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.
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