Judicial Trends on Exclusive Territorial Agreements in Vertical Restraints: Case-Based Examination of AAEC

ABSTRACT

Exclusive territorial agreements adversely affect the competition in the market, as well as the market entry in certain cases. This research article examines the evolving judicial trends on exclusive territorial agreements in vertical restraints, focussing on judgments given by the Competition Commission of India (hereinafter called as ‘CCI’). Through a case-based analysis, this paper delves into how CCI has interpreted these agreements especially under Section 3(4) of Competition Act, 2002 (hereinafter called as ‘the Act’) to examine their impact on creating an Appreciable Adverse Effect on Competition (hereinafter called as ‘AAEC’). In this paper, the landmark cases of CCI, like JSW Paints case and others, highlights how exclusive territorial restrictions imposed by manufacturers on distributors/dealers can foreclose market access, lead to price rigidity and limit intra-brand competition. Judicial authorities consider balancing both anti-competitive effects and potential efficiency justifications. This paper aims to provide a clear apprehension of the vertical agreements and their further implications of maintaining competitive market structures in India.

KEYWORDS

Exclusive Territorial Agreements, Vertical Restraints, Competition Law, Appreciable Adverse Effect on Competition (AAEC), Section 3(4) of the Competition Act, Market Foreclosure, Anti-competitive Agreements, Competition Commission of India (CCI), Exclusive Distributorship

INTRODUCTION

Under the Act, exclusive territorial agreements are a form of vertical restraint, wherein a manufacturer restricts a distributor/dealer’s purchase/sale within a specified geographic area. These distributors/dealers are also prevented from selling outside this particular specific geographic area. They are considered as ‘Vertical Agreements’ because they occur between businesses/enterprises operating at different stages of distribution chain/production. These vertical agreements are governed under Section 3(4) of the Act, which includes other arrangements like tie-in agreements, refusal to deal, resale price maintenance, etc. The CCI is established under Section 7 of the Act. It is the regulatory body responsible to prevent anti-competitiveness, ensure freedom of trade, promote consumer rights and promote fair competition practices in India. An exclusive territorial agreement can raise concerns under Section 3(1) read with Section 3(4) of the Act, if in the relevant market it causes AAEC. AAEC is used to describe agreements that harm competition in India, as it has a negative impact on market competition. Factors like barriers to entry, driving out competitors, foreclosure, consumer impact, etc are considered when the CCI determines if an agreement harms competition or not, as mentioned under Section 19(3) of the Act.

VERTICAL AGREEMENTS UNDER SECTION 3(4) OF COMPETITION ACT, 2002

Section 3(4) of the Act talks about anti-competitive agreements between individuals or enterprises operating at different levels of production/distribution chain, known as ‘Vertical Agreements.’ These agreements relate to activities such as production, supply, distribution, storage, sale, pricing, or trade of goods and services. Only certain agreements which are likely to cause AAEC in India are prohibited. Not all vertical agreements are automatically considered anti-competitive. They are evaluated based on their potential ability to actually affect the competition in the market. The provision identifies the following types of restrictive vertical arrangements:

Tie-in Arrangement – It is also called a ‘tying contract’, wherein the seller sells a product on a condition of buying another product.
Exclusive Dealing Agreement – It is a contract wherein one party agrees to buy all or some of the goods and services exclusively from one party and prohibits from doing business with other competitors.
Exclusive Distribution Agreement – It is a contract between a supplier and a distributor giving the distributor the exclusive rights to sell the supplier’s products in a particular geographical area.
Refusal to Deal – It is an agreement between two or more companies to not do business with a particular third party, essentially boycotting them.
Resale Price Maintenance – It is a contract between a manufacturer and a retailer wherein, they agree to sell a product, not below the fixed or minimum price value.

EXCLUSIVE TERRITORIAL AGREEMENTS UNDER THE COMPETITION ACT, 2002

Exclusive territorial Agreements are a form of vertical restraints wherein a supplier restricts a distributor’s sales to a specific geographical area. This prevents the distributor from selling outside the assigned territory, limiting intra-brand competition. These agreements are assessed under Section 3(4) of the Act, which may cause AAEC in the market. Such agreements are not per se illegal, but, if they harm the competition by creating monopolistic market conditions or excluding competitors, then they will be considered as illegal.

Illustration 1: A car manufacturer, XYZ Motors, appoints ABC Dealers (P). Ltd. as its exclusive distributor for South India, restricting it from selling cars outside this specified region. Simultaneously, DEF Dealers Pvt. Ltd. is assigned as the exclusive distributor for North India with a similar prohibition. If in case, a customer in North India wants to purchase a car model that is only available with ABC Dealers in South India, then, they are unable to do so. This restriction reduces consumer choice and intra-brand competition, ultimately violating Section 3(4) of the Competition Act if it results in AAEC.

