ANTITRUST LAW: Ninth Circuit upholds Kodak's liability for monopolizing the "aftermarket" for servicing of its equipment but vacates some damages and modifies injunction. by Harvey M. Applebaum and Thomas O. Barnett (Mr. Applebaum is a partner at Washington, DC's Covington & Burling whose practice includes antitrust and international trade matters. Mr. Barnett is also a partner in the firm who is active in the antitrust practice.) The 9th U.S. Circuit Court of Appeals recently opened a new chapter in Kodak's continuing antitrust saga in Image Technical Services Inc. v. Eastman Kodak Co. 1 The court affirmed the judgment of the U.S. District Court for the Northern District of California holding Kodak liable for monopolizing and attempting to monopolize the market for servicing its photocopier and micrographic equipment, but it vacated a substantial portion of the damages award and modified the injunction against Kodak. In doing so, the court shed light on the process of defining a relevant antitrust market in the þaftermarketþ context. It also undertook to harmonize the antitrust laws with Kodak's rights under the patent and copyright laws, an area the court described as "a field of dissonance yet to be harmonized by statute or the U.S. Supreme Court." 2 Kodak manufactures, sells and services high-volume photocopier and micrographic equipment. Kodak also manufactures some of the parts necessary to service its equipment, arranges with other manufacturers to produce other parts on a proprietary basis and purchases the remaining parts on the open market. Beginning in the early 1980s, Kodak began to face increasing competition from independent service organizations, or ISOs, for the servicing of its equipment. According to the ISOs, Kodak responded to the competition by ceasing its prior practice of selling repair parts to ISOs, penalizing Kodak equipment owners who hired ISOs and pressuring parts manufacturers not to sell parts to ISOs. Kodak's efforts were alleged to have prohibited ISOs from competing effectively for service business and to have allowed Kodak to maintain at least 80 percent of the service market. In 1987, a group of ISOs sued Kodak, alleging tying and monopolization violations of secs. 1 and 2 of the Sherman Act. The district court granted Kodak's motion for summary judgment on the ground that Kodak's lack of market power in the sale of new equipment precluded the exercise of any market power in the aftermarket for parts and service. The 9th Circuit reversed, and the Supreme Court upheld the denial of summary judgment in one of the most significant antitrust decisions of this decade. 3 The Supreme Court held that a separate antitrust market could exist for the parts or service of a single brand of durable equipment, and that it was a question of fact as to whether Kodak had power in the aftermarket for its own equipment.
On remand, for reasons not disclosed in the opinion, the ISOs dropped the tying claims and the Section 1 conspiracy claims that were the focus of the Supreme Court decision. On their remaining claims, the ISOs persuaded a jury that Kodak had monopolized or attempted to monopolize the market for servicing its equipment and obtained a verdict totaling $71.8 million, after trebling. Based on this verdict, the district court imposed a 10-year injunction requiring Kodak to sell all parts used to repair its equipment to ISOs on "reasonable and nondiscriminatory terms and prices." The injunction also prohibited Kodak from interfering with the ISOs' efforts to obtain parts from non- Kodak sources. In a lengthy opinion, a 9th Circuit panel unanimously upheld the district court judgment that Kodak had violated Section 2 of the Sherman Act and overturned a portion of the damages award. A 2-1 majority modified the injunction as well. The court turned first to the definition of the relevant product market which, the ISOs argued, consisted of all parts used to repair Kodak equipment. Kodak contended that because one kind of part cannot substitute for another -- for example, a gasket cannot replace a bearing -- each type of part constituted a separate relevant product market. According to Kodak, the ISOs were required, but failed, to introduce separate proof of Kodak's market power over each of the thousands of individual parts markets. The 9th Circuit rejected this assertion on the ground that Kodak ignored "commercial realities" that require a servicer of Kodak equipment to have access to all parts so as to be able to perform any necessary repairs. The court observed that the Supreme Court appeared to envision an þall partsþ market in its 1992 decision in the same case, and that prior decisions supported aggregating different products or services into a single relevant market when consumer expectations appeared to support such an approach. 