Going to Market in Asia and Around the World: Differing Competition Rules for Distribution

The Association of Southeast Asian Nations (ASEAN) nations (Vietnam, Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore and Thailand) agreed to adopt competition laws by 2015. Half of them have; half have yet to do so. The laws in place, and those that can be anticipated, vary in some important respects from the rules applicable in the U.S., Europe and Latin America1, and can significantly affect the way companies distributing goods to these nations structure their relationships.

The panel will examine key vertical competition rules in each region to highlight the differences, and the varying options available to marketers of goods, including:

1. Resale price maintenance (supplier control of reseller’s pricing)

a. U.S.: Federal law judges resale price maintenance under the rule of reason, and usually permits it ever since the U.S. Supreme Court’s 2007 decision in Leegin Creative Leather Products, Inc. v. PSKS, Inc., 551 U.S. 877, 127 S. Ct. 2705 (2007). But there are circumstances discussed by the Supreme Court where such restrictions could be found unlawful even under Leegin. Moreover, individual States within the U.S. have their own state antitrust laws, and not all follow the new federal rule. Notably, New York, California and Maryland are among the states that continue to apply the per se rule against resale price maintenance. (Thus, a supplier’s establishment of a fixed resale price or a minimum resale price remains a potential problem. Maximum resale price maintenance is generally permitted under the rule of reason under State Oil Co. v. Kahn, 522 U.S. 3, 118 S. Ct. 275 (1997).

b. China: Chinese Anti-Monopoly Law (AML) prohibits vertical agreements that fix resale prices or set minimum resale prices. It is, however, not clear whether the AML views resale price maintenance (RPM) as hardcore or per se violation, as the AML provides a set of exemptions for RPM (Art 15 AML), such as technological improvement, research and development, efficiency enhancement and public interest. Given these exemptions, it is likely that China will view RPM in a manner similar to that of the US by applying a US style benefits and harm test (Rule of Reason). In Rainbow v. Johnson & Johnson Medical, the First Intermediate Court dismissed allegations of RPM, requesting from the distributor to be provided with proof that RPM allegations had an effect on competition, which the distributor was unable to provide. It seems from this decision that Courts do not consider RPM illegal per se. Same in Maotai and

1 In the case of Latin America it is important to stress that there is no uniform or harmonized set of rules to regulate competition and distribution. Some countries’ legislation contains no specific law whatsoever on these subject matters, while others are heavily regulated. Nevertheless the tendency is to eliminate protective laws that usually gave disproportionate protection to local distributors or sales agents to the detriment of the interests of the foreign supplier and often times to the detriment of market opening and consumer interests as well. In the area of competition, some countries have adopted very modern laws and have strong regulatory bodies; some have poor or deficient laws or weak regulatory agencies and others have no competition or antitrust laws at all, albeit, most legal systems contain rules preventing monopolistic practices and fostering free competition and free markets.

For purposes of this panel the analysis of the situation in Latin America will focus on those countries with a Free Trade Agreement with the United States Wuliangye, where the court demonstrated reluctance to consider RPM illegal per se. An expert group is currently drafting guidelines on vertical agreements and available exemptions and defenses. Until such guidelines are issued the Courts will consider RPM on a case by case basis, and it is thus difficult to provide clear answers.

c. Europe: Post-Leegin, there has been debate in the EU on RPM, but little has changed. RPM is generally prohibited virtually per se, in effect, with some potential leeway for new market penetration initiatives. The Vertical Restraints Block Exemption Regulation (“VBER”)2, which provides a safe harbour for certain types of vertical agreements where there is no market power (below 30% market share) offers no protection if RPM is involved. There is no Colgate equivalent in the EU. RPM is regarded as the situation where the supplier directly or indirectly dictates fixed or minimum resale prices of the buyer. Indirect RPM may take a number of forms, but includes agreements fixing the distribution margin, fixing the maximum level of discount the distributor can grant from a prescribed price level, making supplier rebates and reimbursement of promotional costs subject to downstream pricing level, linking price to competitors’ resale prices, or threats, intimidation, warnings, penalties, delay or suspension of deliveries or contract terminations. Monitoring systems or measures reducing incentives to discount can increase the effectiveness of RPM. In theory, the possibility of a defence to RPM exists under Article 101(3) of the TFEU, but it is likely to be available only in a narrow set of circumstances. 3

