Ukraine: Commercial Agency: a Thousand and One Questions - Parts I, II and III

Originally published in The Ukrainian Journal of Business Law, March 2006

The world has grown smaller, by now, thanks to globalization and e-commerce. Now while staying in your office you can easily enter a contract with a German agent to purchase goods, which are produced by a Singaporean manufacturer, and will be delivered to you by a Swedish transportation company. The intermediary business is rapidly influencing the establishment and development of local markets and creation of strong contractual relations between those who can offer and those who want to buy or use goods, technologies, rights, services etc. Intermediary companies, e.g. commercial agents, sales representatives, distributors, exclusive importers, franchisers as well as occasional intermediaries and brokers help to start up businesses seeking to expand to large multinational corporations looking for a market as well as large manufacturers to expand into a certain market. At the same time international intermediary work in business usually requires the application of mandatory provisions of foreign law that makes this sort of agreement "potentially dangerous", as without knowledge of the national regulation of the agent's activities or the principle's scope of powers, the corresponding party can face serious problems in ensuring its business interests or legal rights.

However, the number of companies offering goods and services for cross-border trade using third party relationships as a distribution mechanism is growing increasingly. The indicated third party relationships may be divided into three main groups: (i) commercial agency; (ii) distribution and (iii) franchising.

A commercial agency in international trade is defined as activities of a commercial agent (a company or a self-employed intermediary) that has continuing authority to negotiate the sale or the purchase of goods on behalf of another person or company, usually called the 'principal', or to negotiate and conclude such transactions on behalf of and in the name of that principal. Distribution in international trade is defined as activities in which the supplier, who grants the distributorship to one or more distributors, offers them the right to sell the products manufactured or distributed by the supplier, in their own name and on their own account. Franchising is a system of marketing goods and/or services, which is based upon close and ongoing collaboration between separate and independent undertakings, the franchisor and franchisees, whereby the franchisor grants its franchisee the right, and imposes the obligation, to conduct business in accordance with the franchisor's concept. The right entitles and compels the individual franchisee, in exchange for a financial consideration, to use the franchisor's trade name, and/or trade mark and/or service mark, knowhow, business and technical methods, supported by continuing provision of commercial and technical assistance, within the framework and for the term of a franchise agreement, concluded between parties for this purpose.

We do not intend to cover all the said activities. But taking into account the growing interest and real need of users we shall try to present the real situation in the area of legal regulation of the agency from the point of view of Ukrainian law. A commercial agency in international trade provides a convenient structure enabling a foreign supplier to penetrate an overseas market. By using the services of an agent, the principal can benefit from the knowledge and local connections of the agent, avoid the investment and commitment of managerial resources required by the establishment of a branch or subsidiary, and by taking advantage of the agent's services on a commission basis, can effectively test the overseas market on a "no cure, no pay" basis.

Notwithstanding the advantages of using a commercial agency as a vertical distribution mechanism, manufacturers and others who use the latter internationally face a myriad of legal issues in pursuing their business goals e.g. national regulations or absence of the latter, mandatory liability provisions, competition issues, etc.

In view of the above we hereby introduce a series of articles dedicated to the legal aspects of commercial agency relations starting with the present article, which addresses the general provisions of Ukrainian legislation on agency relations.

Our ambitious goal is not only to acquaint the audience with the latter and pour light on "sacred areas" but to help potential principals or agents to sail between the "reefs" for the common good of their business.

PART I

Agency Relations Under Ukrainian Law: Danger Foreseen is Half Avoided

Commercial agency received special regulations in Ukraine only in 2004, when the new Civil Code of Ukraine (the Civil Code) and Commercial Code of Ukraine (the Commercial Code) came into force. The Civil Code governs general obligations and contractual matters e.g. freedom of contract, performance of obligations, breach of contract, general principles of representation, etc. The Commercial Code sets out special provisions on commercial intermediation (agency relations)¹. In addition, the relations established in the process of commercial intermediation (agency activities) may also be regulated by other regulatory and legal acts adopted according to the Commercial Code and determining the specifics of commercial intermediation in particular sectors of commercial activities². Moreover, matters of agency relations not regulated by the said acts shall be regulated by the relevant provisions of the Civil Code on a mandatory agreement. Besides, the relevant provision of the Private International Law Act of Ukraine should apply to commercial agency relations with a foreign element³.

Ukrainian legislation still does not provide for a separate act dealing with a commercial agency (including international) and related questions (for instance, indemnity) that entails the necessity to observe quite a long list of laws and regulations in order to be confident that all the aspects of agency relations are duly set. Besides, the absence of such a unified act creates the need to develop quite a comprehensive agency agreement to cover all issues the parties want take care of.

