On 1 August 2013, the very same day of the fifth anniversary of China’s Anti-Monopoly Law (“AML”), Shanghai Higher People’s Court (“Shanghai Higher Court”) made a final judgment on the Rainbow v. Johnson & Johnson case.  It is the first case of vertical monopolistic agreement and the court overruled the judgment of the first instance, and ruling for the appellant (i.e., the plaintiff). This case is also the first anti-monopoly case in China where the second-instance court reversed the judgment of the first instance court and ruled in favor of the plaintiff.

Summary of the Case

The parties in dispute are Johnson & Johnson Medical (Shanghai) Ltd., Johnson & Johnson Medical (China) Ltd. (collectively “J&J”) and Beijing Ruibang Yonghe Science and Technology Trade Company (“Rainbow”), one of their distributors. The issue in dispute is whether J&J set a minimum resale price (“RPM”) in the distribution contract with Rainbow. Rainbow had been a business partner with J&J for 15 years as its distributor of staplers and suturing products. According to the distribution contract, J&J authorized Rainbow to sell its product to hospitals in specific districts in Beijing with a minimum resale price. However, J&J discovered that Rainbow acquired distributorship in an unauthorized district by bidding at a price that was below the minimum resale price set by J&J. Consequently, J&J withheld Rainbow’s deposit, terminated its distributorship in several hospitals and eventually terminated supply entirely.

On 2010, Rainbow filed a lawsuit against J&J in Shanghai No. 1 Intermediate People’s Court (“Shanghai No. 1 Intermediate Court”). Rainbow alleged that J&J conducted RPM, which breached Article 14(2) of the AML and asked to be compensated for its losses of RMB14.4 million. On 18 May 2012, Shanghai No. 1 Intermediate Court ruled against Rainbow, finding that the plaintiff failed to prove that the RPM agreement had restrained or excluded competition.

On 1 August 2013, Shanghai Higher Court, which went through three hearings (the first hearing in public, while the other two in private), made a final judgment, reversing the judgment of the lower court.  The Shanghai Higher Court ordered J&J, the appellee, to compensate for Rainbow, the appellant’s losses of RMB 530 thousand within ten days after the judgment became effective. Other charges against J&J were dismissed.

Overview of the Judgment

  •  Anti-competitive effect is an essential element in the finding of monopolistic agreements, both horizontal and vertical

Shanghai Higher Court made it clear that the definition of monopolistic agreements under Article 13 of the AML (which stipulates that monopoly agreements shall refer to agreements, decisions, or other concerted conducts that eliminate or restrict competition), applies to vertical monopolistic agreements.

Shanghai Higher Court is of the view that, to find a horizontal agreement under Article 13 of the AML as a monopolistic agreement, a precondition is that the agreement shall have the effect of eliminating or restricting competition.  Generally speaking, compared to vertical monopolistic agreement, the anti-competitive effect of horizontal monopolistic agreement is much more significant, as it eliminates or restricts competition directly.  Since elimination or restriction of competition is a necessary element even for horizontal agreements which are more harmful, to prove a vertical monopolistic agreement, the effect of elimination or restriction of competition must also be proved.

  • The burden to prove the anti-competitive effects of RPM lies in the plaintiff

According to the judgment by Shanghai Higher Court, the burden of proof under Civil Procedural Law will be reversed only by express terms under laws, regulations or judicial interpretations., The rule of burden of proof regarding horizontal monopolistic agreements under Article 7 of the Provisions of the Supreme People’s Court on Several Issues concerning the Application of Law in the Trial of Civil Dispute Cases Arising from Monopolistic Conduct (“Anti-Monopoly Judicial Interpretation”) shall not apply to vertical monopolistic agreements.1

Shanghai Higher Court further held that, since no current laws, regulations or judicial interpretations have particular provisions regarding the burden of proof in a vertical monopolistic agreement, the general principle that “the burden of proof is upon the party who claims” under the Civil Procedural Law shall apply.  In other words, the burden to prove the anti-competitive effects of a vertical monopolistic agreement shall still lie in the plaintiff. The court made it clear that in a PRM dispute, the plaintiff bears the burden to prove the existence of the RPM agreement, as well as its anti-competitive effects.

  • Four factors to evaluate anti-competitive effects of RPM agreements

Shanghai Higher Court set out four factors to evaluate whether RPM agreements eliminate or restrict competition:

  1. Whether there is sufficient competition in the relevant market (primary condition);
  2. Whether the defendant has a strong market position (prerequisite and basis);
  3. Motivation of the defendant to conduct RPM (important  factor);
  4. Effects of RPM on competition — both anti-competitive and pro-competitive effects shall be considered.
  • Calculation of damages

In the judgment, Shanghai Higher Court analyzed the appellant’s claim for damages in details. Its major views are as follows:

  1. The loss of profits of the relevant product in dispute (medical stitching instruments) bears a direct causal relationship with the appellee’s implementation of the RPM, thus the appellant is  entitled to claim compensation of such losses;
  2. The damages under item (1) above shall not be calculated according to the principle under the Contract Law, which would be the loss of profits should the appellant comply with the RPM. Instead, loss of profits shall be calculated according to normal profits in the relevant market;
  3. To calculate the normal profits of distributors in the relevant market, the following factors shall be considered: differences of prices between the relevant product manufactured by the appellee and other manufacturers, purchase prices, discounts and taxes of distributors, and the profit assignment between appellee and distributors;
  4. Other losses claimed by the appellant shall not be considered, such as loss of profits of irrelevant products, loss due to high purchase prices, loss of anticipated profits, harm of business reputation, staff redundancy, loss due to overstocked products, and loss of marketing expenses, etc.

