SCUS Holds That All Vertical Price Restraints Are Subject to Rule of Reason

June 28, 2007. The Supreme Court of the U.S. (SCUS) issued its opinion [55 pages in PDF] in Leegin Creative Leather Products v. PSKS, an antitrust case regarding minimum resale price maintenance by manufacturers and intermediate distributors.

The SCUS reversed the judgment of the Court of Appeals, held that all vertical price restrains are to be judged by the rule of reason, and that the SCUS's 1911 opinion in Dr. Miles Medical Co. v. John D. Park & Sons Co., which is reported at 220 U.S. 373, is overturned.

Resale price maintenance (RPM) exists when a manufacturer agrees with its distributor(s) to set the minimum price that the distributor(s) can charge for the manufacturer's goods. Prior to this opinion, RPM was subject to the antitrust per se rule, rather than the lighter rule of reason standard.

This opinion changes the law for vertical RPM. After this opinion, horizontal agreements among competitors to fix prices remain per se violations of the Sherman Act.

The case will impact the way some consumer information technology (IT) and other electronics products are marketed. It will also likely incent IT sector manufacturers to develop new products.

Manufacturers of consumer IT devices sometimes offer products that include numerous new and complicated features and services. But, many consumers do not know what the features are, or how to use the products. In order to promote adoption of new technologies, and sales of their products, manufacturers have an interest in distributors' disseminating information about the new devices through advertising, in store demonstrations, training of employees, and customer support. But, these services impose costs on the distributors who provide them. This can create a free riding situation, when some distributors go to the trouble to provide such information and support, but others do not. The presence of free riders, offering the products at lower prices, disincents other distributors from educating consumers. This, in turn, disincents manufacturers from offering complex devices that require consumer education. And this inhibits innovation in the IT sector.

The Office of the Solicitor General (OSG) submitted an amicus curiae brief in which it explained this free rider problem. The OSG wrote that "an individual retailer has an incentive to free ride on the provision of those services by rival retailers. A retailer offering no services but a lower price can sell to consumers who have been educated by retailers that do provide the services desired by the manufacturer and the consumer. The problem is exacerbated by catalog retailing and the advent of the Internet, as consumers may visit traditional, brick-and-mortar retailers to examine a product and select its features but then purchase the product at a discounted price from a catalog or on-line retailer, whose very lack of ``bricks and mortar´´ affords point-of-sale services impossible and whose lack of expenses for bricks and mortar gives them a competitive advantage over traditional retailers who provide the services that some manufacturers desire."

The use of RPM can incent distributors to engage in consumer education efforts. Thus, this opinion will make it easier for manufacturers to provide such incentives in the marketing of consumer communications, music and satellite radio devices, and other IT products.

The relevant statute, Section 1 of the Sherman Act, which is codified at 15 U.S.C. § 1, provides little guidance. It merely states that "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." Section 1 also contains a criminal prohibition. The rest of the law exists in judicial interpretation and agency enforcement.

The SCUS held in 1911 in Dr. Miles that intrabrand vertical price fixing by manufacturers or intermediate distributors is a per se violation of the Sherman Act. That is, a manufacturer cannot fix the minimum price at which retailers sell its product.

More recently, the SCUS has issued opinions that have eroded the Dr. Miles rule. For example, it has held that vertical nonprice restraints and maximum resale price maintenance are not per se unlawful under the antitrust laws. Yet, until the just released opinion, the basic rule was that minimum resale price fixing was a per se violation.

PSKS, the plaintiff below, runs a women's clothing and accessories store. It filed a complaint in the U.S. District Court (EDTex) against Leegin Creative Leather Products (LCLP), which makes women's accessories, alleging violation of Section 1 of the Sherman Act, in connection with LCLP's suggested resale price policies. The District Court awarded $3.6 Million in treble damages to PSKS.

The U.S. Court of Appeals (5thCir) affirmed in a non-precedential opinion [PDF]. The District Court and Court of Appeals both applied the antitrust per se violation rule to LCLP's imposing of a minimum price fixing agreement on its retailer, PSKS.

The SCUS granted certiorari on December 7, 2006. See, story titled "Supreme Court Grants Certiorari in Antitrust Cases" in TLJ Daily E-Mail Alert No. 1,501, December 8, 2007.

