McDermott Will & Emery has a strategic alliance with MWE China Law Offices, a separate law firm based in Shanghai. This China Law Alert was authored by MWE China Law Offices lawyers David Dai and Lawrence Hu.
Chinese law enforcement agents and market watchdogs are carrying out a nationwide campaign to crack down on controversial Supermarket Charges by large-scale retailers against suppliers.
On 19 December 2011, The Working Plan of Clearing Up Non-Compliant Supermarket Charges (the Plan) was jointly issued by China’s Ministry of Commerce, National Development and Reform Commission, Ministry of Public Security, State Administration of Taxation, and State Administration of Industry and Commerce under due approval by Central Government. According to the Plan, the above five government agencies launched a nationwide campaign from December 2011 to June 2012 to investigate and crack down on the illegal slotting fees charged by large-scale retailers against suppliers.
Supermarket Charges, mainly slotting fees that shopping malls and supermarkets charge suppliers for access to their stores, have long existed in the Chinese retail sector since China’s market opened up in the 1990s. Although, the implementation of Supermarket Charges was for good reason—they paved the way for the quick expansion and development of China’s retail business—the over-reliance of Chinese retailers on such easy-come revenue has created huge problems, including, but not limited, to the loss of drivers for retailers to improve their operational capacity to stay competitive and the increase of commodity prices consumers ultimately have to pay.
In the absence of regulation at first inception, Supermarket Charges were justified by mutual agreements between retailers and suppliers. However, given the dominant market powers of large-scale retailers, more and more slotting fees, in the name of festival fees, new opening fees, decoration fees, bar-code fees, contract re-signing fees, information fees and so on, are being imposed on suppliers, particularly small and medium suppliers who do not have the bargaining power to stand up for their own rights. As such, the legality and reasonableness of Supermarket Charges have been gradually debated and challenged by Chinese legal and business communities.
In October 2006 the Chinese government rolled out regulations to regulate Supermarket Charges, which prohibit retailers from charging promotional fees outside the contractual service fee, fees under the guise of signing or re-signing contracts or service fees for festivals, anniversaries, new openings, re-openings or listings, without providing additional promotional services. However, since then, little has been achieved by these regulations. In fact, statistics show that Supermarket Charges have actually increased instead of reduced.
Retailers to be Investigated
The supermarkets subject to investigation and crackdown under the Plan include those that satisfy the following conditions:
- The largest store is more than 6000 square metres
- The number of stores is more than 20
- The total revenue of 2010 exceeds more than RMB 2 billion
However, even if supermarkets that do not meet the above requirements are informed against by suppliers to have collected noncompliant Supermarket Charges, they will be included in the Scope by the above five government agencies at a provincial level, and will end up being reported to its counterparts under the Central Government.
Clarification on the Business Model and Chargeable Fees
In order to clear up misunderstandings, the Plan categorizes the business models between supermarkets and suppliers with their profit-generating mechanism being identified respectively. The details are as follows:
Purchase and Resale: The supermarkets under this model may derive income from the differential between the resale price to end consumers and the purchase price from suppliers.
Leasing of Counter: The revenue source under this model is from the fee placed on leasing of counters.
Consignment Sale: The supermarkets under this model mostly rely on their consignment service fee.
This has paved the way for how to further judge the legality of Supermarket Charges, as the Plan provides that charges beyond the above definitions of income sources under each model will be subject to clearing up.
Subsequently, with respect to commonly used Supermarket Charge items, the Plan goes into details from two perspectives. One is regulating the Promotion Fee. According to the Plan, the Promotion Fee refers to the one charged on the service provided by supermarkets to suppliers’ brands through printing posters, launching promotional activities and placing advertisements, etc. Further, the Promotion Fee should be expressly stipulated in the agreement and fully performed by the supermarkets.
