A landmark decision of the European Court of Justice (ECJ) issued on 6 December 2017 confirmed that a supplier of luxury goods may prohibit authorised retailers part of a selective distribution system from selling its products on third party e-commerce platforms.
In the case at issue the request for a preliminary ruling was submitted by the Oberlandesgericht Frankfurt am Main (Higher Regional Court, Frankfurt am Main) in 2016 in the context of a dispute between Coty Germany GmbH, a supplier of luxury cosmetics established in Germany, and Parfümerie Akzente GmbH, an authorised distributor of those goods, concerning the prohibition, under a selective distribution contract between Coty Germany and its authorised distributors, of the use by the latter, in a discernible manner, of third-party undertakings for internet sales of the contract goods.
Specifically, Coty Germany brought an action before the national court seeking an order prohibiting Parfümerie Akzente from distributing products via the platform ‘amazon.de’.
The Oberlandesgericht Frankfurt am Main, also in view of the divergent interpretations of the earlier ECJ’s Pierre Fabre decision issued in 2011, by the courts and competition authorities of the Member States decided to stay the proceedings and to refer to the European Court of Justice questions concerning whether a selective distribution system that has as its aim the distribution of luxury goods constitutes an aspect of competition that is compatible with Article 101(1) TFEU and, specifically, whether the general prohibition imposed on members of a selective distribution system to use, in a discernible manner, for internet sales, e-commerce platforms of third-party companies, is compatible with that rule.
In its ruling the ECJ’s, referring to its settled case-law, stated first of all that a selective distribution system for luxury goods designed primarily to preserve the luxury image of those goods does not breach the prohibition of agreements, decisions and concerted practices laid down in EU law, provided that the resellers are chosen on the basis of objective criteria of a qualitative nature, which are laid down uniformly and are not applied in a discriminatory fashion, nor go beyond what is necessary.
The Court then found that EU law does not preclude a contractual clause which prohibits authorised distributors of a selective distribution network of luxury goods from using, in a discernible manner, third-party platforms for internet sales of the goods in question, provided that the clause is appropriate to preserving the luxury image of the goods, it is laid down uniformly, not applied in discriminatory manner and is proportionate in the light of the objective pursued.
The ECJ further noted that, in circumstances such as those of the main proceedings, these conditions are met and therefore prohibition of the use, in a discernible manner, of third-party undertakings for internet sales does not constitute a restriction of customers nor a restriction of passive sales to end users. Such latter restrictions are automatically excluded from the benefit of a block exemption because they are liable to have severely anticompetitive effects.
1. Selective distribution system: general remarks
The adoption of a selective distribution system for companies operating in the field of luxury and fashion is one of the key factors in the process of evaluation, which allows the trademark owner to protect the prestige and renown of its brand and to guarantee the quality of the products to be distinguished, from the time of the product ideation to its delivery to the final user.
Article 1, let. e) of Regulation (EU) No 330/2010 broadly defines it as a distribution system where the supplier undertakes to sell the contract goods or services, either directly or indirectly, only to distributors selected on the basis of specified criteria and where these distributors undertake not to sell such goods or services to unauthorised distributors within the territory reserved by the supplier to operate that system.
Therefore, the ban on the resale of products to subjects other than end consumers, unrelated to the network established by the manufacturer, is therefore the “heart” of selective distribution, because through it the goods bearing the trademark are marketed exclusively through retailers who meet certain standards of professional competence, which allows the manufacturer to guarantee uniformity of service at points of sale, coordinated management of logistics, training of personnel specialized in the sale of prestigious products and the control of the disposal of unsold products.
The products subject to selective distribution are usually high-class goods with a high symbolic value, bearing trademarks which convey a message of exclusivity, which can be jeopardized even in the absence of likelihood of confusion.
Selective distribution systems are therefore justified not only in the interests of the trademark owner to consolidate its brand awareness and to preserve around its own products an aura of luxury which enables consumers to distinguish them from similar goods, but also in the interest of the consumers to be guaranteed a high level of quality of service, in line with the standard set by the manufacturer.
These principles have been applied and confirmed by the European Court of Justice in the Coty case, where the Court noted that the quality of luxury goods is not simply the result of their material characteristics, but also of the allure and prestigious image which bestows on them an aura of luxury.
These aspects, the ECJ further noted, are essential for luxury goods since they enable consumers to distinguish them from other similar goods. Therefore any impairment to that aura of luxury is likely to affect their actual quality.
2. Selective distribution and trademark exhaustion
The success of this kind of distribution system cannot, in any case, be independent of effective control by the trademark owner.
The development of the free riding phenomenon in the context of a selective distribution system lies in the fact that third party resellers, not belonging to the system, appear on the market as apparent authorized retailers generating in consumers the belief that the reseller belongs to the selective distribution network arranged by the trademark owner.
In recent years this phenomenon has been the subject of a wide debate amongst scholars and case-law, often with opposing positions on the interpretation of trademark exhaustion doctrine and unfair competition by the unauthorized reseller.
Article 5 of the Italian IP Code (likewise Article 15 of the EU Directive No. 2015/2436) provides that the exclusive rights of the trademark’s owner “are exhausted once the products protected by an industrial property right have been put on the market by the owner or with his consent in the territory of the Country or in the territory of a Member State of the European Union or the European Economic Area”. Paragraph 2 further specifies that “This limitation on the powers of the owner does not however apply when there are legitimate reasons for the owner himself to oppose further marketing of the goods, in particular when the condition of the same has been modified or altered after being put on the market”.
