Alerts and Updates

U.S. Supreme Court Holds That Vertical Price Restraints Are No Longer Per Se Unlawful

July 2, 2007

On June 28, 2007, the United States Supreme Court overruled 96-year-old precedent governing Sherman Act standards on resale price maintenance. In Leegin Creative Leather Products, Inc. v. PSKS, Inc., No. 06-480, the Court held that resale price maintenance agreements are not per se unlawful under section 1 of the Sherman Act, which prohibits agreements in restraint of trade. Instead, vertical price restraints, like other vertical restraints, are subject to the "rule of reason," requiring courts to assess their competitive effects on a case-by-case basis to determine whether the restraints "unreasonably" restrain trade. Price fixing agreements among competitors (horizontal agreements) remain per se unlawful.

In its 1911 decision in Dr. Miles, the Court held that resale price agreements, like price agreements among competitors, were per se unlawful. Relying on the Court's 1919 Colgate decision, which held that a manufacturer had the right to refuse to deal with a reseller of its products, many manufacturers and distributors have established Manufacturer Suggested Retail Prices (MSRPs), and some have adopted policies of refusing to continue to sell to retailers who sell below such prices.

Despite the risks of litigation entailed by the per se rule against vertical minimum price restraints and court decisions that have implied per se unlawful agreements based on conduct to coerce compliance with MSRPs, Leegin elected to exercise extensive control over the minimum prices charged by the retail distributors of its products. Leegin, a manufacturer of leather products, chose to avoid mass retail outlets, instead selling its "Brighton" products principally in independent, small boutiques and specialty stores. It sought a high level of customer service, suggested retail prices and adopted a policy of refusing to sell to discounters. Leegin further implemented a program providing special incentives to retailers who pledged to sell at Leegin's suggested prices. PSKS owned a store in Texas that had been part of this program, but withdrew from it, sold Leegin's Brighton products at a discount, was terminated by Leegin and sued. The District Court refused to allow Leegin to present economic testimony on procompetitive reasons for its conduct, finding the per se rule against vertical minimum price restraints applied, and the Court of Appeals affirmed.

In a 5-4 decision, the Supreme Court overruled its 1911 decision in Dr. Miles and held that vertical price restraints are to be judged under the rule of reason. Most commercial restraints are assessed under the rule of reason. However, those practices that "would always or almost always tend to restrict competition and decrease output," have "manifestly anticompetitive" effects and "lack . . . any redeeming virtue" are deemed unlawful per se.

The Court noted that there are procompetitive justifications for resale price maintenance, similar to those that justify other vertical restraints. The Court explained that minimum resale price maintenance can stimulate competition between manufacturers of different brands (interbrand competition) by limiting competition among competing sellers of a single brand (intrabrand competition). According to the Court, limiting intrabrand competition "encourages retailers to invest in tangible or intangible services or promotional efforts that aid the manufacturer's position as against rival manufacturers" and also may "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." Further, without resale price maintenance, free riding on marketing and promotional efforts of high-service retailers may result in retail services that enhance interbrand competition being "underprovided." Resale price maintenance also can increase interbrand competition "by facilitating market entry for new firms and brands."

The Court, of course, did not hold that resale price maintenance is per se lawful. On the contrary, the Court suggested that in some cases vertical agreements setting minimum resale prices may have anticompetitive effects, "and unlawful price fixing, designed solely to obtain monopoly profits, is an ever present temptation." The Court suggested that resale price maintenance might facilitate a manufacturer cartel by assisting in identifying price cutting manufacturers. It also might be used to organize cartels at the retailer level, and the courts may more closely examine resale price maintenance initiated by retailers as opposed to manufacturers.

The Court rejected the argument that the per se rule should apply because resale price maintenance can lead to higher prices for the manufacturer's goods. Rather, the Court concluded that such agreements may promote interbrand competition, and observed that, in general, the interests of manufacturers and consumers are aligned with respect to retailer profit margins, as manufacturers seek efficient distribution and will tolerate increased costs only if the increase in demand from enhanced services will more than offset a negative effect on demand of a higher retail price.

