The Asia-Pacific Antitrust Review 2019

China: Vertical Agreements

19 March 2019

JunHe LLP

Chinese Academy of Social Sciences

In recent years, antitrust issues related to vertical agreements have triggered disputes between suppliers and distributors, as well as complaints from interested parties. Since 2013, resale price maintenance (RPM) has been subject to heightened antitrust scrutiny. The probes, led by China's National Development and Reform Commission (NDRC) with the support of the delegated local enforcers, resulted in fines exceeding two billion yuan against suppliers and distributors of ­liquors, baby formulas, automobiles, medical devices, eyeglass lenses and consumer electronics, among others.

In March 2018, the three Chinese antitrust agencies respectively under the NDRC, the State Administration for Industry and Commerce (SAIC) and the Ministry of Commerce (MOFCOM) were integrated into the newly established State Administration for Market Regulation (SAMR). RPM continues to be among the SAMR's enforcement priorities.

By the end of 2018, a number of investigations against RPM were ongoing. Although no investi­gations have been initiated against stand-alone non-price vertical agreements, investigations on abuse of dominance have been related to vertical arrangements such as exclusive dealing, and tying and bundling. On the other hand, the divergence between private and public enforcement against RPM remains.

Recent developments in antitrust rule-making relevant to vertical agreements

The Anti-Monopoly Law (AML), effective from 1 August 2008, is the main antitrust legislation in China. The AML prohibits monopolistic agreements that eliminate or restrict competition, unless the agreements meet the criteria of exemptions. In general, the AML exemption rules require that the overall efficiencies and benefits of the agreements outweigh the negative effect on competition of the agreements.

As regards vertical restraints, article 14 of the AML prohibits vertical monopolistic agreements that fix resale prices and restrict minimum resale prices. Article 14 also contains a catch-all prohi­bition on other types of vertical monopolistic agreements as determined by the competition authority. Article 15 of the AML sets out an exemption mechanism and provides defences to undertakings against findings of infringements of article 14. An agreement caught by article 14 is valid and enforceable if it satisfies the conditions of article 15. In order to be exempted, under­takings bear the burden of proof to show that the alleged agreements fall into one of the statutory scenarios listed in article 15 and, except for export cartels and other circumstances as prescribed by law or the State Council (China's central government), that the agreements do not sub­stantially restrict competition in the relevant market and allow consumers to share interests derived therefrom.

The analytical framework established by the AML is abstract and leaves a rather significant level of uncertainties when assessing the legality of vertical agreements. To increase transparency and reduce compliance cost, the NDRC had led the drafting of guidelines accompanying the AML by clarifying the NDRC's analytical approaches. The drafting of the Enforcement Guidelines on Vertical Price Monopolistic Agreements started in October 2017 and achieved substantial progress by the end of 2017.1 After the antitrust enforcement function of the NDRC integrated into the SAMR, the drafting work was suspended but is expected to be resumed by the SAMR in due course.

General rules on vertical agreements2

Based on previous enforcement experience, the SAMR drafted the Provisions of the Prohibition on Monopolistic Agreements (the draft Monopolistic Agreements Provisions) in late 2018 and published a draft for public consultations in January 2019. The draft Monopolistic Agreements Provisions integrated the relevant rules on monopolistic agreements promulgated by the NDRC and the SAIC previously.

The draft Monopolistic Agreements Provisions clarify the application of prohibitions and exemptions under articles 14 and 15 for RPM and establish market thresholds ('safe harbour') for presumed exemptions. If each of the undertakings to a vertical agreement holds no more than 25 per cent market share in the relevant market and the agreement does not contain RPM, unless it is proved to prevent or restrict competition, the agreement is presumed to meet the standards of article 15 and is thus exempted from the prohibition of article 14.

The draft Monopolistic Agreements Provisions list several factors for assessing the competitive effects and legality of vertical agreements that are not blacklisted in the Monopolistic Agreements Provisions (ie, non-price vertical restraints). These factors include the facts of reaching and implementing the agreement; market competitive conditions; market share and market power of the undertakings; the effect of the agreement on price, quality, market entry, technical advancement, consumer and other undertakings; as well as other factors considered as relevant by the SAMR. However, the draft Monopolistic Agreements Provisions do not contain detailed guidance on the legality of non-price vertical restraints, as with the NDRC's draft Enforcement Guidelines on Vertical Price Monopolistic Agreements. More guidance on the assessment of non-price vertical restraints is expected to be considered in the SAMR's follow-up rule makings.

