Pharmaceutical companies face harsher antitrust compliance challenges

Introduction

On November 16 2017, four months after seeking comments, the National Development and Reform Commission (NDRC) released its Price Conduct Guidelines for Operators of Drugs Prone to Shortages and APIs.(1) These are the first price-related anti-monopoly guidelines concerning a specific industry to be published since the Anti-monopoly Law was implemented.

The guidelines provide risk assessment warnings and compliance guidance regarding monopolistic pricing behaviour in the drugs prone to shortages and active pharmaceutical ingredient (API) markets. For the first time, the guidelines clarify that enforcement agencies use the so-called 'prohibition plus exemption' principle to identify monopolistic pricing agreements and certain abusive activities (eg, unfair pricing and refusal to deal). In addition, the guidelines remove controversial provisions which were included in the draft guidelines, such as those concerning exclusive dealing.

Pharmaceutical enterprises affected by the guidelines are advised to conduct their anti-monopoly risk audits with reference to the guidelines and adopt stricter compliance measures in order to identify and prevent the relevant legal risks.

Scope of application

The guidelines define 'drugs prone to shortages' as drugs that are unable to be supplied sufficiently in a certain area, which can include:

Chinese herbal medicines;

Chinese herbal decoction medicines;

Chinese patented medicines;

antibiotics;

biochemical medicines;

radiopharmaceuticals;

serums;

vaccines;

blood products;

diagnostic drugs; and

chemical and natural raw materials used in the manufacture of pharmaceutical preparations.

However, the guidelines do not provide a specific definition of 'unable to be supplied sufficiently'.

The guidelines regulate not only producers of drugs prone to shortages and APIs, but also natural persons, legal entities and other organisations engaged in operations or services involving such drugs and APIs, such as exclusive and non-exclusive distributors. Two API general distributors were penalised for abuse of dominance before the guidelines were issued. The scope of the guidelines is consistent with previous practice and includes manufacturers, distributors and medical institutions.

Horizontal monopolistic pricing agreements

The guidelines do not deviate from the definition of 'monopolistic agreements' set out in the Anti-monopoly Law, which includes agreements, decisions and concerted practice.(2) Such agreements can be reached in writing (including through email, text message, WeChat or other instant message platforms) or verbally.

The guidelines cover a wider range of horizontal agreements than the NDRC Provisions on Anti-price Monopoly implemented on February 1 2011. The new guidelines not only list types of pricing-related behaviour, but also refer to other types of monopolistic agreement that are not directly price related (eg, output limitation, market segmentation and boycotting). Although these activities are not directly price related, the ultimate goal is to encourage overall price increases or convergence. These provisions also further expand, refine and thus increase the practicability of the provisions on horizontal monopoly agreements provided for in Article 13 of the Anti-monopoly Law, which will enable enterprises to conduct internal inspections.

Prohibition plus exemption principle

Article 6 of the guidelines clarifies that the NDRC strictly complies with the prohibition plus exemption principle when investigating monopolistic pricing agreements. As such, the acts stipulated in Articles 13 and 14 of the Anti-monopoly Law are expressly prohibited; however, business operators can apply for exemptions if the requirements of Article 15 of the Anti-monopoly Law can be met. Previously, due to the law's unclear provisions and the lack of implementing rules and guidance in this regard, academics and practitioners disputed which principle should apply to monopoly agreements in China. This dispute has mainly focused on whether the per se illegal principle or rule of reason should be applied when analysing and defining monopoly agreements. For the first time, the guidelines clarify that:

enforcement agencies should apply the prohibition plus exemption approach to monopolistic pricing agreements; and

the NDRC does not apply the per se illegal principle when investigating monopolistic pricing agreements.

However, it remains to be seen whether the courts will change the rule of reason approach that they have consistently applied in monopolistic agreement cases.

Identifying dominant market position

In addition to complying with the dominant market position criteria provided for in the Anti-monopoly Law, the guidelines also emphasise that "market share is a key element in measuring market power of operators". Further, according to the guidelines, the assessment of an entity's market share "can take into account the actual production capacity of operators, potential capacity, intellectual property and other factors". This is the first time that the NDRC has clearly stipulated that market share can include an entity's potential production capacity, which has undoubtedly set a higher bar and more stringent compliance requirements for operators of drugs prone to shortages and APIs with high market shares.

Further, the guidelines define a 'dominant position' as substantive control of other operators. Article 7 of the guidelines stipulates that "enforcement agencies shall consider the circumstances in which there is evidence that the operator exercises substantive control over the relevant enterprises to obtain dominant position". The guidelines do not elaborate on 'substantive control'. In practice, imposing exclusive supply obligations on suppliers of APIs or drugs prone to shortages and accepting their prices and thus controlling their production and sales by way of an underwriting or exclusive agency agreement may be considered substantive control.

