China: New Precedents Find Resale Price Maintenance Unacceptable Under Chinese Anti-Monopoly Law

Within the same week, the Shanghai Higher Court and one of China's antitrust antitrust regulators have issued decisions that resale price maintenance ("RPM") violated China's Anti-Monopoly Law ("AML"). 

The decision of the Shanghai Higher Court involved an agreement between Johnson & Johnson ("J&J") and a distributor, prohibiting the resale of J&J products below a certain price.  This decision was followed by the largest set of antitrust fines to date for RPM violations, imposed by the National Development and Reform Commission ("NDRC"), one of China's antitrust agencies.

Read together, the Court decision and NDRC's recent RPM enforcement actions indicate that, although RPM technically is subject to a rule of reason analysis, courts and regulators in China are reluctant to accept any alleged procompetitive benefits unless they are substantiated with evidence and outweigh any anticompetitive effects. The lesson is that companies should steer clear of RPM requirements when dealing with distributors in China.

The J&J Decision 

The litigation arose after J&J terminated a distribution agreement because the distributor sold suture products below the minimum resale price stipulated in the agreement. The distributor sued, alleging the RPM violated the AML. The court of first instance ruled in favor of J&J on the basis that the plaintiff did not provide any evidence of anticompetitive effects from the RPM clause, only a short product description from J&J's website. Given that the plaintiff did not submit any other evidence, the court did not assess the possible procompetitive and anticompetitive effects of the RPM clause. 

On appeal, the Shanghai Higher Court decided that RPM is not per se or automatically illegal, but rather is subject to something similar to a rule of reason analysis, which balances likely procompetitive and anticompetitive effects. The Court looked at 4 factors: (1) the level of competition in the market, (2) the defendant's market position, (3) motives for implementing the RPM, and (4) and competitive effects of the RPM obligation.  The Court concluded that the RPM clause was illegal, given J&J's "leading" market position with a market share of "more than J&J's estimation of 20%," its "control" over prices (which had remained largely unchanged for 15 years), and the "obvious" anticompetitive effects with no obvious procompetitive competitive benefits. 

The Court rejected the defendant's arguments that the RPM agreement in fact was procompetitive. First, J&J argued that RPM helped to ensure distributors' reasonable profits, enabling them to focus on service to maintain the safety and reputation of the J&J products.  This could help promote interbrand competition, particularly in terms of safety and service. The Court found that distributors did not actually promote distribution services or product safety in the market for suture products, as J&J, not the distributor, ensured product quality and safety and trained doctors and nurses; there were no specific requirements for storage and shipping; and there was no inter-brand quality difference. The Court held that RPM was not necessary to achieve those benefits alleged by J&J.  In conclusion, the Court suggested that there was no need to protect the J&J distributors from intrabrand price competition because of the distributors' limited roles.

Second, J&J argued that RPM was necessary to avoid a free-rider problem of low-price distributors taking advantage of the greater marketing efforts and customer service provided by full-service distributors. The Court again found no evidence to support this argument, noting that every distributor must have J&J's specific authorization to sell to a given hospital, so distributors cannot free-ride on each other. It does not appear that the Court considered evidence about whether J&J's RPM restraints were imposed at the behest of distributors, or whether any leakage existed of sales between distributor territories, both of which might have tended to support J&J's anti-free-rider defense.

Third, the Court dismissed J&J's argument that the RPM promoted market entry. The Court noted that, when the RPM arrangement was put in place, J&J's products already had been present in the Chinese market for 15 years.  It reasoned that, because J&J already was a brand with a high reputation, it did not need and was not using RPM to promote new brand entry.

The Court also considered other possible procompetitive justifications not raised by J&J. It found that J&J's products are well known by users and have an excellent reputation, so that there was no need for J&J to use RPM to maintain its brand reputation or image. It found the products in question to be mature products subject to stable hospital demand, so there was "no need" to use RPM to encourage the maintenance of inventory or to reduce risks of market uncertainty. The Court also found that, because J&J allocates hospital customers among distributors, distributors hardly can compete for customers, and the number and scale of distributors are strictly controlled by J&J.  Therefore, J&J had no need to use RPM to protect or expand distributor systems.

Much of the Court's analysis and general discounting of J&J's defensive arguments seems to rely on the fact that J&J already was a success in the sutures business before its implementation of the RPM arrangement. However, the Court does not appear to have addressed whether institution of the RPM restraint may have been important to maintain or grow J&J's market position. It appears that the Court found J&J's defenses to without merit, rather than outweighed by anticompetitive effects.

It is unclear whether the Court considered competitive effects from an industrywide perspective, for example whether other competing branded suppliers also use such RPM arrangements. Anticompetitive effects may be less likely if there are few RPM-enforcing suppliers or they lack market power, because then it is more difficult for suppliers to use RPM either to facilitate collusion or abuse their market position.

The NDRC Enforcement Actions 

In February 2013, NDRC issued what then were the largest antitrust fines ever imposed in China. The penalties of RMB 449 million (USD 71 million) were imposed on two leading Chinese liquor manufacturers, Wuliangye and Maotai, for their minimum resale price arrangements with distributors. It appears that, because the two companies cooperated with the investigation, NDRC imposed fines of only 1% of annual revenues, the lowest possible fines available (the maximum is 10%) under the penalty provisions of the Anti-Monopoly Law. 

This was surpassed on August 7 by a new record set of NDRC fines totaling RMB 670 million (USD 107 million) against a group of leading infant formula suppliers.  According to NDRC's announcement, the suppliers implemented fixed or minimum resale prices.  NDRC found that the RPM implementations had unfairly enabled the suppliers to maintain high prices for infant formula products in China and substantially lessened intrabrand and interbrand competition to the detriment of consumers, and that there were no justifications for exemption under the AML.
Pursuant to the leniency provisions of the AML, NDRC exempted three manufacturers from any monetary penalty, because they proactively reported their improper RPM agreements, provided important evidence to NDRC, and actively undertook rectifying measures. The remaining six suppliers were fined between 3% and 6% of their most recent annual China revenues. 

While in these two sets of investigations NDRC's assessment of RPM restraints also followed a "rule of reason" analysis, it is unclear whether the investigated companies offered any procompetitive justifications for the restraints or how NDRC may have weighed them against their anticompetitive effects.  In both of the NDRC enforcement actions, the agency granted penalty reductions or exemptions to companies that turned themselves in and/or cooperated in the investigations.  NDRC's leniency towards these cooperating suppliers indicates that its leniency program apparently is available not only to cartel participants, but also to companies involved in vertical agreements such as RPM clauses, an approach that even goes beyond the leniency regimes available in other jurisdictions. 

Conclusion 

These recent government enforcement actions and the J&J decision signal that, while formally subject to a rule of reason analysis, RPM obligations are unlikely to be found compatible with the AML, especially when employed by established competitors. This skepticism about RPM is consistent with the approach that exists in most other antitrust jurisdictions, although perhaps more aggressive than in the United States, which evaluates RPM under a true rule of reason analysis.  In the absence of differing guidance on the particular circumstances under which Chinese courts or regulators may be open to recognizing the potential procompetitive benefits of RPM, the safest approach is for companies to avoid RPM requirements when dealing with distributors in China. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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