Notion of Commercial Agent

Ukrainian legislation in force does not provide for a clear definition of commercial agent. At the same time, Article 295 of the Commercial Code defines commercial intermediation (agency relations) as business activities (entrepreneurship)⁴ that envisage services provided by commercial agents to business entities in the process of their commercial activities by way of intermediation on behalf, for the benefit and under control of the entity represented⁵. Paragraph 2 of the said Article states that a commercial agent shall be a business entity (citizen or legal entity)⁶ engaged in commercial mediation in accordance with its competence based on the agency agreement. Paragraph 3 also provides that entrepreneurs, although acting for another's benefit but on their own behalf, shall not be deemed as commercial agents. Proceeding from the above the following characteristics of the commercial agent may be defined: (i) a business entity⁷, (ii) provides services of intermediation to the principal, (iii) acting on behalf, for the benefit and under the control of the latter.

Agency Agreement: Formal Requirements

It should be noted that pursuant to Article 296 of the Commercial Code, agency relationships in Ukraine can arise from an agency agreement or when a commercial agent enters into an agency agreement for the benefit of a business entity being not entitled thereto or exceeding powers provided with further approval (in the form of written approval or by conduct) of the said entity. The latter possibility is directly provided for by Ukrainian legislation and provides for the principal obligations to the agent.

Ukrainian law requires an agency agreement to be concluded in writing (Article 297 of the Commercial Code) i.e. by entering into a single document or by exchange of notes, faxes, telegrams etc. or through confirmation of receipt of orders to be fulfilled. Moreover, it is provided that if any of the parties demands the agency contract may be notarized (Article 209 of the Civil Code). Failure to comply with a written form of the agency agreement does not entail its invalidity (Article 218 of the Civil Code). Denial by one of the parties of the fact that the transaction was concluded or the contesting of some of its parts shall be proven with documentary evidence, means of audio/video recording and other evidence, except for testimonial evidence. It shall be noted that if the agency agreement was not concluded in writing, but one of the parties performed an act and the other party confirmed its performance, the said agreement can, in the event of a dispute, be found valid by a court.

Essential Provisions of the Agency Agreement

Pursuant to Article 638 of the Civil Code, an agreement shall be concluded if the parties have duly reached consensus on all its essential provisions. Pursuant to Article 297 (2) of the Commercial Code, the provisions on the following issues shall be considered as essential: the sphere, nature and procedure of mediation services provided by the agent (scope of the agent's authorities), rights and obligations of the parties, terms and amounts of reimbursement to the commercial agent, duration of agreement, sanctions applied in the event of violation of the agreement.

Therefore, if the parties do not agree on one or more of the above, an agency agreement may be considered as having not been concluded. The consequences of recognition of the agreement as unconcluded in the event of the absence of the legal fact, which entails legal effects, are not stipulated in the law directly but we believe that the consequences of such unconcluded agreements may be the same as for invalid agreements.

Agent's Authorities

Pursuant to Article 297 of the Commercial Code "under the agency agreement the commercial agent is obligated to provide services to the principal with regard to conclusion of agreements or facilitation thereof (provision of actual services)". Moreover, the agreement shall specify the sphere, nature and procedure of mediation services provided by the agent, rights and obligations of the parties etc.

Proceeding from the above, we are of the opinion that the agent's authorities (powers) shall be provided in the agency agreement. The latter primarily applies to the power to enter into contracts on behalf of the principal. The said authority shall not be considered as deriving directly from the agency agreement, but it shall be specifically provided therein (contract clause). Therefore, the parties to the agency agreement should set out therein the scope of the agent's authorities e.g. to facilitate the conclusion of the agreements by the principal and/or to conclude agreements on behalf of the principal.

As far as conclusion of the agreements without authorization of the principal or in excess of authoritiers is concerned the following should be noted. Such agreements shall be deemed to be approved by the principal unless the actions of the commercial agent are directly rejected by the principal with notification of the third party. The law does not provide for any details of such notification. According to the general principals of civil law such notification shall be made in writing and send to the third party at the earliest reasonable convenience⁸. It shall be noted that subsequent approval of the agreement by the principal shall bring this agreement into legal effect from the day of its conclusion. Therefore, even if the parties do not stipulate the agent's right to conclude the agreements on behalf of the principal, such agreements shall be valid unless the principal rejects such actions of the agent before the third party. If the principal does not provide the third party with written notification on rejection of the agreement concluded by the agent within a reasonable period of time or the terms provided for by the agreement, he will be bound by the latter.

Sub-Agents

According to Article 300 of the Commercial Code, the agent shall personally perform all the actions under the agency agreement unless otherwise agreed by the parties and/or envisaged by the agency agreement. Therefore, the agent is strictly prohibited to assign the rights under the agency agreement to other entities at his own discretion.

Notwithstanding the above and proceeding from the general principles of civil law, we are of the opinion that the agent should be entitled to entrust a third party with the performance of the agency agreement only if he is forced to do so by circumstances aimed at protecting the interests of the principal (Article 1005 of the Civil Code). In such a case the agent shall immediately notify the principal thereof and after having done so he shall be liable only for a lack of due diligence in the substitute's choice but not for his actions.

