10 December 2009
The authorities charged with enforcing prohibitions governing day-to-day trading behaviour — known as “behavioural prohibitions” — in China’s new Anti-Monopoly Law (AML) are still drafting implementation rules. Consequently, a great deal of uncertainty remains regarding when and how the behavioural prohibitions will be more actively enforced, and what compliance steps businesses with operations or sales in China should be taking at this time.
In this article, we examine the main aspects of the behavioural prohibitions that will affect future China-related pricing conduct of business operators, and we provide some high-level compliance tips based on information in the relevant draft implementation rules and international experience.
Role of the NDRC
The AML regulatory regime is unique in how it divides enforcement jurisdiction for the behavioural rules into rules governing price and non-price specific conduct. The former will be handled by the National Development and Reform Commission (NDRC), while the latter will be dealt with by the State Administration of Industry & Commerce (SAIC). Accordingly, it is the NDRC that will set the agenda in terms of enforcement methodology and priorities for review of business pricing under the AML.
The NDRC has rolled out significant competition-related training and education programs for key staff in its Department of Price Supervision in recent months, to prepare these staff for their new AML-related responsibilities. Usefully, the authority has received assistance in these training efforts from key competition agencies in more mature antitrust jurisdictions such as the European Union and the United States.
However, the extent to which the training will translate into sound decision making may largely depend on how appropriately the enforcement work is delegated by the Department of Price Supervision to lower-level agencies.
While the NDRC is reported to employ approximately 40,000 people at its different functional levels across the Mainland, the number of staff in its Department of Price Supervision, which is charged with competition-related responsibilities (let alone those with experience in this area), is very small. This has raised concerns about the prospect of key investigation and enforcement roles being handled by staff at the lower city or county levels.
However, draft procedural measures released by the NDRC in June suggest that these lower level bodies will primarily assist with information gathering. Thus, at least for the time being, it seems that decision-making and enforcement in cases involving foreign parties will be handled at the national level.
Of course, the extent to which these delegation rules are applied in practice may depend on the volume of cases the NDRC is required to handle going forward. There are also lingering fears that if the agency is overburdened with cases, it may focus on sectors with which it is most familiar via its other price-regulation supervisory roles (in particular utilities, health care, education, and parts of the transport sector), as well as cases involving foreign parties.
Multinational businesses that operate or sell in China will find that the price-related activities that may raise concerns under the AML are similar to those likely to raise antitrust issues in jurisdictions throughout Europe and in the United States. However, as discussed below, there are signs that the NDRC may apply some unique treatment to particular pricing issues. Business representatives will need to be mindful of this when setting their pricing strategies and engaging in trade negotiations.
Article 13(i) of the AML prohibits a business operator from agreeing with a competitor to fix or change the price of products or services. This is one of several “horizontal” monopoly agreements referenced in the law. Other examples include joint boycotts and market divisions by competitors.
The NDRC's draft rules in this area elaborate on the basic wording in Article 13 by providing examples of the different forms price-fixing conduct may take. For example, the draft confirms that it will also be a breach of Article 13(i) for competitors to agree on a standard formula to calculate prices or to collectively decide that they will refrain from discounting.
Interestingly, the draft rules also refer to agreements between competitors on production output or sales limits as constituting price-related violations of the AML. This is an example of how the demarcation lines between NDRC and SAIC jurisdiction may become blurred. The impact this kind of conduct has on price may be more properly characterised as “indirect” rather than “direct,” and thus could be seen as falling under the ambit of SAIC.
Many other kinds of conduct that would otherwise seem to fall within the SAIC's jurisdiction could also be viewed as being indirectly related to price. Consequently, there are concerns that jurisdictional uncertainty could raise the prospect of regulatory forum shopping by complainants and overlapping investigations by SAIC and NDRC.
The draft rules also confirm that competing firms may be regarded as coordinating their pricing, even in the absence of evidence of a clear agreement between them, if:
- There is some “consistency” in their pricing activities (such as if changes to the pricing offered by the various competitors fluctuates by similar levels and at similar times) and
- Those competitors have engaged in some form of prior communication.