Noncompliant Charges are also forbidden. Noncompliant Charges are divided up into six subcategories: (i) fees for the renewal of agreements; (ii) barcode fees exceeding their actual costs or ones repeatedly charged; (iii) store decorating fees; (iv) fees charged for festival celebration, store celebration, new store opening business, etc; (v) sale rebates irrelevant to the sale volume goal, or those that are forced to return even if the conditions of sale volume goal are not achieved; and (vi) other fees irrelevant to the promotion service.
Steps of Investigation and Crack-down
The Plan sets forth the following steps to investigate and crack down on questionable Supermarket Charges by large-scale retailers:
Self-Investigation: The Plan requires all of the supermarkets to do self-investigation on Supermarket Charges in 2010 and 2011, and to report the results to the relevant government agencies before Jan 15, 2012.
Joint Investigation: The investigation team covering different government agencies at district, city and province levels will launch a joint investigation on all of the chain stores from February 2012 to April 2012.
Require Correction: Following the above two steps, the stores are required to return Noncompliant Charges to the suppliers, serious districts will then be subject to re-investigation by government agencies.
Summary and Legislation: In the end, the investigation team and government agencies concerned summarise all the problems encountered in the investigations and propose corresponding solutions to move the legislation process forward.
The Plan is intended to clear up the relationship between supermarkets and suppliers by categorizing it into three models. However, such defined models may not be able to match Supermarket Charges seamlessly. For example, if the relationship between supermarkets and suppliers is deemed as a purchase-and-sale, the ownership of suppliers’ commodities will generally be transferred to supermarkets after shipment. Then, the above-mentioned promotion activities conducted by supermarkets are for the benefits of themselves instead of suppliers only, which seems not to be appropriate for supermarkets to charge so-called Promotion Fees from suppliers.
Further, Shanghai High People’s Court issued an interpretation (Interpretation) several years ago, under which the relationship between supermarkets and suppliers was defined as a collaboration, as compared with a traditional purchase-and-sale or lease relationship. The Interpretation further legalized three categories of Supermarket Charges: Vendor Allowance (rebate calculated based on the volume of suppliers’ commodities that have been successfully sold to end consumers), Promotion Fee (the fee for the promotion service provided by supermarkets to suppliers) and Channel Fee (the fee for the size and number of chain stores, the display place of commodities, etc.). By comparison, the Plan does not fully echo the Interpretation in the Channel Fee. For example, if supermarkets launch a new chain store and charge a fee item named the Fee of Start-Up of a New Store, the Interpretation and the Plan hold different views on this with the former deeming it legal and the latter maintaining its illegal. In summary, a consensus on Supermarket Charges is far from being reached, which may confuse the community going forward.
Despite the confusions discussed above, it is advisable for either supermarkets or suppliers to do something to be in full compliance with the Plan and its relevant investigation.
From supermarkets’ side, it is recommended they do at least three things: review their contracts with suppliers to check if there are charge items that are blacklisted by the Plan; consider whether to shift the amount under such blacklisted items to others that are not blacklisted; and rename the original charge items to ones that sound compliant, if possible.
From suppliers’ perspective, they should take advantage of this opportunity to minimize their burden by amending their contracts in execution. By reviewing all of their contracts with supermarkets, they may approach supermarkets to delete the blacklisted charge items under the claim of avoiding supermarkets’ being challenged by government agencies.
In doing the above, both supermarkets and suppliers should take care of the corresponding tax implications and invoice treatments, as well to keep agreements and practices fully compliant with China laws and regulations.
The MWE China Law DifferenceMWE China Law Offices in Shanghai, which has a strategic alliance with McDermott Will & Emery, is one of few firms that have kept an eye on the distribution industry and is capable of advising on all issues in this industry. We view the current relationship between supermarkets and suppliers as a complex legal structure that is subject to the regulation of contract law, tax law, competition law, pricing law and other regulatory regimes. We have represented a leading supermarket in the acquisition of another store focused on Mainland China, and successfully helped this client identify all the tax noncompliance acts (especially for tax and invoice treatments of Supermarkets Charges) and establish an internal compliance policy. We also helped several leading clients in the Fast-Moving-Consumer-Goods industry engage in reviewing their contracts with almost all of the supermarkets around Mainland China.