In this regard, the ECJ settled case law clearly states that the existence of a selective distribution agreement is one of the “legitimate reasons” which excludes the application of the exhaustion doctrine of the trademark after the goods have been put on the market, pursuant to Art. 7 No. 2 of Directive 2008/95/C.E. (now, Article 15 EU Directive No. 2015/2436).
Applying these principles, the ECJ clarifies that what is important for the exclusion of the exhaustion doctrine is the confusing effect of the existence of a commercial link between the unauthorized reseller and the trademark’s owner which jeopardizes, or potentially jeopardizes, the aura of luxury and prestige that the trademark’s owner tries to preserve through the adoption of a selective distribution system.
Leading scholarly literature and settled case law have often acknowledged that also the use of false capacity, i.e. pretending to be an authorized reseller which is part of the selective distribution system implemented by the trademark owner, might amount to trademark infringement.
In this regard, the Court of Catania, in a recent ruling issued on 29 November 2016 in proceedings brought by the fashion company Bulgari against an unauthorized reseller, acknowledged that the use of the brand “BVLGARI” on the unauthorized reseller’s web site in order to advertise the sale of Bulgari’s products generated the belief in the public that reseller was part of Bulgari’s distribution network.
The Court further stated that the burden of proof of the existence of “legitimate reasons” pursuant to Art. 15 EU Directive No. 2015/2436 had been fulfilled by the trademark owner since Bulgari was able to prove:
1 – The implementation of a selective distribution system, based on contractual clauses to impose precise quality standards on distributors;
2 – That the goods at issue were luxury or prestige items;
3 – That the sale of Bulgari’s product by an unauthorized reseller, for its specific methods which were not in accordance with the well-known trademark’s owner standards, resulted in an actual prejudice to the prestigious and exclusive image of Bulgari, not respecting any of the quality standards imposed on authorized resellers.
3. Violation of a selective distribution system and unfair competition
Italian case law also analysed a further aspect concerning the role of the third party unauthorized reseller in the context of a selective distribution system, i.e. whether inducing an authorized dealer to violate its contractual obligations may amount to a violation of the selective distribution system and therefore a breach of contractual obligations.
Selective distribution agreement is legally binding only between the parties. Therefore, the ban on the resale of products to subjects unrelated to the network established by the manufacturer, other than end consumers, is not binding to third parties, such as the unauthorized reseller.
In the past decade, Italian case law often held the view that the unauthorized reseller is always free to buy the goods intended for selective distribution, pursuant to the constitutional freedom of the enterprise. The violation of a selective distribution system by those who are not contractually bound by such a system does not amount to unfair competition, since the obligations between the manufacturer and its authorized dealer are not binding for the third party.
In this regard, a landmark case of the Court of Palermo, following a more recent trend, acknowledged that the interference of a third party with a selective distribution system may amount to an act of unfair competition such as “involving in another’s breach of obligations”, which has to be considered an independent act of unfair competition prohibited pursuant to Art. 2598, No. 3 Italian Civil Code.
If the selective distribution network is legitimately created by the trademark’s owner, in compliance with the antitrust regulations, the acts of third parties not belonging to the network consisting in selling (despite having been made aware of the existence of the selective distribution system) products bearing that mark may be considered acts of unfair competition.
Specifically, the Court noted that there may be unfair competition exclusively in the case whether the unauthorized reseller is aware, or has been made aware, of the existence of a selective distribution agreement. Therefore, “once he receives such communication it is no longer a question of irrelevance due to the relativity of obligations principle exclusively between the manufacturer and the distributer” and then “continuing to sell trademarked products even after the manufacturer has notified that a selective distribution system was implemented amounts to unfair competition”.
4. Practical implications
The above mentioned cases deal with different aspects related to the same issue: enforcing trademark rights in the context of a selective distribution strategy in the luxury field in order to protect brand owners against different forms of free riding.
These rulings provide helpful guidance for companies in the luxury field as to what is permissible and can be done to enforce selective distribution against distributors in breach of their contractual obligations and unauthorized resellers.
In conclusion some basic guidelines in this area of luxury goods are:
1. the selective distribution system implemented by the trademark owner to distribute luxury goods must be based on contractual clauses which impose precise quality standards on distributors, i.e. it must be compliant with the antitrust regulations,
2. it is essential to prove that the products in questions are luxury items and that the selective distribution system is necessary to protect their luxury image,
3. the restrictions imposed on distributors must be consistent with the aim of protecting that luxury image, they must be applied in a non-discriminatory manner and should not go beyond what is necessary.
4. the requirements of the selective distribution system need to be regularly assessed by the brand owner to guarantee they remain fit for purpose,
5. restrictions on sales on third-party platforms, such as Amazon or Ebay, to protect a luxury image are allowed only provided that this does not give rise to a total prohibition on online sales,
6. beside trademark infringement, in order to prove unfair competition by the unauthorized reseller for interfering in the selective distribution agreement, i.e. involvement in another’s breach of obligation, it is necessary to prove awareness on the part of the unauthorized distributor of the existence of a selective distribution agreement between the trademark’s owner and its reseller.