Article: Increase in Vertical Price Restraint Enforcement in China

In recent months, Chinese anti-monopoly enforcement actions scrutinizing and penalizing pricing-related issues have noticeably increased. A growing number of foreign companies in consumer-facing industries have received significant penalties for setting pricing restrictions—usually minimum resale prices—on contractual counterparties down the supply chain. A particular target of the enforcement authorities has been the automotive industry, which has been the subject of numerous regulatory actions, but cases in this area are not limited to that sector; the authorities have also taken action in the liquor and healthcare industries.

The most recent development is that on April 15, 2016, the Shanghai Pricing Bureau, a provincial- level authority for pricing-related anti-monopoly enforcement actions, imposed a fine of USD 340,000 on South Korean tire company Hankook. See Shanghai Price Bureau Administrative Penalty Decision (Shanghai Hankook Tires), Case No. 2520160001 (April 12, 2016). The decision found that Hankook established minimum resale price restraints through its agreements with its distributors, under which Hankook had implemented minimum price lists, “market norm” security deposits, and warning letters when distributors offered prices below the minimum. This penalty was just one in a series of administrative decisions penalizing vertical price restraints in the automotive industry in the last 18 months. To date, Chinese anti-monopoly law enforcement authorities (the “AMEAs;” including National Development and Reform Commission, the State Administration of Industry and Commerce, and the Ministry of Commerce) have imposed fines totaling more than RMB 2 billion (approximately USD 300 million) on major automakers and spare-parts suppliers; five out of seven actions are related to vertical price restraints. (See Liu Weiyan, Anti-Monopoly Guidelines for the Auto Industry Targets Resale Price Maintenance and Presumptive Exemptions Remain Difficult, National Business Daily (April 25, 2016).)

In addition, on the legislative front, during March 23 to April 12, 2016, China’s National Development and Reform Commission (“NDRC”), a ministry-level agency under the State Council (national executive) solely responsible for pricing-related anti-monopoly enforcement, released the Draft Anti-Monopoly Guidelines for the Automotive Industry (the “Draft Guidelines”) for public comment. As China’s first industry-specific anti-monopoly guideline, the Draft Guidelines aims to provide further clarifications regarding vertical price restraints in the automotive industry.

Both the Draft Guidelines and recent ramp-up in enforcement activities signal the Chinese government’s proactive ongoing efforts to target and deter vertical monopolistic activities, especially in the automotive industry. The materials below will give an overview of notable recent cases and the key provisions of the Draft Guidelines, highlighting the key practical issues and implications for anti-monopoly enforcement.

Vertical Price Restraints Enforcement Overview. The key body of law in China governing vertical price restraints is found in China’s Anti-Monopoly Law (the “AML”). Older Chinese statutes, such as the Anti- Unfair Competition Law, Price Law, and Contract Law also address aspects of vertical price restraints in China. The key AML provision addressing vertical price restraints would be Article 14 which, together with Article 15 on statutory exemptions for monopoly agreements, creates a “prohibition/exemption” structure. The language in Article 14 is cautiously worded but explicitly forbids monopoly agreements with counterparties that fix the price or set a minimum price for the prospective resale of products—two statutorily specified types of vertical price restraints. In addition, Article 14 (3) delegates to AMEAs the authority to identify and outlaw other types of vertical monopoly agreements.

For the prohibitions under Article 14, the AML also enumerates a set of statutory exemptions in Article 15. These include enhancement of product efficiency, quality, or standardization, and improvements to the competitive efficiency of small and medium-size businesses, in all cases imposing the burden of proof on the defendant, plus in most cases (including those just outlined) an additional burden of showing there is no serious harm to overall competition and consumers share in the benefits created.

The AML took effect on August 1, 2008. However, publicized enforcement actions against vertical price restraints are a more recent development. This activity began with one incident of private enforcement action arising out of the AML—Rainbow v. Johnson & Johnson, the first and, so far, only published case of private enforcement, which was litigated in the Shanghai courts in 2012 to 2013. See Beijing Ruibang Yonghe Technology Trade Co. Ltd. v. Johnson & Johnson Medical (Shanghai) Co. Ltd., Johnson & Johnson Medical (China) Co. Ltd., Shanghai Higher People’s Court (2013), CLI.C.2134356. Administrative enforcement of the AML soon followed in 2013 and has been ramping up since. Of the five sets of administrative decisions publicized to date, the two most recent sets of decisions were in cases against the automotive industry and the most notable enforcement actions have all been in consumer-facing industries:

- On February 22, 2013, the provincial-level NDRCs in Guizhou and Sichuan provinces imposed fines totaling USD 70.5 Million on Chinese liquor distilleries Kweichow Moutai (Guizhou Moutai) and Wuliangye Group. The distilleries produced baijiu, a popular and usually expensive local liquor in China. (See Press Release, PRC Central People’s Gov’t, Moutai and Wuliangye Are Given the Largest Fines in Our Country’s Antimonopoly History (Feb. 22, 2013).) According to the government releases, these two entities violated the AML by imposing pricing controls and geographical sales restrictions on distributors. This enforcement action was notable in part because it was taken against prominent local companies, which is generally considered less common.

