Selective distribution agreements are increasingly used as a way of imposing restrictions on distributors. Such agreements can work. But failure to comply with competition law can result in substantial fines and other problems. In December 2018, American fashion brand Guess was fined EUR 40 million ($48.99 million) for breaching European Union competition law. After a delay of several weeks, on the heels of Guess and the European Commission agreeing on a non-confidential version of the Commission’s decision, the full decision has been published.
In addition to confirming the Commission’s zero tolerance approach to bans on online sales, restrictions on sales between authorized wholesalers and retailers; and resale price maintenance in selective distribution networks, the decision also provides a valuable insight into the Commission’s approach to online advertising restrictions which may be imposed by brands on their distributors. Such restrictions include authorized distributors not being allowed to bid on the brand’s trade marks when using the Google Adwords service.
Guess’ selective distribution network
At the heart of the case was the selective distribution system that Guess maintains across Europe through agreements with wholesalers; brick and mortar mono-brand retailers (franchisees); and multi-brand retailers (i.e., “authorized distributors). European competition law prohibits agreements and concerted practices between undertakings, that (i) may affect trade between Member States and (ii) have as their object or effect the prevention, restriction or distortion of competition within the internal market, unless they meet the conditions for an exemption.
While selective distribution networks can come within the European competition law framework, brands do need to ensure that their selective distribution networks are operated in such a way as to promote the legitimate objective of brand preservation. The view of the European Court on this point is that selective distribution networks are acceptable as long as: (1) resellers are chosen on the basis of objective criteria of a qualitative nature; (2) the objective criteria are laid down uniformly for all potential resellers and not applied in a discriminatory fashion; (3) the characteristics of the product in question necessitate such a network in order to preserve its quality and ensure its proper use; and (4) the criteria laid down do not go beyond what is necessary.
Guess’ distribution agreements and sales terms fell short of this high standard by a long way. They contained a number of restrictions, which were grouped by the European Commission into five categories, from “online advertising restrictions,” “online sales restrictions,” and prohibitions that “authorized distributors could not cross-sell to other Authorized Distributors” to rules that prevented “authorized distributors [from] selling to consumers outside of their allocated territory” and “Resale Price Maintenance” guidelines.
1. Online advertising restrictions
Guess’ agreements with their Authorized Distributors required each Authorized Distributor to obtain Guess’ written approval before carrying out any advertising campaigns or other promotional activities. Clauses such as these are common in distribution agreements. However, this restriction led to Authorized Distributors requesting Guess’ approval before bidding on a Guess trade mark for the purpose of the Google AdWords service. Guess refused to approve such requests.
The European Court had previously decided in its Coty judgment that a clause within a selective distribution agreement would be lawful provided that it: had a legitimate objective; was laid down uniformly for all potential resellers; was applied in a non-discriminatory fashion; and did not go beyond what was necessary.
Applying this test to the online sales restrictions imposed by Guess, the Commission made much of the fact that it was clear from Guess’ internal emails and documents that Guess was not pursuing the (legitimate) interest of the preservation of its brand image within the selective distribution system. Rather, Guess’ objectives in refusing to allow Authorized Distributors to bid on a Guess trade mark were to increase sales from and traffic to its own online store at the expense of sales from its wholesalers’ websites, and to keep its own Google Adwords spend down.
Nor did the enforcement or protection of the Guess trade mark provide a “legitimate objective.” Trademark law would allow Guess to prevent third parties from advertising products identical to those for which the Guess trade mark is registered using an identical keyword if the advertisement was likely to cause confusion amongst consumers as to the origin of the goods. Yet, there was no likelihood of confusion as to trade origin here because the Authorized Distributors were proposing to use the Guess trade mark to sell genuine Guess products!
Finally, the European Commission concluded that the restrictions had the object of reducing “the ability of authorized retailers to advertise and ultimately to sell the contract products to customers, in particular outside the contractual territory or area of activity and to limit intra-brand competition” and so breached competition laws.
2. Online sales restrictions
Guess’ agreements with its Authorized Distributors prohibited online sales without Guess’ prior written approval and Guess’ right to refuse to provide such approval was not linked to any quality criteria. Again, the Commission highlighted Guess’ e-commerce strategy, of promoting its own online shop and protecting Guess’ own online sales activities from intra-brand competition by its authorized retailers. The online sales restrictions limited the Authorized Distributors’ ability to sell Guess products outside their territory or brick and mortar shop and thus breached competition laws.
