GUJARAT NATIONAL LAW UNIVERSITY

SEMESTER VIII

COMPETITION LAW PROJECT

Project topic: Vertical Agreements & its effect on trade: The Solutions
to the Legality of such Agreements under American, European and
Indian Antitrust Jurisprudence

SUBMITTED TO:

UDAYAKUMARA RAMAKRISHNA B.N.

SUBMITTED BY:

DAMODAR SOLANKI (13A033)

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 TABLE OF CONTENTS

A. Introduction 3

B. Theories on Vertical Restraints ... 5

C. EU Jurisprudence: Block Exemptions 7

D. United States: The Rule of Reason . 9

E. India: Appreciable Adverse Effect ... 12

Conclusion .... 14

References 15

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 A. INTRODUCTION

Vertical agreements, in the nature of arrangements between enterprises that operate at different
stages of market which are, or likely to be harmful, are considered to be bad in the eyes of the law.
Such likelihood becomes more evident when where one or both of the parties to the agreement
have significant market power. Nevertheless, most vertical agreements increase consumer welfare.
But keeping in mind the adverse effects such agreements may have, many systems of competition
law prohibit the practice of resale price maintenance, whereby a supplier of products dictates a
fixed or minimum price at which they may be resold. Some examples of resale price maintenance
are as follows.1

The Federal Court of Australia imposed record penalties of more than AU$ 1million against
weight-loss venture Chaste Corporations and three individuals. The Competitions Bureau of
Canada reached a settlement with John Deere Ltd., under which more than 8,600 consumers across
Canada, who bought a lawn-tractor from John Deere received a 5% cash rebate upon initiation of
a price-maintenance investigation. In South Africa, a humungous penalty was imposed upon
Italtile for settling prices to franchisees. Further, exclusive dealing agreements may also infringe
competition law, for example where a supplier agrees to deal with only one distributor in a
particular territory, or where a distributor is required to purchase products exclusively from one
supplier, thereby foreclosing access to the market for other suppliers. However, agreements of this
kind also may have pro as well as anti-competitive effects and a detailed study of the market and
other relevant analysis is usually needed to determine whether the agreement is anti-competitive
in nature and by its effect.2

To sum up, and for an explicit definition, Vertical Agreements are those that arise in a channel of
distribution of firms at different levels of trade or industry i.e. between a manufacturer and
wholesaler, between a supplier and customer or between a licensor of technology and his licensee.
Examples of vertical restraints include nonlinear pricing, quantity forcing, full-line forcing, resale

1
William S. Comanor and H. E. Frech III, The Competitive Effects of Vertical Agreements: Reply, The American
Economic Review, Vol. 77, No. 5 (Dec., 1987), pp. 1069-1072
2
William S. Comanor and H. E. Frech III, The Competitive Effects of Vertical Agreements?, The American Economic
Review, Vol. 75, No. 3 (Jun., 1985), pp. 539-546

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price maintenance, territorial restrictions, exclusive dealing, partial exclusive dealing, tie-in sales,
refusal to deal, etc.

Vertical restrictions often contain:

Dealing Restrictions such as exclusive territories, selective distribution or exclusive

purchasing under which one firm undertakes not to deal with competitors, or certain
competitors, of the other;
Non-linear pricing like fixed per unit price;
Price restrictions such as reasonable price maintenance and recommendations of resale
price.

The dual nature of vertical agreements exists because they are mostly the result of complex
business negotiations. Agreement can therefore not be pushed into straight-jacket schemes, since
every agreement differs from one another as business relationships do. Therefore for competition
law purposes, classifications take place in form of components of vertical restraints. In practice,
many vertical agreements may use of more than one of these components. To give an example,
exclusive distribution is usually to limiting the number of buyers the supplier can sell to and at the
same time limiting the area where the buyers can be active. The first component may lead to the
foreclosure of other buyers while the second component may lead to price discrimination.

