The Transatlantic Divide on Verticals—The Underlying Reasons and the Way Forward

1. Vertical Agreements and EU Competition Law “Labels”

As this article focuses on the area of EU competition law that may seem exotic to U.S. lawyers, it is helpful to start with the description of the EU regulatory framework and the key concepts and notions that are used in the EU in the assessment of vertical agreements.

Similarly to Section 1 of the Sherman Act, Article 101 of the Treaty on the Functioning of the European Union (TFEU) provides for a broad prohibition of anti-competitive agreements that may affect trade between EU Member States. That prohibition applies both to agreements between competitors (or so-called “horizontal agreements”) and to agreements between companies operating on different levels of production and distribution of the same product or service (so-called “vertical agreements”). The notion of “vertical agreement” covers broadly agreements whereby one party purchases an input (product or service) from a manufacturer or a wholesaler for further processing or resale. As will be explained in more detailed below, the Commission has developed detailed rules under which some types of vertical agreements benefit from a presumption of legality, whereas other are presumed to be restrictive of competition. These rules are adopted in the form of binding regulations, which establish safe harbors for some type of agreements and list standard restrictions that are presumed to be anticompetitive. The Commission has also adopted numerous soft laws: guidelines, notices, guidance papers, which set out in detail the Commission’s approach to the assessment of typical agreements and restrictions included in such agreements. Although these soft laws in principle do not have any binding force, ³ they are followed by the Commission and by national courts and competition authorities in the EU. ⁴

The key EU rules on vertical agreements are included in the Block Exemption Regulation on Vertical Restraints (VBER) ⁵ and in the accompanying Commission’s Guidelines on Vertical Restraints. ⁶ The VBER establishes a safe harbor for certain types of vertical agreements (in essence agreements between parties whose market shares do not exceed 30% in any upstream or downstream markets). However, the VBER is not applicable to agreements that include any of the so-called hardcore restrictions listed in the VBER. Moreover, an agreement including one of the hardcore restraints is presumed to restrict competition and to be illegal.

The list of hardcore restraints included in the VBER includes resale price maintenance and, subject to limited exceptions, restrictions on territory into which or customers to whom the buyer in a vertical agreement may sell contract products. ⁷ The VBER and the Guidelines on Vertical Restraints contain a set of very complex rules relating to the types of territorial and customer restrictions that could be imposed on the buyer party in a vertical agreement. In exclusive distribution agreements, ⁸ whereby the seller party appoints only one distributor in a given territory (i.e., guarantees to the distributor that it would not appoint another company a distributor), it is possible to restrict “active” sales into territories or to customer groups reserved for the supplier or to another distributor. The notion of “active” sales relates to actively pursuing a customer in a specific territory. But if the distributor is not exclusive in a given territory, it is not possible to prevent other distributors from selling into that territory (and it is also not possible to prevent that distributor from selling into other territories, even if such territories are reserved to another distributor). Further, “passive” selling, which refers to sales made in response to unsolicited requests from customers, cannot be obstructed. The Commission generally views online sales as passive selling and therefore treats as a hardcore restraint any restriction on sales to customers within the EU via the Internet. Moreover, practices broadly referred to as “geo-blocking,” whereby retailers prevent online shoppers from purchasing if the shopper’s location or country of residence ⁹ are also considered hardcore restrictions. Other restrictions, such as exclusive supply arrangements (i.e., obliging the buyer to source contract products only from the supplier) and noncompetes are not included in the VBER list of hardcore restrictions. Agreements that contain them can therefore benefit from the safe harbor, as long as the parties’ market shares do not exceed 30% on any downstream or upstream markets. ¹⁰

Though in other fields the EU competition law has moved to an effects-based approach, when it comes to vertical restraints, the approach is still largely form based. A restriction on territory or buyers to whom the buyer can sell contract products that does not fit one of those narrow categories is presumed to be anticompetitive and illegal regardless of the parties’ market power. The presumption of illegality applies even if the parties have very clearly no market power. Indeed, agreements containing one of the hardcore restrictions are specifically excluded from the benefit of the safe harbor, which the Commission created for agreements between parties who have de minimis market shares, which covers, among others, vertical agreements between parties whose shares in the relevant market do not exceed 15%. ¹¹ It is hard (if not impossible) to justify the EU approach to vertical restraints and the distinctions made in the EU rules with respect to treatment of different types of restrictions in terms of economic efficiency. As discussed below, the notions or categories used to assess vertical agreements under EU rules have also no equivalents under the U.S. rules.

