The franchise agreement may contain an exclusive supply clause, which obliges the franchisee to purchase the products it sells directly from the franchisor or from a supplier or suppliers determined by the franchisor. In this article, we will analyze whether this action is legal, and the limits or consequences of this type of exclusive clauses in the franchising sector.
What is an exclusive supply clause and what problems does it raise?
The purpose of an exclusive supply clause is to require franchisees to purchase their products directly from the franchisor or designated suppliers. Thus, the “franchise” requires its franchisees to distribute only products that it manufactures itself or that are offered by approved suppliers.
This exclusive supply clause allows the franchisor to allow franchisees to purchase the products stipulated in the contract only from the franchisor, or from any supplier previously approved by the franchisor. For their part, suppliers may reciprocally undertake to supply the designated products only to franchisees, or on the contrary, to supply other buyers. The inclusion of this clause allows the franchisor to preserve the image of the brand and its products, protecting the essence of its franchise and ensuring competitive prices in the acquisition of these products. The exclusive supply clause is permitted in the franchising sector, falling outside Article 101.1 TFEU (agreements between undertakings and concerted practices) as they are necessary to maintain the identity and reputation of the network, provided that they meet certain conditions as we will see below.
It is worth mentioning, that this type of clauses raise competition concerns when they lead to a blockage in the market both from the cartel point of view (e.g. the existence of exclusive supply contracts in the market creating a cumulative network effect) and from the point of view of abuse of dominant position, due to their foreclosing or attenuating effect on competition in the product supply market (Articles 101 and 102 of the TFEU).
Conditions for the validity of an exclusivity clause in franchise agreements
We should start by mentioning that Article 101(1) TFEU prohibits all agreements between undertakings, decisions by associations of undertakings and concerted practices which may affect trade between EU countries and which may prevent, restrict or distort competition.
To be lawful under competition law, an exclusive supply clause in a franchise agreement must serve to maintain the common identity and reputation of the franchised network.
EU Regulation 2022/720 (EUATR) of May 10, 2022, on the application of Article 101 of the TFEU, states in Article 1.f) that a “non-competition clause”, i.e. one that contravenes the prohibition of Article 101.1 of the TFEU, is defined as: “any direct or indirect obligation that prohibits the buyer from manufacturing, procuring, selling or reselling goods or services that compete with the contract goods or services, or any direct or indirect obligation that requires the buyer to purchase from the supplier or from another company designated by the supplier more than 80 of its total purchases of the contract goods or services and their substitutes in the relevant market, calculated on the basis of the value or, where it is current practice in the sector, the volume of its purchases in the preceding year.”
Under the premise of this article, there is an obligation to purchase up to 80% of the goods and services from the franchise or its designated suppliers. However, Article 5, in relation to the excluded restrictions, provides that any (direct or indirect) non-competition clause whose duration is indefinite or exceeds five yearsThe exemption in relation to the prohibition of agreements between undertakings which may affect trade between Member States (Article 101(3) TFEU) does not apply to it. Consequently, a limit of five years is established for this type of clauses, and thus, this type of agreements would fall under the application of Article 101.3 of the TFEU by which the provisions of Article 101(1) TFEU are declared inapplicable.
From the wording of this regulation, and applying it to the particular case of the franchise sector, we can extract that the products that mainly mark the aesthetics, quality and peculiarity of the franchise can be the object of exclusive distribution, and therefore be included in this 80%. However, all generic products that can be found in any other establishment do not fall within these parameters, so there would be a free market for the franchisee, and should be included in this remaining 20%.
In the new Regulation 2022/720 on vertical agreements, such as franchising contracts, which replaces the old Regulation 330/2010, the following new regulations are included which was in effect until May 31, 2022, establishes that only a “non-competition clause” will be considered to be that which requires the franchisee to purchase from suppliers or other companies designated by the franchisor more than 80% of its total purchases of the contractual goods or services. It is therefore understood that nullity only exists for the excess over the 80% established, being therefore free to contract 20% of the franchisee’s supplies.
The key to purchasing exclusivity lies in the competitive advantage offered by the volume of purchase of the franchise’s products, and it is this advantage that justifies exclusivity in authorized suppliers, which in turn allows the franchise to charge royalties for this competitive advantage and for the global service it offers, hence the European legislation is pronounced in this regard.
At Navas & Cusi, we understand the importance of understanding and properly addressing exclusive supply clauses in franchise agreements. Our franchise law experts are available to help you assess the legality and consequences of such clauses on your business, ensuring that a balance is maintained between the common identity and reputation of the franchised network and compliance with competition regulations.