Anand Sree, Senior Associate.
Exclusive clauses in commercial arrangements such as purchase and supply agreements, dealership agreements are commonplace in the supply chain. They are either encountered upstream (while purchasing a good/service) or downstream (while selling a good/service). Competition law recognizes two broad categories of exclusive agreements, i.e., (a) Exclusive Supply Agreements; and (b) Exclusive Distribution Agreements, based on whether the restriction operates upstream or downstream.
Exclusive Supply Agreements
Exclusive Supply Agreements are defined under Section 3(4)(c) of the Competition Act, 2002 ("Act") as agreements restricting the purchaser from purchasing/dealing with goods other than those of the seller. Exclusive supply agreements operate a restriction on the seller. Exclusive supply agreements are also known as 'single branding' agreements or 'quantity forcing' arrangements. Under EU Competition law, an agreement that induces the buyer to purchase more than 80% of his requirement from a particular seller/supplier constitutes a 'single branding' agreement.1 Exclusive Supply Agreements can be de jure as well as de facto.
A de jure exclusive supply agreement operates as a direct restriction on the buyer/distributor/supplier from procuring/buying goods from a competing supplier or source.
A de facto exclusive supply agreement is when the seller manipulates the contract covenants in such a manner that the buyer is induced to concentrate all its requirements from a single seller. Usually, the seller acting on the prior knowledge of the buyer's product/input requirement for a particular year specifies an off-take quantity in the contract knowing fully that the said specified quantity constitutes the majority of the purchaser's total demand of a particular product during a specific period of time. Other examples of contractual clauses that induce de facto exclusivity include the imposition of minimum purchase requirements, minimum stocking requirements, conditional rebates, etc. Competition authorities particularly tend to view such off-take requirements as problematic when the contract also induces the buyer to disclose to the seller its requirement of a particular product for a particular year.
Another contractual clause that may result in de facto exclusivity is an 'English clause,' which obligates the buyer to report any better offer to the seller and permits a buyer to accept such an offer only when the supplier does not match it. It is also known as "meeting the competition" or "Right of first Refusal". Incidentally, such clauses have the same effect as the Single branding clauses on competition since the buyer is obliged to reveal who makes the better offer, i.e. because they remove the free choice of the buyer to accept any improved offer (because they have to notify the supplier first). It may be noted that a fair competitive process is always full of uncertainties for the future outcome which makes every market player give the best offer in anticipation of the competition and any restriction that reduces uncertainties in the process of selection, is likely to adversely affect competition.
Exclusive Distribution Agreements
Section 3(4)(c) of the Act defines an exclusive distribution agreement as an agreement that limits, restricts, or withholds the output or supply of any goods or allocate any area or market for the disposal or sale of goods. An exclusive distribution agreement operates as a restriction on the seller.
An exclusive distribution agreement can manifest as a territorial restriction, where the supplier agrees to sell his products only to one distributor for resale in a particular territory, or as a customer restriction, where the supplier is restricted to sales only to a particular group of customers. It is quite popular in the pharmaceutical sector where chemists are appointed exclusively for institutional sales to large buyers like hospitals etc.
Exclusive distribution agreements can also operate as an agreement providing for an exclusive medium/channel for sale/distribution of goods, e.g., either offline or online. Under EU competition law, online sales are treated as passive sales, and any restrictions on such passive selling are considered as a hard-core restriction.
Assessment of exclusive agreements under Indian Competition Law-
Exclusive agreements may be assessed both under Section 3(4) as well as Section 4 of the Act.
Section 4(1) of the Competition Act prohibits an enterprise or group from abusing its dominant position. A dominant position is nothing but the possession of significant market power, which enables a firm to (i) Operate independently of the competitive forces prevailing in the relevant market; or (ii) Affect its competitors or consumers or the relevant market in its favor.2
Vertical agreements under per Section 3(4) of the Act are not per se anti-competitive. They are anti-competitive only if such vertical agreements cause an appreciable adverse effect on competition (AAEC) in India. As per the Competition Commission of India's ("CCI") decisional practice, vertical agreements cause AAEC only if the firm imposing such vertical restraint possess the market power to foreclose competition.
Thus, exclusive agreements are anti-competitive under Section 3(4) or Section 4 of the Act only when the parties involved have significant market power.
Market Power as a concept is not defined under the Act. However, substantial market power or dominant position is determined on consideration of factors such as market share, size, resources, the importance of competitors, economic power, commercial advantages, vertical integration, consumer dependence, entry barriers, market structure, and market size.
These factors are also considered by the CCI for the assessment of market power for the purposes of Section 3(4) of the Act. In its decisional practice, the CCI has considered factors such as market share, the structure of the market3, duration of the agreement4, entry barriers5 , etc. while determining market power for assessment of agreements under Section 3(4) of the Act.
The CCI's decisional practice further reveals that market shares are often considered as a crucial indicator of market power. For assessment of exclusivity clauses under Section 3(4) of the Act, the CCI may require firms to hold at least 30 percent market share in the relevant market to deem it as sufficient market power to cause AAEC.6 This is in line with the assessment of vertical restraints under EU competition law, where the Guidelines on Vertical Restraints provide that vertical restraints are likely to raise competition concerns only when the market share thresholds exceed 30%.
For determining a dominant position, the CCI has considered a market share exceeding 50% as an indicator of a dominant position.7
Demonstration of anti-competitive effects
The imposition of exclusive agreements by a dominant enterprise may amount to a per se violation under Section 4 of the Act, in violation of Section 4(2)(a)(ii) and Section 4(2)(c) read with Section 4(1) of the Act, provided the exclusivity is not objectively justified. Therefore, there is no obligation to demonstrate anti-competitive effects.
