Franchise plays a special role in competition law (see here and here for our earlier franchise blogs). A franchisor is often permitted, for instance, to restrict the commercial freedom of franchisees in order to protect the accumulated knowledge, intellectual property rights and uniform image of the franchise formula. However, franchise agreements and the restrictions they contain are also often submitted to civil courts and competition authorities in the EU on the grounds of alleged violation of the cartel prohibition.
The cartel prohibition means that companies may not make agreements that have the restriction of competition as their object or effect. Franchise agreements in violation of the cartel prohibition are void. Competition authorities, such as the European Commission (the “Commission”) or the Netherlands Authority for Consumers and Markets (“ACM”) may furthermore impose high fines for violations of the cartel prohibition.
In practice, the Commission’s Vertical Block Exemption Regulation (the “Block Exemption”) and the Guidelines on Vertical Restraints (the “Guidelines”) form an important part of the competition-law review of franchise agreements: the Block Exemption provides a safe harbour for franchise agreements if (i) the market share on the relevant market(s) of both the franchisor and the franchisee does not exceed 30% and (ii) the agreement does not contain hardcore restrictions. The franchise agreement is then considered to promote economic efficiency.
The current Block Exemption and Guidelines date from 2010 and expire on 31 May 2022. Moreover, due to the challenges and opportunities of today’s digital economy, the current rules are partly outdated and are considered inappropriate. The application of the Block Exemption to online trading and other platforms, such as Amazon and Bol.com, has been the subject of debate, for instance. For these reasons, the Commission has published drafts for a new Block Exemption and new Guidelines. The new rules are to enter into force on 1 June 2022. The main changes are addressed in this blog.
Draft Block Exemption
The conditions of the Block Exemption will remain largely unchanged. A vertical agreement may not contain hardcore restrictions and the companies involved may not have market shares in excess of 30%. The draft Block Exemption does contain a new precondition, however. Vertical agreements that have the restriction of competition between franchisor and franchisee as their object, whether or not in conjunction with other agreements or practices, may no longer make use of the Block Exemption. That seems self-evident, since object restrictions such as market-sharing agreements are deemed to be harmful to competition due to their nature and scope. An exemption for (vertical) object restrictions would therefore thwart the effective enforcement of competition law. Anyone familiar with the Block Exemption will immediately notice the favourable change in the structure of the draft Block Exemption. The hardcore restrictions in Article 4 are now explained per form of distribution. This system improves the readability of the draft Block Exemption.
As in the past, the draft Guidelines contain a chapter that emphasises the specific characteristics of franchising, such as the uniformity of the trade name, the business concept and the licensing of intellectual property rights. Vertical restraints and obligations for the franchisee that are essential to the franchise formula continue to justify an exception from the cartel prohibition. The provisions of the draft Block Exemption and draft Guidelines that are most relevant to franchises are individually explained below.
Resale price maintenance
Also within a franchise network, resale price maintenance remains prohibited. Resale price maintenance means the use of minimum or fixed (resale) prices. A franchisee must be entirely free to determine its sale/resale price. Franchisors may apply recommended prices, but they may not enforce compliance with a recommended price by threatening to stop supplying or to terminate the franchise agreement.
ACM has paid more attention to resale price maintenance in recent years. In September 2021, Samsung was fined over 39 million euros for unlawfully influencing the sales prices of television sets. According to ACM, Samsung persuaded retailers to raise their prices to the level desired by Samsung, under the guise of “recommended prices”. Retailers that charged too low a prices were consistently urged by Samsung to increase those prices.
Exclusive and selective franchise networks
The new structure of the Block Exemption and Guidelines still allows franchisors to exclusively allocate territories or groups of customer to franchisees. Although the term “exclusive” suggests otherwise, it follows from the draft Block Exemption that within an exclusive network “a limited number” of franchisees may be appointed for a designated territory or group of customers. However, when more than one exclusive franchisee is appointed for a territory or a group of customer, the number of franchisees must be in proportion to the allocated territory or group of customer and to the investments required for the exclusive sale.
A franchisor is also free (in keeping with the rules on selective distribution) to create a closed network of franchisees. A closed network allows a franchisor to prohibit the selected franchisees from selling the franchised goods or services to other distributors. The franchisor thereby protects the uniform appearance and the identity of its franchise formula.
The new Block Exemption makes it easier to operate exclusive or selective franchise networks alongside each other. Other franchisees (and their customers) may be prohibited, for instance, from actively selling in territories where the franchisor operates an exclusive system. Other franchisees (and their customers) may furthermore be prohibited from selling both actively and passively to unauthorised distributors in territories where the franchisor operates a selective system. This makes it easier for franchisors to establish closed franchise networks.
