Incoterms_® and Commercial Contracts

1 APPLICATION OF US ANTITRUST LAWS TO INTERNATIONAL AGREEMENTS⁷⁰

a. US federal and state antitrust statutes

The US antitrust laws apply to all companies and individuals doing business in the United States and to conduct that occurs outside of the United States if the conduct in question has a “direct, substantial and reasonably foreseeable effect” on competition within the United States⁷¹. Therefore, an agreement between a US Franchisor and its Master Franchisee, Area Developer or Franchisee may become subject to US antitrust laws if it has a direct and substantial impact on competition in the United States. It is important for US Franchisors expanding internationally to have an understanding of the antitrust law issues that affect relationships with foreign Franchisees and how to address such issues.

The principal US federal antitrust laws are the Sherman Act, the Clayton Act and the Robinson-Patman Act. In addition, recently, the Federal Trade Commission (FTC) has used Section 5 of the Federal Trade Commission Act (FTC Act) to pursue claims of unfair competition. Several the US states have also adopted their own antitrust statutes.

The Sherman Act⁷², enacted in 1890 prohibits every “contract, combination … or conspiracy, in restraint of trade or commerce among the several States or with foreign nations”.⁷³ This prohibition has been interpreted to proscribe only unreasonable restraints of trade⁷⁴. Under the Sherman Act it is also a felony for anyone to “monopolize or attempt to monopolize,” or “conspire … to monopolize”.⁷⁵ The Sherman Act attempts to prevent the artificial raising of prices by restriction of trade or supply and protects competition, rather than competitors, unlike, for example, EU law, which tends to protect competitors in the marketplace, sometimes even at the expense of market efficiencies and consumers.

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The Clayton Act⁷⁶, adopted in 1914, proscribes certain additional activities that had been discovered to fall outside the scope of the Sherman Act. The Clayton Act only applies to arrangements governing the lease or sale of “goods” or “other commodities,” and does not apply to arrangements regarding services, licenses or other intangible property. So, it has limited application for franchises. The Clayton Act also addresses issues that arise as a result of mergers and acquisitions, and it proscribes mergers and acquisitions if the effect of the merger or acquisition “may be substantially to lessen competition”.⁷⁷ In this case, it would affect potential mergers among Franchisors in similar industries.

The Robinson-Patman Act⁷⁸ amended the Clayton Act in 1936 and proscribes certain anti-competitive practices where manufacturers engaged in price discrimination against equally situated distributors. Contrary to the Sherman Act and the Clayton Act, which are aimed at protecting competition and prohibiting conduct that lessens or eliminates competition by means of “unreasonable” restraints of trade and monopolistic behavior, the Robinson-Patman Act affords protection to individual competitors⁷⁹.

b. Critical US antitrust issues applicable to franchising

Under US law, restraints of trade that are the subject of antitrust scrutiny are categorized as either vertical or horizontal restraints⁸⁰. Only “unreasonable” restraints of trade are unlawful under US antitrust laws. Certain restraints have been characterized as “per se illegal”, and such restraints are agreements between competitors to fix prices, boycott suppliers, allocate customers or territories or rig bids⁸¹. All other restraints are subject to evaluation under what is known as the “rule of reason”, in which the court takes into account all applicable circumstances⁸².

For purposes of Section 1 of the Sherman Act and Section 3 of the Clayton Act, there must be an “agreement” or “conspiracy”, and this requirement has been interpreted to mean a “knowing commitment to or adherence to a course of conduct or plan.”⁸³ Although a principal and its agent cannot conspire for purposes of the antitrust laws, currently there is no consensus that a Franchisor and Franchisee are considered such a “single” company for purposes of antitrust laws⁸⁴.

Vertical restraints are analyzed differently depending on whether they are price or non-price restraints. Maximum and minimum price fixing (i.e., a supplier’s prohibition against a dealer reselling above or below a certain price) is subject to a rule of reason analysis⁸⁵. Normally, a Franchisor’s
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argument that a pricing cap or floor supports inter-brand competition will win over a Franchisee’s position that it unreasonably restrains intra-brand competition⁸⁶. Franchisors may suggest the prices at which their Franchisees sell goods at retail in cooperative advertising funded in whole or part by Franchisor⁸⁷. Of course, good practice would dictate that the phrase “at participating locations only” be added so the public is not misled when a Franchisee does not offer those prices. This is especially helpful when the Franchisee’s Unit is in a unique venue with higher costs, such as airports and hotels.

