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Managing Partner, ARZINGER
Supply Chain and Antitrust Risks: Recent Trends in Ukrainian Competition Law
Cooperation between manufacturers and legally independent distributors in a single supply chain is widespread due to its cost effectiveness. The latter is based on the combination of distributors’ sales experience at the local level, the existing infrastructure and the orientation in the national standards of doing business, etc. Consequently, on the one hand, such partnership minimizes a great number of commercial risks for manufacturers but, on the other hand, it entails legal ones.
In particular, the independence of parties to agreements in a single supply chain (so-called vertical agreements) gives reason for competition authorities to analyze such agreements in terms of their impact on competition.
Legal Regulation and Enforcement: Current Trends of 2016
Legislative regulation of vertical agreements in competition law did not change in 2016. As before, the Law of Ukraine On the Protection of Economic Competition, contains a general prohibition of anticompetitive concerted actions that have led or may lead to preventing, eliminating or restricting competition. This prohibition applies to vertical agreements as well as to horizontal ones in general. However, in order to apply such a prohibition to vertical agreements, the competition authority should prove the existence of anti-competitive effects.
It is worth noting that the Ukrainian competition authority (the AMCU) has not yet clarified its approaches to the analysis of vertical agreements and applicable restrictions. Nevertheless, the need for detailed regulation of this issue is evident. The comparably scarce enforcement experience in this area shows that neither the national authority nor businesses fully understand how vertical agreements can impact competition. At the same time, the adoption of the mentioned clarifications is Ukraine’s obligation under the Association Agreement between the European Union and its member states, of one side, and Ukraine, of other side, to implement the Commission Regulation (EC) No.330/2010 of 20 April 2010 on the application of Article 101 (3) of the Treaty on the Functioning of the European Union to categories of vertical agreements and concerted practices. A positive trend is the competition authority’s public statement that the project has already been launched. Thus, a business will be able to submit its comments soon, but, for the time being, it should start learning to analyze and anticipate the possible antitrust risks of terms and conditions without waiting for the competition authority to provide its official stance.
After all, the authority does not intend to focus solely on rule-making, but will actively perform its most important function — control over compliance with the applicable competition laws.
Red Flags in Goods Supply Business Practices from the AMCU’s Viewpoint
In 2016, the AMCU evaluated supply contracts between exclusive importers (Ukrainian subsidiaries of major pharmaceutical manufacturers) and local distributors of medicinal products for the first time in the history of Ukrainian antitrust enforcement. Through its two decisions taken in respect of Alcon Ukraine and Servier Ukraine Ltd. and their distributors, the AMCU has actually started summing up a large-scale investigation into the Ukrainian market of medicinal products initiated back in 2011.
These decisions are expected to be followed by others, as the AMCU keeps investigating a number of other analogous cases. The importance of the AMCU’s decisions for the pharmaceutical market as well as for other markets where trade is organized in a similar way can hardly be overstated.
We can already say that companies at least in the supply chain of electronics and digital technology, automotive, food, cosmetics and household chemicals are already in the sights of the competition authority. In fact, companies should consider the authority’s findings in the mentioned cases as a starting point for analyzing their own business practices.
What Practices Can, in the AMCU’s Opinion, Have a Negative Effect on Competition?
1. Exclusive import and ban on export (re-export)
If there is substantial market power, the AMCU considers establishing a model of exclusive import through a single subsidiary while prohibiting export (re-export) by its distributors as an attempt to gain control over the market. Following the AMCU’s logic, exclusive importers, together with distributors, are able to control the volumes of goods on the market and, thus, the prices along the entire supply chain, right up to the prices for end consumers.
2. Distributors’ reporting
In its decisions, the AMCU points out that the provision of reports by distributors on product movement allows parties to agreements to further control the directions and volumes of goods supplied.
The exclusive import model, export (re-export) restrictions and implementation of reporting mechanisms in the presence of market power are regarded by the AMCU as an integral tool resulting in the overall control of trade flows and saturation of demand and supply.
3. Discounts and bonuses
The AMCU may regard purchase price discounts, bonuses for meeting certain additional conditions (e.g. maintaining inventories of products in warehouses, meeting procurement targets, early payments, etc.) as an anti-competitive mechanism. The competition authority is especially concerned by sales promotion tools, which are different for single distributors or specific/unique for a single or group of distributors. Such conditions can discriminate against other distributors, thereby creating unequal conditions for competition at the relevant trading levels in the supply chain. According to the AMCU, specific discounts/bonuses in distribution channels lead to the existence of a “nominal” (contractual) price as the basis for calculating customs duties or trade margins and a “real” price including the discounts/bonuses mentioned above.
4. Unreasonably high prices of goods
To sum up, the above contractual relations between exclusive importers and distributors in the presence of significant market power eventually created conditions for economically unjustified price increases for the end consumer.
AMCU’s Further Steps — What Businesses Should do to Avoid or Minimize Antitrust Risks
The AMCU’s existing practice in respect of vertical agreements can certainly not be considered impeccable, as some of its findings remain highly questionable for both the business and legal community. But should we really refer all the unanswered questions solely to the AMCU? We have to admit that the practice of the world’s leading competition authorities regarding this type of cases is largely controversial in general and often lends itself to criticism. It is obvious that the problem lies in the complexity of vertical agreements as economic ties per se, the line between their pro-competitive and anti-competitive effects often being quite a thin one. At the same time, the further movement of the competition authority towards developing the practical assessment of vertical restraints looks quite unique.
Together with the complexity of the problem, possible liability of companies for the violations committed not only by company executives but also by authorized persons, who take management decisions (for instance, decisions on cooperation), increases antimonopoly risks. This fact is confirmed by the practice of the competition authorities.
Thus, all these circumstances cumulatively entail the necessity for companies to unify its internal procedures in accordance with the requirements of antitrust laws. Practice shows that only implementation of internal programs and strict performance of their provisions can guarantee the company lower risks of receiving fines for their activity.
The AMCU has made it clear that a particular business practice should be justified by economic considerations and, at the same time, should satisfy the interests of end consumers (a must!). Therefore, companies should review the terms of cooperation with partners carefully and apply a comprehensive approach to the issue of both commercial and anti-trust substantiation of certain terms of contracts. In order to prevent antitrust risks manufacturers should develop internal documents for regulating selection of commercial partners (distributors and/or retailers) as well as the main commercial conditions of cooperation with them. Such documents may be implemented in various legal forms: commercial policies, programs, internal rules, etc.
These internal documents may vary depending on the business areas, though there are some general principles applicable to all of them. The non-discriminatory principle should be singled out as the first one. It means that commercial conditions should be equivalent to all business partners only if there is an economic justification for different conditions. Such economic justification may include the existence of various purchasing volumes, marketing activities, storage and logistics facilities, etc.
Special attention should be paid to the giving of discounts and bonuses. The main rule regarding discounts and bonuses is avoidance of distortion of competition between commercial partners operating on the same market. Similar to implementation of commercial conditions, there should be economically justified approaches to the provision of discounts and bonuses.
In some cases the development and implementation of the mentioned internal documents require a lot of effort and resources from the companies. Moreover, the enlisting of qualified lawyers to this process may be considered as highly recommended. These efforts are reasonable, since they help to develop a defence strategy for the case of possible dialogue with the competition authority and significantly mitigate the risks of antitrust violations with imposition of a fine in the amount up to 10% of a company’s annual turnover.