This article is written by Aarchie pursuing a Certificate Course in Competition Law, Practice And Enforcement from lawsikho.com.
The Competition Act comprises a non-exhaustive list of vertical agreements that may be only prohibited upon an investigation of the CCI that they cause or can probably cause, an appreciable adverse effect on competition (AAEC) in India. The types of vertical restraint identified in the Competition Act include exclusive supply agreement, tie-in arrangements, exclusive distribution agreement, resale price maintenance & refusal to deal. Our point of discussion here will pertain to the exclusive agreements only.
What are exclusive agreements?
An exclusive agreement is an agreement between two or more two parties for the purchase of goods exclusively from the prescribed seller in the agreement. The main component of an exclusivity agreement is the understanding that the buyer will not purchase the goods, provided by anyone else other than the seller for the specified time period of the agreement. Hence, it dictates that the seller is the exclusive supplier of the specified goods to the buyer. This agreement generally happens in a vertical seller/buyer relationship where a buyer consents to buy exclusively from the seller. Competition law takes into consideration the two broad categories of exclusive agreements, i.e.,
(a) Exclusive Distribution Agreements; and
(b) Exclusive Supply Agreements.
Exclusive distribution agreement
An exclusive distribution agreement is defined under Section 3(4)(c) of the Act as an agreement that restricts, limits, or withholds the supply or output of any goods or designates any area or market for the sale or disposal of goods. An exclusive distribution agreement operates as a restriction on the seller. An exclusive distribution agreement can also be identified either as a territorial restriction, where the seller agrees to sell his products only to one distributor in a particular group of consumers or in a particular territory. This is quite prominent in the pharmaceutical sector where chemists are exclusively appointed for institutionalised sales to large buyers like hospitals etc.
Moreover, exclusive distribution agreements operate as agreements providing for an exclusive channel/medium for distribution of goods/sales, e.g., either online or offline. Exclusive Supply Agreements as defined under Section 3(4)(c) of the Competition Act, 2002 (“Act”). These agreements restrict the purchaser from dealing with goods or purchasing goods other than those of the seller. These agreements are a kind of restriction on the seller. They are referred to as ‘single branding’ agreements or ‘quantity forcing’ arrangements. Exclusive Supply Agreements can be of both types: de jure and de facto.
- A de jure exclusive supply agreement operates as a direct restriction on the buyer from buying goods from a competing source.
- A de facto exclusive supply agreement is one where the seller manipulates the covenants of the contract in such a way that the buyer is influenced to concentrate all its requirements from a single seller.
Assessment of exclusive agreements
The prohibition on vertical restraints is applicable to “enterprises”, including those entities which perform non-sovereign economic functions. Sovereign functions of the government include activities undertaken by the government dealing with currency, atomic energy, space, and defence, etc. In other words, if a government entity is engaged in some activity of economic nature, its conduct would be subject to inspection under the Act. The CCI can also assume its jurisdiction for enterprises operating outside the territory of India as long as the anti-competitive effect of the agreements entered into by these enterprises can be seen in India as was done in the Intel Corporation case (Case no. 5 of 2019).
The CCI on recognizing the existence of either the exclusive supply or the exclusive distribution agreement is required to measure the probable pro-competitive benefits against the possible anticompetitive harm arising from a vertical restriction. The likely anticompetitive harms that the CCI may examine under Section 19(3) of the Act include:
- creation of barriers for new entrants in the market
- driving existing competitors out of the market; and
- foreclosure of competition by creating barriers against entry into the market.
The factors aggravating competition that the CCI is likely to examine, under the same section, if they offset the anti-competitive harm arising out of a vertical restraint include:
- accrual of benefits to consumers;
- improvements of production or distribution of goods or provision of services; and
- promotion of economic, scientific, and technical development by means of production or distribution of goods or services.
