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China continued its enforcement initiative in 2014, targeting cartel agreements and other ‘monopoly agreements’ prohibited under China’s Anti-Monopoly Law (AML). Building on several years of active enforcement, the National Development and Reform Commission (NDRC) and the State Administration for Industry and Commerce (SAIC), together with their regional offices, have firmly established their position in the international spotlight with a series of high-profile enforcement actions against domestic and foreign companies covering a broad range of alleged anti-competitive conduct. Notably, these cases have reflected both a further expansion into global cartel enforcement with its contribution to the worldwide Auto Parts investigation, as well as the launch of high-profile domestic cases involving Chinese and multinational companies in a number of sectors such as automotive, cement, insurance and contact lenses.
This article provides an overview of the key developments in cartel enforcement in China and the significance of these developments for businesses. For these purposes, cartel developments are defined as covering prohibited coordinated conduct, including horizontal agreements such as price fixing or market allocation among competitors; and vertical agreements such as resale price maintenance (RPM). Both types of agreements are treated as ‘monopoly agreements’ under articles 13 to 16 of the AML and are subject to essentially the same enforcement rules.
The NDRC and the SAIC have distinct but often overlapping enforcement authority over different forms of anti-competitive conduct under the AML. More specifically, the NDRC has enforcement authority over price-related anti-competitive agreements such as horizontal price fixing and RPM. The SAIC is responsible for enforcement related to non-price restraints such as market allocation, output restrictions and vertical restraints other than RPM. In addition to competition enforcement under the AML, the NDRC and the SAIC also have enforcement authority over related statutes like the Anti-Unfair Competition Law and the Price Law.
The enforcement decisions in 2014 provide a valuable window into the ongoing development of the enforcement regime in China. Building on the key enforcement actions over the past year, this article outlines some of the agencies’ positions on substantive issues that are taking shape as these enforcement activities progress. The article will also highlight procedural developments that have allowed regulators to investigate and prosecute violations more effectively, while noting some areas where further development is required. Finally, the article will extrapolate from this review some relevant enforcement trends and discuss the implications for companies operating in China.
Horizontal agreements – particularly traditional hard-core cartel agreements – have been an enforcement priority for both the NDRC and the SAIC since the AML came into effect. So far, these horizontal agreements have accounted for the majority of the agencies’ enforcement actions. While the enforcement of horizontal cartel agreements traditionally focused on local violations by domestic companies, enforcement in this area is becoming increasingly active in targeting global cartels and conducting domestic investigations involving multinational companies.
Price fixing, customer and market allocation, output restrictions and joint boycotting are explicitly prohibited as monopoly agreements under article 13 of the AML. Horizontal agreements do not have to be oral or written contracts, but rather can take various forms: joint announcement, commitments, self-discipline policy or other concerted action. Article 15 contains a non-exhaustive list of circumstances in which a monopoly agreement may be exempted, where the agreement is concluded for:
- improving technology, or researching and developing new products;
- improving product quality, reducing costs, enhancing efficiency, harmonising product specifications and standards, or dividing work based on specialisation;
- enhancing the competitiveness of small and medium-sized enterprises;
- serving social public interests such as energy saving, environmental protection and disaster relief;
- alleviating decreases in sales or cuts in production overcapacity in periods of economic downturn; or
- safeguarding legitimate interests in foreign trade.
Each of the first five conditions additionally requires that the agreement does not significantly restrict competition in the relevant market and allows consumers to share the resulting benefit. As with other jurisdictions, horizontal monopoly agreements are subject to close scrutiny and the NDRC has indicated that it would be very difficult for the parties to a traditional hard-core cartel agreement to prove such agreement falls within the exemptions under article 15 of the AML.
Most significantly for foreign companies, the NDRC joined the United States, European Union, Japan and other jurisdictions in the long-standing global cartel enforcement efforts targeting the auto parts sector in 2014. Building off a multi-year global investigation, the NDRC found that eight Japanese auto parts manufacturers (Hitachi, Denso, Asian Industry, Mitsubishi Motors, Mitsuba, Yazaki, Furukawa and Sumitomo) had agreed over the span of nearly a decade to fix the prices of at least 13 products for the Chinese market, including starters and alternators. Separately, the NDRC found that four bearing manufacturers (Fujio, Seiko, JTEKT and NTN) had engaged in a monopoly agreement that effectively raised bearing prices in the Chinese market. These manufacturers allegedly held meetings in Japan and Shanghai for more than a decade to discuss guidelines, timing and magnitude of price increases for China and other Asian markets. Altogether, the NDRC imposed record breaking fines of 1.24 billion renminbi, including the largest-ever fine for a single company of 290.4 million renminbi. The Auto Parts investigation was the NDRC’s second major foray into international cartel enforcement, after previously following global regulators in sanctioning six multinational LCD panel makers from Korea and Taiwan a total of 353 million renminbi.
