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FAQ About RPM After Leegin

August 29, 2007

By: Gregory M. Garrett

A long-settled antitrust doctrine, known as the Dr. Miles rule from the 1911 Supreme Court opinion in which it was first announced, was overturned by the Supreme Court in its recent decision of Leegin Creative Leather Products v. PSKS Inc.  In Leegin, the Supreme Court held that minimum resale price maintenance (“RPM”) will no longer automatically violate the Sherman Act (in antitrust terms, be a “per se” violation), but rather will be tested according to an approach that focuses on the economic impact of the restraint (i.e., the “rule of reason”).  What effect Leegin will have, and what opportunities and challenges it will present to manufacturers, distributors, and retailers, will have to be seen as businesses and the courts come to terms with the opinion.

Dr. Miles held that vertical minimum price restraints, i.e., agreements between a supplier and its customers to require that the supplier’s product be resold at or above a stipulated price, were deemed to be an automatic, or per se, violation of the Sherman Act.  Under the Dr. Miles rule, then, a manufacturer could not require a retailer to sell the manufacturer’s goods at or above a certain price as a condition for allowing the retailer to carry its goods--such an agreement would be unenforceable and a violation of the Sherman Act as a contract in restraint of trade.  In recent years, this rule had come to be criticized by some economists and members of the antitrust bar who argued that, given current economic realities, the automatic ban on minimum resale price maintenance actually results in inefficiencies, higher prices, and a lack of services for consumers.

That criticism is likely one reason why the Supreme Court decided to hear Leegin, which involved the legality of a vertical price restraint imposed by Leegin, a manufacturer of leather goods that refused to sell its line to retailers that discounted the goods below Leegin’s minimum suggested prices.  Applying Dr. Miles, both the district court hearing the case and the Fifth Circuit on appeal held Leegin’s conduct unlawful under the Sherman Act.  Although Leegin had tried to present expert testimony to the district court on the procompetitive effect of Leegin’s pricing policy (evidence that would be relevant to showing that Leegin’s conduct would satisfy a rule of reason analysis), that evidence was excluded by the lower courts on the ground that any vertical price restraint was automatically unlawful under Dr. Miles, and thus that the rule of reason was irrelevant.

The Supreme Court held otherwise.  In a 5-4 opinion authored by Justice Kennedy, the Court ruled that resale price maintenance agreements should now be judged according to a rule of reason approach.  In support of its opinion, the court looked to its decisions dealing with other types of restraints of trade, in which the rule of reason is generally employed, and in which the per se rule is limited to restraints (such as horizontal price fixing agreements) thought to have “manifestly anticompetitive effects” and to lack “any redeeming virtue.”  From that starting point, the Court treated the Dr. Miles opinion--which it asserted was based on a common-law rule against restraints on alienation, rather than on a study of the per se rule’s economic effect--as a legal dinosaur deserving of extinction.

Finding that “the economics literature is replete with procompetitive justifications for a manufacturer’s use of resale price maintenance,” and that even those “skeptical of resale price maintenance acknowledge it can have procompetitive effects,” the court refused to reaffirm the per se rule.  Although much of the economics is beyond the scope of this article, one economic consideration is easy to understand--the Court held that “[a]bsent vertical price restraints, the retail services that enhance interbrand competition might be underprovided.”  In other words, a per se rule where resale price maintenance is prohibited allows deep-discount retailers to “free ride” on those retailers who provide better service.  “Consumers might learn, for example, about the benefits of a manufacturer’s product from a retailer that invests in fine showrooms, offers product demonstrations, or hires and trains knowledgeable employees,” and then walk across the street to a discounter and buy the product for less.  The Court reasoned that such a result could ultimately lead retailers to reduce services, thereby harming consumers’ ability to receive the level of service they would otherwise prefer.  The dissent, written by Justice Breyer, challenged the majority on several grounds, including arguments that (1) removing the per se rule would cause consumers to be harmed as prices would increase, and (2) the Court’s abandonment of a nearly 100 year-old precedent was not proper given the doctrine of stare decisis.

