Hong Kong: China’s Antitrust Tigers Grow Teeth

Last Updated: 1 September 2010
Article by Martyn Huckerby, Tingting Cai and Sharon Wong

China's competition law regulators have taken important steps to strengthen the enforcement of its competition regime, with a number of cartel investigations, some further implementation rules, and another conditional merger control decision. Imprisonment is the maximum penalty as a result of the above.

In this review, we focus on recent cartel investigations by the National Development and Reform Commission (NDRC), as well as the draft implementation rules recently published by the NDRC and the other regulators responsible for enforcing the PRC Anti-Monopoly Law (AML), namely the State Administration of Industry and Commerce (SAIC) and the Ministry of Commerce (MOFCOM). We also cover the decision by MOFCOM's Anti-Monopoly Bureau (AMB) to impose conditions on the acquisition of Texas-based pharmaceutical company Alcon by Switzerland's Novartis.

Overview of the AML regulators

Under the AML, Chinese regulators have wide ranging powers to investigate suspected monopolistic conduct. While MOFCOM focuses on merger control, NDRC and SAIC are authorised to investigate monopoly agreements and abuse of market dominance, with NDRC responsible for price related conduct including price cartels.

SAIC issued two procedural rules in June 2009 setting out the framework of its investigation procedures (see our earlier alert. However, there have been no formal reported investigations undertaken by SAIC and the procedural rules have not yet been tested. In contrast, NDRC has been actively investigating price cartel violations.

Part 1: NDRC price investigations

Domestic airfare price fixing

In March 2009, it was alleged, at the request of several major airlines in China, that TravelSky (a state-owned company controlling the distribution of air tickets in the domestic market) adjusted its discount policies. TravelSky's policies raised airfares offered by all airlines in its network, including large carriers such as Air China, China Eastern and China Southern Airlines. The increase resulted in widespread customer complaints.

NDRC reportedly carried out an informal investigation into TravelSky in April and May 2010. However, the suspected cartel conduct ceased soon after through further fare adjustments. Airlines did not comply with the agreed cap on discounts and instead offered the public additional discounts on air tickets. It is likely that such rectification was the result of the NDRC's investigation, although no formal announcement was made by the NDRC.

Rice noodle cartel

On 30 March 2010, NDRC announced the result of its first publicised price cartel investigation since the AML came into effect. The investigation was conducted jointly by NDRC, the Guangxi Price Bureau, and the local municipal government against 33 rice noodle producers in Guangxi. Those rice noodle producers were found to have collectively raised the price of rice noodles (the staple food of the region) through "price raising and profit sharing" agreements.

Fines of up to RMB 100,000 were imposed on the producers. In addition, it was reported that 12 individuals involved were arrested for the suspected criminal offence of "forcing to deal". "Forcing to deal" is defined under Article 226 of the PRC Criminal Law (Criminal law) as "forcing others by violence or the threat of violence to sell or buy goods and/or to provide or accept services". Such conduct may result in imprisonment for a period of up to three years.

Tableware disinfectant price cartel

According to NDRC, its local counterpart, the Xiamen Price Bureau, intervened in a proposed price cartel at the end of April 2010. On 19 April, the tableware association in Xiamen, together with its members, decided (in writing) that as of 1 May, they would collectively raise the distribution price of tableware disinfectant products by RMB 0.10 per five-piece set. Xiamen Price Bureau initiated an investigation upon receipt of information from a whistle-blower. Following its investigation, the Xiamen Price Bureau determined that the proposed price increase was in violation of the 1997 Price Law (Price Law) and intervened to prevent the price increase from taking effect.

Farm products price fixing

On 1 July 2010, it was reported that NDRC published a series of decisions concerning price cartels in relation to farm products that were handled by its local counterparts responsible for pricing issues. The reported price violations included the following:

  • Jilin Corn Centre, a farm products wholesaler, was found to have colluded with others to manipulate green bean prices. It was alleged that Jilin disseminated false information on there being a low harvest of green beans in October 2009. The result was a substantial price increase in China. A fine of RMB 1 million was imposed on Jilin Corn Centre;
  • a trader in Shandong was found to have stored up to 3,000 tons of garlic, since June 2009, in an attempt to manipulate the market price. The local price authority commenced its investigation in May 2010 and imposed a fine of RMB 100,000; and
  • Henan Cold Storage Association issued a document in March 2010 requiring its members to charge prices in the range of RMB 260-320 per ton for garlic storage. The local price authorities determined that the conduct amounted to price fixing and imposed a fine of RMB 80,000 on the association.