Further down the automotive supply chain, the NDRC also concluded two investigations targeting horizontal monopoly agreements among car distributors uncovered in the context of a broader industry investigation focused on vertical price restrictions. In August 2014, the NDRC regional office in Shanghai fined four Chrysler distributors for meeting to agree on prices for certain maintenance and repair services. The NDRC also separately found that Chrysler had imposed minimum resale price requirements on its distributors. In September, the regional office in Hubei similarly fined 10 Audi distributors for agreeing to fix or change product prices. The FAW-Volkswagen sales representative was alleged to have been involved in organising meetings of the distributors for the purposes of implementing vertical price restrictions. It is reported that investigations of other automotive companies are also still ongoing.
The NDRC’s enforcement initiatives not only targeted foreign companies engaging in horizontal monopoly agreements. The NDRC also published several decisions in 2014 imposing significant fines on Chinese companies. In the Jilin Cement case, for example, three cement producers were sanctioned with fines totalling 114 million renminbi for agreeing to fix cement prices. Separately, the Zhejiang Insurance Industry Association was found to have organised a meeting between provincial-level insurance companies to agree on a new car discount ratio and unified handling fee for commercial car insurance based on market share.
Separately, the SAIC released several decisions this year involving non-price horizontal monopoly agreements. In Zhejiang, eight concrete manufacturers were found to have agreed to allocate markets under the auspices of a trade association. In Chongqing, four individuals were found to have divided up quarry customers in Wuxi city. In Inner Mongolia, six firework wholesalers were found to have engaged in market-sharing activity under the pretext of a law requiring the each wholesaler to sell fireworks within a designated region.
Beginning in 2013, the NDRC expanded beyond the traditional enforcement of horizontal agreements by launching a series of high-profile enforcement actions against RPM agreements. RPM is of particular importance for multinational companies in China due to the legal and practical reality that many rely heavily on domestic distributors to access these growing markets. The NDRC has also recognised that RPM arrangements can be intertwined with horizontal cartel agreements, as reflected in the overlapping cases involving foreign car distributors.
Article 14 of the AML explicitly prohibits fixing resale price and setting minimum resale price. RPM conduct may also be exempted if such conduct falls within the exemptions under article 15. Despite the lack of official guidance, a 2013 article by two NDRC officials takes a broad approach to what can constitute an unlawful restriction on resale prices. In addition to explicit contractual terms directly relating to resale price, the article insists that RPM can take subtler forms such as:
- linking restrictions on sales into unauthorised territories to the resale price;
- capping the maximum discount offered by downstream distributors;
- fixing the distribution margin for downstream distributors;
- setting the minimum distribution margin for downstream distributors;
- fixing the minimum operating profit for downstream distributors; and
- setting the minimum tax burden ratio for downstream distributors.
In addition, the article notes that the supplier can implement de facto RPM where it strictly monitors the resale price of its distributors or ties rebates to the resale price.
While the NDRC’s assessment of the RPM restraints under investigation appears to have suggested that some form of anti-competitive effect is required, the decisions have not provided details on how the analysis should be applied. It is generally understood that NDRC considers RPM to be ‘in principle prohibited’ under article 14 of the AML, and that it would be up to the companies involved to prove that the RPM in question can be exempted under article 15 of the AML. This essentially means that the NDRC is setting a high bar for RPM to be free of enforcement challenge. This in turn may indicate that the NDRC is leaning towards taking a ‘restriction by object’ approach towards RPM analogous to the EU position, meaning RPM is automatically regarded as restricting competition without the need to prove it’s actual effect on competition.
In contrast, the Chinese courts appear to be adapting a US ‘rule of reason’ approach for use in private enforcement, where the effect on competition needs to be proven and then balanced against any pro-competitive effects. In the 2013 Shanghai High Court ruling in Rainbow v Johnson & Johnson, the court affirmed that RPM should be subject to a standard similar to a rule-of-reason analysis. Further, the Court clearly set out four main factors for determining whether the RPM conduct has an anti-competitive effect, namely sufficiency of competition in the relevant market, the defendant’s market position, the defendant’s motives in imposing RPM and the actual impact on competition. Notwithstanding the seemingly apparent divergence, the Court did not appear to require strong evidence to reach the conclusion that the RPM conduct did indeed have the requisite anti-competitive effect; namely, the evidentiary threshold for finding anti-competitive effects in the defendant’s alleged conduct appears to be fairly low.