2. U.S. Rules on Vertical Restraints

Vertical restraints are assessed in the U.S. under Section 1 of the Sherman Act, in line with the relevant case law of the U.S. courts. Section 1 states broadly that contracts “in restraint of trade or commerce” are illegal. Unlike in the EU, there are no regulations or soft laws including a more specific description of the restrictions that are considered illegal under Section 1. The interpretation of Section 1 and the framework for assessing vertical restraints is based on the case law developed by the U.S. courts during the course of over the century since the adoption of the Sherman Act.

The treatment of vertical restraints in the U.S. has evolved over time. Vertical restraints were not a concern for the antitrust enforcers in the U.S. until the 1950s, when the U.S. government began to pursue them aggressively. ¹² In White Motor, the first case targeting vertical restraints that reached the U.S. Supreme Court in 1963, the U.S. enforcement agencies asked the court to establish a rule of law preventing a manufacturer from limiting the area and the customers to whom its distributors could resell its products. The Court declined to hold that such restrictions were unlawful per se, reasoning that there was not enough experience in handling such cases. ¹³ However, in Schwinn, ¹⁴ decided just four years later in 1967, the U.S. Supreme Court held that exclusive distribution should be per se prohibited.

The per se treatment of nonprice vertical restraints proved to be only a short-lived episode in the history of U.S. antitrust law. ¹⁵ Only ten years after Schwinn, in the landmark Sylvania judgment, ¹⁶ the Supreme Court held that nonprice vertical restraints should be subject to the “rule of reason” treatment. The Court, citing extensively the work of Robert H. Bork, reasoned that such restraints were meant to create incentives for retailers to offer the necessary services for customers searching for a particular type of product and therefore promoted interbrand competition. As such, they do not infringe the Sherman Act and should be assessed based on their actual effects on the market, even though they may restrict intrabrand competition. The treatment of vertical restrains in the U.S. has become more and more lenient over the last forty years. The last bastion of per se treatment of vertical restraints fell thirty years after Sylvania. In Leegin, ¹⁷ the U.S. Supreme Court held that there was insufficient basis for treating resale price maintenance as per se illegal considering that “economics literature is replete with procompetitive justifications for a manufacturer’s use of resale price maintenance.” ¹⁸ Accordingly, nowadays, the rule of reason applies to both price restraints (minimum resale price maintenance) and nearly all nonprice restrictions, ¹⁹ meaning that the court applies the “totality of the circumstances” test to decide whether the challenged practice promotes or suppresses market competition.

The same principles apply to the assessment of vertical restraints in the context of online commerce. In an official statement, the U.S. antitrust agencies said that economic theory did not provide a basis for treating vertical restrictions differently depending on the presence or extent of online sales in the market. With respect to the distinction between “active” and “passive” sales in the online context, the U.S. agencies commented,

U.S. law does not distinguish between active and passive sales in the treatment of vertical restraints. The economic literature does not provide a strong basis for such a distinction. Vertical externalities may exist for both active and passive sales. This means that vertical restraints can have procompetitive benefits in either case. ²⁰

3. The EU Schism on Vertical Restraints and the Driving Force Behind It

The EU rules on vertical restraints have also been evolving, but in a different direction than in the U.S. The EU rules applicable to nonprice vertical restraints have become stricter and more pervasive. As shown below, the driving force behind this development was the perceived necessity to ensure that private companies do not prevent free movement of goods and services within the EU’s internal market, or “the single market objective,” which is viewed as a separate goal from the goal of enhancing economic efficiency or promoting consumer welfare, which has been generally accepted as the main goal of EU competition rules. ²³ In its Vertical Guidelines of 2010, the European Commission, the EU law competition enforcement agency states that: “[c]ompanies should not be allowed to re-establish private barriers between member states where state barriers have been successfully abolished.” ²⁴

To understand the preoccupation with market integration, let us start from the beginning. EU competition law has grown out of two Articles included in the Treaty of Rome of 1957, which established the European Economic Community (EEC), the predecessor of the European Union. The Treaty of Rome had an ambitious objective: to create “the foundations of an ever closer union among the peoples of Europe” by integrating the economies of the six Western European countries, the EU’s founding members. Its signatories committed to dismantling all customs tariffs and nontariff barriers to trade within the EEC. The Treaty of Rome guaranteed the free movement of goods, services, persons, and capital within the EU. It also included, as the first ever regional trade agreement, ²⁵ two rather open-ended rules: Article 85, which prohibited agreements that had “as an object or effect the prevention, restriction, or distortion of competition” and “may affect” trade within the EU; and Article 86, which prevented “dominant” companies from abusing their market power.