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 B. THEORIES ON VERTICAL RESTRAINTS

Keeping the aforementioned in mind different jurisdictional authorities have dealt with vertical
agreements in their own manner and right. The present study entails the approaches of authorities
regulating antitrust practices with regard to vertical agreements.3

In the academic debate, the position had swung from regarding vertical restraints as suspect for
competition to a generalised perception that they were innocuous for competition by the early
1980s. An argument in favour for this change was that economists were more cautious in their
assessment of vertical agreements and less willing to make sweeping generalisations. In general,
in economic theory two main schools of thought can be distinguished when dealing with vertical
restraints:4

The Chicago School has used neoclassical insights to argue in general that only a limited number
of cases concern antitrust laws. Researchers asserted that antitrust law mainly should address
horizontal arrangements and practices. For vertical arrangements, the Chicago School argued that
the occurrence of allegedly anti-competitive practices spells no efficiency loss and may in fact
even be pro-competitive. Therefore, the Chicago School denies the anti-competitive character of
vertical restraints and maintains that vertical restraints should be treated as completely lawful
agreements. According to this learning, vertical restraints are agreements between producers of
complementary goods or services rather than competing suppliers of substitutes. Suppliers of
such goods or services (complementary) have no interest in raising the price of a complementary
product because by definition it will decrease the demand for its own product. So if manufacturers
accept a vertical restraint, which limits retail competition, there must be some offsetting efficiency
justifications. This reasoning can also be related to the well-known discussion on inter-brand vs.
intra-brand competition. From a Chicago-type perspective, a well-functioning inter-brand
competition among producers can substitute intra-brand competition among retailers. However,

3
David Spector, Exclusive contracts and demand foreclosure, The RAND Journal of Economics, Vol. 42, No. 4
(Winter 2011), pp. 619-638
4
The Wider Concerns of Competition Law, Article 81 EC and Public Policy by Christopher Townley, Review by:
OKEOGHENE ODUDU, Oxford Journal of Legal Studies, Vol. 30, No. 3 (Autumn 2010), pp. 599-613

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recent literature on vertical foreclosure challenges the Chicago Schools friendly position on
vertical restraints.5

Modern European Economics: Despite the tremendous impact of the Chicago School, many
European (as well as Post-Chicago) scholars and practitioners of antitrust have restrictions about
specific Chicago School applications. Analyses did not support the view, argued by the Chicago
School in particular by Bork that all vertical restraints should be legal. Rather, recent analyses
argue for a more detailed investigation of the relevant issues. Critical voices often find Chicago
applications as unrealistic, divorced from observations in actual markets, and tending to obscure
the importance of dynamic considerations, asymmetric information, and strategic behaviour.
Others have balked at the normative commitment of the Chicago School to efficiency
considerations alone. In response to this critique, some scholars have been applying recent
economic insights to challenge the simplistic microeconomic learning of the Chicago School, even
while retaining its fundamental economic commitment to efficiency concerns. Vertical agreements
may contain certain restriction to competition that, in the absence of significant market power by
the companies involved, nevertheless generally improve production and distribution of the goods
and services concerned. However, such agreements can also have negative effects on the market,
in particular by partitioning markets or by foreclosing markets.6

5
Robert Lane, Competition Law, The International and Comparative Law Quarterly, Vol. 61, No. 4 (October 2012),
pp. 991-1005
6
Yannis Karagiannis, The lyse Treaty and European Integration Theory, German Politics & Society, Vol. 31, No.
1 (106), Special Issue: The lyse Treaty at Fifty (Spring 2013), pp. 48-69

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 C. EU JURISPRUDENCE: BLOCK EXEMPTIONS

Under Community Law, in general, the prevailing view is that the restrictions imposed in vertical
agreements (known as vertical restraints) are only liable to have significant anti-competitive
effects when they are engaged in by firms with market power. This approach, however, does not
apply to so-called hardcore restrictions, in particular resale price maintenance, which are liable to
infringe the Article 81(1) in most occurrences.

This evolution in Community Law has been brought about by the entry into force in 2000 of the
Vertical Agreements Block Exemption and Vertical Guidelines. The provisions therein allow
parties to use a broadly drawn out exemption under Article 81(3) which allows parties to
participate, with a certain degree of freedom to contract, in such agreements provided that hardcore
restrictions are avoided and the conditions set forth under the Block Exemption are respected.

The next step is to understand how Community Law deals with vertical agreements outside the
block exemption. In this regard, the Vertical Guidelines identify principles to be applied in
analyzing the application of Article 81(1) & (3). In doing so, the Vertical Guidelines also serve as
a tool to assess the risk of an individual agreement being found to restrict competition to an
appreciable extent as a result of the cumulative effect of similar vertical restraints applied by
competing suppliers.