The Commission emphasises that franchisors that also operate at retail level (dual distribution) should beware of the exchange of sensitive competitive information with franchisees. Under the draft Block Exemption, the exchange of information on prices and customers may be exempt only if the combined market share of the franchisor and franchisee at the retail level does not exceed 10% and no restriction of competition by object is involved. Following the public consultation on the draft Guidelines, the Commission clarified the rules on the exchange of information between a supplier (franchisor) and a distributor (franchisee). Examples given of information that may not be exchanged include future prices to be charged by the franchisor and the franchisee, and the possibly competing products sold by the franchisee. Larger franchisors that also supply directly to consumers will have to be more careful in the future when exchanging and inquiring about commercial pricing and other strategies or sales information. Partly in light of the compulsory exchange of information prescribed by the new Wet franchise (Franchise Act), it may be worthwhile for franchisors to put safeguards in place (such as Chinese walls).
The emergence of online sales plays an important role in the draft Block Exemption and draft Guidelines. The main case law of the Court of Justice on this point has therefore been included in the draft legislation. Following the Coty judgment (in which it was ruled that a ban on online platform sales of luxury products is permitted), it is apparent from the draft Guidelines that a general ban on online platform sales is not a hardcore restriction. According to the Commission, a ban on online platform sales restricts only the conditions on which the online sale takes place: in principle, such a prohibition therefore does not restrict passive sales in a specific territory or to a specific group of customers.
On the other hand, a general ban on price comparison websites is considered a hardcore restriction. The Commission does not regard a price comparison website as an online sales channel, but rather as an advertising channel. Restricting online advertising opportunities, including price comparison websites, hinders a franchisee’s passive sales to customers located outside its physical territory who want to buy online, which constitutes a hardcore restriction.
Previously, a franchisor was allowed only in exceptional circumstances to charge franchisees different (wholesale) prices for online and offline sales channels (dual pricing). The draft Block Exemption has created more room for this form of price differentiation. Provided that the price difference between online and offline sales channels is related to the different investments and costs of the various sales channels, the Block Exemption may be applied. The Commission thereby acknowledges that online and offline sales generally involve different investments and sales costs. But if a price difference applied by the franchisor has the prevention of online sales by franchisees as its object, that does constitute is a hardcore restriction. In light of the different characteristics of online and offline sales channels, a franchisor may apply different rules to online sales and sales in brick-and-mortar shops. However, the different rules may not lead to a restriction of online sales.
Non-compete clauses are clauses that provide that a franchisee may not engage in competing activities or must purchase more than 80% of its goods or services via the franchisor. Provided that the preservation of the common identity and reputation of the franchise network so requires, a non-compete obligation for the duration of the franchise agreement is still permitted under the draft Block Exemption. The term of the franchise agreement is then irrelevant, provided that the non-compete obligation does not exceed the term of the franchise agreement.
A non-compete agreement after the termination of the franchise agreement is valid only if it:
- relates to the goods or services that were the subject of the franchise agreement;
- is limited to the premises or land from which the franchisee operated;
- is indispensable for the protection of the know-how that the franchisor has transferred to the franchisee; and
- does not last longer than one year after termination of the franchise agreement.
We find it remarkable that the Commission has opted to allow non-compete clauses after termination of a franchise agreement only subject to the condition that they are limited to the premises and land where the franchisee operated: this condition means that a franchisor cannot prevent a franchisee from engaging in competitive activities from new premises or from another (nearby) city. The new Franchise Act, on the other hand, does allow Dutch franchisors to enforce a non-compete clause after termination of the franchise agreement that prohibits the franchisee from engaging in competitive activities in its former catchment area.
In recent years, the digital economy and the related sales opportunities have given rise to a great deal of case law within the European Union. The dynamic online playing field in which franchisors and franchisees reach their customers therefore urgently required an adjustment of the policies of competition authorities.
The draft Block Exemption and draft Guidelines provide a good impression of how the Commission, following the case law of the Court of Justice, intends to assess vertical agreements. The assessment and exemption of franchise agreements will remain largely unchanged, but, in order to avoid fines, franchisors who themselves also supply to consumers must be more careful than in the past when it comes to the unauthorised exchange of sensitive competitive information with franchisees.
Franchise agreements that were in force on 31 May 2022 but do not meet the conditions of the draft Block Exemption will be exempted from the cartel prohibition until 31 May 2023 provided that they did meet the conditions of the old Block Exemption. Franchisors will therefore have sufficient time to review their agreements and make changes where necessary.
Information on dawn raids by ACM and the European Commission can be found at invalacm.nl