Protection of competition was seen as an important element to help create the internal EU market, and the principal focus in the early years of EU competition law were practices that interfered with the integration of the Member States’ economies. ²⁶ These concerns were shaped the reasoning in the landmark Grundig/Consten judgment of the European Court of Justice. ²⁷ The case concerned a contract in which Grundig, a German manufacturer of electronics, appointed Consten its exclusive distributor in France. Consten undertook to place regular orders, provide publicity and to set up a repair workshop to provide guarantee and after-sales service. Consten was obliged not to sell competing products in France and not to make deliveries to countries outside the contract territory. Consten was also authorized to register Grundig’s trademark in its own name in France, which Consten used to stop other parallel imports of Grundig radios from Germany to France. The parallel importers, in turn, complained to the European Commission, which adopted the decision stating that Grundig and Consten violated the prohibition against anti-competitive agreements incorporated in Article 85(1) of the Treaty of Rome (which has now become Article 101 TFEU) and “are required to refrain from any measure likely to obstruct or impede the acquisitions by third parties…of products set out in the contract, with a view to their resale in the contract territory.” ²⁸

The parties appealed to the Court of Justice, arguing that Article 101(1) TFEU did not apply to vertical agreements and that the arrangement was necessary to prevent free riding by parallel traders on the efforts made by the distributor. Alternatively, they submitted that “the rule of reason” should apply and that exclusive distribution agreements are not harmful to competition but, in fact, increase competition between products of different manufacturers. The Court disagreed, noting that the arrangement had given Consten “absolute territorial protection” for the territory of France (which the parties secured by transferring Grundig’s trademark to Consten) and that “the isolation of the French market” made it possible to charge higher prices for Grundig products. The judgment makes clear that the Court’s key concern was the restriction of parallel trade within the EU, which was seen as incompatible with the major goal of the EU: the creation of the Single Market:

an agreement between producer and distributor which may tend to restore the national divisions in trade between Member States might be such as to frustrate the most fundamental objectives of the Community. The Treaty, whose preamble and content aim at abolishing the barriers between States, and which in several provisions gives evidence of a stern attitude with regard to their reappearance, could not allow undertakings to reconstruct such barriers. ²⁹

But exclusive distribution, as such, was not objectionable. Already in 1967, the Commission adopted a regulation establishing a presumption of legality for exclusive distribution agreements that prevented a distributor from seeking customers, establishing any branch or maintaining a distribution depot outside the contract territory. ³² The same provision was included in the updated version of the block exemption regulation adopted in 1983. ³³ Accordingly, territorial restrictions in exclusive distribution agreements benefited from the presumption of legality, regardless of the parties’ market shares, as long as the parties did not prevent parallel trade or so-called “passive sales” to customers from outside the exclusively allocated territory. Due to the relatively wide safe harbor established by the block exemption of 1967 and in its successor, the block exemption of 1983, exclusive distribution agreements were a common choice for the parties setting up a distribution system within the EU. ³⁴

That framework, however, was criticized for its lack of flexibility. The block exemption regulations were narrow and rigid: they listed permitted clauses and did not cover any agreements that contained clauses other than those listed. An agreement containing restrictions falling outside the scope of the block exemption regulation had to be individually notified to the Commission, which assessed it under the EU competition rules. An agreement requiring an individual exemption was not enforceable unless it had the Commission’s blessing. ³⁵

