On 10 May 2022, following a lengthy review and public comment period that began in October 2018, the European Commission (EC) adopted the new Vertical Block Exemption Regulation (VBER) accompanied by new Vertical Guidelines (Guidelines). The new VBER and Guidelines will come into force on 1 June 2022.
In July 2021, the EC staff proposed revised rules relating to vertical relationships, and various stakeholders (including a large consortium of brands represented by Baker McKenzie) provided substantial feedback to the EC about the effects of such proposals on the franchise and consumer goods industries. After a lengthy feedback process, many of the stakeholders’ concerns were addressed (including concerns relating to the effects of new “dual distribution” rules on franchise systems), and the new VBER and Guidelines are aimed to provide more clear and up-to-date rules and guidance to businesses.
Among other things, under the new VBER and Guidelines, the safe harbor will still apply to franchise relationships provided they neither contain hardcore restrictions nor the franchisor’s and franchisee’s individual market shares do not exceed 30% of the relevant market. Notably, the safe harbor will not apply to certain types of exchanges of information between a franchisor and franchisee in a dual distribution system unless the information is directly related to the implementation of the franchise agreement or necessary to improve the production or distribution of the goods or services subject of the franchise. As such, franchisors will need to examine their flow of information to and from franchisees to determine whether such information must be restricted.
Background
Article 101(1) of the Treaty on the Functioning of the European Union (TFEU) prohibits agreements that restrict competition. The so-called Vertical Block Exemption Regulation provides an automatic safe harbor from antitrust scrutiny for vertical agreements (i.e., agreements between businesses operating at different levels of the vertical supply chain) if certain criteria are met and provided that the parties each have a market share below 30% and the vertical agreements do not contain any hardcore restrictions (e.g., restricting online sales, certain territorial restrictions, customer restrictions, fixing resale prices). Agreements that fall into the safe harbor of the VBER are legally permissible from a competition perspective and no further assessment is required.
The EC has been historically aware that franchisors must be able to coordinate and exchange information with downstream franchisees, distributors and resellers. While a franchisor and franchisee do not compete on the upstream level, they may compete on the downstream level (i.e., with respect to consumers). Under the previous VBER framework, dual distribution arrangements – where a brand owner sells its goods or services through independent franchisees, distributors or resellers, as well as directly to end customers (e.g., company-owned units, online or other distribution channels) in the EU market – were exempt vertical relationships, falling within the safe harbor.
As such, brand owners and franchisees, distributors and resellers could freely exchange information in the context of their vertical relationship (e.g., a brand owner could collect sales information about its products from franchisees, distributors and resellers) as long as the brand owner does not use the information in a manner which is considered hardcore (e.g., imposing restrictions that limit the reseller’s/franchisee’s freedom to determine its resale price, prohibiting online sales, etc.). Further, franchisors routinely establish company-owned operations and sell products or services directly to customers (in fact, company-owned operations often help build the brand and drive franchise sales), and at the same time, act as a supplier to the franchisee network. Any inability of a franchisor to share commercially sensitive information with its franchisees could result in a drastic breakdown in the viability and functioning of franchise networks and would likely require franchisors to take drastic (and administratively difficult) actions such as putting “ethical walls” in place between the parts of its organization responsible for relationships with franchisees and company-owned operations, limiting the information currently collected from franchisees, stopping collection of such information, separating teams, or scaling back company-owned operations and, possibly, direct sales operations.
Last summer, the EC proposed to narrow the safe harbor for dual distribution by implementing reduced aggregate market share thresholds and assessing the ability to exchange information within the dual distribution system through the lens of the more-restrictive EU Horizontal Guidelines (typically meant to address agreements entered into between companies operating at the same level in the market). If enacted in its originally proposed form, the ability for franchisors to share commercially sensitive information with franchisees would have been severely restricted.
As a result of tremendous efforts by the industry, the feedback given to the EC was overwhelmingly negative, forcing the EC staff to reconsider their approach to dual distribution entirely.
