Hedge Funds, Investors and Fees

Data released by Preqin(1) indicates that hedge fund returns have rallied strongly in 2013 and continue to improve. Event driven funds represented the most successful hedge fund strategy over Q1, returning 3.8%. Whilst even macro-funds, which underperformed in early 2013, have recently benefited dramatically as a result of “Abeconomics”(2) (e.g. London-based Sloane Robinson’s Japan fund has risen 44.6% in 2013).

According to Hedge Fund Research(3), Q1 also saw industry assets rise by $122bn, that is the largest quarterly inflow for over two years. This leaves industry assets at $2.375trn, i.e. the greatest value ever managed by the industry.

However, these inflows and returns come after four years where the average macro fund returned just over 7 per cent. That is, four years where hedge funds, which traditionally employed the two and 20 fee model, have cumulatively returned less than would have been achieved by a passive index fund tracking the S&P 500.(4)

In addition to the above, institutional investors are now the single dominant class of hedge fund investor, accounting for just under 75% of industry assets and almost half of pension funds expect to increase allocations to hedge funds by $100 million or more in 2013. The risk/return profile sought by these investors differs from that sought by the High Net-Worth Individuals that historically formed the hedge fund investor base.(5)

Whilst the hedge fund industry has been remarkably resilient to amendments being made to fee structures(6). The relative under-performance of Hedge Funds has combined with this change of investor base is leading to an increasing pressure on the hedge Fund industry to offer alternative fee structures. That is, a) the industry has not delivered the absolute returns that would justify the fees demanded and b) investors believe that fees should be reduced to reflect these lower return expectations.

Accordingly, recent fund launches, have incorporated alternative fee structures to address these concerns. That is, these structures utilise a management fee whereby a 20% profit share is maintained but management fees diminish in proportion to any increase of firmwide assets under management, thereby incentivising the manager to concentrate on performance, rather than marketing and “asset gathering,” as a source of income.

(1) http://www.preqin.com/blog/101/6605/event-driven-hf-performance
(2) Where increased quantitative easing from the Bank of Japan has led to a rise in the Nikkei 225 of 32% and a 11.4% fall in the yen/dollar exchange rate.
(3) https://www.hedgefundresearch.com/hfrx_reg/index.php
(4) Which produced a 22% gain over the last four years.
(5) Deutsche Bank Alternative Investment Survey (the “DB Survey”) suggests that wealthy individuals targeted 10% annual returns but have a relatively high tolerance for return volatility, whilst institutional investors target a 8% return but place a premium on returns having a low correlation to broader markets.
(6) The DB Survey suggests that only 29% of investors who negotiate fees are successful more than half of the time.

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Increased Scrutiny of SEC Broker Dealer Registration Requirements

Placement Agents and Transaction Fees Risk Triggering SEC Broker-Dealer Registration Requirements

David W. Blass, chief Counsel of the Security and Exchange Commission (the “SEC”), used his speech to the American Bar Association this month to move market participants and regulators towards a common understanding of “broker-dealer registration” regulation in the US, encourage Private Funds to review their fund raising arrangements and invite suggestions for an exemption “written specifically for private fund advisers” to the existing registration requirements.

Legal Background:
Under the US the Exchange Act a “broker” is largely defined as any person engaged in the business of effecting transactions in securities for the account of others. Absent an available exemption or other relief, such activity generally triggers a requirement to register under Section 15(a) of the Exchange Act and become a member of FINRA. It is worth noting that such a registration is arduous and expensive to the point that Mr Blass specifically acknowledged that “many advisers, particularly smaller advisers, may not be able to afford… to either hire a broker-dealer or register as a broker-dealer themselves.”

In response to the above, private funds have typically adopted the view that:
(i) a sponsor selling interests in a private fund either is not “engaged in the business of effecting transactions” or is not acting for the account of others; and
(ii) that receipt of transaction fees by a private fund sponsor should not trigger broker status.

