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After Many Twists and Turns China's First Vertical Monopoly Agreement Dispute has Ended Comments on Rainbow v. Johnson & Johnson

2013-8-2

 

Beijing Ruibang Yonghe Technology and Trade Co., Ltd. ("Rainbow"), with registered capital of RMB 6.9 million, is a Beijing-based private enterprise that mainly engaged in the sale of medical devices. Rainbow was a distributor selling Johnson & Johnson's Ethicon brand staplers and surgical sutures.

Johnson & Johnson (Shanghai) Medical Equipment Co., Ltd., Johnson & Johnson (China) Medical Equipment Co., Ltd. (hereinafter jointly referred to as "Johnson & Johnson") was founded in 1994 in Shanghai, and is a wholly foreign-owned enterprise of Johnson & Johnson.  Johnson & Johnson produces and sells medical devices, including Ethicon brand stapler and surgical suture.

In August 2010, Rainbow filed an anti-monopoly lawsuit to the Shanghai No. 1 Intermediate People's Court ("Intermediate Court"), alleging that Johnson & Johnson set a minimum resale price for surgical sutures in their distribution agreement, violating Article 14.2 of the Anti-monopoly Law of China ("AML"). The hearing was conducted by Shanghai Intermediate Court on February 3, 2012. On May 18, 2012, the Intermediate Court issued a judgment and dismissed all Rainbow's claims.

Rainbow appealed, and the Shanghai Higher People's Court held three hearings on August 30, 2012, October 30, 2012, and January 21, 2013. On August 1, 2013, the fifth anniversary of the AML, the Shanghai Higher People's Court announced the final Judgment, overturned the Intermediate Court's civil judgment, and ordered Johnson & Johnson to indemnify Rainbow's economic losses of RMB 530,000.

This is an antimonopoly agreement civil dispute triggered by the resale price maintenance ("RPM").  The judgment was issued while the National Development and Reform Commission ("NDRC") was actively pursuing its own RPM investigations, and there were many twists and turns from the first trial to the appeal. The Judgment on the RMP will have an impact on future disputes over vertical monopoly agreement, and will provide guidance for enterprises on drafting the terms on pricing in a distribution agreement.  This article will compare the judgment of the Shanghai Higher People's Court and the judgment of the Intermediate Court, combined with the NDRC RPM investigation practice, to provide comments on the Rainbow v. Johnson & Johnson.

I. Background

Johnson & Johnson and Rainbow signed a distribution agreement ("Distribution Agreement") on January 2, 2008. The Distribution Agreement provides that Rainbow sells Johnson & Johnson's Ethicon surgical suture in the area specified by Johnson & Johnson from January 1, 2008 to December 25, 2008.  The Annex to the Distribution Agreement stipulates that Rainbow shall not sell Ethicon surgical suture at a price less than that stipulated by Johnson & Johnson.  The Annex to the Distribution Agreement also defines the distribution area of Rainbow.

In March 2008, Rainbow won a bid supplying surgical sutures to the People's Hospital by offering a price less than the price stipulated by Johnson & Johnson in the Distribution Agreement.  Johnson & Johnson alleged that Rainbow breached the Distribution Agreement by selling surgical sutures below the minimum resale price, and supplying surgical sutures beyond the defined distribution area.  On July 1, 2008 Johnson & Johnson sent a letter to Rainbow deducting its bond of RMB 20,000 and terminating its distribution right in Beijing Fu Wai Hospital and Beijing Plastic Surgery Hospital.

On August 26, 2010, the Intermediate Court accepted the Complaint filed by Rainbow against Johnson & Johnson re the dispute over vertical monopoly agreement.  On February 3, 2012 the Intermediate Court held a public hearing.

On May 18, 2012, the Intermediate Court held that a business operator shall assume civil liability under Article 50 of the AML, if (1) it implemented the monopolistic conduct, (2) others suffered losses therefrom; and (3) the monopolistic conduct and the losses have a causal relationship. Since there is insufficient evidence to approve any of the above factors, the Intermediate Court dismissed all Rainbow's claims.

