China Competition & Trade Review (Issue #1 - August 2019)

With the recent trade tensions between China and the United States, companies conducting business in both countries face new and escalating uncertainties. Trade and export controls in one country can conflict with competition policy in the other. Requirements are evolving quickly, new measures are introduced regularly. These complex and shifting conditions can lead to confusion about on-the-ground competitive conditions and the laws framing them.

Accordingly, O’Melveny is introducing a new series of China Competition and Trade Reviews, through which we will periodically share information about important antitrust, competition, and trade developments in China. We’ll aim for updates a couple of times per year and as especially important events warrant.

This first installment offers a brief overview of:

1. China’s new Unreliable Entities List, which may bar certain companies from conducting business in China;
2. Mega-mergers between Chinese state-owned enterprises, which suggests a shift in Chinese policy from domestic competition to international dominance;
3. The latest antitrust fine for abuse of dominance, which may impact businesses with long-term, minimum-purchase supply agreements;
4. Revisions to China’s Anti-Unfair Competition Law, which now makes it easier for companies to protect trade secrets;
5. A trio of new regulations intended to implement China’s Anti-Monopoly Law, which together provide increased guidance for companies; and
6. Recent developments in Hong Kong, one of the world’s newest competition regimes, where the law is evolving rapidly.

If you have questions about these developments or any others pertaining to China, please contact any of the key contacts listed to the left.

1. China Creates an Unreliable Entities List

China’s Ministry of Commerce (MOFCOM) recently announced that it is creating an “Unreliable Entities List,” which will name any enterprise, organization, or individual who damages the interests of Chinese companies or threatens China’s national security. Inclusion on the list will impact one’s ability to conduct business in China. The move appears to be in response to the United States’ addition of Huawei to the US Entity List in mid-May, which effectively barred Huawei from receiving US goods.

• Details Uncertain. MOFCOM has not announced which (if any) companies or individuals will appear on the list; the procedure by which they will be added; or the restrictions that will result, although named entities will likely have difficulty conducting business in China.
• Potentially Offending Conduct. MOFCOM has identified certain actions that may trigger inclusion, including (1) failure to obey market principles and the spirit of contract law; (2) blockading, ceasing to supply, or otherwise discriminating against Chinese firms for non-commercial reasons (conduct that might also be pursued as abusive under the Anti-Monopoly Law); (3) seriously harming the rights and interests of Chinese enterprises; and (4) threatening China’s national security interests.
• Implications. The Unreliable Entities List places companies with operations in both the US and China in a difficult position, as they will need to navigate compliance with US export control and trade restrictions as well as China’s requirements of continued supply.

2. Mergers Between Chinese State-Owned Enterprises

China Shipbuilding Industry Corp. (CSIC) and China State Shipbuilding Corp. (CSSC)—state-owned enterprises and the largest shipbuilding companies in China—recently announced that they will merge. The combined firm will be the world’s second-largest shipbuilder. The combination is notable for a few reasons.

• First, CSIC was formed in 1999 after being split from CSSC. At the time, the Chinese government was seeking to stimulate domestic competition. Now, the government’s focus seems to have shifted to creating huge, “national champion” companies. The trend is arguably in tension with the government’s recent claims that the market should govern resource allocation.
• Second and relatedly, the merger follows a number of mergers between China’s other state-owned enterprises, including those between (1) CNR and CSR, which resulted in the world’s largest train maker; (2) ChemChina and Sinochem, which resulted in the world’s largest industrial chemicals firm; (3) China Ocean Shipping Company and China Shipping Group, which resulted in the world’s largest shipping fleet; and (4) State Nuclear Power Technology and China Power Investment Corp., which resulted in the third largest nuclear reactor operator in China.
• Third, the merger targets one of ten sectors prioritized by China’s “Made in China 2025” initiative, which seeks to transition China away from low-cost manufacturing and to the production of higher value products and services. With respect to shipping, the plan calls for Chinese vessels to use 80 percent domestic components by 2025.

3. Eastman Chemical Fined for Abuse of Dominance

In April, China’s antitrust enforcer fined Eastman Chemical roughly $3.6 million for abusing its dominant position in the market for alcohols used in latex paints. Eastman had entered supply agreements that obligated customers to purchase 60 to 80 percent of their annual needs from Eastman. The contracts were deemed unlawful because they limited customers’ product choices and prevented other firms from entering the alcohol market. Key considerations include:

• Uncharted Territory. Minimum purchase agreements are not explicitly mentioned in China’s Anti-Monopoly Law, and the Eastman case appears to be the first time a minimum purchase agreement has resulted in fines. The case suggests that China’s antitrust regulator, SAMR, will pursue any action that it believes is at odds with the spirit of the Anti-Monopoly Law.
• Fine Calculation. The fine of $3.6 million represented 5 percent of Eastman’s total 2016 turnover in China, not just the affected Chinese turnover.
• Guide Posts. The offending facts—(1) minimum purchase requirements between 60 and 80 percent of a customer’s annual needs; (2) two to three year contract terms; and (3) foreclosure of 20 percent of the market—offer guide posts. Potentially dominant companies will want to tread carefully with minimum purchase agreements with terms longer than 2 years and/or with minimum purchase requirements approaching 60 percent of a customer’s needs.

4. Revisions to China’s Anti-Unfair Competition Law

China recently revised its Anti-Unfair Competition Law to increase trade secret protections. While the law is not a traditional antitrust statute, it seeks to prevent business abuses that undermine competition. The recent changes will benefit multinational corporations in a number of ways.

