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Is It Lawful to Sell a Product Below Its Cost?

Raul de Cruïlles's picture
Published: 21/11/17 - Country: Spain

Selling below cost could be defined as a commercial practice whereby a company sells products at a price below the production cost so that the sale would make the company lose money. A priori, a company would have no interest in losing money with a sale, however, this practice can be used for commercial or economies of scale related purposes, so that such practice would be within the framework of the market economy and free pricing provided for in Article 38 of the Spanish Constitution.

However, selling below cost can also be used for the purpose of unfairly harming competitors, and it may even harm the whole market.

That is why this practice is subject to special regulation in our legal system.

On the one hand, selling below cost is regulated by the Law 15/2007, of  July 3, on the Defense of Competition (LDC), which aims to guarantee the existence of effective competition between companies, promoting and controlling market freedom and efficiency through the National Commission of Markets and Competition (NCMC) or the corresponding regional authority.

This Law on the Defense of Competition (LDC) regulates the disciplinary proceedings in this matter, and establishes a maximum term of 18 months for rendering a judgement. In this context, a legal action can be initiated by operation of law or through a formal complaint (therefore, a company can report a competitor if they think that the latter is selling below cost) . In  these proceedings, acts of unfair competition which by distorting free competition may affect the public interest could be investigated. In the event that the Administration considers that such prohibited practice has existed (Article 3), it may pronounce a sentence by declaring the existence thereof, and impose measures such as court orders to cease such practice within a specified period, the imposition of behavioral or structural conditions or obligations, the removal of the effects of the unfair competition act, and fines which in the case of selling below cost could amount up to 5% of the total turnover of the offending company corresponding to the immediately preceding tax year.

The Law on the Defense of Competition (LDC) also regulates compensation for damages caused by practices restricting competition, which can be claimed by those injured before the Civil Jurisdiction. The Law 1/2000 of Civil Procedure provides a procedure of access to sources of evidence specific for this matter introduced by the Royal Decree-Law 9/2017 of May 26 through which European Union Directives in the fields of finance, trade, health, and movement of workers are transposed.

On the other hand, selling below cost is specially regulated by Article 14 of the Law 7/1996, of January 15, of Retail Trade Regulation (LRTR) which establishes a general prohibition of this practice in the field of retail trade, which is extended to wholesale trade by the Additional Provision 6. However, as we will see later, the recent case-law of the Court of Justice of the European Union introduces some important nuances to the interpretation and application of these provisions.

The Law on Retail Trade Regulation (LRTR) regulates the disciplinary proceedings applicable in the Autonomous Communities (Spanish administrative regions) under which the selling below cost  contrary to the provisions of Art. 14 could result in a sanction to the company of € 6,000 to € 30,000, and even in the closure of the company, establishment or industry in case of a third recidivism.

In particular, the aforementioned Article 14 provides that:

"1. Notwithstanding the provisions of the previous article, no sales below cost may be offered or made to the public apart from the cases regulated in chapters IV and V of Title II of this Law (SALES PROMOTION ACTIVITIES such as sales (discounts), promotions, liquidations, sales with a gift or premium and direct sale offers), unless the person who carries it out has the objective of reaching the prices of one or more competitors with the capacity to significantly affect their sales, or in the case of perishable products that are intended to be sold on dates close to their expiration date.

In any case, the provisions of the Law on Unfair Competition must be respected.

2. For the purposes indicated in the previous section, it will be considered that there is a sale below cost when the price applied to a product is (i) lower than the price initially paid to acquire it (purchase price) according to the invoice after deduction of the proportional part of the discounts included therein; or (ii) lower than the replacement price if this is lower than the purchase price minus the discounts or (iii) lower than the actual production cost when the product is manufactured by the seller plus the indirect taxes levied on the transaction.”

[…]

However, we must point out that regarding the above provision, the recent Judgment of the Court of Justice of the European Union (Fifth Chamber) of October 19, 2017, Rec.C-295/16, states that the Directive 2005/29 / EC of the European Parliament and of the Council of May 11, 2005 on unfair commercial practices of companies in their relations with consumers in the internal market must be interpreted as opposing a national provision containing a general prohibition of offering or making sales below cost and establishing exceptions to said prohibition based on criteria that do not appear in the Directive itself.

Following this judgment, we can understand that the prohibition of Art. 14 of the Law on Retail Trade Regulation is not in conformity with EU Law, since the sale below cost is not among the practices provided for in Annex I to the Directive, and therefore the imposition of a sanction shall apply only if the sale below cost can be described as "unfair".

In any case, the Law on Retail Trade Regulation must only apply to the relations between companies and consumers (retail trade), so the extension of its scope to the wholesale trade provided for in the Additional Provision 6, a priori and according to the EU case-law mentioned above, should not be deemed applicable, nor should the rule of distribution of the burden of proof established in the provision studied.

