Exclusive dealing clauses are commonly found in vertical agreements such as supply or distribution agreements. They arise where one party must deal exclusively with another party or where one party accepts a restriction on its dealings with other parties. In many cases exclusive dealing will not harm competition and it can sometimes be pro-competitive.
Types of exclusive dealing arrangements
Exclusive dealing clauses can be found in exclusive purchasing, supply or distribution agreements or where there is a commitment to certain volumes or percentage targets that roughly equate to total purchasing requirements. Exclusive dealing can also be found in agreements that allow re-supply only to a particular area, a customer or a group of customers. Exclusive dealing can also be indirect where incentives such as loyalty rebates are paid only if certain parameters are met.
Why should you be concerned?
Exclusive dealing may amount to an abuse of market power or may otherwise be anti-competitive if it reduces competition, amounts to market sharing or limits competitors' access to the market. An exclusive dealing clause is likely to contravene:
- the Second Conduct Rule (SCR) where it involves an undertaking with a substantial degree of market power and it has the object or effect of harming competition;
- the First Conduct Rule (FCR) where the agreement or arrangement has the object or effect of harming competition.
You are likely to have market power where you are not effectively restrained by your competitors (i.e. you can charge above market rate or can restrict output or quality for a sustained period of time). Unlike the European Union where an undertaking with less than 40% market share is unlikely to be considered dominant, neither the Competition Ordinance nor the Competition Commission provides an indicative market share threshold below which an undertaking may be deemed as holding a substantial degree of market power.
Let's take a look at two of the most common types of exclusive dealing: exclusive purchasing or supply (contractual obligations) and conditional rebates (de facto exclusivity).
When are exclusive purchasing or supply obligations illegal?
An exclusive purchasing obligation requires a customer to purchase all or a substantial proportion of its requirements of a product from a particular supplier. The same applies to an exclusive supply obligation, where the supplier is required to sell its products only to the purchaser.
Such an obligation risks breaching the SCR where the undertaking imposing the obligation has a substantial degree of market power, and the purpose or effect of the exclusive dealing clause is to harm competition. For example, supply exclusivity may foreclose a competitor if it prevents a competitor from acquiring necessary inputs from an efficient supplier and where there is no alternative supplier. It could also prevent a possible new player from entering the market or a competitor from expanding.
Factors to be taken into account when assessing the competition risk of an exclusivity clause include market power, duration of the exclusivity and reasons for it, barriers to entry and the existence of other exclusivity arrangements in the market.
If the undertaking does not have substantial market power, exclusivity could still breach the FCR if it reduces competition between distributors or retailers or otherwise disguises market sharing.
What about conditional rebates?
Everyone loves rebates but these can be a form of de facto exclusivity. Conditional rebates are often granted to customers as a reward for purchasing from the supplier. It can induce customer loyalty and is generally considered pro-competitive. But when rebates are granted by an undertaking with substantial market power, competitive concerns may arise if they have the effect of market foreclosure.
Retroactive rebates are rebates granted on all purchases from the supplier when a purchasing threshold is reached during a period. Incremental rebates are different in that, when a purchasing threshold is reached, rebates are granted only on purchases above such purchasing threshold. Under retroactive rebates, customers are less likely to purchase from alternative suppliers since they would lose the rebate in respect of all products purchased. They therefore have the potential of foreclosing the market and are more likely to raise concerns.
The purchasing threshold can be individualised or standardised. Thresholds are individualised if they are tailored to the particular requirements of each customer, and standardised if the same thresholds apply to all customers. An individualised threshold allows the supplier to maximise its foreclosure effect, and is therefore more likely to raise competition concerns.
Do I need to change my current practices?
The first step is to review your vertical agreements, rebate structures and purchase, supply or distribution practices. The following types of conduct may also be problematic under the Competition Ordinance:
Exclusive customer allocation - obligations on the supplier to supply exclusively to a particular customer
"English clauses" - or most favoured nation clauses - contractual terms to match more favourable terms offered by competing suppliers
Minimum stocking requirements - minimum number of products retailers are required to stock
Slotting allowances - fees paid by suppliers to retailers for placing their products on the shelves
Incentives provided free of charge in return for an exclusive stocking commitment
Whether the arrangement has the object or effect of harming competition will depend on the facts of each case and the dynamics of the market.
I may be in breach. Will any exclusion or exemption apply?
The Ordinance excludes and exempts certain conduct from breaching the Ordinance. In relation to the prohibitions that may concern exclusive dealing:
- An undertaking is exempt from the SCR if it has a total gross global turnover of HK$40 million or less for the turnover period; or
- Two or more undertakings are exempt from the FCR if they have a combined total gross global turnover of HK$200 million or less for the turnover period and it does not involve serious anti-competitive conduct (such as market sharing).
- An undertaking is exempt from the FCR if the agreement contributes to improving production or distribution or promotes technological or economic progress.
What are the consequences of anti-competitive exclusive dealing?
- There are two possible enforcement approaches the Competition Commission can take depending on the seriousness of the alleged offence:
- issue an infringement notice, providing the undertaking an opportunity to make a commitment to comply with the requirements of the notice within a specified compliance period; or
- institute proceedings in the Competition Tribunal without first issuing an infringement notice.
If the Competition Tribunal finds an offence has been committed, it can issue a fine of up to 10 per cent of the undertaking's group turnover in Hong Kong for the duration of the infringement (with a three-year cap) for each offence.
Next week we will look at margin squeezing, a specific type of exclusionary conduct under the SCR.
You may also wish to read our 'Are you ready for the Hong Kong Competition Ordinance check list' to see how prepared you are for the new law, which you can find here.