Sector-specific rules: anti-monopoly guidelines on the automobile market3

The NDRC's investigations into China's automobile market had resulted in series of infringement decisions against major passenger car manufacturers and their authorised dealers. Global brands such as Chrysler, Audi, Mercedes-Benz, Nissan, GM or their Chinese joint ventures were fined for RPM relating to new cars and replacement parts. In most of the cases, the authorised dealers of the automobile manufacturers were also fined because the RPM organised by the manufacturers and then implemented by the authorised dealers effectively established price cartels among the dealers.

The NDRC's investigations into the automobile market revealed that vertical restraints were similar and in parallel among automobile brands and were mainly imposed by automobile manufacturers. Competition among authorised dealers had been found distorted while effective compe­tition was insufficient between authorised and independent after-sales service providers. The SAMR continues the investigations into the automobile market.

Given that the NDRC had gained on-the-ground experience from investigations and enforcement activities in the automobile market, in June 2015, the Anti-Monopoly Commission of the State Council delegated the NDRC to lead the drafting of the Anti-Monopoly Guidelines on the Automobile Market (the draft Automobile Guidelines). Since the drafting work started, the NDRC drafting team has conducted a series of interviews and surveys, circulated questionnaires to interested parties and held public workshops for interested parties to discuss the contents of the draft Guidelines. Most automobile manufacturers operating in the Chinese market, as well as major upstream suppliers and downstream distributors, actively took part in the drafting process by attending the workshops and submitting feedback. In March 2016, the NDRC published the draft Automobile Guidelines and sought public comments.4 By December 2018, the drafting work and formalities were completed and the draft Automobile Guidelines are at the final step to be promul­gated by the Anti-Monopoly Commission of the State Council.

The draft Automobile Guidelines mainly focus on vertical restraints, covering vertical agreements and abuse of dominance relating to vertical restraints in aftermarket. The draft Automobile Guidelines state that the key of antitrust assessment is the restrictive effect on competition actually caused by the conduct. According to the effect on competition, unilateral conduct such as business policies and instructions may be construed as vertical agreements and therefore be subject to the relevant rules of the AML.

The draft Automobile Guidelines emphasise that RPM is strictly prohibited under article 14 of the AML. However, based on the NDRC's investigations and feedback from interested parties, the draft Automobile Guidelines list four RPM scenarios that are common in the Chinese market where undertakings may claim exemptions. The four scenarios include:

  • RPM for the launch of new energy vehicles;
  • RPM when dealers act as intermediaries;
  • RPM in government procurement where selling price is required for bidding the procurement projects; and
  • RPM in e-commerce sale by automobile suppliers.

In the last three scenarios, the transactions are actually made and the selling prices are agreed between automobile suppliers and the buyers. In such circumstances, the dealers are involved to facilitate the transactions by delivering automobiles, collecting payment and issuing invoices, and their roles are different from distributors in an independent and complete sense.

The draft Automobile Guidelines recognise the efficiency-enhancing effects of territorial and customer restrictions imposed by automobile suppliers without significant market power, but blacklist four types of territory and customer restrictions that lead to high prices and less choice for consumers. Automobile suppliers may claim individual exemptions on a case-by-case analysis if they impose the restrictions set out below on authorised dealers and are able to prove that the restrictions satisfy the conditions of article 15 of the AML. The four types of blacklisted restrictions include:

  • restrictions on passive sale of dealers;
  • restrictions on cross-supplies between dealers;
  • restrictions on the sale of spare parts required for repair and maintenance work by authorised dealers and repairers to end users; and
  • except for sub-contracting arrangements, restrictions agreed between automobile manu­facturers and suppliers on the sale of spare parts, repair tools, diagnostic equipment or other equipment by the suppliers to dealers, repairers or end users.

In supplementary provisions, the draft Automobile Guidelines list factors to be considered when assessing whether a sub-contracting arrangement exists, which is comparable to the relevant EU competition rules.

As regards competition concerns in the automobile aftermarkets, the draft Automobile Guidelines noted that the market for repair and maintenance services and for the distribution of spare parts is generally brand-specific in nature, and that competition is lessened compared with the market for the sale of new automobiles. The draft Automobile Guidelines recognise that spare parts and technical information are key inputs for effective competition in the aftermarket and thus pay close attention to abusive conduct in the aftermarkets related to vertical restraints in the distribution and accessibility of parts and technical information.

Two types of exclusive dealings regarding spare parts initiated by automobile manufacturers holding dominant positions in the aftermarkets of their branded automobiles are being monitored, including:

  • exclusive purchasing obligations imposed on authorised network members (ie, restrictions on buying from alternative sources); and
  • except for parts produced under sub-contracting arrangements, exclusive supply obligations imposed on parts suppliers by restricting such suppliers from selling private brands parts directly to the aftermarket.

