Shanghai High Court Held Johnson & Johnson Liable for Illegal Vertical Retail Price Fixing Agreement under the Anti-Monopoly Law

 

On August 1, 2013, the Shanghai High Court released its decision on the anti-monopoly case between Johnson & Johnson and its distributor in China Rainbow Medical Equipment & Supplies Co. (“Rainbow Medical”).  The decision vacated the first instance judgment and held the retail price maintenance (“RPM”) provision in a distribution agreement between the parties violated the Anti-Monopoly Law (“AML”).  It ordered Johnson & Johnson to pay RMB 530,000 in damages as well as be responsible for most of the court fees.  In this well written decision, the Shanghai High Court addressed several important legal issues left un-resolved by the first instance judgment of the Shanghai First Intermediate Court and provided important guidance on the legality of RPM provision between business operators at different levels of the supply chain under the AML.  The dispute at issue involves a RPM provision in the distribution agreement which sets forth the minimum retail price for certain Johnson & Johnson products in China.  After Rainbow Medical distributed these products to a third party below the set minimum price, Johnson & Johnson terminated the distribution agreement.  In response, Rainbow Medical filed a civil lawsuit against Johnson & Johnson, claiming that the RPM provision violates Article 14 of the AML, which prohibits price fixing in vertical agreements, and sought RMB 14 million in damages.  In a decision released in May 2012, the Shanghai First Intermediate People’s Court ruled in favor of Johnson & Johnson, and Rainbow Medical appealed.  The decision from the Shanghai High Court is final and non-appealable.

 

In overruling the lower court’s decision and holding Johnson & Johnson liable for AML violation, the Shanghai High Court laid out its analysis in six parts:

 

First, with regard to the application of AML, even though Rainbow Medical’s bidding (and selling products to hospitals) below the set minimum price and Johnson & Johnson’s subsequent confiscation of Rainbow Medical’s deposit took place before August 1, 2008 when the AML came into effect, the High Court held that the AML is applicable to this dispute because the agreement and alleged AML violations at issue extend beyond August 1, 2008.

 

Second, with regard to standing, the Shanghai High Court held that a party to the vertical agreement is able to sue under Article 14 of the AML as a party to a monopoly agreement may suffer damages from the monopoly acts.  In addition, allowing a contracting party to sue also helps pursue the illegal acts as the contracting party likely has better knowledge about the scope of the monopoly agreement than any non-contracting parties.

 

Third, the Shanghai High Court clarified that, even though the term “monopoly agreement” is only defined in Article 13 of the AML covering horizontal agreements, the same definition is applicable to all relevant provisions of the AML, including Article 14 that deals with vertical agreements.  Thus, for both horizontal and vertical agreements, only those with the effect of eliminating or restricting market competition may be found in violation of the AML.

 

Fourth, because Article 7 of The Provisions of the Supreme People’s Court Regarding Law Application in Adjudicating Anti-Monopoly Law Civil Disputes only provides burden shifting in AML cases involving horizontal agreements (i.e. defendant carries the burden to prove the agreement at issue does not have the effect of eliminating or restricting market competition), a similar rule does not apply in vertical agreement cases and the plaintiff bears the burden to prove that the agreement at issue has the effect of eliminating or restricting market competition.  Since Chinese law has never explicitly created a category of agreements that violate the AML per se, the Shanghai High Court here applied the rule strictly in accordance with the text of the statute and judicial interpretation.

 

Fifth, with regard to whether the vertical agreement at issue is a monopoly agreement, the Shanghai High Court adopted a four-pronged analysis: first, whether there is sufficient competition in the relevant market; second, whether the defendant has a strong position in the relevant market (but may not reach the level of market dominance); third, whether the purpose of the RPM provision is to avoid price competition in the relevant market; fourth, whether the anti-competitive effect of the RPM provision far outweighs its competitive effect. 

 

The Shanghai High Court goes into great length for this part of the analysis.  It defines the relevant market as the market for medical sutures in the territory of mainland China using the substitutability analysis from both the supply and demand sides. The Shanghai High Court did not adopt the Hypothetical Monopolist Test (also known as Small but Significant and Non-transitory Increase in Price Test, or SSNIP test) for this case, reasoning that the SSNIP test is not required for cases where the scope of the relevant market can be determined by the substitutability analysis.   Based on the relevant market, the Shanghai High Court further found that there is little price competition and a high barrier of entry, leading Johnson & Johnson to influence the market competition with its strong market position and bargaining power in product pricing.  In particular, Johnson & Johnson was able to keep the price for its medical sutures fairly constant for 15 straight years, a strong indication of Johnson & Johnson’s power to set market price. In addition, the Shanghai High Court found that the RPM provision was put in place with the purpose to preclude price competition with very little pro-competitive effect.  It had resulted in the elimination of the intra-brand price competition, decrease of inter-brand price competition, and squeeze-out of efficient distributors.

 

Sixth, the Shanghai High Court held that the contract principle should not be used for calculating damages in an AML case. Instead, the amount of damages should be based on the loss to consumers resulting from the agreement’s negative effect on market competition.  In particular, in a vertical price fixing case, the court should use the normal profit of a participant in the relevant market for calculation of damages, rather than the profit of the plaintiff in this case, because the plaintiff may already enjoy a higher margin arising from the price fixing agreement.

 

This case has received wide attention from legal professionals in the relevant field as well as the general public.  Other than being the first appellate decision on the issue of vertical price fixing, this is also the first appellate decision in an AML case in which the defendant was found liable for AML violations.  This decision indicates that Chinese courts will hold vertical monopoly practices under scrutiny and lays an important framework for future vertical agreement analysis.