This article has been written by Sakshi Deo pursuing the Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from LawSikho.
Restraints are divided into two categories in competition law: horizontal and vertical. Horizontal agreements are made between companies that compete on the same level in the market. Vertical agreements are those involving companies that have a supply connection. Vertical agreements exist between companies that operate at distinct stages of the manufacturing process. Before a product reaches a client, it goes through a production chain that includes obtaining raw materials, processing, making the final product, distributing and selling the product, and so on. As a result, vertical agreements are an important part of business and, in some ways, a replacement for vertical integration. Vertical restrictions have a mixed influence on the competitive process and must be assessed based on their appropriateness.
Vertical restraints are agreements between companies or organizations at various stages of the manufacturing and distribution process that restrict competition. Price restraints, such as price maintenance and price discrimination, and non-price restraints, such as refusals to deal, exclusive dealing, tie arrangements, market-access arrangements, and consignment selling, are examples of vertical restraints. A vertical constraint occurs when a soft drink manufacturer enters into an exclusive agreement with a university, barring the university from selling any competing soft drink on campus.
Vertical constraints are conditions that a company imposes on its distributors or retail dealers in general. Resale price maintenance, in which a retailer is prohibited from selling below the manufacturer’s suggested retail price; territorial allocation, in which a distributor is required to limit its sales efforts to a specific geographic area; and exclusive dealing, in which a distributor or retailer is prohibited from carrying the products of a competing manufacturer are some of the prime examples of vertical restraints. Vertical restraints can be divided into a variety of categories. In the first, referred to as “exclusionary vertical constraints,” competitors may be denied access to desired wholesale or retail venues. Competing manufacturers are denied access if a particular group of distributors or retailers chooses to deal exclusively with a single manufacturer, forcing them to seek alternate distribution or retail channels or build their own. At the distributor or retail level, the second type of vertical constraint has an immediate impact on intraband rivalry. The manufacturer controls competition among its own wholesale or retail dealers in one way or another, for example, by requiring them to operate within their allotted (sometimes exclusively assigned) territory or by imposing a minimum retail price. The initial impact, as stated, is limited to intrabrand competition. Vertical restrictions benefit customers rather than harm them by stimulating the formation and development of efficient product distribution streams from manufacturer or distributor to consumer; streams that can lower consumer prices but would be jeopardized if leached onto by competitors.
How does it work?
Vertical restraints have an impact on market competitiveness only when the firm applying the restraint already has market dominance. Because competition from other businesses’ products (inter-brand competition) is limited in such instances, it is preferable to have enough competition among distributors and retailers of the firm’s products. If, on the other hand, the firm implementing the vertical restraint has considerable power in the market or if there is sufficient inter-brand rivalry, the restriction on the rivalry between distributors and retailers of the same brand (intra brand competition) may have little effect on the market.
The CCI, short for the Competition Commission of India, governs the laws that regulate vertical agreements and dominant firm behavior. The Director-General, the CCI’s investigative arm, assists the CCI (DG). Moreover, sector-specific regulatory authorities (such as the Telecom Regulatory Authority of India (TRAI) established under the Telecom Regulatory Authority of India Act, 1997, and the Petroleum and Natural Gas Regulatory Board established under the Petroleum and Natural Gas Regulatory Board Act, 2006 are empowered to encourage and sustain competition in their respective sectors, including anticompetitive conduct by businesses operating in those sectors.
Types of vertical agreements
Vertical agreements are governed under the Competition Act of 2002 (hereafter referred to as the Act). The Act lists the following types of vertical barriers that are prohibited only if the CCI can prove that they cause, or are likely to produce, a substantial adverse effect on competition (AAEC) in India, despite being an exhaustive list:
- Tie-in arrangements: Exclusive supply agreements that prevent the customer from acquiring or dealing with the seller’s or anybody else’s goods in any way;
- An exclusive distribution contract that limits, or withholds the supply of goods, or allocates regions or markets for scrapping or sale of goods.
- Refusal to deal, which restricts or is likely to restrict the person or persons from or to whom products are purchased and sold; and
- Resale price maintenance (RPM): any agreement in which products are sold on the premise that the resale price will be the seller’s price unless it is expressly stated that prices lower than those prices will be charged.