New VBER and Guidelines
The new VBER and Guidelines are aimed to ensure that the safe harbor is neither too broad nor too narrow and to address commercial realities which have been reshaped by the growth of e-commerce and online sales. Among other things, the new VBER and Guidelines address: (i) dual distribution, (ii) selective distribution and exclusive distribution and (iii) online sales.
Fortunately, franchise relationships remain covered by the new VBER, provided they do not contain hardcore restrictions that would otherwise remove the franchise relationship from the protections of the VBER and, as noted above, provided that the franchisor’s and franchisee’s individual market shares do not exceed 30% of the relevant market. If either the franchisor or the franchisee holds more than 30% of the market for the goods or services contemplated by the agreement, the safe harbor exemption does not apply. This does not mean that the franchise relationship is automatically problematic, but it will be subject to individual assessment. Vertical restraints contained in franchise agreements are assessed using the principles applicable to the distribution system that corresponds to the particular franchise agreement (e.g., selective distribution or exclusive distribution).
With respect to dual distribution, the unrestricted exchange of information within a dual distribution system is no longer exempted under the new VBER and Guidelines. Under Article 2(5) of the new VBER, the safe harbor exemption will not apply to the exchange of information between a supplier and buyer in a dual distribution system that is: (a) not directly related to the implementation of the vertical agreement; (b) not necessary to improve the production or distribution of the contract goods or services; or (c) fulfills neither of those two conditions.
As a result of the request made by the consortium of brands represented by Baker McKenzie, Section 4.4.3 of the new Guidelines provides specifically for franchising agreements that:
“[w]hether an exchange of information in a dual distribution scenario is directly related to the implementation of the vertical agreement and necessary to improve the production or distribution of the contract goods or services within the meaning of Article 2(5) of [the new VBER] may depend on the particular model of distribution… [u]nder a franchise agreement, it may be necessary for the franchisor and franchisee to exchange information relating to the application of a uniform business model across the franchise network”.
Further, the new Guidelines give examples of information that is “directly related to the implementation of the vertical agreement” or “necessary to improve the product or distribution of the contract goods or services”, including, technical information, sourcing information, customer-specific sales information, pricing, marketing information (including information on promotional campaigns), and performance-related information. The new Guidelines also contain examples of information exchange that are unlikely to fulfill the conditions for exemption under the VBER, for example, information related to the intended future prices in the franchisor’s own stores and websites and in the franchisee’s stores.
The new Guidelines do not offer legal certainty as to the type of dual distribution information exchanges which would qualify for exemption under the VBER. Further, and due to the fact that the Guidelines are not binding on the national competition authorities and courts of the EU member states, there is the possibility of different approaches to enforcement across these member states. As such, franchise systems must, among other things, monitor developments under the VBER and Guidelines at the EU- and member states-level. Under the new VBER and Guidelines, a franchisor can no longer assume that all types of dual distribution information exchange will be exempted. Rather, a franchisor should tread carefully and assess the circumstances within each member state in which it is operating and what types of information exchanged within its franchise system may be exempted (with particular focus on information related to the franchisor’s own direct to consumer operations).
With respect to online sales, the new VBER and Guidelines broaden the exemption relating to a franchisor’s ability to charge the same franchisee, distributor and reseller different wholesale prices for products to be sold online and offline (as long as the differences are reasonably related to differences in costs or investments) and the ability to set different criteria for online and offline sales in selective distribution systems.
Practical consequences
Although the initial proposals were controversial, as a result of industry efforts, the new VBER and Guidelines reflect a more balanced approach than was initially proposed to regulating dual distribution arrangements and relaxing the restrictions on online sales. However, the new VBER and Guidelines do represent a stricter approach to dual distribution arrangements compared to the original VBER and Guidelines (under which dual distribution, including information exchange, was exempted). While many of these changes have been welcomed by the industry, cross-border franchisors will need to remain attentive to any concrete guidance issued by EU member states on precisely what types of dual distribution information are exempted under the VBER.
Baker McKenzie’s EU Competition Law and Global Franchise and Distribution teams continue to monitor the new VBER and Guidelines.
