Week 12 Vertical Agreements

Reading from Whish

 law on vertical agreements fundamentally reformed as a result of adoption by European Commission of Reg
2790/99 which entered in to force June 2000 – reg should be read in conjunction with Guidelines on Vertical
Restraints - reg expired May 2010 so commission now thinking about how to amend law or move forward
The Distribution Chain
 supplier of services or producer of goods will either acquire them for own consumption or will want to
supply to market
 this can be done in number of ways e.g.
1.vertical integration where it carries out production, sales and distribution itself,
2.or could use commercial agent to find customers
3.or may supply products to distributor whose function is to resell them to other persons who may or may
not be the final consumer
 we will consider how law impacts each of these 3 situations i.e. vertical integration, agency agreements and
vertical agreements with 3rd parties
 simple distribution chain = producer retailerconsumer
 other scenarios – wholesaler may carry out intermediate function standing between producer and retailer =
producer wholesalerretailerconsumer
 vertically integrated producer might deal directly with consumer e.g. by mail order, by establishing own
retail outlets or by selling through internet e.g. Apple supplies music from its ‘iTunes’ website direct to
consumer = Apple/iTunesConsumer
 there can be other configurations e.g. brand owner in food industry might subcontract manufacture to a sub
contractor, brand owner may then negotiate sales directly with supermarkets and engage a transport
company to arrange for physical distribution of products from the subcontractor to the supermarket
Vertical Integration
 achieved internally but setting up retail outlets in high street or by establishing subsidiary companies to
which task of distribution is entrusted
 some firms can sell products through internet which gets rid of need for distributors = disintermediation
 alternatively vertical integration can be achieved through external growth by taking over distribution
networks downstream in the market
 different options need to be considered separately by each firm – for some it may be easier to appoint
distributor/undertaking that has knowledge of and expertise in distributive trade, it might be too expensive
to set up or take over distribution channels
 however if you set up your own then it could be more efficient
 Non application of article 101 to agreements within a corporate group:
vertical integration motive could be that it can lead to immunity from competition law because in
general internal affairs of a company are not subject to competition law
ECJ confirmed in Viho v Commission that art 101(1) does not apply to parent subsidiary agreements which
means intra group agreement forbidding subsidiary from exporting or selling at less than a certain price
would not infringe art 101(1)
so vertical integration may not be most logical thing to do but it acts as good defence from anti trust
attack
 Application of art 102 to the behaviour of the group
V.I may be regarded as factor indicating dominance and thus may be guilty of an abuse depending on how
it behaves on market
 Application of EC Merger Regulation to vertical integration
vertical merges = notifiable to commission under EC Reg where community threshold dimensions are
satisfied
 general proposition = vertical integration can lead to economic efficiencies – fact that is explicitly
recognised in commission guidelines on non horizontal mergers
but commission has required modifications and abandonments of vertical mergers e.g. Time-Warner/AOL
approval of commission was required which was granted subject to severance of structural links between
AOL and Bertelsmann, a competitor of Time-Warner
Commercial Agents
 Function of sales agent is to negotiate business and to enter in to contracts on producers behalf, agent may
be paid commission for business it transacts or may be paid salary
 Agents position is analogous to that of an employee, does not share in profits or losses or bear any risks
 Non application of art 101 to agency agreements
when agent is negotiating it is treated as employee forming part of the business organisation of the
principal so agreement is internal matter rather than agreement between undertakings so art 101 does not
apply
commercial agents is more of a continental Europe thing, doesn’t happen in UK
directive adopted by council on commercial agents to protect them from unfair dismissal
 Application of Commission’s Vertical Guidelines to agency agreements
1962 commission published notice saying agency agreements not subject to art 101 but it became
necessary to amend this especially since case law of ECJ in Suiker Unie v Commission and Vlaamse
Reisbureaus made it clear that it was not entirely reliable
notice was replaced by section II (paras 12-20) of commission’s vertical guidelines
guidelines should be read subject to judgements of CFI and ECJ in particular DaimlerChrysler AG v
Commission and Confederacion Espanola de Empresarios de Staciones de Servicio v Compania de
Petroleos SA
para 12 = agency agreement – one person negotiates and or concludes contracts on behalf of another for
purchase or sale of goods or services by or from the principal
para 13 = in case of ‘genuine’ agency agreements art 101(1) does not apply, ‘non genuine’ ones may be
