China: The NDRC Flexs Its Muscles - How To Mitigate Price Fixing Risk In The New Era

Last Updated: 16 June 2014
Article by Tao Jie and Wang Pei

China is growing into its role as a major economic power, and the competition regulators are stepping up to the plate. Merger control filings exceeded 200 in each of the last two years, and conditional clearances have imposed both structural and behavioral remedies. But merger control clearance is but one of the competition regulatory controls that China now employs. Fair pricing is the remit of the NDRC, and recent developments show that the NDRC is stepping into retail price maintenance and is forging a path to curtail international cartel behaviors. Each of these developments signals the maturing nature of the NDRC's role. And each counsels for heightened care across the board, including care with contracts, rigorous compliance programs and clear whistle blowing policies and procedures.

Retail Price Maintenance

With slightly over twenty investigations of retail price maintenance under its belt, the NDRC made headlines with two proceedings involving leading Chinese liquor brands, Maotai and Wuliangye. The NDRC went after each for illegally fixing minimum prices for distributor resales. The regulatory basis for sanctioning anti-competitive vertical price restraints is clear. In each case, the provincial arm of the NDRC took action. Maotai handed over RMB247 million in penalties, and Wuliangye, RMB202 million.

The fact that the provincial offices of the NDRC were on the front line is of some interest. It seems that the offending price-fixing in each of the Maotai and Wuliangye matters was widespread, and possibly nationwide. The central level NDRC may have played a coordinating role, but at the end of the day, the two provincial NDRC offices took action. It will be interesting to see if this pattern continues going forward, with local and provincial offices taking the lead, even when the sanctioned vertical restraints on pricing are broadly applied across regional and national markets.

The penalties, while unprecedented in China, have been widely viewed as quite low. In the Wuliangye case, the provincial NDRC's published announcement specifically stated that the amount represented one percent of the related sales revenue, the regulatory minimum. The minimum amount was imposed based on the full cooperation given by Wuliangye. Similar considerations seem to have been at play in the Maotai case as well. Interestingly, the one percent penalty referred to "related" sales revenue without specifying how "related" revenue was defined for purposes of the calculation. Perhaps only specific products involved? The published announcement mentioned that minimum prices were set with distributors on a national basis, and seemed to cover the period beginning in 2009. Was "related" sales revenue calculated for the entire period? These and other questions regarding remedies remain unclear, and await further published actions or additional guidance from the NDRC.

International Cartels – No Free Ride in China

Visible enforcement of fair pricing rules has not been confined to the domestic market. The NDRC has also gone after horizontal price fixing cartel arrangements. Earlier this year, it imposed penalties of RMB353 million on four Taiwanese and two Korean LCD manufacturers for their participation in an illegal price fixing cartel agreement. This LCD case is reportedly the first time the NDRC has pursued multinational companies. The penalties in China followed after action was taken against the cartel in other jurisdictions, including the United States and the European Union. From this case, it seems apparent that China, through the NDRC, is stepping on to the international stage, and expects to play a role in policing international cartels. The LCD investigation was extensive, spanning several years and likely provided the NDRC and its staff with a broad range of useful experience. We can expect that this experience, and this precedent, will be put to further use going forward, as the NDRC takes its place among the major global regulators battling international cartels who engage in horizontal price fixing to the detriment of the market.

Interestingly, the LCD cases also imposed behavioral requirements on the offenders. They were required to commit to the general requirements of fair dealing in price setting in the Chinese market, and to provide extended warranty periods for products sold in China. The imposition of these behavioral requirements may echo the approach taken in certain high-profile conditional merger control approvals recently announced by MOFCOM. Perhaps this congruent approach signals a policy, on the part of both regulators, to mandate terms that they each deem appropriate in an effort to protect the orderly functioning of the domestic market.