Recognizing the limitations of this approach, ³⁶ the Commission embarked on the broad reform of the EU competition law in the late 1990s. The so-called modernization of EU competition law was meant to make the substantive rules more in line with the modern economic analysis and the procedures more flexible. ³⁷ In 1999, the Commission adopted a new Block Exemption Regulation on Vertical Restraints, ³⁸ the first “modern” block exemption regulation, which was meant to introduce a more economic approach to the assessment of vertical restraints. ³⁹ The framework established in the Block Exemption Regulation on Vertical Restraints of 1999 was largely readopted in the Block Exemption Regulation on Vertical Restraints of 2010, ⁴⁰ which is currently the binding law. Both block exemption regulations were accompanied by Guidelines on Vertical Restraints, a bulky document with more rules on the practices the Commission considers anticompetitive in the context of distribution agreements. ⁴¹ The Guidelines were meant to assist companies in the self-assessment of their distribution agreements, as following the change in the EU antitrust procedure, the companies were no longer required to notify their agreements to the Commission (and no longer had the option of having the Commission vet their agreements). ⁴²

Though the new block exemption regulation only included a list of “hardcore” or blacklisted restrictions and covered all agreements other than those including blacklisted clauses, the list of “hardcore” restrictions has been significantly expanded as compared to the previous block exemptions. Further, to ensure that any potentially anticompetitive agreements did not benefit from the block exemption, the 1999 Block Exemption Regulation included a 30% market share threshold: only agreements between the parties whose market shares did not exceed that threshold could benefit from the safe harbor. ⁴³ Agreements that included hardcore restrictions fell outside the safe harbor and were presumed to be anticompetitive regardless of the parties’ market power. Further, hardcore restrictions were considered to be anticompetitive and therefore violate Article 101(1) TFEU and unlikely to fulfill the conditions of Article 101(3).

In the new framework, exclusive distribution or “the restriction of territory into which, or of the customers to whom” a distributor may sell, was labelled as a “hardcore” restriction. ⁴⁴ There are certain exceptions to this rule, the most significant of which relates to the possibility of restricting “active sales into the exclusive territory or to an exclusive customer group reserved to the supplier or allocated by the supplier to another buyer, where such a restriction does not limit sales by the customers of the buyer.” ⁴⁵ Thus, to qualify for the safe harbor, restrictions on active sales cannot be imposed for target territories, in which the manufacturer distributes its products via nonexclusive distributors. So, for example, if the manufacturer has entered into a nonexclusive distribution agreement in France, it cannot prohibit active sales into France, even if it has reserved all other European Economic Area (EEA) territories to itself or exclusive distributors.

There are also specific requirements as to the exclusive allocation of territories to distributors. For a territory to be allocated exclusively to a distributor, the supplier must agree to sell its products only to one distributor ⁴⁶ and cannot retain the ability to appoint additional distributors in that territory at a later time. ⁴⁷ As a consequence of this rule, appointing an additional nonexclusive distributor (or even just having the capacity to do so) would make in principle unlawful a limitation on active sales into that territory by other distributors. ⁴⁸ What is more, the Vertical Guidelines stress, “[a] territory or customer group is exclusively allocated when the supplier agrees to sell its product only to one distributor for distribution in a particular territory or to a particular customer group and the exclusive distributor is protected against active selling into its territory or to its customer group by all the other buyers of the supplier within the Union….” ⁴⁹ Put differently, the restriction must be imposed in parallel on all of the manufacturers’ distributors in the EEA, outside the target territory. In practical terms this means that a supplier can prevent the distributor from making active sales outside its territory ⁵⁰ only insofar as (1) the active sales restriction must relate to a territory or a customer group reserved by the supplier or allocated to a single exclusive distributor; and (2) the same restriction must be imposed on all of the distributors of the supplier operating in the EEA; ⁵¹ and further, (3) the distributor itself cannot impose any restriction on sales made by his own customers, so, for example, the supplier cannot prevent the distributor from selling to traders and cannot require the distributor to impose any limitations on the distributor’s customers. Obviously, distributors should always be allowed to make passive sales, inside and outside their exclusive territory/customer group. Thus, when it comes to exclusive distribution, the “modernized” regime is, in fact, far more restrictive than its predecessors. The conditions for exempting exclusive distribution agreements are difficult to meet, and any restriction on the territory or customer to whom the distributor may sell that does not meet these conditions is labelled as a hardcore, presumptively illegal restraint. What was the reason behind the adoption of such restrictive rules? Unsurprisingly, the Commission explained that the inclusion of the general prohibition on resale restrictions reflected “the concern to further market integration” and was driven by the need “to protect the possibility of arbitrage by intermediate and final purchasers to a greater extent.” ⁵²