d. Latin America: In most Latin American jurisdictions setting a Resale Price is not illegal per se. However, if: a) the party presumed responsible of the conduct has a substantial power over the relevant market, and b) the conduct refers to goods or services related to the relevant market, the situation is subject to analysis as a “Relative monopolistic practice” (“vertical agreement”) under the rule of reason. Resale prices are not regulated different than vertical price fixing, a practice that is allowed, provided that said actions do not harm the competition between the different economic agents in the same relevant market or does not affect consumers interests.

2. Alternative pricing constraints (e.g., suggested pricing, minimum advertised price (MAP) programs)

a. U.S.: It is perfectly lawful in the U.S. for a supplier to suggest resale prices, so long as there is no enforcement mechanism and the customer remains truly free to set its own prices. In addition, a supplier may establish a unilateral policy against sales below the supplier’s stated resale price levels and unilaterally choose not to business with those that do not follow that policy, because it is only agreements on resale pricing that may be per se unlawful. United States v. Colgate & Co., 250 U.S. 300, 307 (1919). But care must be taken not to take steps that would convert such a unilateral policy into an agreement.

Minimum Advertised Price policies that control the prices a supplier advertises, but not the actual sales price, are also generally permitted, although the issue of what constitutes an advertised price for online sales can have almost metaphysical dimensions

2 Commission Regulation (EU) No 330/2010 on the application of Article 101(3) of the Treaty on the Functioning. of the European Union to categories of vertical agreements and concerted practices. 3 Where RPM is used during the introductory period of expanding demand; RPM is required for a coordinated short term low price campaign (2-6 weeks) in a franchise system (a distribution system applying a uniform distribution format); or in relation to complex/experience products, where the extra margin would allow distributors to provide additional pre-sales services and free- riding is a problem. b.. China: Suggested pricing is in compliance with Chinese AML, for as long as it remains a suggestion. Article 14 of China’s Price Law requires that undertakings must not “work collaboratively to control market prices to the detriment of the lawful rights of other undertakings or consumers”. Consequently mandatory pricing violates Chinese AML.

Minimum Advertised Price Policies are not regulated under PRC laws, but seem permissible, as long as they are not mandatory for the final price.

c. Europe: In principle, recommended or maximum resale prices set by the supplier are permissible. However, they should be operated carefully to ensure they do not, in effect, constitute indirect resale price maintenance. It is notable that there is no mention in EU guidance of Minimum Advertised Pricing programmes, a common practice in the US. It is likely that such a practice in the EU would be viewed as an indirect means of RPM and would not benefit from the VBER. Reliance on economic benefits arguments would entail risk in the absence of guidance a case law on the issue.

d. Latin America: Suggested pricing policies are not forbidden, provided such policy remains at the level of suggestion or recommendation. When the suggestion becomes mandatory or an imposition of the price, that conduct normally violates antitrust laws in most Latin American countries. Some countries put restrictions to suggested pricing policies such as, if the suggested pricing policy is made public, this suffices to render the policy null and void.

In some jurisdictions MAPs are allowed, others explicitly prohibit such practice and others analyze such situation under rule of reason parameters. Substantial power of the market, impact on access to competitors and other conditions are normally examined by the regulatory authorities to determine whether a MAP policy is legal or not.