To ensure sufficient access to technical information on repair and maintenance, two types of vertical restraints regarding technical information imposed by automobile manufacturers holding dominant positions in the aftermarkets of their branded automobiles are being monitored, including:

  • restriction on the rights and channels of repairers to access technical information for specific branded automobiles; and
  • reaching agreements with the suppliers of repair tools, diagnostic equipment or other equipment, and restricting such suppliers from selling the relevant repair tools, diagnostic equipment or other equipment to dealers or repairers.

The judicial review on the Hainan fish feeds decision5

Public enforcement against RPM seemed quiet in 2017 and 2018 compared with 2016, when the fines on Medtronic and SAIC General Motors exceeded 118 million and 200 million yuan respectively. Nevertheless, the first judicial review in 2017 on an infringement decision against an RPM agreement was of great significance in defining the boundary between antitrust and freedom of pricing strategies for enterprises doing business in China.

Hainan Provincial Price Bureau fine producers of fish feeds for RPM

In October 2016, the Hainan Provincial Price Bureau (Hainan Bureau) fined seven fish feed producers after finding that most producers of fish feed in Hainan province imposed RPM on distributors.

One of the producers, Yutai Feeds Ltd (Yutai), imposed RPM in 2014 and 2015 through signing fixed-term contracts with its distributors. The contract required that the distributor bear the confidentiality obligations on Yutai's discount standards and that the distributor's selling price shall follow the guiding prices set by Yutai, otherwise Yutai shall have the rights to reduce discounts given to the distributor. The Hainan Bureau found that distributors sold below Yutai's guiding prices and Yutai did not punish the distributors. However, it considered Yutai's conduct as reaching a monopolistic agreement prohibited by article 14 of the AML and fined Yutai 200,000 yuan after considering the relevant factors of the whole investigation.

The infringement decision was also based on article 48 of the AML, which stipulates that if the monopolistic agreement has not been implemented, a fine of no more than 500,000 yuan may be imposed. Yutai was dissatisfied with the infringement decision and brought a suit to the Haikou Intermediate People's Court (Haikou Court).

The trial court revoked the Hainan Bureau's decision

The Haikou Court ruled in favour of Yutai and held that a finding of a monopolistic agreement prohibited by article 14 should not depend solely on whether the parties reached an agreement on RPM, but also on whether the agreement has the effect of eliminating or restricting competition, based on the concept of monopolistic agreement defined by article 13 of the AML.

The Haikou Court went further to state that, to determine whether Yutai's RPM agreement had the effect of eliminating or restricting competition, the business scope and market share of Yutai, the competitive level of the relevant market, and the extent of impact of the RPM on the supply and price of the products must be considered comprehensively. After considering evidence of the aforementioned factors, the Haikou court held that Yutai's RPM did not constitute a monopolistic agreement and revoked the Hainan Bureau's decision.

The appellate court upheld the Hainan Bureau's decision

The Hainan Bureau appealed to the Higher People's Court of Hainan (Hainan Court) and argued that RPM agreements are illegal by object. The Hainan Bureau argued that RPM agreements constitute monopolistic agreements prohibited by article 14 of the AML as long as they are reached, and they do not need to be assessed if they cause the eliminative or restrictive effect on compe­tition. In individual cases, if the undertakings involved are able to prove that an RPM agreement meets the criteria of article 15 of the AML, the agreement may be exempted.

The Hainan Bureau pointed out that the Haikou Court twisted the meaning of 'monopo­listic agreement' defined by article 13 of the AML by narrowing the definition to cover agreements restricting competition by effect only. Article 13 of the AML defines 'monopolistic agreements' as agreements, decisions or other concerted practices that 'eliminate or restrict competition' but not that 'cause the effect of eliminating or restricting competition'. Thus agreements that 'eliminate or restrict competition' under article 13 should include agreements that restrict competition by object and those that restrict competition by effect.

The Hainan Bureau further argued that those horizontal and vertical agreements explicitly prohibited by articles 13 and 14 of the AML are agreements eliminating competition by object. Such agreements have been proven by long-term antitrust practice to be serious restrictive agreements and thus do not require an effect analysis. The Hainan Bureau noted that such an interpretation of article 13 is similar to the interpretation of the comparable EU competition rules.

The Hainan Court accepted the argument of the Hainan Bureau and overthrew the verdict of the Kaikou Court. In a judgment rendered in December 2017, the Hainan Court further pointed out that public enforcement is distinct from private litigation brought under the AML. According to article 50 of the AML, undertakings shall bear civil liabilities if their monopolistic conduct has caused losses to others. Therefore, private litigation against RPM does require the plaintiff to establish an antitrust injury in order to be entitled to damages.

