1 Antitrust Basics Brown Bag Series Lesson XII: Vertical Restraints Stacey Anne Mahoney Constantine Cannon LLP Wednesday, August 15, 2007

2 2 Attorney Work Product Types of Vertical Restraints of Trade Vertical Non-Price Restraints on Distribution Distribution Restrictions Dealer Terminations Refusals to Deal Vertical Non-Price Restraints on Purchasing Tying Arrangements Exclusive Dealing Reciprocal Dealing Vertical Price Restraints Minimum Resale Price Maintenance Maximum Resale Price Maintenance Consignment Arrangements Suggested Resale Prices Most Favored Nation Clauses Promotional Programs

3 3 Attorney Work Product Governing Statutory Law Sherman Act § 1 “Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several States, or with foreign nations, is declared to be illegal.” Sherman Act § 2 “Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other person or persons, to monopolize any part of the trade or commerce among the several States, or with foreign nations, shall be deemed guilty of a felony....” FTC Act § 5 “The Commission is hereby empowered and directed to prevent persons, partnerships, or corporations... from using unfair methods of competition in or affecting commerce and unfair or deceptive acts or practices in or affecting commerce.” Clayton Act § 3 “It shall be unlawful for any person engaged in commerce, in the course of such commerce, to lease or make a sale or contract for sale of goods, wares, merchandise, machinery, supplies, or other commodities... for use, consumption, or resale... or fix a price charged therefor, or discount from, or rebate upon, such price, on the condition, agreement, or understanding that the lessee or purchaser thereof shall not use or deal in the goods, wares, merchandise, machinery, supplies, or other commodities of a competitor or competitors of the lessor or seller, where the effect of such lease, sale, or contract for sale or such condition, agreement, or understanding may be to substantially lessen competition or tend to create a monopoly in any line of commerce.”

4 4 Attorney Work Product “The finder of fact must decide whether the questioned practice imposes an unreasonable restraint on competition, taking into account a variety of factors including specific information about the relevant business, its condition before and after the restraint was imposed, and the restraint’s history, nature, and effect.” State Oil Co. v. Khan, 522 U.S. 3, 10 (1997). The basic inquiry under the Rule of Reason is whether the vertical restraint in question “is one that promotes competition or one that suppresses competition.” National Society of Professional Engineers v. United States, 435 U.S. 679, 691 (1978). Vertical Restraints are Generally Subject to Rule of Reason Analysis

5 5 Attorney Work Product Interbrand, rather than intrabrand, competition is the “primary concern of antitrust law.” Continental T.V., Inc. v. GTE Sylvania Inc., 433 U.S. 36, (1977). See also Volvo Trucks N. Am. v. Reeder-Simco GMC, Inc., 546 U.S. 164, __, 126 S. Ct. 860, 872 (2006). Generally speaking, negative effects on intrabrand competition of vertical non- price restraints are insufficient to establish liability pursuant to § 1. See, e.g., Business Elecs. Corp. v. Sharp Elecs. Corp., 485 U.S. 717, , (1988). A key analytical issue is whether the restraint provides the “[p]otential for simultaneous restriction of intrabrand competition and stimulation of interbrand competition.” Sylvania, 433 U.S. at Vertical Restraints are Generally Subject to Rule of Reason Analysis (cont.)

6 6 Attorney Work Product Vertical Restraints are Generally Subject to Rule of Reason Analysis (cont.) Ultimately, the question is whether the anticompetitive effect of the vertical restraint in question substantially outweighs the procompetitive effect for which the restraint is reasonably necessary. It is a very fact specific inquiry.

7 7 Attorney Work Product Vertical Restraints are Generally Subject to Rule of Reason Analysis (cont.) Recent Supreme Court cases confirm application of the Rule of Reason even for vertical price-based restraint claims. State Oil Co. v. Khan, 552 U.S. 3 (1997) (holding that maximum resale price maintenance is subject to rule of reason analysis) (unanimous decision) (overruling Albrecht v. Herald Co., 390 U.S. 145 (1968)). Leegin Creative Leather Products, Inc. v. PSKS, Inc., 127 S. Ct (2007) (holding that minimum resale price maintenance is subject to rule of reason analysis) (5-4 decision) (overruling Dr. Miles Medical Co. v. John D. Park & Sons Co., 220 U.S. 373 (1911)).

8 8 Attorney Work Product Vertical Restraints are Generally Subject to Rule of Reason Analysis (cont.) Dual Distribution Systems In an interesting analytical anomaly, where a manufacturer simultaneously supplies product to a distributor pursuant to a non- price vertical distribution restraint, e.g., a customer restriction, and competes with that distributor in selling the same product to the purchaser population, courts have applied a vertical restraint rule of reason analysis despite the apparent horizontal aspect of the challenged restraint. See, e.g., White Motor Co. v. United States, 372 U.S. 253 (1963). United States v. Arnold, Schwinn & Co., 388 U.S. 365 (1967), overruled on other grounds by Continental T.V., Inc. v. GTE Sylvania Inc., 433 U.S. 36 (1977). And, more recently, AT&T Corp. v. JMC Telecom, 470 F.3d 525 (3d Cir. 2006).

