Too Restrictive? Non-Compete Clauses in EU

In business, it is common for supplier/distributor agreements to include some kind of non-compete clause to protect the business interests and market position of the supplier.  

The intention of such clauses is to restrict the trading activities of the distributor for a specified period of time and within a certain geographical area, for example, preventing them from selling competing products or engaging in business activities that directly compete with the supplier's products. 

The primary goal of a non-compete clause is to ensure that distributors remain loyal to the supplier and do not undermine their market strategy. 

Designed to prevent unfair competition and protect confidential information, trade secrets, and business interests, they can be designed to grant the distributor exclusive rights to sell the supplier’s products within a specific territory with  a reciprocal agreement by the distributor not to sell a competitor’s product; they can stop distributors from poaching a supplier’s customers or clients for the benefit of competing businesses, or they can restrict the distributor’s ability to engage in competitive activities for a limited period of time after the end of the distribution agreement. 

Non-compete clauses are generally reasonable tools that help protect the supplier’s business but they can very easily slip beyond the bounds of reasonableness and become overly restrictive on the distributor, and if the distributor is located in the EU, they can easily fall foul of EU Competition Law if not carefully drafted by someone who fully understands the legislation.  

“Beware: non-compete clauses with EU distributors that are too vague can easily fall foul of EU Competition Law” 

In the EU, competition laws were introduced to ensure fair trading across the regions by banning agreements and practices that create an unbalanced playing field , i.e. 

• Fixing prices or trading conditions. 

• Limiting or controlling production, markets, or technical development. 

• Sharing markets or sources of supply, i.e. controlling what is available to the consumer. 

• Apply different conditions to equivalent transactions, placing some companies at a competitive disadvantage,  

• or even making the agreement of one contract subject to acceptance of other obligations that are not related to the contract itself. 

Non-compete clauses (particularly those that are designed to survive the end of the distribution contract), can very easily reflect one or more of those prohibited traits and be challenged as “unfair” and in breach of EU competition law. 

So How Does the Supplier Protect his Business Interests? 

The EU acknowledged that in supplier and distributor contracts, it is sometimes necessary for the supplier to provide the distributor with commercially sensitive information to enable them to sell the products successfully, information such as Trade Secrets, Pricing Strategies or Ongoing Client Relationships. 

It was accepted that in such circumstances, the supplier would need to be able to protect what the distributor can do with that information. So, to ensure fairness to all, they defined limited circumstances in which non-compete clauses could be considered exempt from EU  Competition Law restrictions. They were defined as: 

Objective Necessity – to prevent the know-how and assistance provided by the supplier from benefitting competitors, 

High Commercial Risks – where trade secrets have been passed to the distributor to enable sales. 

Quality Control – to ensure the quality of sales and services, to benefit the customer e.g. in terms of safety of electrical goods. 

Whether or not a business can depend on the exemptions is not straight forward and depends on many things, such as the size of the market share held by the businesses concerned, and how long the distributor is likely to be restricted by the clause. 

Most importantly, the exemption will not allow the restrictions to go beyond what is necessary to protect the supplier's interests. 

“Each non-compete clause must be considered on its own merits - what works for one company may not be the right fit for another.” 

Note:  It is important to note that this is not an exhaustive list of restrictions or exemptions but merely a sample to illustrate why it is important to give non-compete clauses sufficient attention. 

To Qualify for Exemption 

To qualify as an exemption a clause must fulfil all four of the following criteria: 

1. It must relate only to goods or services which compete with those specified in the contract. 

2. It must be limited only to the area from which the distributor has operated during the contract period. 

3. It must be necessary to protect know-how transferred by the supplier to the distributor, and  

4. The duration of the obligation cannot exceed a period of one year after termination of the contract. 

Hardcore Restrictions 

There are a number of activities that can NEVER be exempted from the EU Competition laws,  

known as the “Hardcore Restrictions”, these include: 

• Price fixing 

• Territorial or individual customer restrictions 

• Restricting sales of parts for repairs 

• Selective distribution systems 

Consequence of a Breach 

There are a range of penalties that can result from a breach, which include: 

• Voidance of the clause, or even the whole contract; 

• Directors can be disqualified  

• and in very extreme circumstances, there is even a risk of a custodial sentence 

• but in reality the most likely risk is a financial penalty that can be imposed, up to the value of 10% of the perpetrator’s entire worldwide turnover. 

“Potential Fine: Up to 10% of Worldwide Turnover” 

To Conclude 

Non-compete clauses in distribution agreements are essential tools for protecting business interests, but if they relate to trading in the EU they must be carefully crafted to ensure they comply with EU competition law.  

Balancing the need for protection with the principles of fair competition requires a thorough understanding of the EU legal framework and market dynamics and it would be wise for suppliers and distributors to seek legal assistance to ensure their agreements do not inadvertently breach the EU’s strict competition laws.