4 The court further noted the administrative convenience of addressing the parts market on a single aggregate basis, rather than separately, for thousands of different parts. As an additional supporting factor, Kodak conceded that it controlled 100 percent of approximately 30 percent of the parts used to repair Kodak equipment. Control over this portion could, by itself, provide Kodak sufficient means to exclude competing ISOs from the service market. Turning to the issue of market power, the court declined to address Kodak's arguments on jury instruction for its failure to object at trial. Limiting its consideration to the sufficiency of the evidence of market power in the all-parts market, the court readily affirmed the district court ruling. On appeal, Kodak conceded that it controlled at least 50 percent of the parts market through its patent and other proprietary rights, and the court found that this market share supported the attempted monopolization claim. In addition, the ISOs introduced sufficient evidence that Kodak had inhibited them from obtaining parts through other sources to support a jury conclusion that Kodak controlled 65 percent or more of the parts market - a share large enough to support the monopolization claim. Although Kodak's market share would not support an inference of market power if there were no barriers to entry to the parts market, the court quickly disposed of any such argument, noting that "Kodak has 220 patents and controls its designs and tools, brand name power and manufacturing capability." 5 These factors, combined with Kodak's contractual arrangements with other parts manufacturers, its high share of the service market and economies of scale, "support a finding of high barriers to entry by new
manufacturers and to increased output by established suppliers." 6 The court next turned to Kodak's challenge to the instruction allowing the jury to find conduct improper merely because it "unnecessarily excludes or handicaps competitors." 7 Kodak argued that the ISOs were required to prove that access to repair parts from Kodak was "essential" to competing in the service market. The challenged jury instruction, Kodak argued, reflected the "looser" monopoly leveraging standard from the 2d Circuit decision in Berkey Photos Inc. v. Eastman Kodak Co. 8 The court rejected the argument that the ISOs must proceed under an "essential facilities" theory. Rather, a monopolist may not refuse to deal, even unilaterally, without an adequate business justification, if the refusal so hinders competition in a second market that the monopolist will attain -- or threatens to attain -- monopoly power in the second market. As for the jury instruction, the court agreed with Kodak that the 9th Circuit had rejected the Berkey monopoly- leveraging theory, but it upheld the instruction, when considered with other instructions, as requiring the ISOs to show that any handicapping of competitors enabled Kodak to monopolize or threaten to monopolize the service market. In the instant case, wherein Kodak held over 80 percent of the service market, the ISOs had met this burden. Nor was the court persuaded by Kodak's efforts to derail the jury verdict on the basis of its quality control and intellectual property business justifications. First, the court construed the jury instructions as precluding the jury from "second guess[ing]" Kodak's business judgment by comparing less restrictive alternatives for achieving Kodak's business objectives. The court further found no plain error in allowing the jury to find that Kodak's proffered business justifications were pretextual. The court then turned to Kodak's argument that the patent laws provide it with an absolute right to refuse to sell or license its patented parts or copyrighted materials -- an issue of first impression in the 9th Circuit. The court reached a compromise between the antitrust and intellectual property laws by holding that "a monopolist's 'desire to exclude others from its [protected] work is a presumptively valid business justification for any harm to consumers.'" 9 Once asserted, the presumption is subject to rebuttal by the plaintiff. Although the district court failed to instruct the jury on this presumption, the 9th Circuit found the error "more probable than not harmless." 10 It relied on evidence that Kodak's proffered business justification of protecting its patented parts was pretextual. Kodak's own parts manager testified that "patents 'did not cross [his] mind' at the time Kodak began the parts policy." 11 Further, Kodak's challenged policies applied to all parts, not just those subject to patents. After affirming a portion of the damages award based on a yardstick comparison with non- Kodak service revenues of ISOs, the court reversed the damages for an ISO that had exited the market. Because other ISOs, rather than Kodak, took over the business left by the exiting ISO, the court held that the exiting ISO's failure was not fairly attributable to Kodak's illegal actions. The court additionally vacated the award of damages for lost sales of used equipment. The district court had dismissed the monopolization claim of a used equipment sales market, and the ISOs' damages evidence failed to account for lost sales attributable to their dismissed claims. This portion of the case was remanded for a new trial.