SEC Scrutiny:
As private funds have become an increasingly important participant in the financial marketplace the SEC has however increased its scrutiny of private fund advisers and existent market practices. In this context, Mr Blass emphasized the “serious consequences” that would apply to a unregistered broker-dealer by reference to the recent Ranieri case brought by the SEC in March 2013.

In this case the SEC charged Ranieri Partners LLC (“Ranieri”), a private firm that had raised over $500m using an unregistered consultant whose compensation was calculated as a percentage of capital commitments made to the funds by investors introduced by it. Despite the fact that no fraud was alleged to have been committed by either Ranieri of the consultant, the SEC penalised Ranieri’s fund manager and marketing personally in addition to the unregistered consultant. In this action the SEC applied the following sanctions:
(i) $375,000 applied on Ranieri;
(ii) $75,000 applied to a director of Ranieri that had acted as a marketing employee;
(iii) the above director was also restricted from acting in a supervisory role at any investment adviser or broker-dealer for nine months; and
(iv) the third-party consultant was permanently barred from working in the securities industry.

As noted in his Mr Blass’s speech, a possible consequence of acting as an unregistered broker-dealer is that securities transactions intermediated by an unregistered broker-dealer could potentially be rescinded/rendered void.

Placement Agents/Finders as Broker-Dealers:
Whilst not all fund raising that utilise an external fund-raiser would give rise to a broker-dealer registration requirement, Mr Blass described a number of indicative activities that the SEC consider might betoken a registration requirement. These include:
(i) Marketing securities (shares or interests in a private fund) to investors;

(ii) Soliciting or negotiating securities transactions; or

(iii) Handling customer funds and securities.

The above activities will be particularly relevant if they are remunerated by a compensation structure that is dependent upon the outcome or size of the securities transaction i.e. a “salesman’s stake.” Mr Blass, for example, noted that “the SEC and SEC staff have long viewed the receipt of transaction-based compensation as a hallmark of being a broker.”

Fund Manager Staff as Brokers:
Mr Blass’s speech further noted that a private fund manager with a dedicated sales force of employees working within a fund’s marketing department may risk falling within the broker-dealer definition. That is private fund managers are not exempt from SEC scrutiny merely as a result of fundraising functions being “in-house” or because their compensation is not expressly tied to capital-raising efforts (e.g., fixed salaries and fixed bonuses).

Mr Blass offered some basic questions that private fund managers should consider when when reviewing their fundraising staff structures. These included:
(i) What role is played by these staff in soliciting and/or retaining investors?
(ii) Do employees who solicit investors have other responsibilities or is their primary responsibility soliciting investors?
(iii) How are employees who solicit investors for a private fund compensated? I.e. do these employees receive transaction-based compensation?

In relation to the above, Mr Blass noted the “Issuer exemption” available under Exchange Act Rule 3a4-1 is generally unlikely to be available to private fund advisers.

Private Equity Fund Practices:
[In Europe market standard is for private fund sponsor’s receipt of transaction-based fees (e.g. “closing fees” or “success fees”) is largely, if not entirely, offset against advisory fees payable by the fund.] Mr Blass noted that such arrangements, in his view, “would not appear to raise broker-dealer registration concerns.”

In contrast many US based funds operating leverage buyout strategies will directly retain “investment bank activity” fees charged to a portfolio company as compensation for structuring transactions and soliciting purchasers etc. Such a structure may give rise to a registration requirement. As Mr Blass noted “taking the activity out of the private equity space and applying it in other contexts would leave little question about the need for broker-dealer registration.”

A number of parties have suggested to the SEC that such practices should not give rise to a registration requirement as the general partner should be viewed as the same person as the fund, i.e. no transactions are undertaken for the “account of others.” Mr Blass strongly attacked this suggestion stating that the fact that “the fee is paid to someone other than the fund — here the general partner — makes crystal clear to me that, at least for potential broker-dealer status questions, the fund and the general partner are distinct entities with distinct interests.”