Competing and Exclusivity Issues

Ukrainian law provides for two kind of agency relationships: monopoly and non-monopoly (Article 299 of the Commercial Code). Under a monopoly agency agreement the agent shall refrain from acting for competitors of the principal within the territory and time boundaries envisaged by an agreement. But if the agency agreement does not comprise such a requirement, the agent is free to act for the principal's competitors provided that the interests of the other persons being represented by the agent at the same time are not in conflict with the issues the agent is invited to resolve for the principal.

Pursuant to Article 299 (2) of the Commercial Code the parties to the agency agreement may agree on the time and territorial boundaries within which the agent is prohibited to act for the competitors of the principal. Therefore, we believe that according to the said Article it should be possible to extend contractually the agent's non-competition obligation to the promotion of non-competing goods of competing manufacturers as well as the agent's non-competition obligation to the promotion of competing goods outside the contractual territory.

Ukrainian law does not contain provisions on agency exclusivity issues. Therefore, the latter may be provided for by the agency agreement. When the exclusivity is absolute i.e. clearly provided for by the agency agreement, under Ukrainian law the principal shall not be entitled to appoint other agents. Pursuant to Article 299 of the Commercial Code, if the agreement does not state anything with regard to the agent's exclusivity the principal is entitled to appoint other agents or distributors, having duly notified the agent of such appointments without paying any compensation.

PART II

Agent and Principal: Conflict of Interests

Acceptance of Business: is a Principal Obliged to Accept Business Passed to Him by Agent?

Agency relationships consist not only of obligations of the agent to provide services to the principal with regard to conclusion of agreements or facilitation thereof but of the obligations of the principal with regard to acceptance or refusal of the business⁹ and/or orders transmitted to him by the agent.

Ukrainian law does not set out any rules on whether the principal is free to decide if he wishes to accept or to refuse business passed to him by an agent. Providing for the obligation of the agent to inform the principal of every instance of mediation in conclusion of agreements and of every agreement concluded for the benefit of the latter¹⁰, Ukrainian law contains no provision on return obligations of the principal e.g. to inform the agent within a reasonable period about his decision to accept or to refuse an order transmitted by the agent.

Providing for no regulations on acceptance of business by the principal under the agency agreement, Ukrainian legislation, by setting out the principle of freedom of contract, allows the parties to settle the said issue therein. Taking into account the above, we believe that in order to avoid any possible conflicts or disputes in future the parties to out agency agreements should set out therein whether the principal is free to decide if he wishes to accept or refuse business passed to him by the agent, notification procedure and terms, agent's right to commission in such cases, etc.

Agent's Right to Commission: Better to be Regulated in an Agreement

In international trade practice most commercial agents are paid a percentage of the net sales value of the goods which they market for the principal. In many cases where an agent has an exclusively defined territory he is entitled to commission on all sales in this territory whether generated by him or not. Ukrainian law defines provisions of an agency agreement on the terms and amounts of remuneration¹¹ to the commercial agent (commission) as essential ones¹². Pursuant to Article 638 of the Civil Code an agreement shall be concluded if the parties have duly reached consensus on all its essential provisions. Therefore, if in the absence of any provision as to remuneration between the parties to the agency agreement the latter may be considered as unconcluded¹³. As far as the amount of the commission is concerned, Ukrainian law does not limit in any way the freedom of parties to agree upon the rate of commission.

Business on Which Commission is Due

Commission in international trade is normally paid on the sales generated either by the agent in his territory (and possibly, though not usually, outside his territory) or on all orders received from the agent's territory (where he has an exclusive territory). Ukrainian law does not provide any details with regard to the definition of the business on which commission is paid. Therefore, the parties shall provide the definition of the basis of commission in the agency agreement as well as any other related provisions e.g. deduction of cash discounts, carriage and insurance, sales taxes etc. In addition, the parties may provide for an agent's right to commission on successive sale with customers previously acquired by him for the principal as well as his right to commission on direct sales made by the principal in the territory. Pursuant to Article 301 (6) of the Commercial Code, the parties may also stipulate in the agency agreement the terms of payment commission to the commercial agent for the business concluded or carried out after contract termination. We suppose that it is in the best interests of both parties to provide the latter in the agency agreement.

Moment When the Right to Commission Arises

According to Article 301 of the Commercial Code, the agent is entitled to commission upon the payment made by the customer pursuant to the agreement concluded through the agent's mediation, unless otherwise envisaged by the agency agreement. Therefore, it is possible to conclude that the general rule established by Ukrainian law provides that the agent is entitled to receive commission only after the receipt by the principal of the payments from the customers under the concluded agreements.

