US and EU Vertical Restraints

Seeking out a Balanced Jurisdiction

Introduction

The global market is fueled by a seemingly endless supply of business dealings. Buyers approach sellers, sellers market their goods and services to buyers, and competitors work to win the end consumer. Often though, the tactics used in creating these dealings and capturing the business of the end consumer surpass the bounds market regulators have set to maintain a competitive landscape. In many of the domestic markets feeding the global economy, conduct which distorts the market in a way unduly burdening another party, whether that be a competitor or consumer, may be labeled anti-competitive and against the intentions of regulators. These anti-competitive behaviors often warrant criminal penalty, unwinding of business deals, or fines up to 10% of the offender’s annual turnover in order to restore market competition to equilibrium.

In the last ten years, the exponential growth of online transactions has created global reach for even the smallest companies. Compliance with competition regulations in all active jurisdictions is thus necessary to conduct business in the global market, but compliance with the varying bodies of competition law is becoming increasingly difficult. Due to enforcement asymmetries and regulation incongruencies, even operating amongst jurisdictions with strong trade likelihood such as the United States and European Union can be difficult for an untried or ill-equipped company. It may then be wise for growing businesses to limit the scope of potential agreements to one jurisdiction until adequate compliance can be ensured in others. A factual inquiry must be made as to which jurisdiction a developing business, without robust compliance processes, should limit itself to in order to avoid competition law upsetting its agreements. If presented with the option of developing agreements in the United States or the European Union, the United States will present a more fair, reasoned treatment to such agreements.

Overview of Anticompetitive Restraints

United States antitrust regulation states anti-competitive behavior can be found in “contracts, combinations, and conspiracies in restraint of trade.” One party interacting with another in the marketplace can leave the party’s agreements subject to scrutiny if it leads to, or attempts to restrain, trade. Agreements are further delineated into “two types, horizontal and vertical.” Where horizontal restraints occur amongst market competitors on the same rung of the supply chain, vertical restraints are those agreements between market participants at different rungs. Categorizing deals into horizontal and vertical buckets determines the treatment regulators will give the agreement in an investigation.

Many market spectators regard horizontal agreements as unsavory, quickly disparaging the deals as dodgy, believing they only take place in discreet locations, cloaked in secrecy. Regulators treat horizontal arrangements analogously, marking agreements between participants in the same rung of the supply chain, typically competitors, as per se illegal, giving no consideration to the chance a justifying market benefit may exist. The whole market, but for the party’s involved in horizontal agreements, spurn the dealings. Vertical agreements, however, have the potential to create economic synergies and stability in the industry that benefits the market as a whole and often the end consumer. These agreements “can improve economic efficiency within a chain of production or distribution by facilitating better coordination between the participating undertakings. In particular, they can lead to a reduction in the transaction and distribution costs of the parties and to an optimization of their sales and investment levels.” As such, vertical deals can and should be made in broad daylight with encouragement from the market. Encouragement is unlikely to come from affirmative statements by a regulator, but will instead derive from the regulator’s predictable application of laws and the development of a robust body of case law with which a business may make self-assessments.

Compliance with the regulations in question comes from various bodies of competition law. The more practiced regulators, the United States and the European Union, comprise two of the top markets by Gross Domestic Product (GDP) at $23 trillion and $17 trillion respectively. As such, a market participant is highly likely to have started conducting business within one of these domestic markets and to be considering whether to operate exclusively in the domestic market or expand into another. A business must develop a full comprehension of the risks their agreement faces in each jurisdiction. Failure to comprehend these risks may lead to a business decision with strong economic potential but huge regulatory hazard, the fallout of which could destroy the business. The relevant risk assessment rests on the treatment of agreements in each jurisdiction with the goal being to operate in the jurisdiction which creates the lowest regulatory risk and the greatest freedom to enter lucrative deals; a jurisdiction which balances the need for competitive markets with the necessity of satisfying the interests of market participants.