Can we expect to see more cases similar to the LCD case? We believe that is likely. Accordingly, if there is any regulatory action outside of China aimed at an alleged international cartel affecting your business, self-reporting in China should be carefully considered at an early stage, to lay the foundation for lenient treatment by the NDRC.

Contracts – Key Considerations

In the retail price maintenance context, the NDRC identified a number of practices that led to sanctions. The most obvious is the express mention of a minimum price. But the offending behavior did not stop there. There were additional features to some of the programs, including contractual rights to penalize distributors who did not comply with the minimum pricing requirement. Direct monetary penalties were involved, as well as the reduction or withdrawal of sales support services and the possibility of limiting additional supply. What is not clear, however, is whether one of these features alone, or some combination of them, would be sufficient to support the imposition of penalties. The prudent seller will no doubt exercise more caution with its distributorship contracts. That said, even if those contracts do not raise price fixing issues on their face, subsequent performance of those "clean" contacts could also lead to the same results. Accordingly, while important, a clean paper trail, by itself, may not serve to mitigate the risk of an investigation, and the imposition of penalties based on behaviors and expectations arising during the course of performance of a distributorship relationship. In short, we can expect that substance will trump form as the NDRC continues to police illegal price fixing activities.

The New Landscape

Several lessons should be learned from these developments. Leniency for cooperation underlies the Maotai and Wuliangye cases. The regulations expressly give the NDRC a significant degree of discretion to reduce penalties to reward cooperative behavior during investigations. More than this, however, the rules also encourage whistle blowing, and state that successful whistle blowers, who are themselves culpable, may have penalties reduced or waived in appropriate cases. These features of the rules apply across the board, and it appears that the NDRC is taking them seriously. These tools, when well deployed, significantly increase enforcement, mobilize private resources to assist the regulator and ultimately have a deterrent effect that may be nearly as powerful as larger monetary penalties might eventually become. Moreover, although we have yet to see significant activity in this area, the rules provide private rights of action for those harmed by illegal price fixing activities. In short, as the NDRC continues to flex its muscle, we would expect that these aspects of the regulatory regime will contribute to more self policing across industries.

Some uncertainties linger on the substantive law. The relevant rules, on their face, appear to strike a balance between a per se violation approach, similar to the European Union, and a rule of reason doctrine similar to the approach espoused by the US Supreme Court. Specifically, for both horizontal and vertical price fixing, the prohibition is first clearly set out, followed in a separate section by exceptions that would excuse the otherwise illegal price fixing behavior. Accordingly, on their face, the rules appear to provide something akin to an affirmative defense, once price-fixing has been established.

A current private right of action case in Shanghai squarely raises this issue. The court of first instance held that the plaintiff was required to produce evidence demonstrating the anti-competitive effects of the defendant's alleged price fixing activities, evidently viewing anti-competitive effects as an essential element of the claim. The case is currently on appeal, and although the outcome cannot be predicted, it would seem that this approach may not be consistent with regulatory framework. However, regardless of the outcome of the Shanghai case, additional judicial interpretations and nationally applicable regulatory guidance will be needed to fully clarify this fundamental point.

The Way Forward

The NDRC, like MOFCOM, is showing its strength in policing and penalizing illegal price fixing arrangements, both vertical and horizontal. This trend can be expected to continue, and mitigating risk requires a proactive approach. The first step involves a careful review of all affected contracts and documentation, but that is not the only measure needed. Equally important is raising awareness of various practices, outside of what is embodied in your contracts, which could give rise to an allegation of price fixing. A robust training program should be in place, and it should be coupled with whistle blowing policies and procedures designed to alert management to potential assertions of non-compliance in advance. Moreover, if regulatory actions that may affect you are being taken in other jurisdictions, early consideration of voluntary disclosure in China is warranted. Leniency for self-reporting, whistle blowing and full cooperation in any NDRC investigation can be expected, and should be sought, as appropriate. Finally, as with other Chinese competition laws and regulations, management should keep abreast of developments, particularly those with potential wide-ranging effect on your business.

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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