Non-price restraints are also evaluated under the rule of reason⁸⁸. Although case law characterizes tying as a per se violation, the analysis involved is so fact-intensive and dependent on economic data that it is, in reality, a rule of reason analysis⁸⁹. A plaintiff attempting to prove an unlawful tying arrangement must establish that (a) there are two separate products; (b) the sale of one product is conditioned upon the purchase of another product; (c) the seller has sufficient economic power in the market for the “tying product” to coerce purchase of the tied product; and (d) a not insubstantial amount of commerce in the market for the tied product is affected⁹⁰. In analyzing tying claims, a requirement that a Franchisee purchase products only from approved sources has been identified as a contractual limitation (i.e. the requirement is set forth in the Franchise Agreement) rather than Franchisor’s market power⁹¹.

The grant of territorial exclusivity by a Franchisor to a Franchisee is presumptively legal because it serves to strengthen inter-brand competition⁹². A Franchisor’s prohibition on Franchisees selling outside of a specified Territory will be subject to a rule of reason analysis⁹³.

Horizontal price fixing (i.e. agreements to fix the price at which goods will be sold or purchased) is per se illegal⁹⁴. Agreements among competitors to allocate customers, divide territories or otherwise restrict competition for customers are also per se illegal⁹⁵. Thus, any agreement among Franchisees to stabilize, peg or fix prices at which they sell goods or services to customers are per se illegal.

Although courts have not addressed this issue, it has been suggested that a difference in Franchise Fees charged by a Franchisor would not be actionable as price discrimination in the “sale” of a commodity and thus would not violate the Robinson-Patman Act⁹⁶.

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c. State antitrust laws

In addition to the federal antitrust statutes, the US states have adopted antitrust laws, which codify state common law prohibitions against anticompetitive restraints⁹⁷. Like their federal counterparts, such laws provide the basis for criminal prosecutions as well as private causes of action for injunctive relief or recovery of multiple damages and attorney’s fees. Some state antitrust laws may differ significantly from the federal statutes, especially as it relates to (a) availability of private right of action; (b) applicable statutes of limitations; (c) range of fines imposed as civil or criminal penalties; and (d) availability of multiple damages in private actions⁹⁸. Although most states have enacted statutes that prohibit the same types of conduct prescribed by the Sherman and Clayton Acts, there are only a few states that have adopted laws that are counterparts to the Robinson-Patman Act⁹⁹.

In addition to the increased efforts by federal regulators to step up antitrust enforcement, state regulators have continued their vigorous antitrust enforcement as well. For example, the state of Maryland has enacted legislation that overturns the Leegin decision¹⁰⁰. In addition, 15 other states already have had legislation that could be interpreted as rendering resale price maintenance per se illegal¹⁰¹. Therefore, before assuming that a Franchisor can establish minimum resale prices for its goods and services, the Franchisor must examine the governing law of the agreement. So, for example, if Maryland law governs the agreement, then Maryland’s prohibition on minimum resale price maintenance could make any attempt to establish minimum prices per se illegal.

In addition to the state antitrust statutes, the state franchise statutes also have an important impact on competitive activities of Franchisors and Franchisees.

2 APPLICATION OF ANTITRUST LAWS OF THE EUROPEAN AND ITS MEMBER STATES

a. Introduction

Within the European Union the law of the European Communities applies. It is subdivided into primary and secondary Community law. Primary Community law forms the quasi constitution of the Community and stands at the top of Community-law hierarchy of norms and consequently enjoys priority over secondary Community law. The secondary law is enacted on the basis of the primary law and is directly binding or applicable for the member states and/or for their individuals and corporations (supranational). It prevails over national law¹⁰².

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One of the central Community competition rules for companies is Article 81 of the European Community Treaty (ECT). Pursuant to this Article, agreements between companies, resolutions in favor of commercial federations and coordinated behavior which are apt detrimentally to affect trade between the member states are forbidden if they intend or cause perceptible restrictions on competition. Agreements which breach this prohibition are null and void pursuant to Article 81 paragraph 2 of the ECT. In principle, this regulation would also apply to cross-border Franchise Agreements, i.e. cross-border Franchise Agreements would be regarded as cartels and would thus not be permitted.

