September 17, 2013

Johnson & Johnson Held Liable for Violation of PRC Anti-Monopoly Law

On August 1, 2013, the fifth anniversary of the People's Republic of China Anti-Monopoly Law (AML), the Shanghai High People's Court rendered final judgment on an antitrust dispute between two Johnson & Johnson subsidiaries in China and their former distributor in Beijing. The judgment, which overturned a lower court ruling, held that the two subsidiaries were liable for damages resulting from attempts to enforce a vertical monopoly agreement against the distributor. As the first antitrust judgment relating to vertical monopoly agreements in China, the case signals the stance of the Chinese courts towards vertical trade restraints and provides guidance for future cases.

Case Recap

Johnson & Johnson subsidiaries Johnson & Johnson Medical (Shanghai) Ltd. and Johnson & Johnson Medical (China) Ltd. (together referred to hereafter as J&J) signed annual distribution agreements with Beijing Ruibang Yonghe Technology and Trading Ltd. (Ruibang) for distribution of J&J's medical suture products in Beijing over a period of 15 years. In the agreements, J&J stipulated a minimum resale price.

In March 2008, Ruibang sold J&J's suture products to a local hospital below the minimum resale price. J&J terminated the agreement then in effect with Ruibang, confiscated its deposit and ceased supplying it with the suture products. In response, Ruibang filed a lawsuit at the Shanghai First Intermediate People's Court against J&J in 2010, alleging that the minimum resale price requirement was in violation of the AML and claiming RMB14,399,300 (approximately US$2.3 million) in damages. That court held that Ruibang failed to meet its burden of proof. Ruibang then appealed to the Shanghai High People's Court, which held that the minimum resale price requirement was a violation of the AML and ordered J&J to compensate Ruibang for RMB530,000 (approximately US$86,000).

Vertical Monopoly Agreements

In China, vertical monopoly agreements are anti-competitive agreements between upstream and downstream business operators, generally for the purpose of fixing retail prices or setting a floor for them. They are distinguished from horizontal monopoly agreements, which are anti-competitive agreements between business operators who compete with each other in a market.

The AML generally prohibits vertical and horizontal monopoly agreements. However, it cannot be easily concluded that this is a "per se" prohibition, since there are seven broad exemptions (for foreign companies, the broadest being "to safeguard legitimate interests in foreign trade and foreign economic cooperation") from monopoly agreement prohibitions which may be invoked if a vertical or horizontal monopoly agreement "does not seriously restrict competition in the relevant market and enables consumers to share in the benefits generated thereby." Considering the availability of these broad exemptions and the likelihood that most business operators will be able to create an argument that consumers are benefited by what they do, it would seem reasonable to conclude that some vertical and horizontal monopoly agreements will not be determined to be illegal if they do not seriously restrict competition in the relevant market.

Court's Reasoning

This was in fact the line of reasoning used by the Shanghai High People's Court in its consideration of the J&J case. It employed four lines of inquiry: the adequacy of competition in the "relevant market," the position of J&J in that market, the purpose of J&J's minimum resale price requirement and the anti-competitive effect of this requirement.

Using a substitutability approach, the court defined the "relevant market" as the medical suture products market in mainland China. It determined that new business operators cannot easily enter this market due to high entry barriers and that there therefore is insufficient competition in this market.

The court went on to find that J&J was a leading business operator in this market, with transactions representing more than one-fifth of total market sales. Noting that J&J managed to retain the same minimum resale price for 15 years, the court concluded that this was indicative of J&J's power to set prices in this market.

The court then determined that, with its strong market position, J&J was able to use the minimum resale price to preclude price competition in the relevant market and maintain high sales prices.

The court also found that the minimum resale price violated the distributor's right to set its own prices, resulting in an "anti-competitive" effect that violated the AML.

With regard to the damages sought by Ruibang, the court agreed to award it for lost profits due to the early termination of distribution agreement, but held that the amount of the lost profits should be based on the normal profit margin level in the relevant market (16 percent), rather than Ruibang's profit margin under the distribution agreement (23 percent). It calculated the lost profits at RMB530,000. Other damages claimed by Ruibang were denied by the court.

The chief judge of the case, Ding Wenlian, mentioned in an interview after the verdict was rendered that the judgment reflects the legislative purpose of the AML, which, as provided in its Article 1, is to "prevent and restrain monopolistic practice, safeguard the fair market competition, and to protect the benefits of consumers and the common interests of society."

Our Comments

This judgment of the Shanghai High People's Court is significant in several respects.

First, this is the first time that a high-level court in China ruled in favor of and awarded damages to a distributor plaintiff in a vertical monopoly agreement case. With this outcome, it may be expected that other distributor plaintiffs will take similar cases to court in the future, instead of taking them to the administrative authority in charge of execution of price-related provisions of the AML, the National Development and Reform Commission (NDRC), since the latter can only punish offenders with fines payable to the government and not award damages payable to plaintiffs.

Second, it appears that there may be some differences in the interpretation of the antimonopoly agreement provisions of the AML by the Shanghai High People's Court and the NDRC. As noted above, the Shanghai High People's Court tried to determine whether the J&J agreement had a serious restrictive effect on competition in the medical suture products market in mainland China. On the other hand, it appears that the NDRC and its local counterparts, in recent antimonopoly agreement cases against LED Panel manufacturers, white liquor distillers and infant formula products companies, did not give much consideration to whether these agreements seriously restricted competition. Since these cases are not well reported, it is not entirely clear whether the monopoly agreements at stake were horizontal or vertical in nature. However, looked at broadly, these cases leave the impression that the NDRC may be less inclined than the Shanghai High People's Court to consider the effects on the relevant market when examining monopoly agreements.

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