With the increasingly tougher enforcement of the Anti-Monopoly Law (hereinafter also referred to as the “Law”) in 2013, more and more enterprises begin to concern about risky violations of the Law, among which the clause on restricting sales regions signed between the operators and their downstream distributors is one of the focus issues. This type of agreement has a variety of names, such as market dominance agreement, region restriction agreement and exclusive sales agreement, etc. Nevertheless the content of these agreements are basically the same by reflecting the phenomena that the suppliers require the distributors not to carry out sales activities beyond the territory restriction; or on that basis, further restrict that the distributors can only carry out sales activities within the designated territory so as to reduce the realistic possibility of cross-territorial sales; or even further, clearly prohibit the distributors from any cross-territorial sales, which means that even if customers from other regions actively send offers or invitations for offer, the distributors will still be prohibited from selling any commodity to such customers.

1. Provisions concerning Vertical Market Segmentation Agreement under the Anti-Monopoly Law and Other Related Laws

The Law lists protocols, decisions or other coordinated acts with the purpose of eliminating or restricting competition (collectively referred to as “monopoly agreements”) as its regulated objects, and further divides them into horizontal monopoly agreements and vertical monopoly agreements based on different signers. In a horizontal monopoly agreement signed between operators in competition with each other, “dividing the sales market or raw material procurement market” is expressly prohibited for the reason that although this type of agreements might bring benefits like economies of scale or lower costs, yet since no competition exists in the designated territory, consumers will have no opportunity of selecting products and sellers and also suppliers will lose motivation in technology development, but rather to the contrary, suppliers are likely to raise prices through production control. Consequently, horizontal market segmentation agreements have obvious negative effects on the society and are prohibited in almost all countries. In China’s first anti-monopoly case investigated by the administrative authority for industry and commerce, i.e. the case concerning penalties upon the monopoly agreement on the concrete market in Jiangsu province, the concrete committee of the construction material and machinery industry association in Lianyungang city and 5 local concrete enterprises were fined up to a total amount of nearly one million RMB for their conclusion of a monopoly agreement to divide the market .

Different from the horizontal monopoly agreement, a vertical monopoly agreement is usually signed between upstream and downstream operators, and generally between an operator and its trading party. The agreement on territory restriction mentioned above serves as a typical embodiment for it. Since the sales territory is restricted, distributors of the same brand are not allowed to enter the market of another brand, and thus this type of agreement can also be regarded as a vertical market segmentation agreement. Before the implementation of the Anti-Monopoly Law, cautious enterprises such as Guangzhou Toyota Motor Co., Ltd. released the cross-territorial restriction on sales and permitted its distributors to sell products to other territories because of its concern about potential violation of the Law by the prohibited cross-territorial sales in jts distribution model . Nevertheless, different from the horizontal monopoly agreement, the Law only enumerates two prohibited types of vertical market segmentation agreements, namely restricting the selling price and minimum resale price, without any express provision on the vertical market segmentation agreement but instead only a save clause providing “other monopoly agreements as determined by the anti-monopoly law enforcement authorities under the State Council”, which gives certain discretion to the anti-monopoly law enforcement authorities and authorizes them to prevent some vertical agreements that severely restrict competition but are not expressly provided by the law.

According to the save clause, the State Administration for Industry and Commerce (hereinafter the “SAIC”), as the law enforcement authority for non-price monopoly agreement, tried to refine the clause and added the following provision, “an operator is prohibited from concluding with its trading party any agreement which by effect eliminates or restricts competition and harms consumers’ interests” during the legislation of the Provisions of the Administrations for Industry and Commerce on Prohibiting Acts of Monopoly Agreements (hereinafter the “Provisions”) ; However, when the Provisions were officially promulgated, the foregoing provision on vertical monopoly agreement was deleted. In the announcement of punishment upon the vertical monopoly agreement between Kweichow Moutai and Wuliangye released by the National Development and Reform Commission (hereinafter the “NDRC”) in 2013, in addition to restricting the lowest resale prices, Wuliangye’s prohibitions on cross-regional and cross-channel sales were also mentioned. However, in this case, the vertical market segmentation was not expressly ruled as illegal, but instead was only determined as one of Wuliangye’s means to restrict the resale prices . The companies received no additional penalty from either the SAIC or the NDRC. Therefore, it is easy to figure out that in practice, law enforcement authorities still focus on horizontal monopoly agreements and abuse of dominant market position, hold a relatively loose attitude and adopt a cautious way of handling non-price vertical monopoly agreements, including the vertical market segmentation agreement.

