China Competition & Trade Review (Issue #3 - March 2020)

O’Melveny’s China Competition and Trade Reviews offer periodic updates about important antitrust, competition, and trade developments in China. The Reviews are intended to help companies navigate China’s rapidly evolving regulatory landscape with practical, on-the-ground insights into the country’s competitive conditions and the laws framing them.

This third installment offers a brief overview of:

1. The impact of the novel coronavirus (Covid-19) outbreak, which is upending business in China, slowing M&A activity, and forcing the government to modify regulatory procedures;
2. Proposed revisions to China’s Anti-Monopoly Law, which greatly increase penalties for anticompetitive agreements and merger clearance violations, while also increasing SAMR’s investigatory powers and clarifying a number of important concepts in the law;
3. China’s proposed Merger Review Regulations, which bolster divestiture obligations and narrow the types of joint venture transactions qualifying for simplified clearance review;
4. China’s new whistleblower reward system, which allows employees anonymously to report serious antitrust violations in exchange for substantial financial rewards;
5. Important new compliance guidelines that encourage companies to abide by international best practices, create robust compliance departments, and foster a culture of compliance; and
6. A major decision from China’s Supreme Court, in which it held that Chinese courts retain jurisdiction over private antitrust disputes despite arbitration clauses in the parties’ contracts.

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

1. The Impact of the Novel Coronavirus (Covid-19) Outbreak

The novel coronavirus (Covid-19) outbreak has upended business in China, with manufacturing lines shuttered, employees sequestered, and regulatory procedures slowed. Even in areas where there are relatively few confirmed cases of the virus, Chinese authorities have taken every precaution to slow the spread of infection. This means that businesses face a number of new reporting obligations—including employee travel history and health information—inspections, and authorizations, often varying by province or city. But even when companies are approved to resume operations, a single infection among employees can bring things to a halt, forcing large numbers of employees into quarantine. The result has been a marked slowdown in China as supply lines convulse and companies grapple with the human and economic fallout. While the situation is evolving rapidly, some of the noteworthy economic impacts of Covid-19 include:

• M&A Activity is Down. Perhaps unsurprisingly, the Covid-19 outbreak has slowed M&A activity in China. The number of deals in Mainland China and Hong Kong is down more than 50 percent when compared to the same period last year, while the value of those deals is down over 75 percent compared to 2019. Some commentators suggest that M&A activity will quickly recover in the second half of 2020, noting that total deal value in China tripled in the six months after China contained the SARS virus in 2003. Other observers caution that economic recovery will be more complicated following the Covid-19 outbreak since China’s growth was already slowing, its economy is loaded with debt, and credit has been harder to come by.
• A Wave of Force Majeure Certificates. In light of the Covid-19 epidemic, many companies have been unable to fulfill their contractual obligations. To shield those companies from legal risk, China has issued more than 1,600 force majeure certificates. The certificates are meant to exonerate companies for their nonperformance by “proving” that they experienced circumstances beyond their control and therefore cannot be subject to legal action or contractual penalties. To date, the force majeure certificates apply to contracts with a combined value of roughly $16 billion.
• Other Business Challenges Abound. A recent survey by the American Chamber of Commerce in Shanghai found that most American manufacturers with operations in China do not have enough staff to operate their production lines. Many employees are subject to travel restrictions and quarantines, even when healthy. Companies often lack a sufficient number of protective masks for employees, which generally is a requirement for resuming operations. And finished goods can be stranded, as trucking and shipping lines have closed. In fact, drivers are often forced into self-quarantine when entering new Chinese provinces—the equivalent of crossing state lines—resulting in congestion at air cargo depots, container ports, and warehouses. Together, these impacts are likely to impact demand and output over the coming months.
• New Rules are Meant to Ease Some Burdens. As it seeks to ramp up economic activity, China has eased some of its regulatory burdens. The State Administration for Market Regulation—China’s antitrust authority—now requires companies to submit pre-merger notifications online and has vowed to improve the efficiency of transactions subject to simple case review. Previously, SAMR required all submissions to be filed in person with hard copies. The General Administration of Customs also released measures meant to speed up inspection times for imported raw materials, food, and agricultural products, while also simplifying import registration and filing procedures.