Illustration 2: A pharmaceutical company, Medi Care Pharmaceuticals, enters into an exclusive territorial agreement with Distributor P for Maharashtra and Distributor Q for Gujarat. These distributors are not allowed to supply medicines outside their designated territories. If a hospital in Gujarat needs a life-saving drug immediately, but Distributor Q is out of stock, it cannot procure the drug from Distributor P in Maharashtra. This restriction may result in denial of access to essential medicines, raising anti-competitive concerns under Section 3(4) of the Act.

EXCEPTIONS TO ANTI-COMPETITIVE AGREEMENTS AND ABUSE OF DOMINANT POSITION

The exceptions to prohibition on anti-competitive agreements are provided in Section 3(5) of the Act. It allows any person to impose reasonable conditions to protect their intellectual property rights under laws like Copyright Act, 1957, Patents Act, 1970, Trade Marks Act, 1999, Designs Act, 2000, and others. Agreements solely for exporting goods/services from India, as such agreements which do not affect domestic competition. Section 4 prohibits the abuse of a dominant position by an enterprise. Dominant position allows a business entity to act independently of its consumers and competitors. It is illegal to abuse that power, but not illegal to have a dominant position. Abuse of dominant position occurs when the power is misused to deny market access, impose unfair terms, discriminatory pricing, or force unnecessary obligations on other parties. It also includes using dominance of one market to gain an unfair advantage of another.

PRECEDENTS
JSW PAINTS PVT. LTD. v. ASIAN PAINTS LTD. (2019)

JSW Paints alleged that Asian Paints used to prevent dealers from partnering with other dealers in Bengaluru, Hubli, Kochi and Kozhikode. They were threatened with supply cuts, denial of discounts and removal from loyalty programs if they associated with JSW Paints. This allegedly resulted in exclusive supply agreements and refusal to deal violating Section 3(4) read with Section 3(1) of the Act. Factors which the Commission investigated while determining Section 4 (Abuse of Dominant Position) of the Act is violated or not:

DELINEATION OF RELEVANT MARKET: ‘Relevant Market’ consists of ‘Relevant Product Market’ (RPM) and ‘Relevant Geographic Market’ (RGM). The RPM is defined under Section 2(t) of the Act, meaning, ‘a market comprising all those products or services as inter-changeable or substitutable by the consumer, by reason of characteristics of the products or services, their prices and intended use’. A common test used to identify a Relevant Market is the Significant and Non-Transitory Increase in Price (SSNIP) Test, which examines whether consumers would switch to other suppliers if the price of a product or service increases by a small but significant amount.

Factors defining an RPM are:

Definition of product or service
Identifies potential competitors
Demand-side Interchangeability or Substitutionality of the product (Demand-side substitution is when consumers switch to a different product when the price of the original product increases)
Prices
Intended end-use

Factors defining an RGM are:

Contours with regard to territory within which the conditions of competition for supply of goods or provision of services are distinctly homogeneous and can be distinguished from the conditions prevailing in the neighbouring areas
Location of customers
Transportation cost
Market structure
ASSESSMENT OF DOMINANCE: Section 4(a) of the Act defines ‘Dominant Position’ as ‘a position of strength enjoyed by an enterprise, in the relevant market, in India, which enables it to:

Operate independently of competitive forces prevailing in the relevant market; or
Affect its competitors or consumers or the relevant market in its favour’

The market share of the product or service is also taken into consideration while assessing the dominant position.

ABUSE OF DOMINANT POSITION: Its factors are:

Denial of market access is a severe form of abuse of dominant position
Limited the availability of alternate products in the relevant market for consumers thereby reducing the competition in the market
The final consumers may also be deprived of choice to purchase different kinds of products or services at competitive prices

In the present case the ‘Relevant Market’ was defined as the ‘market for manufacture and sale of decorative paints by the organised sector in India.’ Asian Paints held a dominant position, having 55% market share. CCI found a prima facie case of abuse of dominant position under Section 4(2)(c) and Section 3(4) and directed for an investigation under Section 26(1) of the Act.

