Background

On 1 August 2013, Shanghai High People’s Court (the “Court”) made a final judgment on the reportedly first civil action of a vertical monopolistic agreement whereby Johnson & Johnson Medical (Shanghai) Ltd. and Johnson & Johnson Medical (China) Ltd. (collectively “J&J”) entered into and implemented a vertical monopolistic agreement by imposing a minimum resale price on Beijing Ruibang Yonghe Technology and Trading Co., Ltd. (“Rainbow”), a distributor of J&J, in violation of the Anti-monopoly Law (“AML”) of the People’s Republic of China. Consequently, J&J was ordered to indemnify the loss of profit incurred by Rainbow arising from such monopolistic agreement in the total amount of RMB530,000. As far as judicial practice is concerned, this judgment shed some light on a few key issues in the recognition of a vertical monopolistic agreement, especially the establishment of minimum resale price, as summarized below.

Highlights of the Judgment

Establishment of Minimum Resale Price Not a Per Se Violation

There are technical arguments on whether the resale price maintenance, including fixing of resale price and establishment of minimum resale price, is a “per se” violation of the AML, i.e., the resale price maintenance, by itself, constitutes a vertical monopolistic agreement regardless of its effect on competition, or needs to be assessed under the rule of reason, i.e., the legitimacy of resale price maintenance depends on whether such arrangement has anticompetitive effect.

The Court concluded in the judgment that a particular resale price maintenance would be recognized as a vertical monopolistic agreement only if such arrangement has the effect of eliminating or restricting competition, which implied that the Court did not consider the establishment of minimum resale price to be a per se violation of the AML. In the opinion of the Court, a judicial interpretation of the AML made by the Supreme People’s Court in 2012 indicates that the anticompetitive effect arising out of a given agreement is a precondition of the recognition of a horizontal monopolistic agreement. As a vertical restraint generally causes less anti-competitive effect than a horizontal restraint does, the same effect must be present in the recognition of a vertical monopolistic agreement.

On the other hand, as the government agency responsible for striking pricing-related monopoly, the National Development and Reform Commission (“NDRC”) has yet to reveal its stance toward the presence of anti-competitive effect in the recognition of a vertical monopolistic agreement. Particularly, in light of the recent penalties the NDRC imposed on certain milk powder suppliers for resale price maintenance, NDRC did not disclose details of its recognition of such vertical monopolistic agreements. Nevertheless, even if NDRC holds the same opinion as the Court with respect to the required presence of anticompetitive effect in a monopolistic agreement, it is widely believed that NDRC may likely not subject itself to the “burden of proof” as heavy as a plaintiff would bear in a civil action.

Four Elements for Consideration in Exploring Anti-competitive Effect

With the effect of eliminating or restricting competition seemingly a precondition of a monopolistic agreement, the Court then identified four elements to be considered when exploring the existence of such anticompetitive effect, as discussed below:

1. Competition Status in Relevant Market

The Court noted that the lack of sufficient competition in the relevant market is the primary condition for the establishment of a minimum resale price to constitute a vertical monopolistic agreement because consumers in a sufficiently competitive market would be able to switch to alternatives if the price of a given product is artificially inflated.

To begin with, the Court identified the relevant product market and geographical market based on an analysis of demand substitution, and concluded that an analysis of supply substitution was not necessary in this case. The Court also noted that market concentration, market entry thresholds, and bargaining powers of downstream market need to be accounted for in exploring the existence of sufficient competition.

In the case of J&J, the Court concluded that there is no sufficient competition in the relevant market based on the observations that (i) motives of bargaining are absent from the downstream market as the costs of relevant product are shifted to end users, (ii) downstream player’s loyalty to J&J brand decreases demand flexibility, (iii) thresholds for entering into the relevant market are high due to the marketing authorization required for the relevant products and the relationship-based sales model, and (iv) the prices of J&J products remained level consistently for 15 years.

2. Strong Market Powers

According to the Court, the anti-competitive effect in the context of resale price maintenance is also conditioned upon the defendant’s possession of “strong market powers”, which is notably different from the term “dominant market powers” as used in another dimension of the AML, i.e., abuse of dominant market powers. The Court, however, did not specify any market share criteria for the determination of “strong market powers”; rather, as stated in the Court’s judgment, “strong market powers” are reflected by the capabilities to control pricing.