Kodak persuaded the court to modify the 10-year injunction imposed by the district court in several important respects. First, the court struck the provision requiring Kodak to sell parts to ISOs at "reasonable prices," recognizing that Kodak has the right to charge whatever prices the market will bear, even monopoly prices. The court added, however, a requirement that Kodak sell such parts on a non-discriminatory basis to end-users as well as ISOs and ISO buying groups. As a result, end-users -- the ISOs' customers -- apparently can purchase parts directly from Kodak at the same price as the ISOs do. Second, the court's modification requires Kodak to sell only the parts it manufactures itself. Because the injunction prohibits Kodak from interfering with ISOs' obtaining of parts from non-kodak manufacturers, the court struck as redundant the requirement that Kodak sell such parts to ISOs. Third, the court struck the application of the injunction to Kodak's "successors and assigns," and added a provision terminating application of the injunction to sales of Kodak parts in the event Kodak exits the service market for copier or micrographic equipment. Judge Helen W. Gillmore dissented from this portion of the opinion on the ground that it severely limits the application of the injunction, as illustrated by Kodak's recent sale of its copier service operations to Danka Office Imaging Co. Although Danka apparently stipulated in the district court that it would abide by the injunction, Judge Gillmore suggested that Kodak now has exited the copier market and thus that the new termination clause may have been triggered already. The 9th Circuit decision is unlikely to constitute the final episode in the Kodak saga. Each party already has filed a petition for rehearing -- with Kodak also suggesting rehearing en banc -- and a petition for certiorari is almost a certainty. Kodak is also defending against similar claims by ISOs in other jurisdictions. Meanwhile, ramifications of the decision may be felt throughout the economy. As predicted by many, the Supreme Court's 1992 Kodak decision has generated more aftermarket antitrust claims. The 9th Circuit decision upholding Kodak's liability and a substantial portion of the damages award should encourage these claims even more. Although commentators and courts will weigh in on this most recent Kodak decision, the 9th Circuit provided its own assessment of the implications of the Kodak litigation for manufacturers: "After Kodak, unilateral conduct by a manufacturer in its own aftermarkets may give rise to liability and, in one-brand markets, monopoly power created by patents and copyrights will frequently be found. Under current law the defense of monopolization claims will rest largely on the legitimacy of the asserted business justifications." 12 The Supreme Court, moreover, soon may have an opportunity to revisit its 1992 decision and to evaluate its application by the 9th Circuit, as well as by other courts of appeals. 1 1997 U.S. App. LEXIS 22608 (9th Cir. Aug. 26, 1997). 2 Id. at *60.
3] Eastman Kodak Co. v. Image Technical Services Inc., 504 U.S. 451 (1992). 4 See, e.g., U.S. v. Philadelphia National Bank, 374 U.S. 321, 356 (1963) (grouping various banking services). 5 1997 U.S. App. LEXIS 22608, at *29. 6 Id. 7 Id. at *31. 8 603 F.2d 263 (2d Cir. 1979), cert. denied, 444 U.S. 1093 (1980). 9 1997 U.S. App. LEXIS at *64, (quoting Data General Corp. v. Grumman systems Support Corp., 36 F.3d 1147, 1187 (1st Cir. 1994)). 10 Id. at *60. 11 Id. at *68. 12 Id. at *62. Reprinted with permission from September 29, 1997 edition of The National Law Journal. Copyright 1997, The New York Law Publishing Company.