On 4 November 2014, the SAIC published a decision in which it found that Pizhou branch of the Xuzhou City Tobacco Corporation (“Pizhou Tobacco Branch”), a tobacco sales company, had abused its dominant position by treating customers of equal standing in a discriminatory manner without justifiable cause.  The Pizhou Tobacco Branch is the only entity that is authorized by the government to engage in the wholesale distribution of cigarettes due to the government’s monopoly of tobacco production and supply in China.  The SAIC’s local branch in Jiangsu found that the Pizhou Tobacco Branch had supplied two of its identified key account customers (“KA customers”) with different volumes of cigarettes and at different levels of frequency.  The Jiangsu AIC considered that the two KA customers had equal standing and that their different treatment by the Pizhou Tobacco Branch was discriminatory in nature.  Therefore, it imposed a fine of RMB 1.7million on the Pizhou Tobacco Branch for violating Article 17 of the PRC Anti-Monopoly Law (the “AML”), which prohibits business operators in a dominant market position from engaging in abusive conduct that eliminates or restricts competition.

We set out below some points that are of particular relevance to undertakings subject to the jurisdiction of the AML in evaluating the legal risks of conduct which may constitute an abuse of a dominant market position.

1.       Which entity should be fined

It is interesting to note that the Pizhou Tobacco Branch was fined, even though it is only a branch of the Xuzhou City Tobacco Corporation.  According to Article 14 of the PRC Company Law, a branch does not qualify as an independent legal entity and its civil liabilities should be borne by its parent company.  Therefore, it is arguable that the Pizhou Tobacco Branch’s parent company, Xuzhou City Tobacco Corporation, should have been fined rather than the Pizhou Tobacco Branch itself.

In the SAIC’s responses to queries raised by the Wuhan AIC (dated 16 June 1990) and the Anhui AIC (dated September 1999) respectively, it specifically stated that branches set up by a legal entity can be the subject of an administrative penalty, even though they cannot bear civil liabilities independently.[1]  According to these responses, the SAIC’s view is that branches which have registered as economic entities with their local AIC are engaged in business operations and therefore can be the subject of an administrative investigation and consequent penalties.

Therefore, in practice, if a branch of an independent legal entity violates the AML, the SAIC may penalize the branch instead of its parent company.  Accordingly, the SAIC may use the annual turnover of the branch instead of the parent company to calculate the fine.

2.      Determining whether two customers have equal standing

Article 17(6) of the AML prohibits dominant market players from treating customers of equal standing differently, in terms of price, volume etc., without justifiable cause.  In practice, however, it is very difficult for business operators to determine whether their customers have equal standing and should be treated equally.  In the present case, the Jiangsu AIC analyzed the circumstances of the two relevant KA customers, providing some insight into its approach in this regard.

While determining whether the relevant customers, Golden Eagle Company (“Golden Eagle”) and Jiangsu Happy Buy Company and Xuzhou Happy Buy Company (“Happy Buy”), had equal standing, the Jiangsu AIC carefully considered the Pizhou Tobacco Branch’s distributor classification policy. According to its policy, the Pizhou Tobacco Branch divided its 7,300 retailers into 42 categories according to the form of their business, location and size. In particular, it selected its KA customers by evaluating their cigarette retail qualifications, compliance with tobacco sales laws, ability to settle accounts, their location, sales capability, fairness in trading, etc.  Golden Eagle and Happy Buy were classified as KA customers by the Pizhou Tobacco Branch based on the above standards.   

After examining the circumstances of Golden Eagle and Happy Buy, the Jiangsu AIC concluded that they were customers of equal standing, as they were both: (i) at the retail level of the distribution chain; (ii) classified by the Pizhou Tobacco Branch as KA customers and had entered into KA customer agreements with the same terms and conditions; and (iii) were willing and able to sell a relatively high volume of cigarettes. The Jiangsu AIC also pointed out that even though each customer had its own characteristics, the above factors were sufficient to show that they were of equal standing.  

3.      What behavior would be considered discriminatory

It is clear from the Jiangsu AIC’s reasoning that it did not object to the categorization of customers into different groups according to specified criteria.  It was also not problematic that the Pizhou Tobacco Branch had different sales policies for KA customers and customers in other categories.  However, the Jiangsu AIC considered that treating two KA customers differently constituted discriminatory treatment prohibited by Article 17(6) of the AML.

The Jiangsu AIC found that the Pizhou Tobacco Branch treated Golden Eagle and Happy Buy differently in as least two aspects: the frequency which with it supplied its cigarettes and the quantities of bestselling cigarettes it supplied to each.  First, Golden Eagle was entitled to purchase supplies twice a week, while Happy Buy was only allowed to place orders once a week. Second, Golden Eagle was entitled to order a maximum of 300 boxes of bestselling cigarettes in each purchase, while Happy Buy was only allowed to order up to 20 – 50 boxes.  The Jiangsu AIC considered that the Pizhou Tobacco Branch had intentionally manipulated the supply of cigarettes to different KA customers, which was discriminatory conduct.

4.      Justifiable causes for discriminatory treatment

The Pizhou Tobacco Branch argued that Golden Eagle had strong business capabilities, large volumes of sales and it provided more jobs compared with the other distributors, and therefore it should receive more favorable treatment.  The Jiangsu AIC did not accept this argument.  It found that Golden Eagle’s larger volume of sales was a consequence of the Pizhou Tobacco Branch’s historical preferential treatment to it, rather than the reason for it. 

It is interesting to note that Golden Eagle is in fact an affiliate of the Pizhou Tobacco Branch and it had been enjoying free office space provided by the Pizhou Tobacco Branch up to 2011.  However, the Jiangsu AIC did not consider that this justified the Pizhou Tobacco Branch’s favorable treatment to Golden Eagle.  It considered that the Pizhou Tobacco Branch should treat Golden Eagle and its non-affiliated retailers equally.

In practice, business operators tend to treat their affiliates as group members and consequently treat them more favorably.  However, when a business operator holds a dominant market position, it should be cautious about favoring its affiliated companies over its non-affiliated trading parties, as such conduct could constitute an abuse of dominance following this case.  

5.      Which year should be used to calculate turnover

The AML stipulates that antitrust regulators may fine undertakings which violate the AML between 1-10 percent of their sales revenue from the previous year. However, the AML is silent on the definition of “previous year”.  In the present case, the Jiangsu AIC imposed a fine on the Pizhou Tobacco Branch equal to 1 percent of its sales revenue in 2012, i.e. the year prior to the year in which the Jiangsu AIC initiated its investigation.

This approach is different from the approach that has been taken by the NDRC in other cases.  The NDRC has previously calculated fines by reference to the turnover from the year preceding the year in which it makes its penalty decision. The difference in approach by the different authorities should be borne in mind by business operators which are evaluating the possible range of fines for potential violations of the AML.

Summary

The SAIC has released several decisions relating to abuses of dominance this year, which demonstrates its increasing confidence in dealing with abuse of dominance cases, as well as its intention to clarify important aspects of Article 17 of the AML.[2]  With the publication of more decisions, we are certain that we will see more clarity and stability in antitrust enforcement in China.  Business operators will also benefit from the improvements in transparency by the antitrust enforcement authorities as it will enable them to better understand the boundaries of their behavior and identify what conduct will likely constitute a violation of the AML.