DealMakers - Q1 2022 (released May 2022)
Navigating competition law compliance in dual distribution relationships
by Neil Mackenzie and Hadassah Laing
Competition law generally classifies relationships between firms as vertical (supplier and customer) or horizontal (competitors or potential competitors). The nature of the relationship has important implications for how the law applies.
In South Africa, arrangements between firms in vertical relationships are regulated by section 5 of the Competition Act. Aside from minimum resale price maintenance, which is prohibited outright, vertical arrangements are analysed under the so-called rule of reason. This analysis seeks to identify precisely the anti-competitive effects and pro-competitive gains arising from the arrangement, before determining, on balance, whether the arrangement should be prohibited. Because vertical arrangements generally have positive, neutral or mixed effects on competition, section 5 is invoked relatively infrequently.
Horizontal arrangements are governed by section 4 of the Competition Act and receive more aggressive treatment. There is virtually global consensus amongst competition enforcers that agreements between competitors pose significant risk to effective competition. Arrangements between competing firms that involve any form of price fixing, market allocation and/or collusive tendering are prohibited, and attract administrative penalties and criminal sanctions.
Dual distribution – where horizontal and vertical relationships meet
Because of the stark differences in the treatment of vertical and horizontal agreements, a hotly contested area of competition law enforcement is so-called dual distribution. This is a situation where a firm sells a product to its distributor, but also supplies the product to downstream customers directly, in competition with the distributor. As a result, the relationship between the supplier and distributor has both horizontal and vertical components.
Consider, for example, the risk and complexity that arises where the agreement between supplier and distributor includes a territorial restriction reserving a particular territory for the supplier, and an adjacent territory for the distributor. Should this be considered an efficiency-enhancing vertical arrangement that promotes investment without the risk of free-riding, or is it automatically unlawful market allocation between competitors, in contravention of section 4 (1) (b) (ii)? The answer depends on the specific facts in each case.
Recent case precedent – the importance of characterisation
The importance of properly characterising the nature of the relationship as either vertical or horizontal, and the difficulties entailed in doing so, have been confronted in a number of South African cases. Most recently, in Aranda Textile Mills and Mzansi Blanket Supplies v Competition Commission, the Competition Appeal Court explained :
There may be instances where a firm’s conduct will, on the face of it, fall within the ambit of section 4 (1) (b), but their conduct will not be found to fall within the object of the [sic] section 4 (1) (b) in which case no contravention will be established.
…the absence of a characterisation enquiry could well produce a false positive, meaning that a contravention is found when upon a proper analysis by way of characterisation the true object of s4 (1) (b) will not be found. A characterisation enquiry into the conduct should be made... as this makes for a constitutionally compliant approach.
… characterisation is important as it ensures that competition law does not unnecessarily hamper or obstruct pro-competitive and genuine commercial transactions from occurring.
Statements like the aforementioned in case precedent improve legal certainty and provide firms some comfort that their efficiency-enhancing distribution arrangements will not necessarily be misconstrued as unlawful cartel conduct. However, this does not remove all of the risk associated with dual distribution structures. A critical aspect of proper compliance is the management of information exchanges between the supplier and distributor, to ensure that the economic relationship between them remains genuinely vertical.
Practical (draft) guidance from Europe
While there is no guidance on this issue in South African case law, the European Commission has recently published a draft amendment to its existing Guidelines on Vertical Restraints , which provides helpful direction. In particular, the document specifies a number of specific types of information which, if exchanged in a dual distribution relationship, would be considered pro-competitive and thus defensible:
Technical information, such as information relating to the registration, certification or handling of goods, or information that enables a party to adapt the goods to a customer’s requirements;
Supply information, such as information relating to production, inventory, stocks, sales volumes and returns;
Aggregated customer service information, including information relating to customer purchases, preferences and feedback;
Prices at which the goods are sold by the supplier to the buyer;
Certain resale price information, such as information relating to the supplier’s recommended or maximum resale prices and information relating to the prices at which the buyer resells the products, provided that such information exchange is not used to restrict the buyer’s ability to determine its sale price or to enforce a fixed or minimum sale price;
Information relating to the marketing of the products, including information on new goods or services under the vertical agreement, as well as information on promotional campaigns for products; and
Performance-related information, including aggregated information communicated by the supplier to the buyer relating to the marketing and sales activities of other buyers of goods or services, provided that this does not enable the buyer to identify the activities of particular competing buyers.
Information relating to the volume or value of the buyer’s sales of goods or services relative to the buyer’s sales of competing goods or services.
By contrast, exchanges of the following information would give rise to the risk of the relationship appearing predominantly horizontal, and the exchange potentially falling foul of section 4:
Information relating to the actual future prices at which the parties will sell goods or services downstream;
Customer-specific sales data, including non-aggregated information on the value and volume of sales per customer, or information that identifies particular customers, unless in each case such information is necessary to enable a party to adapt the goods or services to a customer’s requirements or to provide guarantee or after-sales services or to allocate customers under an exclusive distribution agreement; and
The exchange of information relating to goods sold by a buyer under its own brand name with a manufacturer of competing branded goods, unless the manufacturer is also the producer of the own-brand goods.
It bears emphasis that the European Commission’s recent guidance is still in draft form for public comment. The final, amended guidelines will be of further interest and value.
Dual distribution remains a complex issue where a vigilant approach to compliance is essential. However, recent developments in South African case precedent, and practical guidance from other jurisdictions allow this area to be navigated with increasing confidence. More guidance in a South African context pertaining to the types of information sharing that result in pro-competitive gains or technological benefits outweighing the harm of competition, akin to the European Commission’s draft guideline, would be welcomed.
Mackenzie is a Partner and Laing a Candidate Attorney | Fasken (Johannesburg).
1 190/CAC/DEC20 (CAC) paras 78, 82 and 86.
2 OJ C 130, 19.5.2010, p. 1.