caught and must be analysed under later sections of vertical guidelines and the block exemption
para 13 says deciding factor is ‘the financial or commercial risk borne by the agent in relation to the
activities for which he has been appointed as an agent by the principal’
Criterion of Risk
A) Para 14-18 of Vertical Guidelines:
- para 14 – 2 types of financial or commercial risk that are relevant in determining ‘genuine’ agency:
1. Those that are directly related to contracts concluded and or negotiated by the agent on behalf of the
principal such as financing of stocks
2. Those risks that are related to ‘market specific investments’ meaning risks that the agent undertakes in
order to be appointed
- para 15 – where agent bares no risk or insignificant risk in relation to these then agreement falls out of art
101(1), where more risk is taken on agent treated as independent dealer and so agreement can be under art
101(1)
- para 16 – question of risk must be assessed on case by case basis and with regard to economic reality
rather than legal form
- para 17 – says list in para 16 about what duties of agents mean it is not in art 101(1) is not exhaustive
- para 18 – where agent is not within art 101(1) all obligations on agent will fall outside art 101(1) as well
B)Judgements and decisional practice
- DaimerChrysler – Commission decided that dealer distributing Mercedes-Benz cars in Germany were
responsible for and bore risk of wide range of activities including acquisition of demonstration vehicles so
agreements were under art 101(1)- fine imposed on DC as German dealers were subject to export bans. On
appeal CFI disagreed and fine annulled. CFI reviewed terms of the standard form agreement and noted that
German dealers did not buy vehicles for resale nor where they required to hold a stock of new vehicles
 - Souris/Topps – commission rejected argument that agreements between Topps (producer of Pokemon
products) and Rautakirja and NMPP were genuine agency agreements, considered that each accepted some
sort of risk, commission went further and said that obligations in question went beyond the types of
provision that fell outside art 101(1) since they related not to agency agreement itself, instead they were
part of an attempt to exclude 3rd party parallel importers from the market
- Confederacion Espanola de Empresarios de Staciones de Servicio v Compania de Petroleos SA
question arose of whether the operators of service stations in Spain selling motor fuel did so as agents or
independent dealers. ECJ set out criteria to be used:
1. The risks linked to the sale of goods and
2. The risks linked to investments specific to the market
- ECJ said risks should be assessed ‘on basis of criteria such as ownership of goods, contribution of costs
linked to their distribution, their safe keeping, liability for any damage caused to goods or by goods to third
parties and the making of investments specific to sale of those goods’ – if risk is negligible the art 101(1) not
applicable
Provisions in genuine agency agreements that may infringe art 101(1)
- para 19 and 20 – two situations in which there could be an infringement of art 101(1) in case of genuine
agency agreement:
1. Where agreement contains exclusive agency or non compete provisions – agency agreements are
supposed to be intra brand but non-compete provisions could affect inter brand competition and would
infringe art 101(1) of led to foreclosure of market – this idea approved by ECJ in CEPSA case
2. Para 20 – art 10191) might be infringed where agency agreement facilitates an anti-competitive
agreement or concerted practice; this could occur where number of principals use same agents whilst
collectively excluding others from using these agents or where they use agents for colluding or to exchange
sensitive market information
Vertical Agreements: Competition Policy Agreements
 Vertical Agreements: possible detriments to competition
Inter-brand and intra-brand competition
- obvious that horizontal agreements to fix prices etc should be prohibited; in this situation firms combine
their market power to their own advantage
- vertical agreements do not involve combination of market power – VA only likely to have effect when firm
imposing vertical restraint already has market power – where this is the case competition with other firms
products = ‘inter brand competition’ may be limited: as a result it may be desirable to ensure that there is
competition between distributors and retailers in relation to the products of the firm with market power –
so called intra brand competition
- do single branding agreements have an effect on inter brand competition? – this depends on how much
market power the firm has that is in the single branding agreement
- the extent of inter brand competition in the relevant market will determine the extent to which intra brand
competition is a cause for concern
Consten and Grundig v Commission
- ECJ rejected argument that there was a horizontal agreement between undertakings instead of a vertical
agreement
- said it was exclusive agreement which conferred absolute territorial protection upon a distributor
the single market imperative and intra brand competition
- comp law has less concern with restrictions of intra brand competition than with restrictions of inter brand
competition
