Corporate lawyer, № 9, September 2012

Julia Borisova, Attorney at Capital Legal Services

When entering into a distributorship agreement, the parties do not always fully and thoroughly assess antitrust restrictions and requirements stipulated by laws to protect competition. Let us examine general restrictions for entering into a distributorship agreement subject to recent legal changes and law enforcement practice.

According to the definition used in Federal Law No.135-FZ “On protection of competition” dated 26.07.2006 (the “Competition Law”), distributorship agreements are vertical agreements, i.e. agreements between business entities that do not compete with one another; when one entity purchases a product or is its potential purchaser, and the other provides a product or is its potential seller and they, consequently, operate on different product markets.

Activity area and ‘target group’

In previous editions of the Competition Law the list of general prohibitions did not include establishing a distributor’s activity area in a distributorship agreement. The provisions that may not be included into a vertical agreement were subsequently defined by law; however, the prohibition to restrict the area of the distributor’s activity was not directly incorporated into the law. While examining a case, the Directorate of the FAS – the Federal Antitrust Service of Russia recognized the supplier’s actions as inadmissible control, which may result in dividing the product market based on the area or the structure of sellers or buyers. The court indicated that since the company’s control of distributors’ business activities resulted in the unsubstantiated refusal to enter into an agreement with a particular seller and may result in unsubstantiated refusal to enter into agreements with other potential commercial brokers, the company’s actions breach the prohibition established by Part 3 Article 11 of the Competition Law (see Decree No.F09-1942/11-S1 of the Federal Commercial Arbitration Court of Ural Circuit on case No.А76-15244/2010-45-358 dated 29.04.2011).

To avoid such situations, the Third Antitrust Package has included into the Competition Law the regulations specifying that actions of business entities performed within vertical agreements do not constitute control of business activities.

The effective antitrust legislation (Article 11 of the Competition Law) contains a prohibition on entering into competition restricting agreements (cartels) which result in dividing a product market based on the area or the structure of sellers (or buyers).

In breach of this prohibition the suppliers (distributors) include into distributorship agreements the provisions that stipulate the distributor’s (dealer’s) obligation to conduct activities on a particular territory, as well as the prohibition to enter into agreements with buyers outside the area defined in a distributorship agreement and liability for failing to fulfill this obligation in certain cases. Such provisions can be found not only in distributorship agreements, but also in work instructions, commercial policies and other documents regulating relations between the supplier and the distributor.

The FAS, having performed a scheduled inspection of a company’s activities and having analyzed the relevant documents and materials and data, revealed that the distributor limited the number of dealers and subdealers in the regions. Based on the available information, the FAS initiated a case on possible violation of Article 11 of the Competition Law due to control over business entities’  activities, which may result in dividing the product market on an area basis (see Resolution and Order of the Committee of the FAS of Russia on Case No.1 11/154-09 dated 29.01.2010).

Distributors often do not directly stipulate product market division in a distributorship agreement; however, in practice such principle takes effect in the course of cooperation with contractors.

For example, in a recently examined case, the Committee of the FAS established that the distributor divided activities of dealer centers on an area basis. Despite the fact that the law expressly stipulates that is it impossible to classify vertical agreements as imposing control, distributor’s actions (not expressly stated in the agreement) were classified as activity control of independent business entities (dealers), which results in or may result in dividing the product market on an area basis (Resolution of the FAS of Russia on violating antitrust legislation on case No.1 11/132-11 dated May 31, 2012).

The Committee of the FAS indicated that despite the earlier exclusion from dealer agreements of provisions envisaging such restrictions, the following actual circumstances testify to the fact that that a territorial principle of selling products has been retained:

• placing information on the official site about each dealer’s activity area, including a prohibition to carry out product supplies in a different area;

• informing the consumers that they need to purchase products from dealers carrying out business activities in the nearest territory;

• distributing letters to consumer entities indicating the need to purchase products from particular dealers, including by providing written permits for supplies;

• written refusals of dealers to supply products to consumers beyond the area on which they are authorized to operate.

Thus, it is necessary to ensure that not only do distributorship agreements, commercial terms of cooperation and interaction policies, but also the information published on a company’s official website comply with the requirements of the antitrust law.

Direct sales and operation on one market

Until recently, it was debatable whether the supplier carrying out direct product sales to customers and the distributor, are competitors operating on one product market, and whether the agreements between them are covered by the requirements of Part 1 Article 11 of the Competition Law.

