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European Commission's review of the VBER – what does this mean for franchising?

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United Kingdom

The VBER will expire on 31 May 2022 and the European Commission is reviewing its effectiveness to determine whether to allow it to lapse, to prolong its duration, or whether it requires revision. This article explores the process so far and examines what this review means for franchising.

First – a recap….

A franchise or distribution agreement is at risk of infringing European Union ("EU") competition law if it has the object or effect of restricting competition and is capable of affecting trade within the European Economic Area ("EEA").

The equivalent domestic competition rules apply if trade in an EU member state is (or is capable of being) affected by the agreement in question. The Competition and Markets Authority ("CMA") is responsible for enforcing UK competition law.

In order to maintain uniformity, protect know-how and operate a network effectively across sales channels and geographies, a franchise agreement will often seek to regulate areas such as online activity, marketing, territorial rights, reserved channels, supply obligations, pricing and non-competes. However, competition law prohibits "hard core" restrictions, such as restrictions of a franchisee's ability to set their own prices or a ban on their ability to sell online, and only allows certain other types of restrictions if either:

  1. they are essential for (i) maintaining the identity/reputation of the franchise network or (ii) protecting the transfer of the franchisor's know-how, the so called "Pronuptia test";
  2. the parties' respective markets shares is low enough to mean that the restrictions have no appreciable effect of competition; or
  3. they comply with the "safe harbour" of the Vertical Block Exemption Regulation ("VBER").

An infringement of competition law can lead to substantial fines on the parties concerned.  The non-financial implications are equally severe, including damage to business reputation, the unenforceability of contracts, the risk of third party damages actions and even personal sanctions (fines, director disqualification and imprisonment) imposed on executives of the parties concerned. A number of household brands have recently fallen foul of these regulations, including the likes of Guess, Casio, Hello Kitty, Nike, Universal Studios and Ping.

So what's new?

The VBER will expire on 31 May 2022 and the European Commission ("EC") is reviewing its effectiveness to determine whether to allow it to lapse, to prolong its duration, or whether it requires revision to take account of market developments since 2010 (most notably with regard to online sales and online platforms).

Timeline of the EC's review so far

On 8 November 2018, the EC published an evaluation and fitness check roadmap for the VBER.

On 4 February 2019, the Commission launched a public consultation, by way of an online survey, to collect views and information on the relevance of the VBER and its accompanying Guidelines on Vertical Restraints ("VGL").

On 13 December 2019, the Commission announced the publication of the national competition authorities ("NCA") contributions to the review. NCA highlighted issues, which they consider need to be addressed, including:

  • The current definition of vertical agreements – this should take into account the emergence of new market players (i.e. online platforms and nature of commercial relationship with companies that use them)
  • The distinction between independent traders and agents acting on behalf of a supplier
  • The application of the 30% market share threshold in relation to online platforms
  • The need for a clear distinction between hardcore restrictions and restrictions by object
  • The lack of definition of active and passive sales and how to deal with internet sales
  • Questioning the effectiveness in the prevention of territorial restrictions
  • Lack of legal certainty around assessment of resale price restrictions in the context of selective distribution networks
  • Need for more complete, coherent and up-to-date guidance on the use of third-party online platforms and price comparison websites and brand bidding in online advertising
  • The need for guidance on the criteria for the individual assessment of dual pricing and possible alternatives for remunerating specific services rendered by physical stores that would not raise competition concerns
  • The need for more detailed guidance on the legal qualification and assessment of retail most-favoured nation

On 5 February 2020, the EC published a summary of the discussion at a stakeholder workshop held in November 2019. The topics discussed included franchising related issues (and, in particular, the transfer of know-how – as discussed further below) and also broader concerns including:

  • Clarity regarding the agency concept – concerns were raised on the lack of clarity as regards the underlying requirements, particularly the notion of "market specific" investments and the number of principals that an agent can have and the impact of the transfer of the title or possession of the goods concerned from the principal to the agent
  • Dual distribution (i.e. Article 2(4) of the VBER) – the extent to which dual distribution is covered by the VBER given that the scope of Article 2(4) is too narrow as it does not encompass wholesaler/retailer relationships and that agreements between independent importers and their distributors are not block exempted in the context of dual distribution (in particular, with regard to the automotive sector)
  • The adequacy of the 30% market share threshold
  • The adequacy of the retail price maintenance (RPM) and the relationship with retail price recommendations, aggressive price competition by low-cost online distributors, and  maximum prices
  • Online related issues – guidance on online sales restrictions, dual pricing, and protections against free-riding by online distributors
  • Selective distribution and  exclusive distribution (and the interplay between the two)
  • The 5-year duration of non-compete obligations
  • Access to data – in particular, third party access to machine generated/Internet of things data

Key concerns for franchising

Know-how

As touched on above, a key area of importance with regards to the VBER and franchising concerns the transfer of know-how.

Know-how is a crucial characteristic of the franchising distribution model. The know-how being transferred will not always be anything technical, it can simply be such know-how which enables a franchisee to present itself as offering the same quality of products and/or services as other franchisees. Nevertheless, this is the cornerstone of the model which allows for consistency across the network.

There is a distinct absence of a definition in the VBER as to what is franchising and know-how. There also needs to be more clarity that both concepts are directly associated.

RPM

Concerns raised in the EC's consultations regarding RPM also have particular application to franchising, with some franchise stakeholders commenting that RPM can contribute positively to promote the common identity and reputation of the franchise network.

Many franchisors will keenly wait to see if there will be any further relaxation in this area to reflect the specific nature and identity of franchises.  

Conclusion

In general, stakeholder responses to the EC's consultations highlighted that there should be clearer examples in the VGL of how vertical restraints may affect both franchisors and franchisees to enable an easier application of the VBER to particular issues which primarily affect the franchise relationship.

More clarity is needed in the VBER and the accompanying guidance to ensure that the important pillars of franchising – such as the transfer of know-how – are protected and more thought should be given to this specific arrangement so that franchisors and franchisees can benefit from the safe harbour of the VBER.

The majority of the respondents to the EC's consultation support the prolongation of the VBER, but the key topics highlighted by stakeholders show that there is a need for revision in light of the current market – particularly in terms of the explosion of the e-commerce market.

The review of the VBER provides a valuable opportunity for specific franchising concerns to be raised and – hopefully – taken on board, so that a revised the VBER provides adequate protection for franchises.

The review is now in the impact assessment phase, the purpose of which is to verify the existence of any problem related to the current functioning of the VBER identified during the previous evaluation phase (including the consultations) and to assess whether further action is needed and to analyse potential solutions.  The impact assessment phase will take approximately 24 months and so expect a final determination in shortly before the VBER expires in May 2022.

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