In the appeal, the Shanghai Higher People's Court conducted detailed analysis on six major disputes, and finally overturned the Intermediate Court's civil judgment and ordered Johnson & Johnson to indemnify Rainbow economic losses of RMB 530,000. The six major disputes are as follows:

The Distribution Agreement was entered before and terminated after the implementation of the AML. Is the AML applicable to this case?

Rainbow itself is a party of the Distribution Agreement and is a signing and implementing party of the RPM. Does Rainbow have a standing to sue?

Whether "the effect of eliminating or restricting competition" is a necessary factor in determining a monopoly agreement of the RPM under Article 14 of the AML?

If so, in a vertical monopoly agreement dispute, who bears the burden of proof to show the agreement has an effect of eliminating or restricting competition?

Whether the RPM agreement in the case constitutes a monopoly agreement?

Whether the claims for damages of Rainbow should be granted?


II.The Distribution Agreement was Entered before and Terminated after the Implementation of the AML. Is the AML Applicable to this Case?

Johnson & Johnson alleged that the Distribution Agreement was entered into and the action taken by Johnson & Johnson against Rainbow re breach of contract before the implementation of the AML, and there is no action taken by Johnson & Johnson afterwards. Therefore, Johnson & Johnson believes the AML should not be applicable to this case.

The Shanghai Higher People's Court held that the AML was implemented on August 1, 2008.  Even though the Distributional Agreement was entered on January 2, 2008, but it was effective until December 31, 2008.  After the implementation of the AML, Johnson & Johnson did not terminate the Distribution Agreement, but continued to perform the agreement with the distributor, and carried out the accused monopolistic conduct. Therefore, the AML should be applicable to this case.

The significant of this case is that it interprets "entering into" monopoly agreements under the AML.  Article 3 of the AML provides, "monopolistic conduct in this Law shall include: (1) monopoly agreements entered into between business operators." Article 13 of the AML provides, "competing business operators are prohibited from entering into the following agreements: …" Article 14 of the AML provides, "business operators are prohibited from entering into the following monopoly agreements with their trading counterparts: …" and Article 46 of the AML provides, "Where a monopoly agreement has been entered into but has not been implemented, a fine of not more than RMB500,000 may be imposed." According to the literal interpretation, the AML emphasizes the process of entering into a monopoly agreement, such as competitors repeatedly meeting to discuss price increases. Whether the price actually increases, would then seems only related to the amount of fines or damages.

We believe that the effect of eliminating and restricting competition can only be reflected during the implementation of the monopoly agreement, therefore, the "entering into the following monopoly agreements" should not be interpreted as only punishing the activity of "entering into" a monopoly agreement. The Shanghai Higher People's Court's decision confirms the above understanding. This suggests that the provisions restricting competition in a contract (such as a JV agreement) entered into before the implementation of the AML may still need to be further scrutinized.  

III. Rainbow itself is a party of the Distribution Agreement and is a signing and implementing party of the RPM. Does Rainbow have a standing to sue?

Johnson & Johnson alleged that the Distribution Agreement was concluded and jointly implemented by Rainbow and Johnson & Johnson. According to Article 1 of the AML, the aims of the AML are to protect fair market competition, consumers' and public interests.  It does not protect the interests of the participants and implementers of the monopolistic conduct. Thus, competitors and consumers who suffered from the monopolistic conduct have the standing to sue, but it does not include the participants and implementers of the monopolistic conduct. Therefore, Rainbow has no standing to sue.

The Shanghai Higher People's Court held that the parties to the monopoly agreement could be both the participants and implementers of the monopolistic conduct and the victims of the monopoly agreement. They would thus fall into the scope of the person who suffered losses under Article 50 of the AML. If they were not allowed file civil lawsuits against the monopoly agreement, the parties could not get remedies for their civil rights. In addition, only parties to the agreement know about the content of the agreement, consumers usually do not. If parties of the monopoly agreement who know the information and have the evidence to file antimonopoly lawsuit do not have standing, the unlawful act of monopoly agreements will be hard to be investigated and punished.

We would like to emphasis that the victims of the vertical agreement may not always be the distributors.  In a "channel is the king" market, the distributor who controls the distribution channel may have more negotiating power than suppliers. In this case, the suppliers may be the victims of the vertical agreement. Thus, using words such as "participants", "implementers" and "victims" in the judgment is proper, and will leave the space for other kinds of anti-monopoly lawsuits in the future.