- restriction of intra brand comp is likely to raise concerns only where inter brand competition is weak
- however linked to this is another concern: integrity of single market – community courts and commission
concerned about how vertical agreements that lead to a division of national markets even where restrictions
relate to intra brand rather than to inter brand comp
- strict treatment of export bans, determination to maintain parallel imports and reluctance to allow
distributors to enjoy absolute territorial protection are all issues affecting intra brand rather than inter brand
comp
- law on vertical agreements as a component – single market integration – that will not be found in other
(domestic) systems of competition law
Commentary in Vertical guidelines on the negative effects of vertical restraints
- para 107 notes 4 possible negative effects arising from vertical restraints which EC comp law aims at
preventing :
1. Foreclosure of other suppliers or buyers by raising barriers to entry
2. Reduction of inter brand competition including the facilitation of both explicit and tacit collusion
3. Reduction of intra brand competition between distributors of the same brand
4. the creation of obstacles to market integration
- para 104 suggests that there can be many types of vertical agreements grouped in to 4 categories
1. A single branding agreement
2. A limited distribution group
3. A resale price maintenance group
4. A market partitioning group
-Single Branding Group: buyer is induced to concentrate its orders for a particular product on one supplier,
agreement to not purchase from competing products, such agreements in commission’s view may foreclose
access to the market , facilitate collusion, restrict inter brand competition within retail shops and in of tying
force buyer to pay higher price for tied products than would otherwise be the case
- Limited Distribution Group – consists of agreements which have as their main element that the
manufacturer sells to only one or a limited number of buyers , such agreements may lead to foreclosure at
the buyers level of the market , facilitate collusion and lead to reduction or even total elimination of intra
brand comp
- Resale distribution group – agreements which impose minimum, fixed or recommended resale prices,
main neg effects = reduction in intra brand comp, increased transparency of prices which may facilitate
collusion between manufacturers or between distributors
- Market Partitioning group – buyer is restricted as to where it buys or resells a particular products, main
neg effect = reduction of intra brand competition and partitioning of the market thereby hindering market
integration , may also facilitate collusion
Vertical Agreements: possible benefits to competition
- para 115 says vertical restraints have positive effects, para 116 sets out 8 situations in which vertical
restraints may help realise efficiencies and development of new markets
1.Free rider problem – one distributor may take free ride on investment of another e.g. retailer may invest
in particular brand and create demand for it, has obvious interest in preventing another retailer from making
sales where it made no contribution to the demand. Commission states free riding can occur between
buyers only on pre sale services and not on after sales services , free riding only a problem when product is
new and of reasonably high value. Exclusive distribution agreements may be used to counter problem of free
riding – if A appoints B as exclusive distributor for France this will provide some degree of immunity from
intra brand comp
2. Opening up and entering new markets – ‘special case of free rider problem’ manufacturer wants to enter
new geographic market and this requires its distributor to make ‘first time investments’ - may be necessary
to protect distributor from competition so it can recoup investment by charging higher prices temporarily –
so distributors in other markets should be restrained for limited period from selling in the new market
3. Certification of free rider issue – certain retailers have rep for stocking only ‘quality’ products – in such a
case manufacturer must limit its sales to such retailers since otherwise its products may be delisted
4. Hold up problem – supplier or buyer needs to make client specific investments and will not commit to
these until supply agreements have been concluded –party making investment may require long term supply
 agreements so it knows it will recoup its losses, may also seek a non compete agreement
5. Hold up problem where know how is transferred – know how transferred by one firm to another it may
be necessary to impose non compete provision on recipient of know how to ensure it is not used by
competitors of owner of it
6. Economies of scale in distribution – may lead to lower retail prices, vertical agreements might contribute
to this including exclusive distribution and exclusive purchasing
7. Capital market imperfections – supplier may lend to buyer and vice versa e.g. brewer which makes loan
available to operator of public house or cafe, supplier may impose non compete and buyer may insist e.g. for
exclusive supply
8. Uniformity and Standardisation – V.R’s may help promote brand image of product and increase its
attractiveness to consumers by bringing about uniformity and quality standardisation = typical of selective
distribution and franchising systems.