On the other hand, agreements under Section 3(4) anti-competitive only if they cause an AAEC in India. As per Section 19(3) of the Act, the CCI is obligated to demonstrate that the anti-competitive effects arising out of an agreement namely: (i) creation of barriers to new entrants in the market; (ii) driving existing competitors out of the market; and (iii) foreclosure of competition by hindering entry into the market. However, it has been observed from the CCI's decisional practice that the assessment of anti-competitive factors under Section 19(3) of the Act is mostly a theoretical rather than an empirical exercise.
The primary theory of harm for exclusive supply agreements is that it may result in foreclosure of the market for competing suppliers and potential suppliers. This market foreclosure may, in turn, have an adverse effect on inter-brand competition.
The foreclosure theory for exclusive dealership agreements is that an upstream manufacturer with market power would use such exclusive dealing restrictions to prevent a potential new entrant from having access to the vital input of a distribution network, which would ultimately prevent entry, and allow the incumbent to keep growing his market share. Exclusive dealership agreements may also foreclose competition at the distributor level.
Besides foreclosure, such exclusive dealing restraints may also produce other anti-competitive effects such as:
- Softening of inter-brand competition- may serve to facilitate collusion between suppliers (under the Bertand competition model-i.e. where firms compete on prices.)
- Softening of intra-brand competition - may serve to facilitate collusion between dealers (under the Cournot competition model-i.e. where firms compete on quantities)
- The commitment problem-the problem a monopolist faces to prove his commitment to a dealer - by offering secret discounts etc.
Consideration of pro-competitive effects/justifications
The determination of AAEC is a balance between these positive and negative factors provided under Section 19(3) of the Act. The positive effects provided under Section 19(3) of the Act are: (i) accrual of benefits to consumers; (ii) improvements in production or distribution of goods or provision of services; or (iii) promotion of technical, scientific and economic development by means of production or distribution of goods or provision of services.
Some pro-competitive effects/justifications that the CCI may consider in case of exclusive supply agreements include cases where the supplier makes buyer-specific investments like investment in production lines etc. to service a particular buyer, or where the buyer is offered a discounted price based on a commitment to off-take a specific quantity etc.
The pro-competitive effects/justifications that the CCI may consider in the case of exclusive distribution agreements include (i) Protection of brand image8 in case of quality-driven products, (ii) Prevention of "free-riding"- another dealer/distributor unfairly taking advantage of the promotional efforts made by another dealer etc.
Exemption provided to IPRs under Section 3(5)
The assessment of an exclusivity agreement under Section 3(4) of the Act may also involve an assessment as to whether the exclusivity in question qualifies for other exemptions provided under Section 3.
Section 3(5)(i) provides for a limited exemption that the holder of an intellectual property right may impose "reasonable restrictions" that are necessary for the protection of intellectual property rights. In the case of RKG Hospitalities Pvt. Ltd v. Oravel Stays Pvt. Ltd9, the CCI held that the exclusivity imposed by the franchisor was justified considering that know-how was shared with the franchisee.
In practice, however, the CCI has adopted a narrow interpretation of Section 3(5)(i) of the Act. Only restrictions that satisfy the twin limbs of 'necessity' as well as 'reasonability' are permitted by the CCI.
In conclusion, it is seen that there is no straight-jacket formula for the assessment of exclusive arrangements under the Act. Each assessment is carried out by the CCI on a case by case basis with due consideration of a host of factors including the market power of the parties concerned, the pro-competitive effects arising out of the agreements, and any economic justifications that the parties may have. Depending upon the market position held by the parties, CCI can assess them either under the provisions relating to abuse of dominant position (under section 4 of the Act) or those relating to vertical agreements (under section 3(4) of the Act) or both.
However, it has to be borne in mind that an enterprise's dominant position has traditionally carried with it a higher burden of proof to justify its conduct. Although, there is no precedent in India, the CCI is likely take a leaf out of the EC's Guidelines on Vertical Restraints and may require a dominant enterprise imposing an exclusive arrangement to justify its conduct by demonstrating the following: (i) that the exclusivity results in pro-competitive efficiencies; (ii) that the exclusivity is indispensable to generate the pro-competitive efficiencies; (iii) that the likely pro-competitive efficiencies outweigh the likely anti-competitive effects; (iv) that the conduct does not eliminate effective competition; and (v) that the party passes on the efficiency benefits to the end-consumers.
Note - The above article is based on the webinar conducted on the same subject by the Authors on 5th June 2020 and the details thereof first published on the Antitrust & Competition Law Blog on 7th July 2020. The same can be assessed here.
2. Explanation to S.4 of the Competition Act, 2002.
3. Accessories World Car Audio Pvt Ltd v. Sony India Pvt. Ltd, Case No. 03/2020 decided on 11 May 2020.
4. M/s Himalaya International Ltd. V M/s Himalaya Simplot Pvt. Ltd and Ors., Case No. 92/2013 decided on 06 March 2014.
5. M/s Karni Communications Pvt. Ltd v. Haicheng Vivo Mobile & Ors., Case No. 25/2018 decided on 19 June 2019.
6. Automobiles Dealers Association v. Global Automobiles Ltd and Ors., Case No. 33/2011 decided on 03 July 2012.
7. Kapoor Glass (India) Ltd. v. Schott Glass India Pvt. Ltd., Case No. 22/2010 decided on 29 March 2012.
8. Ashish Ahuja v. Snapdeal and Anr., Case No. 17/2014 decided on 19 May 2014.
9. Case No. 03/2019 decided on 31 July 2019.
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