Another important modification made in 1999 was the introduction of rules that restricted the organization of online sales. The Vertical Restraints Guidelines of 1999 ⁵³ stated that, as a matter of principle, “every distributor must be free to use the Internet to advertise or to sell products” and that any restriction in that regard would only comply with the VBER “to the extent that promotion on the Internet or sales over the Internet would lead to active selling into other distributors’ exclusive territories or customer groups.” ⁵⁴ The Vertical Guidelines of 1999 made clear, in essence, that a ban on online sales would be considered as equivalent to a ban on passive sales and, as such, treated as a hardcore restriction. The Commission further specified that “the supplier cannot reserve to itself sales and/or advertising over the Internet.” ⁵⁵ The revised Vertical Guidelines published in 2010 have gone further and listed a number of additional practices falling into the hardcore category including (1) an agreement obliging an (exclusive) distributor to prevent customers located in another (exclusive) territory from viewing its website or automatically re-routing its customers to other websites; (2) an agreement obliging an (exclusive) distributor to terminate consumers’ transactions over the internet once their credit card data reveals an address outside that distributor’s territory; (3) an agreement limiting the proportion of overall sales that could be made online; and (4) an agreement requiring the distributor to pay a higher price for products resold online. ⁵⁶

Restrictions on cross-border e-commerce have now become Commission’s focus as a part of its project to create a “Digital Single Market.” In this context, the Commission launched an inquiry into e-commerce sector in the EU and began again targeting vertical restraints on cross-border trade within the EU. In its Preliminary Report on the E-Commerce Sector Inquiry published in September 2016, the Commission concludes that “a number of territorial restrictions” customarily included in online distribution agreements “may raise concerns regarding their compatibility with Article 101 TFEU.” ⁵⁷ It identifies restrictions on active sales (in territories that were not exclusively allocated to another distributor or reserved to the supplier) as an example of potentially problematic clauses ⁵⁸ and singles out contractual clauses requiring geo-blocking (which typically involves preventing customers residing in another EU Member State from making purchases online) ⁵⁹ as hardcore restraints. ⁶⁰ Moreover, the Commission also said that a number of new practices could be potentially problematic (though they would not amount to a “hardcore restriction”). This included preventing distributors from selling on online platforms, such as Amazon or eBay ⁶¹ and obliging the distributor to have at least one brick-and-mortar shop (even though this was previously allowed in the Vertical Guidelines of 2010). ⁶²

It appears that the E-Commerce Sector Inquiry has brought a change in the Commission’s approach to vertical restraints. As mentioned above, in the decade following the adoption of Regulation 1/2003, there have been very few cases challenging vertical agreements and the Commission focused on carters. By contrast, shortly following the publication of the Preliminary Report of the Inquiry, the Commission launched investigations against numerous companies with the view to assessing whether their online sales practices are in line with EU competition rules. ⁶³ One of these cases targets geo-blocking practices relating to the distribution of video games, namely by preventing the activation of a video game by customers who downloaded it from a site in another EU Member State. Another case looks into possible price discrimination between customers booking hotels based on their nationality or country of residence. ⁶⁴ According to the Commission, such practices could breach Article 101(1) TFEU because they prevent consumers from buying cheaper products that may be available in other Member States and “lead to the partitioning of the Single Market.” ⁶⁵ Accordingly, the goal behind these enforcement efforts appears to be the elimination of perceived barriers to trade within the EU rather than economic efficiency.

4. Restraints on Trade Outside the EU

Another factor confirming that EU rules on territorial restraints are driven by the market integration rationale is that when it comes to restrictions on parallel imports from outside the EU, the Commission and the EU Courts have been far less eager to intervene. The Commission’s Vertical Guidelines state that the “list of hardcore restrictions applies to vertical agreements concerning trade within the Union” and refer to the Court of Justice’s ruling in Javico v Yves St Laurent. ⁶⁶ The same restriction is assessed differently depending on whether it affects trade between France and Germany or trade between the U.S. and Germany, or, for that matter, post-Brexit, between the UK and Germany.