To prevent Franchise Agreements from being registered individually with the EU Commission and being individually exempted from the EC cartel prohibition, following the Pronuptia decision¹⁰³, the Commission of the European Communities adopted the EU Block Exemption Regulation for Franchise Agreements¹⁰⁴, which came into effect on 1 February 1989.

This regulation in its current version in force (Regulation N° 330/2010) (BER)¹⁰⁵ reflects a broader view of the distribution sector and is founded on a more economic viewpoint of the impact of restraints in an agreement than the more legalistic viewpoint that prevailed in Regulation N° 4087/1988.

Franchising is not mentioned in the text of this BER, but in the Guidelines that accompany the text.

The BER is based on the principle that all vertical restrictions that do not fall under the prohibited clauses are permitted. Pursuant to Article 4 of the BER, it does not apply to Franchise Agreements which have the following purpose:

• fixed prices and minimum prices;
• maximum prices and recommended prices which in reality amount to fixed prices or minimum prices due to pressure;
• restriction of active onward sale, with the exception of a restriction of active onward sale in areas or in customer groups which the Franchisor has allocated exclusively to another Franchisee or has reserved for itself, insofar as these restrictions are directly imposed upon the Franchisees; or
• restriction of cross-supplies among Franchisees within one System.

If Article 4 of the BER is breached, the entire Franchise Agreement does not fall under the BER. Rather, the entire agreement is null and void for cartel reasons.

Article 5 of the BER includes restrictions that are invalid under the prerequisites named therein, whose invalidity leaves the rest of the Franchise Agreement unaffected.

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b Articles 101/102 of the Treaty on Functioning of the European Union (TFEU)

Within the European Union two sets of competition laws apply, those that are contained in the European Union’s own legislation and those of each member state. Sometimes the legislation of a member state mirrors that of the European Union (as is the case within the United Kingdom) but sometimes a different approach is adopted (as is the case with Germany). This section will, therefore, deal with not only European Union competition laws, but also, by way of brief comparison, the competition laws of the United Kingdom and Germany.

c Application

Articles 101 and 102¹⁰⁶ of the TFEU are the primary sources of EU competition law. Article 101 deals with anticompetitive agreements, decisions and concerted practices — and is the article that has the greatest impact on franchising — and Article 102 regulates abuses of a dominant position and which has, so far, not been applied to franchising within the European Union. Article 101 prohibits “all agreements between undertakings, decisions by associations of undertakings and concerted practices which may affect trade between member states and which have as their object or effect the prevention, restriction or distortion of competition within the internal market.”¹⁰⁷ The effect of entering into an agreement that violates Article 101(1) is that either the whole agreement or the offending provisions (depending on the seriousness of the breach) will be void and unenforceable. In addition, the parties are liable to substantial fines of 1,000,000 Euros (approximately US$1,600,000) or, if greater, 10% of worldwide sales.

i. Exceptions and exemptions

To avoid having to deal with a large number of notifications of Franchise Agreements for the purposes of seeking an exemption under Article 101(3), the European Commission initially published a block exemption (a general exemption that applies to a category of agreements) for Franchise Agreements¹⁰⁸, which was replaced by a block exemption applying to all vertical agreements, including Franchise Agreements¹⁰⁹. Vertical agreements are those between entities at a different level of trade, such as Franchisors and Franchisees, and generally do not give rise to serious competition law issues. The purpose of a block exemption is to set out the conditions under which an agreement will be treated as complying with Article 101(3) and is, therefore, exempted from the prohibitions set out in Article 101(1). In addition to publishing a block exemption (the BER), the Commission has published a Notice on Agreements of Minor Importance¹¹⁰ and a Recommendation in relation to Small and
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Medium-Sized Businesses¹¹¹ (SMEs). In practice, most Franchise Agreements within the European Union are entered into by Franchisors and Franchisees that are SMEs or that have a market share of less than 15% and are therefore unlikely to be regulated by Article 101 in the first place. Nevertheless Franchisors generally seek to comply with the BER.

Further, an effect on trade between member states is an essential element for bringing Article 101 into play. Many Franchisors, especially those with relatively small franchise networks, which operate in only one country within the European Union, believe that their agreements are unlikely to have such an effect on trade between member states. This view may not be justified. The European Court indicated in the Pronuptia¹¹² case that Franchise Agreements are capable of affecting trade between member states “even if they are concluded between enterprises established in the same member state”, if they “prevent the franchisees from setting themselves up in another member state”.¹¹³ In practice, Franchise Agreements will not contain an express prohibition on setting up in another member state, but franchises are almost invariably granted for specific areas and Franchisees are not allowed to set up their place of business outside their allocated area.