Next Steps:
Mr Blass’s speech included an appeal to Private Funds to actively engage in open dialogue with the SEC and propose suggestions for the creation of a specific exemption from the broker-deal registration requirements for private fund managers. Nonetheless, the recent enforcement action and on-going scrutiny undertaken by the SEC demonstrates that this continues to be a key area of concern for the SEC and Private Fund Managers should proactively review (a) transaction fees they charge portfolio companies, (b) their engagement of placement agents and (c) the roles undertaken by in-house staff that focus on fund raising.

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In my, admittedly limited, experience legal advisers need to effectively manage BOTH a) the legal aspects, and b) the logistics of a fund raising, for a fund raising to be successful.

I have been told that a EURO3bn fund raising an be run by 3 lawyers. Nonetheless, I assume such a raising was done a limited number of investors and/or took place over an extended timetable. Recently I was involved in the closing of a “mega-fund”, involving about 100 investors, was significantly oversubscribed and run by an “aggressive PE House” and as a result was closed in about a third of the time usually used for a fund closing. So following this experience, set out below are what resources, in my humble opinion, should you utilise to orchestrate a PE mega-fund (Euro2-4bn) raising.


Legal Teams
Client/Investor Call Team:

Realistically at least some members of the PE house will be virtually camped at your firm throughout the closing stages of the fund raising. A senior relationship partner + mid level associate should stick with the client in the client suite. This team will attend most calls with investors and be responsible for getting client sign off on each position taken in respect of the documentation drafting.

Lawyer Management Team:
The second matter partner + a junior associate should have an over-view administrative side of the transaction. This partner should manage/coordinate the legal team that actually produces the fund documentation. The client will often engage with this partner, but this partner is the one that ultimately coordinates the fervent below-water leg action that ensures that the fund closing duck travels along so smoothly.

Side Letter Team:
A partner, senior associate and junior associates. The majority of the legwork on Side Letter drafting and investor management can be easily done by junior associates. Ensuring that drafting is consistent across side letters with the “agreed house position” is the role of the partner. E.g. the partner will agree with the PE House what wording should will be used when an investor requests comfort as to a cap on the fund size, whilst the junior associates will utilise this wording in their drafting when it is appropriate to do so. NOTE that ultimately the partner will “sign off” on each Side Letter signed out, so there is a real risk that they become the bottle neck that slows down the Side Letter process. They must therefore ensure that they have enough capacity and/or assistance from senior associates to ensure that sign off can keep pace with the pace of side letters generated by the junior associates working in this team.

Investor Management/LPA Team:
LPA drafting should be controlled by a very senior associate/partner who is a) familiar with the various nuanced approaches it is possible to take with each aspect of an LPA and b) aware of the history and needs of this particular client. This drafting team will work extensively and closely with the PE House and Client team to establish what positions the PE should take vis a vis the LPA.

There should be atleast 1 associate per every 10-15 investors. These associates will manage negotiations with their investors and feed the LPA requests of those investors into the drafting team.

A PE mega-fund, can easily involve negotiations with 100 investors. The constant drafting of the legal team, investor requests/redrafts, PE House negotiations etc to deal with the interaction of so many parties can therefore quickly lead to an extremely inefficient allocation of lawyer capacity. Therefore, from an early stage on a mega-fund, at least one (and ideally two) paralegals should be employed to keep the Investor Email/Document Filing, Investor Status Spreadsheet, Investor Comment Spreadsheet, Call Pack Production and Call Timetabling (see below) up to date.

These tasks are often allocated to trainees, but on a large transaction allocating such tasks to a trainee becomes inefficient in terms of a) costs (i.e. 12hours a day can be easily taken up by these tasks and PL time in the UK is usually charged out at about 60% the cost of trainee time) and b) trainee development (i.e. such tasks are vital to the transaction and require legal understanding, but beyond a certain level will not develop a trainees capacity to be able to ever be the “legal advisor” on a PE fund closing.)

Keeping Track
The sheer number of investors involved in a PE mega-fund can add an effectively debilitating level of complexity to the fund raising process unless suitable management/accounting processes are utilised. The following are some simple spreadsheets which if maintained by a paralegal throughout the transaction can save a lot of time and costs.