M/S KARNI COMMUNICATION PVT. LTD. v. HAICHENG VIVO MOBILE (INDIA) PVT. (2019)

Karni Communication Pvt. Ltd. (Informants) contended Haicheng Vivo (Opposite Party) imposed:

Minimum Operation Price (MOP): Vivo shall fix the MOP for resale or disposal of the stock and Karni Communications Ltd/ shall ensure its retailers not less than MOP is being charged. But higher than MOP can be fixed.
Market Infiltration Price (MIP): No sale will be made either by the Informants or by their retailers beyond the Authorised Distributor Zone.
Restriction on online sales:

Sale would not be allowed through online channels of distribution
Sold online and below MOP
If sale made on online platform, then, it will cancel all payouts to the Distributor
Cancelled all payouts if distributor didn’t adhere to the restrictions
Territorial restrictions on online sales

Vivo defended by stating that the MIP system helped tracking of IMEI numbers, ensured fair competition among the retailers and curbed counterfeit products. MOP was justified as a safeguard against predatory pricing and to maintain retailer profit margins without an increase in consumer prices. CCI noted that Vivo held a market share below significant dominance level (9.7% in Q4 2018) and found no evidence of market power abuse. The Commission held restrictions on online sales did not withhold the product supply and the MIP and MOP were not proven to cause AAEC in the smartphone distribution market. Restriction on online sales on the distributors doesn’t directly withhold the supply of Vivo products in the market and customers have the option to buy it through online retail platforms. Due to lack of evidence the allegations of cartel facilitation with the All-India Mobile Retailers Association (AIMRA) were deemed to be unsubstantiated. Hence, no violation of Sections 3(4) or 3(3) of the Act was found by the CCI and dismissed the claims against Vivo.

TAMIL NADU CONSUMER PRODUCTS DISTRIBUTORS ASSOCIATION v. FANGS TECHNOLOGY PVT. LTD. & ORS. (2018)

Fangs Technology (OP-1) entered into a ‘Vivo Distributorship Agreement’ with its distributors, wherein it had the right to add, delete, amend or alter any of the clauses of the Distributorship Agreement, which will be binding on its distributors even if they don’t agree to it. The distributors are:

Not allowed to given any discount to the retailers
Supposed to comply with the pricing
Not allowed to directly appoint retailers in their respective territory
Not allowed to sell directly to the corporate customers
Prohibits from doing business in Oppo and Honor brand of mobile phones within the designated territory and elsewhere
Distributorship agreement to be renewed annually
Threatened to terminate the agreement

The Informant alleged that the Distributorship agreement imposed unfair terms like termination threats, debit notes for performance failures, required substantial investments without security due to annual renewals, bear the cost of damaged phones and arbitrary penalties. To prove the allegations, the following had to be examined:

Delineate the relevant market
Establishment of dominance
Abuse of dominant position

Once these three are proven, then it can be held to be in violation. CCI delineated the relevant market as the ‘market for smartphones in India’. The Commission found that the Informant had failed to establish the dominance of Vivo (OP-1) in the relevant market and did not present evidence to prove that the agreement’s clauses had anti-competitive effects. The restriction on distributors working with Oppo and Honour was to protect Vivo’s intellectual Property and technical know-how from global competitors. CCI dismissed the matter, as there is no contravention of Sections 3 or 4 of the Act.

M/S K.C MARKETING v. OPPO MOBILES MU PVT. LTD. (2018)

K.C Marketing, the Informant entered into a Sub-super Mobile Distributorship Agreement of Oppo mobiles in South and Central Maharashtra. The agreement was considered to be anti-competitive, especially Clauses 8 and 9 prohibited online sales and sales outside a demarcated sales region. Oppo smartphones were freely available both online and offline through multiple platforms, and moreover the market share of Oppo was only 10-13%, compared to other dominant players like Samsung holding the maximum shares. CCI held these restrictions to not be anti-competitive as they did not foreclose the competition. There is no bar on the customers of one sales region to purchase Oppo products from a dealer in another sales region. The restriction to sell within the demarcated sales region is to protect the interests of all Sub-super Distributors/Dealers who have invested in Oppo distributorship. There is no intra/inter brand competition restriction due to such geographical restriction. The Commission held, no AAEC is caused and hence no violation of Section 3 of the Act. Anti-competitiveness in vertical restraints must be assessed on a case-to-case basis focussing on their actual effect on the market and not merely their sole existence.

VISHAL PANDE v. HONDA MOTORCYCLE AND SCOOTER INDIA PVT. LTD. (HMSI) (2017)

The CCI examined AAEC of HMSI, under Section 3(4) of the Act. A condition was imposed on the Opposite Party (OP) in the Dealership Agreement, restricting the Informant from selling vehicles outside a specified geographic area (entire territory of India). Honda held a dominating position in the scooter market with a share of 43.30% and 56.82% and not the motorcycle market during the same period. The allegations included tie-in agreements of lubricants, oil, batteries, etc from designated suppliers, RPM, discount control mechanism, abused its dominant position and territorial restrictions conferred to specific areas for sales. Prima facie Honda was held to contravene Section 3(4) and 4 of the Act. CCI directed Director General (DG) to conduct further detailed investigation into Honda dealership practices.