This suggests a need to exercise a degree of caution in cases where business operators are active in sectors with regular competitor forums (such as trade association meetings) and where prices fluctuate regularly but with relative consistency between competitors.
According to the NDRC's draft rules, the NDRC may be allowed to draw a presumption of illegality based merely on prior communications between two or more competing parties in the sector — unless the pricing alignment is readily explained by others factors. Any such presumption may prove difficult to rebut unless a valid alternative subject of those communications is fully and convincingly documented.
Notably, there is a general exemption to the prohibition relating to price-fixing and other “monopoly agreements” under Article 15 of the AML, in addition to specific exemptions for “crisis” and “export” cartels that are likely to have application only to domestic PRC companies. Under this Article, a relevant agreement may qualify for the exemption if it can be shown the agreement has:
- A valid purpose (examples of which are listed in the Article);
- An impact that does not seriously lessen competition; and
- Benefits that consumers can share in.
The general consensus among commentators is that the exemptions are rarely going to have application to traditional price-fixing cartels. It may be very rare that a participant in the cartel can show their conduct was for a legitimate purpose and could benefit consumers.
The exemptions are likely to have more relevance to other forms of competitor collaboration, such as certain competitor joint ventures, which may involve some coordination of pricing at the level of the joint venture or the parents. At this stage, guidance is still pending from the Chinese authorities on such issues. It remains uncertain to what extent detailed guidance in regimes like the European Union and the United States has relevance in China.
Resale Price Maintenance
Article 14 of the AML prohibits stipulating a specific or minimum resale price that downstream distributors or retailers can charge for goods that a business supplies to them for resale. The AML refers to this as a prohibited “vertical” monopoly agreement.
While there is some ongoing uncertainty on this issue, it appears from the text of the AML (and the NDRC's draft implementation rules) that resale price maintenance will be unlawful per se, unless one of the exemptions in Article 15 applies. That is to say, the NDRC won't need to demonstrate that the relevant conduct lessens competition. This may effectively be presumed.
However, the list of approved purposes under the Article 15 exemptions includes, usefully, instances where the agreement under review has a purpose such as "reducing costs, enhancing efficiency.... implementing division of specialization... [or] enhancing competitiveness of SMEs."
It will be prudent to identify and cite pro-competitive reasons for any resale price restrictions in relevant China-related distribution agreements, as well as provide key internal and external communications that recommend or explain the arrangements.
For example, the agreements might state (where applicable) that the arrangements:
- Maximise the effectiveness and efficiency of the distribution channel and
- Ensure that one retailer that invests time and resources in promoting a relevant product and providing exemplary after-sales service is not “undercut” by another retailer, which does none of these things and simply rides off the hard work of other retailers.
However, for companies with product ranges that are not subject to significant competition in China, it may be difficult to argue that competition, which in such cases can only occur at the intra-brand level, is not substantially reduced by resale price maintenance arrangements. Under the aforementioned criteria for application of the Article 15 exemption, this would mean the exemption could not apply regardless of whether there were sound pro-competitive justifications for the resale price restriction. In such cases the focus may need to be on “recommended” resale pricing for the time being.
Finally, it is worth noting that in many jurisdictions where similar prohibitions apply, the prohibition is not violated if the relevant downstream party is acting as the agent of the upstream manufacturer or supplier. This is because, at law, title to the supplied goods will not pass, and thus no “resale occurs”. However, it is not yet clear whether the authorities will take a favourable approach to this kind of arrangement in China in the context of the AML.
Relevant Pricing Conduct by Dominant Firms
The AML prohibits businesses that enjoy a dominant market position from abusing that position of dominance. The law contains detailed guidance on when and how dominance may be deemed to exist, discussion of which is beyond the scope of this article. For present purposes, however, it is prudent to note that dominance may be assumed (in the absence of compelling evidence to the contrary) if a business operator has a market share in China exceeding 50 percent.
Once a business is assessed as having a dominant market position, it is subject to a set of single-firm conduct rules that don't apply to other companies, including smaller competitors. Those rules focus not only on preventing the use of market power by firms to exclude existing or potential competitors from the market, but also on preventing what may be termed as “exploitation” of dominance.