The emphasis in the Vertical Guidelines is placed squarely on the economic principles that
determine whether an agreement should considered, overall, to be positive or negative for
competition. There is, for example, a substantial discussion of the specific types of efficiencies
that may be generated by the main types of vertical agreements, which is a key element in the
application of Article 81(3). The approach of the guidelines however blurs the distinction between
Articles 81(1) and 81(3).

It is often not possible to deduce whether a particular factor identified by the Commission suggests
that there is unlikely to be an appreciable restriction of competition under Article 81(1) or,
alternatively, whether the factor is only relevant in demonstrating the criteria for exemption under
Article 81(3) are met.

In addition to the Vertical Agreements Block Exemption and the Vertical Guidelines, the main
source of guidance is the case law of the European Courts and the past decisional practice of the

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Commission. The case law of the European Courts is relatively sparse in this field. At least outside
of territorial restrictions, single branding and selective distribution. In relying on the Vertical
Guidelines, it should be noted that they are not formally binding and they must be read subject to
such case law.

It has nevertheless been noted, the Commission by publishing guidelines intended to apply to
future cases, is bound by the principles of equal treatment and legitimate expectations. Thus, under
certain circumstances guidelines may produce legal effects. Also, CFI referred to the Vertical
Guidelines in its ruling in Treuhand v. Commission.

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 D. UNITED STATES: THE RULE OF REASON

By the late nineteenth century, the distribution of wealth in the United States had undergone a
dramatic shift and was largely centralised in the hands of a small number of corporations and
powerful individuals. It was feared that if economic power was concentrated in the hands of a
select few, additional concentration of market power would naturally occur, and would result in
trusts that would use their power to oppress individuals and injure the public. In order to preserve
competition and ensure that further concentration of wealth or power did not occur, Congress
passed the Sherman Antitrust Act in 1890.In passing the Sherman Act, Congress did not intend to
codify a comprehensive antitrust law, which provided judicial mandates that were set in stone.7

Rather, Congress intended to give the courts great power to interpret section 1 of the Sherman Act
by utilizing broad language to which the courts could give shape. Additionally, the very
language restraint of trade, adopted in Section 1, was intended to invoke the common law
tradition of antitrust jurisprudence, and not merely to codify a static meaning to which the common
law had arrived by 1890. Relying on these factors, the Supreme Court has recognized that the
general presumption that legislative changes should be left to Congress has less force with respect
to the Sherman Act...

This reasoning has allowed the Court to alter antitrust policy when it feels that the rationale
underlying a decision has been discredited, and to do so by giving far less weight to notions of
stare decisis than it would in other cases.

If read literally, the Sherman Act would make any agreement that re- strained trade illegal;
however, courts have read the Act as only banning agreements which unreasonably restrain
competition.

This is because every restraint on competition restricts trade, but sometimes even an agreement
limiting competition may be beneficial to society. Recognizing this fact, the Supreme Court in

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Susana Cabrera, Konstantin Jrgens, lvaro Gonzlez, Bruno L. Peixoto, Mark Katz, Elisa Kearney, Lorena Pavic,
Juan Coeymans, Mauricio Jaramillo, Luca Ojeda, Claire Webb, Ausra O. Pumputis, Paul Schoff, Jing Chua, Peter
Wang, Yizhe Zhang, Pallavi S. Shroff, Harman Singh Sandhu, Gunnar Wolf, Michael Clancy, Franois Brunet, Eric
Paroche, Susanne Zuehlke, Jan Philipp Komossa, Alberto Pera, Valentina Caticchio, Vassily Rudomino, Selin
Beceni, Stephen Kon, Gordon Christian, Jai Bhakar and Heather Irvine; International Antitrust, The International
Lawyer, Vol. 44, No. 1, International Legal Developments Year in Review: 2009 (SPRING 2010), pp. 45-69

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Standard Oil Co. v. United States proffered that analysis under the Sherman Act required the
exercise of judgment in each case and that such judgment should be con- ducted under the standard
of reason, or rule of reason.

