A Rule Of Reason For Vertical Price Fixing - Part II

Thursday, November 1, 2007 - 01:00

This is the second half of an examination, begun in last month's issue, of the Supreme Court's recent rejection in the Leegin case of its 96-year-old rule against resale price maintenance ("RPM"). In this installment, the authors assess the potential practical ramifications of the decision in the U.S., as well as overseas attitudes concerning RPM.

When these words are first published, the Supreme Court's decision in Leegin Creative Leather Products, Inc. v. PSKS, Inc. , 127 S. Ct. 2705 (2007), will barely be four months old. Yet, in its wake, there will have been: (i) a class action brought under state law against Leegin, challenging the same conduct on which Leegin's argument prevailed under federal law (already filed); (ii) views stated publicly by leading state enforcement officials that the Leegin decision may place the burden on a defendant to prove that enhanced service outweighs anti-competitive effects from any RPM agreement (already expressed); and (iii) untold numbers of businesspersons asking their in-house counsel, "Now I can set pricing along with my [supplier, distributor, or retailer], right?"

For the near future, at least, the last question may pose quite a challenge. As discussed in last month's article, the Leegin decision replaced a bright-line rule holding minimum RPM to be per se unlawful with a balancing test under the Rule of Reason. The challenge now becomes figuring out how to balance asserted pro-competitive justifications and potential anti-competitive effects, based upon questions raised by the Court's general "guidance" on the matter: Is there a risk of cartel effects from RPM among suppliers in the product category? What was the impetus for the arrangement? What other outlets are available on the retailer level?

As a practical matter, each of the following "real world" issues would seem to merit inquiry in assessing risk under the Sherman Act in undertaking a minimum RPM agreement:

Is this a service-oriented business?
Encouraging customer service can be a pro-competitive rationale for RPM. Accordingly, the higher the level of service demanded in the business, the lower the risk for this factor.

Is there a dominant supplier or retailer in the product category?
Risk and market share, too, are likely inversely related. If each participant possesses little or no market power (say, 20 percent share or less), this factor should be less troubling, but if a participant on either level possesses arguable market power (say, 30 percent or more), concerns may be raised about the availability of other outlets.

What is the impetus for the restraint?
RPM instituted by a manufacturer - arguably seeking to encourage investment and discourage low-service retailers - is likely to be less troubling than RPM suggested or coerced by retailers (particularly, a retailer cartel) who may be inefficient and merely seeking to enhance margins.

How broadly is RPM adopted within the product category?
The more the merrier - NOT! If many or all suppliers adopt minimum RPM, the price effects may be the same as in a cartel, and that's a lot to counterbalance.

What is the effect on interbrand prices?
As discussed in Part I of this article, the Supreme Court has repeatedly emphasized that interbrand competition is the primary focus of the antitrust laws. If it seems likely that interbrand prices will rise as a result of the contemplated RPM (especially if there is no evidence of enhanced retail services to consumers), caution may be warranted.

What evidence exists of discussions about RPM among retailers or suppliers in the product category?
If there are no discussions, then clearly this is a low risk factor. However, opportunities for competitors to talk exist in virtually every industry - e.g. , at trade association meetings - and evidence of actual discussions could be portrayed as using RPM to achieve cartel-like results.

Even after weighing those factors, though, the "whether, when, and how" questions for instituting a minimum RPM agreement may not be answered for many suppliers. For example, if a group of retailers request RPM, a supplier should be careful that any response not only represents, but is perceived as, an independent business decision. And timing may also be a concern. For the small player, or a participant in a highly fragmented market, it may be of little import, in terms of effect on competition, whether one adopts RPM first, last, or somewhere in between. For a dominant player, however, there may be concerns that being a first mover could be characterized as sending a "message" to the industry and make one a target of any lawsuit or investigation, as well as that being among the last to adopt could push the envelope too far in terms of an oligopolistic industry's participation.

Given all of these complications and others, a threshold question also should be, "Do we really need an RPM agreement?" A manufacturer may want RPM in order to encourage investment, services, and promotions, and thereby increase demand for its products in competition with other brands - activities that might be compromised by free-riding, low-overhead retailers. Those (legitimate) goals, however, might also be realized through a unilateral minimum resale price ("UMRP") policy, whereby the manufacturer announces a minimum resale price but neither solicits nor accepts any agreement on it. Such a policy, and the supplier's decision to terminate non-complying purchasers, may be fully protected as unilateral conduct under the Colgate doctrine, provided that the policy is properly drawn and administered .

If the decision is made to pursue RPM, the paper trail will be important here, too. One should know whether a supplier's documents, for example, support or contradict arguments that RPM was instituted to, among other things, give consumers more choice in terms of service/price selections; potentially give consumers more choice in outlets by encouraging returns on investment and facilitating new entry; and increase demand and interbrand competition as a consequence. Evidence of requests for RPM from inefficient retailers seeking to forestall innovations in distribution or induce exclusive dealing arrangements likewise should be taken into account.

Yet, all of those considerations, among others, just address the direct result of the Leegin decision: the application of the Rule of Reason to a vertical agreement on price under Section 1 of the Sherman Act. But plaintiffs can be expected to adapt - perhaps by searching for horizontal elements in the RPM agreement on the supplier and/or purchaser level, perhaps by trying to plead a case for conspiracy to monopolize or a power buyer controlling retail prices, or otherwise under federal law.