Investor Comment Spreadsheet:
Each investor will typically initiate negotiations with the PE House by setting out a series of requests for each document involved in the closing (largely focusing on the LPA). In order to save time and ensure a consistent response is given to investors, these requests and their responses once considered and agreed upon by the PE house should be collated into a single word searchable document/spreadsheet. Before raising new investor requests with the PE House, the responsible associate can search this document to check if the query has been asked /responded to before.

Investor Status Spreadsheet:
The stage of negotiations reached with each investor and “next steps required” for each investor should be collated into a single document/spreadsheet each day. The paralegal maintaining this spreadsheet should approach each associate working on the fund raising late afternoon each day to get an update of the status of each investor they are responsible for. This document can be used by the PE House/management team to inform their strategy for the efficient utilisiation of resources throughout the fundraising.

Call Timetable and Call Packs:
A timetable for each week’s calls with investors should be collated and easily accessible to the PE House and each lawyer working on the fund raising.

For each call, a “call pack” including recent/important correspondence with that investor, important information about that investor and any submitted requests/drafting amendments and responses and current Side Letter raft should be produced. This allows the PE House/Call team to bring themselves up to speed at short notice of the issues to be faced during that call. These will, obviously become more and more useful as first closing approaches as time becomes increasingly pressured, calls happen with diminished preparation time and the call teams become increasingly tired.

Consolidated Side Letter:
A Master Side Letter will act as the basic template for each Side Letter. Many investors will however request additional items to be addressed in their Side Letter. A single document with all Side Letters copied and pasted into it is therefore an extremely simple, but a very useful drafting aid for the Side Letter team as it allows the junior associate drafting the first draft of each SIDE LETTER to search for where similar issues have been previously raised by other investors and respond with consistent/”client signed off” language.

If a team of PE executives are going to be camped in your office, they will consume a) many breakfasts, lunches and dinners and b) many “snacks” prepared by your firm’s kitchen. The big meals should obviously be nutritious, varied and delicious (thankfully our menus are designed by a Michelin starred chef and thoroughly check all the above boxes). I suspect however that an under appreciated aspect of “deal nutrition” is that many/most firms will serve tea/coffee with high sugar snacks like biscuits and/chocolate bars. These snacks will form something between 10-30% of the deal team’s calorific intake each day. Now the deal team of any major transaction will have to deal with significant amounts of stressed, tiredness and swings of emotion. This emotional rollercoaster has real effects on the deal that is ultimately achieved.

I personally think that deal produces enough emotion that the deal team should not have to additionally deal with rising and crashing blood-sugar levels. I.e. snacks a firm offers should be made up of complex carbohydrates (e.g. flapjacks oatcakes), sugar should be avoided if possible and provided in the form of honey rather than refined sugar (e.g. the flapjacks), and more firms should think of offering things like cashew nuts, pumpkin and sunflower seeds rather than Quality Street chocolate. No-one will complain about chocolates, but there must be a benefit in keeping people awake and level headed when they are discussing £[X]bn of investment over a number of months.

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The Nadir

Going forward this blog will alternate between 1) life in law, and 2) the law. Hopefully 1 will be interesting to people, and 2 will be useful lawyers. Lawyers may find both interesting and useful but they hardly count as people do they 😉