Unfairly high or low pricing. The main pricing activity that can generate “exploitative conduct” risks for dominant business operators is mentioned in Article 17(i) of the law — selling products at an unfair high price or purchasing products at an unfair low price.
A similar prohibition exists in Europe, but it has rarely been enforced. As the European regulators have openly acknowledged, it can be difficult to apply such a prohibition in a way that does not seem arbitrary and subjective. Perhaps for these reasons, the United States has avoided introducing this kind of prohibition altogether.
Accordingly, there have long been concerns about how the prohibition could be applied in China.
Early versions of the NDRC's draft implementation rules appeared to justify these concerns, as they stipulated that pricing might be deemed to be unfairly high if it generated, for example, profit margins above 20 percent. A similar formula was provided for determining if pricing was “unfairly low.”
This formulaic approach to the prohibition was roundly criticised, and was seen as indicative of the gap between the instincts of some NDRC officials on these kinds of prohibitions and current best practices. Thankfully, a different approach was adopted in the revised draft published for public consultation in August.
First, this revised draft stated that the prohibition would not be applicable if the relevant customer or supplier of the dominant firm is unable to acquire the same product or a substitute at a reasonable price.
Second, the draft provided for assessment of the fairness of pricing by reference to a range of factors, rather than a set formula. For example, in relation to unfair high pricing, the factors to be considered include whether the sale price is obviously higher than the cost or is substantially higher than the same product sold by other business operators.
Discriminatory pricing. This is a practice that has received attention in recent times due to significant investigations in Europe and Asian jurisdictions such as Japan and Korea, in particular concerning Intel's alleged practice of making payments to computer makers in exchange for their boycott of Intel's rivals.
Article 17(vi) of the AML may also address this type of conduct. It states that a business which enjoys a dominant market position may not give different treatment, in respect of transaction prices, to equivalent transaction counterparts.
The NDRC's draft implementation rules explain when transaction counterparts will be deemed equivalent. According to the current draft, this will be the case when the transaction terms applicable to transaction counterparts are (other than in relation to price) the same or similar — with particular regard to matters such as the relevant products at issue (and their type, quality and grade), the transaction method, quantities concerned, payment settlement and after-sales service.
This suggests that in circumstances where a business wishes to provide significant discounts or rebates to one customer but not to another, it may be necessary to demonstrate that those discounts or rebates are attributable to genuine cost savings from the arrangements with that customer, for example. Other examples would be where large-volume orders may reduce unit costs, or where a prompt payment discount reduces the supplier's financing costs.
This is distinct from the provision of more favourable pricing terms in return for “customer loyalty” (fidelity rebates, or up-front payments to secure a long term exclusive contract, for example), which on the basis of international experience is more likely to be seen as an anti-competitive and unlawful activity because it may facilitate foreclosure of large sections of the market in which the relevant business operator is dominant.
Below cost pricing. Article 17(ii) of the AML prohibits a business operator from selling products at prices below cost.
Similar prohibitions exist in many competition laws around the world, usually based on concerns that such below-cost pricing (or “predatory pricing,” as it is often called) may have the purpose of shutting out prospective or existing competitors from the market. Competition regulators are generally keen to avoid a situation where the relevant dominant business operator is able to revert to very high pricing after driving out existing or prospective competitors.
In this context, it is notable that the NDRC does not seem to require a showing that the element of “recoupment of earlier losses” is a likely outcome of a business operator's “below cost” pricing. This is in contrast to the prevailing approach of the US authorities to this type of prohibition.
One of the key issues that need to be tackled is calculating relevant business costs, in order to determine if a dominant business operator has set prices that fall below these costs. Different regimes have adopted different measures of cost for this purpose. To date, NDRC is yet to provide substantive guidance on this point.
This lack of guidance obviously presents some impediments to compliance efforts. In the interim, it is suggested that a prudent approach, based on comments from NDRC officials and some brief guidance published in relation to broadly similar pre-AML prohibitions in China laws, may be to assume that European cost-calculation methodology will apply.