Policy Argument for a Balanced Business Jurisdiction

The “rules on competition are designed to ensure fair and equal conditions for businesses, while leaving space for innovation, unified standards, and the development of small businesses.” The rules should then balance the development of business interests with the adequate protection of those interests in the face of undue abuse or adverse action. Proper balance would be likely to spur economic growth and promote competition at the same time. A jurisdiction operating with policies that do not balance private interest with competition is susceptible to economic breakdown because the market requires trust. If participants do not trust the market to create predictable results, save for some level of market risk, there is no reason to do business there when another jurisdiction will provide them with better treatment. Low levels of reliance on the system are reasons for a business to stay away from the jurisdiction. If the system regulating the domestic market is not trusted or is unpredictable, the economy of that market will suffer and be surpassed by other markets. For instance, in India there are high levels of reported corruption and low levels of contract enforcement measures, the system regulating the marketplace is unreliable. Thus, it becomes an unattractive place for business. A country like India misses out on startups building headquarters there and established multinational enterprises expanding to their market, bringing foreign direct investment, and skilled workers along with it.

The perfect jurisdiction will not exist for any business, but there will always be one that is more advantageous than the other. When expanding a business into the vastness of the global market, and without the backstop of a rigid and tested compliance and regulatory team, understanding where it will face the least amount of high-level compliance risk will be imperative to deciding whether or not to enter that market. There is a clear difference in the application of the rules on vertical restraints between the United States and the European Union and this analysis finds the United States to have more pro-business enforcement measures. As such, a business entering vertical agreements is likely to incur less risk doing so in the United States.

Overview of Major Jurisdictions Regulations

Antitrust law in the United States is governed by Article 1 of the Sherman Act which declares “every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce . . . to be illegal.” Similarly, the European Union, in Article 101 of the Treaty on the Functioning of the European Union (the “TFEU”), states “all agreements between undertakings . . . which may affect trade . . . and which have as [its] object or effect the prevention, restriction or distortion of competition within the internal market” are prohibited. TFEU Article 102 further defines the prohibitions, stating “any abuse by one or more undertakings of a dominant position . . . in so far as it may affect trade between Member States.” Seemingly, any restraint on trade would be illegal in both jurisdictions, but enforcement of such a blanket standard of illegality would defeat the economic rewards of doing business. Businesses would refuse to participate in the market if they could not enter lucrative deals.

The solution, evident in the record of enforcement, is for courts to actively prosecute those actions most in contravention to public policy such as horizontal restraints which “lack redeeming virtue [and are] presumed unreasonable.” Regulators thus narrow the regulation’s scope through an unwillingness to prosecute reasonable agreements and instead pursuing deals which create “unreasonable” restraints on trade. American and European regulators clearly share the goal of maintaining competitive marketplaces and allowing business to flow through reasonable agreements. In an age of multinational enterprises such as Philip Morris International, which sells products in 180 countries, it would be prudent to have congruent competition law systems, but enforcement measures between these two major jurisdictions differ noticeably, posing upsized risk to ill-equipped market participants.

Analysis of Vertical Restraints

As stated previously, vertical restraints should not be hidden nor made in the shadows as some horizontal restraints tend to be. Vertical restraints have the potential for economic synergies and market efficiencies. To cite the court in Continental TV v. GTE Sylvania, vertical restraints have the “redeeming virtue” which makes would-be illegal conduct permissible for the betterment of the market. Not all vertical restraints with market benefits are permissible however, as some do not create sufficient benefit to outweigh their anti-competitive effects. If there is not a per se rule or hardcore restriction governing the type of agreement, a well-considered analysis of vertical restraints will involve a weighting of the positive effects of the agreement against the anti-competitive effects to determine if the net outcome is such that the conduct should be permitted for creating a more competitive market. Some positive factors for consideration of the net benefit of the vertical agreement include increased economic efficiencies, lower barriers to entry for new participants, product innovation, and increased consumer choice.

Treatment in the United States

The United States subjects vertical restraints of trade to the rule of reason as promulgated in the case of Continental T.V. vs. GTE Sylvania. The court here held that “under this rule, the fact-finding weighs all of the circumstances of a case in deciding whether a restrictive practice should be prohibited as imposing an unreasonable restraint on competition.” Application of the rule of reason creates a case-by-case consideration of the facts, nuanced by specific market conditions, competitive landscapes, and consumer trends as opposed to a per se determination conduct is illegal without due consideration of the specific circumstances. This mode of treatment for vertical restraints was not always the case though. In the 1968 case of Albrecht v. Herald Co., a newspaper publisher set a maximum price route owners could charge. When route owner Albrecht exceeded that maximum price, Herald Co solicited the homes on the route and started to service customers themselves at the maximum price it had set instead of Albrecht’s higher price. The Supreme Court found “schemes to fix maximum prices, by substituting the perhaps erroneous judgment of a seller for the forces of the competitive market, may severely intrude upon the ability of buyers to compete and survive in that market.” While the Court of Appeals attempted to reason a positive market externality for the price ceiling in the form of price gouge protection for consumers given the territorial control route owners had on the market for this particular paper, the Supreme Court held the price fixing conduct to be per se illegal.

