How-to guide: How to assess competition law risks in an agency agreement (UK)

Introduction

This guide will assist in-house counsel, private practitioners and risk and compliance teams with the steps organisations should take when dealing with competition law risks in agency agreements.

It sets out the competition implications of using agency as a commercial model and how to identify genuine agency, as well as considering provisions in agency agreements which present competition law infringement risks. It considers the scope of the Competition Act 1998 and, in particular, the scope of application of the Chapter I prohibition to genuine agency agreements. This guide considers how to assess whether an agreement is a genuine agency agreement and the risks if this is not the case.

This guide covers the following:

Overview – legal framework
Key competition law obligations risks for organisations
The distinction between agents and distributors
Advantages of agency
Assessment of whether an agreement is a genuine agency agreement
Potential abuse of dominant position (the Chapter II prohibition)

Section 1 – Overview – legal framework

An agent is a person with the power to negotiate and/or conclude contracts on behalf of another person (the principal) for the purchase of goods or services by the principal or the sale of goods or services supplied by the principal.

The UK Competition Act 1998 (Competition Act 1998) Chapter I prohibition on anti-competitive agreements (the Chapter I Prohibition) applies to agreements between two or more undertakings (economic entities) where that agreement may affect trade within the UK and where the object or effect of the agreement is the prevention, restriction or distortion of competition within the UK.

As a general matter, the Chapter I Prohibition may apply to agreements between entities operating at the same level of the supply chain, such as competitors (these are known as horizontal agreements) and also to agreements between entities operating at different levels of the supply chain, such as a manufacturer and distributor (these are known as vertical agreements).

The extent to which the Chapter I Prohibition may apply to an agency relationship depends on whether the relationship between the agent and the principal can be categorised as a 'genuine agency agreement'. If this is the case, the Chapter I Prohibition does not apply as the principal and agent are seen, for the purposes of competition law as one commercial entity. If, however, the relationship is not one of genuine agency, then restrictions in the agreement may fall within the scope of the Chapter I Prohibition as a distributor is seen as a different or separate undertaking (although there is still the possibility that restrictions in a distribution agreement may be exempt either because the agreement falls within the scope of a block exemption or is individually exempt due to having certain pro-competitive efficiencies).

The (non-)application of the Chapter I Prohibition on anti-competitive agreements to agency agreements is dealt with in the CMA’s guidance on the UK Vertical Agreements Block Exemption Order (VABEO Guidance), which is discussed in more detail below.

Even if outside of the scope of the Chapter I Prohibition, Chapter II of the Competition Act, which prohibits abuse of a dominant position (the Chapter II Prohibition) could still apply in the context of a genuine agency agreement and this is considered further below.

For more information on the Competition Act 1998 prohibitions, see How-to guide: Understanding the Competition Act 1998 prohibitions.

1.1 Impact of Brexit

The main prohibitions under the Competition Act 1998 closely mirror those in the EU found in Article 101 and 102 of the Treaty on the Functioning of the European Union. Prior to Brexit, UK courts and regulators were previously obliged to minimise any differences between the UK and EU’s competition law regimes. This obligation has now fallen away.

All EU competition law in force before 31 December 2020 was imported into UK domestic law as ‘retained EU law’ at 11pm on 31 December 2020, including block exemptions (which exempt from the scope of competition law certain categories of agreement) and decisions of the EU courts. Accordingly, the EU Vertical Block Exemption Regulation (VBER) in force on 31 December 2020 was retained in the UK following Brexit. The VBER was in force for a set period of time and its expiry date in both its original EU form and as part of retained EU law in the UK was 31 May 2022. Both the EU and UK therefore consulted on separate drafts for the replacement of the VBER and the retained EU law version, a new VBER and Vertical Block Exemption Order (VABEO) respectively. Consultations were also launched on accompanying guidelines on vertical restraints, which includes guidance on the nature of agency agreements. Whilst the replacement block exemptions and their associated guidance are similar to the versions being replaced and each other, the process has now introduced some divergence between jurisdictions and therefore companies should carefully check the relevant jurisdiction’s approach to vertical restraints.

It is important to keep in mind that any UK company (and equally any other company that carries out trading activity affecting EU member states), will still be potentially caught by EU competition law where their conduct infringes the EU rules.

Section 2 – Key competition law risks for organisations

It is important to consider the implications of getting a competition analysis of an agency agreement wrong for an organisation. In a genuine agency agreement, one major attraction for a principal is the ability to control the conditions of sale of products, including price, because the agreement falls outside the scope of the Chapter I Prohibition. If, however, the agreement is not one of genuine agency but is instead properly characterised as an agreement with a distributor, then that same control over conditions of sale will likely fall foul of the Chapter I Prohibition which extends, in particular, to those agreements or practices that:

fix pricing or other sales conditions, whether directly or indirectly
limit or control production, markets, technical development or investment
share markets or sources of supply
apply dissimilar conditions to equivalent transactions with other parties, placing them at a competitive disadvantage; and
make the conclusion of contracts subject to supplementary, unconnected obligations.

