As trade relations between the member states of the European Union and Israel grow, it becomes increasingly important to understand the European Union competition law issues that may arise. One such issue is the possible injury a seemingly routine distribution agreement may cause to competition in the relevant markets.

Under Article 36 of the EU-Israel Association Agreement, anti-competitive agreements, practices, and abuses of a dominant position are considered incompatible with the agreement if they affect trade between the EU and Israel. This short article will provide some general guidelines for drafting distribution agreements that are meant to be valid in the EU. While this article does not cover all of the EU competition law issues relating to distribution arrangements, the objective of this article is to give a general overview of the EU competition rules relating to distribution agreements and should help business people, lawyers and consumers understand the application of EU competition law when preparing cross-border agreements between companies in the EU and Israel.

Article 81 of the Treaty Establishing the European Community ("EC Treaty"), which sets forth, among other things, EU competition rules that relate to distribution agreements – also known as "vertical agreements" -- prohibits certain practices that restrict competition and/or contain restraints on the supplier or the distributor, so-called "vertical restraints.

Examples of prohibited vertical restraints include exclusive or selective distribution or supply, exclusive customer allocation, quantity forcing, non-compete, franchising, and tying arrangements. It should however be noted that distribution agreements which simply determine the price and quantity for a specific sale and purchase transaction do not normally restrict competition.

Vertical restraints may not only have negative effects but also positive effects. They may, for instance, help a manufacturer enter a new market, or avoid the situation in which one distributor "free rides" on the promotional efforts of another distributor, or allow a supplier to depreciate an investment made for a particular client.

However, the EU Commission has adopted the so-called ‘Block Exemption Regulation’, which provides a safe harbor for most vertical agreements, including distribution agreements. The Block Exemption Regulation renders by exemption the prohibition of Article 81(1) inapplicable to vertical agreements entered into by companies with a market share not exceeding 30%.

Whether a distribution agreement actually restricts competition and whether in that case the benefits outweigh the anti-competitive effects will often depend on the market structure. In principle, this requires an individual assessment of each particular case, but the following guidelines may be used to determine whether a specific distribution agreement has anti-competitive effects:

1. First, does the supplier or the buyer (distributor) have a market share exceeding 5 percent; and does the supplier generate EU-wide revenues exceeding EUR 40 million distribution?

The European Commission has clarified that, where neither the supplier nor the buyer (distributor) meet the above thresholds, such distribution agreement will not generally be considered to have anticompetitive effects in the EU (but member state competition rules may apply).

2. If the thresholds under no. 1 above are met, does the distribution agreement contain any so-called ‘hard-core’ restraints?

In general, if a distribution agreement includes a 'hard-core' restriction, it will usually not benefit from any of the safe harbors created under EU competition law, including the Block Exemption Regulation.

The hard-core restrictions include:

- Resale price maintenance: a supplier is not allowed to fix the price at which distributors can resell its products. However, the imposition of maximum resale prices or the recommendation of resale prices is normally not prohibited

- Restrictions concerning the territory into which, or the customers to whom, the buyer may sell: This restriction relates to market partitioning by territory or by customer. Distributors must remain free to decide where and to whom they sell. The Block Exemption Regulation contains exceptions to this rule, which, for instance, enable companies to operate an exclusive distribution system or a selective distribution system.

- Selective distribution: Firstly, selected distributors can in no way be restricted in the end-users to whom they may sell. Selective distribution therefore can not be combined with exclusive distribution, with the exception that it is allowed to apply a location clause: the supplier may commit itself to supply only one distributor in a given territory and can require the distributor to sell only from a given location. Secondly, the appointed distributors must remain free to sell or purchase the contract goods to or from other appointed distributors within the network. This means that appointed distributors cannot be forced to purchase the contract goods exclusively from the supplier.

- Spare Parts: Agreements that prevent or restrict end users, independent repairers and service providers from obtaining spare parts directly from the manufacturer of the spare parts. An agreement between a manufacturer of spare parts and a buyer which incorporates these parts into its own products (original equipment manufacturer) may not prevent or restrict sales by the manufacturer of these spare parts to end users,
independent repairers or service providers.

3. If the distribution agreement contains no hard-core vertical restraints as described under no. 2 above, does the market share of the contracting parties exceed 15 percent in the relevant market(s)?

Absent certain 'hard-core' restrictions, such as price fixing or clauses granting absolute territorial protection, a distribution agreement will not be considered to have an appreciable effect on competition if the market share for the products in question does not exceed 15 percent.

4. Does the agreement fall within the "Block Exemption Regulation"?

The Block Exemption Regulation creates a general presumption of legality for vertical agreements concerning the sale of goods and services depending on the market share of the supplier or the buyer. Vertical agreements can only benefit from the Block Exemption Regulation if the market share held by the supplier does not exceed 30% of the relevant market in which he sells the contract goods or services.

After having assessed the guidelines above, if it is concluded that the vertical agreement (a) does have an effect on trade between member states, and (b) does not fall within the terms of the Commission’s Block Exemption Regulation or other exempting guidelines/regulations, it is necessary to conduct an ‘individual assessment’ of the agreement in order to determine whether it falls within the prohibitions set forth in article 81(1). If both such conclusions are true, then an individual assessment may be performed to ensure whether the conditions for an exemption under article 81(3) are satisfied, which allows for certain exemptions in situations where sufficient efficiencies of those agreements outweigh their anti-competitive effects.

While this article does not cover all of the issues relating to distribution arrangements, it is meant to give a general idea as to the factors involved with respect to antitrust law and to encourage keeping in mind the antitrust issues that may arise while preparing cross-border agreements between companies in the EU and Israel, especially those related to the sale and/or provision of goods and services.

[1] The author would like to thank Yaacov Houdijk, Adv., for his assistance in the research for this article