- On August 7, 2013, the national-level NDRC imposed fines totaling USD 105 Million on nine suppliers of infant formula powder, mostly those of foreign brands. (See Press Release, NDRC, Biostime and Other Milk Powder Manufacturers Are Fined a Total of RMB 668.73 Million for Anti-Competitive Behavior in Breach of the Anti-Monopoly Law (Aug. 7, 2013).) The enforcement sweep came after the melamine scandal affecting local infant formula powder suppliers in 2008, which led to a prolonged increase in demand and price for foreign formula powder. In the 2013 actions, the NDRC waived fines for entities that cooperated in the investigation by providing evidence and voluntarily reducing prices. However, all entities were denied eligibility for AML exemptions, on the basis of a finding that a serious impediment to competition among brands had occurred.

- On May 29, 2014, the national-level NDRC imposed fines totaling USD 2.98 Million on various contact lens suppliers, most of whom were foreign. (See Press Release, NDRC, A Portion of Eyeglass Lens Manufacturers Are Penalized for Resale Price Maintenance Conduct (May 29, 2014).) Contact lenses have historically been an industry with high profit margins. Penalties were set based on the seriousness of anti-competitive effects, and some were mitigated on the basis of the degree of cooperation.

- Between late 2014 and late 2015, various provincial-level NDRCs or their Pricing Bureaus announced a set of four similar decisions against foreign auto manufacturers of luxury and high mid-range vehicles: Chrysler (USD 4.98 Million), Volkswagen Group (USD 37.7 Million), Mercedes Benz (USD 55 Million), and Nissan (USD 3 Million). (See Press Release, PRC Central Gov’t, Chrysler Is Fined RMB 31.68 Million for Implementation of Price Monopolies (Sept. 11, 2014); Press Release, PRC Central Gov’t, Volkswagen Is Fined RMB 240 Million for Implementation of Price Monopolies (Sept. 11, 2014); Press Release, PRC Central Gov’t, Mercedes Is Fined RMB 350 Million for Implementation of Price Monopolies in Jiangsu (April 23, 2015); Press Release, Guangdong Development and Reform Commission, Nissan Is Fined for Implementing Price Monopolies in Guangdong Province (Sept. 10, 2015).) Three of the four decisions cite vertical price restraints in the aftersales auto parts markets, which may suggest that one of the key interests in the enforcement actions was ensuring that the spare parts and service and repairs markets were leveled for more competition.

- On April 15, 2016, as a part of the same case discussed above in the introduction, Shanghai provincial-level NDRC imposed a fine of USD 340,000 on South Korea’s Hankook Tires.

Enforcement Highlights and Implications. Given the lack of specificity and definition in the AML’s construction and with the broad discretionary power granted to enforcement authorities in China, the published cases present a set of key practical issues that deserve attention and careful analysis. Fortunately, the Draft Guidelines appear to provide some clarity with respect to application in specified circumstances, and recent enforcement actions help to highlight some noteworthy implications for foreign enterprises in China.

Recommended Prices: Disguised Resale Price Maintenance? Through the recent AML enforcement cases, Chinese courts and regulators have shown vigilance in identifying and penalizing vertical price restraints disguised as recommended resale prices. In the 2014 case against the contact lens suppliers, the national-level NDRC first found that the suppliers had enforced recommended prices in such a way that it was clear they were actual price restrictions rather than optional recommendations. Later in that year, Chrysler was also found to have illegally implemented hardline vertical price restraints despite having contractually stipulated “recommended” resale prices. In both cases, it is evident that, on the matter of pricing, function prevails over form. To avoid any doubt, the Draft Guidelines clarify that the AMEAs will take an “actual effect” approach to determine, on a case-by-case basis, whether recommended prices violate the AML.