The Court noted that when only a few manufacturers in an industry employ resale price maintenance, there is little likelihood the practice is facilitating a manufacturer cartel. Similarly, because of interbrand competition, a retailer cartel is unlikely when only a single manufacturer in a competitive market uses resale price maintenance. The Court emphasized that the practice is unlikely to have anticompetitive effects where a retailer or manufacturer lacks market power (the power to increase prices or decrease output in the market as a whole).

Following Leegin, many companies likely will re-examine and consider modifying distribution agreements and pricing policies. Licensors may have more flexibility in drafting pricing provisions in license agreements, particularly in competitive markets and where necessary to allow introduction of new products in an efficient manner. However, in recognizing concerns regarding horizontal cartels; retailer induced resale price maintenance; and the "ever present temptation" of "unlawful price fixing, designed solely to obtain monopoly profits," the Leegin decision suggests that litigation and antitrust liability risks remain in resale price maintenance agreements, particularly in highly concentrated markets. In addition, the Leegin decision does not address state antitrust laws, and foreign jurisdictions may also prohibit minimum resale price restraints. Nevertheless, the Leegin case, like GTE Sylvania in 1977, which made vertical territorial restraints subject to the rule of reason, likely will have substantial effects on businesses, distribution and pricing policies and consumers. Courts, lawyers and businesses have been relieved of the difficult task of attempting to find the fine line between lawful unilateral conduct in refusing to deal with a discounter permitted under Colgate and per se unlawful violations of section 1 of the Sherman Act under Dr. Miles. Now they must confront the rule of reason.

Other Supreme Court Antitrust Cases Decided This Term

In other antitrust cases in this term of the Supreme Court, the Court determined in Credit Suisse Securities (USA) LLC v. Billing, No. 05-1157 (June 18, 2007), that securities underwriters' alleged practices in connection with initial public offerings were not subject to liability under the antitrust laws because the securities laws are "clearly incompatible" with application of the antitrust laws, where: (1) regulatory authority existed under the securities laws to supervise the activities in question; (2) the responsible regulatory entities actually did exercise that authority; (3) there was a resulting risk that the securities and antitrust laws, if both applicable, would produce conflicting guidance, requirements, duties, privileges, or standards of conduct; and (4) the possible conflict affected practices that lie squarely within an area of financial market activity that the securities laws seek to regulate.

In Bell Atlantic v. Twombly, No. 05-1126 (May 21, 2007), the Court redefined the standards to be applied in assessing whether allegations of the existence of an agreement or conspiracy in restraint of trade are sufficient to withstand a motion to dismiss. The Court held that the complaint must contain enough factual matter, which, taken as true, would suggest that an agreement was made. An allegation of parallel conduct and a bare allegation of conspiracy will not suffice. There must be "plausible" grounds to infer an agreement, and conduct that is consistent with both lawful conduct and with a conspiracy is not sufficient to establish plausibility. This decision will likely result in more challenges of conspiracy allegations in antitrust and other cases on motions to dismiss, and also in requests to stay discovery pending decisions on such motions, as the Court recognized that significant costs involved in such discovery might be avoided by applying the plausibility standard on motions to dismiss.

In Weyerhaeuser Co. v. Ross-Simmons Hardwood Lumber Co., No. 05-381 (Feb. 20, 2007), the Court held that claims that a competitor (Weyerhaeuser) alleged to have a 65 percent share of the market for alder sawlogs in the Pacific Northwest could not be held liable on Sherman Act § 2 monopolization claims based on "predatory bidding" conduct (such as paying too much for raw materials and overbuying to impede competition) unless the plaintiff established a dangerous probability that Weyerhaeuser could recoup its losses from such conduct in the marketplace. The Court applied the requirement of a dangerous probability of recoupment from the predatory pricing context as articulated in its Brooke Group decision in 1993.

For Further Information

For more information regarding the impact of these decisions or regarding other antitrust matters, please contact Antitrust & Competition co-chairs Edward G. Biester III or Wayne A. Mack, a member of our Antitrust and Competition Practice Group, or the attorney with whom you are in regular contact.

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