Leegin will undoubtedly engender, as Justice Breyer predicted, “considerable legal turbulence as lower courts seek to develop workable principles” applying the rule of reason in the resale price maintenance context.  And it likely will result in many questions for businesses as they seek to enter into dealings in a world where resale price maintenance is no longer prohibited as a matter of law.  A partial list of expected questions and probable answers follows.  Of course, every situation is different, and, before acting, consultation with experienced antitrust counsel is essential.

Question 1:  I work for a manufacturer, and we would like to enter into contracts with our distributors so that they will sell our products at no less than a specified price.  Can we do this without risking lawsuits under the federal antitrust laws?

Answer 1:  If your company entered into such contracts before Leegin, those agreements in and of themselves would violate the federal antitrust laws.  After Leegin, such agreements will not automatically violate the federal antitrust laws.  Instead, if the contracts are challenged, the court will look at all the circumstances surrounding the contracts, including an examination of the type of business your company is in, and the history, nature, and effect of the agreements.  Ultimately, the agreements will be legal under the federal antitrust laws so long as your company has a justification for the practice and the benefits of the agreements outweigh the harms they cause.

Question 2:  What about state antitrust laws?

Answer 2:  Under the state antitrust laws, your company is at a greater risk for lawsuits based on agreements setting minimum resale prices.  Most states have interpreted their antitrust laws the same way the Supreme Court interpreted the Sherman Act before Leegin, meaning that such agreements have long been deemed automatically illegal under most state antitrust laws.  Furthermore, being mostly elected officials, state attorneys general are far more likely to prosecute resale price maintenance agreements than are the federal authorities; the reason is that such agreements raise prices to consumers, and consumers are voters.  Therefore, even if the agreement is legal under the federal antitrust laws, you still need to determine whether the agreement will be legal in a given state.

Question 3:  I work for a distributor, and a group of our retailers has been pressuring us to institute agreements with all of our retailers requiring that they sell at or above a certain price.  Can our company do this after Leegin?

Answer 3:  In this situation, the distributor may be more at risk of lawsuits (both from private parties and the government) than if the distributor decided to institute minimum price agreements on its own.  A court could find that because the pressure for minimum price agreements came from a group of retailers who compete against each other, the agreements are more likely to be illegal.

Question 4:  I work for a retailer.  We would like one of our suppliers to enter agreements with all of its other retailers to sell at or above a certain minimum price.  The distributor has told us that it cannot do this because of the federal antitrust laws.  Can the distributor now do as my company asks without being sued for violating the federal antitrust laws?

Answer 4:  The distributor can now enter into these agreements without automatically violating the antitrust laws.  But the size and economic power of your retailer employer, and whether it would sign the same agreement, are factors that a court would consider in deciding whether those agreements are lawful.  And as in Answer 3 above, the fact that the request originates with the customer makes the agreement problematic.  After examining all of the circumstances, a court could still decide that the agreements are illegal under the federal antitrust laws.  If your company commands a large share of the retail market, it is more likely that the agreements would be found unlawful.

Question 5:  I work for a manufacturer.  For years, we have told our distributors that if they sell for less than our suggested resale price, we will no longer sell to them.  We, however, have never had the distributors sign contracts stating that they would sell at that price.  How does Leegin affect this practice?

Answer 5:  Your company is free to continue doing business this way, and Leegin does not affect the legality of that practice.  Instead, Leegin offers your company another way to get the distributors to sell at the minimum price you want.  The main advantage flowing from Leegin to companies like yours is that you no longer have to terminate your relationships with distributors and retailers.  Instead, you may enforce any agreements you have on minimum resale price.

Question 6:  I work for a distributor, and we have been asking our state legislature to require that all distributors in the state sell at a certain percentage markup from list price, without taking into account discounts or rebates.  The legislature has refused to do so, stating that such a state law would not survive in court.  How does Leegin affect this?

Answer 6:  It is very likely that the courts will uphold state laws like this after Leegin.  In fact, the chair of Tydings’ antitrust practice has authored a brief article on that question.  See Thomas M. Wilson, III, An Unintended Consequence of Leegin, Antitrust & Trade Regulation Report (BNA), Vol. 93, No. 2310, at 27 (July 6, 2007).

