The new Vertical Block Exemption Regulation – what does it mean for franchising in Europe?
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Since the Commission started is consultation, Fieldfisher franchise partner, Jordi Ruiz de Villa, has been involved in advocating on behalf of the European franchise community via his association with the Legal Committee of the European Franchise Federation ("EFF"). We expect the definitive new VBER and accompanying guidelines to be published in May.
This article explores some of the key issues, which have been discussed during the consultations and their potential impact on European franchising. If you are interested in reading about the UK Government's parallel review and proposed update to the retained VBER in the UK, please read more. If you would like to know about dual distribution systems in general and the impact of the proposed new rules for the EU, please read more.
Firstly, a recap on how competition law intersects with European franchise agreements
A franchise agreement is a type of "vertical agreement", which is at risk of infringing EU competition law if it has the object or effect of restricting competition and is capable of affecting trade within the European Economic Area ("EEA"). The European Commission (the "Commission") is responsible for enforcing EU competition law between member states.
In order to maintain uniformity, protect know-how and operate a network effectively across sales channels and geographies, a franchise agreement will often seek to regulate areas such as online activity, marketing, territorial rights, reserved channels, supply obligations, pricing and non-competes. However, competition law prohibits agreements that are anti-competitive, thereby only allowing certain types of restrictions if either:
- the parties' respective market share is low enough to mean that the restrictions have no appreciable effect on competition; or
- the parties' respective market share is low enough to benefit from the "safe harbour" of the VBER and the agreement does not contain any "hardcore" restrictions, such as restrictions of a franchisee's ability to set their own prices or a ban on their ability to sell online.
Further, certain provisions that are essential for (i) maintaining the identity/reputation of the franchise network or (ii) protecting the transfer of the franchisor's know-how, fall outside the remit of competition law altogether (the so called "Pronuptia test").
An infringement of competition law can lead to substantial fines on the parties concerned. The non-financial implications are equally severe, including damage to business reputation, the unenforceability of contracts, the risk of third party claims and even personal sanctions (fines, director disqualification and imprisonment) imposed on executives of the parties concerned.
The changing landscape for franchise systems
Since the VBER was last updated, advances in consumer habits and technology have had a huge impact on the way in which consumers buy products and services and otherwise interact with brands. Whereas franchising systems used to be able to operate largely as their own distinct sales channels, perhaps chiefly confined to a bricks and mortar operation, this is no longer the case in the age of the omni-channel consumer.
As such, some franchised systems are at an arguably competitive disadvantage to large corporately owned and operated businesses due to:
- the increasing need for brands to organise themselves around the consumer in a consistent and holistic manner (irrespective of whether a franchisee or the franchisor is selling the product or service); and
- the limitations which competition law imposes on franchise systems to protect the consumer.
In addition to this, in the last 10 years we have seen the emergence of powerful online market places and intermediary businesses, some of which sell products and services to consumers in direct competition to other resellers on the same platform. These businesses have an in-built advantage derived from the information they receive from their customers and the resellers.
The vast majority of franchised systems operate as "dual distribution" systems – i.e. systems where both franchisor and franchisee operate in the same market, selling goods and services to customers – but here ends any meaningful similarity with most other dual distribution systems. Key areas of difference include:
- unlike other systems, where direct sales by the supplier may have evolved over time, dual distribution is an intrinsic part of almost all franchise systems – the franchisor needs to develop its brand and know-how before it can license it to franchisees; and
- franchise systems require an extensive vertical exchange of information in order to function properly. A franchisor needs to collect all manner of information in order to monitor compliance with the system, ensure uniformity and update and improve the know-how.
It is worth noting that franchise system in the EU used to be governed by a specific block exemption, but since 2000, franchising has been governed by the general VBER. As the VBER applies to a variety of dual distribution systems, franchising continues to be susceptible to the risk of accidental and adverse regulation.
Perhaps the key topic of debate for the franchise community during the consultation phase of the revised VBER has been in relation to the Commission's attempt to redress the imbalance of power in some dual distribution systems and the potential adverse impact this would have on franchise systems.