NDRC draft rules on penalties for price violation

Following these recent price fixing cases, NDRC issued draft rules that set out penalties for illegal pricing conduct. The draft rules are based on the Price Law and are intended to combat irregular market pricing of basic and essential goods.

Under the draft rules, illegal pricing conduct, fabricating and disseminating price-raising information, stockpiling commodities to induce shortages, seeking excessive profits, and colluding to manipulate prices in serious cases can lead to revocation of business licence. Where the quantum of illegal income cannot be determined, fines ranging from RMB 200,000 to RMB 2 million may be imposed.

The draft rules also state that the AML and/or the Criminal Law may also apply in certain circumstances.

Implications

Despite indications to the contrary, NDRC has been primarily relying on its powers under the Price Law rather than on the AML. NDRC's approach may be due to its familiarity with that legislation and the exclusive and independent jurisdiction afforded under it. As noted above, under the AML, NDRC shares its jurisdiction with SAIC and MOFCOM.

The suggestion that cartelists may be imprisoned is a particularly significant development arising from NDRC's recent cartel activity, particularly as the AML does not expressly provide for criminal liability for monopolistic offences. It is likely that the authorities will continue to rely on the Criminal Law as an essential tool in their enforcement activities against those engaging in anti-competitive conduct.

Part 2: MOFCOM divestiture rules

On 8 July 2010, MOFCOM released the Provisional Measures on the Implementation of Assets or Business Divestiture for Concentrations of Undertakings (Divestiture Rule), which had the effective date of 5 July 2010.

Process of divestiture

According to the Divestiture Rule, an undertaking whose merger approval has been conditioned upon a divestiture of assets will be required to find an appropriate buyer within a time period prescribed by MOFCOM's review decision. If the undertaking fails to find a buyer by the stipulated deadline, an independent trustee will be empowered to conduct a 'trustee divestiture' instead.

In principle, the divested assets or business must be transferred to the selected buyer within three months upon the execution of a sale agreement. However, MOFCOM may at its sole discretion grant an extension on a case-by-case basis.

The following diagram illustrates the process of divestiture more generally:

Parties and their roles

The Divestiture Rule clearly delineates the relevant parties and their roles in a merger divestiture. These are as follows:

  • Divestiture obligor - A divestiture obligor is an undertaking who is a party to a proposed concentration and is required by MOFCOM to complete the divestiture in order to proceed with its proposed merger. Assets or business to be divested by the divestiture obligor may be transferred to a buyer either through a self-divestiture or trustee divestiture.
  • Divestiture supervisor - A divestiture supervisor must be engaged by the divestiture obligor in both an undertaking or trustee initiated divestiture. Divestiture supervisors oversee the entire divestiture process and report to MOFCOM. A divestiture supervisor can be a natural person, a legal person or other organisation who is capable of undertaking the task. The divestiture obligor is required to submit qualified supervisor candidates within 15 days after MOFCOM's review decision.
  • Divestiture trustee - If a divestiture obligor fails to identify an appropriate buyer and reach a sale agreement by the prescribed deadline, a divestiture trustee is appointed to take over the divestiture process. To effect a trustee divestiture, the divestiture obligor must, within 30 days prior to the commencement of the divestiture process, submit trustee candidates to MOFCOM for approval. Once endorsed and engaged, the divestiture trustee is entitled to independently handle the divestiture on behalf of the divestiture obligor and is required to report to MOFCOM rather than the divestiture obligor. A divestiture trustee can be a natural person, a legal person or other organisation.
  • Buyer - A buyer of the divested assets/business must be independent from the parties to the relevant merger and have no relationship with the parties that would substantially impact on their interests. In addition, the purchase itself must not give rise to any competition issues.