3. Exclusive territories and customer allocation

a. U.S.: Exclusive territories are judged by the rule of reason in the U.S. and are generally permitted, in the absence of market power. Customer allocation by competitors, however, is a horizontal arrangement rather than a vertical one and is per se illegal. It is thus critical that the impetus for exclusive territories come from the supplier in a vertical arrangement and not from dealers or distributors making a horizontal allocation of territories.

b. China: China imposes restrictions on both dominant distributors in respect of exclusive distribution and dominant suppliers in respect of territorial restrictions: Unless there is an applicable justification, a dominant supplier is prohibited from imposing “unreasonable restrictions on the territory of the sales” (Art 5 (1) SAIC Regulations). In some circumstances dominance is presumed to exist when an undertaking has a market share as low as 10 percent. If supplier is dominant, it is unclear in Chinese law or practice what comprises sufficient justification. In determining under the SAIC Regulations what comprises sufficient justification for a territorial restriction, SAIC is required to consider whether the practice is conducted on the basis of ordinary operating activities and ordinary interests, and how the territorial restriction will affect economic efficiency, public interests and development of the economy (Art. 8 SAIC Regulations). Unfortunately there is neither case law nor further guidance from the SAIC on this issue.

As regards customer restrictions the same ambiguity exists: According to SAIC Regulation 54 a dominant supplier / distributor must not impose “additional unreasonable restrictions on … customers targeted”. c. Europe: Vertical restraints policy in the EU is dominated by the desire to avoid compartmentalisation of the single EU market through contractual arrangements. Exclusive appointments are permitted, subject to limitations on the degree of protection which a supplier can afford its exclusive distributor. A supplier may legally prevent a buyer from selling actively to customer groups or territories reserved exclusively for the supplier or to another reseller. A supplier cannot prevent other buyers from responding to unsolicited demand in an exclusively reserved territory; i.e. from making passive sales. Consequently, suppliers cannot offer their exclusive distributors within the EU complete territorial protection from parallel imports from other EU territories except in very limited circumstances involving new product launch. Where distributors are non-exclusive they cannot be protected either from active or passive sales

d. Latin America: Generally speaking contractual provisions or practices (whether expressly agreed upon or implied written or oral), which effects include exclusive distribution agreements between no competing economic agents, are not considered a violation to the antitrust laws, provided that there is no market power.

Most legislations contain provisions indicating that fixing, imposing or establishing an exclusive distribution of goods or services, in regards with line of customers, line of products, geographical location, even if it is for an specific periods of time, including the division, the distribution or the allocation of clients or suppliers, among economic agents which are not competitors are not per se prohibited, but may constitute relative monopolistic practices and are subject to scrutiny under rule of reason parameters.

In those countries where special laws to protect local distributors or sales agents or representatives are still in force, exclusivity provisions are normally acceptable.

4. Restrictions on active or passive selling out of assigned territory

a. U.S.: U.S. antitrust law does not make a distinction between active and passive selling, and it is generally permissible for a supplier to prohibit all out-of-territory sales by a distributor, both active and passive, in the absence of market power.

b. China: There is no distinction between active and passive selling out of the assigned territory in China and it is generally possible to restrict sales out of the assigned territory, unless it is imposed by a dominant supplier who “unreasonably restrict the territory of sales”. In order to evaluate such “unreasonable restriction, SAIC has to consider whether the practice of territorial restriction is conducted on the basis of ordinary operating activities.

c. Europe: This is explained above in 3(a) in relation to exclusivity. Active sales are regarded as those involving a distributor actively approaching individual customers. Passive sales occur when a distributor responds to unsolicited requests from individual customers, including the delivery of goods to those customers. General advertising which reaches a customer outside of the distributor's territory will be regarded as passive selling. Advertising is considered active selling only where it is specifically targeted at customers outside the distributor's territory (and which would not be an attractive investment if the advertising did not reach those customers).

There are a limited number of situations where active and passive sales can be restricted: a wholesaler can be prevented from selling to end users; distributors in a selective distribution system can be prevented from selling to unauthorized distributors; and a buyer of components (supplied for incorporation) can be prevented from reselling them to competitors of the supplier. d. Latin America: Restrictions on passive or active selling outside the territory are normally not regulated in the Latin American antitrust laws. However is it common practice to establish provisions in distribution agreements forbidding the sale of products out of the allocated territory. Violation of this type of obligation could lead to early termination of the distribution relationship for cause. On the other hand an interesting discussion has taken place in regards with parallel importation from an authorized source, the result of which varies from one country to the other.

