China’s Anti-Monoploy Law enforcement authorities handed down the first ever penalty decision on vertical monopoly agreements - Moutai & Wuliangye case - at the beginning of this year, and made the verdict and decision rationale published to the general public. A consistent investigation has recently been carried out on the milk powder industry for their alleged vertical monopoly agreements. There seems to be a pressing need for companies operating in China to review and evaluate the legal compliance of their vertical business arrangements. For this purpose, it is critical to have an accurate understating of the identification criteria of vertical monopolistic agreements adopted by the Chinese law enforcement authorities at this stage.

We intend to summarize in this article the basic approach and identification criteria adoped by the Chinese law enforcement authorities towards vertical monopolistic agreements, drawing from the first-hand experiences gained through our engagement in Beijing-Benz case and Moutai & Wuliangye cases, as well as from the on-going investigation pertaining to the milk powder industry. We hope it would be helpful for  companies with operation in China to strengthen their anti-monopoly risk management and legal compliance standard.

I. Different opinions on the identification of vertical monopoly agreements

Pursuant to Article 14 of the Anti-monopoly Law, verticle monopolistic practices include (1) fixing resale price; and (2) restricting minimum resale price. There is also a catch-all clause captures all “other monopolistic agreements as identified by the State Council’s anti-monopoly law enforcement authority”. Regarding the identification criteria of vertical monopolistic agreements, there exist divergent opinions:

Opinion of PRC Judicial Institutions

In Ruibang v. Johnson & Johnson Medical, the first litigation case regarding vertical monopolistic agreements in China, the court of first instance held that Ruibang did not demonstrate the market share of the products under the distribution agreement, the competition level of the relevant market, and the supply and price fluctuation of the products. On the contrary, Johnson & Johnson Medical provided evidence on the existence of a variety of upstream suppliers for similar products. The court therefore dismissed Ruibang’s allegation for insufficient proof of evdience that the minimum resale price restraints set by Johnson & Johnson Medical in the distribution agreement are of monopolistic nature and therefore has violated the Anti-monopoly Law. Apparently, the court of first instance adopted the Rule of Reason in the identification of vertical price monopoly, requiring comprehensive competition analysis of relavant market, market share and level of competitive etc.

Opinions of the academia and EU

Many legal scholars strongly criticized the ruling of Ruibang v. Johnson & Johnson Medical, for its application of Rule of Reason to vertical monopoly analysis. Similarly, according to the EU Commission’s Guidelines on Vertical Restraints amended in 2010 and the Commission Regulation (EU) on the Application of Article 101(3) of the Treaty on the Functioning of the European Union to Categories of Vertical Agreements and Concerted Practices, vertical price restraints are classified as hardcore restrictions, and are not eligible to benefit from De minimis doctrine. Only under extremely special circumstances, exemption can be granted on a case-by-case basis on the ground of efficiency defense. The mainstream opinions still hold that vertical price constriants would categorically constitute violation of competition law.

In addition, Chinese academia have initiated extensive discussions on the scope of “other vertical monopolistic agreements” apart from the vertical price restraints expilictly stipulated in the PRC Antimonopoly Law. They have explored the merit to place practices such as resale area limitation, exclusive distribution and exclusive supply etc. under the governance of the Anti-Monoploy Law, in order for defining a clear boundary for all the arrangements and constrains that shall be subject to strict anti-monopoly scrutiny.

II. Criteria adopted by law enforcement authorities for identifying vertical monopoly agreements

Fixing resale price being deemed as illegal per se

Despite the final verdict of Ruibang v. Johnson & Johnson Medical is still pending, anti-monopoly law enforcement authorities have clearly provided their viewpoints with regard to vertical monopolistic agreements in Beijing Benz case and Moutai & Wuliangye cases, as well as in the ongoing investigation on the milk powder companies.

In 2012, we participated in the investigation on Beijing-Benz’s “double restrictions” policy (restricting minimum resale price and geographical restrictions). The law enforcement authorities regard minimum resale price restriants as vertical monopoly per se. No reference was made to the detailed analysis of relevant market and market share of Beijing-Benz.

In Moutai & Wuliangye, materials published in 2013 show that the law enforcement authorities has taken note of the fact that “Moutai has established a seller market in liquor and spirit products, with little elasticity due to low substitutability and high market share, which significantly limits the consumers’ choices”, but it is also clearly stated that the penalty decision on Moutai was made solely on the basis of typical minimum resale price restraints, and did not premise on Moutai’s market share.