Generally, all parties to the relevant merger must comply with the divestiture requirements stipulated in MOFCOM's review decision. Other overarching obligations include maintaining the pre-divestment value of the to-be-divested assets/business, ensuring the availability and accessibility of information to potential buyers and providing necessary support and assistance to effect the eventual transfer of the divested assets/business.

Throughout the divestiture process, MOFCOM will remain actively involved as the overseeing entity. It will be responsible for supervising the appointment of divestiture supervisors and divestiture trustees, the selection of buyers and the conclusion of proposed sale agreements and, at all times, ensuring that the divestiture complies with review decision requirements.

Implications

The Divestiture Rule establishes the practice of involving third parties as divestiture supervisors and divestiture trustees during merger divestitures, which is in line with approaches often used in other jurisdictions, including that of the European Commission. The rules also align with MOFCOM's practice in its previous merger divestment decisions (e.g. Panasonic/Sanyo and Pfizer/Wyeth).

However, the rules are limited to procedural aspects of implementing merger divestiture decisions. The circumstances in which a divestiture will be viewed by MOFCOM as an appropriate remedy to a proposed merger remains unclear. Firms seeking merger approval from MOFCOM in circumstances where the target business is in the same or a related sector to that of the acquirer should generally be prepared to potentially divest certain assets or a part of its business in order to secure clearance.

Part 3: Novartis merger control decision

On 13 August 2010, MOFCOM published its decision to conditionally clear the acquisition of Texas-based pharmaceutical company Alcon by Switzerland's Novartis.

Novartis and Alcon both develop, manufacture and distribute pharmaceutical products and eye care products globally, including in China. Novartis' proposed acquisition of Alcon was reported to MOFCOM on 20 April 2010. On 17 May 2010, MOFCOM decided to implement a second phase review when it identified the competition concerns.

During the merger review, MOFCOM examined the notification materials, discussed with the parties and conducted investigations in the industry. The following competition issues were identified by MOFCOM:

  • In the ophthalmological anti-infection product market - MOFCOM considered that the merged entity would have a 55% global market share and a 60% market share in China. MOFCOM believed that Novartis could obtain significant market power in China post-transaction, which would potentially restrict or eliminate competition in the market. This conclusion was reached despite the fact that Novartis' current Chinese market share is less than 1%. Novartis agreed to strategically exit the relevant market both globally and in China.
  • In the contact lens product market - MOFCOM considered that the merged entity's global market share would be far higher than other competitors at nearly 60%. In China, the merged entity would have a 20% market share, which is only second to Hydron Contact Lens Co., Ltd. (Hydron), who is also the exclusive supplier for Novartis' contact lens care products. In light of the partnership, MOFCOM determined that the merged entity would likely collude with Hydron in terms of the price, quantity, sale region etc. of contact lens care products, which would eliminate or restrict competition in the relevant market.

To eliminate the identified adverse impact on the acquisition, MOFCOM required that Novartis not sell its ophthalmological anti-infection products in China for five years and terminate its distribution partnership with Hydron.

This case is the first conditional merger control of 2010 and while MOFCOM has not been particularly interventionist in recent times, it confirms that MOFCOM remains willing to intervene in global mergers where it identifies a competition concern. It is likely in the current case that the timing of MOFCOM's decision and the outcome was influenced, in part, by the approach adopted by regulators in other jurisdictions. This highlights the importance of adopting a global strategy and ensuring issues in China are considered as part of it.

Firms involved in a merger in the same or related sectors should anticipate any overlap between parties in a market in China, including where there is only a small incremental increase in market share. MOFCOM's decision is also a further example of its willingness to impose remedies that require on-going monitoring, and the need for merging parties to be flexible in negotiating merger clearance with MOFCOM.

Part 4: Other developments

MOFCOM and SAIC have also been taking important steps towards clarifying their approach to administration and enforcement of the AML:

  • On 12 January 2010, MOFCOM released a set of interpretative guidelines to facilitate better awareness and understanding of regulations issued in November 2009 on merger notification and review (the notification and review measures were discussed in our December 2009 alert). The interpretations are intended to fill in some of the "gaps" in the AML that have yet to be clearly addressed. Even with such interpretative guidelines, however, certain key issues still remain unclear, including the notion of "control" to clarify what constitutes a concentration; and
  • On 25 May 2010, SAIC published the Draft Provisions on Prohibiting Monopoly Agreement, Draft Provisions on Prohibiting Abuse of a Dominant Market Position and Draft Rules on Prohibiting Abuse of Administrative Powers to Eliminate or Restrict Competition. The first two were updates of rules that were released for comment in April 2009 (see our previous Review). The updated rules provide less restraints on vertical agreements, broader reach of potential abuse of dominance and include language regarding prohibition of abuse of IP rights.

