China: New Administrative Measures For Automobile Sales: To Forge A Better Relationship Between Manufacturers And Distributors

After a lapse of twelve years, the Ministry of Commerce ("MOFCOM") has amended their 2005 Automobile Brand Sales Management Implementation Measures ("2005 Brand Measures") to reshape the relationship between vehicle manufacturers and distributors. Rapid growth in China's automobile industry for over a decade has seen that the brand licensing-based business model once dominant under the 2005 Brand Measures becomes increasingly unsuccessful.

This brand licensing business model previously contributed to a substantial increase in production and sales; however, in recent years there has been a gradual slowdown in the growth rate of China's automobile sales. This slowdown, coupled with a large increase in car brands, as well as the rise of independent distributors willing to participate independently in the market called for amendments to the 2005 Brand Measures by taking into account the factors Such as the increasingly tense relationship between manufacturers and distributors as the 2005 Brand Measures definition of distributors as being "subordinate" in their relationship with manufacturers has become increasingly obsolete and out of step with market developments.

In addition, since 2014, an antitrust agency in China, the National Development and Reform Commission ("NDRC"), has initiated a number of anti-monopoly investigations into leading car manufacturing brands. This has led to the NDRC punishing a number of manufacturers involved in fixing the resale prices of cars and spare parts. Many brands have increasingly seen a disconnect between manufacturers and distributors, and a further escalation of the conflicts between the two (such as distributors refusing to take delivery due to inventory pressure, manufacturers needing to pay distributors large subsidies, etc.). This has all resulted in the need for the automotive industry to revise this brand licensing-based business model over time.

The new Administrative Measures for Automobile Sales (the "New Measures") promulgated by MOFCOM on April 14, 2017 aim to address some of the issues facing the automotive industry. The New Measures are designed to promote a better relationship between manufacturers and distributors, and to help them work together for the purpose of continuous development. We see some promising progress with these New Measures. However, whether administrative regulations such as these New Measures can 'reshape' the economic relationship between manufacturers and distributors, and whether this can achieve its goals remains to be seen. At the same time, it is still uncertain as to whether the New Measures will be implemented in the context of the NDRC rigorous enforcement of the Anti Monopoly Law in conjunction with its draft Antitrust Guidelines for the Auto Industry (yet to be promulgated).

This briefing is intended to provide a brief overview and preliminary analysis of some of the key points in these New Measures. This briefing will also seek to look at the possible impacts of the New Measures based on our understanding of the automotive industry, and involvement in several anti-monopoly law enforcement cases in this industry.

1 Liberalization of non-authorized and multi-brand operations

The New Measures clearly state that distributors may sell vehicles without the approval of a supplier (i.e. the original manufacturer or importer). However, sales unauthorized by supplier must be disclosed to the consumers, and non-authorized distributors cannot engage in business activities while describing themselves as 'authorized distributors' of the supplier. This follows the State Administration for Industry and Commerce ("SAIC")'s decision to cancel the registration for brand authorizations. MOFCOM is once again seeking to clarify in the New Measures that in addition to traditional authorized distribution model in the form of '4S' shop of manufacturers', distributors are allowed to sell vehicles through different channels (including but not limited to sales to multi-brand stores and car supermarkets).¹ This is specifically reflected in Article 24 of the New Measures, which requires that the supplier not restrict the distributor from "supplying products from other suppliers". Article 24 also requires that suppliers not "restrict the supply of spare parts and other after-sales services for vehicles from other suppliers". This article applies to the sales of spare parts and accessories as well as after-sales services of the "multi-brand", "authorized and nonauthorized" business.

In this regard, a vehicle manufacturer may protect itself by asking the distributor for a given brand to set up a separate showroom for the manufacturers' products. The manufacturer may also ask the distributor to meet specific business requirements and to maintain the basic brand image. Although manufacturers can require separate showroom for their products, the New Measures also stipulate that manufacturers "shall not mandate an unreasonable operating area, building structure and designate brands or vendors of paid design, construction , building materials, general equipment and office facilities".