In Javico, YSL entered into two distribution agreements with Javico, whose registered office was in Germany, whereby, in one contract, Javico agreed to distribute YSL’s products in Russia and Ukraine and in the other contract in Slovenia (which was then not an EU member). The contracts provided that the products could not be reimported in the EU, where YSL used different distributors. Shortly after concluding the agreement, YSL discovered that products, which should have been distributed in Russia, Ukraine and Slovenia, had been sold in EU countries. YSL brought proceedings in France for breach of contract and the French court sought guidance from the Court of Justice as to whether such clauses were contrary to Article 101 TFEU. The Court noted that agreements that restrict parallel trade within the EU are considered a restriction of competition “by object” but that this rule did not necessarily apply to agreements that restrict parallel trade from outside the EU. ⁶⁷ The Court held that such restrictions are generally not “intended to exclude parallel imports and marketing of the contractual product within the [EU] but as being designed to enable the producer to penetrate a market outside the [EU] by supplying a sufficient quantity of contractual products to that market.” ⁶⁸ Thus, the Court concluded that

an agreement in which the reseller gives to the producer an undertaking that he will sell the contractual products on a market outside the Community cannot be regarded as having the object of appreciably restricting competition within the common market or as being capable of affecting, as such, trade between Member States. ⁶⁹

The Commission has been generally reluctant to pursue distribution agreements that limit imports or parallel trade from outside the EU. In Haladjian Frères, which concerned an agreement whereby Caterpillar, a U.S. manufacturer of site machines, limited the imports of spare parts sold outside the EU into the EU, the Commission refused to act on complaints from parallel importers. On appeal, the General Court noted that

in order to justify the application of the competition rules to an agreement concerning products purchased in the United States for sale in the [EU], that agreement must, on the basis of a range of elements of fact and of law, make it possible to envisage with a sufficient degree of probability that it is capable of having a more than insignificant influence on competition in the [EU] and on trade between Member States.…The mere fact that conduct produces certain effects, no matter what they may be, on the Community economy does not in itself constitute a sufficiently close link to be able to found Community competence. In order to be capable of being taken into account, that effect must be substantial, that is to say, appreciable and not negligible. ⁷¹

To be sure, the geographic reach of the EU competition law potentially extends beyond agreements that directly concern the conduct of the parties within the EU. ⁷² And neither the Commission nor the Court said that territorial vertical restraints were legal if they did not directly obstruct trade within the EU. But agreements only affecting exports into the EU have so far not featured high on the list of the Commission’s enforcement priorities.

5. The EU Assessment Framework: Tightening the Straightjacket

Part of the problem with the EU rules on vertical restraints is the framework created by the Commission’s regulations and soft laws, under which companies are effectively discouraged from concluding agreements that include any of the restrictions identified as “hardcore” by the Commission.

A hardcore restraint is not quite equivalent to a per se illegal restraint under the U.S. antitrust rules: a hardcore restraint could, in principle, be permitted if it creates efficiencies that outweigh its negative effects on competition. This is an argument that is used by the EU officials to justify the broad scope of the “hardcore” category. Fear not, the Commission says, when the agreement is really procompetitive, it will not be condemned. ⁷³ However, where a hardcore restriction is included in an agreement, the entire agreement is presumed to fall within Article 101(1) TFEU and it is also presumed that the agreement is unlikely to fulfil the conditions for exemption under Article 101(3) TFEU. This is true even if the parties have very small market shares. ⁷⁴ To put this into perspective, exactly the same presumptions apply in the case of a price fixing cartel.

Although it is open to undertakings to demonstrate procompetitive effects under Article 101(3) TFEU in an individual case, ⁷⁵ in practice, the vast majority of practitioners advise against including hardcore restraints in an agreement. First, few companies want to risk that an agreement they conclude is invalid and the inclusion of a hardcore restriction creates a risk for the validity of the whole agreement.

Second, there are virtually no cases in which restrictions classified as “hardcore” by the Commission were ruled to be procompetitive. To the contrary, in recent judgments, the Court of Justice confirmed that certain types of vertical restraints could restrict competition “by object,” that is, regardless of their actual effects on the market, ⁷⁶ and held that contractual clauses preventing a distributor from making online sales are a hardcore restriction. ⁷⁷ In other recent judgment, the Court of Justice held that an agreement that includes a hardcore restraint could be caught under Article 101 TFEU regardless of the parties’ market shares, “independently of any concrete effect that it may have” on competition. ⁷⁸ Applying this logic, a manufacturer of widgets with a 2% share cannot appoint an exclusive distributor and afford him territorial protection (unless it sets up an exclusive distribution system throughout the EU) or ban a distributor from selling widgets online as that would amount to a “hardcore restraint,” presumably violating Article 101(1) TFEU and presumably not eligible for an exemption ender Article 101(3) TFEU.

