China Ups Scrutiny of Healthcare Industry, Expands Blacklist

Chinese regulators are ratcheting up their scrutiny of corruption at drug and medical device makers and their agents that do business in the country and putting some companies on a blacklist that limits or bars them from selling products in the country.

China's National Health and Family Planning Commission (NHFPC), the agency responsible for improving medical and healthcare services in the country, published the new rule last month, which creates a two-tier blacklist system.

“The new blacklist uses a two-strike policy,” explains Nathan Bush, Singapore-based partner in the litigation department of law firm O'Melveny & Myers. The first appearance on the blacklist will trigger a two-year debarment, banning the drug or medical device maker, or its agents, from selling products to state-funded hospitals in the province where the bribery took place.

Those appearing on the list twice in five years will face a two-year nationwide debarment from selling their products to state-run hospitals. “The new blacklist raises the risks that mis-steps by individual employees anywhere in China can jeopardize sales everywhere in China,” says Bush.

The revised rule, which takes effect on March 1, replaces the original one published by the Ministry of Health in 2007, which kept the blacklist private; the new rule establishes that the blacklist will now be made public for the sake of greater transparency. The new rule also states that the blacklisting of one subsidiary does not result in the blacklisting of the parent or other affiliates. 

The move is part of a broader effort by Chinese authorities to eradicate widespread bribery and corruption from the country's healthcare sector. “In principle, more vigorous enforcement by Chinese authorities of domestic anti-corruption rules may actually deter corrupt conduct in a sector long-plagued by allegations of bribery,” Bush says.

“The ramifications of these actions will, without a doubt, extend into the United States,” says Xiang Wang, Asia managing partner for the law firm Orrick Herrington Sutcliffe. Any time Chinese authorities sanction a foreign company for providing bribery to government officials, that can trigger an investigation under the Foreign Corrupt Practices Act, he says. As a result, the revised blacklist system should serve as a warning to U.S. companies doing business in China to pay attention to anti-bribery and anti-corruption laws both in and outside China, he says.

With the new blacklist yet to take effect, and the previous blacklist not made public, China life sciences experts don't want to speculate on what specific companies that could appear on the list. “It's difficult to predict with any certainty whether companies that have had issues in the past will appear on the national blacklist,” says Charles Comey, a partner with the law firm Morrison & Foerster.

According to the NHFPC, however, drug and medical device makers and distributors, or their agents, will be placed on the blacklist of a given province if they have been:

Criminally convicted of paying a bribe;

Found guilty of minor bribery offenses but weren't punished by China's courts or prosecuted by the People's Procuratorate;

Investigated and penalized for bribery by disciplinary authorities of the China Communist Party; or

Penalized by other administrative authorities for bribery.

Companies will receive advance notice in writing by the provincial health authority before being blacklisted and will be given an opportunity to contest the allegations through a written response or a hearing, “but it is not possible to challenge the underlying criminal conviction or administrative penalty imposed by other authorities through this channel,” says Bush.

“The blacklist system may prod some multinational companies to restructure their Chinese operations internally, or to overhaul their distribution systems to contain potential blacklisting risks to specific product lines or regions.”

—Nathan Bush,

Partner,

O'Melveny & Myers

Each provincial public health authority must then report to NHFPC within one month of publishing the blacklist, at which point NHFPC will publish such information on its Website. Among the information published on the blacklist will include the name of the company or agent, its business address, and specific details of the alleged wrongdoing.

In addition to being disqualified from supplying products, state-funded hospitals in other provinces may reduce such companies' bidding scores during collective tenders, also for a period of two years. Katherine Wang, chief China life sciences adviser in the Shanghai office of law firm Ropes & Gray, says that means blacklisted companies will “face immediate negative consequence at the operational level as they will be deprived of the qualification to attend tenders or supply to hospitals.”

In some respects, China's blacklist system is more stringent than other countries. “In many other jurisdictions where blacklists are used, corporate structures are designed to isolate debarment risks, and settlement agreements with authorities are drafted to limit debarment risks to specified affiliates,” says Bush.

Targeting Foreign Companies?

Whether such a blacklist system will favor domestic companies still presents worries for U.S. companies. “Concerns persist that enforcement efforts targeting foreign suppliers might effectively benefit domestic competitors, which may face less scrutiny or lighter penalties,” says Bush.

Not all experts in the life sciences industry see it that way. Because the blacklist applies to both local and foreign companies, “the risk exposure of U.S. drug and medical device companies is not necessarily higher than their Chinese counterparts,” Wang says.

Nonetheless, foreign companies cannot afford to not do business in China. According to an analysis conducted by consulting firm McKinsey & Co., China's healthcare spending is forecast to nearly triple to $1 trillion by 2020 from $357 billion in 2011.

“With growth on this scale, the sector is ripe for opportunity and continued abuses,” says Comey. The new rules signal that China is serious about promoting growth and minimizing illegal practices in one of the most important sectors of its national economy, he says.

The new rule also requires that hospitals sign an integrity purchase and sales agreement that lists the name of the appointed representative of the entity, and further notifies the entity that it will be blacklisted in the event of bribery.

Food and Drug Safety Blacklist

Life sciences experts in China mull the possibility of a similar blacklist system being established for other industries. “Although the NHFPC's blacklist is technically limited to the healthcare sector, its effective implementation might inspire similar measures in other public procurement areas,” says Bush.

Indeed the blacklist system is being considered for other legal violations in China. China's Food and Drug Administration, for example, published proposed rules last month that would give Chinese regulators the authority to blacklist companies that violate food and drug safety laws. The CFDA stated that the intent of the rule would be to “strengthen the supervision and management of food and drug safety.”

Similar to the bribery blacklist for drug and medical device companies, the CFDA's proposed rules signal a renewed effort by Chinese authorities to crack down on the food and drug industry, which has sparked consumer outrage over the last few years after several tainted products—from baby formula to meat products—caused a number of injuries and deaths. In 2008, for example, melamine-tainted formula sold by a domestic provider caused the deaths of six children and sickened thousands more.

According to the proposed rules, food and drug companies would appear on the blacklist if they:

Purchase or use food additives or food-related products that don't meet  China's food safety standard, or if they add other illegal substances;

Concealing relevant information or providing false materials to apply for administrative license;

Failing to comply with production license requirements, mislabeling products and not responding appropriately to food safety incident cases;

Using false, unsubstantiated or misleading marketing specifically related to drug claims.

In the case of serious breaches of violations, blacklisted companies could even have their licenses revoked. The CFDA would manage the blacklist through its Website, and it would also be responsible for investigating and administering penalties. Food and drug companies will appear on the blacklist within 15 days following an administrative penalty decision.

In some respects, China's blacklist system may prove to be a helpful deterrent for U.S. companies in fighting bribery and corruption. “The blacklist system may prod some multinational companies to restructure their Chinese operations internally, or to overhaul their distribution systems to contain potential blacklisting risks to specific product lines or regions,” says Bush.

“Foreign businesses in China are well-advised to develop and enforce comprehensive compliance policies covering every employee whose job duties may place him or her in a position to engage in bribery,” says Comey. “Companies should leverage counsel's expertise and their own government relations teams to understand the practical aspects of policy enforcement at the local level, since enforcement practice can vary between local jurisdictions in China.”