IV. Whether "the Effect of Eliminating or Restricting Competition" is a Necessary Factor in Determining a Monopoly Agreement of the RPM under Article 14 of the AML?

Johnson & Johnson alleged that only when the RPM has the effect of eliminating or restricting competition can it constitute a monopoly agreement. Instead, Rainbow alleged that the RPM will inevitably affect intra-brand competition and the RPM in a vertical agreement itself constitutes a monopoly agreement.

In the first trial, the Intermediate Court held that Article 14 of AML prohibits business operators "from entering into any of the following monopoly agreements with their trading parties: ..." According to Article 13 (2) of the AML, "monopoly agreements referred to in this Law shall mean the agreements or decisions to eliminate or restrict competition or other collaborative acts". Therefore, a monopoly agreement under Article 14 of AML cannot only be determined by whether a RPM agreement has been entered into, but it is also necessary to consider Article 13 (2) of the AML, to see whether such agreement has the effect of eliminating or restricting competition.  

In the appeal, the Shanghai Higher People's Court stated, after going through the whole context of AML, that there are four sentence patterns of the type "… referred to in this Law shall mean …" in the AML. They are: Article 12, "business operators referred to in this Law shall mean…"; Article 12, "the relevant market referred to in this Law shall mean …"; Article 12, "monopoly agreements referred to in this Law shall mean …"; and Article 17, "dominant market position referred to in this Law shall mean …". Obviously, these sentence patterns expressly define relevant terms "in this Law". Logically, these terms shall be applied to the whole context of the law, rather than just one article. Thus, the definition of the monopoly agreements under Article 13 is also applicable to the vertical agreement stipulated by Article 14.

Moreover, the Shanghai Higher People's Court stated, Article 7 of the Provisions of the Supreme People's Court on Several Issues Relating to Laws Applicable for Trial of Civil Dispute Cases Arising from Monopolies (the "AML Judicial Interpretation") provides: "where the monopolistic conduct sued falls under any types of monopoly agreements prescribed in Items (1) through to (5) of Paragraph 1 of Article 13 of the AML, the defendant concerned shall bear the burden of proof to show that the relevant agreement has no effect of eliminating or restraining competition". These items cover horizontal agreements. Accordingly, horizontal agreements stipulated under Article 13 of AML shall be presumed to have the effect of eliminating or restricting competition and thus constituting a monopoly agreement. This is probably because it is commonly believed that the effect of restricting competition of a horizontal agreement is much stronger than a vertical agreement.

The Shanghai Higher People's Court's analysis clarifies that the vertical RPM agreement itself does not necessarily violate the AML – it is not a per se prohibition. The Court will take into consideration of effect of the agreement, and whether it eliminates or restricts competition. Therefore, if a distributor claims damages based on a signed and sealed RPM distribution agreement, it may not be endorsed by the Court, unless the plaintiff can prove that the vertical agreement has a stronger effect of eliminating or restricting competition than the any pro-competitive effect. This needs to be demonstrated by economic experts.

The relevant comments by the Shanghai Higher People's Court highlighted four commonly used terms in the AML: "business operators", "the relevant market", "monopoly agreements" and "dominant market position". These terms apply to the whole context of the AML, and they are very likely to be the center of disputes in anti-monopoly lawsuits and anti-monopoly law enforcement in the future.

V. In a vertical monopoly agreement dispute, who bears the burden of proof to show the agreement has an effect of eliminating or restricting competition?

Article 7 of the AML Judicial Interpretation provides, "where the monopolistic conduct sued falls under any types of monopoly agreements prescribed in Items (1) through to (5) of Paragraph 1 of Article 13 of the AML, the defendant concerned shall bear the burden of proof to show that the relevant agreement has no effect of eliminating or restraining competition" But the AML Judicial Interpretation does not clarify the distribution of burden of proof in terms of circumstances stipulated by Items (1) and (2) of Article 14 of the AML, which cover vertical agreements.