So the “life questions” one thinks of at 2am on a Friday night when they are still in the office and doing filing and they now that they will have to be back on Sunday:
• Am I doing this inefficiently, could I do it faster without compromising on accuracy?
• After working a 19hour day yesterday and being back in the office at 8:30am today is it possible possible to do anything without errors?
• Is it possible to do highly iterative, unstimulating work perfectly or will there always by a typo somewhere?
• Am I wasting my life or is this an investment that everyone has to make?
• Is staring at screens, doing this repetitive menial work making me dimmer? Really, is the fact that I am doing this, for free and eagerly an indication that I am not intelligent enough to ever be successful?
• If this is an investment of time/life, why is this the investment?
• Is this really making me more able to manage my clients’ legal risk or enhance their comercial opportunities?
• Has this training contract taught me process but made me dimmer and a less capable thinker?
• So my friends work as insurance brokers and underwriters, they work less hours, their work is more enjoyable and they get paid more than me. Other friends work as bankers (if they are not being made redundant), they work less hours, their work is more enjoyable, they get bonuses and regardless of those bonuses they get paid more than me. Other friends are civil servants (in Australia), they work SIGNIFICANTLY less hours, can go surfing regularly and get paid more than me. My secretary works less hours, gets paid 1.5*her hourly wage when she works beyond 5:30pm and regardless of that overtime gets paid more than me….
• What the F***? am I doing with my life?

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Defaulting Investor clauses

The below looks at gearing a “Defaulting Investor” clause in a PE Side Letter in an LP’s favour i.e. in favour of the investor rather than the PE House.

Note, I have not recreated copied n pasted the clause as it would appear in the side letter, but rather I have broken the clause down into the various concepts that make up the clause. In doing so I hope a) to give an insight into the basic purpose of the clause and b) avoid infringing anyone’s IP rights.

LP Friendly Version

[1] [2] (The LP, when demanded by the GP, fails to pay the capital it owes/originally committed to the Fund) (Such failure is the fault of the LP to a) make a capital payment or b) return distributions) (such failure includes the failure of any investor in the LP to make its contributions to the LP) (=the LP is defined as a “Defaulting Investor” at the point that the LP gives notice of its failure to the GP), (the LP’s rights in the Partnership is segregated into “Defaulting Partner” “non-Defaulting Partner” in proportion to the amount of capital not paid when called e.g. if the LP only makes 70% of its required Capital Contribution, then 30% of its interest in the Fund is treated as a “Defaulting Partner” [3]). [4]

[1] Note there is no overt restriction of the LP’s right to invest in other/competing investment funds.
[2] As a practical measure a GP friendly version of this clause would restrict investments into investment funds other than short term money market funds.
[3] An extremely pro-GP version would treat the LP as a Defaulting Investor, subject to the GP’s discretion, in relation to the entire value of the called for contribution. Though in practice especially in the current market, a clause would almost never be so “pro-GP.”
[4] A pro-GP variation of this clause would explicitly not that nothing in this clause, or the GP’s actions in relation to this clause would compromise the GP’s rights under the LPA to take action against the LP with regards to the interest allocated as “Defaulting Partner.”

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First Week of International Funds

I finished my second seat with the rarest of events, the finishing of a matter. Yes, the last (substantive) email was sent out by myself in the last couple of hours of Friday night and last Monday I started my third seat “International Funds”.

Three early impressions:
1) Funds is by far the most interesting niche of “Corporate Legal Work” world;
2) Staying healthy and having a social life will take genuine skill (i did not leave my office before 1am this last week!); and
3) Knowing the nuanced difference between the approaches taken by each juridiction towards structuring and drafting each aspect of a fund invaluable and frankly, brilliantly interesting.

more to follow shortly (though also quite likely to be late at night/typo filled/carrying a faint air of exhaustion 😉

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Fixed/Minimum Retail Price Maintenance in Vertical Distribution Networks

This title suggests that the post below would be a useful cure to insomnia. Ironically, because there is so little clear/correct guidance on this point creating this memo for my firm meant that I actually only left the office at 2:35am. So for the sake of letting the world’s trainees actually go to bed…

