China’s Intervention Against Vertical Agreements

On December 9, 2016, the PRC National Development and Reform Commission (NDRC) handed down its decision against medical device company Medtronic for having concluded and implemented a vertical monopoly agreement by maintaining fixed- and minimum resale price (RPM). NDRC imposed a fine of CNY118 million, which stood for 4% of the revenue for the products involved, and was one of the highest fines imposed by Chinese antitrust administrative authorities in that year.

So far, the NDRC has investigated and fined more than 20 domestic and international companies involving a variety of industries, including liquor, infant formula, automobile, lenses and contacts, medical device and household appliance, for RPM conduct. Because the enforcement against vertical monopoly agreement will continue to be a focus of the Chinese antitrust administrative authorities, it is important for companies to have a better understanding of the relevant regulations and enforcement practices to minimize the risks.

TYPES OF VERTICAL MONOPOLY AGREEMENTS

Article 14 of the PRC Anti-Monopoly Law (AML) lays out the types of vertical monopoly agreements. Business operators should not conclude agreements with business counterparties to fix resale price, impose minimum resale prices, or conclude other types of vertical monopoly agreements identified by the antitrust administrative agencies.

Unlike in the U.S. and EU, RPM is the only type of vertical monopoly agreement explicitly provided in the law. Although Article 14 contains a catch-all clause according to which the antitrust administrative agencies can deem ‘other type of agreements’ as vertical monopoly agreement in breach of the AML, the Chinese antitrust authorities are generally cautious in creating new types of infringements that are not explicitly provided in the AML. Currently, none of the Chinese antitrust authorities have penalized companies based on the catch-all clause in Article 14 of the AML.

Typical vertical restrictions other than RPM include: territory restriction, exclusive distribution/supply, tying, etc. Even though these conducts are not explicitly provided as vertical monopoly agreements in the AML, they may still cause problems under the AML.

A company with a dominant market position may breach the AML for abuse of dominance if it imposes vertical restraints. In November 11, 2016, the PRC State Administration for Industry and Commerce (SAIC) penalized Tetra Pac for exclusive arrangement, tying and royalty rebate. SAIC’s decision against Tetra Pac is based on Article 17 (abuse of dominance) rather than Article 14 (vertical monopoly agreement) of the AML. Overall, companies with low market share should be subject to lower risks for imposing vertical restraints other than RPM. But this is not risk free, because assessing the likelihood of being considered dominant can be difficult. Even if a company’s market share is lower than 30%, technically, it may still be deemed to have a dominant market position, as the AML does not provide a safe harbor for abuse of dominance. Not to mention that the antitrust authorities have wide discretion in determining dominant market position.

In addition, resale territory restrictions and single branding restrictions may be deemed as measures to implement RPM if the restrictions are linked with the dealers’ resale prices, as NDRC noted in the Medtronic case. Thus companies should be careful with any link between resale territory or single branding restrictions imposed on dealers and the interference with their resale price.

RPM - PER SE ILLEGAL OR RULE OF REASON?

The basic rules for RPM in China are similar to those in the European Union and the United States: A manufacturer should not fix the resale price of its dealers or restrict the dealers’ minimum resale price; RPM under genuine agent/ consignment agreement is lawful, because genuine agent acts in the name of the principal and is not deemed a
‘transaction counter-party’ in the meaning of Article 14; recommended resale price and maximum resale price are generally allowed, unless structured in a way that constitutes RPM or abuse of a dominant market position such as predatory pricing.

In addition, there was a debate in China regarding whether RPM should be per se illegal or should be subject to the rule of reason. The Chinese courts had found in favor of the rule of reason in various civil litigations, requesting that an anti- competitive effect should be an essential element in the finding of monopolistic agreements and that the burden to prove the anti-competitive effects of RPM should lie with the plaintiff. The court would always look into the company’s market power in the relevant market and the  competitive restraint from competitors. For the court to deem RPM a vertical monopoly agreement breaching the AML, the plaintiff has to prove that there is insufficient inter-brand competition and that the defendant has considerable market power. The NDRC, as the antitrust administrative authority, holds the view that RPM conducts should be illegal, unless the company can prove its conduct falls under the exemptions under Article 15 of the AML. Whether there is sufficient inter-brand competition in the relevant market did not seem to have a major effect on the NDRC’s decision.

This debate may have ended following an administrative litigation judgment handed down by the Hainan High People’s Court in December 2017. The case was brought up by Yutai Company (a fish feed company) against the administrative decision issued by the Hainan Price Bureau (the Hainan branch of NDRC) in February 2017 for the RPM provisions in the distribution agreement between Yutai and its distributors. The court of first instance followed the rule of reason approach and found that due to Yutai’s limited market presence, its resale price fixing agreements with its distributors had no anti-competitive effect and therefore, did not constitute a monopoly agreement.

However, on appeal, the Hainan High People’s Court reversed the judgement and upheld the Hainan Price Bureau’s administrative ruling. The Hainan High People’s Court ruled that in order to achieve the legislative goals of the AML in preventing monopoly conducts and protecting the interests of the consumers and the general public, administrative enforcement agencies do not need to prove the anti-competitive effect of RPM conducts in antitrust administrative investigations.

The Hainan High People’s Court did not reject the rule of reason theory completely. It reckoned that in order to claim damages caused by monopoly conduct through civil litigations, the anti-competitive effect must be proved by the plaintiff as the basis for further demonstration that the monopolistic conduct caused damages. Thus the burden of proving the anti-competitive effect may remain a hurdle in future civil litigations involving RPM. After this case, it is unlikely that the PRC courts will quash the NDRC’s administrative rulings against RPM based on lack of anti- competitive effect. Considering the NDRC is an active enforcer with significant investigation powers, and considering the enforcement against vertical monopoly agreement will continue to be a focus of the NDRC, companies should be extremely cautious with RPM conduct regardless of their market powers in China and the competition status in the relevant markets.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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