If an agreement is found by a court or regulator to be in breach of the Chapter I Prohibition, the implications are potentially very serious. They could include the following:

the offending provision in the agreement will be void. This means that it will no longer have effect or be enforceable. Where it is possible to sever the offending provision from the remainder of the agreement then the rest of the agreement will remain in force. A well-established common law principle is that the rest of a contract may remain effective once the unlawful provision(s) are removed, so long as the contract still makes sense and reflects the original intentions of the parties, thereby passing the ‘blue pencil test’. The ‘blue-pencil test’ is a judicial standard that the courts use to decide whether to invalidate the whole contract or only the offending words. If the offending provision cannot be severed, then the whole agreement will fall
the parties may be fined up to 10% of annual worldwide turnover
the parties may then find themselves exposed to damages claims by other organisations that have been suffered loss or damage as a result of the anti-competitive agreement
the parties may receive onerous directions from the regulatory authority on how to avoid further infringement moving forward
high legal costs
potential reputational damage; and
disqualification as a director and/or a criminal prosecution.

See further How-to guide: Understanding the Competition Act 1998 prohibitions.

There is no procedure for obtaining pre-clearance from the CMA that a particular agency agreement is compliant with competition law. It is therefore incumbent on an organisation entering into an agency agreement, or reviewing an existing one, to assess carefully whether any provision is compliant.

In addition to the Chapter I Prohibition, companies should also be mindful of the possible application of other competition laws where their activities may affect trade elsewhere.

Section 3 – The distinction between agents and distributors

In the context of competition law, the distinction between agents and distributors is crucial, as it dictates, to a large extent, where risk lies between the parties. In broad terms, an agent is closely connected to their principal, whereas a distributor has more distance, responsibility and freedom.

The relationship between an agent and a principal is relatively close so they are not seen as two separate undertakings for the purposes of the Chapter I Prohibition. Instead, they are seen as parts of the same, single undertaking. As the CMA puts it, ‘The Chapter I prohibition does not apply to agreements between undertakings which form part of a single economic unit or entity. Agents may be classed as undertakings but the Chapter I prohibition does not apply to agency agreements where the agent is considered to form an integral part of its principal, and they are therefore treated as a single economic entity for the purpose of competition law’ (paragraph 4.8, VABEO Guidance).

If there is a relationship of genuine agency, contractual provisions between the parties in question will fall outside the Chapter I Prohibition, which results in a lower risk of infringing competition rules for both the principal and the agent.

A distributor, on the other hand, is a separate entity from a supplier. An agreement between a distributor and supplier that restricts competition will fall within the scope of the Chapter I Prohibition and therefore amount to an actionable infringement.

There can be considerable scope for argument in any given case as to whether a party is genuinely an agent or, in reality, a distributor. In the event of a dispute, the court or regulatory body will consider which part bears risk on a case-by-case basis, with regard to the economic reality of the situation rather than the legal form of the agreement (paragraph 4.16, VABEO Guidance).

Section 4 –Advantages of agency

When considering and weighing up the competition law risks around agency and distribution, it is worth considering some of the broader commercial and legal implications.

For the principal, agency can provide:

a quick route to market because there is no need to set up its own sales and distribution teams;
a higher degree of control when compared with distribution, for example over pricing, discounts, promotions and other sales strategies;
the ability to establish and grow its own relationships with customers and target customers; and
a lower risk of competition infringement (see Section 2, above).

For the agent, agency can provide:

a lower barrier to entry in terms of cost (marketing and real estate costs are likely to be lower than for distributors);
a way to avoid product liability as this risk remains on the shoulders of the principal. For example. if a product is faulty, a customer would potentially have a cause of action against the principal, not the agent; and
a right to compensation upon termination of the contract if the products are goods rather than services, as this is likely to be deemed to be a commercial agency (The Commercial Agents (Council Directive) Regulations 1993).

There may also be tax implications flowing from your choice of agency or distribution, so it is advisable to check this with a tax expert in your jurisdiction.

Section 5 – Assessment of whether an agreement is a genuine agency agreement

For the reasons set out above, a key question in all circumstances is whether a commercial relationship is to be interpreted as one of agency or, in reality, is one of distribution.

5.1 Factors relevant to a genuine agency agreement

It is stated in the VABEO Guidance (paragraph 4.11) that: ‘In certain circumstances, the relationship between an agent and its principal may be characterised as one in which the agent no longer acts as an independent economic operator. This applies where the agent does not bear any or only insignificant financial or commercial risk associated with the contracts concluded or negotiated on behalf of the principal’.