What are the key issues with the proposed revised VBER for franchise businesses?
1. Change in market share thresholds for information exchange in dual distribution agreements
Under the current rules – if neither franchisor nor franchisee have an individual market share exceeding 30% – dual distribution agreements where a franchisor also sells directly to end users can automatically be exempt from the EU prohibition on anti-competitive agreements.
However, under the first proposal for the new rules, the exemption would stop applying to information exchanges in a dual distribution agreement if the combined market share of the brand and its distributor exceeds 10%.
This change in market share threshold places a substantial part of the European franchise sector into the uncertain borderlands between compliance and non-compliance.
Representative bodies, such as the EFF, have petitioned the Commission (in collaboration with other brand and retail associations) to delete the 10% threshold and include an acknowledgment in the new rules that franchise systems operating a dual distribution system should be allowed to operate on a presumption that their information exchange is necessary and pro-competitive (see below). These stakeholders are optimistic that the Commission will drop the 10% threshold, but watch this space.
2. The "need to know" principle
In February 2022, the Commission put forward an additional proposal whereby an information exchange in a dual distribution system may be exempt if it is "necessary to improve the production or distribution of the product". We understand that this new substantive assessment will apply to dual distribution arrangements that fall within the 30% individual threshold for the broader exemption.
This suggests that franchise systems which operate a dual distribution model should limit information exchange to a "need to know" basis. This change of approach could have widespread ramifications for franchise systems, which operate a dual distribution model.
The EFF and other trade associations believe that the draft new rules should include a presumption that the exchange of information in a franchise that operates a dual distribution system is necessary and pro-competitive and the burden should sit with the Commission to prove otherwise. This position has been reinforced by an expert report[1], which was commissioned as part of the ongoing consultations with the Commission.
However, the Commission is yet to clarify its position.
3. Positive and negative lists of examples
The guidelines which will accompany the new rules will contain a non-exhaustive list of information which is deemed to be necessary and unnecessary to improve the production or distribution of the product. Exchanges of customer-specific data, including non-aggregated information on sales and data, which might identify a particular customer will fall into the list of negative examples.
As mentioned above, this is problematic for franchise systems operating a dual distribution model as they rely on this type of information exchange. For example:
- using integrated point of sale systems for the sharing of sales data;
- using customer data to ensure that the customer receives targeted offers and to improve services across the network;
- using customer feedback in franchisee audits, as part of assessing system compliance; and
- using customer data within a franchisor-controlled mobile app, where customers can earn and redeem coupons across the network.
Requiring franchisors and franchisees to prove the "need to know" across these various integrated touchpoints may create an unsustainable compliance burden for most franchise systems operating a dual distribution model.
4. Confusion between franchise e-commerce and intermediary "hybrid platforms"
Franchise networks – particularly hotel franchises – often allow franchisees to market and/or sell products and services to consumers via the franchisor's principal website.
The new draft rules contain a statement that the VBER should not apply to providers of online intermediation services where they have a hybrid function, that is where they sell goods or services in competition with undertakings to which they provide online intermediation services. Unless otherwise clarified in the new guidelines, this arguably takes this type of e-commerce activity in franchise systems outside the safe harbour of the VBER.
On a wider and more positive note, the proposed new rules bring commercial opportunities for brands, as dual distribution may be permitted at wholesale and import level of trade. Further, and for the first time, suppliers may charge distributors a higher wholesale price for products intended to be sold online, effectively subsidising brick and mortar sales. Further improvements are also expected for exclusive and selective distribution.
Conclusion
The current VBER will expire on 31 May 2022. Franchisors will have until 31 May 2023 to bring their existing franchise agreements within the new rules.
We will be watching closely to see if there are any last minute changes to the new rules and guidelines when they are published in May.
Franchisors should therefore consider taking this opportunity to:
- review their existing franchise agreements which apply across Europe; and
- carry out a compliance audit to verify their likely market share position and/or consider if their current practices on information exchange are likely to remain within the safe harbour of VBER.
If you would like to more detail about the proposed updates to the VBER on dual distribution systems, please read more