3. Authorized Distributors could not cross-sell to other Authorized Distributors
Guess’ distribution agreements and sales terms contained a number of different restrictions which prevented Authorized Distributors from cross-selling within the network, including active and passive sales restrictions, such as disincentives. These restrictions were aimed at ensuring that only Guess or the national wholesaler could supply the retailers operating in each national market and that wholesalers purchased only from Guess and did not resell the contract products to other wholesalers or retailers outside their allocated territory.
4. Authorized Distributors were not allowed to sell to consumers outside of their allocated territory
Each Authorized Distributor was only permitted to sell Guess products within its own allocated territory. This meant that Guess restricted active and passive sales to end users located outside the allocated territory.
5. Resale Price Maintenance
Guess’ sales terms allowed Guess to impose a minimum resale price and required Authorized Distributors to respect these prices or risk paying damages and/or Guess refusing any future supplies. Guess also monitored that its recommended retail prices were observed and applied higher retail prices in Western Europe than in Eastern Europe. The European Commission confirmed that these restrictions breached competition law and had no place in a selective distribution system.
Vertical Agreements Block Exemption Regulation
The European Commission went on to consider whether the 5 restrictions described above could benefit from the exemption provided to certain vertical agreements (including agreements that establish a selective distribution network) by the VBER. This was unlikely given that 4 out of the 5 restrictions in question were textbook examples of “hardcore restrictions” and hardcore restrictions can never benefit from the safe harbour provided by the VBER.
Interestingly, the European Commission concluded that the restriction on online advertising restrictions could not benefit from the VBER. This was because the restriction limited Authorized Distributors from advertising and ultimately selling Guess products to customers outside their territory or area of activity. Accordingly, the restriction had the object of restricting active or passive sales to end users by members of a selective distribution system operating at the retail level of trade, which is a hardcore restriction.
Take home points
With the foregoing in mind, there are several points for brands to takeaway. The Commission’s investigation of Guess started as a follow-up to their e-commerce sector inquiry. Whether you are a brand owner wishing to set up a new selective distribution network, or a distributor or retail member of such a network, it is vital that you are aware of the European Commission’s red flags so that you can ensure that you stay on the right side of European competition laws.
Selective distribution agreements are useful in controlling the quality of dealers who are able to market and sell a brand’s products, which is of huge benefit to certain brand owners at the prestige or luxury end of their sector. The flipside to this is that selective distribution agreements cannot be used to impose territorial or online selling restrictions on authorized distributors.
Selective distribution agreements should be reviewed carefully to check whether they include any restrictions which might preclude sales outside of the distributor’s territory or which may make such sales more difficult. A requirement to obtain the brand owner’s prior consent before selling online will be as problematic as an outright ban if: the brand owner’s discretion to provide consent is absolute; or if it is not backed up by quality criteria which are applied consistently.
Advertising restrictions which have traditionally been included in selective distribution agreements with a view to protecting brand integrity may be anti-competitive if they restrict the authorized distributor from marketing and selling outside their territory.
A brand owner’s conduct in operating the selective distribution agreements must respect competition laws. Although the restrictions on bidding on Guess’ trade marks in the context of the Google Adwords service were not expressly set out in written agreements or sales terms, Guess’ conduct in refusing the requests amounted to an agreement for the purpose of European competition law.
A brand owner’s internal and confidential policy reasons for enforcing restrictions against its distributors will be considered by the Commission when determining whether the restriction had a legitimate objective. Businesses should ensure that their legitimate objectives are well documented in internal documents in case of any future investigation.
The restriction of online passive sales by authorized distributors in a selective distribution network to consumers living outside of their territory is now also prohibited by the EU’s new Geo-blocking Regulation, which came into force on 3 December 2018. As the European Commission highlighted in their statement of 30 November 2018, “the Geo-blocking Regulation is part of a wider set of measures aimed at boosting e-commerce in the Single Market, such as the revised Consumer Protection Cooperation Regulation, the new rules on cross border parcel delivery services, the new rules for digital contracts, and the new VAT rules for electronic commerce.”
It also demonstrates the Commission’s commitment to removing barriers to online shopping. In doing so, consumers can benefit from purchasing goods online from retailers located in less affluent countries which may sell at lower prices than their counterparts in other countries.
Sian Barr is a senior associate in Fox Williams’ commerce and technology team.