In 1997, State Oil v. Khan overturned the court’s conclusion in Albrecht, finding that not all price fixing restraints were to be treated as per se illegal. Instead, the court in Khan, analyzing a restraint in which a petroleum products distributor attempted to control the pricing of a retailer by eliminating incentive to charge prices above the distributor’s suggested price, found that “vertical maximum price fixing . . . should be evaluated under the rule of reason.” The court’s decision that a rule of reason analysis was required in the case of price fixing rested on the fact that as time passed, case law indicated far more potential positive effects of maximum price fixing than were available to the court in Albrecht. This record of positive potential along with the reversal of per se treatment for other nonprice restraints and exclusive territory arrangements indicates the court is no longer able to “predict with confidence that the rule of reason will condemn" price fixing every time and as such, should consider each arrangement’s reasonableness amidst its circumstances.

Nearly forty years after Albrecht and only ten years after Khan, in 2007, a vertical agreement to create price floors was justified with pro-competitive benefits in a well-considered rule of reason analysis by the Supreme Court in the case of Leegin Creative Leather Prods., Inc. v. PSKS, Inc. Until then, price floors were deemed unlawful per se by the court in Miles Med. Co. v. John D. Park & Sons Co. For nearly one hundred years the per se designation stood, until the case of Leegin overruled Miles Med thanks to developments in “economics literature” which pointed to plentiful procompetitive effects of resale price maintenance. In the overruling case, Leegin sold its leather products to retailers with a distinct price floor the retailers could not sell below. Leegin discovered Kay, a subsidiary of PSKS Inc., to be selling Leegin products below the price floor and subsequently cut off the retailer. The court found “minimum resale price maintenance . . . prevents the discounter from undercutting the service provider. With price competition decreased, the manufacturer's retailers compete among themselves over services.” Effectively, the court in Leegin found that some types of price fixing or maintenance can alleviate the problem of free riding. The economics of the problem are as follows. One business invests in marketing, branding, and overall sales efforts for the product. The business establishes brand recognition and makes the consumer aware that its product solves the consumer’s problem. The free rider then comes in with the same product and takes a “free ride” on the overhead of the other participant, expending little to no effort or capital on the sale themselves. The business which put in the effort loses out to the free rider who is able to undercut their unit economics due to the lack of overhead costs. The business cannot compete with the free rider and thus competition is diminished. Conduct that forty years earlier would have been deemed per se illegal for defeating competition is, thanks to the precedent of Khan, the only thing maintaining a competitive landscape in the Leegin case.

The continued development of vertical restraint analysis in the United States opens the door for engagement in agreements without fear of outsized antitrust liability. As shown above, as markets evolve and more information is gathered about the effects certain actions have on competition, many of the regulated actions will tend to track towards a rule of reason treatment to understand the specific circumstances. As such, the rule of reason is a beneficial tool to businesses in rapidly evolving industries where the ability to operate quickly, entering predictable vertical agreements which are defendable with justifications, is pivotal to economic success. The immediate application of the rule of reason considers all market effects a vertical restraint may create and enables a more deeply nuanced analysis of those effects, bearing in mind the realities of doing business and need for participants to protect their interests. The rule of reason promotes market efficiencies and indicates to businesses that if an arrangement can be reasonably justified, there is no reason it should not be engaged in. Use of the rule of reason analysis in assessing vertical agreements is inherently balanced and a good reason for businesses looking to enter vertical agreements to do so in the United States. European regulators, however, take a different approach, as analyzed below.