The Shanghai Higher People's Court held that the principle of conversion of burden of proof can only be applied in a civil litigation when there is a clear stipulation by laws, regulations and judicial interpretations. Because the current laws do not stipulate that the defendant shall bear the burden of proof to show that the relevant agreement under Article 14 of the AML, the court should obey the principle that "who makes claims shall bear the burden to prove its claims". Thus the appellant must prove that the RPM agreement has the effect of eliminating and restricting competition.  The principle of burden of proof that is applicable to horizontal agreements under Article 7 of the AML Judicial Interpretation does not apply to vertical agreements. Therefore, the appellant should first prove the existence of a RPM agreement, then provide evidence that the RPM agreement has the effect of eliminating or restricting competition. This final evidence may include arguments that the relevant market competition is not sufficient, the appellee has a very strong market position, the appellee aims to restrict competition, and the RPM agreement has a negative influence on market competition, etc. The appellee may of course present rebuttal evidence.

The reason why the AML Judicial Interpretation distinguish the burden of proof with respect to "having an effect of eliminating or restricting competition" between the horizontal agreement and vertical agreement is that according to rule of thumb, monopoly agreements prescribed in Items (1) through to (5) of Paragraph 1 of Article 13 of the AML are very likely to have a strong anti-competitive effect. There is no need for the plaintiff to prove it. However, in terms of vertical agreements, such as the RPM, they have the possibility of promoting competition, so they should be analyzed on a case-by-case basis.

 

VI. The Competition Analysis of a Vertical Monopoly Agreement

The economic analysis accounts for a large proportion in the judgment of the Shanghai Higher People's Court. It is a good reference to enterprises involved in vertical monopoly agreement lawsuits or investigations.

The High Court of Shanghai held that when analyzing the nature of the RPM, there are four prongs that should be considered, and that constitute the basic method for the Shanghai Higher People's Court to analyze and evaluate the RPM. They are:

  • whether the relevant market competition is sufficient;

  • whether the defendant has very strong market position; 

  • the motive of the defendant to impose the RPM, and

  • the competition effect of the RPM.

 

1. Whether the Relevant Market Competition is Sufficient

The Shanghai Higher People's Court held that insufficient competition shall be the first prong to determine if an RPM constitutes a monopoly agreement. Only when market competition is insufficient does the court need to analyze the effect that the accused monopoly agreement has in the next step.

In a market with sufficient competition, consumers have enough choice to buy products from competing firms; while in a market without sufficient competition, because of lack of substitutable products, not only do intra-brand products lose price competition, inter-brand products could also come to a tacit understanding on pricing.

The Shanghai Higher People's Court held that to evaluate whether the relevant market competition is sufficient, the court not only needs to consider market concentration, but also needs to consider the substitutability of products-in-suit, the difficulty that potential competitors have for entering into the relevant market, the competitive situation of the downstream market, and other factors affecting the competitive situation of the relevant market.

In this case, the Shanghai Higher People's Court held: (1) the medical suture is a disposable medical supply in surgery, the patients assume the expense, so hospitals are not very sensitive to the price of the suture and as buyers their price competition motivation is weak. (2) there is high brand loyalty to the suture. (3) Because China imposes strict restrictions on market access in the medical device market, and brand loyalty has been formed, there are relatively high obstacles to entering into the market. In sum, the Shanghai Higher People's Court held that competition in the medical suture market is insufficient.

The analysis of sufficiency of the competition is in line with the Maotai, Wuliangye RPM investigation case. In that case, although there are many kinds of liquors in the market, not every liquor brand can participate in the market competition of high-end liquor. Because of the consumer's preference to certain brands, it is hard for other liquor products to get access to the high-end liquor market, and leads to insufficient competition in the high-end liquor market.

 

2. Whether the Defendant has a Strong Market Position

The Shanghai Higher People's Court held that enterprises implementing the RPM must have a strong market position and to be able to affect market competition. The market position of an enterprise can be evaluated by the interaction between an enterprise's pricing conduct and market competition. An enterprise without a strong market position usually must adapt to the market, rather than affecting the competition, let alone leading the market.

As to what level of competition is required for a "strong market position", the Shanghai Higher People's Court held that the market position of enterprises is reflected by their abilities to control price. If a company has a strong ability to control price and an absolute advantage in pricing negotiations with purchasers, then the company should be deemed as having a strong market position to effect market competition.