Key Points on Legitimate Retails Price Restrictions
1 Summary
1.1 Historically, the EC treated fixed or minimum resale price maintenance (FRPM) as being entirely incompatible with EC competition law. To this end, a 2011 SJB client guidance note and 2011 Ashurst guide on Selective Distribution contained similar statements that:
“it is essential to note that whilst the supplier can impose high standards of quality and service, it cannot seek to control the retail prices charged by its distributors. Imposing a fixed or minimum resale price upon a buyer is not allowed.”
1.2 However, the EC’s 2010 Vertical Guidelines show some softening of the traditional strict stance on this subject. The Vertical Guidelines recognised that resale price maintenance may, in some circumstances, lead to economic efficiencies and therefore meet the test for clearance under Article 101(3) of the Treaty on the Functioning of the European Union (“TFEU”).
1.3 Nonetheless, the guidance suggests that an FRPM would only be acceptable for brief periods of time. That is, any price maintenance is likely to only be exempted under Article 101(3) during an initial product launch period, or for short-run co-ordinated promotions across a franchise or distribution networks. Emphasising this point, in 2002, the Commission exempted certain multi-lateral interchange fees for cross-border payments with Visa cards . However in 2008 the Commission began an investigation into Visa’s multilateral interchange fees, following expiry of the exemption granted in 2002.
1.4 As such common practice guidelines vertical agreements and Article 101(3) regularly state that guidance along the lines of:
“It is highly unlikely that an agreement containing fixed or minimum RPM would meet the criteria for exemption under Article 101(3). Restrictions on a buyer’s ability to determine its minimum resale prices constitute “hard-core” restrictions for the purpose of the new vertical agreements block exemption which, if included in a vertical agreement, mean that the block exemption cannot apply. Furthermore, such clauses cannot be severed from an agreement so the entire agreement is void.”
1.5 The below note sets out the EC’s approach to assessing a FRPM and guidance on the economic context in which it may allow for a FRPM to exist in a select distribution agreement. However, any guidance to clients in this regard should emphasise that:
(a) including FRPM in an agreement gives rise to the presumption that the agreement restricts competition and thus falls within Article 101(1); and
(b) the presumption that the agreement is unlikely to fulfil the conditions of Article 101(3).

2 Legal Background
2.1 Article 101 of the TFEU prohibits agreements that have as their object or effect the restriction, prevention or distortion of competition within the EU and which have an effect on trade between EU member states. As regards vertical agreements the category of restrictions by object includes, in particular, fixed and minimum resale price maintenance.
2.2 The block exemption of vertical agreements does not apply to agreements containing a FRPM. Specifically the Block Exemption notes that: “This Regulation should not exempt vertical agreements containing restrictions which are not indispensable to the attainment of the positive effects mentioned above; in particular, vertical agreements containing certain types of severely anti-competitive restraints such as minimum and fixed resale-prices… irrespective of the market share of the undertakings concerned.” As such, the anti/procompetitive effects of the FRPM will be considered entirely within the framework set out by Article 101(3) .
2.3 For an FRPM to qualify under article 101(3) it must satisfy each of the following conditions:
(a) contributes to improving the production or distribution of goods or promotes technical or economic progress, while
(b) allowing consumers a fair share of the resulting benefit, and which does not:
(i) impose on the undertakings concerned restrictions which are not indispensable to the attainment of these objectives;
(ii) afford such undertakings the possibility of eliminating competition in respect of a substantial part of the products in question.
The Commission is unlikely to consider this condition to be satisfied if the agreement does no more than improve the economic position of the parties to the agreement.