• Compensation Increased. Plaintiffs can now seek punitive damages—up to five times the loss suffered by the plaintiff—for trade secret infringements carried out with malicious intent. Separately, the maximum statutory compensation has increased to RMB 5 million (from RMB 3 million) when a plaintiff cannot determine its losses.
• Coverage Expanded. The law now covers misappropriation by individuals and entities. Previously, the law applied only to trade secret infringement by business operators, effectively omitting abuses by employees and former employees.
• Burdens Reduced. The revised law introduces a burden-shifting mechanism. Plaintiffs need only provide preliminary evidence that they took measures to protect the trade secrets and reasonably demonstrate that the trade secrets were infringed. The burden then shifts to the defendant to prove that the alleged trade secret falls outside the scope of the Anti-Unfair Competition Law or that it did not commit the infringement.

5. A Trio of New Antitrust Regulations

On September 1, 2019, three regulations meant to implement China’s Anti-Monopoly Law take effect: (1) the Interim Regulation Prohibiting Monopoly Agreements; (2) the Interim Regulation Prohibiting Conduct Abusing Dominant Market Positions; and (3) the Interim Regulation Preventing Conduct Abusing Administrative Rights. While the regulations clarify procedural and substantive elements of the Anti-Monopoly Law, they largely represent a continuation of existing practices.

• Monopoly Agreements. The first regulation covers anticompetitive agreements and other concerted practices. It makes clear that many forms of conduct—including cartel conduct and resale price maintenance—are per se violations of the Anti-Monopoly Law. The regulation also specifies which factors SAMR will evaluate when determining whether concerted practices exist, including unity in conduct, a meeting of the minds, information exchanges, market structure, the existence of reasonable explanations, and the state of competition, among other things.
• Abuse of Dominance. The second regulation generally deals with single-firm conduct and clarifies how dominance is determined. Specifically, it indicates that market shares can be measured with reference to sales value, sales volume, or other norms. For industries related to the Internet or intellectual property, for example, SAMR can consider business models, user numbers, network effects, foreclosure effects, data control, and countervailing buyer power. Importantly, the regulation offers detail on what constitutes abusive conduct, including excessive or below cost pricing, refusal to deal, exclusive dealing, discriminatory practices, and tying. It also addresses potentially valid reasons for the relevant conduct.
• Administrative Monopoly. The third regulation is aimed at competitive abuses by Chinese government agencies. While SAMR is not empowered to sanction its sister agencies, it can issue guidance and recommendations for how to rectify the offending behavior, which may include restrictions on the free movement of goods, services, and investments, as well as exclusivity/exclusionary practices.

6. Hong Kong Developments

Hong Kong’s Competition Ordinance took effect in 2015, and the law is rapidly developing. In fact, almost every court decision and regulator action represents a step into uncharted waters. A few notable developments from the last few months include:

• First Infringement Decisions. In May, the Hong Kong Competition Tribunal—the court that oversees all competition cases—issued its first two merits decisions, both of which found companies liable for violating the Competition Ordinance. In the first case, the Tribunal concluded that four IT companies engaged in bid rigging related to a tender process held by the YWCA. In the second case, the Tribunal found that ten decorating contractors allocated markets/customers and fixed prices when they allocated floors within buildings under renovation, agreed not to solicit business from each other’s allotted tenants, and jointly produced a promotional flyer advertising prices. Both decisions relied heavily on EU law, although both applied a “beyond reasonable doubt” standard of proof.
• Enforcement Against Individuals. At the end of 2018, the Hong Kong Competition Commission—Hong Kong’s antitrust regulator—filed its first enforcement action against individuals. The case contends that three construction companies and two individuals conspired to allocate customers and coordinate prices. Individuals who violate the Competition Ordinance can be enjoined, disqualified from corporate boards, and fined. Importantly, the law does not limit the amount of applicable fines. To impose a pecuniary penalty, however, the Competition Commission must satisfy the standards of criminal proof.
• New Cooperation Policy. Hong Kong recently adopted a Cooperation and Settlement Policy, which establishes a framework for companies implicated in cartel cases to cooperate with the Competition Commission. The policy supplements Hong Kong’s existing Leniency Policy, which offers full immunity to the first entity to cooperate. The Cooperation Policy allows subsequent immunity applicants to secure reductions in penalties up to 50 percent in exchange for their willing cooperation, including the proffer of documents, information, and witnesses.
• Exemption Applications. Entities and trade associations have begun to seek exemptions from the Competition Ordinance, but without much success. First, a number of banks sought to exempt a voluntary banking code that prohibited the imposition of certain types of fees, interest rates, and charges. The Competition Commission rejected the request, indicating that exclusions are narrow and generally apply when the relevant conduct is compelled by a competing law. Second, a pharmaceuticals trade group asked the Competition Commission to exempt its quarterly sales survey. The application is still pending, but Hong Kong’s consumer watchdog has raised concerns with the request, fearing that the survey will result in the exchange of competitively sensitive information.

This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Philip Monaghan, an O'Melveny partner licensed to practice law in England & Wales, Ireland, and Hong Kong, Scott Schaeffer, an O'Melveny counsel licensed to practice law in California and the District of Columbia, Lining Shan, an O'Melveny senior legal consultant in the firm's Beijing office, and Charles Paillard, an O'Melveny associate licensed to practice law in France and a registered foreign lawyer in Hong Kong, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

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