Dawn raids have proved the anti-cartel authorities in China mean business when cracking down on international firms

Some of the world’s biggest brands are preparing their staff for dawn raids by China’s anti-monopoly agencies in the wake of hostile legal decisions against long-standing distribution agreements. The latest victim is US pharmaceutical company Johnson & Johnson, whose contract with a distributor had remained unchallenged for 15 years [see box].

Companies found in breach of relatively recent official policies on retail price maintenance deals have been given hefty fines of up to 6% of annual revenues in China, with serious offences attracting fines of as much as 10% of revenues in China. 

In a widespread campaign, the authorities have so far taken action against the pricing of everything from infant milk powder to scallops to jewellery, and, in Johnson & Johnson’s case, bandages and sutures. Simultaneously, the authorities are also investigating pricing by 60 pharmaceutical companies, including some foreign firms. With potentially enormous implications, they are also reportedly collecting data on the pricing of all foreign cars. 

Resale price maintenance (RPM) arrangements are a particular concern, setting out important lessons for international companies. As law firm Jones Day warned late last year: “The lesson is that companies should steer clear of RPM requirements when dealing with distributors in China.” 

Moreover, the authorities aren’t just picking on international brands. Their actions form part of a general campaign against allegedly anti-competitive arrangements.

Tough penalties

Two big Chinese liquor manufacturers were given penalties of $71m (€52.2m) over their minimum resale price arrangements with distributors. Although the fines were equivalent to 1% of annual revenues in China – the lowest that could be charged – they were the largest anti-trust penalties imposed in China.

But this particular authority – the National Development and Reform Commission (NDRC), one of four anti-trust agencies – was just warming up. In August, the NDRC imposed penalties of $107m (€79m) against a group of producers of infant formula. It took issue with arrangements with suppliers that allowed the manufacturers to maintain high prices that, the agency claimed, reduced competition to the detriment of consumers. 

The conclusion from all this activity is obvious. “In light of the recent series of investigations and new record fines for RPM practices,” warns law firm Mayer Brown, “clients should be mindful of the focus of multinationals and be on the alert for any pricing practices that could raise anti-monopoly issues”.

Rewards of co-operation

But how should an investigation be handled? As lawyers point out, co-operation with the authorities is vital, even though companies may feel aggrieved at the abrupt change in attitude towards what may have been long-standing commercial practice. 

The benefits of co-operation became clear in the infant formula case, when three of the nine manufacturers in the sights of the NDRC volunteered the details of their RPM contracts, provided important evidence and hurriedly rewrote the contracts. The three were handsomely rewarded for their good behaviour by escaping any monetary penalty, while the other six suppliers under investigation were fined between 3% and 6% of their most recent annual revenues in China. 

The looming threat of hefty penalties has prompted companies to rescind their contracts with distributors and start again. “While formally subject to analysis by rule of reason, RPM obligations are unlikely to be found compatible with anti-monopoly laws,” points out Peter Wang of Jones Day.

In the meantime, companies should be prepared when the enforcement authorities come knocking. The best rule of thumb appears to be: keep calm and comply. 

Mayer Brown states: “In light of the increasing enforcement activities of the [authorities] in relation to anti-monopoly conduct rules – such as those dealing with cartels, vertical agreements and abuse of dominant market position – business must be ready and prepared to deal with an investigation in a way that best protects the interests of the company.” That means making planning and training a priority for any business with substantial operations in China. 

Boardrooms must also be aware that a raid may come at any time unannounced – officials have the power to conduct onsite investigations without notice. 

Mayer Brown’s Hannah Ha believes a well-prepared company can avoid the worst. “How an investigation is handled can make all the difference to a business’s prospects of being found to have infringed anti-monopoly laws and whether leniency is granted,” she says. She recommends frontline staff – receptionists, legal advisers and designated response teams such as risk managers – should be given advanced training.

Designated staff should be trained to react immediately. At least three people are required: one to create a written record of everything, including staff who have been interrogated and documents that have been inspected; one to assist the officials; and another – ideally a lawyer – to take charge of any additional liaison with the officials. 

Although the protocol for a raid is important, the main principle should be one of co-operation. “Do not appear unhelpful or obstructive,” emphasises Ha. Most important of all, do not impede an investigation, either by failing to provide information or by destroying evidence. 

Further, the moment the door has closed behind the officials, companies need to activate a follow-up strategy, including calling in expert advice where necessary. 

Veterans of such raids say a comprehensive risk-assessment procedure should follow any onsite investigation. If the review reveals that conduct falls short of the prevailing standards, prompt remedial action will minimise the penalties and the impact on reputation. Every step of the repair work should be done in close consultation with legal advisers and duly recorded. 

When the officials come back, as they probably will, they will expect to see full details of the remedial process. 

Johnson & Johnson taken by surprise

It was the decision against Johnson & Johnson that, more than any other, rammed home the turnaround in China’s approach to anti-trust issues and spurred international firms into action. 

The case started over a dispute with the pharmaceutical company’s long-time distributor, which took upon itself to sell suture products below the minimum resale price defined in the agreement. The distributor wanted to expand into another market, but an aggrieved Johnson & Johnson rescinded the deal. 

In response, the distributor took the American giant to court on the grounds that the resale price maintenance (RPM) policy to which it had long complied violated anti-monopoly laws. 

Johnson & Johnson won the first round but lost on appeal, when the Shanghai Higher Court concluded that the RPM clause was in fact illegal. 

Although Johnson & Johnson argued that the arrangement was pro-competitive because, among other things, it helped ensure reasonable profits to the distributor, the court disagreed on this
and with almost every other argument the company advanced. 

The upshot is that many global brands are rewriting historic pricing arrangements and that RPM deals may be off the agenda completely. As Peter Wang of Jones Day warns: “The safest approach is for companies to avoid RPM requirements when dealing with distributors in China.”