In May 2012, the Presidium of the FAS declared that the objective of the distributorship agreement is distribution of a manufacturer’s products by the distributor (see Resolution No.5-15/1-2 of the Presidium of the FAS dated 23.05.2012). Therefore, the product manufacturer and the distributor selling such goods on one product market will not be competitors, provided the following conditions are fulfilled:

1. on such product market the distributor sells the products that he purchased from that manufacturer;

2. the distributor does not manufacture substitute products.

Provided the said conditions have been fulfilled, the requirements of Part 1 Article 11 of the Competition Law will not apply to distributorship agreements.

Nevertheless, it is important to take into account the following when entering into a vertical agreement:

1. an agreement containing provisions restricting competition may be classified as a different type of agreement that results in or may result in restricting competition pursuant to Part 4 Article 11 of the Competition Law (save for vertical agreements recognized as acceptable pursuant to Article 12);

2. the very agreement recognized as an acceptable vertical agreement may contain provisions of a cartel nature (for instance, on establishing delineation between the supplier and the distributor based on the product sales area).

Bonuses/discounts

Parties to a distributorship agreement are always focused on a long-term and mutually beneficial cooperation, therefore, the goods supplier who is interested in increasing the purchase volume, guarantees that the distributors receive bonuses and discounts, provided they fulfill the conditions of cooperation. And this seemingly economically logical condition may create another risk area.

As a rule, the distributorship agreement stipulates discounts and bonuses not only based on the volumes of purchased products, but also on such indices as duration of cooperation, client potential, etc.

From the perspective of doing business, everything is economically reasonable and justified. However, offering different terms of cooperation (in this case different in the pricing policy) must not only be based on clearly defined criteria and be secured in the cooperation terms available to all distributors, but must also have a proper economic and technological justification. While examining one of the cases, the court established that according to the company’s marketing policy, certain clients may be provided individual discounts in the amount of up to 20%. When providing such discounts, the long-term positive cooperation with the client and its strategic importance for the company, etc., are taken into account.

After analyzing the conditions of individual discounts, the Directorate of the Federal Antitrust Service of Russia made a conclusion that such conditions fail to comply with the criteria of economic and technological justification for the following reasons:

• there is no comprehensive procedure for using them;

• no clear criteria are indicated for defining the concept of “long-term positive cooperation with the client” which allow establishing how long a distributor needs to cooperate with the company in order to receive a discount in the future;

• no mechanism is outlined for adequate assessment of strategic importance of the company’s client;

• no variation limits are established for discounts off of the prices stipulated by the company’s policy (see Decree of the Federal Commercial Arbitration Court of North Caucasus Circuit on case No.А63-6244/2011 dated 19.03.2012).

The absence of clearly defined criteria allows to arbitrarily interpret the introduced terms and criteria when entering into agreements and to make decisions on providing a discount to a particular distributor while applying prices at one’s own discretion.

In such case the supplier’s actions may be classified as restricting competition by a business entity establishing different prices for the same product without economic, technological or other justification (see Decree of the Federal Commercial Arbitration Court of Volgo-Vyatsky Circuit on case No.А79-9164/2010 dated 19.10.2011).

Price fixing: minimum, recommended and maximum prices

Article 11 of the Competition Law prohibits vertical agreements between business entities, provided such agreements result or may result in establishing a product resale price.

The seller establishing a maximum product resale price for the buyer was excluded from among these prohibitions by the Third Antitrust Package. Therefore, the current edition of the Competition Law, as opposed to the previous one, allows the supplier to determine maximum prices within which the distributors may sell the purchased goods.

As regards minimum prices and mandatory resale prices, they still may not be established by the product supplier and such a condition of the distributorship agreement will definitely be interpreted as a violation of the antitrust legislation.

For example, in the above mentioned case in the course of an antitrust investigation the FAS of Russia found that the company controlled pricing and not only determined the resale price for the sold goods, but also imposed financial liability for failing to comply with the respective provisions of the agreement (see Resolution and Administrative Writ of the Committee of the FAS of Russia on case No.1 11/154-09 dated 29.01.2010). As a result, the company was recognized to have violated Part 3 Article 11 of the Competition Law (the edition in effect prior to the Third Antitrust Package being adopted) for coordinating the actions of business entities, which could result in dividing the goods market based on a territorial principle and establishing prices for such products.

A controversial issue arises in connection with recommended prices, since the term “recommended” prices may often conceal minimum or mandatory product resale prices; therefore, establishing recommended prices should be reviewed from the perspective of practical application.

Sale of competing goods

Article 11 of the Competition Law prohibits vertical agreements between business entities in the event a seller establishes in the agreement that a buyer cannot allow sale of goods of a competing business entity. Such prohibition does not apply to agreements on the buyer selling goods under a trademark or brand name of the seller or manufacturer.

