China: Vertical Agreements

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 2 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 former Chinese antitrust agencies – 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 (the SAMR). RPM continues to be among the SAMR’s enforcement priorities.

By the end of 2019, 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 is resolved by the Supreme Court’s ruling in the Hainan fish feeds case.

Analytical framework of vertical agreements under the AML

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.

Recent developments in antitrust regulations relevant to vertical agreements

On 1 July 2019, the SAMR released the Interim Regulation of Prohibiting Monopoly Agreements (Interim Regulation), effective 1 September 2019, which converges and develops prior antitrust administrative rules. However, the Interim Regulation does not unfold any development sub­stantial to vertical agreement analysis, nor does it set out specific provisions on non-price-related vertical agreements. Moreover, compared to the previous public draft dated 30 January 2019, ¹ the Interim Regulation does not adopt safe harbour for vertical agreements, eliminating the previously proposed presumption of benign vertical agreement for undertakings below the 25 per cent market share threshold. ² The official explanation of excluding safe harbour in the Interim Regulation is that the upper-level law (ie, AML) has no provisions on the market share threshold and other elements related to safe harbour, which means that safe harbour shall not be included in the SAMR regulations unless enabled by the AML. Notably, the Draft Amendment to AML (released on 2 January 2020) also makes no mention of safe harbour provisions.

One notable development on vertical agreement is the Shanghai Anti-Monopoly Compliance Guide for Business Operators (Compliance Guide), released by the Shanghai Administration for Market Regulation at the end of 2019, where antitrust risk of non-price-related vertical agreements (including exclusive distribution, exclusive purchase agreement, restriction on passive sales, and territory and customer restrictions) is highlighted in parallel with RPM risks. Moreover, consistent with the Supreme Court’s ruling in the Hainan fish seed case (as discussed below), the Compliance Guide indicates that the burden of proof is on the undertakings to show RPM agreements are not anticompetitive.

Sector-specific rules: anti-monopoly guidelines on the automobile market ³

The NDRC’s investigations into China’s automobile market resulted in a 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 2019, 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 to 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 made and the selling prices agreed between automobile suppliers and the buyers. In such circumstances, the dealers 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 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 decision ⁵

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 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 do not ‘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.

Final decision of the Supreme Court

Yutai filed a petition for a retrial to the Supreme Court following the unfavourable reversal by the appellate court. The Supreme Court issued a ruling on 18 December 2018. The ruling recognised that RPM agreements generally have both anticompetitive and procompetitive effect and held that RPM agreements are not illegal per se despite being typical vertical agreements. Moreover, the Supreme Court opined that the element of anticompetitive effect is essential to claims under article 14 and article 13, which means vertical agreements are illegal only if they are deemed as anticompetitive in nature. However, the Supreme Court conceded that comprehensive economic analysis of all vertical agreements for the purpose of competition effect assessment may significantly increase enforcement cost and reduce enforcement efficiency. In the context of contemporary China’s market environment and enforcement reality, requiring that antitrust authorities conduct comprehensive economic analysis may not fit with current antitrust enforcement purpose. Therefore, the Supreme Court held that antitrust authorities may find an RPM agreement illegal without proving whether such agreement has any restriction on competition. The burden is on the undertakings to prove the RPM agreement does not eliminate or restrict competition. As a result, the Supreme Court dismissed Yutai’s petition for retrial.

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.

Since the Supreme Court’s ruling against Yutai, the divergence between private and public enforcement against RPM has been resolved. The prevailing view is that antitrust authorities may find an RPM agreement illegal without proving whether such agreement has any restriction on competition, and the burden is on the undertakings to prove the RPM agreement does not eliminate or restrict competition.

The trends of public enforcement priorities

RPM apparently continues to be among the priorities of the SAMR as it is still the only vertical restraints specified in the AML and relevant regulations. Therefore, the risk for RPM would be still significantly higher than non-price vertical restraints, especially considering the convergence between private and public enforcement against the RPM.

Furthermore, the amendment of the AML is under public consultation and we believe that various comments would have been raised by the public related to further elaboration of non-price vertical restraints and introducing safe harbour mechanism. We have witnessed that the Shanghai Compliance Guide has moved one step further with a few non-price vertical restraints specified, such as exclusive purchasing or restriction on passive sales.  However, due to lack of explicit superior rules, the safe harbour mechanism is still pending in such guidance and waiting for more solid basis from upper-level law.

Notes