There have not been further court decisions on RPM since Rainbow v Johnson & Johnson, which is still understood as a valid precedent. In the meantime, the NDRC has continued to have an active enforcement initiative against RPM agreements in China, and announced several penalty decisions for RPM agreements in 2014 that appear to reinforce its close to ‘restriction by object’ approach to RPM. In May, for example, the NDRC announced that three regional offices in Beijing, Shanghai and Guangdong had imposed fines totalling 19 million renminbi on frame lenses and contact lenses manufacturers. Concluding its 10-month investigation of the optical lens industry, the NDRC discovered that four frame lenses producers (Essilor, Zeiss, Hoya and Nikon) and three contact lenses companies (Bausch & Lomb, Johnson & Johnson and Weicon) engaged in various forms of RPM. The companies allegedly enforced compliance with suggested retail prices by imposing penalties on distributors, such as deducting money from deposits, halting supply and cancelling sales commissions. The NDRC also conducted an extended investigation into RPM practices by foreign car manufacturers. As a result, the NDRC imposed fines of 248.6 million renminbi on Audi and 31.7 million renminbi on Chrysler for several forms of RPM. Several manufacturers (Jaguar Land Rover, Toyota, Honda and BMW) reportedly resolved the investigation without formal penalties by announcing price cuts for cars or spare parts.
Calculation of fines
As cartel enforcement becomes more active, more cases involving big companies and significant fines are likely to be seen. Article 46 of the AML provides that the applicable fine should be assessed at 1 per cent to 10 per cent of the offending company’s relevant sales revenue for the preceding year. The agencies are also entitled to confiscate alleged unlawful gains. However, the agencies have not yet published clear rules on the calculation of fines or unlawful gains and several important questions remain unsettled. The SAIC is expected to issue guidelines for the calculation of fines in 2015.
NDRC officials have provided some informal guidance on the calculation of fines in a trade publication article, stating how fine levels should correspond to the seriousness of the offence. In particular, the article suggests that fines of 8 per cent or more are appropriate for the most serious offences; 5 per cent to 8 per cent for moderate offences; and less than 5 per cent for minor offences. In practice, the highest fine percentages to date have been in the Auto Parts investigation, where the unlawful conduct was found to be serious and long-term. In particular, several manufacturers were subject to a fine of 8 per cent of the previous year’s turnover in China where their conduct related to multiple products or they initiated the unlawful pricing discussions. Four other manufacturers were subject to a lower fine of 6 per cent of the previous year’s turnover where their involvement was limited to one product or they only participated in some of the pricing discussions. As cartel enforcement becomes more established, significant fines for the most serious cartel offences are expected to become increasingly common.
Enforcement cases to date have not been entirely clear on what sales were the basis for fine calculations, including any limitations by geography or relevant business lines. Consistent with prior decisions, several NDRC officials authored an article that appears to suggest that the NDRC may ultimately calculate the fine on some level between the revenue generated from the affected products within China and the global revenue for the full product portfolio. There is also some ongoing ambiguity as to the relevant year’s turnover for calculation of fines. While the NDRC appears to be inclined to treat the ‘preceding year’ as the year before the sanctions are imposed, the SAIC enforcement decisions appear to interpret the ‘preceding year’ as the year before discovery of the alleged conduct.
Leniency rules exist under both the AML and the general administrative law. Article 46 of the AML requires ‘reporting of information on an anti-competitive agreement and provision of important evidence’ as a precondition of partial or full leniency. The general administrative law includes a more flexible mechanism allowing infringing companies to qualify for varying degrees of reduced sanctions depending on the level of their cooperation with the investigation and their initiative in taking rectification measures. Furthermore, the NDRC and the SAIC have discretion to suspend an investigation without penalties under article 45 of the AML where the parties undertake specific measures to rectify the anti-competitive conduct.
In practice, the agencies have been taking a flexible but unconventional approach to leniency that is broader in practice than in mature regimes like Europe and the United States. While the AML requires self-reporting as a condition of leniency, the general administrative law includes a more flexible mechanism allowing companies to qualify for varying degrees of leniency depending on their level of cooperation and initiative in taking rectification measures. The leniency provisions extend beyond horizontal cartel offences to also cover RPM cases, where multiple companies have obtained full exemption of fines in a single investigation.
The enforcement actions in 2014 demonstrate that proactive cooperation can result in full leniency or a significant reduction in fines. In the Auto Parts and Bearing cases, for example, two applicants were given full immunity as the first companies to cooperate in each investigation. In the Auto Parts case, Hitachi was reportedly granted immunity after providing written evidence to NDRC several weeks after an initial dawn raid. In the Bearing case, Nachi was given full immunity as the first company to self-report and provide evidence in the case. The NDRC reported that the company would otherwise have been subject to fines of 10 per cent due to the seriousness of the offence, which included directly negotiating and implementing price increases on multiple occasions over a span of more than 10 years. The second leniency applicant in each case received a 50 per cent reduction in fines as a result of its cooperation, reducing the applicable fine from 8 per cent to 4 per cent. Generally, the effect of a leniency application can depend largely on the varying extent to which each company provided important evidence, cooperated with the investigation and carried out active self-rectification. Having said that, the NDRC has not provided details on what would qualify for each factor.