The vetting system created a constant stream of case law from the Commission and allowed the companies to present their individual cases. But the vetting system was abolished in 2004, when Regulation 1/2003 ⁷⁹ introducing a major overhaul of the procedures for the application of the EU competition rules entered into force. Regulation 1/2003 introduced an enforcement system based on the direct application of EU competition rules. It also empowered national competition authorities and national courts in EU Member States to apply all aspects of the EU competition rules. In the decade following the adoption of Regulation 1/2003, the Commission has hardly initiated any new investigations targeting vertical territorial restraints. ⁸⁰ Instead, the Commission made fight against international cartels its enforcement priority and has largely left the enforcement of the EU rules on verticals to the national competition authorities in the EU Member States. But this has created a situation where there are fewer opportunities to test and review the Commission’s framework established by the Block Exemption Regulation on Vertical Restraints and the Vertical Restraints Guidelines.

One could hope that the case law from the EU Member States could address these issues. Since 2004, national competition authorities in the EU Member States are competent to enforce EU rules together with national competition rules. In line with Article 3 of Regulation 1/2003, when national competition authorities apply national competition law to agreements or practices that may affect trade between Member States, they must also apply the EU competition rules. When they apply EU competition rules, they must of course follow the relevant EU precedent; they must also interpret EU law in line with the soft laws adopted by the Commission. ⁸¹ But national competition laws are largely not harmonized, meaning that EU Member States are able to adopt at the national level competition rules that are different from EU competition rules. The only limitation in that regard is included in Article 3 of Regulation 1/2003. In line with that provision, in relation to agreements which may affect trade between Member States, applying national competition law may not lead to a stricter outcome than the position under the Article 101(1) TFEU. In other words, national competition rules should not prohibit agreements that would be permitted under Article 101(1) TFEU. ⁸² Consequently, Member States are free to adopt at the national level less restrictive rules than the EU rules. ⁸³ Thus, territorial restrictions could be allowed, for example, in the context of local agreements that do not affect trade between EU Member States and to which Article 101(1) TFEU is therefore not applicable. Indeed, no market integration rationale would dictate policy against restrictions on parallel trade at the national level. Alas, Member States largely follow the Commission’s approach to vertical restraints. A number of EU Member States have replicated the EU rules on verticals at the national level or directly refer to the EU rules. For example, in Germany, a rather flexible framework for the assessment of verticals has been replaced with a regime based on the EU rules. ⁸⁴ In Demark, Ireland, and Poland, regulations based on the EU Block Exemption Regulation have been adopted. ⁸⁵ In Romania, Sweden, and Greece, the national competition laws simply refer to the EU framework. Other jurisdictions, like France, also follow the EU rules and EU precedents even in the assessment of strictly local agreements. As a result, parties wishing to depart from the EU framework will find little comfort in national competition rules and precedents at the Member State level. For these reasons, most companies opt for legal certainty and avoid the inclusion of any hardcore restrictions in their agreements. ⁸⁶

6. Are Market Integration and Consumers Welfare at Odds with Each Other?

The Commission acknowledges that absent market power vertical restraints are unlikely to give rise to competitive concerns. The Vertical Guidelines state that:

a reduction of competition between the distributors of the same brand will lead to a reduction of intra-brand competition between these distributors, but may not have a negative effect on competition between distributors in general. In such a case, if inter-brand competition is fierce, it is unlikely that a reduction of intra-brand competition will have negative effects for consumers. ⁸⁷

