The Doctor Is Out, But Is Resale Price Maintenance In?

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1 July 2007 / Issue 20 A legal upate from Dechert s Antitrust Group The Doctor Is Out, But Is Resale Price Maintenance In? Key Questions for Clients Consiering Resale Price Maintenance (RPM) after Leegin 1. Why o you want to aopt RPM? A strong business rationale to promote interbran competition will be critical to overcome any legal challenge to the program. 2. Is the impetus for RPM coming from your retailers? Group pressure for RPM emanating from your retailer network can be use as evience that the restraint is facilitating a retailer cartel, or supporting a less efficient, but ominant, retailer. 3. Do others in your inustry have resale price maintenance policies? If the manufacturers employing RPM o not account for a ominant share of the market, a court will be less likely to conclue that the practice coul facilitate a manufacturer cartel. 4. What is your market share? Low market share makes it less likely that a manufacturer s RPM agreements coul even potentially achieve the kins of anticompetitive effects escribe in Leegin. 5. How oes Leegin affect the law in the states where you want to sell? Not all state antitrust laws follow the feeral law. RPM may continue to be illegal per se in some states, an state attorneys general may continue their enforcement efforts in this area. Supreme Court Overturns 96-Year- Ol-Preceent On June 28, 2007, in a lanmark 5-4 ecision, the Supreme Court funamentally change the law governing antitrust claims base on allege resale price maintenance ( RPM ) agreements. The Court sai goobye to one of its longstaning antitrust preceents, Dr. Miles Meical Co. v. John D. Park & Sons Co, 1 when it rule that resale price maintenance woul no longer be per se illegal. Leegin Creative Leather Proucts v. PSKS, Inc., No , S.Ct., 2007 WL (June 28, 2007). Leegin (pronounce like legion ) involve an antitrust challenge to Leegin s policy of refusing to sell its specialty leather goos an accessories to retailers who iscounte below suggeste prices an its relate marketing program, which require participating retailers to plege to sell at the suggeste prices. The trial court preclue the efenant from introucing expert testimony regaring the pro-competitive effects of its policies because RPM agreements were per se unlawful uner Dr. Miles. After losing at trial, the efenant challenge the application of the per se rule to its conuct. Boun by Dr. Miles, the Fifth Circuit affirme. The Supreme Court grante certiorari to reconsier the question it ecie long ago in Dr. Miles, namely whether vertical minimum resale price maintenance agreements shoul continue to be treate as per se unlawful. In an opinion by Justice Kenney, the Court U.S. 373 (1911).

2 ecie to jettison the per se rule. The ecision reste on several key points: Dr. Miles represente a eparture from the accepte rule-of-reason stanar for evaluating restraints generally, an for evaluating vertical restraints specifically, uner the Sherman Act. The unerpinnings of Dr. Miles ha been eroe by subsequent ecisions recognizing the ifferences in economic effect between vertical an horizontal agreements, ifferences the Dr. Miles Court faile to consier because it relie on formalistic legal octrine rather than emonstrable economic effect. The abunant economic literature recognizing pro-competitive justifications for a manufacturer s use of resale price maintenance argue against a per se approach, which is reserve for situations in which the practice always or almost always restricts competition an ecreases output. A manufacturer in a competitive market will generally have no incentive to overcompensate its retailers with inflate margins, since to o so woul not increase the manufacturer s margin, but woul reuce the sale of its proucts. Applying a per se rule to vertical price fixing an the rule of reason to other vertical restraints create an anomalous situation which rove manufacturers to less efficient istribution methos an create legal istinctions that became a trap for the unwary. Rule-of-Reason Guieposts Possible pro-competitive justifications: Manufacturers consiering a resale price maintenance program after Leegin must still make sure it will withstan scrutiny uner the rule of reason. This will require a soun pro-competitive justification. The majority opinion offere several possibilities. These inclue: encouraging retailers to invest in proviing aitional services for consumers by offering the retailer a guarantee margin; giving consumers more options, allowing them to choose among low-price, lowservice brans; high-price, high-service brans; an brans that fall in between; facilitating market entry for new firms an brans; an minimizing the risk of free-riing situations in which iscounting retailers capture some of the eman generate by other retailers who invest in increase services, thereby reucing the incentive to o so. Potential anti-competitive effects: While shutting the oor on Dr. Miles, the Court also clarifie the specific types of interbran anti-competitive effects that might support a rule-of-reason violation. The Court note that an RPM agreement might be use to facilitate a horizontal manufacturer or retailer cartel, forestall innovation in istribution that ecreases costs, or exclue rival manufacturers. Relevant factors to consier in etermining whether or not such an anticompetitive use of RPM is plausible inclue, among others: the number of competing manufacturers that have aopte RPM agreements; whether the impetus for the RPM agreement was the manufacturer or its ealers; an whether the participating manufacturers an retailers possess market power in a properly efine relevant market. The Court observe that anti-competitive uses of RPM are unlikely in situations in which the participating retailers or manufacturers lack market power, or in which only a few manufacturers in a relevant antitrust market use RPM. Implications for Manufacturers Manufacturers with free rier issues: The manufacturers with the most immeiate interest in Leegin are likely to be those who currently employ programs to prevent free riing. These may either take the form of vertical territorial or customer restrictions or a program seeking to take avantage of the Colgate oc- July 2007 / Issue 20 2

