China: Vertical Agreements

Antitrust issues related to vertical agreements have triggered disputes between suppliers and distributors, as well as complaints from interested parties, in recent years. 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, have resulted in fines exceeding two billion yuan against suppliers and distributors of liquors, baby formulas, automobiles, medical devices, eyeglass lenses, consumer electronics, pasteurised milk, turbo oil products, etc. By the end of 2017, a number of investigations against RPM were ongoing.1 Thus far, no investigations have been initiated against stand-alone vertical non-price restrictions.

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 authorities. 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 by clarifying the analytical approaches of the enforcement authorities, it was reported that the NDRC has led the drafting work of a number of guidelines accompanying the AML and is endeavouring to accelerate the promulgation procedures in 2018.2

General rules on vertical price monopolistic agreements3

The NDRC started drafting the Enforcement Guidelines on Vertical Price Monopolistic Agreements (the draft Enforcement Guidelines) in October 2017 based on its enforcement experience. On 30 November 2017, a workshop was held and the draft Enforcement Guidelines was circulated to 30 antitrust practitioners and scholars for comments. The NDRC drafting team is revising the draft Enforcement Guidelines and expects to carry out public consultations in 2018.

The draft Enforcement Guidelines include detailed explanations of the NDRC’s analytical approach on key questions identified in enforcement. These questions include, but not limited to:

  • the form and substance of vertical agreements;
  • the application of the prohibitions and exemptions under articles 14 and 15;
  • presumed exemptions and individual exemptions; and
  • competitive effects and assessment of legality of specific vertical restraints.

The NDRC’s enforcement experience indicates that undertakings often use price and non-price restraints together to achieve the desired price effect. Therefore, the scope of the Enforcement Guidelines covers both price and non-price vertical restraints with an emphasis on the effect of the restraints on competition and price.

It is noteworthy that the presumed exemptions and individual exemptions established by the draft Enforcement Guidelines are comparable to the mechanism under the EU vertical block exemption regulations. Presumed exemptions refer to the situation that, if each of the undertakings to a vertical agreement holds no more than 30 per cent market share in any of the relevant market and the agreement does not contain any of the blacklisted restraints, the agreement is presumed to meet the standards of article 15, and thus is exempted from the prohibition of article 14. Individual exemptions refer to the situation that, if market share of any of the undertakings to a vertical agreement exceeds the 30 per cent threshold or the agreement contains any of the blacklisted restraints, the agreement will not be presumed to meet the standards of article 15 but the undertakings may assess if the agreement may be individually exempted on a case-by-case basis.

One of the highlights of the draft Enforcement Guidelines is clarifying that undertakings bear the burden of self-assessment and prior notifications are not required for exemptions under article 15. If the NDRC initiates an investigation against an agreement, the undertakings involved are allowed to apply for exemptions any time before the NDRC’s decision is rendered.

Sector-specific rules: anti-monopoly guidelines on the automobile market4

The NDRC’s investigations on China’s automobile market have resulted in series of infringement decisions against major passenger car manufacturers and their authorised dealers. To date, 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, authorised dealers of the automobile manufacturers were also fined because the RPM organised by manufacturers and then implemented by authorised dealers effectively established price cartels among dealers.

The NDRC’s ongoing investigations on the automobile market revealed that vertical restraints are similar and in parallel among automobile brands and are mainly imposed by automobile manufacturers. The NDRC also found that competition among authorised dealers is distorted while effective competition does not exist or is insufficient between authorised and independent after-sales service providers in the automobile market.

Given that the NDRC has 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 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 feedbacks. On 23 March 2016, the NDRC published the draft Automobile Guidelines and sought public comments before 12 April 2016.5 By 31 December 2017, the drafting work and most formalities were completed and the draft Automobile Guidelines are approaching 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 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 and undertakings may claim exemptions. The four scenarios include:

  • RPM for 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 efficiency-enhance effects of territorial and customer restrictions imposed by automobile suppliers on authorised dealers 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 network members 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, the restrictions agreed between automobile manufacturers and suppliers of the sale of related 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 NDRC notes that the markets for repair and maintenance services and for the distribution of spare parts is generally brand-specific in nature, and that competition is lessened compared to 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 initiated by automobile manufacturers holding dominant positions in the aftermarkets of their branded automobiles regarding spare parts are under monitoring, 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 supplying private brands parts directly to the aftermarket.

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

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

The judicial review on the Hainan fish feeds decision6

Public enforcement against RPM seemed quiet in 2017 compared to 2016, when the fines on Medtronic exceeded 118 million yuan and on SAIC General Motors exceeded 200 million yuan. Nevertheless, the first judicial review in 2017 on an infringement decision against a RPM agreement is of great significance in defining the boundary between antitrust and freedom of pricing strategies for enterprises supplying and distributing goods and services in China.

Hainan Provincial Price Bureau fine producers of fish feeds for RPM

In September 2015, the Hainan Provincial Price Bureau (Hainan Bureau) investigated the fish feeds market and imposed fines in October 2016 on seven producers after finding that most producers of fish feeds 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 shall 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 for 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 brought a suit to challenge the infringement decision 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 only depend on whether the parties reached an agreement on RPM, but also depend on whether the agreement has the effect of eliminating or restricting competition, based on the definition of monopolistic agreement given by article 13 of the AML.

The Haikou Court went further to state that, in order 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 thus 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. 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 as 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 the 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 convergence between the courts and the competition authorities and the trends of enforcement priorities

Prior to the judicial review on the Hainan fish feeds 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 is expected to better align public enforcement with private rights as regards RPM.

In the public enforcement front, RPM apparently continues to be among the priorities of the NDRC given that various types of vertical price fixing were found during the NDRC’s investigation that are detrimental to China’s mission to establish a unified, open and competitive market as well as to the welfare of consumer and the society as a whole. Although both the NDRC and the SAIC are 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 cases under the background of the specific industry, the risks of RPM are significantly higher than non-price vertical restraints.

Base on the relevant guidelines and the Hainan Court’s decision, non-price vertical restraints, if challenged under the AML, will be treated as restrictions by effect and thus require an analysis on effect under article 14. The antitrust risks for non-price vertical restraints (eg, exclusive purchasing arrangement) 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.

For example, the NDRC’s market inquiries into the automobile market indicated that vertical restraints, including RPM and non-price restrictions, are among major reasons that have resulted in excessively high prices of automobiles and replacement parts for Chinese consumers. Thus, companies need to remain vigilant, avoid directly or indirectly reaching RPM with their distributors, review dealership agreements and reinforce the legality of non-price vertical restraints by substantiating the efficiency gains generated therefrom.

Notes

1 The three Chinese competition authorities include: NDRC, responsible for monopolistic conduct related to pricing; State Administration for Industry and Commerce (SAIC), responsible for monopolistic conduct other than pricing; Ministry of Commerce (MOFCOM), responsible for merger control.

2 Economic Information Daily, ‘The review mechanism of fair competition will be advanced further within the year’ (in Chinese), www.jjckb.cn/2018-01/30/c_136934788.htm, 30 January 2018.

3 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.

4 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.

5 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).

6 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).

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