Vertical Agreements: Section 3(4)

A vertical agreement is one between enterprises at different levels of the production or distribution chain, typically a manufacturer and its distributors or a supplier and its dealers. Such parties are not competitors; they are cooperating to bring a product to market, and their restrictions often serve a legitimate purpose. That is why Section 3(4) raises no presumption and requires the appreciable adverse effect to be established. In practice the decisive question in every vertical case is whether the supplier has enough market power for the restraint to matter, because a restriction imposed by a firm with no power simply moves business to its rivals.

1. The Provision

Section 3(4) provides that any agreement amongst enterprises or persons at different stages or levels of the production chain in different markets, in respect of production, supply, distribution, storage, sale or price of, or trade in, goods or provision of services, including the five kinds listed, shall be an agreement in contravention of Section 3(1) if such agreement causes or is likely to cause an appreciable adverse effect on competition in India. The five listed kinds are tie-in arrangement, exclusive supply agreement, exclusive distribution agreement, refusal to deal and resale price maintenance, and each is defined in the Explanation to the sub-section.

2. Tie-in Arrangements, Tying and Bundling

A tie-in arrangement is defined as one requiring a purchaser of goods, as a condition of such purchase, to purchase some other goods. The seller uses the buyer's demand for one product, the tying product, to require the purchase of a second, the tied product. Four ingredients are ordinarily looked for.

1. Two separate products. There must be two products for which there is separate demand. Where buyers never want one without the other, or where the combination is an integrated product, there is no tie.
2. Market power in the tying product. Without it the buyer simply goes elsewhere, and the arrangement cannot foreclose anything.
3. Coercion. The purchase of the second must be a condition of obtaining the first, though the condition may be practical rather than contractual, as where the products are supplied only as a package or the warranty is voided by using another supplier.
4. Foreclosure of a not insubstantial part of the market for the tied product. This is where the harm lies: rivals in the tied product lose access to the buyers who must take the seller's version.

Bundling is the related practice of selling products together on terms that make separate purchase unattractive. Pure bundling offers the products only as a package; mixed bundling offers them separately as well, but prices the package so far below the sum of the parts that few buy separately. Bundling is not a tie in the strict sense, because separate purchase remains possible, and it is examined under Section 3(4) by its effect, or under Section 4 where the seller is dominant.

3. Exclusive Arrangements and Refusal to Deal

• Exclusive supply agreement. Defined as any agreement restricting in any manner the purchaser in the course of his trade from acquiring or otherwise dealing in any goods other than those of the seller or any other person. The restriction is on the buyer, who agrees to buy only from this supplier; the harm is that rivals of the supplier lose access to that buyer, and where enough buyers are tied up, to the market.
• Exclusive distribution agreement. Defined as any agreement to limit, restrict or withhold the output or supply of any goods or allocate any area or market for the disposal or sale of the goods. The restriction is on the distributor, who is given a territory or a class of customers and confined to it.
• Refusal to deal. Defined as any agreement which restricts, or is likely to restrict, by any method the persons or classes of persons to whom goods are sold or from whom goods are bought. It covers the collective refusal, which is horizontal, and the supplier's insistence that a dealer not supply particular customers, which is vertical.
• Exclusive dealing is the general expression for arrangements of the first two kinds, and is not itself a statutory term.

The analysis of all three is the same. One asks what proportion of the market is foreclosed, for how long, and whether alternative routes to market remain. A short exclusivity in a market with many distributors forecloses nothing; a long exclusivity covering most of the available distribution capacity may leave a rival with no way of reaching customers. The justification usually offered is investment protection: a distributor asked to invest in showrooms, training or after-sales service will not do so if a rival can take the benefit of that investment.

4. Resale Price Maintenance

Resale price maintenance is defined as including any agreement to sell goods on condition that the prices to be charged on the resale by the purchaser shall be the prices stipulated by the seller unless it is clearly stated that prices lower than those prices may be charged. The definition therefore condemns the fixing of a resale price, and expressly permits the stipulation of a price from which the dealer is free to go lower.