3 When might an FRPM satisfy the 101(3) Conditions:

    Guidance Specific to Selective Distribution Networks

3.1 The EC Vertical Guidance detail a number of circumstances when the article 101(3) conditions might be met. With respect to selective distribution networks, the EC particularly emphasises that, subject to the nature of the product being suitable, the following economic rationales may apply:
(i) resale price maintenance may be justifiable to eliminate free-riding, on the basis that retailers which invest in additional customer services may cut back on such services if they are undercut on price by retailers which do not provide such services ; or
(ii) resale price maintenance may help create a brand image by imposing a certain measure of uniformity and quality standardisation on the distributors, thereby increasing the attractiveness of the product to the final consumer and increasing its sales. This can, for instance, be found in selective distribution and franchising.
NOTE: However the EC does emphasise that whether consumers actually overall benefit from extra promotional efforts depends on whether the extra promotion informs and convinces and thus benefits many new customers or mainly reaches customers who already know what they want to buy and for whom the extra promotion only or mainly implies a price increase.
3.2 In general the above arguments will be strongest for new products, for complex products, for products of which the qualities are difficult to judge before consumption (so-called “experience products”) or of which the qualities are difficult to judge even after consumption (so-called “credence products”).
3.3 In relation to context the “Free-Rider” rationale above, the Vertical Guidance notes however that for there to be “a real free-rider issue” the following criteria must apply:
(i) it can only occur on pre-sales services and other promotional activities, but not on after-sales services for which the distributor can charge its customers individually;
(ii) the product will usually need to be relatively new or technically complex or the reputation of the product must be a major determinant of its demand, as the customer may otherwise very well know what he or she wants, based on past purchases;
(iii) the product must be of a reasonably high value as it is otherwise not attractive for a customer to go to one shop for information and to another to buy; and
(iv) it must not be practical for the supplier to impose on all buyers, by contract, effective promotion or service requirements.

    Guidance Relating to Resale Price Restrictions in General

3.4 The Vertical Guidance suggests that the following arguments may be used by an undertaking to justify FRPM in its agreements;
(i) in relation to a manufacture launching new product,
(A) FRPM may provide the distributors with the means to increase sales efforts and if the distributors in this market are under competitive pressure this may induce them to expand overall demand for the product and make the launch of the product a success, also for the benefit of consumers;
(ii) In relation to franchise system or similar distribution system;
(A) FRPM may allow for the coordination of a uniform distribution format or short term low price campaigns (2 to 6 weeks in most cases) which will also benefit the consumers; or
(iii) in relation to experience or complex products,
(A) the extra margin provided by RPM may allow retailers to provide (additional) presales services.
3.5 When assessing an FRPM within the framework of Article 101(3) The EC will consider the following:
(a) efficiency gains of the FRPM must fully off-set the likely negative impact on prices, output and other relevant factors caused by the agreement.
(b) an analysis of remaining competitive pressures on the market and the impact of the agreement on such sources of competition.
NOTE: The assessment of restrictive agreements under Article 101(3) is made within the actual context in which they occur and on the basis of the facts existing at any given point in time.
3.6 The Vertical Guidance notes that once the parties substantiate that likely efficiencies result from the inclusion of a FRPM in their agreements and that all the conditions of Article 101(3) are fulfilled, it is then for the EC to assess the likely negative effects on competition and consumers. In this regard the EC will be particularly conscious of the risk that the FRPM will:
(i) facilitate collusion between suppliers by enhancing price transparency in the market;
(ii) eliminate intra-brand price competition or facilitate collusion at the distribution level;
(iii) generally soften competition between manufacturers and/or between retailers;
(iv) negatively affect the public by preventing distributors from lowering their sales price for that particular brand;
(v) lower the pressure on the margin of the manufacturer, in particular where the manufacturer has a commitment problem, i.e. where he has an interest in lowering the price charged to subsequent distributors;
(vi) lead to the manufacturer foreclosing smaller rivals; or
(vii) reduce dynamism and innovation at the distribution level by preventing price competition between different distributors and/or hinder the entry and expansion of distribution formats based on low prices.

Annex A:
Case Law

Uniform Eurocheques
Uniform Eurocheques is an example in which an individual exemption was granted for what was in effect a price-fixing agreement. The 15,000 financial institutions operating the eurocheque system had entered into a five-year agreement relating to the acceptance of eurocheques, which provided for a uniform commission of 1.25% to be charged.

The Commission was prepared to grant an exemption on the basis of the benefits of the system as a whole, which enabled customers to know that they would have the benefit of a common charge in each member country. The fixed commissions were relatively small and reasonably necessary for the overall benefits.

Visa Payment Schemes
In Visa payment schemes, the Commission found that the multilateral setting of the interchange fee constituted a restriction of competition but that such a fee, as it was set in a reasonable and equitable manner (including a close linkage to costs for certain transactions), had sufficient countervailing benefits for it to be eligible for exemption.