TOYOTA KIRLOSKAR MOTOR (P) LTD. v. CCI (2016)

Toyota Kirloskar Motor Private Limited, Ford India Private Limited and Nissan Motor India Private Limited appealed the order of CCI in Shamsher Kataria v. Honda Siel Cars India Ltd. & Ors. (2011) before the Competition Appellate Tribunal (hereinafter called as ‘COMPAT’) under Section 53B of the Act. The Informant, Mr. Shamsher Kataria alleged that authorised dealers could source spare parts only from Original Equipment Manufacturers (OEMs) or the approved vendors and sell the spare parts to independent repairers. Hence, such agreements are exclusive supply agreements under Section 3(4)(b) of the Act. The COMPAT held that the appellants are abusing their dominant position and hence violative of Section 4(2)(a)(i) of the Act.

MR. MOHIT MANGLANI v. M/S FLIPKART INDIA PVT. LTD. & ORS (2014)

Flipkart and other e-portals had been campaigning online about Chetan Bhagat’s upcoming book ‘Half Girlfriend’ and exclusively held 100% market share of exclusively selling it. The OPs argued that each product shouldn’t be narrowly defined, but should rather be done by considering substitutable products and distribution channels, including both offline and online sales. CCI held, every individual product cannot constitute a relevant market, as none of the OPs were dominant in the online market. Vertical agreements like exclusive distributorships are only considered as anti-competitive when they cause AAEC. These exclusive agreements did not create any entry barrier or foreclosure competition, as there existed offline retailers or e-commerce platforms as other alternatives. Territorial distributorship agreements in vertical restraints can affect AAEC when the manufacturers grant exclusive rights to specific distributors only for a specified geographic region by restricting parallel imports or sales by other distributors in the same market. Such agreements hinder the competition by limiting market access for other distributors, reducing the competition or increasing the prices for consumers. If new players are prevented from entering the market or foreclosure then they can lead to AAEC under Section 3(4) of the Act. In this present case, CCI dismissed the allegations under Section 26(2) for lack of evidence of AAEC.

RESEARCH METHODOLOGY

The research methodology adopted in this article is ‘Doctrinal Methodology,’ relying on primary sources like Sections 3 and 4 of the Competition Act, 2002 and judgments produced by the CCI and COMPAT. Secondary sources include research articles, research papers, and online publications of other scholars to analyse vertical agreements and AAEC. A case-based approach is also adopted by assessing the significant judgments given by the CCI, enabling this research article.

REVIEW OF LITERATURE

Executive Vice-President Margrethe Vestager, who’s in charge of competition policy, stated about the new Vertical Block Exemption Regulation (hereinafter called as ‘VBER’) accompanied by the new Vertical Guidelines: “The revised Vertical Block Exemption Regulation and Vertical Guidelines are the result of a thorough review process. The new rules will provide companies with up-to-date guidance that is fit for an even more digitized decade ahead. The rules are important tools that will help all types of businesses, including small and medium enterprises, to assess their vertical agreements in their daily business.”

SUGGESTIONS

CCI, to ensure a balanced approach towards exclusive agreements under vertical restraints, must adopt a more subtle analysis and adopt a more comprehensive approach of AAEC under Section 19(3) of the Act. Under Section 3(4) of the Act, rather than presuming anti-competitive harm, they must start focussing on the actual market impact by factors like barriers to entry, market share, consumer welfare, impact on interbrand and intrabrand competition as outlined under Section 19(3) of the Act. Self-assessment tools must be encouraged for businesses to ensure if they are complying with the law or not without having a rigid and rigorous approach of case-to-case basis assessment. Explicit guidelines of vertical restraint could be offered to businesses. Awareness among Small and Medium Enterprises (SMEs) about the implications of territorial restrictions would be useful. Finally, harmonising with ‘European Union’s VBER’ would offer a more balanced perspective on dealing with exclusive territorial agreements.

CONCLUSION

This examination of judicial trends in exclusive territorial agreements highlights the ever-evolving approach of the CCI towards balancing the anti-competitive concerns and efficiency of the market. While such agreements ensure product quality, reduce distribution costs and enhance supply chain efficiency they can lead to denial of market access, harm the consumers when misused and foreclosure of competition. There still exists a lot of grey area surrounding the vertical agreements. A robust competition regime can be developed by harmonising practices from the European Union and the United States. The final aim should be to bring a regulatory framework that detects anti-competitive arrangements without affecting any legitimate business practices. Abrupt interpretations on vertical agreements still pose a threat for businesses. Legitimate businesses will gain when having explicit guidelines with a case-specific approach. Finally, a strike of balance between business freedom and statute regulation will be essential in ensuring consumer welfare and market dynamism.

AUTHOR

Deepika K.M, 4^th Year BBA., LL. B student at MKPM RV Institute of Legal Studies, Bengaluru.

REFERENCES

Judicial Trends on Exclusive Territorial Agreements in Vertical Restraints: Case-Based Examination of AAEC

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