A notable feature of the recent enforcement cases by the NDRC is that many companies under investigation have offered price cuts to obtain favourable treatment or to bring the investigation to an early end. For instance, a number of foreign car manufacturers have publically committed to cut their prices for cars, spare parts and repair or maintenance services as a gesture of willingness to cooperate. NDRC’s willingness to negotiate price-related commitments in the form of price reductions appears to echo its traditional role as a price regulator.
Recent enforcement activity shows that cases originate from various sources. Complaints from competitors, customers or suppliers tend to be the most important sources of investigations. The NDRC has also conducted broader sector inquiries swiftly followed by investigations into infringements by individual companies. In such inquiries, the authority first sends generic questionnaires to a variety of market players and subsequently targets certain companies for follow-up inquiries or even formal investigation. In its probe of the automotive sector, the NDRC reportedly began with an ‘industry sweep’ sending requests for information to many major multi-national car manufacturers.
At the start of an investigation, the NDRC and the SAIC will typically conduct a dawn raid of the target businesses. Officials from both agencies have relatively broad investigatory powers under the relevant regulations and the agencies’ general enforcement practice; namely, officials can:
- enter into companies’ business premises for investigation;
- inquire into companies’ employees and interested parties;
- review and copy companies’ books and records;
- seal and detain evidence; and
- check companies’ bank accounts.
As the agencies gradually accumulate experience, their investigative skills are becoming increasingly sophisticated. While the NDRC’s announcements of enforcement decisions do not offer details as to how it or local DRCs conducted their investigations, articles written by NDRC officials have described in detail the tactics and skills used during the course of investigations. The NDRC has also become increasingly experienced in calling up a task force to carry out the investigation. Investigation teams are generally designed to include a range of specialised experts in law, technology or accounting. They have also been using increasingly high-tech investigative techniques, including forensic IT techniques to recover deleted e-mails.
Article 52 of the AML provides for sanctions for the obstruction of an investigation and concealing, destroying or falsifying documents. In serious cases, fines against companies can be up to 1 million renminbi. The agencies are also entitled to impose fines against individuals for obstructing the investigation. Criminal penalties with imprisonment of up to three years can be imposed in extreme cases. Recently, two companies in Hainan Province were fined for transferring and destroying financial data requested by the investigating agency.
The pace of the investigations can vary dramatically. While some cases have had final decisions announced only a few months from the launch of the formal investigation, other cases have reportedly lasted several years. Under article 43 of the AML, parties under investigation have a formal right of defence, meaning a right to present their explanations and arguments during the course of an investigation. In practice, defendants may have a limited window to present defences. In certain cases, the NDRC was reported to have sought a confession from the parties within days of a dawn raid. There is also no formal mechanism for limiting the scope of the investigation. Since attorney–client privilege protections do not apply in China, communications with counsel are not protected from disclosure to the same extent in China as in other jurisdictions.
In the meantime, there have been some notable improvements in relation to due process and transparency, particularly in the latter half of 2014. Both the NDRC and the SAIC have confirmed that the parties under investigation have a formal right to external counsel. The authorities have also started publishing detailed decisions in their websites even though they are not obligated to do so under the AML.
Article 53 of the AML also allows parties to seek reconsideration or bring an administrative litigation to challenge a decision. In the only known administrative litigation to challenge an agency decision, three concrete companies sought to overturn a decision by the local price bureau sanctioning them for price fixing. The case was reportedly dismissed in December for failure to comply with the general three month statute of limitations.
The active enforcement against monopoly agreements in 2014 has firmly established the enforcement regime in China. As the NDRC and the SAIC gradually expand enforcement capacity and accumulate experience, enforcement is only expected to increase. On the substantive side, cartels (including international cartels) are likely to continue to be an enforcement priority. The NDRC is also clearly taking a hard line on RPM and enforcement will likely remain robust. In terms of procedure, the authorities have developed skills and gained experience in relation to conducting investigations including dawn raids.
Companies doing business in and with China cannot afford to overlook this jurisdiction in their global competition compliance programmes. Companies should pay careful attention to the development of the China-specific features of the AML enforcement and the authorities’ growing readiness for continued vigorous enforcement. Against this rapidly developing environment of AML enforcement, companies are advised to closely examine their business practices, carefully assess the associated risks and take necessary actions to address any non-compliance.