In individual cases, however, placing singular importance on eliminating barriers to cross-border trade has proved to be difficult to reconcile with promoting economic efficiency. Procompetitive justifications for territorial restrictions in distribution agreements within the EU have generally not been accepted, even where the purpose of the restriction was ostensibly to expand cross-border sales. Indeed, in the seminal Consten and Grundig case, the purpose of the restrictions on parallel trade was to ensure that the French distributor would have the incentive to promote and expand the sales of Grudig products in France. In the Volkswagen case mentioned above, the German car manufacturer was accused of violating competition rules by preventing the reimportation into Germany and Austria of discounted cars it sold it Italy (presumably with the view to expanding in the Italian market, which is dominated by the Italian car manufacturer, Fiat). The Commission reasoned that Volkswagen’s conduct could not be justified because

consumers do not share in the resulting benefit. Consumers are prevented from taking advantage of the single market and of differences in the price of motor vehicles between the Member States. The right of consumers to buy goods of their choice anywhere they want in the single market is restricted. ⁹⁰

Excessive regulation of distribution may, in fact, be harmful for promoting cross-border trade. It could discourage manufactures from offering their products in low-priced markets. It could promote economically inefficient vertical integration. ⁹² There seems to be at least circumstantial evidence that the straightjacket of rules created by the Commission leads to less than efficient choices in organizing distribution networks in the EU. It appears that following the adoption of the stricter rules on territorial restraints in exclusive distribution agreements, there has been a decrease in the popularity of exclusive distribution in the EU. ⁹³ The fall in the popularity of exclusive distribution agreements was accompanied by a more widespread use of the so-called “selective distribution” systems. ⁹⁴ Prior to the entry into force of the Verticals Block Exemption of 1999, selective distribution agreements were not subject of a specific block exemption regulation, though were the subject of extensive decision-making practice of the Commission and case-law of the EU courts. ⁹⁵ The Vertical Block Exemption of 1999 established a blanket prohibition on customer and territorial restrictions and provided for narrow exceptions from that prohibition for exclusive distribution and selective distribution arrangements. Under that framework (which has been retained in the Vertical Block Exemption of 2010), the formula of selective distribution allows for the inclusion of location clauses and for preventing and prohibiting the distributor from making sales to unauthorized dealers. It does not, however, allow the supplier to prevent the distributor from making active sales outside its territory. ⁹⁶ One possible explanation for this shift to selective distribution is that it is a rather flexible framework (at least, as compared to the exclusive distribution framework as envisaged by the EU rules), which allows for some degree of control over distributors. It seems likely that at least some manufacturers, discouraged from exclusive distribution model by the straightjacket of rules, treat selective distribution as their second best choice. That likely means that they are unable to organize their distribution in the most efficient manner.

Conclusion

The current, strict EU approach to territorial vertical restraints does not seem to contribute to economic efficiency or market integration. A more laissez-faire approach is not likely to undermine the single market. On the contrary, it could benefit the single market objective by allowing manufactures to guarantee protection from free-riding to their distributors and thus encourage them to promote products imported from other EU Member States. ⁹⁷ The Single Market objective should be redefined in a more flexible manner and, on that basis, implemented in a new effects-based framework for the assessment of vertical restraints. That new framework would be easier to reconcile with the standard consumer welfare analysis.

The transatlantic gap on verticals has so far given rise to fewer clashes than the divergences in other areas. Unlike cross-border mergers or cases targeting unilateral conduct of global corporations, distribution typically concerns local markets. In several cases, the Commission and the Courts indicated such agreements were outside the scope of their jurisdiction. This is why, perhaps, the differences in the treatment of vertical restraints in the EU and U.S. have generally been in less in the spotlight than the divergences relating to merger control or abuse of dominance/monopolization.

But U.S. companies have to be mindful of EU competition rules when they organize distribution at the worldwide level. Any restrictions of trade within the EU, even if they are imposed on a distributor based in the U.S., would likely be caught under the EU competition rules. What is more, a ban on exports into the EU (including, e.g., a ban on exports outside the U.S. or on setting up a website through which the distributor could target the EU market) could also be potentially caught. ⁹⁸

As the Commission focuses its enforcement efforts on restrictions on online trade with the view to creating a “Single Digital Market” and the importance of e-commerce increases, vertical restraints may well become the next transatlantic conflict zone. But the new EU investigations targeting vertical restraints are also an opportunity for the Commission to consider how best to assess effects on both competition and trade that vertical restraints may have. In the best case scenario, this new wave of EU investigations into vertical restraints triggers a reflection over the current regime and, hopefully, its overhaul in favor of a more flexible framework allowing for an effects-based analysis.