Commercial agency agreements, vertical restraints and the limits of article 811

1. Commercial agency agreements, vertical restraints and the limits of article 81(1) Dr. Ioannis Lianos UCL Faculty of Laws

2. 2 Structure of the presentation The concept of vertical restraints and the evolution of article 81(1) towards an effects-based approach Article 81(1) and the commercial agency exception: a policy in search of an economic justification Conclusion: A new institutional economics perspective to vertical coordination: vertical restraints as hierarchies and networks

3. 3 The concept of vertical restraints and the evolution of article 81(1) Different forms of vertical relationships: Vertical integration by ownership (a firm carries out both production and distribution of its product) Vertical contractual integration Agency agreement (the firm distributes the products via a commercial agent) Distribution agreement (the firm supplies the products to a distributor, which resells them to other undertakings or the final consumer Vertical restraints: it depends on the concept of restraint (link with the competition law standard)

4. 4 Vertical restraints and the competition law standards Is it possible to have a single competition law standard in EC competition law for vertical restraints? No formal merger control before 1989 Injury to competition v injury to competitors Total welfare (economic efficiency) v Consumer welfare (distributive justice) Effects-based approach v. competition as a process of rivalry Neoclassical economics (market power-market failure) v. Ordo-liberal school (economic freedom- absence of economic constraint) The objective of market integration: influence directly and indirectly EC competition law (not examined in this presentation)

5. 5 Injury to competition v injury to competitors Broad interpretation of article 81-1 Restriction of the freedom of undertakings to compete on the market Why such a broad interpretation? Article 81-3/exclusive competence of the Commission Notification and legal authorization system Exemption was a constitutive act Changes brought by Regulation 1/2003 – legal exception regime/decentralisation of Art. 81-3 Competition as a process of rivalry

6. 6 Injury to competition v injury to competititors Case 56/65 STM [1966] ECR 234 Agreements should be assessed in their market context In the light of the competition which would occur if the agreement in question were not or had not been made (counterfactual test) Appreciable restriction of competition – de minimis (if less than 15% of market share- Art. 81-1 does not apply) Vertical restraints Guidelines (para. 121): the central enquiry focuses on the market power of the undertakings concerned (Guidelines art. 81-3, para. 25-26) Factors considered (market position, entry barriers, maturity of the market, level of trade, nature of the product)

7. 7 Injury to competition v injury to competititors (cont.) Case T-168/01 GlaxoSmithKline (171) “not every agreement which restricts the freedom of action of participating undertakings, or of one of them, necessarily falls within the prohibition in Art. 81-1 […] it is still necessary to demonstrate that the limitation in question restricts competition, to the detriment of the final consumer” But, Case 56-58/64, Consten & Grundig : “the wording of article 85 (new Article 81) causes the prohibition to apply, provided that the other conditions are met, to an agreement between several undertakings. Thus it does not apply where a sole undertaking integrates its own distribution network into its business organization” See also Case C-73/95P Viho Europe BV v Commission [1996] Article 81 did not apply because Parker Pen held 100% of the shares of its subsidiaries and controlled their marketing activities

8. 8 Implications of the welfare effects based approach Trade off between positive and negative effects to consumer welfare Cost-benefit analysis. But problem in EC competition law Bifurcation of Art. 81 Burden of proof (art. 2, Reg. 1/2003) – the burden of establishing infringement lies with the party or authority alleging it (art. 81-1) – the burden of establishing a defence which justifies the behaviour as legitimate lies with the undertaking found prima facie restricting competition (art. 81-3) No rule of reason analysis under Art. 81-1 Case T-112/99 Métropole Télévision e.o. v. Commission [2001] ECR II-2459, para. 74 More recently, Case T-328/03 O2 GmbH v Commission [2006] para. 69

9. 9 Implications of the welfare effects based approach (cont.) Possible explanation: 81-1 as an allocative efficiency enquiry; Art. 81-3 as a productive efficiency enquiry Need to quantify the productive efficiencies for the purpose of the cost-benefit analysis test/ This can only be done by the parties to the agreement However, the distinction between productive and allocative efficiency is artificial Transaction efficiency gains are also considered under Art. 81-1 – ancillary restraints doctrine Main operation has globally pro-competitive effects/ancillary operation is necessary and directly related to the main operation/ proportionality test/analysis of positive effects in abstracto/kind of quick look rule of reason

10. 10 Implications of the welfare effects based approach (cont.) What are these efficiency gains taken into consideration under Art. 81-1? Franchising agreements Selective distribution Agency agreements exception cannot be explained in economic welfare terms It does not make a difference from an economic welfare point of view if the distributor is an agent or an independent trader. Only the effect on the consumer counts. Prices raise in both of the cases.