Waiver of Right to Commission

Many agency contracts in international trade provide for the loss by the agent of his right to commission if his does not claim the latter within a defined period of time. We believe that there is a risk that such a provision may be considered by Ukrainian courts as an implicit shortening of the limitation of action period, which is prohibited by Ukrainian law. At the same time, Ukrainian law allows the parties to envisage such provision by using a different concept and wording. Proceeding from the concept of waiver of material right provided for by Ukrainian law¹⁴, the parties may stipulate in the agency agreement that the agent shall be considered as having waived his right to commission if he does not claim the latter within the defined period of time.

Non-Execution of Accepted by the Principal Business and Agent's Right to Commission

Different situations may arise when the principal does not perform an agreement concluded on the basis of the order transmitted by the agent which was previously accepted. A lot of questions emerge as to whether the agent is, nevertheless entitled to commission or the agent is entitled to commission only if and to the extent the non-performance is due to reasons for which the principal is responsible. In the latter case, what are the reasons for which the principal shall be responsible e.g. accepting return of goods for commercial reasons or when the risk exists that the customer will not pay, non-performance by the principal in cases where he is entitled to do so by the contract with the customer, etc. In addition, similar questions may also arise when the business is accepted by the principal, the agreement with the customer is entered into and performed in future by the principal but the customer, in his turn, does not perform the contract, i.e. does not pay the amounts due.

Ukrainian legislation regarding the said issues is ambiguous. At the same time, as stated above, the moment when the right to commission arises is directly linked with the moment of receipt by the principal of the payments from the customers under the concluded contracts, unless otherwise envisaged by the agency agreement. Thus, though there are no direct provisions we are of the opinion that the agent would not be entitled to commission if the principal does not perform the contract concluded on the basis of the order transmitted by the agent and accepted, unless otherwise provided for by the agency agreement. In addition, even if the principal does perform the contract entered as a result of the agent's activities but the customer does not pay the amounts due, the agent would, nevertheless, not be entitled to commission, unless otherwise provided for by the agency agreement. Thus, we believe that the latter provisions are very principal-friendly e.g. allowing the principal to act at his own discretion after the acceptance of the business passed to him by the agent without paying any commission to the latter.

Proceeding from the above, we believe, that for benefit of both parties, and especially for the agent's benefit, terms and condition related to agent's right to the commission in case of non-execution of business accepted by the principal (related both to non-execution by the principal as well as by the customer) should be set out in the agency agreement/contract.

Del Credere Agents: Are They Admissible Under Ukrainian Law?

Many questions arise in international trade transactions when a person in consideration of extra remuneration guarantees to his principal that third parties with whom he enters into contracts on behalf of the principal will duly pay any sums which become due under those contracts — a so called del credere agent. Shall that person be considered an agent at all taking into account the quasi-agency relations arising due to the taking of risk on transactions or should that person be considered as acting on his own account.

The general rule provided for by Ukrainian law sets out that the agent, unless otherwise provided for by the agency agreement, does not guarantee to the principal execution by third parties of the obligations stipulated in the commercial agreements concluded through the agent's mediation.¹⁵ At the same time, it also stipulates that the parties to the agency agreement can envisage that the agent receives additional remuneration if he undertakes to guarantee execution of the agreement concluded by him for the benefit of the principal.¹⁶ Notwithstanding the above, while considering the present issue Ukrainian legislation on financial services, which are determined as activities to be conducted solely by authorized financial institutions, shall be taken into account. The latter refers to the guarantee to financial operations that may be conducted in Ukraine only by authorized financial institutions¹⁷. Therefore, as of now the provisions of an agency agreement providing for issuance of guarantees by a Ukrainian agent can be considered inoperative. At the same time, we believe, that Article 301 (3) of the Commercial Code should be considered as the first step in the direction of allowing the del credere clause in Ukraine. However, taking into account the fact that the Ukrainian financial market is only just sprouting, Ukrainian legislators are trying to restrict financial operations performed in order to secure stability on the market. The situation is changing rapidly and, therefore, del credere agents may become operational in Ukraine in the near future.

The said, however, does not exclude in general the possibility of the parties to the agency agreement providing some sort of del credere clause and/or del credere commission, though Ukrainian legislation does not operate directly through such terms. Proceeding from the basic principals of the law of obligations, an agent and a principal can stipulate corresponding rules in their agency agreement subject to applicable law and imperative rules thereon if any.

The Principal's Trademarks: the Safe Way

Often within the cooperation framework under the agency agreement, the principal authorizes the agent to use his trademark and/or other proprietary rights in the context of his promotional activity. The latter may be provided in a simple letter of authorization or in an agency agreement or a party may deem it necessary to sign a separate license agreement for that purpose.

Ukrainian law entitles the trademark owner (holder of the relevant certificate) to give a permit (license) to another person for the use of trademark on the basis of the license agreement. The latter shall contain essential provisions setting out that the quality of goods and services produced or rendered under the license agreement shall not be lower than those of the certificate holder, and that the latter shall exercise control over the fulfilment of this provision. The license agreement is valid provided it is in writing, signed by the parties and further registered at the State Department of Intellectual Property with the Ministry of Education and Science of Ukraine.