Types of Prohibited Vertical Monopoly Agreements. The recent enforcement cases also indicate that other types of vertical monopoly agreements, such as geographic restraints, may also be on the Chinese regulators’ radar. In those cases, although the findings of liability were all limited to vertical price restraints under AML Article 14 (1) or (2), several decisions did include findings of contractual geographical restrictions on distributors, preventing them from selling outside of authorized districts. While geographic restraints are not an express part of AML vertical restraint law, the use of AML Article 14 to incidentally cover vertical geographic restraints has been common in previous NDRC enforcements. It is possible that the NDRC, the administrative authority in these cases, was only granted enforcement authority against pricing-related violations. It is also likely that the AMEAs, despite their delegated authority, tend to refrain from enforcing against vertical restraints not explicitly prohibited by Article 14 (1) or (2).

Going a step further, the Draft Guidelines specifically delineate other types of prohibited vertical monopoly agreements, including certain types of geographic and customer-based restraints. This not only provides more clarity on how Chinese courts and regulators will evaluate the legality of vertical restraints, but also signals a more comprehensive enforcement effort.

Anti-Competitive Effect: Is Vertical Monopoly Agreement Per Se Illegal? One of the more elusive issues under the AML is whether Article 14 prohibits all vertical monopoly agreement regardless of their anti-competitive effects. The AML Article 13 explicitly defines monopoly agreement as any agreement, decision, or other concerted action that eliminates or restricts competition. Thus, in theory, a finding of anti-competitive effect is a necessary and contestable element of liability. However, in practice, there appears to be a jurisdictional split in enforcement.

In the private action, Rainbow v. Johnson & Johnson, the Shanghai courts held that anti-competitive effect is an essential element of any claim against vertical monopoly agreements. Furthermore, in these types of private litigation, it is the plaintiffs who bear the burden of proof and there is no presumption that it has been satisfied. However, the NDRC has been sending out a very different message. The Director General of NDRC’s Price Supervision and Anti- Monopoly Bureau has indicated that the agency will take a rather simplistic “prohibition plus exemption” approach. In the case against Hankook, the documents included only very cursory and conclusory remarks about anti-competitive effects. Some of the previous government releases did provide more detail, but the nearly-formulaic description of anti-competitive effects in the Hankook case may indicate that there was no meaningful investigation into whether Hankook’s restraints created any appreciable anti-competitive effects.

Unfortunately, the Shanghai courts’ line of reasoning on the elements of a claim and presumption has never been tested against an administrative enforcement action. Although the AML Article 53 grants the People’s Courts the power of review, to date, no defendant has ever requested judicial review of an administrative determination on vertical price restraints. After all, in China, a defendant who prevails in a civil litigation action may nonetheless be subject to administrative penalties on the same set of facts.

Statutory Exemptions. At a glance, the AMEAs appear to have taken a hardline stance against vertical price restraints by limiting the contestability of anti- competitive effect, but further observation actually indicate that regulators may be open to expanding eligibility considerations for statutory exemptions, at least for the automotive industry. Building on the “prohibition plus exemption” structure outlined by the AML, the Draft Guidelines provides considerably more detailed guidance and further specification, essentially moving to a more finessed approach that may include presumptive exemptions and case-by-case exemptions. For example, with respect to geographic and customer- based restrictions, the Draft Guidelines discuss presumptive exemptions for any entity without “clear market power,” which defined as less than a 25%-30% market share (under normal circumstances). It is worth noting that these proposed presumptive exemptions are strikingly similar to the European Commission’s Block Exemption Regulations.

On vertical price restraints, the Draft Guidelines describe specific scenarios that should qualify for AML Article 15 case-by-case exemptions in the automotive industry, including resale price maintenance during the rollout phase of new energy vehicles (e.g. the initial nine months), when the distributor is a true agent, during government procurement tender bidding, and when e-commerce platforms are being used merely as an intermediary to facilitate completion of sales with end customers. With respect to case-by- case exemptions, the NDRC has also circulated for public comment the Draft Guidelines on the General Conditions and Procedures for Monopoly Agreement Exemptions. These aim to provide detailed guidance on the conditions and procedures for monopoly agreement exemptions, as successful exemptions have been a rarity in the eight years since the AML came into effect.

Conclusion. In sum, vertical price restraint administrative enforcements have so far, either by accident or design, mostly targeted foreign companies and industries with high profit margins. Historically, vertical price restraints have been a widespread practice across industries in China, and the policy drivers behind the recent scrutiny by regulators may be part of a broader government push against practices that increase prices for consumers. In any event, for the time being, vertical price restraints appear to be high on the enforcement agenda for Chinese regulators and should be accounted for in MNC compliance planning for China operations.