If the agent bears no significant financial or commercial risk, the agreement will be construed as a genuine agency (further details on these financial/commercial risks are below). It then follows that the principal will not be at risk of infringing the Chapter I Prohibition, as it is one and the same entity with the agent.

To ascertain whether a relationship of genuine agency exists in any given case, it is therefore necessary to identify whether the agent in question is taking on any financial and/or commercial risk.

The VABEO Guidance (paragraph 4.12) helpfully assists by providing a framework covering three types of financial/commercial risk that are material to the categorisation of an agreement as an agency agreement in the consideration of the application of the Chapter I Prohibition.

It is not necessary for all three of these types of risk to be present. Rather, the presence of one is sufficient. Furthermore, anything greater than a minor, insignificant amount of assumed risk is sufficient for the agency not to be considered genuine.

The three types of risk are as follows:

contract-specific investments that are directly related to the contracts in question, such as the financing of stocks
market-specific investments that are specifically required for the type of activity for which the agent has been appointed by the principal and which are necessary to enable the agent to conclude and/or negotiate the particular type of contract. Such investments are usually sunk, which means that upon leaving that particular field of activity the investment cannot be used for other activities or sold other than at a significant loss in equipment, premises or training of personnel. Examples would be investing in a petrol storage tank in a petrol retailing business, or specialised software for selling insurance policies in an insurance business and
risks relating to other activities undertaken in the same product market, to the extent that the principal requires these activities to be taken as part of the agency relationship by the agent at its own risk, and not on behalf of the principal.

The exception is if the principal reimburses the agent, in which case the agent is not out of pocket and bears no risk (see paragraph 4.17 of the VABEO Guidance).

According to paragraph 4.14 of the VABEO Guidance in an agency agreement it is typically the case that the agent:

does not acquire the property in the goods bought or sold under the agency agreement and does not itself supply the services bought under the agency agreement;
does not contribute to the costs relating to the supply/purchase of the contract products, including the costs of transporting the goods;
does not maintain at its own cost or risk stocks of the contract goods, including the costs of financing the stocks and the costs of loss of stocks and can return unsold goods to the principal without charge;
does not take responsibility for customers' non-performance of the contract (for instance for non-payments by the customer), with the exception of the loss of the agent's commission;
does not assume responsibility towards customers of other third parties for loss or damage resulting from the supply of the contract products (unless the agent is at fault);
is not, directly or indirectly, obliged to invest in sales promotion, including through contributions to the advertising budget of the principal or to advertising or promotional activities specifically relating to the contract products;
does not make market-specific investments in equipment, premises or training of personnel;
does not undertake other activities within the same product market required by the principal under the agency relationship;
does not undertake responsibility towards third parties for damage caused to the product sold;
does not take responsibility for other types of financial risks such as the risk of incurring costs due to deferred payment from credit cards or the risk of customer insolvency;
does not make market-specific investments in customer support services, such as after-sales and technical support, to the extent that these services affect the relationship between the agent and the principal in that market.

You should also consider (according to paragraph 4.20 of the VABEO Guidance) other factors relevant to the analysis of whether the principal and agent are not considered separate undertakings for competition law purposes. These factors include:

the level of influence of an agent in determining its commercial strategy, including whether an agent is in a position to determine or influence the terms on which it makes sales;
the unity of conduct in the market of the principal and the agent, including the extent to which an agent undertakes a very considerable amount of business for its own account on the market for the product in question, as an independent dealer;
the number of principals on behalf of whom the agent acts. The extent to which the agent acts for a large number of principals may indicate that the agent is independent and not an integral part of its principal’s undertaking;
whether the principal and agent are perceived by third parties and on the market as forming one and the same economic unit.

Where the purported agent bears one or more of the relevant risks described above, the agreement between agent and principal will not constitute an agency agreement for the purpose of applying the Chapter I Prohibition. The agent will be treated as an independent undertaking (a distributor) and the agreement will be subject to the possible application of the Chapter I Prohibition in the same way as any other vertical agreement.

5.2 Effect of an agreement being a genuine agency agreement

The VABEO Guidance makes clear (at paragraph 4.29) that where a relationship between two undertakings is characterised as an agency agreement, all obligations imposed on the agent in the agency agreement in relation to the contracts concluded and/or negotiated on behalf of the principal fall outside the scope the Chapter I prohibition. Accordingly, the inclusion within the agency agreement of the following types of restrictions will be acceptable:

limitations on the territory in which the agent may sell these products;
limitations on the customers to whom the agent may sell these products; and/or
the prices and conditions at which the agent may sell or purchase these products.

These types of provisions are acceptable because they form ’an inherent part of the agency agreement because these obligations relate to the ability of the principal to fix the scope of activity of the agent in relation to the contract goods or services’ (VABEO Guidance, para 4.29).