In addition, the guidelines follow the relevant provisions of the Anti-monopoly Law with regard to a presumed dominant position. The NDRC confirmed the principle of presumption that it employed in the Second Pharma Co Ltd and Handewei Pharmaceutical Co Ltd abuse of dominance case, which resulted in the imposition of penalties on July 28 2017.(3) In this case, the joint market share of Zhejiang Second Pharma Co Ltd and Tianjin Handewei Pharmaceutical Co Ltd was determined to exceed two-thirds of the isoniazid API market (with the relevant market share of each company determined to have never fallen below one-tenth). In its penalty decision, the NDRC also analysed the level of reliance of other operators, which was a barrier to identifying whether the two companies held a dominant position.

Abuse of dominance

The guidelines discuss five specific types of abuse of dominance:

unfair pricing;

refusal to deal;

restrictive transactions;

the charging of unjustified fees; and

differential treatment.

The remainder of this update focuses on unfair pricing, refusal to deal and other activities which tend to cause controversy in practice.

Identification of unfairly high prices

Abuse of market dominance through unfairly high selling or unfairly low purchasing prices is a risk for API operators. In the Second Pharma Co Ltd and Handewei Pharmaceutical Co Ltd abuse of dominance case, the API manufactures were penalised for selling the isoniazid API at unfairly high prices. According to the Anti-monopoly Law, the determination of whether a price is unfairly high need not consider whether there is a justifiable reason for increasing the price; rather, such a determination can be reached solely based on the price increase. 

However, in the 2011 Provisions on Anti-Price Monopoly, the NDRC specifies the factors that should be considered when determining unfairly high prices. To some extent, there are valid reasons for such acts, including cost changes and price increases. The guidelines expand the factors identified in the Provisions on Anti-Price Monopoly and set out several criteria for determining whether a price increase is fair. The considering factors for unfairly high selling or unfairly low purchasing prices provided for in the Provisions on Anti-Price Monopoly and the new guidelines include competitors' prices over the same period and cost increases or decreases. The guidelines contain a new provision that compares historical prices in the relevant region with those of different regions over the same period.

Before the guidelines were released, enforcement agencies were already considering factors such as cost, changes in market supply and demand and competitor's prices over the same period when investigating and dealing with unfairly high selling prices. According to published cases, the criteria for selling products at unfairly high prices include "sharp price hikes" and "price multiplied by x times the previous year". 

When determining unfairly high prices, enforcement agencies would compare existing prices with the previous prices in the same period and focus on the level of increase. Enforcement agencies would also consider other factors that can lead to price increases, such as rising production costs and changes in market supply and demand. In the Second Pharma Co Ltd and Handewei Pharmaceutical Co Ltd abuse of dominance case, the highest selling price of isoniazid APIs was 19 times higher than the highest selling price of the previous year and neither company provided any evidence that the substantial price increases were justified due to rising costs or changes in market supply and demand. As such, the NDRC concluded that the two companies were selling goods at unfairly high prices in violation of the Anti-monopoly Law. The guidelines have now clarified the determination and supervision of price hiking by operators.

Removal of illegality of exclusive dealings provision

Article 9 of the draft guidelines stipulated that operators could not abuse their market dominance to implement exclusive dealings and control prices. In practice, exclusive dealings usually include underwriting or exclusive agency or sales agreements. During the public consultation on the draft guidelines, concerns were raised over the provision prohibiting exclusive dealings and it was recommended that it be deleted.(4) Exclusive dealing is not illegal by its nature and laws should not prohibit undertakings with market dominance from:

choosing their own nationwide or regional general agent or distributor; and

conducting business by way of exclusive distribution.

Arguably, the risk of violating antitrust law stems from the possible manipulation of prices and the disruption of competition after obtaining a monopoly by way of exclusive dealings, which is not essentially different from controlling prices through other means. A separate listing of the rules prohibiting exclusive dealings is somewhat superfluous and could easily lead to an improper interpretation, thus affecting the normal business practices of enterprises which adopt exclusive dealing modes. The final guidelines have removed the rules on exclusive dealings and focus on price manipulation by dominant market players by way of exclusive dealing.

Refusal to deal

According to the guidelines, operators of drugs prone to shortages and APIs with market dominance cannot refuse to deal with a counterparty in a disguised form by setting unfairly high selling or unfairly low purchasing prices without justifiable reasons for doing so. Compared with the draft guidelines released for comment, the final guidelines clarify that the impact of refusing to deal on competition in the downstream market can be considered when analysing whether there is a justified reason for the refusal, taking into account the fact that "the existing production capacity of undertakings cannot satisfy market supply, or the product must be provided for its own production use, and its supply or own production use do not seriously exclude the downstream market competition".

After the release of the draft guidelines, a proposal was submitted to the NDRC:

recommending that it clarify the legal characteristics of a refusal to deal; and

specifying that the fact that an undertaking competes in both the upstream and downstream markets is such a characteristic.(5)

According to prevailing antitrust theory, the aim of refusing to deal is not to seek profit from the counterparty to the transaction, but rather to force it out of the market so that it cannot obtain the basic conditions or raw materials required for production and operation, by which the refusing undertaking can squeeze out competitors and control and influence the relevant market.(6) Therefore, in the API field, a refusal to deal with regard to typical antitrust law will generally involve an undertaking with dominance in the API market which also participates in the downstream market (ie, the preparations market). In order to enhance or consolidate its competitiveness in the preparation product field, the operator will usually leverage its market power in the API market to the downstream preparation market by means of ceasing the supply to competitors in the downstream market and blocking off the APIs for its own use, through which it may restrain competition in the preparations market.

