New spate of cases reveal how poorly structured sales incentives can trigger administrative penalties

I. Review of the Enforcement Actions against Tire Manufacturers for Commercial Bribery

Performance based compensation incentives are a common way to encourage sales for many businesses around the world. However, the legality of such incentives is now in question within Shanghai — if not China as a whole — after local branches of the Administration for Industry and Commerce (the “AIC”) in Shanghai concluded in 2016 that such practices by several well-known international tire manufacturers constituted commercial bribery.

The tire manufacturers include Bridgestone, Michelin, Giti, Yokohama and Kumho. Among the cases, the administrative action taken against Bridgestone (China) Investment Co., Ltd. (“Bridgestone China”) by Shanghai Municipal AIC has attracted the most attention. In this article we examine how the seemingly typical promotional incentive schemes used by these companies ran afoul of the Anti-Unfair Competition Law of People’s Republic of China[1] (the “AUCL”) and the 1996 State Administration for Industry and Commerce Interim Regulation on Prohibition of Commercial Bribery[2] (the “SAIC Interim Regulation”).

Under the AUCL, it is deemed commercial bribery if a business offers something of value in order to encourage the sale or purchase of commodities or services.[3] Article 8 of the AUCL further provides that offering a “secret-off-the-books rebate” to a counterparty should be deemed bribery. The AUCL, the SAIC Interim Regulation and other regulations provide important safe harbors from the broad sweep of these requirements. Specifically:

  • Express Discount or Intermediary Commission. The AUCL permits for “express” discounts (i.e. included in the contract terms) or commissions to “intermediaries” provided that they are accurately recorded on the books and records. The SAIC Interim Regulation defines discount as a concessionary price expressly offered by business operator in the contract. This can take two forms: a deduction at the time of the purchase or a rebate.[4]
  • Nominal promotional gifts. The SAIC Interim Regulation allows giving nominal promotional gifts based on common commercial practice.[5]
  • Service fee for sales promotion. According to the Administrative Measures on Fair Trading between Retailers and Suppliers[6], it is permissible for manufacturers or distributors to pay service fees charged by retailers for sales promotions, such as publishing promotional brochures and posters, (the “Measures”). A retailer must obtain its supplier’s consent and explicitly stipulate the promotional activities and service fee standards in contract in order to qualify for the safe harbor.[7]

Notwithstanding these safe harbors, there is still sufficient ambiguity under the AUCL that authorities retain broad discretion to determine what types of sales behavior should be punishable as constituting commercial bribery.

(i) Background of the Bridgestone case

According to the Shanghai Municipal AIC’s penalty decision[8], during the period from September 2013 to April 2014, Bridgestone China, through its distributors, provided online shopping gift cards to 1,275 retailers that achieved certain sales targets. In addition, during the period from July 2013 to April 2014, with a view to promoting winter sales, Bridgestone China offered 460 travel vouchers (worth RMB5,999 each) to 154 retailers for every 500 tires purchased. Shanghai Municipal AIC ruled that the gift cards and travel vouchers scheme resulted in Bridgestone China realizing illegal gains of RMB17,395,026.49.

Shanghai Municipal AIC’s rationale for penalizing the sales incentives were that (1) Bridgestone’s intent in offering the gift cards and travel vouchers was to promote sales and increase its market share and (2) such gifts, taken from an objective perspective, influenced the behavior of downstream retailers, which in turn excluded Bridgestone’s competitors from business opportunities.

Shanghai Municipal AIC further noted that such exclusionary strategy was not based on improvement of Bridgestone’s product quality, improvement of supporting services, more reasonable product pricing or other “normal” methods of market competition. Instead, Bridgestone improved its competitive position by bribing retailers with large ticket gifts, which were sufficient to substantially influence normal market competition and damage the interest of competitors. Therefore, Shanghai Municipal AIC concluded that Bridgestone China’s act constituted commercial bribery and violated Article 8 (1) of the AUCL. In addition to forfeiture of its illegal gains, Bridgestone China was fined RMB150,000.

(ii) General comparison of the Bridgestone case and four other cases

We briefly summarize the findings of actions taken by district-level AICs against Michelin, Giti, Yokohama and Kumho, and compare them with the Shanghai Municipal AIC’s findings in the Bridgestone case.

Please click here to view the table. 

II. Anatomy of the Decisions

From this chart, a noticeable similarity can be seen among the cases in terms of the form of in-kind rewards, the authorities’ apparent reasoning, the date of the decisions, and scale of the forfeiture imposed on tire manufacturers.

(i) A result-oriented approach

Based on the pattern established by these cases, it appears that the Shanghai AICs focused exclusively on the perceived anti-competitive effect of in-kind rewards. Broadly speaking, the notion that companies should not be permitted to take actions that are exclusionary is consistent with the application of anti-competition law in other jurisdictions.