1. Minimum resale price maintenance. The dealer may not sell below a stated price. This is the harmful form. It removes price competition between the dealers of the same brand, it makes a supplier-level cartel easier to police because any cheating shows up at the retail level, and it can foreclose an efficient discount retailer who cannot use its lower costs.
2. Maximum resale price maintenance. The dealer may not sell above a stated price. This is generally benign and often beneficial, since it prevents a dealer with local market power from exploiting customers, and it falls outside the statutory definition, which is directed at a floor rather than a ceiling.
3. Recommended prices. Permissible if genuinely recommended. The question is always whether the recommendation is enforced, by withholding supply, by reducing discounts, by monitoring and warning, or by a system requiring dealers to seek approval before offering a discount; where it is, the recommendation is resale price maintenance in substance.
4. Minimum advertised price restrictions. A restriction on the price at which a product may be advertised, as distinct from the price at which it may be sold. It is less restrictive in form but produces much the same effect in a market where customers shop by advertised price, and is examined as a variant of resale price maintenance.

5. Territorial, Customer and Parity Restrictions

Three further restraints appear constantly in distribution agreements and are examined under the opening words of Section 3(4) even though they are not among the five listed kinds.

• Territorial restrictions. The dealer is confined to a territory. An exclusive territory given to one dealer, with others free to sell into it passively, is less restrictive than an absolute prohibition on selling outside the allotted area, which eliminates competition between dealers of the same brand altogether.
• Customer restrictions. The dealer may sell only to a defined class, as where a wholesaler may not supply end users, or an industrial distributor may not sell to retail. The analysis mirrors territorial restriction.
• Most favoured nation or parity clauses. The supplier promises that the buyer will receive terms no worse than any other buyer, or, in the platform context, the seller promises the platform that it will not offer better prices elsewhere. A narrow parity clause covers only the seller's own direct channel; a wide parity clause covers all other channels including rival platforms.

6. Non-Compete Clauses, Franchising and Distribution

A non-compete clause restrains a party from carrying on a competing business during or after the agreement. In Indian law two provisions meet here. Section 27 of the Indian Contract Act, 1872 makes an agreement in restraint of trade void as between the parties, subject to the exception for the sale of goodwill and to the position under the partnership legislation. Section 3(4) asks a different question: whether the restraint forecloses competition in a market. A covenant of reasonable duration and scope, ancillary to a legitimate transaction such as a franchise or the sale of a business, is ordinarily unobjectionable under the Competition Act; one that extends far beyond what the transaction requires, or that is imposed by a firm with market power across a substantial part of the market, is not.

Franchise agreements combine several of these restraints at once: exclusive territory, exclusive supply of inputs from the franchisor or nominated sources, price recommendations, and non-compete covenants. The justification is the protection of the brand and of the franchisor's investment in the system, and Indian practice accepts that restraints necessary to maintain uniformity and quality across a franchised network are legitimate. What is examined is whether a particular restraint is necessary for that purpose or goes beyond it, the commonest example being a requirement to buy from the franchisor inputs that are not brand-specific and are freely available in the market.

7. Section 3(4) and Section 4

The same conduct will often be examined under both provisions, as it was in Kataria, and the differences should be kept clear.

8. How a Vertical Case Is Analysed

1. Define the relevant market, in its product and geographic dimensions, under Sections 2(r) to 2(t) and 19(5) to 19(7).
2. Establish the agreement and identify the restraint, and confirm that the parties are at different levels in different markets.
3. Assess the supplier's market position. Without meaningful market power a vertical restraint rarely produces an appreciable adverse effect, because buyers and dealers have alternatives.
4. Measure foreclosure. What proportion of the market is tied up, for how long, and what routes to market remain for rivals; consider also the cumulative effect where many suppliers in the market use similar restraints.
5. Weigh the justification under the beneficial factors in Section 19(3): protection of investment, prevention of free riding, assurance of quality and after-sales service, and the avoidance of double marginalisation.
6. Reach a single conclusion on appreciable adverse effect, remembering that there is no separate efficiency defence and that the benefits are weighed in the same exercise as the harm.

9. Related Topics and Provisions