Vertical restraint: the ‘grey rhino’ in anti-monopoly compliance

With China stepping up its anti-monopoly efforts, law enforcers are cracking down on manufacturers or wholesalers seeking to control the eventual price of their products and services via vertical restraints

Recent years have witnessed a growing prominence in China’s anti-monopoly compliance. Besides heavily fined e-commerce cases involving “choice of two” or “big data-enabled price discrimination”, vertical restraint, especially resale price maintenance (RPM), has garnered considerable attention from law enforcers. RPM refers to a type of agreement that a manufacturer or wholesaler enters into with its distributors in an attempt to control the resale price of its own products or services. As such arrangements are commonplace, many companies fail to realise illegalities and underlying risks until it is too late.

This article analyses a highly illustrative case of vertical restraint, takes into account the amendments to the Anti-Monopoly Law (AML) and latest rulings of the Supreme People’s Court, and aims to put forth regulatory trends in vertical agreements, as well as the key points in compliance.

EMBLEMATIC CASE

In September 2021, the Administration for Market Regulation of Zhejiang province (Zhejiang AMR) disclosed on its website an anti-monopoly decision for administrative penalty with respect to a manufacturer of electrotechnical products that fixed or restricted resale prices in vertical agreements. The manufacturer was fined 3% of its China-wide turnover in 2020, amounting to about RMB290 million (USD45.5 million).

Under article 14 of the AML, “undertakings are prohibited from reaching any of the following monopoly agreements with their trading parties: (1) fixing the price of commodities for resale to a third party; and (2) restricting the minimum price of commodities for resale to a third party.” Commonplace in the multiplayer distribution system of products, vertical restraint has long attracted the attention of anti-monopoly law enforcers. Beginning with early cases involving liquor and infant milk powder, to the pharmaceutical case published in the first half of 2021, or even the above-mentioned case, they invariably reflect the anti-monopoly efforts of the regulators on RPM.

In this case, the RPM agreement was founded because the manufacturer executed a distribution contract that included market management and mark-up percentage clauses, issued pricing policies, and demanded that distributors sign letters of undertaking. Furthermore, it ensured the implementation of price restrictions via strict appraisal, engagement of intermediaries for price maintenance, and punitive measures.

The Zhejiang AMR also briefly analysed the competitive effects of its action, concluding that the manufacturer, by taking advantage of its vantage point in the market and distributors’ dependence on its key products, excluded and restricted distributor competition to the detriment of consumers’ lawful rights and interests.

LEGISLATIVE AND JUDICIAL CHANGES

It should be noted that, under current legal provisions of the AML and administrative law enforcement, there is no requirement for the parties in question to possess certain market share or power in order to constitute vertical restraint. Therefore, producers and manufacturers, even with relatively low market share, can still be liable for vertical restraint if they impose restrictions over resale prices. This has been especially evident in administrative enforcement, which follows a “prohibit in principle, but with exceptions of exemption” approach.

The recent draft amendment to the AML made certain changes in this regard, reflecting trends already indicated in local and sector guidelines.

First, it specified that vertical restraint must also have the effect of eliminating or restricting competition, and therefore would not be prohibited if the operator is able to prove that the relevant agreement does not have such effect. In addition, a “safe harbour” system was introduced. Exemptions will be granted for operators able to prove that their market share in the relevant market is lower than a certain criterion, unless evidence suggests that the arrangement still has the effect of eliminating or restricting competition.

Similarly, in two recent cases concerning transformer switch and drug reverse payment agreements, the Supreme People’s Court also made it clear that the key to identifying monopoly agreements is the effect of eliminating or restricting competition, and that the manner and context of executing the agreements did not affect the determination.

In both cases, the background that the relevant agreements were entered into as a mediation or settlement agreement in judicial procedures was relegated to referential materials, while their effect of eliminating or restricting competition served as the key to the determination of monopoly agreements.

Although both cases involved horizontal agreements, they nevertheless provide guidance for the determination of vertical restraints and are in line with the underlying logic of the draft amendment to the AML.

PRACTICE AND COMPLIANCE

Vertical restraint taking the form of RPM is common in practice. Many companies relying on distributors to sell their products more or less exert some level of control over the eventual price. In contrast with the prevalence of RPM in actual business dealings, anti-monopoly actions in this regard have been limited, principally due to limitations in law enforcement resources.

However, in cases of stock shortage, mass price rise, or complaint filed by any distributor, consumer or third party, risks of anti-monopoly investigations will surge. Based on current cases, companies generally find it very difficult to mount a defence.

If found to be have entered into and implemented a vertical monopoly agreement, companies may be ordered to cease illegal acts, have unlawful gains confiscated, and be fined from 1% to 10% of the turnover of the previous year. Operators should be mindful to not impose restrictions over distributors’ resale prices, range of discount and method of pricing in their distribution contracts, sales policies and key performance indicators, and avoid such requirements in business dealings.

With compliance in mind, companies may still set the prices to distributors at their discretion, as well as recommended retail prices, but are not allowed to transform them into fixed prices by imposing punitive or incentive measures. Meanwhile, the authors remain watchful for law enforcers’ approaches to emerging business models on the market, such as limiting to the highest resale price, customised discount, and distributor profit sharing.

Angus Xie is a compliance expert at Han Kun Law Offices. He can be contacted on +86 10 8524 5866 or by email at angus.xie@hankunlaw.com

Guo Xiao is an associate at Han Kun Law Offices. She can be contacted on +86 10 8516 4103 or by email at xiao.guo@hankunlaw.com