While several sector-specific regulators in India implement laws aimed at promoting competition in their respective industries, the CCI’s powers are in addition to, not in place of, other statutory regulators.
Under Section 3 of the Competition Act 2002, any agreement that has or is likely to have an appreciable adverse effect on competition (“AAEC”) in India is considered anti-competitive. Any agreement that “causes or is likely to cause an appreciable adverse effect on competition inside India” in the manufacture, supply, distribution, storage, or acquisition or control of products or services is prohibited under Section 3 (1) of the Act.
Section 19 (3) of the Act specifies certain factors for determining AAEC under Section 3:
- Creation of barriers to new entrants in the market;
- Driving existing competitors out of the market;
- Foreclosure of competition by hindering entry into the market;
- Accrual of benefits to consumers;
- Improvements in production or distribution of goods or provision of services;
- Promotion of technical, scientific and economic development by means of production or distribution of goods or provision of services.
Although the Act does not particularly identify either horizontal or vertical agreements, the text of Sections 3 (3) and 3 (4) makes it obvious that the former is directed at horizontal agreements and the latter is aimed at vertical agreements.
Any agreement in violation of Section 3(4) of the Act between enterprises or persons at different stages or levels of the production chain in different markets in respect of production, supply, distribution, storage, sale or price of, or trade-in goods or provision of services, including (a) tie-in arrangement; (b) exclusive supply agreement; (c) refusal to deal; (d) resale price maintenance, shall not be considered a valid agreement. As can be shown, these agreements are not anti-competitive. Only if these agreements cause or are likely to cause an AAEC in India would they violate Section 3(1) of the Act. Vertical agreements relating to operations referred to in Section 3(4) of the Act, on the other hand, must be assessed under the Act’s rule of reason analysis. In other words, vertical agreements would be seen as anti-competitive (agreements that prevent competition) only if their execution results in or is likely to result in an appreciable adverse effect on competition (AAEC) in India and such agreements would be invalid as any agreement that results in an AAEC is prohibited. Thus vertical agreements are valid agreements as long as they do not result in an AAEC. The Act’s operative provision dealing with abuse of dominating position is Section 4 of the Act. Section 4 makes it illegal for any company to take advantage of its dominant position. The term “dominant position” is defined in the Act as “a position of strength enjoyed by an enterprise in the relevant market in India that allows it to operate independently of competitive forces prevailing in the relevant market; or affect its competitors, consumers, or the relevant market in its favor.”
In the case of Akhil R Bhansali v Skoda Auto India Pvt Ltd, it was observed that with the greater goal of encouraging and maintaining market competition, the Competition Act tries to restrict vertical restraints that create or are likely to cause an AAEC in India. In order to ascertain if a vertical agreement would result in an AAEC, the CCI is also likely to consider the impact on consumers’ interests.
In the case of Shri Shamsher Kataria VS. Honda Siel Cars India Ltd., the CCI observed that an agreement in its entirety should not completely eradicate competition and the benefits gained out of the short-termed efficiency of the agreement should not be overshadowed by the long term losses as a result of the eradication of competition.
In conclusion, the question of whether vertical constraints are anti-competitive is still being contested. The limits can be justifiable in many cases. When a distributor is forced to invest in promotion, he/she will almost certainly seek protection from “free-riders” who could profit from their expenses by selling the same product for less. The exclusivity may be granted over a specified territory or consumer group, or a resale price may be imposed. Economic theories support the view that if inter-brand competition exists, then restrictions on intra brand competition through vertical restraints should not be capable of restricting competition, and the efficiency-enhancing effects of vertical agreements would outweigh any possible risks. As a result, vertical agreements are an important aspect of any business and, in some ways, a surrogate for vertical integration. Vertical constraints have a conflicting impact on the competitive process, and their appropriateness must be evaluated. Vertical agreements, on the other hand, have some negative consequences, including the eviction of other suppliers or buyers by raising entry barriers, the reduction of inter-brand competition, the reduction of intra-brand competition among distributors of the same brand, and the creation of market integration barriers. Vertical agreements, depending on the conditions, can be advantageous or destructive to competition.
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