Proceeding from the above, Ukrainian law allows the parties to the agency agreement to provide authorization to the agent to use the principal's trademark and/or other proprietary rights in the context of his promotional activity in either the agency agreement or in separate license agreements provided that essential mandatory provisions are met.

PART III

Agency Agreements Under EU Competition Rules

The competition rules of the European Union ("EU") are of fundamental importance for conclusion and operation of commercial representation as well as for protecting commercial agents vis-à-vis their principals as the differences in national laws concerning commercial representation can sufficiently affect the latter. The said rules apply not only to agreements entered into by both parties of the EU Member States but also agreements, which are entered into by parties from other countries but have effect within the EU. Even though the EU competition law rarely causes problems in relation to agency agreements, such rules impose a number of constraints which should be considered by the parties when drafting such agency agreements. The present Article sets out the key features of the applicable EU regulations. The flow chart of this Article will hopefully help to understand the rules and will facilitate the reading of this overview.

General Overview of EU Competition Rules

The competition rules of the European Community ("EC") substantially affect the drafting of agency agreements that relate to this geographic area. Agency agreements are defined as so-called vertical agreements i.e. agreements entered into by parties operating at a different levels of the production or distribution chain. Vertical agreements which simply determine the price and quantity of a specific sale and purchase transaction do not normally restrict competition. However, a restriction of competition may occur if the agreement contains restraints on the supplier or the buyer ("vertical restraints"). Examples of such vertical restraints are an obligation on the buyer not to purchase competing brands (i.e. non-compete obligation) or an obligation on the supplier to supply only a particular buyer (i.e. exclusive supply). Therefore, although vertical agreements are normally less harmful to competition than horizontal agreements i.e. agreements entered between competitors in the same product market, this does not imply that they may nevertheless restrict competition as described above and, consequently, conflict with the prohibition of restrictive agreements set with in Article 81¹⁸ of the EC Treaty, which provides:

Thus, clauses of agency agreements preventing the parties from dealing with third parties (e. g. obligation of an agent not to market products that compete with those of the principal) or restricting freedom of a agent (e. g. obligation to limit his activity to the territory or to the customers assigned to him) may conflict with the prohibition of restrictive agreements contained in Article 81(1) of the EC Treaty.

Consequences of Infringing EU Competition Law. The clauses of the agreements falling under the prohibition of Article 81 are null and void. Furthermore, in the event of infringement of Article 81 fines up to 10% of worldwide turnover may be imposed by the European Commission or the relevant competition authority of the EU Member State on both principal and agent. In addition, third parties are entitled to bring claims for damages if they have suffered losses through the operation of an anti-competitive agreement of this sort, though such claims are rarely brought.¹⁹

Not Falling and Exempted Agreements. It is obvious that the agreements which do not restrict competition or which otherwise do not fall under the definition of restrictive agreements provided in Article 81 (1). In addition, it shall be noted that even not all agreements containing competition restricting clauses shall be considered unlawful i.e. agreements not falling under the prohibition of Article 81 and agreements caught by Article 81(1) but exempted from prohibition if they fulfill the conditions of Article 81(3).

Agreements Not Coming Under Prohibition of Article 81(1). In some situations the prohibition of Article 81(1) does not apply for reasons which do not regard the restrictive nature of the latter i.e.

1. agreements which do not affect trade between Member States. Case law has developed a rather broad notion of so-called effect on trade criterion²⁰, the main purpose of which is to exclude from the scope of application of Article 81 agreements which exclusively affect the internal market in a single Member State or other third states and have consequently no appreciable affect on competition at Community level²¹. The main idea is that all cross-border distribution agreements within the EU will in principle fall under the said EU competition regulations. As far as domestic agreements and agreements with parties outside the EU are concerned, it shall be noted that even if formally they do not fall under Article 81(1) the effect on inter-state trade within the EU should be considered in every single case.²²
2. agreements which do not affect competition to an appreciable extent under the so-called de minimus rule. Pursuant to the European Commission, for vertical agreements not containing hardcore restraints (please see below) the 15% threshold will normally be applicable²³. Consequently, if the market share²⁴ of both parties is lower than 15% the agreement is generally considered not to have appreciable anti-competitive effects. Where the market is foreclosed by the application of parallel networks of similar vertical agreements by several companies, the de minimis threshold is set at 5 %. It shall be noted that the Court of Justice developed a different approach on the issue. Pursuant to case law, agreements of minor importance do not fall under Article 81(1) if they do not reach the lower threshold (between 1% and 5%)²⁵. Notwithstanding the above, we believe that the Commission's indication will be followed by other authorities. However, it is very hard to define the relevant market that may not like to rely on this notice and it is not legally binding on the Commission in any event. In addition, in some cases if a party has interest in showing that Article 81(1) applies, it should not be excluded that a court may come to a different approach.