Therefore, we can conclude that, the general prohibition of selling below cost provided for in Art. 14 of the Law on Retail Trade Regulation cannot be applied unconditionally. Instead, free pricing will be the general rule and the sanction established by said law will only apply, in order to protect consumers and in each particular case when the sale below cost will be considered an act of unfair competition which harms consumers.

Finally, the practice of selling below cost is also regulated by the Law 3/1991, of January 10, on Unfair Competition (LUC).

Article 17 of said law states that:

"1. Unless otherwise provided by laws or regulations, pricing is free.

2. However, the sale below cost or the sale made at a price lower than the purchase price will be considered unfair in the following cases:

  1. When it is likely to mislead consumers about the price of other products or services offered in the same establishment.
  2. When such practice has the effect of discrediting the image of another product or establishment.
  3. When it is part of a strategy aimed at eliminating a competitor or group of competitors in the market. "

Therefore, selling a product below cost is not unlawful unless one of these three cases occurs, that is, a misleading, denigrating, or predatory sale below cost.

An example of predatory sale below cost will be when the “Company X”, aware of the minor financial support of “Competitor Z”, decides to sell below cost for a a certain period of time so that Z loses sales over a long period of time, being therefore forced to go bankrupt and disappearing from the market. At that moment, X will no longer have competitors, it could set the prices at its own discretion and take over the market with no competition.

According to the Law on Unfair Competition, a company, a freelancer, or any individual or legal entity participating in the market that consider themselves harmed by a sale below cost that might be deemed "unfair", can file a claim in the field of private law in order to obtain a court ruling declaring such practice as unfair and ordering the cessation of such unfair practice, its future prohibition, the removal of its effects, and a compensation for the damages suffered.

A key factor in the claim will be to state that the practice reported should be treated as a "sale below cost".

For this, we can refer to the Judgment 1991 \ 229 of the Court of Justice of the European Communities of July 3, 1991, case AKZO vs. Commission of the European Communities, which set the criteria for determining the sale below cost that the Spanish Courts usually apply. 

According to this ruling a sale will be considered to be made “below cost" "when the sale price is lower than the average of the variable costs. Or, even if it is higher than the average of the variable costs, it is lower than the average of the total costs”.

Likewise, the Judgment 1996/216 of the Court of the European Communities of November 14, 1996 established an objective criterion to prove that there has been an intention to eliminate competitors without having to prove it:

"When a company with a dominant position sets prices below the average of the variable costs, it will be considered that there is always the intention to eliminate the competitors”. However, "when a company with a dominant position sets prices above the average of the variable costs but below the total costs, the intentionality must be proven."

For illustrative purposes, we can mention several cases in which the possible existence of a sale below cost has been analyzed as well as its potential classification as unfair.

The Judgment of the Provincial Court of Barcelona (Section 15) dated May 10, 2005 considered that there has been a sale below cost and an unfair practice in a lawsuit where an undertaker’s also offered the management of funeral procedures for free. This was the subject of a claim filed by an agency that offered such services. The Court understood that the offer of such kind of services for free undoubtedly implied a sale below cost, which was “absorbed” by the provision of other services, and it declared the existence of a predatory purpose of eliminating the competitor from the market with the aim of reestablishing later the payment for such services when there will no longer be a competitor.

For its part, the Judgment of the Supreme Court dated May 30, 2005 also declared the existence of an unfair sale below cost in a dispute between two driving schools. In this case, the Court considered that the defendant made sales below cost thanks to the provision of other services with which it absorbed the losses, and with the objective of eliminating the other driving school from the market. In this case, they both were the only competitors in town.

However, the Judgment of the Provincial Court of Badajoz of November 11, 1997, rejected the claim for sale below cost, in a dispute between competitors in the bakery sector. In this case the Court considered that there was no evidence that the sale price was lower than the cost price, and it specified even that the sale of a product at a price of 0€, if it were very limited, cannot be considered unfair, but within the concept of promotional sale.

Similarly, the Judgment of the Provincial Court of León (Section 1) dated May 19, 2014, rejected the claim in a dispute between companies in the ceramic manufacturing sector, after having analyzed various expert reports, because it considered that the sale below cost has not been sufficiently proven since the knowledge of the costs by the expert was not deep enough, and especially, the unfair nature of the practice reported has not been proven either.

In conclusion, we must note that not always the sale of a product below its cost is illegal, but, on the contrary, the pricing is a priori totally free. Exceptionally, the sale below cost will be considered unlawful when it entails or consist of an "act against competition" with the aim of getting a dominant position in the market; or in case of distorting free competition with damage to public interest. In this case it may be penalized according to the Law on the Defense of Competition and prosecuted through a claim for damages (civil proceedings). Besides, when it is an "unfair practice" its misleading, denigrating, or predatory aim could be reported, in which case administrative sanctions could be imposed under the Law on Retail Trade Regulation and judicial actions of cessation, removal and compensation could be filed under the Law on Unfair Competition.

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Raul de Cruïlles's picture

Lawyer in Judicial and Arbitral Procedures. Legal advice on matters of commercial, financial, corporate, bankruptcy, real estate, patrimonial, insurance and civil liability.