In addition, the Chinese government and other regulators have published statements or draft procedures that may impact on the development of the Chinese competition law regime, including the following:

  • On 12 February 2010 the China Association of Chartered Accountants issued draft measures on the merger of accounting firms which sets out certain procedures and legal requirements that must be followed; and
  • On 5 March 2010 at the 11th National People' s Congress Premier Wen Jiabao stated, in reference to a government work report, that China will open up its monopoly industries to facilitate fair competition among private and state-owned businesses

Concluding comments

Significant progress has been made by China's competition law regulators in the administration of the AML and MOFCOM's latest conditional merger control decision suggests that it continues to adopt a flexible approach to negotiating conditions with merger parties.

The main issue now facing firms engaged in merger activity in China appears to be the duration of the merger filing process, rather than uncertainty regarding the likely outcome. Indeed, Mr Shang Ming, the Director of the AMB, recently confirmed that of more than 140 merger cases handled by the AMB up to the end of June 2010, 95% were unconditionally cleared with five approvals granted subject to conditions and only one case turned down (Coca Cola - Huiyuan).

Lengthy processing periods appear to have been caused by delays in the acceptance of cases, delays resulting from numerous requests for information (and use of a "stop the clock" mechanism) and referral of cases for detailed or "Phase II" review even in the absence of substantive issues. It is hoped that the AMB will continue to add resources to deal with the backlog of cases being considered as M&A activity involving firms with operations in China continues to build momentum. In the meantime, firms involved in notifiable transactions should:

  • engage the AMB at an early stage and agree on the information to be provided in their merger submission;
  • allow time for the merger review process in their deal timetable;
  • consider whether transaction documents should provide for the possibility of intervention by the AMB, even where the Chinese merger control thresholds are not met (reflecting the broad jurisdiction of the AMB to intervene); and
  • be prepared to be flexible when negotiating any clearance conditions with the AMB (which includes understanding in advance in which sectors the firm is contemplating undertaking transactions in the future).

It is clear that NDRC has stepped-up its investigations into illegal pricing conduct and its commitment to enforcement is further demonstrated through the latest implementation rules published by NDRC. That such rules were published under China's Price Law reminds businesses that the PRC competition regime extends beyond the AML. Further, firms operating in China should remind their staff that serious cases of anti-competitive conduct may involve criminal liability (and the potential for imprisonment).

With SAIC now also having published updated versions of its implementation rules relating to anti-competitive agreements and abuse of dominant market position, firms should anticipate more widespread and formal investigations by China's competition law regulators. Firms that have, until now, been delaying taking steps to comply with China's competition law regime should take immediate steps to address any compliance issues in anticipation of vigorous enforcement by China's regulatory tigers in the months ahead.

It is expected that authorities will soon finalise other pending draft rules to address uncertainties in implementing the AML, including:

  • the State Council's draft guidelines on IP-related anti-monopoly law enforcement (discussed in our July 2009 alert);
  • NDRC's draft pricing rules (discussed in our July 2009 alert, which has been subject to further redrafting by NDRC);
  • the Supreme Court's draft rules for anti-monopoly cases (discussed in our November 2009 alert); and
  • national security review of mergers.

Given the recent approach adopted it is clear that the final version of antitrust rules, and the conduct of investigations under them, will provide further illustrations of China's competition regulators having grown teeth.

Disclaimer

The views set out in this publication are based on our experience as international counsel representing clients in their business activities in China. As is the case for all international law firms licensed in China, we are authorized to provide information concerning the effect of the Chinese legal environment. However, we are not admitted to practise Chinese law and are unable to issue opinions on matters of Chinese law. The content of this article is intended to provide a general guide to the subject matter. This publication is only a general outline. It is not legal advice. You should seek professional advice before taking any action based on its contents.

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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