The divergence and convergence between private and public enforcement against RPM

Prior to the judicial review on the Hainan fish feed decision, most private lawsuits challenging RPM were dismissed because courts followed the rule of reason approach and left aside the framework of 'prohibition and exemption' established by article 14 and 15 of the AML. The Hainan Court was clear that the 'prohibition and exemption' on RPM established by article 14 and 15 of the AML should be followed in both public and private enforcement. However, private litigants against RPM bear the higher burden of proof to show that they suffer losses and that there is a causal link between their losses and the alleged RPM. The Hainan Court's judgment was expected to better align public enforcement with private rights as regards RPM.

Nevertheless, the divergence between private and public enforcement against RPM remain. In July 2018, the Shanghai IP Court (with jurisdictions to antitrust disputes) dismissed a private lawsuit filed by a distributor against Hankook Tire. The distributor alleged that Hankook forced it to enter into an agreement that restricted resale prices. The Shanghai IP Court found that Hankook and the distributor reached an RPM agreement. However, the court held that the plaintiff failed to prove anticompetitive harm and the RPM agreement therefore did not constitute a vertical agreement prohibited by the AML.

Also in July 2018, the Guangdong Higher People's Court dismissed an appeal of a private lawsuit filed by a distributor against Gree. The distributor complained that Gree, a consumer appliances manufacturer, implemented RPM. The Guangzhou IP Court (the trial court) held that the RPM did not violate the AML because it did not have the object or effect of eliminating and restricting competition. On appeal, the Guangdong Higher People's Court found that the market for household air conditioners was highly competitive. It concluded that the alleged RPM did not have any anticompetitive purposes and effects and therefore did not constitute a monopolistic agreement prohibited by the AML.

The trends of public enforcement priorities

On the public enforcement front, RPM apparently continues to be among the priorities of the SAMR given that various types of vertical price-fixing were found during the NDRC's previous investigations that are detrimental to China's mission to establish a unified, open and competitive market as well as to consumer welfare. Although the SAMR is of the view that the AML should not be applied rigidly and competitive assessment must be adaptable to individual factual and legal circumstances of each case under the background of the specific industry, the risks of RPM are significantly higher than non-price vertical restraints.

Regarding the divergence between private and public enforcement against RPM, Director General Wu Zhenguo, head of the Anti-Monopoly Bureau under SAMR, stated openly that ­article 14 of the AML expressly prohibits undertakings from entering into monopolistic agreements maintaining resale prices or setting minimum resale prices. DG Wu emphasised that, as seen from the text of article 14, maintaining resale prices or setting minimum resale prices are treated as per se illegal by the AML. However, according to article 15 of the AML, article 14 is not applicable to certain RPM agreements that satisfy the conditions of article 15.6 The draft Monopolistic Agreements Provisions reiterate the above notion.

Regarding non-price vertical restraints, based on the relevant guidelines under drafting and the ruling of the Hainan Court, non-price vertical restraints will be treated as restrictions by effect and thus require an analysis on effect. The antitrust risks for non-price vertical restraints imposed by companies holding significant market power or even dominant positions in the relevant market are higher than those imposed by companies with no market power. Thus, companies are advised to remain vigilant, to avoid directly or indirectly reaching RPM with their distributors, to review dealership agreements, and to reinforce the legality of non-price vertical restraints by substantiating the efficiency gains generated therefrom.


Footnotes

1 Xu Xinyu, 'Deliberations on Several Issues regarding the Drafting of the Enforcement Guidelines on Vertical Price Monopolistic Agreements' (in Chinese), Price Supervision and Anti-Monopoly in China, Vol. 1, 2018.

2 SAMR, Provisions of the Prohibition on Monopolistic Agreements (Draft for Comments), 3 January 2019, http://samr.saic.gov/gg/201901/t20190103_279729.html (in Chinese).

3 Lu Yanchun and Su Hua (Jessica Su), 'Deliberations on Several Key Issues regarding the Drafting of the Anti-Monopoly Guidelines on the Automobile Industry' (in Chinese), Price Supervision and Anti-Monopoly in China, Vol. 5, 2016.

4 NDRC, Anti-Monopoly Guidelines on the Automotive Industry (Draft for Comments), 23 March 2015, http://jjs.ndrc.gov.cn/gzdt/201603/t20160323_798376.html (in Chinese).

5 Administration Litigation Judgement of the Higher People's Court of Hainan, (2017) Qiongxingzhong No. 1180, published on 29 January 2018, http://wenshu.court.gov.cn/Index (in Chinese).

6 The Antitrust Source, Interview with Wu Zhenguo, Director General of China's State Administration for Market Regulation (SAMR), December 2018.

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