Under the rule of reason, the fact-finder must analyze all the facts and circumstances surrounding
an alleged violation of the Sherman Act in deciding whether the conduct in question is an
unreasonable restraint on competition on a case-by-case basis. Information about the particular
business at issue, the restraints history, nature, and effect, and whether the business in question
has market power, are all important factors to consider in judging a practice under the rule of
reason. Weighing such elements allows a court to distinguish between restraints that have
anticompetitive effects and those which stimulate competition and are thus in the consumers best
interest.8

There are certain categories of business practices, however, which are conclusively presumed to
be unreasonable, and are thus judged to be illegal without a substantial inquiry into their effect or
the justification for their use in a particular case.

The fundamental difference between a per se rule and analysis under the rule of reason is that in
the case of per se rules, the Court singles out a few key facts and makes them legally determinative
of whether the practice violates the law. This is far different from analysis under the rule of reason,
which allows for an open-ended inquiry of the business practice in question.

However, analysis of the common law shows that the Supreme Courts definition of consumer
welfare stems less from what is the right definition of consumer welfare than it does from the
needs of society right now.

In 1911, the Supreme Court held that vertical price restraints were per se illegal in Dr. Miles
Medical Co. v. John D. Park & Sons Co. While vertical price restraints were the central restraint
at issue in Dr. Miles, the Court subsequently declared vertical non-price restraints per se illegal as
well. Over the course of the last century, the Court has slowly departed from the Dr. Miles rule in
a piecemeal fashion, striking down the use of a per se rule against vertical non-price restraints in
1977, and against vertical maximum price restraints in 1997. While both cases seriously eroded

8
Kendyl Hanks, Kate David and Stacy Nathanson, Supreme Court Update: Decisions from 2009, Business Law
Today, Vol. 19, No. 1 (September/October 2009), pp. 42-49

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the use of per se rules in judging vertical restraints, they also reiterated that vertical minimum price
restraints represented a unique anticompetitive evil and should remain per se illegal. In 2007, the
Court took up the issue of whether vertical minimum price restraints should continue to be held
per se illegal, or whether the practice should be subject to the rule of reason just as all other vertical
restraints. The Court held 5-4 to overturn Dr. Miles case and its per se rule of illegality against
vertical minimum price fixing, offering the final crushing blow to the use of per se rules in judging
vertical restraints. The primary rationale of the Court was that per se rules are only appropriate if
a practice will always or almost always be found to be anticompetitive if judged under the rule
of reason.9

Thus, as contemporary economic analysis had shown that vertical minimum price restraints may
have some pro-competitive uses, a per se rule of illegality is no longer appropriate.10

9
Barak D. Richman, The Antitrust of Reputation Mechanisms: Institutional Economics and Concerted Refusals to
Deal, Virginia Law Review, Vol. 95, No. 2 (Apr., 2009), pp. 325-387.
10
Alison C. McElroy and Philip Haleen, A Widening Gap? An Overview of U.S. and EU Antitrust Rules for
Franchisors, Franchise Law Journal, Vol. 29, No. 1 (SUMMER 2009), pp. 23-30, 57

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 E. INDIA: APPRECIABLE ADVERSE EFFECT

In India, Section 3 of the Competition Act, 2002, deals with anti-competitive agreements. It
prohibits any agreement with respect to production, supply, distribution, storage, and acquisition
or control of goods or services, which causes or is likely to cause, appreciable adverse effects on
competition within India. Any such agreement is considered void. Though the Act does not use
the words horizontal or vertical agreements, it treats certain kinds of horizontal agreements more
severely, by presuming them to have adverse effects on com- petition. According to 3(3),
agreements between parties (including cartels) that: (1) directly or indirectly determine purchase
or sales prices; (2) limit or control production, supply, markets, technical development, investment
or the provision of services; (3) share the market or source of production or provision of services
by way of allocation of the geographical area of the market, type of goods or services, or number
of customers in the market or any other similar way; and (4) directly or indirectly result in bid
rigging or collusive bidding are presumed to have appreciable adverse effects on competition.