2. Proposed Amendments to China’s Anti-Monopoly Law

Before the Covid-19 outbreak dominated the media spotlight and diverted significant government resources, the State Administration for Market Regulation introduced draft amendments to the Anti-Monopoly Law. The proposed amendments touch many aspects of the law, from merger control to antitrust enforcement, and are the first revisions to China’s antitrust law since it took effect in 2008. Notable proposals include:

• Merger Control. The draft amendments drastically increases penalties for gun-jumping, failure to notify, and breach of restrictive conditions in conditionally-approved transactions. At present, the maximum penalty is a fine of RMB 500,000, or roughly $70,000. The draft amendments increase the maximum penalty to 10% of the offending party’s turnover in the prior year. The proposed amendments also define the concept of “control”—which can determine when a merger filing is required—for the first time. Control exists when an entity can exert or potentially exert a “decisive influence on any other undertaking’s operating activities other major decisions, whether directly or indirectly, whether individually or collectively.”
• Anticompetitive Actions. The proposals also seek to increase penalties for anticompetitive agreements and concerted action in certain situations. In particular, offending entities would now be subject to fines of up to RMB 50 million (roughly $7 million) for entering into anticompetitive agreements, even if those agreements are never implemented and even if the offending company did not have any turnover in the prior year. Companies aiding and abetting anticompetitive conduct can also be fined. And while the proposed amendments still allow companies to defend against claims of anticompetitive conduct by proving that the challenged agreement improves product quality, reduces costs, or increases operational efficiency, the agreement must be necessary to achieving those benefits.
• Special Considerations for Internet Companies. The proposed amendments single out internet companies, allowing SAMR to consider factors like network effects, economies of scale, lock-in effects, and the ability to collect and process relevant data when determining whether an internet company has a dominant market position. The provisions are an apparent recognition of the difficulties of applying traditional market definition tools to digital economies.
• Procedural Amendments. The proposed amendments identify a number of circumstances under which SAMR can suspend the review period for merger clearance, including when parties submit supplementary documents or data. It is unclear whether this tolling method will extend already protracted merger clearance timelines or have some disciplining effect on the regulator. Other proposed procedural amendments include empowering SAMR or clarifying SAMR’s power (1) to update merger notification thresholds from time to time; (2) to investigate mergers even if they fall below the notification threshold; and (3) to work with local police departments in conducting antitrust investigations.
• Fair Competition Review. The proposed amendments also incorporate the fair competition review system into the AML, which requires government bodies at all levels to assess whether their policies are compatible with fair, market-oriented competition.

3. China’s Proposed Merger Review Provisions

On January 7, 2020, SAMR issued draft merger review provisions that are intended to streamline merger clearance reviews, clarify procedures, and consolidate a number of existing merger rules and regulations. Key points include:

• Divestiture Requirements. When divestiture is necessary, the rules offer additional clarity on when an “upfront buyer” might be required.
• Simple Case Reviews. The draft provisions possibly broaden the universe of joint ventures that qualify for a simple case review, which allows for an abbreviated analysis in straightforward transactions. Specifically, transactions in which (1) a joint venture moves from being controlled by two or more undertakings to control by a single one of those undertakings and (2) the controlling undertaking and the JV compete in the same market will no longer qualify for simple case review if the combined market share of the controlling undertaking and the JV exceeds 15 percent.
• Enforcement Authority. The draft provisions allow SAMR to investigate any “illegal implementation” of a transaction. While consistent with current practice, the provisions expressly allow SAMR to pursue enforcement against any violation of the AML in the context of a transaction, including gun jumping, failure to abide by settlement terms, and failure to file.
• Delegation of Merger Review Authority. The draft provisions also allow SAMR to appoint provincial-level agencies to assist with merger reviews, including in investigations into illegal implementations of concentrations within the relevant region.