Apart from the observation that the prices of J&J’s products remained level consistently for 15 years, the Court also noted J&J’s strong control over its distributors in its affirmation of J&J’s possession of “strong market powers”, including that the distributor is subject to (i) the non-compete obligations, prohibiting it from selling competing brands, (ii) segregation of downstream market, prohibiting it from selling to hospitals other than those designated by J&J, and (iii) a distribution contract with a short term of one year only, though renewable. In addition, the Court concluded that J&J acquired leading market share on the ground that “J&J, as a globally well-known multinational corporation, should be able to provide its exact market share [but failed to do so], and given its position in this litigation, its actual market share should be higher than J&J’s estimate of 20.4%”, and that J&J never identified any competitor that holds higher market share than J&J does.

The foregoing reasoning suggested a heavier burden of proof with respect to market share on a large multinational corporation as a defendant, which, though understandable, is inconsistent with the Court’s allocation of burden of proof as further discussed below.

3. Motives of Establishment of Minimum Resale Price

The Court also considered the motives of the establishment of minimum resale price as an element in exploring anti-competitive effect, and concluded that J&J’s motive was to avoid price competition, as evidenced by J&J’s imposing of contractual obligations on the distributors to maintain the pricing level of J&J’s products. In addition, the Court also noted an action plan of J&J requiring distributors to “establish good relationship with physicians in order to mitigate the impact of unfavorable pricing”.

Given the inherent difficulties in proving any motive, it is arguable whether the motive should be included as an element to be considered in exploring anti-competitive effect.

4. Anti-competitive and Pro-competitive Effect of Minimum Resale Price

With the recognition that the establishment of minimum resale price may have both anti-competitive effect and pro-competitive effect, the Court concluded that minimum resale price would constitute a vertical monopolistic agreement only where the anti-competitive effect cannot be fixed or offset by the pro-competitive effect.

In the case of J&J, the Court concluded that the anti-competitive effect included the elimination of intra-brand competition (i.e. no price competition among distributors of J&J’s products) and the avoidance of inter-brand competition (i.e. discouragement of price competition from other brands) whereas no obvious pro-competitive effect was proved. In particular, the Court did not believe there is a need for J&J to (i) improve the quality of products or services, (ii) eliminate insufficient distributors, and (iii) promote market entry of new brand or new product, through the establishment of minimum resale price.

Burden of Proof on Plaintiff

Whereas a defendant alleged to implement a horizontal monopolistic agreement has the burden of proof to demonstrate that the agreement does not have anti-competitive effect according to the judicial interpretation of the Supreme People’s Court, the Court concluded that such reverse of burden of proof does not apply to a vertical restraint. Consequently, a plaintiff must prove the existence of anti-competitive effect in accordance with the four elements noted above, which could be quite difficult to accomplish, especially where a consumer sues for implementing monopolistic agreements.

In the case of J&J, most of the evidences accepted by the Court appear to be circumstantial and, arguably, insufficient to prove the anti-competitive effect arising out of the minimum resale price. Despite the foregoing, the Court appeared to have given full play to its interpretation of, and inference from, the common observations in the relevant market, and eventually ruled in favor of the plaintiff.

Exemptions under AML

According to the AML, even if resale price maintenance constitutes a vertical monopolistic agreement, such arrangement would be allowed if it qualifies any exemption provided under Article 15 of the AML, e.g. improvement of technology and development of new products, increase of small-medium enterprises’ competitiveness, etc.. Such exemptions were not addressed in the J&J case. Nevertheless, the Court’s analysis of the absence of pro-competitive effect shed some light on their stance toward such exemptions. Specifically, as stated in the judgment, the establishment of minimum resale price for the purpose of procuring distributors to improve after-sales services in the event of a new product’s market entry may be reasonable.

Calculation of Loss

In the case of J&J, the Court concluded that the loss of profit incurred by the plaintiff should not be calculated according to the rules under contract law because the calculation according to contract law would result in excessive profit derived from a monopolistic activity. Such opinion implies that a contractual arrangement, i.e., limitation of liability, will likely be unenforceable in the case of monopolistic agreements.

Conclusion

The Court’s judgment on the J&J case may have established a framework of civil action of vertical monopolistic agreement quite favorable to a defendant because a plaintiff would bear the burden of proof to demonstrate not only the existence of a vertical restraint but also the anti-competitive effect arising therefrom. Nevertheless, in view of a court’s potential interpretation of, and inherence from, common observations in support of its judgment and the unclear stance of NDRC, a company should remain very cautious about implementing any resale price maintenance. In any case, a comprehensive analysis of competition risks is advisable if any resale price maintenance is contemplated.