Section 3(4) of the Act deals with vertical agreements. It lists, in particular, five types of vertical
agreements - tying, exclusive supply, exclusive distribution, refusal to deal, and resale price
maintenance, which would be in contravention of the Act, only if they cause or are likely to cause
appreciable adverse effects on competition in India. The term "appreciable adverse effect on
competition" used in Section 3 is not defined in the Act. The Act, however, specifies a number of
factors, which the Commission should take into account when determining whether an agreement
has an appreciable adverse effect on competition, including whether the agreement creates barriers
or forecloses competition by creating impediments to entry, or drives existing competitors out of
the market. The Commission should also take into account the possible pro-competitive effects of
an agreement, viz., benefits to consumers, improvements in the production or distribution of goods
or the provision of services, and the promotion of technical, scientific and economic development
by means of production or distribution of goods or provision of services. Thus, a balanced
assessment is required to be done of the beneficial and harmful effects on competition. This
balancing approach is similar to the 'rule of reason' that prevails in the US and therefore it is said
that in India vertical agreements are subject to the 'rule of reason' and are not presumed to have
adverse effects, as in the case of horizontal agreements The Indian Law on vertical restraints
suffers from several drawbacks.

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Firstly, in India, there are no separate rules governing any specific category of vertical agreement
and all of them are required to be tested for adverse effects under Section 19(3). All vertical
agreements cannot be evaluated by the same standard. For example, the US experience tells us that
in case of agreements like resale price maintenance proving benefits could be more difficult than
proving detriments. So, if we do not lay down standards for evaluating different kinds of vertical
agreements and decide to generally follow the rule of reason approach of the US, then the
Competition Commission of India would face problems similar to those being faced by the US
courts, i.e., a coherent application of the rule of reason to different kinds of vertical agreements.

Secondly, the Act also is similar to the EC law in the sense that it lays down criteria which are to
be taken into account for testing adverse effects. This adverse effects test, however, is an
incomplete adaptation of Art. 81(3) of the EC. The EC laws impose certain compulsory conditions
for exempting vertical agreements- they require that the agreement allow consumers to share in
the benefits, does not impose restrictions that are unnecessary to attaining the efficiency objective,
and does not substantially eliminate competition. All of these conditions are mandatory, whereas
those in the Act are merely permissive. This is dangerous and could create considerable
complications in future, when cases come up before the Competition Commission.

Thirdly, we do not have exemptions given to vertical agreements on the basis of threshold levels
(like the de minimis exemption, or block exemptions given in the EC) and all vertical
agreements are to be tested on the basis of 'adverse effects' on competition. This would create
unnecessary burden on the competition authority.

Further, any effects based test at the outset, would face the problem of precise market definition.
Market definition by itself and subsequent testing for adverse effects is no easy task and requires
complicated economic analysis. To add to the irony, the term 'relevant market' finds no place in
Section 3 of the Act.

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 CONCLUSION

In this regard, the different approaches to tackling vertical agreements, and the legitimacy thereof,
suggests the stage of development each respective jurisdiction has reached. The United States
antitrust mechanism, evolving from the concept of rule of law and drawing parallels from common
law practices, entails a strong role of the courts of law, by conferring upon them not only a wide
spectrum of authority in deciding the legality of vertical agreements but also leaving it up to the
higher judicature to decide even on the applicability of rules and tests as well as the standards by
which the nature of restraint inducing trade agreements are concerned. In the European Union,
influenced also by the civil law model of governance, more force remains with its Committees,
Resolutions, and the like, while the concerned Courts remain obliged to such instruments. In India,
owing the auspices of MRTP, a liberal approach towards vertical agreements is retained.

Notwithstanding so, Indian competition law practices suggests the strong influence of foreign
jurisprudence on this matter. The legitimacy of such agreements remains to be seen in the light of
its economic advantages and disadvantages, which is normally done by invoking the public policy
doctrine.

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 REFERENCES

Phillip A.E., & Hovenkamp, H., 2007, Fundamentals of Antitrust Law, Wolters Kluwer,
3rd Edition.
Hidebrand, D., 2005, Economic Analyses of Vertical Agreements A Self-Assessment,
Kluwer Law International.
Taylor, M., International Competition Law A New Dimension for the WTO?, Cambridge
University Press, Reprint 2008.
Ramappa, T., 2012, Competition Law in India Policy, Issues and Developments, Oxford
University Press.
Faull & Nikpay, 2007, The EC Law of Competition, Oxford University Press. 2nd Edition.
Dhall, V., 2007, Competition Law Today, Concepts, Issues and the Law in Practice; Oxford
University Press.
Van Bael & Bellis, 2007, Competition Law of the European Community, Kluwer Law
International, 5th Edition.

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