Potentially, disputes between the manufacturer and the distributor may arise from the interpretation of what is "reasonable". For example, can the manufacturer request distributors to accept "reasonable" quality and quantity requirements in terms of design and construct equipment and facilities to ensure that it meets specific business needs and maintains the basic brand image? Can the automobile maker require all its distributors to install a standardized Dealer Management System ("DMS") for sake of consistency and compatibility?

In addition, manufacturers cannot ask for the distributors' facilities to include both sales and after-sales service functions. As a result, other than existing 4S stores, there will be more independent automobile showrooms and auto repair shops, especially in new, or tier three and four, cities in China based on market demand.

2 Extended authorization period

For the distributors who continue the existing brand licensing model, the New Measures provide for an "authorized period (excluding shop construction period) generally not less than three years each time, with the first authorization period being generally not less than five years".

It is worth mentioning that the final draft of the New Measures have superseded the MOFCOM's January 2016 draft, which stated that a distribution contract entered into before the implementation of the New Measures and with an authorization period of less than five years will have its cumulative authorization period extended to at least five years.

The removal of this provision from the final draft may indicate to some extent that the New Measures are not retroactive as they will no longer automatically extend the term of existing distribution contracts to five years immediately after the New Measures are implemented.

3 Distributor's sales targets and business policies

Despite opposition from the industry, during the finalization of the New Measures, the MOFCOM decided to retain the prohibition on manufacturers from "specifying the vehicles, types or quantity of spare parts held in inventory, or the required volume of car sales, unless both parties agree otherwise in writing as part of a contract or the extension of a contract". As above-mentioned, for contract extensions, the minimum extension period is fixed at three years. However, given the rapid changes in the market today, manufacturers and distributors are almost certain to find it impossible to sign or renew a contract for containing targets for three years' worth of wholesale/retail sales and inventory.

The specific application of this clause in practice will be subject to market testing. For example, market participants may consider whether to allow both parties to agree on a "basic indicators + corresponding formulas" system and refer to the market variables for specific indicators to make automatic adjustments.

Another important aspect of the New Measures that is closely related to the interests of manufacturers and distributors is the requirement that "the development or implementation of marketing incentives and other business policies shall follow the principles of fairness, impartiality and transparency". For specific operations, "manufacturers shall make business policies clear to the distributors, and the main contents of the temporary business policy shall be made clear to the distributors in the manner as agreed by both parties". Hopefully, detailed rules and law enforcement activities in the future could shed more lights on how the abovementioned principles of "fairness and impartiality" shall be observed during the process of formulating commercial policies by the auto makers.

4 Liberalizing the restriction on cross-district sales

The New Measures would further liberalize the regional distribution restrictions for vehicles and accessories. For example, "manufacturers and distributors may not set limits based on the consumer's residential location" (although in Beijing, Shanghai, Shenzhen, Hangzhou, etc. where limited number of car licenses apply in these cities, many distribution networks for well-known brands have, to a certain extent, already removed this restriction). The New Measures also require manufacturers not to "limit the resale of automobile products (i.e. cars and parts) between distributors". This will also lay the foundation for a more efficient utilization of the automobile resources across the nation.

5 Relaxation of sales of non-original parts by distributors

The New Measures provide that "distributors selling to consumers or providing accessories/parts, other than authentic parts, shall highlight and disclose this fact to the consumers". Under the New Measures, the concept of 'authentic accessories or original parts, the quality-matching accessories, refurbished parts, and recycled parts' have each been defined. Of these terms, the concept of the quality-matching accessories will remain controversial for the foreseeable future. For example, which institutions will be responsible for identifying the "performance and quality standards necessary to meet the standards of the original accessories"? Does the "relevant technical standards" refer to the national standards, industry standards or manufacturer of standards? This may require implementation rules or operational guidelines to be issued by industry associations, national quality supervision bodies and other departments.²

6 Expansion of accessory distribution channels

In the past, accessories manufacturers were only able to supply original parts to the automobile makers and were restricted from producing and selling quality matching parts. The New Measures stipulate that there "shall not be restrictions on transaction counterparty of parts manufacturers", which lifts the restriction on parts producers from supplying original parts and accessories or quality-matching parts to third-parties other than through the automobile makers or their authorized distributors. In addition, the New Measures provide that car manufacturers 'shall not restrict resale of parts by distributors or after-sales service providers', whereby distributors are allowed to resell original parts supplied by parts producers. This is in line with the Guidance on the Promotion of the Vehicle Maintenance Industry to upgrade the Quality of Services, jointly issued by a collection of ten governmental bodies in 2014.

