If the
parties to the agreement appear to have infringed, your client may have a
claim against them for breach of statutory duty. However its first port of call will
be to report them to the CMA for investigation.

Appendix: Flowcharts

This appendix provides two versions of the Chapter I Prohibition flowchart discussed in
this chapter. Appendix A sets out the five-step structure for applying competition law to
distribution agreements, which you will use in SGS 10. Appendix B depicts the same
process in a ‘critical path analysis’ form and may assist you in preparing for SGS10.

Appendix A

Step 1

Does the Chapter I Prohibition apply prima facie?

Apply s.2 CA. Three elements:

 Agreement/decision/concerted practice
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Step 2

Can you rely on a block exemption?

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Appendix B

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Further reading

Whish & Bailey: Competition Law, Oxford University Press 2021

Practical Law for Companies, available through BPP’s Online Library via the Hub,
includes a number of helpful practice notes providing overviews (and detailed
commentary on aspects) of EU and UK competition law from a practitioner perspective.
You can browse these by selecting ‘Competition’ from the list of practice areas on the
Practical Law online front page. The easiest way to access the Practical Law website is
from a PC located at the law school. One resource with particular relevance to this
chapter is: Practical Law Practice Note - Distributorships: An overview
http://corporate.practicallaw.com/6-107-3648

Relevant CMA guidance can be found here:

https://assets.publishing.service.gov.uk/government/uploads/system/uploads/
attachment_data/file/1091830/VABEO_Guidance.pdf

https://www.gov.uk/government/collections/cma-ca98-and-cartels-guidance

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Self-assessment exercise

Atlas plc (‘Atlas’) intends to enter into a series of distribution agreements for the
distribution of its confectionery. All of the distributors are based in the UK. Atlas
intends to give each distributor an exclusive local territory in which to sell, and also
intends to fix the resale price that the distributors will sell at, for the first two years.

1. Is Atlas at risk of breaching the Chapter I prohibition under s. 2 CA? Advise Atlas
what it should do to avoid this risk.

2. If Atlas chooses not to follow your advice, might NAOMI or s.9 CA offer protection
against liability for breach?

3. If A is in breach of s. 2 CA, which government body would investigate and

potentially impose sanctions?

A suggested solution to this exercise can be found on the Hub.

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