In 2008, the Commission began an investigation into Visa’s multilateral interchange fees, following expiry of the exemption granted in 2002. The Commission is investigating the Visa interchange fees in accordance with the principles established in the MasterCard case. In April 2009, the Commission sent a statement of objections to Visa alleging that the multilateral interchange fees set directly by Visa in the EEA for point of sales transactions with consumer payment cards (both cross-border transactions and domestic transactions in nine member states) restrict competition between banks, contrary to Article 101(1) of the TFEU, and do not meet the conditions for exemption under Article 101(3) (Commission MEMO/09/151; see Legal update, Commission sends statement of objections to Visa). In December 2010, the Commission decided to make binding commitments offered by Visa to address the competition concerns that it had identified in relation to the MIFs set directly by Visa Europe in the EEA for point of sales transactions with immediate direct debit cards (see Legal update, Commission accepts binding commitments from Visa Europe).

In December 2007, the Commission announced that it had found that MasterCard’s EEA multilateral interchange fees constituted a restriction of competition and breached Article 101(1). The Commission had found that the interchange fees restricted price competition in that they artificially inflated the base prices charged by banks for accepting payment cards.

Unlike in the 2002 Visa case (above), the Commission did not accept that the MasterCard fee had sufficient countervailing benefits for it to be eligible for exemption. It found that the fees were neither necessary for innovation or efficiency. The Commission stated that it was up to the parties to provide robust proof of any objective efficiencies resulting from the restriction. Any such efficiencies must do more than merely benefit the member banks.

In this case, the methodologies used by MasterCard to calculate the fees were not such as to ensure that both cardholders and merchants obtained a fair share of the benefits of the arrangements (Commission press release IP/07/1959).

MasterCard was required to withdraw its EEA multilateral interchange fee within six months. MasterCard did temporarily repeal the multilateral interchange fee, but subsequently introduced revised terms. In April 2009, the Commission announced that MasterCard had agreed to amend its methodology for calculating cross-border multilateral interchange fees. On the basis of these undertakings, the Commission does not currently intend to take any action against MasterCard for non-compliance with the 2007 decision (Commission press release IP/09/515; see Legal update, Commission statement on MasterCard’s decision to give undertakings in relation to multilateral interchange fees).

MasterCard appealed the Commission’s decision to the General Court. On 24 May 2012, the General Court dismissed the appeal in its entirety. The General Court found, in particular, that the Commission had not erred in concluding that the MIF was not ancillary to the MasterCard system as a whole. It agreed with the Commission that the MIF is not objectively necessary for the functioning of the MasterCard payment system. The General Court also upheld the Commission’s finding that the MIF had a restrictive effect on competition. It also supported the Commission’s conclusion that the MIF did not contribute to technical or economic progress and so did not meet the conditions for exemption under Article 101(3) (Case T-111/08 – MasterCard and others v Commission; see Legal update, General Court dismisses MasterCard appeal).

MasterCard has appealed against the General Court’s judgment to the ECJ (Case C-382/12 – MasterCard, Inc., MasterCard International, Inc. and MasterCard Europe).

Pierre Fabre Dermo-Cosmétique
Whilst this case relates to physical sale restrictions in a selective distribution system, it operates by analogy to demonstrate how the ECJ will consider the economic context of such restrictions and by analogy of FRPM.

On 13 October 2011, the ECJ ruled that, in the context of a selective distribution system, a clause which prevents internet sales by requiring that cosmetics and personal care products are sold in a physical space in the presence of a qualified pharmacist, amounts to a restriction by object within the meaning of Article 101(1) if it is not objectively justified.

This case demonstrates that:
(b) consideration of the objective justification of the clause requires an individual and specific examination of the content and objective, and the legal and economic context of which it forms a part, with regard to the particular properties of the products.
(c) Such a clause will prevent the application of the vertical agreements block exemption.
(d) Such a clause may benefit from individual exemption if the conditions for exemption under Article 101(3) are met, but the burden of proof lies with the undertaking and is onerous.

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