The NDRC, in the course of its anti-monopoly law enforcement in the automobile industry, has also promoted the idea of allowing automobile parts manufacturers and distributors to resell parts and accessories. This is designed to further diversify the sales channels available for parts and accessories and to promote and improve the after-sales sector.

7 Other prohibitions

The New Measures prohibit auto manufacturers from engaging in certain unreasonable business practice vis-à-vis distributors, such as "requiring distributors to bear costs of advertisement and automobile show promotion which are carried out under the name of manufacturers or limiting advertising and media used by distributors". The New Measures also prohibit manufacturers' "interference with the distributors' human resources and financial management as well as other activities within the scope of distributors' own business" (however, the scope and extent of "distributors' own business" may be broad and difficult to define').

8 Conclusion

The New Measures are the product of many years of drafting work. There have been heavy interactions between car manufacturers, distributors and accessories producers throughout the drafting process. The true impacts of these New Measures may not be apparent for a while.

From an anti-trust point of view, we would hope other guidance documents, such as draft Antitrust Guidelines for the Automotive Industry, will be brought in line with the New Measures. In particular, the prohibitions contained in Article 24 of the New Measures seem to overlap with prohibitions of the draft Antitrust Guidelines for the Automotive Industry on vertical restrictions, such as prohibitions on manufacturers from setting unreasonable sales targets or inventory targets for their distributors.

It is worth noting that the legal consequences of violations under these different rules and regulations are markedly different. Under the New Measures, fines are capped at RMB 30,000, yet violations of the Anti-Monopoly Law (the "AML") may lead to fines of up to 10% of the previous years' turnover of a company. Where a manufacturer has violated and been fined under the New Measures, will the anti-trust law enforcement agencies be able to impose a higher penalty on the manufacturer under the AML for the same violation? If not, will this negatively impact the deterrent effect and execution of enforcement actions by the antimonopoly law enforcement?

Additionally, the New Measures contain a number of provisions which appear to conflict with the AML and draft Antitrust Guidelines for the Automotive Industry. For example, the New Measures prohibit manufacturers from engaging in tie-in sales relating to unsold cars, accessories and other goods'. However, the AML only prohibits these types of activities where they are "unjustified" and manufacturers have "market dominance", both of which are the prerequisites for the prohibition to apply.

Similarly, Article 24 of the New Measures prevents automobile manufacturers from restricting distributors from 'distributing products for other automobile manufacturers or suppliers'. However, the draft Antitrust Guidelines for the Automotive Industry recognizes that "automobile suppliers without a market dominant position may impose on the distribution channels exclusive purchase obligations for a certain period given this can raise the quality standard of such distribution channels and is helpful in establishing and maintaining the brand image, while allowing the supplier to increase its brand attractiveness to the consumers and therefore increase sales volumes".

There are still many issues to be resolved from the perspective of ensuring the consistency between anti-trust laws and industry regulations (such as the New Measures). However, in the long run, we believe that the implementation of the New Measures would promote the improvement of the relationship between manufacturers and distributors in the automobile industry. At the same time, we also look forward to receiving further clarifications from the relevant authorities regarding how these rules are expected to operate in practice, either through detailed implementing rules or through further guidance to be provided during future law enforcement.

Footnotes

1 A '4S' store provides four functions as part of a franchise agreement with a manufacturer, namely: (i) Sales of automobiles, (ii) Spare parts, (iii) Servicing, and (iv) Surveys.

2 The quality-matching accessories referred to in this approach is not recognized by the automobile manufacturer, produced by the parts manufacturer, but their performance and quality would meet the relevant technical standards required for the original parts.