The Shanghai Higher People's Court stated, (1) the actual market share in the relevant market should be above the 20.4% estimated by Johnson & Johnson; (2) the price of suture products of Johnson & Johnson remained the same for 15 years, and Johnson & Johnson has very strong control on pricing in the relevant market; (3) Johnson & Johnson has brand influence and strong control over its distributors. In sum, the Shanghai High People's Court held that Johnson & Johnson has a strong market position in the relevant market.

We should emphasis the term "strong market position" used by the Shanghai Higher People's Court. In the appeal, the attorneys for the plaintiff have questioned whether the requirement of proving dominant market position will confuse the requirement of Article 14 with Article 17, which stipulates the abuse of dominant market position.  The Judgment of Shanghai Higher People's Court gave a clear answer: to constitute a vertical monopoly agreement, it is not required to prove a business operator holds market dominance, but just to prove such operator has a "strong market position". For example, the data provided by Johnson & Johnson showed that its market share was around 20% (it didn't reach 50% which is the threshold to be presumed having dominant market position), but Johnson & Johnson was deemed to have strong market position. We consider 20% market share could be a reference for future cases.

 

3. the Motive of the Defendant to Impose the RPM

The Shanghai Higher People's Court held that if a company having a strong market position imposes the RPM with the motive of restraining market competition, because of the advantage of its financial strength, technological conditions and information, as well as strong control power over the upstream and downstream market, the likelihood for the RPM to generate the effect of restricting competition will be greatly increased. Therefore, the motive of imposing the RPM should be a vital factor judging whether the conduct will restrain competition.

The Shanghai Higher People's Court held that the following evidence clearly reflected that the competitive strategy of Johnson & Johnson was to avoid price competition in the suture product market:

(1) the relevant provisions under the Distribution Agreement and its annexes

  • According to Clause 2 of Annex 5 of the Distribution Agreement, distributors were obligated to help Johnson & Johnson to maintain the market price system, and any forms of malicious bidding were prohibited.

  • According to Annex 7a "practical appraisal system of excellent distributors" provides that being, "unable to cope with price-down pressure and thus causing price decreases, or, due to other errors in work, causing damage to the price system" belong to the situation where the distributors should be penalized because of failing to "effectively control the price system".

(2) the evidence re the management of distribution activities of Johnson & Johnson

  • In "Action plan of 2004", regarding the sale of "purse suture" to the hospital, Johnson & Johnson proposed that the distributors should establish a good relationship with most doctors, in order to eliminate the negative factors of Ethicon's price. The Shanghai Higher People's Court expressed the view that Johnson & Johnson, with the uncompetitive price of its suture products, would rather maintain price through maintaining customer relationship

In practice, many enterprises maintain resale price out of many different considerations, and there may be corresponding evidence to justify such arrangements. In this case however, the court found that Johnson & Johnson' motive is to maintain a normal price system and avoid price competition, which is also the original motive of many other enterprises to establish an anticompetitive RPM.

4. the Effect of the RPM on Competition

The Shanghai Higher People's Court held that RPM may promote competition as well as restricting competition. On the one hand, markets have self-healing capabilities; and some effects of restricting competition may soon be corrected by the market. On the other hand, some effects of restricting competition will be offset by other effects of promoting competition. Thus, only if the effect of restricting competition can't be overcame and offset should the RPM agreement be deemed as a monopoly agreement.

The Shanghai Higher People's Court first analyzed the effect of eliminating or restricting competition of the Distribution Agreement. It held that the Distribution Agreement eliminated intra-brand competition, and restrained the freedom of pricing of distributors. However, the court found that the present evidence stopped short of proving that the RPM of Johnson & Johnson suture products contributed to a cartel among producers of suture products.

We believe that in the aspect of the vertical agreement having the effect of eliminating and restraining competition, the evidence of this case is weak compared to the NDRC case of Maotai, Wuliangye. In Maotai and Wuliangye, because the two firms hold a very large market share in the high-end liquor market they form an oligopoly. When Maotai announced a price increase, Wuliangye tended to follow. Under this market situation, the pricing act of Maotai may indirectly affect other competitors' pricing, causing a clear effect of excluding and restraining inter-brand competition on price. However, such a market situation is not apparent in the present case. This may be the weakest point of the Court's argument.

