On August 1, 2013, five years after the promulgation of the Anti-Monopoly Law of China in 2008, the Shanghai Higher People’s Court decided the country’s first vertical monopoly case. In China, vertical monopoly refers to a company’s control over different levels of the supply chain, including the production, supply and distribution of a product, if it has the effect of eliminating or restricting competition in the applicable market.
A supplier and its distributor entered into an agreement under which the distributor was authorized to distribute the supplier’s products in a designated geographic area. The agreement contained a provision prohibiting the distributor from reselling the products below a stated minimum price. The distributor thereafter won a bid to supply the products to a third party by offering a price below the agreement’s minimum resale price. After discovering the distributor’s action, the supplier terminated the distributor’s contractual rights, ceased the supply of products to the distributor, and refused to renew the distribution agreement. The distributor then sued the supplier in the Shanghai First Intermediate People's Court, alleging that the supplier had violated Article 14.2 of the Anti-Monopoly Law of China, which prohibits agreements that set minimum resale prices in a manner that eliminates or restricts competition. The court ruled against the distributor (the plaintiff), finding that it had failed to prove that the agreement had restrained or excluded competition. The distributor appealed to the Shanghai Higher People’s Court, which reversed the lower court’s judgment and ruled in favor of the distributor plaintiff.
The Decision by the Shanghai Higher People’s Court
A major issue in the case under consideration was whether the distribution agreement was a vertical monopoly agreement in violation of the Anti-Monopoly Law of China. Article 14.2 of that Law prohibits business operators and their trading parties from entering into agreements restricting the minimum price of commodities for resale if the agreements restrain or exclude competition.
To determine whether the agreement at issue was a vertical monopoly agreement, the appellate court evaluated its anticompetitive effects; that is, whether the agreement eliminated or restricted competition. Four factors—very similar to a rule of reason evaluation in the United States -- were considered and analyzed by the appellate court:
- Whether there was sufficient competition in the relevant market.
In considering whether there was sufficient competition in the relevant market, the appellate court considered the following factors: the scope of the relevant market, the concentration level in the relevant market, the product’s substitutability, the barriers to entry, and the level of competition of the downstream market.
- Whether the supplier had a strong market position.
The court concluded that the supplier’s strong market position was reflected by its: i) high market share; ii) strong ability to control price; iii) strong brand influence; and iv) strong control over its distributors.
- Motivation of the supplier to set the minimum resale price in the agreement.
The intent by the supplier to eliminate and/or restrict company was a key factor considered by the court in determining the anticompetitive effects of the agreement.
- The effects of the agreement on competition.
The court considered both the anticompetitive and procompetitive effects of the distribution agreement in question, taking into account: (i) the self-healing capabilities of the market to automatically correct effects of the restriction on competition; and (ii) that some effects of restrictions on competition can be offset by the effects of the promotion of competition. The appellate court concluded that the distribution agreement was a vertical monopoly agreement because its restriction on competition was not overcome by its effect of promoting competition.
As noted at the outset, the decision discussed was the first vertical monopoly case in China -- five years after the promulgation of the Anti-Monopoly Law of China in 2008. One obvious lesson to be learned from the ruling is that companies should be aware that having minimum resale price clauses in distribution agreements have legal risks in China. However, as under the Sherman Act in the United States (although some state laws may be to the contrary), an agreement having a minimum resale price clause is not a per se violation of the Anti-Monopoly Law of China. Courts in China will evaluate such agreements on a case by case basis, based on the factors outlined above -- very similar to a rule or reason evaluation in the United States. Further, in a vertical monopoly agreement dispute, the plaintiff will bear the burden of proving the anticompetitive effects of the agreement. In this case, the distributor lost the case at the first instance for failure to provide sufficient evidence, but the decision was reversed on appeal.