Fx Enterprise Solutions India v Hyundai Motor India: Satisfying the Rule of Reason?
Author: Rhea Elizabeth Paul
The author is a student at the National Law School of India University, Bengaluru
Restrictions on competition in the market can broadly be classified into two categories: horizontal and vertical restraints. Horizontal agreements exist between parties at the same market level, and vertical agreements exist between parties at different stages or levels of the production chain.
Of the various types of vertical restraints listed under Section 3(4) of the Competition Act, 2002, this piece focuses solely on resale price maintenance (‘RPM’). RPM is an arrangement in which the buyer is prohibited from selling a product below a particular price.
Fx Enterprise Solutions India Pvt. Ltd. and Ors. v. Hyundai Motor India Limited is the only case in Indian law thus far where RPM between a manufacturer and dealer has been penalised by the CCI. In this post, I shall argue that firstly, Section 19(3) of the Competition Act, 2002, provides for analysis similar to the rule of reason to be carried out in cases concerning vertical restraint agreements, and secondly, in deciding Hyundai, the CCI failed to carry out this rule of reason analysis.
II. The Law
Section 3(4)(e) of the Competition Act, 2002 deals with RPM agreements. It must be read with Section 19(3), which provides a list of six factors. The CCI must consider these factors when determining whether an agreement under Section 3 has an appreciable adverse effect on competition (AAEC). While the first three sub-clauses under this section deal with negative effects that an agreement may have, the remaining three point out efficiency-enhancing effects. Therefore, the framework laid down under this section provides for a balancing assessment, analogous to the rule of reason analysis, by which the CCI may gauge whether a vertical restraint agreement causes AAEC.
III. Analysing the CCI decision using the Rule of Reason
The rule of reason was established more than 120 years ago in Addyston Pipe and Steel Co. v. United States. This enormously influential decision was written by William Howard Taft (who later became both President of the United States and then Chief Justice of the United States Supreme Court), and has been constantly cited as a mainstream principal of U.S. antitrust law, for example, , Leegin Creative Leather Products Inc. v. PSKS Inc.
The Rule of Reason requires a careful examination of the pro- and anti-competitive aspects of an agreement, with the judge, eventually required to decide, considering everything, what was “reasonable” under the circumstances. (Obviously, arrangements like price-fixing or bid-rigging are never subject to the Rule of Reason and are condemned as “per se” illegal.) The doctrine recognises that the economic benefits to such an agreement may outweigh the negative effects, and therefore the facts of each case must be examined individually. For example, in Ohio v. American Express, the Supreme Court concluded, that although American Express’s anti-steering provisions may have increased merchant costs, the analysis also needed to consider the benefits to the cardholders, including the increased value delivered to them in the form of rewards. That decision upheld American Express’s restraints as reasonable.
The rule of reason was recently acknowledged by the CCI in Jasper Infotech Pvt. Ltd. v. KAFF Appliances Pvt. Ltd., where it held that vertical restraint agreements must be subjected that analysis to determine whether the agreement has caused AAEC.
In Fx Enterprise Solutions India Pvt. Ltd. and Ors. v. Hyundai Motor India Limited, the dealership agreement contained three vertical restraint arrangements, one of which involved the imposition of a maximum discount at which dealers could sell Hyundai vehicles. This was enforced through mystery shopping agencies which monitored the discounted prices and reported them to the Opposite Party (OP). In cases of non-compliance to the RPM agreement, the dealer was made to pay a penalty. The Director General identified this arrangement as a violation of the Act, a view that was upheld by the CCI.
While deciding this case, the CCI ignored the unique nature of the automobile industry, where the quality of dealer services play a vital role in the sale of cars. In this context, RPM may be a tool used by the manufacturer to ensure that dealers render the best possible distributional services. While this may effectively raise the consumer price, it acts as an incentive to improve the quality of services offered, by ensuring that the dealer can afford to provide the resources that the manufacturer needs to sell its cars. In this case, Hyundai justified the policy by claiming that the RPM was introduced to prevent discount dealers from free-riding off the promotional services of other full-service dealers. In such situations, the savings from presale service investments may be used to lure customers and attract the demand by offering lower prices.
Hence, a restraint on price discounting is pro-competitive to the extent that it pushes dealers to invest in satisfactory marketing to aid the manufacturer’s position as against rival competitors. One of the parameters under Section 19(3) is the improvement of services. As a result, the CCI ought to have addressed and analysed Hyundai’s defence with respect to free-riding before deciding if the agreement had an appreciable adverse effect on competition. However, as shown in the excerpt below, the CCI failed to recognize that along with price competition, the improvement of services is also an area that benefits consumers.
“RPM can prevent effective competition both at the intra-brand level as well as at the inter-brand level. When a minimum resale price maintenance is imposed by the manufacturer of a particular brand, distributors are prevented from decreasing the sale prices. In other words, the mechanism does not allow the dealers to compete effectively on price. The stifling of intra-brand competition results in higher prices for consumers. In the instant case, the imposition of upper limits on discounts that dealers may offer to final consumers through the discount control mechanism of the OP leads to loss of intra-brand price competition.”
Without engaging in the beneficial aspects of Hyundai’s RPM agreements, the CCI adopted a narrow approach by making the generalised assertion that RPM affected inter-brand competition by relaxing the pricing pressure on competing manufacturers. The veracity of this theory was not supported by any specific evidence in this case, particularly an analysis of Hyundai’s market power which would be a significant factor in such a claim. In M/S Counfreedise v. Timex Group India Limited, it was held that the manufacturer would have to occupy a substantial market share in order for an RPM agreement to have an anti-competitive impact on the market. Therefore, a study of the market power held by the OP is important in concluding on whether an RPM agreement leads to AAEC. Such an analysis was not carried out by the CCI in the present case.
With respect to RPM, the crux of the CCI’s decision in Hyundai was premised on only the price aspect of competition. The CCI held that prescribing a maximum discount effectively increased prices and would thus lead to consumer harm as well as stifle intra-brand competition. However, higher prices alone do not indicate that the agreement has caused AAEC and an effort must be made by the CCI to assess the arrangement according to the parameters set out under Section 19(3). A number of questions regarding the validity of Hyundai’s submissions, such as the prevention of free riding and the specific effects of this RPM agreement on intra-brand and inter-brand competition were left unanswered.
While the absence of an independent investigation was noted by the NCLAT, no further clarifications were given regarding the shortcomings of the CCI’s analysis. Unlike Section 3(3), which raises a presumption of AAEC with respect to horizontal restraints, no such presumption exists for vertical restraint agreements under Section 3(4). Therefore, the burden of proving that the agreement has caused AAEC lies on the CCI and in doing so, any benefits it may have on the market must be taken into consideration. In the present case, by overlooking the pro-competitive effects of the RPM agreement, the CCI failed to conduct a rule of reason analysis in determining whether the agreement caused AAEC.