Leegin Creative Leather Products, Inc. v. PSKS, Inc.

 Leegin Creative Leather Products, a manufacturer of women's accessories, entered into vertical minimum
price agreements with its retailers. The agreements required the retailers to charge no less than certain
minimum prices for Leegin products. According to Leegin, the price minimums were intended to encourage
competition among retailers in customer service and product promotion. When one retailer, PSKS,
discounted Leegin products below the minimum, Leegin dropped the retailer. PSKS sued, arguing that Leegin
was violating Section 1 of the Sherman Act by engaging in anticompetitive price fixing
 mandatory minimum price agreements are per se illegal under the Act - that is, they are automatically illegal
regardless of the circumstances. – Leegan said this rule is outdated and it would be better to use ‘rule of
reason’
 The Court ruled that "Dr. Miles should be overruled and that vertical price restraints are to be judged by the
rule of reason."
 Justice Anthony Kennedy's majority opinion held that Dr. Miles had erred by treating vertical minimum price
agreements between manufacturers and retailers as analogous to horizontal price-fixing agreements
between sellers. The Court cited evidence from the economic literature that vertical minimum price
agreements are rarely anticompetitive and can often function to increase inter brand competition.
Opinion of Justice Kennedy
 In Dr. Miles Medical Co. v. John D. Park & Sons Co 220 U. S. 373 (1911), the Court established the rule that it
is per se illegal under ß1 of the Sherman Act, 15 U. S. Cß1, for a manufacturer to agree with its distributor to
set the minimum price the distributor can charge for the manufacturer’s goods.
 We now hold that Dr. Miles should be overruled and that vertical price restraints are to be judged by the
rule of reason
 The rule of reason is the accepted standard for testing whether a practice restrains trade in violation of ß1.
See Texaco, supra, at 5. Under this rule, the fact finder weighs all of the circumstances of a case in deciding
whether a restrictive practice should be prohibited as imposing an unreasonable restraint on competition.
Continental T. V., Inc. v. GTE Sylvania Inc., 433 U. S. 36, 49 (1977).
 Appropriate factors to take into account include specific information about the relevant business and the
Restraint’s history, nature, and effect
 Resort to per se rules is confined to restraints, like those mentioned, ‘that would always or almost always
tend to restrict competition and decrease output.’
 the Sherman Act’s use of ‘restraint of trade’ ‘invokes the common law itself, . . . not merely the static
content that the common law had assigned to the term in 1890.’ = need to look at things in their context!
 Minimum resale price maintenance can stimulate inter brand competition - the competition among
manufacturers selling different brands of the same type of product- by reducing intra brand competition -
the competition among retailers selling the same brand
  A single manufacturer’s use of vertical price restraints tends to eliminate intra brand price competition; this
in turn encourages retailers to invest in tangible or intangible services or promotional efforts that aid the
manufacturer’s position as against rival manufacturers.
 Resale price maintenance also has the potential to give consumers more options so that they can choose
among low-price, low-service brands; high-price, high-service brands; and brands that fall in between
 Absent vertical price restraints, the retail services that enhance inter brand competition might be
underprovided. This is because discounting retailers can free ride on retailers who furnish services and then
capture some of the increased demand those services generate
 If the consumer can then buy the product from a retailer that discounts because it has not spent capital
providing services or developing a quality reputation, the high-service retailer will lose sales to the
discounter, forcing it to cut back its services to a level lower than consumers would otherwise prefer.
 Minimum resale price maintenance alleviates the problem because it prevents the discounter from
undercutting the service provider. With price competition decreased, the manufacturer’s retailers compete
among themselves over service
 Resale price maintenance, in addition, can increase inter brand competition by facilitating market entry for
new firms and brands. ‘[N]ew manufacturers and manufacturers entering new markets can use the
restrictions in order to induce competent and aggressive retailers to make the kind of investment of capital
and labour that is often required in the distribution of products unknown to the consumer.’
 Resale price maintenance can also increase inter brand competition by encouraging retailer services that
would not be provided even absent free riding

CLASS

 What kind of objectives may resale price maintenance serve?

