The music industry and bans of internet platforms as a distribution canal in Germany and the EU – a never ending story?

What was the judgment about?

Complainant was the Centre for Protection against Unfair Competition (CPUC). The CPUC seeked to forbid the use of the following clause in the manufacturer’s contracts with its dealers: „Product sales on so-called internet-auction platforms, internet marketplaces and through independent third parties are not permitted“. The manufacturer did not include any further stipulations regarding internet distribution in his contracts.

The arguments of the manufacturer

The manufacturer argued that it sold technically demanding products which require specific product advice which only specialized dealers could offer. Hence, the ban would serve the assurance of quality and therefore the end customers’ interests. Like many other brand manufacturers the manufacturer also regarded internet distribution as a threat for his brand image. In particular, free riders give a hard time to specialized dealers: End customers consult extensively with specialized dealers however afterwards turn around to acquire the product on the internet for a lower purchase price, a practice which would not be in the interest of the manufacturers or specialized dealers. However, with his scanty provision in his dealer contract the manufacturer stopped short of what is legally required when it comes to the leeways of restricting internet sales. The CPUC saw an unjustified restraint of trade in the unlimited ban of internet sales because potential end customers were prevented from reaching dealers by using the prohibited distribution channels. The Higher Court of Schleswig followed the line of argumentation of the CPUC. The manufacturer was forced to give up the unlimited ban of internet trade.

Yes, but …

The arguments of the manufacturer make sense and are also recognized under EU and national competition law. Nevertheless, the manufacturer chose the wrong way to bring his interests in line with the mandatory regulations of competition law. What mistakes did the manufacturer make? On the one hand he neglected the fact that a general exclusion of the distribution channel “internet” is basically forbidden. The internet is regarded as one of the most important means to reach all buyers in the European market and, hence, may not be fully excluded as a distribution channel. On the other hand the manufacturer did not make use of the leeways offered under competition law. Competition law permits restrictions of the distribution channel “internet” if such restrictions are equivalent to the distribution standards set by the manufacturer for the stationary trade of specialized dealers. However, this only works in the EU within the scope of selective distribution systems: Selective distribution system means a distribution system where the supplier undertakes to sell the contract goods or services, either directly or indirectly, only to dealers selected on the basis of specified criteria and where these dealers undertake not to sell such goods or services to unauthorized dealers and distributors within the territory reserved by the supplier to operate that system. A selective distribution system is the proper way to distribute quality products which require product advice by specifically trained and experienced dealers and therefore justify the establishment of criteria under which the dealers are selected. If the manufacturer fulfils these requirements under competition law the manufacturer is also allowed to establish quality standards for internet sales provided that these quality standards do not go beyond the standards for the sale of products in the dealer’s brick-and-mortar store.

The manufacturer in the discussed case failed to establish a selective distribution system although the complexity of the products would have allowed him to do so. How unfortunate. He would have also been allowed to establish quality standards for internet sales of his authorized dealers. The Higher Court of Schleswig expressly confirmed that option, however not outside a selective distribution system.

What are the consequences of the judgment?

This recent judgment of the Higher Court Schleswig confirms the ruling legal view that internet sales may be limited by quality standards established within a selective distribution system. Nevertheless, the judgment read and understood in the context of other court decisions which have recently been issued on bans of internet sales. The Higher Court Munich pretty much allowed the ban of internet sales towards dealers. The Higher Court Berlin confirmed that within selective distribution systems internet restrictions are allowed, provided that the manufacturer sticks to his “own rules of the game” and does not supply discounters with his products. As these court rulings deviate from each other in certain aspects, the Higher Court Schleswig permitted that the manufacturer may appeal against the judgment to the Federal Court of Justice. It remains to be seen whether the manufacturer opts for an appeal. The last word may not be spoken here yet although is not to be expected that the Federal Court of Justice will admit the complete exclusion of the internet distribution, in particular not outside the scope of selective distribution systems.

The consequences for the Music Industry

The music industry faces several challenges. Manufacturers in the music industry best maintain their brand image if they limit themselves to specialized dealers. However, they may have to accept the consequence that they do not fully exhaust their sales potential that way. Specialized dealers profit from the brand image of the manufacturer and from the potentially higher sales prize level. Nonetheless, specialized dealers will have to adapt his distribution activities on the internet to the high-class distribution standards as set by the manufacturer.

Furthermore, a selective distribution system only works in the territory in which it is pursued. Sales from adjoining areas into this selectively formed distribution area – potentially for a lower price – may not be prevented. Hence, manufacturers are advised to operate their selective distribution system within the EU or at least reserve the territory of the EU to operate their selective distribution system. Manufacturers may also actively include their importers and distributors into their selective distribution system: Certain areas, in particular the territory of EU states, are assigned to the importers exclusively as usual. At the same time the manufacturers request their importers to select and supply only dealers located in the assigned territory which fulfill the selection criteria given by the manufacturer. An immense task, but legally permitted and serving the interest of the high quality of product distribution in the music industry.

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