5. Restrictions on Internet sales

a. U.S.: Restrictions on online sales are viewed as a non-price vertical restraint like exclusive territories, and so are judged by the rule of reason and generally permitted, in the absence of market power.

b. China: Restrictions on internet sales are treated like assigned territories and are so analyzed by SAIC as to whether it unreasonably restricts the territory of sales.

c. Europe: It is the European Commission’s policy that, in principle, every distributor must be free to use the internet to advertise or sell products; this is generally considered a form of passive selling. Specific efforts by suppliers to ensure potential customers in other territories find them on the web are forms of active selling e.g., paying a search engine to have advertisements displayed to users in a particular territory. Restrictions on passive selling via the internet would include arrangements to automatically re-route customers from other territories to the website of the distributor in their own territory. Higher prices simply because sales are online are not permissible.

Suppliers may ensure websites used by distributors meet objectively justifiable quality standards (particularly relevant if the supplier operates a selective distribution system) or require that use of third party platforms comply with such standards. A distributor can also be required to have a "bricks and mortar" shop, in relation to which it can be required to sell a minimum amount to ensure its efficient operation.

A recent EU case confirmed that a ban on internet sales was not objectively justified, even in the context of a selective distribution system of goods with a prestigious image.

d. Latin America: In most Latin American countries with antitrust laws in force, restrictions on Internet Sales among competitors who do not operate at the same market level are viewed as a territory division, hence analyzed by the rule of reason and generally permitted, in the absence of market power.

6. Restrictions on parallel (grey market) imports

a. U.S.: Parallel importing is not generally viewed as an antitrust issue. For trademarked goods, however, importation of goods bearing the trademark, even if genuine, can be blocked through the U.S. Customs and Border Patrol Service, provided the non-U.S. manufacturer is not affiliated with the U.S. trademark owner under § 526(a) of the Tariff Act, which prohibits the importation of a product manufactured abroad "that bears a trademark owned by a citizen of … the United States and … registered in the U.S. Patent and Trademark Office." In addition, where the parallel imported goods are materially different from the U.S. goods in quality, features, warranty or the like, it may be possible to take action on a theory of trademark infringement where customer confusion is likely to result. E.g., Original Appalachian Artworks, Inc. v. Granada Electronics, Inc., 816 F.2d 68 (2d Cir. 1987); Dial Corp. v. Manghnani Inv. Corp., 659 F. Supp. 1230 (D.Conn. 1987).

There is much less ability to restrict gray market importation under a copyright theory. The Supreme Court held just this year in Kirtsaeng v. John Wiley & Sons, Inc., __ U.S. __, No. 11– 697 (March 19, 2013) that a copyright owner cannot exercise any control over a copyrighted work after its first sale, even if that first sale occurs abroad. Moreover, reliance on an insubstantial element of a product protected by copyright to attempt to block parallel imports may be held to be copyright misuse, which blocks enforcement of the copyright. Costco Wholesale Corp. v. Omega S.A., CV 04-05443 TJH (C.D. Cal. Nov. 9, 2011).

b. China: Whether parallel importing of trademarked products constitutes a trademark infringement is not specifically addressed in the PRC laws and regulations. There are two prevailing opinions regarding parallel importing : Most scholars disagree that such imports constitute trademark infringements based on the “Exhaustion of Rights Doctrine”, while some believe that trademark infringements shall be established in parallel import based on the locality nature of intellectual property rights.