limits intra brand competition so that inter brand competition can do well
intra brand comp = competition within a single brand, among distributors for sale of same brand of given
product e.g. apple products – my imposing fixed price here then intra brand comp disappears – limiting
ability of apple retailers to reduce price of product
can stimulate competition amongst producers
free riding - exclusive distribution
provision of after sale services – selective distribution, need to fulfil certain criteria, also prevents free
riding, exclusive distribution
align the incentives of the manufacturer and the distributor – exclusive dealing – I make investment
providing you only sell my beer and not beer of my competitors
facilitate the new market entry/overcome foreclosure – selective/exclusive distribution – incite someone
to sell your product, franchising
 Vertical price fixing - By imposing price floor, minimum price then you can ensure against free riding, get
people to make sure that they invest first - eliminates competition amongst distributors so then retailers
have to focus on customer service and additional services that they can provide, good way of inciting
distributors to sell other related products too so increases inter brand competition
 For all the efficiency explanations exist alternative vertical restraints – may rely on resale price maintenance
but then alternative is exclusive distribution - don’t want other companies to free ride on your advertising
efforts, your investments
 Difference between exclusive distribution and exclusive dealing – difference lies in who imposes exclusivity
– distribution = distributor imposes exclusivity upon manufacturer, unless I am only distributor in that area I
will not distribute your product whereas in exclusive dealing it is the other way around, manufacturer
imposes exclusivity on distributor
 How should vertical price fixing be treated under art 101 and under section 1 of Sherman Act?
if there is an alternative vertical restraint available then vertical resale price maintenance should be
illegal? Should it be treated differently? Not really because it can be explained on efficiency grounds so it
shouldn’t be illegal by object
what matters is effects of conduct not form of conduct
forcing undertakings to go with less efficient options
difficult to police legally as alternative to resale price maintenance is different for each, some have more
than one
 Vertical restraints and Section 1 of the Sherman Act
per se = illegal by object, no analysis of market, no consideration of reasons of efficiency etc
rule of reason = case by case approach, looking at effects, reasoned analysis, need to examine
circumstances around agreement/conduct, need to examine market, pro and anti competitive effect
 Difference between per se restraint and a restriction of competition by object (within meaning of art
101(1))?
art 101 can allow you to justify under 101(3) whereas per se is point blank refusal, no equivalent of para 3
in per se approach
 section 1 of Sherman Act not bifurcated as art 101
thus agreements are either deemed...
 Reminder: Section 1 of Sherman Act
1911 – Dr Miles case – US supreme court declared that resale price maintenance is a per se restriction
in Leegin US Supreme Court was invited to overrule this precedent
precedent overruled 5-4
 Majority opinion in Leegin
it is not disputed that resale price maintenance may lead to higher prices. Why is this factor inconclusive
in light of the reasoning displayed by the US supreme court?
what is determinant factor according to Justice Kennedy? – what kind of argument did he use to justify
shift to rule of reason approach? = per se rule only justified when we can conclude that something will
always or almost always lead to reduction in output, what mattered to him was that there were pro
competitive effects
a dealer wishing to challenge a resale price agreement must show that the agreement's purpose and
effect is not only anticompetitive but also outweighs any precompetitive benefits to inter brand
competition.
by comparing vertical price fixing with other vertical restraints what kind of argument can you make
concerning prices? – all alternatives to resale price maintenance have negative impact on prices as well so
it’s not a good argument to say that you are forced to sell at a certain price???
vertical price fixing does have impact on prices – are alternatives better? Does not really seem like it – if
you don’t sell at the distributors price you are excluded from that chain, but other vertical restraints won’t
really do you much better = resale price maintenance is efficient!
impact on prices is not deciding factor when deciding whether vertical restraint is illegal – there is
efficiency explanation for resale price maintenance so price is irrelevant because other vertical restraints
also have impact on price
 Dissent by Justice Breyer
anti trust law should not replicate economic thinking
the anti competitive effects of the restraint are often likely to occur
it is not certain that the restraint will serve pro competitive objectives (free riding)
the administrability of the rule is important (the extent to which judges can distinguish between pro and
anti competitive effects) - difficult for judges to determine pro and anti competitive approach
costly to apply rule of reason approach
K talks about logical consequence of the rule?