Exclusive Dealing Contract: Everything You Need to Know
Exclusive dealing contract is between a producer and a dealer in which dealer agrees to purchases only from the producer and prohibited from dealing with other.3 min read
An exclusive dealing contract is an undertaking between a producer and a dealer in which the dealer agrees to only make purchases from the producer and is prohibited from dealing with makers of competing products. In a few cases, this agreement may also favor the dealer, because it limits the number of dealers to whom the producer may sell products. Essentially, in an exclusive dealing agreement, one or both of these happen:
- A manufacturer agrees to sell a specified quantity of its goods or services to a particular dealer.
- A dealer agrees to purchase a specified quantity of goods or services from a particular manufacturer.
Exclusive dealing contracts are legal under the provisions of the Sherman Act and the Clayton Act. The legality of the agreement is tested by the court in the following ways:
- Does the agreement encourage or stifle competition?
- What was the state of the business before the agreement was made?
- What are the possible effects of the agreement on the business?
- What is the state of the business after the agreement is enforced?
Generally, an exclusive dealing contract will be upheld if the contract does not negatively affect trade and competition. This determination is made based on the court's evaluation of the product target market and location.
Can a Manufacturer Refuse to Sell Without an Exclusive Dealing Agreement?
It is common for a producer to refuse to do business with a dealer in the absence of this contract. It is not illegal to draw up an exclusive dealing contract, except when a prior dealership agreement is dissolved due to refusal to undertake such a contract, especially if the contract will restrict trade. Not all exclusive dealing arrangements stifle competition. In fact, many of these agreements set out to encourage competition, and they fulfill this aim.
An Antitrust Analysis of Exclusive Dealing
There are some anti-trust concerns with the creation of exclusive dealing agreements. Four provisions of the United States Laws on Antitrust have challenged exclusive dealing contracts. They are:
- Section 1 of the Sherman Act, which disallows agreements “in restraint of trade”
- Section 2 of the Sherman Act, which proscribes “attempt[s] to monopolize” and monopolization
- Section 3 of the Clayton Act, which disallows exclusivity contracts that may "substantially lessen competition” or tend to create a monopoly
- Section 5 of the FTC Act, which forbids "unfair methods of competition"
In United States v. Microsoft Corp., 253 F.3d 34 (D.C. Cir. 2001), the D.C. Circuit addressed the differences between exclusive dealing under Section 1 of the Sherman Act and Section 2. The court held that the “basic prudential concerns relevant to §§ 1 and 2 are admittedly the same… [but] a monopolist's use of exclusive contracts, in certain circumstances, may give rise to a § 2 violation even though the contracts foreclose less than the roughly 40% or 50% share usually required in order to establish a § 1 violation.”
Recent “rule of reason” studies of exclusive dealing contracts center on a number of elements, including:
- The dealer's market power
- The level of foreclosure from the market
- Barriers to entry
- The length of the contracts
- The potential of exclusivity to raise competitors' costs
- The probability of anti-competitive outcomes
- Valid business justifications
Although most exclusive dealing contracts do not raise issues with competition, a careful examination of the elements highlighted above should be carried out before entering into such an agreement, particularly if one party has considerable market power.
Examples of prohibited contracts include:
- Contracts forbidding a dealer from purchasing goods or services from a manufacturer's competitors
- Contracts preventing a dealer from selling the products of a different producer
- Contracts mandating a dealer to purchase all, or a substantial quantity of, its total requirements of specific products from one specific producer
Is An Exclusive Dealing Contract an Unlawful Covenant Not to Compete?
The State of California possesses a strict code which states that any contracts that prohibit competition are unlawful. The code specifies that any agreement in which a party is prevented from carrying out legal business is prohibited. There are some exceptions to this rule, as provided by the code.According to the Dayton Time Lock Court, exclusive dealing contracts encourage the promotion of new products. To determine the legality or illegality of the agreement, the following criteria are considered:
- The product line
- The target market
- The affected market share.
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