Chinese case law does support a brand owner`s ability to rely on trademark law to stop parallel imports. In 1999 the Guangzhou Intermediate Court held that trademark rights were infringed when “Lux” soap was imported from Thailand into China without the brand owner`s consent

In the Michelin case (1999) the Court held that goods could not be imported because they had not obtained the 3C certification (China Compulsory Product Certification, which is a set of safety standards) and, as a result, the importation constituted an infringement of plaintiff’s registered trademark rights by causing a prejudice to Michelin. Experts read the Michelin case to indicate that parallel importation could be permissible if the importer had obtained the 3C certifications. Importers of parallel goods may find it difficult to get certifications for parallel products as authorities could be reluctant to issue such certifications to importers who are not in a position to provide required information for the products. This is how China often handles controversial IP issues: While the law in China might indicate that importation of parallel goods is permissible, a number of hurdles 8both practical and policy based) may prevent the importation of parallel goods into China.

c. Europe: EU competition law attempts to limit restrictions on parallel trade via the rules explained above. Price discrimination (i.e. “dual pricing policies” which offer discounts for products which are resold only locally or charge a premium price for products intended for export) devised to limit where customers can resell the products will generally infringe competition law.

One potential option which may in effect permit prevention of parallel trade, or indeed sales to discounters from a recommended resale price, is reliance upon trade mark rights. The placing on the market of a product in a Member State generally exhausts the trade mark right and such rights cannot be used to prevent the flow of goods from one State to another. However, in a recent case4 the Court of Justice of the EU allowed the enforcement of trademark rights against a licensee who was selling goods to a discount retailer where the licensee’s action could damage quality of the goods which included “the allure and prestigious usage which bestows on those

4 Case C-59/08. goods an aura of luxury". Whether trademark rights can be relied upon in this way will depend on the facts of each case.

Contractual provisions in a distribution agreement may provide that a distributor is entitled to compensation or other type of remedy when parallel imports occur and the supplier fails to take action to prevent it.

d. Latin America: In most Latin American countries parallel imports are not regulated under anti trust or competition laws or are not regulated at all. However, it is not uncommon for an exclusive distributor in those countries where this is allowed to challenge parallel imports on the basis of unfair competition undue use of intellectual property rights, imitation, reproduction, substitution of trademarks, trade names, denominations of origin, advertising slogans; avoidance of customer confusion under consumer protection laws or even safety and health public order rules in certain type of products, such as food, drugs, agro chemicals and the like.

Further, parallel imports can be regulated under contractual provisions in a distribution agreement, whereby a distributor is entitled to compensation or other type of remedy when parallel imports occur and the supplier fails to take action to prevent it.

7. Restrictions on sales of competing products

a. U.S.: In the absence of market power, a supplier generally is free to restrict a distributor’s sales of competing products, although some state laws limit this ability. Restrictions that extend beyond the term of a distribution agreement are disfavored in some states, and generally must be reasonable as to the products restricted, geographic scope and duration. Where a supplier provides a turnkey operation, as in a classic franchise, such post-term restrictions may be more broadly permitted.

b. China: Unless there is a justification, a dominant distributor is prohibited from requiring a supplier not to deal with the distributor’s competitors (SAIC Order 54/2010, article 5 (3)). In absence of such dominant position of the distributor such restrictions seem permissible.

c. Europe: Exclusive purchasing or “non-compete” obligations normally take the form of an obligation not to handle the products of the supplier’s competitors. The definition also covers any obligation on the buyer to purchase more than 80% of its total demands from the same supplier. A non-compete obligation is not protected by the VBER (and is unlikely to be enforceable) if its duration is indefinite, automatically renewable or exceeds five years. Post-term non-competes are acceptable only if necessary to protect “substantial” know-how, they have a duration of less than one year and are limited to the market on which the buyer operated during the contract period (they must also be limited to the premises and land from which the buyer has operated during the contract period). These conditions will be met in most retail franchise agreements. Long term exclusivity is not permissible where the supplier is dominant.

d. Latin America: In the absence of market power, a supplier generally is free to restrict a distributor’s sales of competing products, but if the economic agent has market power the conduct will be analyzed under the rule of reason.