On this basis, it will be prudent to ensure that pricing for products does not fall below their “average variable cost” (which is basically a matter of adding up all your variable costs like labour, electricity and tangible manufacturing inputs, and dividing by the quantity or units of output).
Where prices of a dominant business operator are set at a level that is higher than this average variable cost, but below what is termed “average total cost” (which you calculate by taking into account both variable costs and fixed costs, like rent and other overheads attributable to the relevant business operation, and dividing that total by units of output), then concerns may only be likely to arise if it can clearly be shown that the business operator had the intent of setting such pricing to eliminate a competitor or deter a potential competitor.
Helpfully, the NDRC's draft rules do provide a list of situations in which below-cost pricing will be considered to be justified, and this includes cases where the below-cost pricing was instituted to match competitor prices — something that is not always accepted as a valid justification for below-cost pricing in other jurisdictions.
Additionally, it appears that below-cost pricing that is introduced simply as part of a short-term promotion by a new market player (who is, for example trying to establish a foothold on the market) will generally be deemed not to violate the AML.
Constructive refusal to deal. For completeness, it is noted that Article 17(ii) of the AML prohibits a dominant business from refusing to trade with trading partners without valid reasons. The NDRC's draft rules elaborate on this prohibition by providing that an unlawful refusal to deal will arise where a “refusal” is disguised in the form of an offer of an “overly high price” offer (by dominant suppliers) or an “overly low price” offer (by dominant buyers) and without justification.
According to the NDRC's draft rules, an overly high price is a price that would lead to no profit after the relevant transaction counterpart's normal production and sale.
This aspect of the draft raises significant concerns, as it does not appear to take into account the level of efficiency of the relevant transaction counterpart, who may suffer a loss as a result of its sale activities due to its own poor business model or operations and not (for example) the price of inputs offered by a dominant supplier.
However, it is possible that this consideration will be taken into account when a determination is made regarding whether the relevant “overly high” or “overly low” price was provided to the customer with “valid reasons.”
Additionally, based on other draft guidance documents published by the SAIC, it appears the prohibition is likely to be of limited application where alternative supply options exist for the relevant customer.
Price of Noncompliance
The NDRC is compelled by procedural regulations to investigate any complaint made in relation to a claimed AML violation if it is accompanied by “sufficient facts and evidence.” The NDRC is also authorised to conduct investigations on its own initiative and has broad powers to conduct dawn raids, question executives, and seize evidence.
Where violations of the law are found to have occurred, any illegal gains can be confiscated by the NDRC, and fines of up to 10 percent of total business turnover in the preceding year may be imposed in serious cases. It seems likely this relates to group turnover in the relevant sector, but this is yet to be clarified. Interestingly, it also appears that these fines start at a minimum of 1 percent, except in cases where leniency may be applied.
Private actions are also permitted for recovery of damages suffered as a result of another business operator's violation of the AML. Additionally, the Chinese authorities are contemplating introducing a “double damages” system to encourage litigation in this area and strengthen the impact of the law.
The AML behavioural rules are not being stringently enforced as yet. However, as the public consultation phase has expired in relation to the NDRC's draft implementation rules regarding pricing issues, more active enforcement of these aspects of the law may be imminent. Accordingly, businesses with operations or sales in China should be introducing necessary compliance initiatives.
In particular, it is important that staff who deal with pricing matters receive training on the issues covered in this article. A priority may need to be placed on ensuring that staff involved in regular formal or informal communications with competitors understand how they should conduct themselves in such activities.
Additionally, staff involved in negotiating and drafting terms of trade with suppliers and customers may benefit from the introduction of clear policies specifying the kinds of arrangements that require competition-related review and sign-off before implementation (such as resale price restrictions, and significant price increases or decreases for particular customers or “across-the-board”).
Based on the experience of other antitrust regimes, price-setting arrangements may soon become one of the areas of business activity most likely to raise issues under the AML. Implementing appropriate training and other compliance steps now can assist business operators avoid having to pay a potentially high price for noncompliance in the future.