Question 7:  I work for a distributor, and one of our suppliers just told us we have to sign a contract agreeing not to resell its products at less than a certain price.  Can we sign this contract without being sued?

Answer 7:  Your agreement with the manufacturer would have been illegal in and of itself before Leegin.  Even though you can still be sued, in order to win the plaintiff will need to prove that the contract is unjustified under the circumstances.  That is true whether the plaintiff is your customer or the government, state or federal.

Question 8:  I work for a retailer.  One of our suppliers just stopped selling to us because we wouldn’t sign a contract agreeing to sell its products at or above a stipulated price.  I found out that the supplier has entered into similar contracts with other retailers in my area.  Can my company sue the supplier for breaking the antitrust laws?

Answer 8:  After Leegin, in order to win such a lawsuit under the federal antitrust laws, you will need to prove that the harmful effects of the collective agreements outweigh their positive effects.  Depending on which state you are in, however, you may be able to prevail under state antitrust law just by showing that the agreements exist.

Question 9:  I work for a manufacturer, and our attorneys have told us repeatedly that if we fix prices with other companies, we might go to jail.  If we agree with our distributors on the price at which they will sell, can the Justice Department send us to jail?

Answer 9:  Your attorneys most likely were referring to fixing prices with your competitors, which often results in prison terms.  But an agreement between a manufacturer and a distributor to set a resale price is not that type of agreement.  Further, because Leegin changed the way courts look at minimum resale price agreements, it is doubtful that the Justice Department will attempt to impose criminal penalties on these “vertical” restraints.  There remains, however, the possibility that one or more states still might opt to prosecute your company.

Question 10:  I work for a specialty retailer, and the manufacturers (that make competing products) ship directly to us.  Each manufacturer has requested that we sell its products at the same or a higher price than the competing products (what the manufacturers call a “most-favored nations clause,” or MFN).  Can we agree to this?

Answer 10:  By agreeing to such terms, you may be facilitating an illegal agreement among the manufacturers to fix resale prices.  If all the competing manufacturers successfully employed MFN’s, there would be no interbrand price competition--the form of competition that the Leegin Court deemed most important to protect.  Although Leegin allows your company to defend its decision to agree with suppliers on minimum resale prices, it does not legalize agreements between competitors to fix prices.  Because the agreements your company enters into with the manufacturers may be found unreasonable as they facilitate this kind of activity, your company could be held liable under the federal antitrust laws.

Question 11:  I work for a manufacturer that wants its distributors to agree not to charge their retailer customers less than a specified price.  I understand that the government is not likely to sue and claim that the agreement is illegal.  If the government doesn’t sue, does my employer have any reason for concern?

Answer 11:  Yes.  Private parties may sue under the antitrust laws and, if they prevail, they collect three times the amount of damages they prove, plus attorneys’ fees.  These types of cases may also be brought as class actions, where one person sues on behalf of many.  From a financial standpoint, your employer has far more reason to be concerned about private suits than about governmental actions.

Question 12:  I work for a manufacturer of consumer electronic products that doesn’t want its retailers discounting those products.  But it also doesn’t want the retailers to resell those products above what used to be called their “suggested” retail prices.  So, my question is this:  May my employer specify the exact price at which its products are to be sold by retailers?

Answer 12:  Probably yes.  Setting a maximum resale price has not been unlawful in and of itself since the Supreme Court so decided in 1997, and, because of Leegin, setting a minimum resale price is no longer automatically unlawful, either.  Consequently, a manufacturer may set both the minimum and maximum resale prices for a product, and, presumably, may also make both prices the same.  It is likely, however, that a court would require more justification for requiring a customer to charge an exact price rather than either a minimum or maximum price.

Question 13:  I work for a manufacturer of consumer products that sells to independent distributors who, in turn, resell to retailers.  May my employer require those distributors to resell only to retailers that formally agree with the distributors not to charge less than the retail price specified by my employer?

Answer 13:  Your employer’s practice of selling directly to distributors should not have any effect on the legality of its setting a minimum price for retailers.  This answer might change, however, in the event that any of those distributors has substantially more economic power than does your employer.

For more information about Leegin and how it may affect businesses today, contact a member of Tydings’ Antitrust Practice Group.

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