Competition law guidance on designing and implementing selective distribution schemes

The Competition Appeal Tribunal (CAT) has provided guidance on the application of competition law to selective distribution arrangements in Up and Running (UK) Limited v Deckers UK Limited. This is the second recent example of a standalone claim for damages in the CAT relating to distribution agreements (the parties reached a settlement in the other case, which raised the issue of minimum advertised pricing). 

The CMA has also been active in this area, having recently updated its rules and guidance on vertical agreements (including, for example, changes to the rules on online sales restrictions and most-favoured nation clauses) and carried out a string of investigations in this area. Most recently the CMA has imposed fines in relation to anti-competitive pricing restrictions in agreements for the supply of Leicester City FC-branded products and domestic lighting products. The European Commission has also pursued cases in this area, for example fining Guess EUR 40 million for restricting resale pricing, online sales and cross-border trade.  

Background

The dispute in this case arose from Deckers’ decision to cease to supply a retailer which was selling its residual stock on a clearance website which had not been approved by Deckers. The CAT considered that Deckers was operating a two-channel distribution strategy:  a main retail channel for seasonal product, and a clearance channel for out of season stock. Some of the details of the selective distribution system were set out in the terms and conditions governing the contract between Deckers and its retailers, although the Tribunal held that it was difficult to “tease out” the criteria for the selection of retailers from this and the other documentary evidence available. The CAT described Deckers’ distribution policy as “incomplete and flawed in its design and operation” and considered that the termination of the retailer’s account under that policy arose from an anti-competitive agreement ‘by object’, which restricted internet sales and prevented discounting on a clearance basis.  

‘Safe harbour’ for purely qualitative selective distribution schemes  

The Tribunal considered that Deckers’ distribution scheme lacked “any meaningful criteria” and provided Deckers with “discretion which [was] exercised without any objectivity or transparency and [was] largely unaccountable, thereby leading to inconsistent and discriminatory outcomes”. Deckers could not therefore benefit from the competition law safe harbour established in Case C-26/76 Metro v Commission for selective distribution systems in which: (i) resellers are chosen on the basis of objective criteria of a qualitative nature; (ii) the criteria are laid down uniformly for all potential resellers and not applied in a discriminatory fashion; (iii) the characteristics of the product justify selective distribution; and (iv) the criteria are proportionate (i.e. do not go beyond what is necessary). 

The CAT’s judgment provides guidance for the design and operation of selective distribution systems more generally. In particular, to benefit from the competition law safe harbour, the criteria for selecting retailers: 

• should be properly recorded (e.g. written down); 
• should not include any quantitative considerations (e.g. not based on the number of existing retailers in a given geographical location); 
• should be objective by avoiding broad requirements that allow for the exercise of individual judgments (e.g. by account managers); 
• should not prevent access to certain sales channels altogether (e.g. a clearance sales channel); 
• should be transparent or visible to existing and potential retailers, and any retailer refused entry to the scheme should be given the reasons for its failure to meet the criteria; and 
• should be applied uniformly to all existing and potential retailers. 

The CAT did not need to consider the other requirements of the Metro criteria but did reach the tentative view that it is possible that a specialised running shoe would justify the protection afforded by the safe harbour, on the basis of the technical aspects of the shoe and differing consumer needs. 

Requirements for prior approval of websites may not be justified if they give the supplier broad discretion 

The CAT considered that the requirement for prior approval of retailer websites by Deckers under its terms and conditions was not justified as it effectively gave Deckers a veto over any online sales initiatives. The clause in question stated: 

“Retailer may only sell Products on a website it owns and/or operates if Retailer has been granted permission to make on-line sales of Products and the website is fully compliant with the Company’s website requirements as are communicated from time to time by the Company, and the contents of the website have been approved in writing by the Company.” 

The Tribunal noted that there was no further guidance given and no criteria formulated, let alone published, to indicate the basis on which Deckers would approve any website with a different name from any bricks and mortar store. These provisions therefore gave Deckers a very wide discretion to make decisions permitting or not permitting online sales, without any accountability for the reasons for those decisions. 

Distribution systems for clearance channels must be carefully formulated  

The CAT found that in this case there appeared to be no criteria for choosing retailers who are admitted to the clearance channel and that Deckers seemed to have decided that it did not wish to admit further retailers into that channel. The Tribunal considered that this was not driven by a concern with the protection of brand image (particularly as Deckers itself was making such clearance sales) but instead was a means by which Deckers could control online sales of residual stock for its own benefit and limit the ability of third-party retailers to sell products in the clearance channel and engage in aggressive discounting. 

It is of course legitimate for a supplier that is genuinely concerned about the brand image of its products to design its distribution system to ensure that clearance sales do not undermine its overall strategy. However, this must be done carefully to ensure that any limitations on entry into a specialised channel are proportionate and justified by the concerns of brand protection.  

Document preservation in a litigation/investigation context 

The CAT was also critical of the unreasonable delay by Deckers in taking steps to preserve documents in light of the litigation. In particular, the Tribunal considered that Deckers’ in-house legal counsel should have required employees to preserve documents much earlier, particularly given that it operated a document retention policy which automatically deleted documents after one year (unless the document was saved in a protected space).  For example, the Tribunal considered that steps should have been taken when there was a credible threat of litigation by the retailer sending an email stating “I am putting you on notice that I shall pursue Deckers through all legal channel” and it was at least arguable that this was the case earlier when the retailer threatened legal action in a text message and wrote that he “welcomed a legal battle”. 

This is another reminder for companies to consider carefully their document preservation policies, in the light of both the possibility of litigation and regulatory intervention. In the context of possible investigations by the UK competition authorities, a new duty to preserve documents will be imposed on businesses when the Digital Markets Competition and Consumers Act comes into force at the end of this year, requiring the preservation of documents where a person “knows or suspects that an investigation is, or is likely to be, carried out by the CMA”.