Beneficial Restrictive Agreements. It shall be noted that all agreements, even if they are restrictive, but meet the requirements under Article 81(3) of helping consumers and providing technological advances, will be automatically exempted from their outcome. Until May 2004 such exemption was made by way of notification to the European Commission but since that date it has been automatic.

Agency Agreements: Falling Within the Scope of Article 81(1) or Not?

The general approach on the said issue was set out by the European Commission in its Guidelines on Vertical Restrains²⁶ providing for criteria for the assessment of agency agreements. Genuine agency agreements do not fall within the scope of Article 81(1). The deciding factor in assessing whether Article 81(1) is applicable to an agency agreement is financial or commercial risk borne by the agent in the relation to the activities for which he has been appointed as an agent by the principal. Two types of financial or commercial risk are material to this assessment:

1. there are the risks which are directly related to the contracts concluded and/or negotiated by the agent on behalf of the principal, such as financing of stocks;
2. there are the risks related to market-specific investments. These are investments specifically required for the type of activity for which the agent has been appointed by the principal, i.e. which are required to enable the agent to conclude and/or negotiate a particular type of contract. Such investments (for example, the petrol storage tank in the case of petrol retailing) are usually irrecoverable costs, because upon leaving the particular field of activity the investment cannot be sold or used for other activities, other than at a significant loss.

The agency agreement is considered a genuine agency agreement falling beyond the scope of Article 81(1) if the agent does not bear any of these two types of risk. Risks being related to the activity of providing agency services in general, such as the risk of the agent's income being dependent upon his success as an agent or general investments in (for instance, premises or personnel) are not material to this assessment.

Block Exemption: Benefits to be Used

Vertical restraints may not only have negative effects but also positive effects. They may, for instance, help a manufacturer to enter a new market, or avoid the situation whereby one distributor 'free rides' on the promotional efforts of another distributor, or allow a supplier to depreciate an investment made for a particular client.

Whether a vertical agreement actually restricts competition and whether in that case the benefits outweigh the anti-competitive effects will often depend on the market structure. In principle, this requires an individual assessment. However, the Commission has adopted the Block Exemption Regulation (the "BER")²⁷, which entered into force on 1 June 2000 and which provides a safe harbor for most vertical agreements including agency agreements. The BER renders by block exemption the prohibition of Article 81(1) inapplicable to some vertical agreements entered into by companies with market shares not exceeding 30 %.

The BER applies in principle to all vertical agreements concerning the sale of goods or services. Although the BER applies in principle to all vertical agreements, it generally does not apply to vertical agreements concluded between competitors.²⁸

The BER contains certain requirements that have to be fulfilled before it renders the prohibition of Article 81(1) inapplicable for a particular vertical agreement:

1. the agreement does not contain any of the hardcore restrictions set out in the BER;
2. the market share cap of 30%;
3. conditions relating to three specific restrictions.

The hardcore restrictions. The BER contains five hardcore restrictions that lead to the exclusion of the entire agreement from the benefit of the BER, even if the market share of the supplier or buyer is below 30%. Individual exemption of vertical agreements containing such hardcore restrictions is unlikely. Hardcore restrictions are considered to be so serious that they are almost always prohibited. Taking into account the fact that almost all hardcore restrictions apply to distribution agreements rather than agency agreements, which are very different in law, we will provide only a list of the latter.

1. resale price maintenance: a supplier is not allowed to fix the price at which distributors can resell his products.
   
   However, the imposition of maximum resale prices or the recommendation of resale prices is normally not prohibited;
2. restrictions concerning the territory into which or the customers to whom the buyer may sell. This hardcore restriction relates to market partitioning by territory or by customer. The BER contains exceptions to this rule, which, for instance, enable companies to operate an exclusive distribution system or a selective distribution system. However, passive sales, i.e. sales in response to unsolicited orders, including general advertising and sales over the Internet, must always remain free;
3. selective distribution: (a) selected distributors can in no way be restricted in the end-users to whom they may sell, (b) the appointed distributors must remain free to sell or purchase the contract goods to or from other appointed distributors within the network;
4. agreements that pre vent or restrict end-users, independent repairers and ser vice providers from obtaining spa re parts directly from the manufacturer of the spare parts.

The 30% Market Share Cap. A vertical agreement is covered by the BER if the supplier of the goods or services does not have a market share exceeding 30%. It is the market share of the supplier on the relevant supply market that is decisive for the application of the block exemption. However, there is one exception. Where the supplier enters into an obligation to supply only one buyer throughout the Community, it is the market share of the buyer on the relevant purchase market, and only that market share, which is decisive for the application of the BER. Thus, in the latter case, the agreement is covered if the buyer of the products does not purchase more than 30% of the relevant purchase market.