Consistent with this approach, it is understood that Section 1 of U.S. Sherman Antitrust Act could apply where an incentive scheme qualifies as, or is in furtherance of, any “contract, combination . . . or conspiracy, in restraint of trade.” Commercial bribery may also, under certain circumstances, constitute “[u]nfair methods of competition in or affecting commerce” under Section 5 of the Federal Trade Commission Act.[13] Unfortunately, the AICs failed to explain how they made a finding of such exclusionary effect in several of the cases (e.g., Bridgestone, Giti, and Kumho).

Moreover, under typical anti-competition analysis, payments to distributors or retailers would not be viewed as exclusionary if such distributors or retailers already were under an obligation of exclusivity to the manufacturer. While the decisions against Michelin and Yokohama specified that the retailers also sold other brands of tires, there is no indication whether the relationship of the manufacturers to retailers or distributors in the other three cases were exclusive.

However, what is most striking about the cases is that the AICs apparently did not consider mitigating factors. Among other things, there was no analysis of the following issues:

  • While all of the decisions show that the Shanghai AICs collected relevant distribution or retail contracts and books and records in their investigations, there is no indication that the AICs gave any consideration as to whether the contracts made explicit provision for the promotional schemes and whether this would cause the schemes to fall into one of the AUCL safe harbors.[14]
  • In some cases (Michelin, Yokohama and Kumho), it was clear that the promotional scheme was duly reflected in the books and records of the tire manufacturers, but compliance with the books and records requirements of the AUCL does not seem to have been considered a defense.
  • It seems to matter who was the recipient of rewards under the promotional schemes or in what context. From a practical perspective, an in-kind reward offered to a business partner rather than its individual employees, would appear more likely to be construed as within the AUCL safe harbors provided other requirements are satisfied. None of the AIC decisions gives any analysis on this issue.[15]

Taken together, these cases signal that even “properly” structured and implemented in-kind rewards, i.e. delivery of in-kind rewards pursuant to written distribution or retail agreements to distributors or retailers rather than their individual employees, may still trigger commercial bribery concerns and be subject to penalty.

(ii) Form of rewards

The five decisions helpfully described the rewards schemes employed by the tire companies. There are at least three notable observations based on a review of these schemes.

First, it may have been an issue that the benefits were paid to individual people, rather than to the businesses, in the form of gift cards or free trips.[16]

Second, the gift card and travel rewards were not related to the companies’ core business products - tires - and this may have heightened AIC’s scrutiny in determining that such rewards constituted bribes.

Third, it is not clear that the reward schemes were clearly included as a contract term between the parties, as opposed to an ad hoc benefit offered by the tire manufacturers in addition to whatever had been explicitly agreed in relevant contracts.

Although not explicitly stated in the cases, based on other precedents, if the in-kind rewards program had taken the form of Bridgestone giving extra tires to its distributors or retailers, this might have been more acceptable insofar as it could be regarded as an effective discount (i.e. retailers and distributors would effectively be purchasing tires at a lower unit price). Similarly, although not as clear-cut, it might have also been acceptable if the in-kind reward was at least ancillary to the product being sold — for example, a tire manufacturer giving wheel wrenches to its distributors or retailers. However, in the absence of explicit guidance from the AIC, it will be a question for corporate compliance teams whether in-kind rewards must be categorically avoided.

III. Lesson Learned and Going Forward

This line of cases seem to reflect an internal position being taken by the Shanghai AICs about traditional in-kind rewards. Although it remains to be seen whether enforcement authorities from other provinces will follow Shanghai’s lead, given Shanghai’s commercial prominence as China’s financial hub, there is clearly room for concern.

In this context, multinational companies would be well advised to revisit their sales incentive programs in China. While the SAIC Interim Regulation allows offering nominal promotional gifts, relying on them to boost sales is probably a bridge too far. As an alternative to promotional in-kind rewards, companies may want to consider using deeper discounts or in-kind discounts as a replacement.[17] As noted above, there is past precedent of administrative courts recognizing that the provision of such discounts is distinguishable from commercial bribery as long as the discounts are stipulated in contract and accurately reflected on the books. For any agreement with distributors about discounts designed to motivate downstream retailers, it is further advisable to insert language specifying how to pass such benefits to retailers and ask for certification from distributors that such benefits are also properly recorded on distributors’ books. That said, caution should be exercised in designing the benefit pass-on mechanism to avoid resale price maintenance prohibited by the anti-monopoly laws, i.e., setting, directly or indirectly, the distributor’s resale price or minimum resale price to the retailer.