The SCUS reversed and remanded, and expressly overturned Dr. Miles.

The SCUS wrote that under the rule of reason, "the factfinder weighs all of the circumstances of a case in decidingwhether a restrictive practice should be prohibited as imposing an unreasonable restraint on competition."

Relevant factors include information about the relevant business, the restraint’s history, nature, and effect, and whether the businesses involved have market power. The Court wrote that the rule of reason is designed to distinguish between restraints "with anticompetitive effect that are harmful to the consumer and restraints stimulating competition that are in the consumer’s best interest".

In contrast, if a restraint is subject to the per se rule, it is necessarily illegal. The Court wrote that "the per se rule is appropriate only after courts have had considerable experience with the type of restraint at issue ... and only if courts can predict with confidence that it would be invalidated in all or almost all instances under the rule of reason ..."

The Court continued that the "economics literature is replete with procompetitive justifications for a manufacturer’s use of resale price maintenance."

It also wrote that "A single manufacturer's use of vertical price restraints tends to eliminate intrabrand price competition; this in turn encourages retailers to invest in tangible or intangible services or promotional efforts that aid the manufacturer’s position as against rival manufacturers. Resale price maintenance also has the potential to give consumers more options so that they can choose among low-price, low-service brands; high-price, high-service brands; and brands that fall in between."

It continued that "Absent vertical price restraints, the retail services that enhance interbrand competition might be underprovided. This is because discounting retailers can free ride on retailers who furnish services and then capture some of the increased demand those services generate."

It added that "Resale price maintenance, in addition, can increase interbrand competition by facilitating market entry for new firms and brands."

The Court conceded that in some circumstances, RPM can have anticompetitive effects, such as a manufacturer cartel, and consequent monopoly profits.

Thus, it concluded that "Vertical agreements establishing minimum resale prices can have either procompetitive or anticompetitive effects, depending upon the circumstances in which they are formed." Thus, a per se rule is inappropriate, because it would prohibit vertical agreement where there are procompetitive effects.

The Court held that the rule of reason applies, and proceeded to offer lower courts some guidance on its application to vertical agreements.

This is a 5-4 opinion. Justice Kennedy wrote the opinion of the Court, which was joined by Justices Thomas, Scalia, Alito and Roberts.

Justice Kennedy was confirmed as a Justice following the Senate's rejection of Robert Bork. Bork's fundamental area of expertise was antitrust law. He advocated the holding of the present opinion in his 1978 book, The Antitrust Paradox: A Policy at War With Itself [Amazon]. See especially, page 288, where Bork wrote that Dr. Miles is based on "mistaken economics". In 1987, his opponents blocked his confirmation as a Justice of the Supreme Court. In the present case, his disciples cited his book.

Justice Breyer, who was appointed by former President Clinton, wrote a long dissent that was joined by Justices Stevens, Souter and Ginsburg. He argued that the rule of law announced in Dr. Miles has been good enough for the Court for nearly one hundred years, and the Congress has not altered the law legislatively, so the Court should not now depart from the doctrine of stare decisis.

He also challenged the economic analysis of the majority. He wrote that "The only safe predictions to make about today's decision are that it will likely raise the price of goods at retail and that it will create considerable legal turbulence as lower courts seek to develop workable principles."

Albert Foer, head of the American Antitrust Institute (AAI) criticized the ruled in a release [PDF]. The AAI represents the interests of the plaintiffs' antitrust bar.

He said that "While rule of reason cases are tough to win, ... manufacturers should not interpret this ruling as a green light to enforce minimum resale prices. Especially in concentrated markets, resale price maintenance agreements will remain risky. And resale price maintenance may still be unlawful per se under state antitrust laws."

This case is Leegin Creative Leather Products, Inc. v. PSKS, Inc., Sup. Ct. No. 06-480, a petition for writ of certiorari to the U.S. Court of Appeals for the 5th Circuit, App. Ct. No. 04-41243. The Court of Appeals heard an appeal from the U.S. District Court for the Eastern District of Texas, D.C. No. 2:03-CV-107-TJW. See also, Supreme Court docket.

Theodore Olson of the Washington DC office of the law firm of Gibson Dunn & Crutcher represents Leegin. Robert Coykendall of the law firm of Morris Laing Evans Brock & Kennedy represents PSKS.