The Conditions. The BER applies to all vertical restraints other than the abovementioned hardcore restraints. However, it imposes specific conditions on three vertical restraints:

1. non-compete obligations during the contract of indefinite duration or which exceed five years i.e. obligations that require the buyer to purchase from the supplier or from an undertaking designated by the supplier all or more than 80% of the buyer's total requirements;
2. post term non-compete obligations i.e. non-compete obligations imposed on the buyer for a period after the termination of his contract;
3. the sale of competing brands in a selective distribution system i.e. if the supplier prevents his appointed dealers from selling specific competing brands, such a restriction does not enjoy the exemption of the BER.

When the conditions are not fulfilled, these vertical restraints are excluded from the exemption by the BER. However, the BER continues to apply to the rest of the vertical agreement if that part is severable (i.e. can operate independently) from the non-exempted vertical restraints.

Withdrawal of the Block Exemption Regulation. The BER confers a presumption of legality. Vertical agreements that meet its requirements normally do not contravene competition rules. In exceptional cases where an agreement does restrict competition and the positive effects do not outweigh the negative effects, the benefits of the block exemption can be withdrawn. The Commission and, where the relevant geographic market is not wider than its territory, the competition authority of a Member State, can take such a withdrawal decision. A decision on withdrawal has only effects for the future and does not have retroactive effects. In particular, withdrawal may be necessary for parallel networks of similar vertical agreements operated by several suppliers on the same market, such as the widespread use of non-compete agreements or selective distribution. Withdrawal may also be necessary in situations where the buyer has significant market power and imposes exclusive supply obligations on its suppliers.

Individual Assessment

The BER does not apply above the market share threshold of 30%. However, exceeding the market share threshold of 30% does not create a presumption of illegality. This threshold serves only to distinguish those agreements which benefit from a presumption of legality from those which require individual examination.

The Commission applies the following 10 general rules for the assessment of vertical restraints in situations where the BER does not apply or where the benefit of the BER may have to be withdrawn²⁹:

1. for most vertical restraints, competition concerns can only arise if there is insufficient competition between brands (called 'inter-brand' competition), i.e. if the re exists a certain degree of market power at the level of the supplier or the buyer or both. Where there are many firms competing in a unconcentrate market, it can be assumed that non-hardcore vertical restraints will not have appreciable negative effects on competition;
2. vertical restraints which reduce inter-brand competition are generally more harmful than vertical restraints that reduce competition between distributors of the same brand (called 'intra-brand' competition). Hence, non-competitive obligations are likely to have more negative effects on competition than exclusive distribution agreements which are not combined with non-compete obligations;
3. however, in the absence of sufficient inter-brand competition, restrictions on intra-brand competition may significantly restrict the choice available to consumers. They are particularly harmful when more efficient distributors or distributors with a different distribution format are foreclosed (kept out of the market);
4. exclusive dealing arrangements are generally worse for competition than nonexclusive arrangements. For instance, under a non-compete obligation the buyer may only purchase and sell one brand, whereas a minimum quantity requirement leaves the buyer some scope to purchase competing goods;
5. vertical restraints are in general more harmful in relation to branded products than in relation to non-branded products. The distinction between branded and non-branded products will often coincide with the distinction between intermediate products and final products;
6. the negative anti-competitive effects of vertical restraints can be reinforced when several suppliers organize their distribution on the same market in a similar way (parallel networks of similar agreements). In particular, single branding (non-compete obligations) or selective distribution can create a cumulative foreclosure effect;
7. the more the vertical agreement involves transfer of know-how to the buyer, the more reason there is to expect efficiencies to arise and the more a vertical restraint may be necessary to protect the know-how transferred or the investment costs incurred;
8. the more the vertical agreement involves relationship-specific investments, i.e. investments made in connection with the agreement and which lose their value upon termination of the agreement, the more justification there is for vertical restraints. For instance, relationship-specific investments by the supplier generally justify a non-competitive obligation for the duration necessary to depreciate the investments;
9. vertical restraints required to open up new product or geographic markets generally do not restrict competition. This holds for two years after the product comes to the market. This rule only applies to non-hardcore vertical restraints, except in the case of a new geographic market where it also applies to restrictions on active and passive selling to intermediaries in the new market when such restrictions are imposed on the direct buyers of the supplier located in other markets;
10. in the case of genuine testing of a new product in a particular territory or with a particular customer group, the distributors appointed to sell the new product on the test market can be restricted in their active selling outside the test market for a maximum period of one year without infringing Article 81(1).

Implications

The number of Ukrainian companies using agency as a distribution mechanism for offering goods and services for the EU market is growing increasingly. Notwithstanding this, the fundamental importance of the EC competition regulations for cross-border trade in goods and services using third party relationships as a distribution mechanism, Ukrainian companies still do not consider the said rules while drafting agency agreements and performing them. Taking into account (i) the application of the EC competition rules not only to agreements entered into by both parties of the EU Member States but also to agreements, which are entered into by parties from other countries but having effects within the EU, (ii) complexity of the said regulations, developing case law and new tendencies as well as (iv) quite severe consequences for infringing the said rules, Ukrainian companies using agency for offering goods and services for EU market should be doubly careful.