The block exemption prohibits certain practices and contractual provisions that would ordinarily often be found in franchise relationships as follows:

ii. Vertical Restraints Block Exemption

The Commission has published a block exemption¹¹⁴ (replacing a previous similar block exemption) the purpose of which is to exempt those vertical agreements that do not contain anticompetitive clauses from the Article 101 prohibition. The BER only applies if the Franchisor and the Franchisee have a market share of no more than 30%. The Franchisor’s market share is calculated on the market in which products and services are sold to consumers. In the case of Franchisees, it is calculated on the market in which they purchase products. The BER is supplemented by guidelines detailing the Commission’s policy concerning aspects of the BER. These guidelines have considerable importance for understanding the Commission’s approach.

iii. Resale price maintenance

Article 4(a) regulates minimum price fixing. Maximum and recommended selling prices are permitted provided that they are not a disguised form of minimum price fixing. Care has to be taken to ensure that pressure is not put on Franchisees, whatever the Franchise Agreement provides, to comply with fixed prices. This pressure can take many forms and could include hardships being
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imposed on Franchisees as a result of quoting prices other than those set by the Franchisor.

Although Franchisors are entitled to require Franchisees to participate in promotions, they cannot require Franchisees to comply with the Franchisor’s prices in such promotions. The Guidelines — but not the BER itself — contemplate that resale price maintenance can, however, be permitted in the following situations: sales promotion during the introduction of a new brand; short-term low price campaign¹¹⁵; and to prevent “free riding” by those dealers who do not “provide (additional) pre-sales services, in particular in case of [expensive] or complex products.”¹¹⁶

iv. Exclusive Territories

Article 4(b) prohibits the restriction of the Territory into which, or of the customers to whom, a Franchisee may sell the contract goods or services. The restriction applies only to “active sales” into the exclusive Territory or to the exclusive customer group reserved to the Franchisor or allocated by the Franchisor. Franchisors should, as a result, ensure that all territories which are unallocated are exclusively reserved to the Franchisor.

The difference between active and passive selling is fundamental to the Commission’s approach. Paragraph 51 of the Guidelines sets out the Commission’s view as to what constitutes active sales and passive sales¹¹⁷.

v. Internet

Further, paragraph 53 of the Guidelines¹¹⁸ makes it clear that the use of the Internet to advertise or sell products constitutes passive sales and that a restriction on the use of the Internet by Franchisees is generally not permitted. The Commission does, however, take the view that “online advertisement specifically addressed to certain customers is a form of active selling to these customers”.¹¹⁹ For instance, Territory-based banners on third-party websites are a form of active sales into the Territory where these banners are shown. In general, an effort to be found specifically in a certain Territory or by a certain customer group is active selling into that Territory or to that
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customer group. Also, paying a search engine or online advertisement provider to have an advertisement displayed specifically to users in a particular Territory constitutes active selling into that Territory.

The Commission regards the following as restrictions on passive selling and, therefore, prohibited as a hard-core restriction:

• Automatic re-routing of customers to the Franchisor’s or other Franchisees’ website;
• Requiring a Franchisee to terminate a consumer transaction once its credit card data reveals an address that is not within the Franchisee’s exclusive Territory;
• Requiring a Franchisee to limit the proportion of overall sales made over the Internet. However, this does not exclude the Franchisor imposing minimum sales requirements on the Franchisees’ sales from their brick and mortar shops;
• Agreeing a higher price for products sold on the Internet¹²⁰.

vi. Noncompetition covenants (including exclusive dealing)

The regulation of in-term and post-term noncompetition covenants is set out in Article 5 of the BER, which, unlike the “hard core” restrictions in Article 4 that invalidate the whole Franchise Agreement, gives rise only to the invalidity of the offending clauses and not the whole agreement.

Noncompetition clauses are prohibited by Article 5(1)(a)¹²¹. The Commission’s definition of a noncompetition obligation contains two elements. The first is a prohibition, in effect, on being involved in a competing business. The second element is not what most business people would consider to be a noncompetition obligation. It is rather an exclusive purchase obligation. If a Franchisor obliges a Franchisee to purchase more than 80 per cent of a Franchisee’s total purchases of the contract goods or services from the Franchisor and/or its nominated supplier, this would constitute a noncompetition obligation. The percentage is calculated on the basis of value and not on quantity unless standard industry practice calculates sales in volumes.