Further, exclusive agreements may be examined both under Section 3(4) as well as Section 4 of the Competition Act. A group or an enterprise is prevented from abusing its dominant position under Section 4(1). A dominant position is nothing but the possession of sufficient market power, which makes a firm competent enough to
(i) work independently of the competitive forces prevailing in the particular relevant market; or,
(ii) influence its consumers or competitors or the relevant market in its favor.
Market Power is not defined under the Act. However, dominant position or substantial market power is determined by taking into consideration factors such as size, market share, resources, economic power, the importance of competitors, vertical integration, commercial advantages, entry barriers, market structure, consumer dependence, and market size.
These factors are considered by the CCI for assessing the market power as under Section 3(4) of the Competition Act. In its judgments, the CCI has considered factors such as duration of the agreement, entry barriers, market share, the structure of the market, etc. while determining market power for assessment of agreements under Section 3(4) of the Act.
Demonstration of anti-competitive effects
- A dominant enterprise imposing exclusive agreements may amount to a direct violation under Section 4(2)(a)(ii) and Section 4(2)(c) read with Section 4(1) of the Act, assuming that the exclusivity is not justified. Therefore, sometimes there might be no obligation to demarcate anti-competitive effects.
- On the other hand, agreements under Section 3(4) are anti-competitive only if they cause an appreciable adverse effect on competition in India as under Section 19(3) of the Act. The CCI is required to demonstrate the anti-competitive effects arising out of an agreement as mentioned above.
- However, it has been seen from the CCI’s previous judgments that the scrutinization of anti-competitive effects as under Section 19(3) of the Act is most of the time a theoretical exercise instead of an empirical one. The primary theory adjudging the harm caused by exclusive supply agreements is that it may result in foreclosure of the market for potential suppliers & competing suppliers.
- This market foreclosure may, as well, have an adverse impact on the inter-brand competition.
- The foreclosure theory for exclusive dealership agreements states that an upstream manufacturer with market power might use such exclusive dealing restrictions to prevent a new entrant from having access to the vital input of a distribution network, which would ultimately deny entry to these entrants, and allow the incumbent player to keep raising his market share.
- Exclusive dealership agreements can also foreclose competition at the distributor level.
- Apart from foreclosure, such exclusive dealing restraints can also have various other anti-competitive effects such as:
- Soften the inter-brand competition;
- Soften the intra-brand competition;
- The commitment problem-this problem is faced by a monopolist in order to prove his commitment to a dealer – for example by offering secret discounts, etc.
Consideration of pro-competitive effects/justifications
Some competition enhancing justifications that the Competition Commission of India may take into consideration in the cases of exclusive supply agreements include instances where the supplier has made buyer-specific investments to serve the interests of a particular buyer, or where the buyer is offered a discounted price in return for a commitment to off-take a specific quantity, etc.
The procompetitive justifications that the Competition Commission of India might consider in the situation of exclusive distribution agreements include:
(i) Protection of brand image (Ashish Ahuja case [Case No.17 of 2014]),
(ii) Prevention of “free-riding”- wherein any distributor/dealer can unfairly take advantage of the efforts for promotion undertaken by another dealer, etc.
In conclusion, it is observed that there is no universal formula for assessing exclusive agreements under the Competition Act. Each assessment is processed by the Competition Commission of India on a case-to-case basis whilst paying due cognizance to a bunch of factors including, any economic justifications that the parties may have, the competition enhancing effects arising out of the agreements, and the market power of the parties concerned. Contingent on the market position the parties hold, the Competition Commission of India can examine them either under the provisions concerned with vertical agreements or with those concerned about the abuse of dominant position or both. Vertical agreements under Section 3(4) of the Competition Act are not prima facie/per se anti-competitive. They are anti-competitive only if they cause an appreciable adverse effect on competition (AAEC). As per the Competition Commission of India’s (“CCI”) judgments, vertical agreements create an appreciable adverse effect on competition only if the firm posing such vertical restriction possesses the adequate market power to foreclose competition. Thus, exclusive agreements can be said to be anti-competitive in certain situations under Section 3(4) or Section 4 of the Competition Act or both, only when the parties in question have significant market power.
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