3 trine permitting manufacturers to terminate iscounting ealers unilaterally. 2 These manufacturers may now want to consier whether some form of RPM is a more efficient way to solve their free-rier issues. E-tailers: Although the Court i not iscuss internet retailing, Leegin may give manufacturers the poisonippe arrow with which to shoot own wiesprea iscounting of their proucts (an resulting evisceration of their bran equity) over the internet. One of the commonly asserte justifications for resale price maintenance in such circumstances is to prevent free riing. Even Justice Breyer, writing for the issent, acknowlege the avoiance of free riing as one of the important consumer benefits of resale price maintenance. Uner a rule-of-reason analysis, this may prove a powerful argument to justify imposing RPM requirements on internet sellers. Intellectual property owners: Of potential interest will be the egree to which Leegin carries over into the intellectual property arena. In 1926, in Unite States v. General Electric Co., 3 the Supreme Court hel that a patent owner coul agree with its licensee on a minimum price which the licensee must charge for articles manufacture uner the license. Subsequent ecisions have unermine this preceent but never overrule it, 4 an most intellectual property owners have therefore been reluctant to incorporate pricing restrictions of any kin in their licenses. Leegin opens the oor to a reconsieration of many of the ecisions that have unermine GE as a reliable preceent. large majority of state antitrust laws require aherence to feeral antitrust preceents, some state laws o not. In states that o not look to feeral law, RPM may be (or coul become) per se illegal. Enforcement attitues may iffer as well. Cases against RPM have been a significant enforcement priority of state attorneys general over the last 25 years. So, whereas the feeral antitrust agencies argue as amicus in Leegin that Dr. Miles shoul be overrule, an amicus brief submitte by a large number of state attorneys general argue just the opposite that Dr. Miles shoul not be overrule an that RPM shoul continue to be governe by the per se rule. This suggests that state attorneys general might continue to police this area, either by exploiting the lines of attack suggeste by the Court or uner state laws that o not require aherence to feeral preceent. Their ability to o so coul be bolstere if state legislatures amen their antitrust laws to reinstate the per se rule for RPM within the state. Such a legislative response woul not be unpreceente. A majority of the states, for example, passe legislation in the 1980s to exempt their state antitrust laws from the Supreme Court s Illinois Brick 5 ecision enying feeral staning to inirect purchasers. Nor woul such legislation necessarily be pre-empte by feeral law. 6 5 Illinois Brick Co. v. Illinois, 431 U.S. 720 (1977). 6 See, e.g., Exxon Corp. v. Marylan, 437 U.S. 117 (1978). Impact on State Antitrust Law an Enforcement A Caution The Leegin ecision eliminate the per se rule for RPM as a matter of feeral antitrust law only. While the 2 Unite States v. Colgate & Co., 250 U.S. 300 (1919) U.S. 476( 1926). 4 See, e.g., Unite States v. Line Material Co., 333 U.S. 287, (1948) (General Electric not applie to crosslicense patents); Unite States v. Univis Lens, 316 U.S. 241, (1942) (General Electric oes not apply after the first sale of a prouct by the licensor); Newbourgh Moire Co. v. Superior Moire Co., 237 F (3 Cir. 1956) (General Electric oes not apply to multiple licenses containing price-fixing provisions); Cummer- Graham Co. v. Straight Sie Basket Corp., 142 F (5th Cir. 1944) (General Electric oes not apply to restrictions on the price of an unpatente goo manufacture using a patente process). July 2007 / Issue 20 3

4 Practice group contacts If you have questions regaring the information in this legal upate, please contact the Dechert attorney with whom you regularly work, or any of the attorneys liste. Visit us at Jeffrey W. Brennan Paul H. Frieman Robin P. Sumner Philaelphia Stephen D. Brown Philaelphia George G. Goron Philaelphia Joseph A. Tate Philaelphia Peter R. Crockfor Lonon Robert C. Heim Philaelphia Chris Watson Lonon Paul T. Denis Kevin T. Kerns Philaelphia Rebecca P. Dick Ewar L. Kling Lonon H. Joseph Escher III San Francisco Christine C. Levin Philaelphia Michael D. Farber Pierre-Manuel Louis pierre.louis@echert.com Carolyn H. Feeney Philaelphia carolyn.feeney@echert.com Isabelle M. Rahman isabelle.rahman@echert.com James A. Fishkin james.fishkin@echert.com Stephen A. Stack, Jr. Philaelphia stephen.stack@echert.com July 2007 / Issue 20 4

5 U.S. UK/Europe Dwww.echert.com Austin Boston Charlotte Hartfor New York Newport Beach Philaelphia Princeton San Francisco Silicon Valley Lonon Luxembourg Munich Paris 2007 Dechert LLP. All rights reserve. Materials have been abrige from laws, court ecisions, an aministrative rulings an shoul not be consiere as legal opinions on specific facts or as a substitute for legal counsel. This publication, provie by Dechert LLP as a general informational service, may be consiere attorney avertising in some jurisictions. Prior results o not guarantee a similar outcome. July 2007 / Issue 20 5