Vertical Agreements – Key Issues for the Food and Drink Sector

In June new rules came into force in both the EU and UK concerning the application of competition law to so-called "vertical" agreements. The new rules will affect food and drink producers and distributors in the UK and across the EU. For those who operate in both jurisdictions, the divergences between the UK and EU rules will add a new level of complexity to an already tricky area of law.

Vertical agreements are between companies at different levels of the supply chain, for example an agreement between a whisky distiller and a distributor, and also the onward agreement between the distributor and a retailer. The nature of food and drink supply chains makes vertical agreements extremely common in the sector, often including the types of agreement most likely to create competition risk (e.g. pricing and distribution constraints).

Because the parties to a vertical agreement are not generally competitors, the agreements enjoy a general (or "block") exemption from competition rules, provided certain conditions are met. Those conditions in turn identify types of agreement that not only are unprotected by the exemption, but are very likely to involve a competition law breach in and of themselves.

The block exemption was previously provided in the EU by the 2010 Vertical Agreements Block Exemption Regulation (known as "VABER"), which was maintained in UK law post-Brexit.

That expired on 31 May 2022, and a new revised VABER came into force in the EU on 1 June. At the same time, a replacement for VABER came into force in the UK (the Vertical Agreements Block Exemption Order, or "VABEO"). Both instruments update the conditions for an agreement to be exempt, but each makes subtly different changes. The law on vertical agreements is therefore now different between the UK and EU, for the first time ever.

The key points

VABER and VABEO each apply the same basic approach: vertical agreements that meet certain conditions (including that neither party to the agreement has a market share, at its level of the supply chain, higher than 30%) are 'safe harboured' for competition law purposes – i.e. the parties do not generally have to consider whether it falls foul of the prohibition on agreements with anti-competitive objects or effects.

However, some types of vertical restriction are not safe-harboured and so may be prohibited, while some "hardcore restrictions" are so serious that including one in an agreement will result in the entire agreement losing the benefit of the block exemption, as well as themselves being very likely to be a competition law breach.

Hardcore restrictions

The following are the key hardcore restrictions likely to be relevant to the food & drink sector:

• Resale Price Maintenance (RPM) clauses, where a seller (e.g. the producer or distributor) directly or indirectly sets a minimum or standard price at which its customer (e.g. the distributor or retailer) must sell or advertise the seller's products – this is the most serious type of 'vertical' breach, consistently leading to large fines. The rule against RPM means that if a retailer wants to sell a premium whisky at a discount, for example, then they must be permitted to do so.
• Restricting the territories into which, or customers to whom, a distributor or retailer can sell products – the producer can restrict "active" sales into a territory or customer group that is allocated to another distributor / retailer or reserved to the producer themselves ("active" sales means pursuing customers), but not "passive" sales where the customer seeks out the sale.
• Preventing members of a selective distribution system (where the producer will only allow sales to or through distributors / retailers who meet certain criteria) from supplying other distributors / retailers within the system. Members can, however, be prohibited from selling outside the system. So if a producer decides only to sell its products through an approved network of independent retailers, those retailers can be prohibited from selling stock on to supermarkets, but can't be prohibited from selling stock to each other.
• Imposing price parity (known as Most Favoured Nation or MFN) clauses – i.e. a buyer requiring the seller to ensure that a product is not offered on better terms on any other platform or channel (called a "wide MFN"), although "narrow MFNs" which stop the seller from undercutting the buyer on its own channels, are permitted. There is some divergence here – the EU rules only prohibit wide MFNs for price comparison websites, whereas the UK rules prohibit them entirely.

The old prohibition on "dual pricing" (i.e. charging the buyer more for products to be sold online than for offline products) has been removed entirely, in recognition that online channels no longer need protection (and that, perhaps, brick and mortar retailers now do). So producers can now offer a discount to distributors / retailers in relation to products for sale on the high street, while charging a higher price for products to be sold online.

Other restrictions

VABER / VABEO will not protect a non-compete clause longer than five years (including if it is indefinite or automatically renewable) or that applies post-termination, though unlike hardcore restrictions that will not remove protection from the whole agreement as long as the offending clause can be severed from the rest of the contract. The new EU rules do allow tacitly renewable non-competes where the contract can be renegotiated or terminated with reasonable notice and at reasonable cost. However, the UK rules still treat tacitly renewable contracts as being longer than five years.

Both VABER and VABEO continue to exempt non-reciprocal "dual distribution" arrangements – i.e. between a producer and a retailer, where the producer also retails its goods directly to end-customers (e.g. a whisky producer that sells its whisky both to supermarkets and to customers in its own shops). However, VABER now makes clear that exchanges of information between the parties are only protected if they are directly related to the implementation of the agreement and necessary to improve the production or distribution of the contract goods or services.

What does this mean for food & drink businesses?

Vertical agreements will continue to benefit from an exemption from the usual competition rules until at least 2028 in the UK (and 2034 in the EU), giving food & drink businesses increased certainty over what competition law will and will not allow in their supply chain arrangements.

The new rules are more favourable to producers. They can now impose the permitted distribution restrictions (e.g. prohibiting active sales into exclusive territories) on their buyer's customers, extending those down the supply chain, and appoint multiple distributors (five under VABER, "a limited number" under VABEO) to a particular 'exclusive' territory. It is also now easier to operate selective distribution systems, and to combine these with exclusive distribution.

There are also significant but double-edged changes for online sales. Most significantly, the change to permit dual pricing could be highly significant for 'brick and mortar' retail, giving producers much more freedom to discount the price of goods to be sold in 'real world' stores. This may produce some rebalancing between physical and online retail, after the old VABER gave significant advantages to the latter.

More broadly, the small but important divergences between the EU and UK rules on vertical agreements mean that producers and distributors operating in both territories will need to understand both sets of rules when drafting their distribution agreements. We have significant expertise advising a range of clients – in the food & drink sector and beyond - on how distribution agreements are affected by competition law, so do get in touch if you need assistance or would like to know more.