In the Chongqing Qingyang Pharmaceutical Co, Ltd abuse of market dominance case,(7) Chongqing Qingyang implemented such a typical refusal to deal. On the contrary, the finding of refusal to deal in the Chongqing Southwest No 2 Pharmaceutical Factory Co, Ltd case was slightly far-fetched.(8) Although Chongqing Southwest refused to supply, which was in line with the characteristics of a refusal to deal, it produced only raw materials and not preparations. Further, it did not compete with downstream enterprises. As such, the aim of its refusal to deal was not to eliminate competition, and it is debatable whether such behaviour should constitute an abuse of market dominance.

China's existing antitrust framework provides no specific definition of 'refusal to deal'. Instead, it refers only to the general legal characteristics of an abuse of market dominance – namely, that an operator will have abused its dominant market position where such abusive behaviour:

is without justifiable reason; and

would eliminate or restrict the market.

Similarly, based on prevailing antitrust theory, the interpretation of a 'justifiable reason' refers to the consideration of the pursuit of legitimate commercial interests – for example, where it is difficult for undertakings to deal with the counterparties to a transaction due to restrictions of supply capacity or purchasing power.(9) It is a welcome development that the guidelines recognise, for the first time, the impact on competition in the downstream markets as a justified consideration. The authors of the guidelines have further suggested that an operator's involvement in competition in both upstream and downstream markets be clearly included as a key legal characteristic of a refusal to deal in the relevant implementation rules of the Anti-monopoly Law.

Comment

In view of the unique monopolistic and infringing pricing behaviours that exist in the API production and circulation markets, as revealed by law enforcement, the Price Conduct Guidelines for Operators of Drugs Prone to Shortages and APIs:

strengthen the API market's price supervision mechanism;

clearly regulate market pricing behaviour with regard to drugs prone to shortages and APIs; and

provide practical guidance for relevant pharmaceutical companies with regard to their pricing behaviour.

The guidelines explain in detail what cannot be done by way of enumeration, which provides undertakings with a standard for self-assessment and imposes more stringent compliance requirements on operators. In addition to monopolistic price-related behaviour, the guidelines provide for other behaviours that disrupt market prices, such as:

prohibiting operators from "fabricating and disseminating information about price hikes";

"hoarding drugs prone to shortages and APIs with tight market supply and fluctuating prices in a large quantity";

"forcing up prices by other means";

"using false or misleading prices to deceive consumers";

"not implementing government fixed prices"; and

"violating the clearly marking prices".

The promulgation of the guidelines will help to:

promote the regulation of market pricing behaviour with regard to drugs prone to shortages and APIs;

establish a fair market environment for the purchase and sale of medicines; and

protect consumer interests.

Operators should conduct internal inspections of their pricing behaviour and related business models in light of the guidelines in order to prevent potential legal risks.

The principles of prohibition plus exemption and market definition, as well as the new factors for identifying refusal to deal and unfair pricing and the concept of substantial control included in the guidelines will pose new antitrust compliance challenges for pharmaceutical enterprises. In practice, the determination of monopolistic behaviour in other industries may also rely on the new guidelines.

This article was first published by the International Law Office, a premium online legal update service for major companies and law firms worldwide. Register for a free subscription.

For further information on this topic please contact Michael Gu or Sihui Sun at AnJie Law Firm by telephone (+86 10 8567 5988) or email (michaelgu@anjielaw.com or sunsihui@anjielaw.com). The AnJie Law Firm website can be accessed at www.anjielaw.com.

Endnotes

(1) The original text of the Price Conduct Guidelines for Operators of Drugs Prone to Shortages and APIs is available here.

(2) For further details, please see "China intensifies pharmaceutical antitrust enforcement: NDRC rules in first-ever concerted practice case".

(3) The notices of the penalty decisions in the Second Pharma Co Ltd and Handewei Pharmaceutical Co Ltd abuse of dominance case are available here and here.

(4) For an analysis of exclusive dealing, see Michael Gu and Sihui Sun, "Drug Operators ' Attention - Price Conduct Guidelines on Operators of Drugs Prone to Shortages and APIs" (Draft for Comments) Put Forward Stringent Compliance Requirements", August 29 2017.

(5) Ibid.

(6) Knowledge of Antitrust Law of the People's Republic of China, State Council Anti-monopoly Commission, People's Publishing House, 2012, p 127.

(7) The notice of the penalty decision in the Chongqing Qingyang Pharmaceutical Co, Ltd abuse of market dominance case is available here.

(8) The notice of the penalty decision in the Chongqing Southwest No 2 Pharmaceutical Factory Co, Ltd refusal to deal case is available here.

(9) Knowledge of Antitrust Law of the People's Republic of China, p 128.