5.3 When can a genuine agency still give rise to infringement of the Chapter I Prohibition?

As a statement of general principle, genuine agency agreements are free from the risk of infringing the Chapter I Prohibition. However, there are some exceptions to be aware of. As referred to above, an agent and a principal are not seen as two separate undertakings for the purposes of the Chapter I Prohibition because of the relative closeness of their relationship. However, the VABEO Guidance (paragraph 4.31) states that, as regards the terms governing the relationship between the agent and their principal may fall within the scope of application of the Chapter I Prohibition. For these purposes they are indeed two separate undertakings. It is therefore important to consider the provisions set out below which could give rise to an infringement:

Exclusivity - a clause aimed at preventing the principal from appointing other agents in respect of a given type of transaction, customer or territory. In the CMA’s opinion such exclusive agency provisions will in general not lead to anti-competitive effects;
Single branding - a clause aimed at preventing the agent from acting as an agent or distributor for companies that compete with the principal;
Post-term non-compete - a clause preventing access to the market by the agent for a period of time following termination of the contract; and
Any clause or practice that facilitates collusion.

The CMA specifically states (paragraph 4.31 of the VABEO Guidance) that even where single branding and post-term non-compete clauses fall within the scope of the Chapter I Prohibition, these types of clauses may benefit from exemption either where they satisfy the conditions for block exemption under the new UK vertical block exemption (the UK VABEO) or the conditions for individual exemption under section 9(1) of the Competition Act 1998.

Section 6 – Potential abuse of dominant position (Chapter II Prohibition)

As set out above, the general rule is that genuine agency agreements will fall outside the scope of the Chapter I Prohibition. However, if either the principal or agent occupy a dominant position in a particular market, an abuse of such dominance might constitute an infringement of Chapter II of the Competition Act, which prohibits such abuse (the Chapter II Prohibition).

In outline, the process for evaluating risk in relation to abuse of dominant position entails assessing:

whether either party to the agency agreement has a dominant position; and
whether the agency agreement or other conduct has the effect of restricting competition through abuse of that dominant position such that it may affect trade within the UK.

6.1 Dominant position

In summary, a supplier could be found to be in a dominant position if it has enough power to act without the normal pressures of a competitive market applying. Market shares are one indicator of market power but are not determinative of market power. The CMA has stated that it considers it unlikely that an undertaking will be individually dominant if its share of the relevant market is below 40%, although dominance could be established below that figure if other relevant factors (such as the weak position of competitors in that market and high entry barriers) provided strong evidence of dominance.

6.2 Abusive practices

The prohibition on abusive practices applies equally in the context of an agency agreement as in the market generally.

The Chapter II Prohibition provides that conduct may, in particular, constitute an abuse if it consists of:

directly or indirectly imposing unfair purchase or selling prices or other unfair trading conditions
limiting production, markets or technical development to the prejudice of consumers
applying dissimilar conditions to equivalent transactions with other trading parties, thereby placing them at a competitive disadvantage
making the conclusion of contracts subject to acceptance by the other parties of supplementary obligations which, by their nature or according to commercial usage, have no connection with the subject of the contracts.

These are examples of the types of behaviour that may constitute an abuse and is not an exhaustive list.

Abusive conduct may come in two forms:

exclusionary conduct – conduct which removes or weakens competition from existing competitors, or establishes or strengthens entry barriers, thereby removing or weakening potential competition
exploitative conduct – conduct which exploits customers or suppliers (for example, excessively high prices)

Competition enforcement tends to prioritise exclusionary conduct, but either form of conduct may be enforced against.

6.3 Exemptions

There are no formal exemptions but if there is an objective justification for the conduct (and the conduct was proportionate), then it may not be regarded as an abuse. The onus will be on the company seeking to rely upon such objective justification to show that the measures taken were proportionate and necessary for protecting legitimate objectives, such as protecting a public interest.

How-to guide: How to assess competition law risks in an agency agreement (UK)

Introduction

Section 1 – Overview – legal framework

1.1 Impact of Brexit

Section 2 – Key competition law risks for organisations

Section 3 – The distinction between agents and distributors

Section 4 –Advantages of agency

Section 5 – Assessment of whether an agreement is a genuine agency agreement

5.1 Factors relevant to a genuine agency agreement

5.2 Effect of an agreement being a genuine agency agreement

5.3 When can a genuine agency still give rise to infringement of the Chapter I Prohibition?

Section 6 – Potential abuse of dominant position (Chapter II Prohibition)

6.1 Dominant position

6.2 Abusive practices

6.3 Exemptions

Additional resources

Related Lexology PRO content

How-to guides:

Checklists:

Quick views:

Filed under

Topics

Organisations

Laws

Brexit

United Kingdom

Competition & Antitrust