4. New Antitrust Whistleblower Rewards

On November 19, 2019, SAMR issued draft provisions governing financial awards for whistleblowers reporting serious violations of law, including antitrust violations. The provisions build on incentives that previously applied to whistleblowers reporting product safety and counterfeiting issues, among other things, but provide more substantial rewards and increase the types of reportable conduct. Key takeaways include:

• Significant Illegal Conduct. The incentives apply only to whistleblowers who report significant illegal conduct, which includes acts that can be sanctioned with the suspension of operations, the loss of business licenses, or large fines. Minor violations do not qualify.
• Only Individuals Qualify. The provisions apply only to individuals, encouraging employees to report serious anticompetitive conduct by their employers. Entities that report anticompetitive conduct will not receive rewards. Neither will individuals who are engaged in the relevant anticompetitive conduct, although they can report illegal conduct through China’s leniency program.
• Substantial Awards. Whistleblowers whose efforts result in successful enforcement actions can receive as much as 5 percent of the fine paid by the relevant violators, up to a maximum of RMB 2 million (roughly $285,000). Rewards will vary, however, based on the quality of the whistleblower’s evidence and the severity of the reported conduct.
• Confidentiality. The draft provisions seek to ensure that whistleblowers remain anonymous—they need not even disclose their identity to SAMR, although SAMR must be able to contact them—and SAMR employees are subject to discipline if they fail to protect a whistleblower’s information.

5. New Compliance Guidelines

Also in November 2019, SAMR issued draft Anti-Monopoly Compliance Guidelines, which recommend ways for companies to develop and implement antitrust compliance programs. The Guidelines generally follow the recommendations issued by other antitrust regulators as well as international best practices. Key recommendations include:

• A Culture of Compliance. The Guidelines encourage businesses to cultivate a culture of compliance, an aim of abiding by antitrust rules in every jurisdiction in which the business operates. This requires senior executives committed to antitrust compliance and an effort to identify antitrust risks based on the company’s conditions, scale, and industry features.
• Compliance Departments. The Guidelines not only recommend that companies create a compliance department, but that they provide it with the resources and independence necessary to effectively evaluate and remedy compliance risks. This includes adequate staffing and the development of compliance mechanisms that can efficiently evaluate compliance status. Compliance departments should also conduct training and ensure that antitrust compliance is a component of employee performance evaluations and incentive programs.
• Reporting to SAMR. The Guidelines also encourage companies voluntarily to submit reports to SAMR detailing their development of antitrust compliance systems and subsequent implementation efforts. The Guidelines do not specify how SAMR will utilize this information.

6. A Major Decision on Arbitration in Antitrust Cases

In Shell (China) Limited v. Hohhot Huili Material Co., Ltd., the Chinese Supreme Court ruled that private antitrust claims cannot be arbitrated, settling a split among lower courts and offering greater clarity for companies with business in China. The issue arose when Hohhot Huili, a Shell distributor in China, alleged that Shell encouraged other distributors to collude in bidding processes. In response, Shell argued that Chinese courts lacked jurisdiction to review the claims because Hohhot Huili’s distribution agreement contained an arbitration provision. The Supreme Court rejected Shell’s argument.

• Judicial Jurisdiction is Expansive. The Supreme Court concluded that the Anti-Monopoly Law requires either an administrative body or a court to evaluate allegations of anticompetitive conduct, leaving no room for arbitration of private antitrust disputes. It explained that the Anti-Monopoly Law is a public enactment with the broad aims of preventing anticompetitive conduct, ensuring fair competition, and protecting consumers. Any claim of anticompetitive conduct consequently reaches beyond the rights or obligations of parties to a single contract, impacting society more generally. As a result, antitrust claims cannot be limited to the narrow confines of arbitration.
• Arbitration is More Limited. The Supreme Court further explained that China’s Arbitration Law applies to contractual disputes and disputes arising from property rights. When a dispute does not concern contractual rights or other property interests, Chinese courts necessarily have jurisdiction.

O'Melveny & Myers LLP is a foreign law firm registered with the Ministry of Justice of the People's Republic of China. Under current Chinese regulations, we are allowed to provide information concerning the effects of the Chinese legal environment, but we are not authorized to practice Chinese law or to render legal opinions in respect of Chinese law. We work in cooperation with a number of Chinese law firms. Should you require a legal opinion in respect of any Chinese law matter, we would be happy to assist you in obtaining one from a Chinese firm.

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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