And on the state level, the battle is just being joined under state antitrust and unfair competition laws, with an uncertain future. It is not hard to conceive that some states may enact statutes outlawing RPM as anti-consumer. Indeed, RPM is already unlawful, at least under the current state of the law, in California, and RPM agreements are not enforceable under New York's Donnelly Act. Ironically, the Supreme Court's determination to remove a "trap for the unwary" in the form of the per se rule may foster not merely difficult analysis under federal law but also wildly varying results across the states.

Meanwhile, the Leegin decision also has made life more complicated for companies that distribute their products overseas as well as in the U.S. At least in the short term, Leegin appears unlikely to alter the bright-line prohibition on minimum RPM that is applied across the border in Canada or by another significant trading partner, the European Union. Under the Canadian Competition Act, minimum RPM remains a per se illegal criminal offense, punishable by fines and/or imprisonment. Unlike the U.S., Canadian law makes no distinction based on whether minimum RPM is imposed by the manufacturer unilaterally or agreed upon. Refusing to supply or discriminating against discounting retailers also may be unlawful. The Leegin decision thus widened the gulf between U.S. and Canadian law on RPM, and poses significant practical challenges for companies desiring to implement a consistent North American distribution policy. In short, practices that might be endorsed by federal courts under Leegin may still create criminal exposure in Canada. The Canadian government has recently convened a Competition Review Panel to evaluate whether amendments to the Canadian competition laws are appropriate. One would expect the Panel to take a hard look at the implications of maintaining per se illegality of minimum RPM in Canada in light of the Leegin decision. However, Canada has traditionally taken a harsher view of minimum RPM and it may not be compelled to adopt the more liberal approach of its U.S. neighbor.

A similarly hard line approach exists in Europe. Under Article 81(1) of the EC Treaty, agreements to fix minimum resale prices are per se illegal. Indeed, their unlawfulness is legislatively enshrined as a "black list" restriction in the block exemption for vertical restraints. The presence of an RPM obligation in a distribution contract will render the entire agreement ineligible for exemption under Article 81(3) and thus unlawful. A supplier can impose upon the buyer a maximum resale price or recommend a certain selling price, provided this does not amount, as a result of the parties' conduct (such as pressure or incentives created by the supplier), to an obligation on the distributor to sell at a fixed price, or to a prohibition on selling below a minimum price. In sum, maximum and recommended resale prices do not constitute "hardcore" unlawful restraints, while fixed and minimum prices do. Interestingly, before the single European market and EC competition law were established, many European countries actually permitted and enforced RPM contractual obligation. However, this more liberal approach to RPM receded with the development of a pan-European system of competition law and enforcement, which imported many of the fundamentals of U.S. antitrust jurisprudence.

Whether the Leegin decision will be imported to the EU and if so, in what form, remains to be seen. It is true that the case law of the European Court of Justice from the 1970s contains the seeds of a Leegin approach, recognizing in the context of selective distribution systems that price competition is not the only competitive variable and that maintaining a certain price may be necessary to provide high quality services. In a passage that is reminiscent of the majority opinion in Leegin , the ECJ observed in Metro/Saba 26/76 [1977] ECR 1875 that what matters in the context of selective distribution systems is whether consumers have the choice to buy from higher priced/service retailers as well as lower priced/service outlets.

However, as Europe has developed its own antitrust rules and philosophy, distinct contrasts stood out from the U.S. model. An important influence on competition policy and practice in Europe is the political objective of achieving single market integration. European distribution networks have traditionally followed national borders, and EU competition authorities have indicated that vertical restraints, especially RPM, may entrench national markets and inhibit pan-European trade and pricing. Consequently, in thinly veiled efforts to promote single market integration, the EC has brought numerous enforcement actions to preserve intrabrand competition in products where a manufacturer's price or non-price restrictions prevented dealers from selling lower priced products (in many cases, motor vehicles) in other EC member states. Unlike what might be expected in the U.S., the fact that there was healthy interbrand competition among car manufacturers in each of those markets apparently did not enter significantly into the competition analysis.

Nevertheless, the EC has been quite versatile in adapting its approaches in response to paradigm shifts in antitrust policy "across the pond." While in the near term minimum RPM may remain per se unlawful in Europe, plaintiffs may find it more difficult to establish the existence of an unlawful agreement between manufacturer and dealer to impose minimum RPM. Indeed, the European Court of Justice's decision last year in Commission v. Volkswagen held that Volkswagen's entreaty to dealers to maintain "strict price discipline" was a unilateral offer and not an unlawful agreement to maintain RPM, absent evidence of acquiescence in one by the dealers. That approach is certainly a start down the analytical road from our Supreme Court's 1911 Dr. Miles decision. Whether it will take the EC decades to reach its destination remains to be seen.

Scott Martin and Fiona Schaeffer are Partners of Weil Gotshal & Manges, resident in the firm's New York office, and members of the Antitrust practice group of the firm's Litigation & Regulatory Department. Mr. Martin is also a member of the Complex Commercial Litigation practice group.

Please email the authors at martinsc@gtlaw.com or fiona.schaeffer@weil.com with questions about this article.