Footnotes

1. Terms used by Chapter 31 of the Commercial Code.

2. Pursuant to Article 305 of the Commercial Code.

3. Foreign element is a feature, which describes the private law relations regulated by this Act and manifested in one or several such forms:

1. at least one of the participants of legal relations is a foreigner, stateless person or foreign legal entity;
2. the subject of legal relations is located on the territory of a foreign state;
3. a legal fact that impacts the origin, change or termination of legal relations, which occurs or occurred on the territory of a foreign state.

4. Article 42 of the Commercial Code defines business activities (entrepreneurship) as a separate, initiative, systematic, own-risk commercial activity, carried out by business entities (entrepreneurs) with the purpose of achieving economic and social results, and generating profit.

5. In the present Article the term "principal" will be used to specify the "entity represented".

6. The Commercial Code (Article 55) defines business entities as parties to commercial relationships that carry out commercial activity, exercising their commercial competence (integrity of economic rights and obligations), have separate property and may be liable under their obligations within this property. The following are deemed to be business entities: (1) commercial organizations — legal entities, established pursuant to the Civil Code, state, municipal and other enterprises, established according to the Commercial Code, as well as other legal entities that conduct commercial activity, and are registered according to the law; (2) citizens of Ukraine, foreigners and stateless persons that conduct business activity and are registered as entrepreneurs according to the law.

7. Please see above.

8. To avoid any possible conflicts or disputes in this respect the parties to the agency agreements should provide the terms and conditions for the mentioned notification therein.

9. The term "business" in the present article refers to all customers engaged and orders transmitted to the principal by the agent exercising his authority under the agency agreement, as well as all agreements concluded by the agent on behalf of the principal.

10. Article 298 (1) of the Commercial Code

11. Wording of Article 297 (2) of the Commercial Code

12. Pursuant to Article 297 (2) of the Commercial Code

13. The consequences of recognition of the agreement as unconcluded in the case of the absence of the legal fact, which entails legal effects, are not stipulated in law directly but it seems that the consequences of such unconcluded agreements are the same as for invalid agreements.

14. Article 12 (3) of the Civil Code

15. Article 303 (2) of the Commercial Code

16. Article 301 (3) of the Commercial Code

17. E.g. banks, financial companies etc.

18. Former Article 85.

19. S Singleton, Commercial Agency Agreements: Law and Practice, 2nd ed 2005, p. 47.

20. Ets. Consten and Grundig-Verkaufs-GmbH v. Commission, cases 56 and 58/64, 13 July 1966, ECR 1966, 299; Societe Technique Miniere v Maschenenbau Ulm, case 66/66, 30 June 1966, ECR 1966, 235; SSI v. Commission, case 240/82, 10 December 1985, ECR 1985, 3831.

21. The said agreements will be governed by the national competition regulations of the state where they produce the relevant effects.

22. F Bortolotti, Antitrust Rules of the European Union Applicable to Agency and Distribution Contracts, Report for International Distribution Institute, pp. 4-8.

23. Commission Notice, OJ 2001, C 368/13.

24. In order to calculate the market share, it is necessary to determine the relevant product market and the relevant geographic market. On the relevant market, the supplier calculates its market share by comparing its turnover achieved on that market with the total value of sales on that market. A buyer calculates its market share by comparing its purchases on the relevant market with the total purchases on that market. For guidance, see the Commission Notice on definition of the relevant market (OJ 1997, C 372, 9.12.1997).

25. Voelk v. Vervaecke, case 5/69, 9 June 1969, ECR 1969, 295; Miller v. Commission, case 19/ 77, 1 February 1978, ECR 1978, 131; Pioneer v. Commission, case 100-103/80, 7 July 1983, ECR 1983, 1825; Distiller v. Commission, case 30/78, 10 July 1980, ECR 1980, 2229.

26. OJ 2000, C 291.

27. Regulation (EC) No 2790/1999, OJ 1999, L 336.

28. Vertical agreements between competitors are, ho wever, covered by the BER if the agreement is non-reciprocal and the buyer has a turnover not exceeding EUR 100 million or the buyer is not a competing manufacturer but only a competitor of the supplier at the distribution level (i.e. a manufacturer sells his products directly and via distributors). 12 Guidelines on Vertical Restrains, Commission Notice, OJ 2001, C 368/13; Competition Policy in Europe: The Competition Rules for Supply and Distribution Agreements, European Commission, 2002.

29. Guidelines on Vertical Restrains, Commission Notice, OJ 2001, C 368/13; Competition Policy in Europe: The Competition Rules for Supply and Distribution Agreements, European Commission, 2002.

Nataliya Y. Mykolska is an associate with Vasil Kisil & Partners, a member of the International Distribution Institute

Dr. Tatyana V. Slipachuk is head of the Private International Law and International Arbitration Department at Vasil Kisil & Partners, a national expert of the International Distribution Institute

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