2. Reasons for the “Loose Attitude” towards Vertical Market Segmentation Agreements
The reasons why domestic legislation currently adopts a relatively loose attitude towards vertical market segmentation agreement may generally be summarized as follows:

(1)Positive effects brought by vertical market segmentation agreements

As an act restricting competition, although vertical market segmentation agreements may assist in realizing the purpose of efficiency, they may inevitably cause positive and negative effects in various aspects on market competition and consumers’ benefits. Nevertheless, nowadays it is generally considered that the promotion of competition brought by such agreements far outweigh their anti-competition effects, among which the Chicago School is a typical representative. The Chicago School believes that a vertical competition restriction agreement is not an agreement between competitors that is designed to jointly restrict the production quantity or raise the product price. On the contrary, common interests of the parties toile in a rise in the output. Therefore, this type of agreement can generally augment social wealth and should be advocated .

Meanwhile, vertical market segmentation agreements are also helpful for reducing the phenomenon of “free-ride” in sales activities and enhancing the enthusiasm of sellers. If numerous sellers of the same brand exist in the same area, “free-ride” may occur between sellers, which mean that every seller hopes others to make more efforts and refuses to contribute its own cost to sales promotion, so that other sellers will not enjoy the benefits of the increased brand value without any effort or contribution. However, if there is only one seller in an area, the investment in sales promotion will be directly linked with its own profits and the enthusiasm of the seller will be greatly enhanced. As a result, both production and sales will be expanded.

More importantly, although vertical market segmentation agreements reduce the competition between sellers of the same brand to some extent, since there is only one seller in an area, the sales becomes more predictable to the seller, which is beneficial to long-term arrangement and optimization of its operating conditions and thereby an increase in the overall competitiveness of the brand. From a more macroscopic perspective, the competition between different brands is intensified, which makes available more choices and lower prices for the consumers.

2. Reference from the loose attitudes towards vertical market segmentation agreements of different countries

Besides the foregoing positive effects brought by vertical market segmentation agreements, advanced experience of countries with pretty mature implementations of competition laws is also a key point for China in the process of reference. In this regard, various countries all hold relatively loose attitudes towards vertical market segmentation agreement. In practice, vertical market segmentation agreements that contain no fixed retail price are generally not prohibited .

Take the United States as an example. In the case U.S. v. Arnold, Schwinn & Co.,388 U.S. 365 in 1967, vertical market segmentation agreement was once determined illegal. In that case, the bicycle manufacturer, the Schiwinn Company, selected 22 operators and required that each operator could only sell bicycles in its designated region. Hence, the judge held that this kind of restriction obviously destroyed competition. However later in 1977 in the case Continental T.V., Inc. v. GTE Sylvania, Inc., such determination on vertical market agreement was completely turned over. With respect to the clause set forth by Continental TV Company that operators could only set up business sites in the designated area, the Supreme Federal Court held that although internal competition might be reduced, competition between such distributors and exclusive distributors of other suppliers in the same region was intensified to a considerable extent. Hence, the location clause in the agreement was not illegal and the case should be analyzed by applying the rational principle. The principle in this case was recognized by the U.S. Department of Justice and was consolidated through the Vertical Restrains Guidelines in 1985. The Guidelines recognized that selective distribution systems, including the regional restriction, should be deemed legal .

Compared with the attitude of the United States, although the attitude of the European Union towards market segregation agreements, from a political view of market integration, seemed relatively stringent, it was still gradually becoming looser. In the famous case Consten and Grundig v. Commission in 1964, the EC Court determined that any agreement that provides distributors with absolute regional protection shall be illegal and cannot be exempted. However, such a judgment was widely questioned. In the regulations about exemptions for exclusive distribution agreements promulgated by the Commission of the European Communities (the “CEC”) in 1983 , an agreement that provides exclusive regional distribution can be exempted under certain circumstances. In December 1999, Regulation 2790/99 was promulgated to supercede the Regulation 1983/83. In the Regulation 2790/99, it is further clearified that “if a vertical restriction agreement prohibits the buyer from selling products in the seller’s exclusive region or any exclusive region preserved by seller for other buyers, this kind of restriction can be exempted when it does not affect the sales of the buyer’s customers. ” After the Regulation 2790/99 expired in 2010, the subsequent Regulation 330/2010  preserved the foregoing clause.