Therefore, a ban on sale of competitors’ goods when selling goods under a manufacturer’s trademark is deemed possible under Clause 2 Part 1.2 Article 11 of the Competition Law.

It should be noted that pursuant to Article 1477 of the Civil Code of the Russian Federation (the “Civil Code”), a trademark means a duly registered designation intended for individualization of a product, with the exclusive right to such designation being confirmed by a respective certificate and registered in the name of one of the legal entities.

Pursuant to Article 1484 of the Civil Code a holder of a trademark is an entity in whose name the trademark is registered. Such entity holds an exclusive right to use the trademark under Article 1229 of the Civil Code in any manner not contradicting the legislation (exclusive right to the trademark). Such limitation must be established expressly for selling goods under the trademark (e.g. in the sales regulations) and not by requirements toward a distributor or dealer.

For instance, the FAS of Russia when examining a case dismissed a distributor’s argument that a ban on selling competitors’ goods was established as a result of selling goods under the distributor’s trademark. The documentation set forth requirements for a sales area where the goods were sold and office premises, but not for a legal entity (the dealer).

The antitrust authority made a conclusion that “prohibitions on selling competitors’ goods were established as pertains to a legal entity without referring to sale of goods <…> under a trademark, which limited the dealer acting as a legal entity in arranging sale of competitors’ goods <...> in other sales areas and under other trademarks” (see Resolution of the Committee of the FAS of Russia dated 07.03.2012 on case No.1 11/112-11).

Companies with a dominant position on the market should be particularly cautious in including such provisions on prohibition of sale and purchase of competing goods.

Refusal to conclude an agreement

Having considered the main limitations which can be found in a distributorship agreement, we should highlight the following important issue: violation of the antitrust legislation may be not only in certain provisions included in the agreement, but also in a groundless refusal to conclude such agreement with certain business entities.

Article 10 of Competition Law prohibits entities with a dominant position on the market to refuse without grounds to conclude, and to avoid concluding, such an agreement. There is therefore a risk that refusal by a company with a dominant position on a certain market may be classified as a violation of the antitrust legislation in form of abuse of dominance.

In practice the company may face difficulties arising from it being unaware that it dominates on a certain commodity or geographical market, or from the difference in viewpoints of the FAS of Russia and the company concerning the boundaries of such market.

Business entities should thoroughly analyze their share on the market and in the event of dominance be careful when refusing to conclude contracts. Such refusal should only be allowed if there are sufficient economic and technological reasons.

Extraterritorial application of Russian antitrust legislation

The institute of giving notice was introduced in 2012. The mechanism authorizes the FAS of Russia to issue notifications requiring dominating business entities whose actions/omissions contain elements of antitrust violation to cease unlawful actions, prior to initiating proceedings. If requirements of the notice are fulfilled, a case on violation of the antitrust legislation is not initiated and the respective entity is not held liable for an administrative offense of the antitrust legislation, since the violation is remedied.

The abovementioned limitations should be taken into account not only by Russian companies, but also by foreign companies supplying goods to Russia due to the extraterritorial principal of the Russian antitrust legislation.

Pursuant to Clause 2 Article 3 of Competition Law, provisions of the said Law apply to agreements reached by and between Russian and/or foreign entities or organizations outside Russia, as well as to their actions, if such agreements or actions affect the competition situation in Russia.

In particular, this was confirmed by a notice issued at the end of June 2012 by the FAS of Russia to a non-resident company with the requirement to cease actions/omissions containing elements of antitrust violation based on Article 39.1 of Competition Law. The FAS of Russia revealed elements of the following violations in the company’s actions:

• company imposing unfavorable terms of an addendum to an international distributorship agreement;

• company unreasonably avoiding to sign a direct distributorship agreement with a Russian legal entity.

Therefore, the FAS of Russia confirmed that provisions of the Russian antitrust legislation apply to actions of foreign entities or organizations, if such actions adversely affect the competition situation in Russia.

P.S. Before an agreement is signed, it should be checked for compliance with the Competition Law

The Russian antitrust legislation contains a number of limitations and restrictions on including certain provisions in distributorship agreements, especially for companies with a dominant position on the market. The main objective of business entities should be to analyze in good time the contract documentation as to its compliance with requirements of the antitrust legislation and to prevent provisions that restrict the competition from being included into distributorship agreements. This allows the company to prevent not only significant penalties on itself and its officers, but also the threat to its goodwill.