Recently two leading liquor producers of China – Moutai and Wuliangye, were severely sanctioned by enforcement authorities of China (i.e. respectively Guizhou Price Control Bureau and Sichuan Development and Reform Commission), for their maintenance of the minimum resale price in distribution agreements. This is the first vertical monopoly agreement case penalized by NDRC, one of three antitrust watchdogs, particularly in charge of pricing-related antitrust enforcement, pursuant to Article 14 of the PRC Anti-monopoly Law (the “AML”).

Back to 2010, a Beijing Company - Beijing Shuibang Yonghe Technical and Trading Co., Ltd. filed a lawsuit with Shanghai First Intermediate People’s Court against Johnson (Shanghai) Medical Appliances Co., Ltd. and Johnson (China) Medical Appliances Co., Ltd., claiming that the defendants, as the suppliers, had violated the AML in respect of distribution agreements imposing a minimum resale price on their distributors. This is the first private-standing litigation case ever tried by the Chinese first-instance court over a vertical monopoly agreement.

Through the limited number of precedent cases, it is still too early to infer or conclude any common attitude or approaches adopted by the Chinese regulators and judicial bodies in connection with the legitimacy of a vertical monopoly agreement. However, the regional distribution agreement (a typical vertical monopoly agreement), which is broadly employed by undertakings in private sectors, is becoming one of the key targets overseen by the Chinese antitrust enforcement agencies and judicial bodies. It is imminent for companies to streamline their business arrangements or distribution agreements accordingly in order to properly prevent the potential antitrust risks.

Regional Distribution Business Model

In a typical dual-distributor model in mainland China, a manufacturer or an exclusive distributor basically develops its market by way of a distribution network across the country or region and sells its products directly to end customers. In order to reign over a stable pricing system and maintain a rational region dissemination, the manufacturer or its exclusive distributor in mainland China would set down a minimum resale price for sub-distributors or retailers and normally confine their sales activities in a designated territory. Where sub-distributors or retailers fail to observe the preset price, the manufacturer or its exclusive distributor would be entitled to claim liquidated damages or even terminate the relevant contract. In these two circumstances, the legitimacy of such typical distribution scheme becomes questionable after the introduction of China’s AML.

Setting a Minimum Resale Price – different views of NDRC and Chinese courts

As far as the resale price maintenance (“RPM”) clause is concerned, it is observed that NDRC and Chinese courts had approached this issue in different ways. Under Article 14 of AML, undertakings are prohibited from entering into any MONOPOLY agreement for purpose of maintaining a minimum resale price. Shall any clause of RPM be deemed as “illegal per se”? In Johnson’s case, the court holds that, in spite of the findings of minimum price maintenance agreement between the parties, there is a need to clarify what is a “MONOPOLY agreement” condemned by AML. By analyzing the actual effects on the market competition resulting from the distribution contract in question, the court held that the distribution agreement is seemingly NOT in violation of Article 14 of AML on the ground that the plaintiff failed to fulfill its burden of proof. That is to say, under article 14 of AML, it is plaintiff’s burden to prove that the RPM agreement has an eliminating or restricting effect on the market competition. However, in Moutai and Wuliangye case, it is hard to deduct from NDRC’s public announcement that analysis of the market position of the concerned companies, or of the actual effect on market competition resulting from such RPM agreement, had been adopted by NDRC. It is more likely that NDRC deemed the RPM was illegal per se and as a result slapped the large sums of fines upon violators. For this reason, undertakings currently still applying RPM in distribution agreements would be highly exposed to anti-monopoly violation risks in China and such RPM clauses and non-observance penalization clauses should be immediately audited and amended to the extent that they are in compliance with China’s AML.

Restricted Territory of Sale – one of high risk areas

Generally speaking, restricted territory of sale would restrict the intra-brand rather than inter-brand competition and therefore is not likely to eliminate or restrict the inter-brand competition. Consumers are able to buy products not only from regional distributors but also from subordinate distributors. Oftentimes subordinate distributors are not prohibited from selling other brand products. As a conclusion, this arrangement arguably could intensify the inter-brand competition which benefits consumers and is normally considered as acceptable.

The American case law shows that the restriction of intra-brand competition is immune from antitrust condemnation. However, in cases where the regional distributor or manufacturer conspires with their counterpart of other brands in relation to a market partition arrangement and eventually extend such arrangement to their subordinate regional distribution agreements, this kind of arrangement between the regional distributors would involve the illegal market partition of different brands. Apparently the current antitrust practice in China has not confronted such scenario by far, but once such a horizontal-distributors-agreement case is brought to the court, such arrangement is still likely to be challenged as cartel or akin-cartel de facto.

Exclusive Dealing – another of high risk areas

In case where the subordinate distributors are prohibited from selling other brand products, they are more than likely to be deemed as an anti-competitive arrangement particularly when their upper-level distributor holds a dominant position in the relevant market. Without any doubt, the upper-level distributor will abuse its market dominance unless it proves otherwise by justifying the reasonableness of such exclusive arrangement.

In general, when adjudicating the legality of a vertical monopoly agreement, the Chinese courts would be more inclined to adopt an “effect-test” approach to assess to what extent such anti-competitive activity has eliminated and restricted the market competition, even if such practices as price fixing or market partition are already in existence. In other words, the market share of the concerned company still acts as a foremost factor in determining whether a vertical monopoly agreement is legal or illegal.

Conclusion

Under the AML regime, it is generally accepted that an undertaking with a merely moderate market share may hardly eliminate or restrict market competition even if it adopts RPM, and thus the RPM should not be outright prohibited. However, since a common rule applied to RPM is yet in absence, per se rule or rule of reason prevails from time to time between different regulators and courts in China. Having said so, in consideration of recent sanctions imposed by NDRC on Moutai and Wuliangye, undertakings are strongly advised to remain cautious when introducing to their distributors the RPM, as well as relevant penalizing clauses for purpose of deterring those that refuse to observe the RPM. While for undertakings holding a market dominance position, restricted territory of sale and exclusive dealing still remain as two top antitrust risks to be managed.

From commercial perspective, it is admittedly true that commercial reasonableness resides in the arrangement of a minimum resale price, and refraining from this practice might lead to adverse effects on its turnover and marketing strategy of businesses. To cope with such dilemma, many foreign undertakings had developed alternative solutions to a minimum resale price in other jurisdictional territories, such as in the United States and EU where the competition law has been well evolved. However, it is still remained to be seen whether such similar practice will also be recognized by Chinese regulators and courts in the future.