Hamilton Pratt

Competition Law

Introduction

The two competition laws which have the most direct effect on franchising are:-

a)  the Competition Act 1998, and

b) Article 81 of the EC Treaty

The Competition Act 1998 (the Act) came into force on 1 March 2000.  Until that time, pre-existing UK legislation (primarily the Restrictive Trade Practices Act) remained in force, but in modified form.

The Competition Act 1998

The Act seeks to bring UK law into line with EC law, so;

a) agreements which affect trade in a substantial part of the UK (which may, in fact, be quite small); and

b) which contain provisions which may prevent, restrict or distort competition are prohibited unless exempt.

Franchise agreements, which normally lay down restrictions on the franchisor (eg: not to grant a franchise in a franchisee's territory) and the franchisee (eg: the products he may sell in the franchise) are capable of coming within the prohibition.

The UK authorities issued a statutory instrument excluding Vertical Agreements (which includes franchise agreements) from the prohibition in the Act but the statutory instrument is being repealed.  However, agreements which comply with the EC Regulation on Vertical Agreements (as to which see paragraph 8.07) will benefit from a 'parallel exemption' from the prohibition in the UK Act.  Most franchisors will not have any difficulty with complying with the EC Regulations.

The Office of Fair Trading has also indicated that agreements where the parties have a combined market share of less than 25% are unlikely to have a significant effect on competition, and therefore are unlikely to be investigated.  The majority of franchise agreements, will fall outside the scope of the Competition Act because either they will comply with the EC block exemption or the parties will have less than 25% of the relevant market.

Article 81 of the EC Treaty

Article 81 of the EC Treaty may regulate franchise agreements if the agreement:-

  • affects trade between member states of the EC and
  • has as its object or effect the prevention, restriction or distortion of competition within the Common Market.

On the face of it most franchise agreements are unlikely to affect trade between  Member States because they are almost invariably between undertakings in the same Member State, do not relate to exports or imports and cover only a small  part of the territory of one Member State.  However, the European Court has held that if an agreement is capable of appreciably affecting patterns of trade and competition in the EC the fact that the parties to an agreement are situated in one Member State or the anti-competitive conduct takes place in one Member State, is irrelevant.   Indeed, specifically in relation to franchise  agreements,  the  European  Court has held that  if  the  agreement prevents a  franchisee  from  setting up in business,  or  from supplying franchisees,  in other Member States then Article 81 is likely to apply.   If Article 81 applies to an agreement the prohibited restrictions are unenforceable and parties to the agreement are subject to fines unless the agreement has been exempted.

The European Commission has published a block exemption for "vertical agreements". This Regulation exempts franchise agreements provided they do not contain any of the prohibited restrictions which the Regulation lists but where a franchisor's market share exceeds 30%, the franchise agreement cannot be exempted by the Regulation.  The prohibited restrictions for the purposes of the Regulations are those relating to resale price maintenance, restrictive covenants, prohibitions on sales outside a franchisee's territory or allocated customers and non-compete obligations.  If a franchise agreement contains prohibited restrictions it will not be exempted.

In addition the Commission has published a Notice which sets out the criteria.

The Notice sets out the quantative criteria for assessing whether there will be an appreciable effect on trade between Member States or on competition and as a result the Commission takes the view that “as a general rule” it will not open proceedings in cases covered by the Notice.  This does not mean that the Notice has the same effect as a block exemption, and indeed the Commission recognises that agreements which are covered by the Notice may nevertheless fall under Article 81(1), but in such cases the Commission will not impose fines and there is no need to notify agreements which fall within the Notice.  The Notice of Agreements of Minor Importance sets out the criteria for assessing whether an agreement is of minor importance as follows:

(a) the undertakings party to the agreement must be undertakings engaged in the production of distribution of goods or in the provision of services generally;
(b) the goods or services which are the subject of the agreement together with other goods or services provided by the contracting parties “which are considered by users to be equivalent in view of their characteristics price and intended use” do not represent more than 10 per cent of the total market for such goods or services in the area of the Common Market affected by the agreement.

The above market share requirements can be exceeded by “no more than one-tenth during two successive financial years” for the Notice to continue to apply.

For the purposes of calculating market shares, the respective market shares of not only the undertakings who are party to the agreement, but also undertakings which the parties directly or indirectly control and undertakings which directly or indirectly control the parties to the agreement, must be taken into consideration.

Further the Notice provides that small and medium sized undertakings (those with less than 250 employees and an annual turnover and a balance sheet value of less than 50 million and 43 million Euros respectively) are unlikely to be regulated by Article 81 because their agreements are unlikely to have an appreciable effect on trade between Member States.

Whilst many franchise networks will fall within the Notice the difficulty with relying on the Notice on agreements of minor importance is that it is difficult to define with certainty the relevant market by which market shares are to be calculated and, of course, market shares can increase during the term of a franchise.