11. 11 Article 81-1 and the commercial agency exception Communication 1962 Single entity doctrine for clauses affecting the market for products Allocation of risks criterion Ancillary or inherent restraints doctrine for restraints affecting the market for agency services The integration criterion Joined Cases 40-48, 50; 54-56, 111, 113 & 114/73 Suiker Unie [1975] ECR 1663 Case C-311/85 Travel Agents case [1987] ECR 3801

12. 12 Article 81-1 and the commercial agency exception (cont.) Agents should not bear any financial risks of the transaction The agent should not engage in the activities of both agent and independent trader in respect of the same market Economic dependence Case C-266/93 Volkswagen [1995] ECR I-3477 The criterion of financial risks AG Tesauro: complete rejection of the economic dependence criterion but also of the theoretical foundation of the immunity on the single entity doctrine

13. 13 Article 81-1 and the commercial agency exception (cont.) Vertical restraints Guidelines (2000) Commission abandons the economic dependence criterion Allocation of risks becomes the important consideration in order to define the existence of a genuine commercial agency agreement Non-compete clauses excluded from the immunity regime if they lead to foreclosure on the relevant market (even if it is a genuine commercial agency agreement)

14. 14 Article 81-1 and the commercial agency exception (cont.) Case T-325/01 Daimler-Chrysler AG v. Commission [2005] Emphasis on the allocation of risks Single economic entity is the theoretical foundation of the exception The criterion of integration should not be given independent evidential value The agents should not bear risks or bear only insignificant risks

15. 15 Article 81-1 and the commercial agency exception (cont.) Non-compete clauses European Commission Repsol : if there is foreclosure, non-compete clauses fall within the scope of art. 81-1, irrespective of the existence of a genuine commercial agency agreement AG Kokott CEPSA Criterion of assimilation or integration of the agent is not a different independent criterion than that of the allocation of risks. Both relate to the concept of economic unit Allocation of risks becomes the important criterion If this is a genuine commercial agency, there is no agreement between principal and agent- art. 81 does not apply (this may also exclude non-compete clauses from the application of art. 81-1 ) welfare analysis does not help to understand the reasons of this specific regime

16. 16 Article 81-1 and the commercial agency exception (cont.) Case C-217/05 Confederación Espanóla de Empresarios de Estaciones de Servicio v. Companía Espanola de Petróleos SA (hereinafter CEEES) [December 14, 2006] “where an intermediary, such as a service-station operator, while having separate legal personality, does not independently determine his conduct on the market since he depends entirely on his principle, such as a supplier of fuel, because the later assumes the financial and commercial risks as regards the economic activity concerned, the prohibition laid down in Article 81(1) of the Treaty is not applicable to the relationship between that intermediary and the principal” Decisive factor: allocation of risk between principal and agent two types of risks: those linked to the sale of the goods and those linked to investments specific to the market However, Art. 81(1) applies to exclusivity and non-competition clauses so far as they entail locking up the market concerned

17. 17 A New institutional economics perspective: vertical restraints as hierarchies and networks Markets, Hierarchies and Networks R. Coase: firm as a governance structure Cost of using the price mechanism Relation specific investments Risk of ex post opportunism Negative externalities (reputation externalities) Ex ante investment inefficiencies (allocation of property rights) Administrative costs of governance Discrete alignment principle Specificity of assets involved Uncertainty that may surround the organization of the transaction Frequency of the transaction (if the transaction takes place often, this spreads the fixed costs necessary to establish a non-market governance mechanism)

18. 18 A New institutional economics perspective : vertical restraints as hierarchies and networks (cont.) Hierarchies Internal organization of the firm (forbearance regime) deeper knowledge of the circumstances surrounding the dispute Undermine the efficacy and integrity of hierarchy Networks- Hybrid forms Formal and informal mechanisms of coordination and cooperation Adaptation clauses Selection of partners Markets (spot markets)

19. 19 A New institutional economics perspective : vertical restraints as hierarchies and networks (cont.) Single economic unit doctrine as a form of hierarchy (forbearance regime) Case C-73/95 Viho Europe BV v. Commission [1996] ECR I-5457 Franchising and selective distribution as networks or hybrids More lenient policy to restrictions that are necessary for the operation of the network Franchise: important relation specific investments, restrictive clauses that are compatible with Art. 81-1 Selective distribution: assure the process of selection of partners in a relational contract

20. 20 A New institutional economics perspective : vertical restraints as hierarchies and networks (cont.) Commercial agency agreements Uncover an hierarchy situation Property rights transferred – less risk of ex post contractual opportunism – less incentives for the principal to incur administrative costs required for instituting a hierarchical organization – indication that there is no hierarchy The same reasoning can apply for any costs bore by the principal or the agent. If the agent bears insignificant risks (costs) compared to the principal, the principal bears essentially the costs – therefore presumption that it is a situation of hierarchy

21. 21 A New institutional economics perspective : vertical restraints as hierarchies and networks (cont.) Implications for the bifurcation of Art. 81 Art. 81-1: conception of the firm as a governance structure (transactional efficiency gains taken into consideration) Analysis should take into account the characteristics of the transaction Organizational framework (hierarchy, network) Proportionality principle: distinguishes between defensive strategic behaviour designed to protect investments from appropriability, thus maintaining ex ante incentives and offensive strategic behaviour that may harm consumers Art. 81-3: conception of the firm as having a productive function (productive efficiencies) cost benefit analysis

22. 22 A New institutional economics perspective : vertical restraints as hierarchies and networks (cont.)

23. THE END!THANK YOU FOR YOUR ATTENTION