Implication of the Case

  • The plaintiff bears relatively heavy burden of proof in antitrust private litigation of vertical agreements

Shanghai Higher Court expressly held that reversion of burden of proof does not apply to vertical agreements, since the Anti-Monopoly Judicial Interpretation does not include a provision to such effect.

Therefore, even though Shanghai Higher Court reversed the lower court’s judgment, it still confirmed the analytical approach adopted by the lower court, namely

  1. the effect of elimination or restriction of competition is a necessary element in the finding of a monopolistic agreement, and
  2. in a dispute related to a vertical monopolistic agreement, it is the plaintiff’s burden to prove the anti-competitive effects of such an agreement.

We notice that Shanghai No. 1 Intermediate Court held against the plaintiff due to its failure to provide sufficient evidence.  In the second instance, both the appellant and appellee hired economic experts to submit economic analysis pursuant to Article 13 of the Anti-Monopoly Judicial Interpretation, which may have affected the court’s judgment. It suggests that plaintiffs must provide sufficient and detailed evidence and analysis to prove that the vertical agreement in dispute has the anti-competitive effect, in order to win the case.

  • How to evaluate whether RPM bears anti-competitive effects

As discussed above, Shanghai Higher Court sets out four factors to evaluate whether RPM bears anti-competitive effects:

  1. To determine whether competition is sufficient in the relevant market, one should first define what the relevant product market and the relevant geographic market is; then, factors such as the bargaining power of buyers, the degree of the reliance on brands, obstacles of market entry, defendants’ power in price negotiations shall be considered to decide the competitiveness of the market.
  2. To evaluate the defendant’s market power, the following factors shall be considered comprehensively: market shares, power in price negotiations, influence of brands and control over distributors, etc.
  3. When the defendant’s motivation to conduct RPM is found to restrict competition, such as to avoid price competition, this would serve as an important factor to finally prove a monopoly agreement.
  4. Shanghai Higher Court also held that RPM can bear both anti-competitive effects and pro-competitive effects. On the one hand, market bears self-repair functions, meaning that market can repair some of those anti-competitive effects quickly. On the other hand, pro-competitive effects will offset some of those anti-competitive effects as well. Therefore, RPM is held to be monopolistic only when it produces anti-competitive effects that are hard to be repaired or offset.

In addition, it is worthwhile to mention that Shanghai Higher Court did not analyze pro-competitive effects or the so-called “efficiency defense” under the framework laid out by Article 15 of the AML.  We understand that the reason may be that the defendant did not consider the RPM in dispute as constituting vertical monopolistic agreement and therefore did not raise Article 15 arguments before the court.  According to Article 15 of the AML, a monopoly agreement may be exempted when a company proves that the monopolistic agreement bears efficiencies or serves public interest, it does not severely restrict competition in the relevant market and that customers will be able to share the consequent benefits.

  • Companies should be highly aware of RPM provisions in distribution arrangements

According to the judgment by Shanghai Higher Court, plaintiffs bear relatively heavy burden to prove that RPM constitutes vertical monopolistic agreements. Nevertheless, the final judgment of the case still suggests that companies shall be highly aware of the legal risks associated with conducting RPM in practice.

In addition, the National Development & Reform Commission (“NDRC”) commenced a series of investigations against RPM, such as the Maotai / Wuliangye case, suggesting that it is aggressively enforcing against RPM conducts.3  Moreover, simply from the information released in the administrative penalty announcement of Wuliangye case, NDRC appears to have conducted some simple quantitative analysis before it concluded that the RPM agreement under investigation had the effect of eliminating and restricting competition.  It seems that the NDRC may not have an aligned approach with the courts in the Rainbow v. J&J case when it comes to the level of burden of proof of anti-competitive effects in a RPM setting.

Finally, it must be mentioned that the AML academia and practitioners are still in dispute on several issues related to this case. For example, considering RPM is already explicitly listed in the AML as a type of vertical monopolistic agreement (just as horizontal price fixing), does the burden to prove anti-competitive effects still fall on the plaintiff? Shall motivation be considered when evaluating anti-competitive effects?

Despite the above controversies, Shanghai Higher Court, with a detailed and well-argued judgment in 44 thousand words, in particular regarding the calculation of damages, demonstrated that the Chinese judiciary is ready to hear complicated antitrust private litigations.  We believe this landmark case would serve as important guidance for future antitrust private actions.