The above should be read subject to paragraph 190 of the Guidelines¹²², which makes it clear that a noncompetition obligation will fall outside Article 101(1) when the obligation is necessary to maintain the common identity and reputation of the franchised network. This reflects the European Court’s judgment in Pronuptia in which the Court indicated that a clause requiring Franchisees “to sell only those goods originating with the Franchisor or the suppliers chosen by the Franchisor may be considered necessary to protect for the network’s reputation”.¹²³

Article 5(b) prohibits post-termination, noncompetition clauses in the
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following terms:

Any direct or indirect obligation causing the buyer, after termination of the agreement, not to manufacture, purchase, sell or resell goods or services unless:

• the obligation relates to goods or services that compete with the contract goods or services;
• the obligation is limited to the premises and land from which the buyer has operated during the contract period;
• the obligation is indispensable to protect Know-how¹²⁴ transferred by the supplier to the buyer; the duration of the obligation is limited to a period of one year after termination of the agreement.

d. Member State example: Legislation in the United Kingdom

In the United Kingdom, the Competition Act 1998¹²⁵ also regulates anticompetitive agreements. The Chapter I Prohibition prohibits and regulates agreements and reflects Article 101 of the TFEU. The stated aim of the legislators in enacting the Competition Act was to ensure that UK competition legislation adopted a similar approach to that of the European Union on which many other member states (such as Ireland and France) have based their own competition legislation. Indeed, Section 60 of the Act sets out the principles that must be applied by the United Kingdom authorities and courts when applying the provisions of the Act with a view to ensuring consistency with community law.

The Competition Act prohibits agreements that prevent, restrict or distort competition and may affect trade within the United Kingdom unless they are exempted by Section 9 of the Act. The term “agreement” includes commercial agreements and concerted practices. Further, the term “agreement” includes oral and written agreements, those agreements that are not legally binding such as gentlemen’s agreements and could also include cooperation between businesses that is not evidenced by any agreement or decision.

A violation of the Chapter I Prohibition results in the offending agreement being held void, and the parties to the agreement may be liable to penalties of up to 10 percent of their UK turnover. Further, third parties who have been harmed by such agreements can pursue damages claims in the UK courts.

Section 9 of the Competition Act provides for exemption of agreements that have beneficial aspects. If an agreement complies with the EU’s BER, it will be exempted under English law.

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e. Member State example: Legislation in Germany

The relevant law regulating competition in Germany is the Act Against Restraints of Competition — Gesetz gegen Wettbewerbsbeschränkungen — (“GWB,” Law against Restrictions of Competition).

The scope of application of the GWB extends to all acts of unfair competition, which means the accumulation and misuse of market power and the limitation of competitive behavior of independent market participants within Germany.

In Germany, the prevention of restrictive competition practices operate at three levels:

• Restrictive agreements (§ 1 GWB): prohibits agreements between businesspeople, as well as concerted practices, which intend or have as their effect the prevention, restriction or distortion of competition; this provision regulates horizontal as well as vertical agreements alike. Previously, German law made a distinction between horizontal agreements (which were prohibited but which could be exempt in certain circumstances) and vertical agreements (which were generally allowed but could be prohibited individually).
• Exploiting a market dominant position (§§ 19-21 GWB): market- dominating companies act unlawfully if they abuse their market position without objective reasons justifying such behavior.
• Mergers (§§ 35 ff. GWB: mergers require a notification to the antitrust authorities (Bundeskartellamt) if the businesses exceed a certain size.

German antitrust law imposes penalties for infringement. Economic organizations, competitors or other competitors affected by the cartel infringement can claim damages or injunctive relief¹²⁶. In addition those who have suffered from the anticompetitive activity can claim compensation for damages¹²⁷. The cartel authorities may also require the anticompetitive behavior to stop¹²⁸. Under certain circumstances cartel authorities and economic organizations have the opportunity to recover the infringer’s profit¹²⁹. In addition the cartel authority may initiate penalty proceedings seeking to impose a penalty on the infringer¹³⁰.

Typical antitrust issues in Franchise Agreements with contact to the German GWE include resale price maintenance, marketing promotions, territorial exclusivity and noncompetition covenants (in-term and post-term).

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