9 9 Attorney Work Product Exceptions to Rule of Reason Analysis of Vertical Restraints Price restrictions related to customer or territorial restraints have been generally deemed to be per se illegal. See, e.g., United States v. Sealy, Inc., 388 U.S. 350 (1967); United States v. Bausch & Lomb Optical Co., 321 U.S. 707 (1944). The other exception to the rule of reason analysis, at least in theory if not in practice, is tying. Courts continue to say that there are certain tying arrangements that “pose an unacceptable risk of stifling competition and therefore are unreasonable per se.” Jefferson Parish Hosp. Dist. No. 2 v. Hyde, 466 U.S. 2, 9 (1984). See also Eastman Kodak Co. v. Image Technical Services, 504 U.S. 451 (1992). Certain courts apply tying analysis to reciprocal dealing arrangements as well, but no reported decision since the mid-1980s has sustained this claim.

10 Attorney Work Product Exceptions to Rule of Reason Analysis of Vertical Restraints (cont.) Per Se Elements A judicial finding of per se unlawful tying requires: Two separate products or services; The sale of one product (the tied product) is conditioned on the purchase of the other (the tying product); The seller has market power in the tying product such that it can restrain trade in the tied product market; and A not insubstantial amount of interstate commerce in the tied product market is affected. See, e.g., Fortner Enters. v. United States Steel Corp., 394 U.S. 495 (1969); In re Visa Check/MasterMoney Antitrust Litig., 280 F.3d 124 (2d Cir. 2001). And maybe: An anticompetitive effect in the market for the tied product. See, e.g., U.S. Phillips Corp. v. International Trade Comm’n, 424 F.3d 1179 (Fed. Cir. 2005).

11 Attorney Work Product Rule of Reason Analysis: Guidance from Leegin “ [C]ertain factors are relevant to the inquiry of whether minimum resale price maintenance is procompetitive or anticompetitive. For example, the number of manufacturers that make use of the practice in a given industry can provide important instruction. When only a few manufacturers lacking market power adopt the practice, there is little likelihood it is facilitating a manufacturer cartel, for a cartel then can be undercut by rival manufacturers.” “Likewise, a retailer cartel is unlikely when only a single manufacturer in a competitive market uses resale price maintenance.” “Resale price maintenance should be subject to more careful scrutiny, by contrast, if many competing manufacturers adopt the practice.” “The source of the restraint may also be an important consideration. If there is evidence retailers were the impetus for a vertical price restraint, there is a greater likelihood that the restraint facilitates a retailer cartel or supports a dominant, inefficient retailer.” “If, by contrast, a manufacturer adopted the policy independent of retailer pressure, the restraint is less likely to promote anticompetitive conduct.” “A manufacturer also has an incentive to protest inefficient retailer-induced price restraints because they can harm its competitive position.” “As a final matter, that a dominant manufacturer or retailer can abuse resale price maintenance for anticompetitive purposes may not be a serious concern unless the relevant entity has market power.” Leegin, 127 S. Ct. at

12 Attorney Work Product Rule of Reason Analysis: Guidance from Leegin (cont.) Market Characteristics of Pro-Competitive Minimum Resale Price Maintenance Lower prices Increases consumer choice Facilitates entry and/or innovation Overcomes free rider problem/facilitates additional services Provides prestige value Facilitates demand and/or inventory stabilization Increases sales of product subject to restraint Market is characterized by highly differentiated products Market is characterized by low barriers to entry

13 Attorney Work Product Rule of Reason Analysis: Guidance from Leegin (cont.) Market Characteristics of Anticompetitive Minimum Resale Price Maintenance Higher prices Imposer of restraint has market power The industry is highly concentrated The restraint is a widespread practice The restraint is driven by retailers (as opposed to manufacturers) The restraint facilitates cartel-like conduct Sales of product subject to restraint would not benefit from increased services Market is characterized by homogeneous product

14 Attorney Work Product Rule of Reason Analysis: Guidance from Leegin (cont.) Leegin May Not Completely Change the Minimum Resale Price Maintenance Law Congress or the States may legislatively overrule Leegin. States may not follow Leegin: 37 states filed amicus curiae with the Supreme Court urging the Court to uphold Dr. Miles and maintain the per se rule against minimum resale price maintenance. Resale price maintenance remains illegal in some foreign jurisdictions.