Besides the United States and the European Union, legislation of other countries also poses a loose attitude towards vertical market segmentation agreements. For example, Article 3 of the Anti-Monopoly Law of Japan expressly forbids improper transaction restrictions that include restriction on transaction objects in violation of the public interests and causing material restrictions on competition in certain transaction fields. However, the impropoer transaction restrictions under the Japanese law only regulate those vertical monopoly acts that restrict the resale prices, instead of including any non-price restriction.

In the light of the foregoing, a relatively loose attitude towards vertical market segmentation agreements is commonly adopted by countries around the world. Since the P.R.C. Anti-Monopoly Law has only been implemented for 5 to 6 years, it is obviously unnecessary to hold a severe attitude towards vertical market agreements that reverses the legislative trend of whole world.

3. Legal tips for concluding vertical market segmentation agreements

Although currently the anti-monopoly law enforcement authorities hold a loose attitude towards vertical market segmentation agreements, it cannot be denied that this type of agreement can still reduce the competition within the same brand and cause some effects of eliminating and restricting competition. Hence, when enterprises sign vertical market segmentation agreements, it is still necessary to take precautions against the risk of violating the law. In some cases, the author suggests referring to the thoughts of the Shanghai Higher People’s Court in the case Beijing Ruibang Yonghe Technology and Trade Co., Ltd. v. Qiangshen (Shanghai) Medical Equipment Co., Ltd. and Qiangshen (China) Medical Equipment Co., Ltd. that involved a vertical monopoly agreement  and considering the anti-competition effects of a vertical market segmentation agreement in the following four aspects:

1)Maturity extent of relevant market

As analyzed above, the severest harm that might be brought by a vertical market segmentation agreement is the restriction of competition within the same brand. If the market is an oligopoly, with the shrink of in-brand competition, the choices of consumers will also shrink naturally. If a distributor is exclusive in a certain region, the possibility of reducing the prices in its own initiative will also be lowered. On the other hand, if the market is full of competition, although the vertical market portion reduces the competition within the same brand, the consequent competition between brands can still provide consumers with adequate choices and lower prices. Hence, before signing a vertical market segmentation agreement, the environment of the entire market should be taken into consideration, including substitutability of the products, ability of price fixing and difficulty level of market access. If competition on the market is relatively inadequate, the parties should be more cautious about the agreement.

2)Market share

In connection with the market maturity, market shares of operators should also be evaluated before signing a vertical market segmentation agreement. Higher market shares indicate greater anti-competition effects on the vertical market segmentation agreement, and vice versa. In practice, many countries and regions, including the EU, treat market share as one of the criteria for determining whether a vertical market segmentation agreement should be illegal. According to Article 162 of the EU Guidelines for Vertical Restrictions, if the market share of a supplier adopting a vertical market segmentation agreement does not exceed 30%, it is highly possible that the agreement will be exempted.

3)Motivation of the operator adopting a vertical market segmentation agreement

Generally speaking, operators adopt vertical market segmentation agreements for reasons such as preventing vicarious inventory, protecting the benefits of distributors, raising the quality of after-sale services and so on. Before signing the specific agreement, operators should reorgarize and screen the reasons to eliminate improper ones that may constitute absolute regional protection. If necessary, operator can also engage a lawyer to analyze from professional perspectives to determine the cogent reasons that may lead to exemption under the Anti-Monopoly Law. Meanwhile, when signing a vertical market segmentation agreement, operator should also include the reasons into the text forming a proper language; thus, even if any law enforcement authority questions the agreement, the operators can cite Article 15 of Anti-Monopoly Law and the relevant economic and law principles to present arguments.

4)Effects of vertical market segmentation agreements

Furthermore, in a vertical market segmentation agreement, specific clauses on regional restriction and their potential consequences should also be taken into consideration and it is inappropriate to include too many clauses that may restrict competition. For example, if the term of the agreement is too long, non-competion will be a long-term obligation and consequently the restricted in-brand competition will also be solidified in a long term, which is not beneficial for the promotion of social economic profits as a whole. Therefore, the term of the agreement generally should be no longer than 5 years. Also as an example, after an operator with an exclusive region sells its products to a buyer, as to whether the buyer is authorized to resell the products across the region (i.e. issues similar to whether a third party can carrry out parallel import to the region), it is recommended that operator not prohibit such resale in the vertical market segmentation agreement so as to avoid the effect of absolute regional protection.

Besides, as an economic constitution, the Anti-Monopoly Law is closely related to the direction of regulation and policy dynamics of the government. Therefore, in routine business operations, the operators can also by themselves or hire professional institutions to collect and analyze information in connection with the anti-monopoly law, so as to to keep up with the tendency of law enforcement and control potential risks of violating the law.