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UK set to charter its own post-Brexit course on competition rules – what does this mean for franchising in the UK?

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The UK Government has published the long-awaited Draft Vertical Agreement Block Exemption Order 2022 ("VABEO"), which will replace the Retained Vertical Agreement Block Exemption regulation ("Retained VABER"), which is due to expire in May 2022. This article considers the changes and likely impact of the VABEO on franchise businesses operating in the UK.

Background

A franchise or distribution agreement is at risk of infringing UK competition law if it has the object or effect of restricting competition and is capable of affecting trade within the UK. 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 agreements that are anticompetitive, thereby only allowing certain types of restrictions if either:

(a) the parties' respective market share is low enough to mean that the restrictions have no appreciable effect on competition; or
(b) the parties' respective market share is low enough to benefit from the "safe harbour" of the EU's Vertical Block Exemption Regulation ("VBER") and the agreement does not contain any "hardcore" restrictions, such as restrictions of a franchisee's ability to set their own prices or a ban on their ability to sell online.

Further, certain provisions that are essential for (i) maintaining the identity/reputation of the franchise network or (ii) protecting the transfer of the franchisor's know-how, fall outside the remit of competition law altogether (the so-called "Pronuptia test").

Post-Brexit, the VBER was transposed directly into UK competition law in the form of the Retained VABER.

The VBER will expire on 31 May 2022, and the European Commission (the "Commission"), the body responsible for enforcing EU competition law between Member States, is in the process of the finalising revisions to the VBER and its guidelines. The CMA has advised the UK government that, following Brexit, the UK should replace the Retained VABER with its own set of UK-specific rules, to be known as the VABEO.

The CMA recommended that the scope of the VABEO should stay largely the same as the Retained VABER. The basic structure and form of VABEO, including market share thresholds, would remain unchanged. However, as the Commission introduces changes at EU level through the revised VBER, the VABEO is set to bring both divergence and renewed alignment between UK and EU rules.

What's new?

1. Territorial and customer restrictions

The VABEO will provide businesses with more flexibility to design their distribution systems according to their needs. This will include allowing:

(a) the combination of exclusive and selective distribution in the same or different geographical areas;
(b) shared exclusivity in a geographical area or for a customer group by allowing the allocation of a geographical area to more than one distributor; and
(c) the provision of greater protection for members of selective distribution systems against sales from outside the geographical area to unauthorised distributors inside that geographical area.

2. Measures promoting brick-and-mortar sales

a) dual pricing (charging the same distributor a higher price for products intended to be resold online than for products intended to be sold offline) will no longer be regarded as a hardcore restriction of competition as long as it does not result in an de facto restriction of online sales; and
(b) the imposition of criteria for online sales that are not overall equivalent to the criteria imposed on brick-and-mortar shops in a selective distribution system will no longer be regarded as a hardcore restriction.

These changes may help contribute to a more level playing field between online and brick-and-mortar retailers, and are largely aligned with the Commission's proposed changes to the Revised VBER.

3. Most favoured nation ("MFN")

Clauses which typically specify that a product or service may not be offered on better terms on any other channels, including, for example, a supplier’s own website or through other intermediaries, such as other distributors or online platforms, will be treated as hardcore restrictions both for online and brick-and mortar sales. This will be a point of divergence with new EU rules, as the revised VBER will only consider MFN clauses hardcode restrictions in the online context.

Other points of divergence from the Retained VABER

4. Dual distribution
 
Dual distribution typically covers situations where a franchisor sells its goods to end customers directly, in direct competition with its franchisees (i.e. it concerns direct competition at the retail level). In general, information sharing risks are more likely to arise at the retail (as opposed to wholesale) level, but dual distribution relationships may currently benefit from a 'safe harbour' exemption under the VABEO if neither party's individual market share exceeds 30% and the agreement does not contain hardcore restrictions.

If either party's individual market share is close to or exceeds the threshold, a franchisor should instead self-assess under the rules applicable to competing businesses, and consider putting in place steps to manage any potential risk of infringing competition law (such as establishing information barriers, limiting access and anonymising/aggregating data). These are potentially detrimental to a franchise system whose maintenance and evolution depends, in part, upon a free flowing exchange of information within the network. In reality, many franchise systems fall below the current market share threshold, but for those which are uncomfortably close to its limits (assessing relevant market share is a complicated science), these rules around dual distribution create a costly ongoing compliance burden.

The good news is that the CMA acknowledges that the dual distribution exemption is increasingly relied upon due to the growing practice of suppliers selling directly to customers through their own websites. To this end, the VABEO will retain the current rules. Further, the VABEO will also extend its 'safe harbour' to dual distribution at the wholesale and importer level of supply, which is currently prohibited. The same is expected at EU level with the revised VBER.

5. Exchanges of information

The cornerstone of the franchise model is the transfer of information or "know-how" which is essential to maintaining a strong and consistent brand identity. Under the VABEO, as long as neither party's individual market share exceeds 30% and the agreement does not contain hardcore restrictions, franchisors and franchisees will be able to freely exchange information (meaning, for example, that a franchisor can collect sales information about its products from its franchisees).

The 'safe harbour' of the VABEO may therefore extend to information exchanges regardless of whether the franchisor operates a dual distribution model. This in stark contrast to the Commission, which is set to limit the application of the revised VBER's 'safe harbour' for information exchanges in dual distribution by introducing a special combined market share threshold of 10%, and a new self-assessment regime.

In its review of the current VBER, the CMA has noted that potential concerns arising from the provision of sensitive information between franchisors and franchisees could be addressed through the use of information barriers, but the CMA has stated that this will be a matter best left for businesses to self-assess.

Conclusion

On the one hand, the VABEO's alignment with the status quo is arguably underwhelming, and cannot be categorised as a "Brexit dividend". Nevertheless, the proposed changes are based on pragmatism and should allow for innovation in the way businesses design their distribution systems. The VABEO is also staying close to the current VBER on certain points that the Commission is now moving away from, such as exchanges of information in dual distribution, while aligning with the revised VBER on other points. The VABEO therefore signals that the CMA is prepared to charter its own course, and where necessary take a pragmatic approach to issues which run the risk of creating unwanted complexity and uncertainty for businesses – of which there has been a lot lately!

The Department of Business, Energy and Industrial Strategy (BEIS) has invited comments on the text of the draft VABEO by 16 March 2022. The VABEO will enter into force on 31 May 2022 and expire on 1 June 2028.

If you would like to discuss any of these issues please do not hesitate to contact Gordon Drakes, co-head of the Franchising team or Miguel Vaz or Jessica Gardner from our Competition and Regulatory team. This article was co-authored by trainee Kristina Holm.

If you would like to know more about the proposed updates to the VBER and their impact on franchising, please read more.

If you would like to more detail about the proposed updates to the VBER on dual distribution systems, please read more 

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