Treatment in the European Union

In analyzing vertical restraints of trade in the European Union and most recently in response to an increase in online dealings, the European Commission issued a revised Vertical Block Exemption Regulation (the “VBER”) in May 2022. The VBER provides guidelines by which companies assess their own compliance with competition laws before a violation is determined by regulators. The VBER sets out specific circumstances such as agreement types, restraint mechanics, and business performance metrics under which the implementation of a vertical restraint is considered compliant. The guidelines seek to make compliance accessible and transparent. If an agreement does not fall within the exemptions or if it contains a hardcore restrictive practice as enumerated in Article 4, the European Commission will make a rule of reason analysis as to the legality of the agreement. However, this analysis is limited to the scope of TFEU Article 1, §101(3) whereby the positive effects justifying the agreement must benefit the consumer at their core.

With ease of compliance in mind, two broad VBER carve outs should put the mind of a business decision maker at ease given the bright line rule they purport to create. Article 1 §8 finds that but for a severe restriction of trade, possessing market share under 30% is an indication the economic efficiencies created by the vertical restraint will outweigh any anticompetitive harms created and the agreement will be presumed valid. Article 1 §2 further exempts those market participants with less than 50 million Euros in annual turnover from liability for TFEU Art. 101(1). A business looking to enter a vertical agreement may see these thresholds for safe harbor then look to its income statement and market share calculations which may place it firmly within the safe harbor exemption, but as the regulators make clear, the guidelines “should not be applied mechanically, as each agreement must be evaluated in the light of its own fact[s].” Application of the VBER guidelines so plainly can result in inaccurate self-assessment and liability for violations as the cases below show.

In the case of Allianz Hungaria v. Gazdasági Versenyhivatal, the difficulty of using the VBER for self-assessment when an agreement does not fit firmly within the limits of the VBER emerges. In Hungary, automobile insurers Allianz and Generali, along with a series of repair shops, entered into vertical “quantity forcing” agreements whereby the repair shops sold insurance, on behalf of the insurers, to their customers. If the shops hit certain thresholds, the payable rate on their work would increase, so there was strong incentive to upsell customers on the insurance. The quantity forcing provision is “entirely benign in most vertical distribution arrangements,” and in fact would have fallen under the VBER safe harbor provisions but for the fact that the two insurers constituted “70%” of the Hungarian automobile insurance market. While the deal itself was not anti-competitive, the character of the participants made it anti-competitive. Smaller insurers may have and likely were engaged in the same practice, and although Allianz and Generali did not act in agreement, their concerted practice covered enough of the market to exceed the 30% threshold and their conduct was deemed anti-competitive.

As indicated above, there is a safe harbor exemption for a business with less than 30% market share and this must be calculated by including those other businesses engaging in the concerted practice even without agreement. It is then increasingly difficult to ascertain market share due to the inclusion of other parties. In some instances, a business may not affirmatively know others are engaging in the conduct. Engaging in the agreement in the case of Allianz under the auspices of a VBER safe harbor, the calculation of Allianz own market share had to be accurate down to a 2.5% margin of error to fit within the VBER exemption. A similar calculation would be required of Allianz for Generali, whose financials they do not have access to, making a market share calculation to such a fine degree exceedingly difficult. The Allianz case shows that despite the best intentions of the VBER to make compliance straightforward and self-assessable, when using its guidelines on circumstances that do not perfectly fit the mold or have clearly large margins for error, the results of a self-assessment may be unreliable and leave a business at risk.

The difficulties of self-assessment are further illustrated by the case of United Brands v. Commission where the pricing and distribution practices of United Brands, selling bananas under the Chiquita Banana trade name in the European Union, was found to be anti-competitive and an abuse of their dominant position in the market. United Brands’ self-assessment, as argued before the Commission, would show they believed they did not have a dominant position in the market because the relevant market they calculated was all fresh fruit. United Brands believed “bananas compete with other fresh fruit in the same shops, on the same shelves, at prices which can be compared, satisfying the same needs.” Defining the market they compete in as the fruit market as a whole does not appear to be an unreasonable assessment, however, the Commission determined that in fact the relevant market was solely “the banana market” as consumers had a “constant need for bananas” and other fruits did “not noticeably or even appreciably entice [consumers] away from the consumption of [bananas].” This determination catapulted the calculated market share of United Brands with the Commission finding it “supplied on average 40 to 45% of the bananas sold in the [European Union].” The company was no longer eligible for a VBER exemption despite the findings of their self-assessment.