In terms of promoting competition, the Shanghai Higher People's Court stated that the RPM can have various effects of promoting competition, such as: preventing "free riding" of other distributors, promoting new brands or new products into the market, promoting quality competition of the product, safeguarding the goodwill of products, providing accurate price information to customers, promoting the development of distributors and the establishment of distribution system, resisting discount sales of competitors, etc. However, they found that the effects of "safeguarding the goodwill of products, and enabling consumers to obtain accurate price information", are not necessary to if the purchaser is very familiar with the products. The effect of promoting the establishment of distribution network may not necessarily benefit consumers. Therefore, the effects of promoting quality of products and service, and promoting new brands or new products into the market are the most critical.

In the aspects of promoting product quality and service, Johnson & Johnson didn't give evidence to prove that the quality of suture products is promoted due to the RPM. Johnson & Johnson have been in the Chinese market for 15 years, and it cannot impose the RPM under the name of promoting new brands or new products into the market. The Shanghai Higher People's Court held that the present evidence is insufficient to prove that the RPM has an obvious effect of promoting competition.

The analysis of the Shanghai Higher People's Court clearly listed the effects of promoting competition that could be brought by the RPM. While not published, the NDRC has conducted detailed analysis regarding the above mentioned effects of eliminating or restraining competition and the effects of promoting competition by the vertical monopoly agreement. From the Shanghai Higher People's Court's perspective, it is permissible to impose RPM when a new product or new enterprise enters into the market, which can ensure distributors promote sales service. This opinion relatively new and is helpful in directing the future conduct of enterprises. Besides, when an operator profits from the RPM, using the profit to improve the products' quality and service can be a defense - but corresponding evidence should be given.

  1. Whether the claims for damages of Rainbow should be granted?

The Shanghai Higher People's Court held that Rainbow has ground under the AML to claim compensation of profit damage for their suture products. According to the facts of this case, the profit damage for suture products claimed by Rainbow has a direct causal relationship with the implementation of the RPM. The RPM agreement constitute a monopoly agreement in this case, thus Rainbow can claim compensation according to the AML.

The profit damage of suture products in 2008 claimed by Rainbow was based on the available profit under the condition that the 2008 Distribution Contract was normally performed.

The Shanghai Higher People's Court held that the damage compensation can't be calculated based on the rules of Contract Law, since that calculation method is in conflict with jurisprudence of the AML. If the RPM agreement constitutes a monopoly agreement, that means the agreement eliminates or restricts competition and caused loss to consumers. Therefore, when claiming compensation, the loss shouldn't be calculated according to the available profit of performing the RPM agreement, but should be calculated by referring to the normal profit of the relevant market. Otherwise it will fall into the logical conflicts of pursuing monopoly profits through an anti-monopoly lawsuit.

According to the specific circumstances of this case, the Shanghai Higher People's Court stated: (1) the price of suture products of Johnson & Johnson is generally higher than others brands' products. Especially the price of the suture product-in-suit is 15% higher than other brands' price. The sale price and profit of Rainbow should be adjusted according to the price and profit of other bands' products. (2) Rainbow should pay tax according to law. After full consideration of the foregoing factors, the Shanghai Higher People's Court determined Rainbow can gain the normal profit which is roughly equivalent to 16% of the sale value before the tax. Accordingly, the courts discretionary decision is that the sale loss of normal profit of suture products in 2008 caused by Johnson & Johnson's monopoly conduct is RMB 530,000. Other compensation claimed by Rainbow is not sustainable.

 

Conclusion

This case is China's first vertical monopoly agreement civil dispute. As most contracts have provisions of the RPM, this case not only affects the dispute between Rainbow and Johnson & Johnson. The result of this case has instructive meaning to the lawsuits of vertical monopoly agreement disputes and the agreements entered into by their operators. To some extent, it may also influence the anti-monopoly law enforcement of the NDRC on the RPM.

The announcement of the judgment comes just at the 5th anniversary celebration of the implementation of the AML. This case, as well as a series of anti-monopoly enforcement cases carried out by the NDRC and the State Administration for Industry and Commerce ("SAIC") show that the AML has entered a new mature stage.

 

Relevant Lawyer

  • Liang DING

    Partner

    Tel:+86 10 5268 2977

    E-mail:dingliang@dehenglaw.com

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