In the aftermaths of Moutai & Wuliangye’s conviction, prices of both liquors plummeted drastically, which has benefited both dealers and consumers. Positive feedbacks from all aspects and corners of the society bolster the confidence of the law enforcement authorities. During the recent investigation against the milk powder industry, the companies under investigation were explicitly admonished that their defense of not knowing the laws is not acceptable, as Moutai & Wuliangye case has already been made known to the public for at least 4 months

Based upon the aforementioned cases, we can conclude that the law enforcement authorities would deem any agreement or arrangement of fixing resale price or restricting minimum resale price as vertical price monopoly per se, unless it could resort to exemptions as stated in article 15 of the Antimonopoly Law.

Focus being on the vertical price monopoly

Insofar as all the concluded anti-monopoly enforcement cases are concerned, only Beijing Benz case has involved the issue of "other vertical monopoly agreements" stipulated in the Article 14(3) of the Anti-monopoly Law. According to our communication with the relevant law enforcement authorities, their efforts currently will be focused mainly on vertical price monopoly. Other vertical restraints that would have effect of excluding or eliminating competition, if discovered during the investigation process, would be assimilated to the investigation on vertical price monopoly.

However, companies with dominant market position, while engaging in vertical restraint behaviours, might be deemed as abusing their market position and be thus convicted.

III. Suggestions on the compliance of vertical agreements

Based on the criteria for identifying vertical monopoly adopted by law enforcement authorities, and the rectification measures imposed on Beijing Benz and Moutai & Wuliangye under enforcement authorities’ supervision, we would like to make some recommendations, for anti-monopoly law compliance purpose, regarding vertical agreements as follows:

Price fixing or setting minimum price in the form of agreements or policies should be strictly prohibited

As discussed above, academia have not reached consensus on whether vertical price monopoly should be regarded as illegal per se. There are no consistent and binding court precedences on this issue, either. However, law enforcement authorities clearly consider such practice as illegal per se. Therefore, for the moment, price fixing or setting minimum price in any manner should be strictly avoided and prohibited.

Price fixing or setting minimum price could not only be manifested in the distribution agreements, but also identified in the relevant distribution policies. In both Beijing Benz and Maotai & Wuliangye cases, distribution policy was also recognized as a form of monopolistic agreement.

Punitive or incentive policies that would in effect make suggested retail price have binding force may also be regarded as vertical price monopoly

Law enforcement authorities would generally accept the usage of suggested retail price in the distribution agreement/policy, if in practice the pricing autonomy of the distributors could be respected. After the Moutain & Wuliangye case, both companies revised their distribution agreements, which have adopted suggested retail price model.

However, as shown in the recent investigation over the milk powder industry, law enforcement authorities suggested that, even if a suggested retail price model is adopted, any punitive or incentive policies that would in effect make the suggested retail price have a mandatory binding force may also constitute vertical price monopoly. Such policies include, for example, penalising dealers by means of termination of contract, reduction of annual quota and withholding of deposits if the suggested retail price is not adhered to, or offering apparently excessive rewards to dealers who would comply with the suggested retail price, which render the suggested retail price compulsory. Therefore, enterprises should be cautious when formulating relevant punitive or incentive policies in their distribution agreements and policies.

Permissible pricing policies

After the Moutai & Wuliangye case, the attorneys of this firm have taken up a good number of counsultacy enquiries from various enterprises. We have noted that some enterprises, being concerned with potential huge fines as seen in Moutai and Wuliangye case, are trying to tranplant compliance program from their overseas parent companies or affiliates. In many cases, these imported experiences and programms are not completely compatible to the Chinese market and might have an  impeding effect on the commercial operations in China. We believe that, on the basis of accurate understanding of the law enforcement authorities’ criteria and full respect for the pricing autonomy of dealers, it should be permissible to provide certain pricing guidance to dealers, with an aim to implement the enterprise’s overall and ultimate price system. Acceptable activities may include making reasonable suggestion for dealer’s pricing policy, assisting dealers in deciding pricing methods compatible with their own conditions, or participating in dealers’ pricing process, etc.

Launching compliance inspection as soon as possible

Having set the tone through the Moutai & Wuliangye case, law enforcement authorities have been paying close attention on pillar industries that are critical to the national economy and people’s livelihood. They continue carrying out an ex-post supervision over the industries which have been previoulsy convicted and penalized, such as automobile and liquor industries, requiring them to report their latest operating policies on a regular basis.

Recently, both central and local anti-monopoly law enforcement teams are undergoing a personal expansion. A large number of professionals from judicial system and the State Council Legislative Affairs Office are recruited by anti-monoply law enforcement agencies. An extensive training on anti-monopoly law implementation has been launched nationwide. We anticipate that law enforcement authorities would regularly shore up its scrutiny and combat on the suspected monopoly behaviors including vertical monopoly. It is thus imperative for enterprises to timely commence inspection on their business operation so as to keep the score on anti-monopoly compliance in order. Recent large-scale anti-monopoly investigation is carried out against the milk powder industry. Who will be the next target?