Dual Distribution, “Price-Squeeze” & Section 2 After linkLine
By: RICHARD J. WEGENER
An area which has historically troubled antitrust courts is “dual distribution,” i.e., those cases in which a manufacturer sells its products to wholesalers and also to retailers, thereby in competition with its wholesalers. In those circumstances, the seller occupies both a horizontal and vertical relationship with its wholesalers.
Originally, the horizontal relationship between the manufacturer and its wholesalers was seen as the most important of the two relationships from an antitrust perspective. Since horizontal restraints are per se illegal, restraints on wholesalers where there was a dual distribution situation were also seen as per se illegal.1
However, as courts gained experience with dual distribution during the 1980s they concluded that the vertical character predominates and removes dual distribution from the horizontal or per se characterization.2 Since then, courts have been able to resolve the horizontal/per se vs. vertical/rule of reason debate as a matter of law.3 They usually conclude that the distribution restraint should be governed by the rule of reason because either (1) the manufacturer acted unilaterally as the source of the restraint, or (2) the restraint’s purpose and effects are identical to those associated with restraints imposed by manufacturers that are not dual distributors. Nonetheless, antitrust has remained intrigued with dual distribution. Why? There are two key reasons.
First, the manufacturer’s closeness to its wholesalers in a dual distribution model raises the traditional Section 1 risk of the manufacturer’s participation in a wholesaler cartel, especially when there are group activities directed at another wholesaler.4
The second involves the “price squeeze” which occurs when the manufacturer cuts prices to its direct buying retail accounts while raising prices to its wholesale accounts. This has the effect of “squeezing” the wholesaler’s profit margin as it competes for retail business against the lower prices charged by the manufacturer. For nearly 60 years the appellate courts have recognized the price squeeze as an independent cause of action under Section 2 against a dominant manufacturer denying the plaintiff a “fair” or “adequate” margin between the wholesale and retail price.5 It was not until two months ago that the Supreme Court expressly considered this antitrust squeeze play – and it did not like what it saw.
In what may be the Court’s key antitrust decision of 2009, in Pacific Bell Telephone Co. v. linkLine Communications, Inc.6, all nine justices held that there is no viable price squeeze claim when there is no duty to deal at the wholesale level, and the price to retailers is above cost. In summary, Chief Justice Robert’s majority opinion concludes:
“Trinko7 holds that a defendant with no antitrust duty to deal with its rivals has no duty to deal under the terms and conditions preferred by those rivals. [citations omitted] Brooke Group8 holds that low prices are only actionable under the Sherman Act when the prices are below cost and there is a dangerous probability that the predator will be able to recoup the profits it loses from the low prices. [citations omitted] In this case, plaintiffs have not stated a duty-to-deal claim under Trinko and have hot stated a predatory pricing claim under Brooke Group. They have nonetheless tried to join a wholesale claim that cannot succeed with a retail claim that cannot succeed, and alchemize them into a new form of antitrust liability never before recognized by this Court. We decline the invitation to recognize such claims. Two wrong claims do not make one that is right.”
Why is linkLine so significant? First, it eliminates a cause of action for a price squeeze under federal antitrust law. As the Court made clear in Trinko, antitrust law rarely imposes a “duty to deal” with competitors. Even in a case involving such a duty, the different standards for establishing “predatory pricing” at the retail level make it very difficult to successfully prosecute a price-squeeze claim.
Second, linkLine highlights the Court’s recent trend allowing firms greater leeway to act unilaterally without fear of antitrust consequences – a trend which includes the Court’s prior decisions in Brooke Group, Trinko, and Leegin9. Furthermore, much of the Court’s reasoning holds the potential for application in varying degrees to other business pricing and marketing programs such as bundled discounts, loyalty rebates, exclusive dealing and tying.
Finally, the majority also expressed real concern about something that is too often lacking in antitrust decisions – the need for clearly communicated rules, including safe harbors within which business knows that their conduct will be insulated from antitrust review.
linkLine is an important new tool for manufacturers who seek to strengthen their ability to compete against other brands. Please contact your Fredrikson & Byron attorney if you have any additional questions or concerns.
1 United States v. Sealy, Inc., 388 U.S. 350 (1967) (territorial agreement between a trademark licensor and its licensees characterized as vertical and found reasonable by the trial court, but characterized as horizontal and thus per se illegal by the Supreme Court).
2 Illinois Corporate Travel v. American Airlines, 806 F.2d 722, 726 (7th Cir. 1986) (Easterbrook, J.) (“[i]f the evidence is consistent with the hypothesis that the firm at the top of the vertical chain designed the restrictions for its own purposes, an inference of [horizontal] conspiracy is inappropriate.”)
3 Electronic Communications Corp. v. Toshiba America Consumer Products, 129 F.3d 240, 243 (2d. Cir. 1997) (“[V]ertical restraints are generally subject to ‘rule of reason’ analysis. . . This is so even if the distributor and manufacturer also compete at the distribution level.”)
4 United States v. General Motors Corp., 384 U.S. 127 (1966) (supplier refused to deal with discounters at urging of dealer group).
5 United States v. Aluminum Co. of America, 148 F.2d 416 (2d Cir. 1945) (it was unlawful to hold the price of aluminum ingot high and the price of aluminum sheet so low that competing sheet rollers were unable to make a living profit.)
6 2009 WL 454286 (U.S. 2009), 96 BNA ATRR 177.
7 Verizon Communications, Inc. v. Law Offices of Curtis v. Trinko, LLP, 540 U.S. 393 (2004).
8 Brooke Group v. Brown & Williamson Tobacco Corp., 509 U.S. 209 (1993).
9 Leegin Creative Leather Prods. v. PSKS, Inc., 127 S.Ct. 763 (2007).