The cases of Allianz and United Brands demonstrate the insufficiency of the guidelines in creating compliance, proving they are not a good substitute for the due consideration given by a rule of reason analysis. Without a clear margin for error, businesses and their lawyers are at risk of incurring large fines for their conduct. The Commission makes clear in §2 of the VBER guidelines the intention of providing such guidelines is to “to help undertakings conduct their own assessment of vertical agreements under the Union’s competition rules,” but it seems without the Commission confirming the calculations and assumptions a business must make in performing a self-assessment are correct, the risk of non-compliance is still outsized if the agreement in question is not a simple one.

A Pro-Business United States

The above analysis indicates that in the pursuit of market efficiency, economies of scale, and economic synergies through vertical agreements, the United States will provide more balanced consideration of private business interests and competition interests than the European Union. The methods of antitrust enforcement in the United States give the circumstances of each individual agreement more consideration and provide reliable, predictable outcomes by which companies can assess risk. Courts in the United States allow for nuanced investigations of the individual circumstances of a vertical agreement by the immediate application of the rule of reason. Full consideration of the economics, industry, and players made with the rule of reason allows for a flexible approach to agreements that may be anti-competitive on their face but are underpinned by positive externalities.

Despite European regulators issuing attractive carve outs and seemingly straightforward guidelines to help to predict outcomes, these tools do not provide the same level of consideration of the United States’ rule of reason which allows any business to make a case for the reasonableness of their agreement. VBER guidelines can best be equated to IRS questionnaires or business entity formation portals provided by the Secretary of State. These tools purport to make the process more straightforward, but as soon as circumstances fall outside what was forecasted, the tool is less than useful and the rigidity of it becomes a nuisance, the cases of Allianz and United Brands illustrate that nuisance. As such, I believe the individual inquiry into each vertical restraint provided by the United States courts makes it the better jurisdiction to do business in.

Further, public policy in the European Union favors integration of the member states into a unified community over all else. This theme of integration prioritization is clear in the case of Consten and Grundig v. Commission. In this case, Grundig was engaged in the manufacture of electronic equipment, specifically radios, and entered into an agreement with Consten for the exclusive dealing of its goods in France. A third party lawfully bought Grundig’s goods in another country and began importing the goods to France in contravention to the exclusive dealing contract Grundig made for the territory. Consten and Grundig’s argued exclusive dealing in the territory effectively bolstered competition by preventing the undercutting of prices by free riders, a similar argument to that of Leegin, but the European Commission and European Court of Justice found it unpersuasive. The balanced approach of the United States would have given the opportunity to defend the agreement in Consten and maybe it would have upheld the justification as the court upheld a similar free ride defense in Leegin, but the balance of private business and pro-competitive interests is skewed by the European Commission’s prioritizing of the integration of member states. The European Court of Justice’s made clear “an agreement between producer and distributor which might tend to restore the national divisions in trade between Member States. . . the Treaty . . . could not allow undertakings to reconstruct such barriers.” If a business, which in concert with others makes up the economic zone the Commission seeks to integrate and protect, cannot rely on the system to allow it to operate for profit in pursuit of efficiencies, the business is unlikely to want to compete in that market and will likely go elsewhere. For these reasons, the United States presents a more favorable business environment; it is better balanced jurisdiction.

Conclusion

This analysis indicates the better jurisdiction in which to enter vertical agreements between the United States and the European Union is the United States. However, in the internet age, where even the smallest enterprising sole proprietor can create cross border transactions with the click of a button or through automated processes, it is crucial that businesses develop deep, full spectrum understandings of competition law as it relates to their proposed agreements in each jurisdiction they operate and each one they hope to expand into. Proactively assessing risks and planning ahead to select jurisdictions with favorable treatment for vertical agreements and other lucrative, economically efficient deals can help a business gain a competitive edge while maintaining regulatory compliance. With a careful assessment of the competitive landscape, a business can increase the likelihood of their success, develop partnerships, and achieve global expansion all while minimizing legal risks and regulatory hurdles. A well-considered, carefully crafted approach to competition law as cross-border transactions and vertical agreements continue to develop is what will set the great businesses apart from the rest.