State Bar of Wisconsin

(Almost) Everything You've Always Wanted to Know About
the Federal Antitrust Laws
(But Were Afraid to Ask)

By Brian D. Winters
Quarles & Brady LLP

Note: This material first appeared in PUR Utility Quarterly and is copyright protected and must not be printed out, downloaded, or in any manner further reproduced without express written permission. For more information or contact information, visit the PUR website at www.pur.com.

This article is an exercise in consciousness raising. It is not designed to provide definitive answers to the full range of issues that arise under the federal antitrust laws. Rather my goal is to provide enough information about key areas of the law to stimulate the asking of intelligent questions. The areas discussed are: 1. horizontal agreements in restraint of trade; 2. vertical agreements in restraint of trade; 3. tying arrangements; 4. exclusive dealing arrangements; 5. monopolization; and 6. price discrimination.

Horizontal Agreements in Restraint of Trade

Section 1 of the Sherman Act states:
Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several States, or with foreign nations, is declared to be illegal.

The Supreme Court decided over eighty years ago that Section 1 can not possibly mean what it says(1) . If every contract that restrains trade is illegal, then every contract is illegal. The whole point of a contract is to restrain trade. During the term of a contract the buyer must deal with the seller and vice versa. What Section 1 makes unlawful, therefore, are "unreasonable" restraints of trade that result from "concerted action" by more than one actor (a "plurality of actors").

What is "concerted action"? Action is concerted when two or more actors have "agreed" to undertake it. An individual firm, acting independently of others firms, cannot violate Section 1. The agreement among the actors may be explicit, such as a written contract, or it may be tacit. The Ninth Circuit has said "[a] knowing wink can mean more than words."(2) Judge Posner, in the Seventh Circuit, analyzes agreement under Section 1 in traditional contract law terms: Has there been a "meeting of the minds"? (3) After a lawsuit (or an indictment) has been brought, antitrust litigators make a lot of money arguing about whether there was or wasn't an "agreement" among the defendants. I offer a rule of thumb: If, a client being totally honest with themself, think they have an "understanding" with another party, then concerted action for purposes of Section 1, has probably occurred.

Here's an interesting wrinkle, though. Concerted action requires more than one actor. Sometimes, despite appearances to the contrary, the law finds only one actor and thus no Section 1 violation. Consider an agreement between a parent corporation and its wholly owned subsidiary. The Supreme Court has held that while these might be two legally distinct entities for many purposes, they are not independent enough of one another to be capable of concerted action under Section 1. (4) The same is true of sister corporations. (5) The Court has also stated that there is "general agreement that Section 1 is not violated by the internally coordinated conduct of a corporation and one of its unincorporated divisions." (6) Some lower courts have reached the same conclusion regarding less than wholly owned subsidiaries. (7) Finally, a firm's own officers or employees cannot "provide the plurality of actors imperative for" concerted action in violation of Section 1. (8)

Note, however, that the members of a joint venture are considered capable of "agreement" under Section 1, (9) as are the members of a trade association. (10)

So, suppose two or more independent actors have agreed on a common course of action. When will that violate Section 1? Answer: when your common course of action unreasonably restrains trade. And when is that?

Some cases are easier than others. Suppose two firms are competitors in some market and their agreement has to do with that market. (This is called a "horizontal" agreement.) If what they have agreed to do is fix prices, then their agreement is per se an unreasonable restraint of trade and unlawful under Section 1. Agreements among competitors to set prices expose the firms involved -- and the executives involved -- to criminal prosecution as well as civil liability for damages. The fines assessed against the firms can be enormous (in the hundreds of millions of dollars) and the executives can actually go to jail.

A "horizontal" agreement to fix prices is nearly always a per se violation of Section 1. It doesn't matter whether the agreement is to set minimum prices or maximum prices or to "stabilize" prices. Horizontal price fixing is unlawful even if the firms involved have only a small share of the market; even if only a few customers or a small geographic area are affected; and even if the prices agreed upon are "reasonable" under some other standard, for example are just high enough to cover costs and yield a market rate of return on invested capital.

"Bid-rigging" by competitors constitutes unlawful horizontal price-fixing, regardless of the specific form it takes, e.g., comparing bids before submitting them, (11) agreeing that one of the conspirators will submit the winning bid, (12) or agreeing to refrain from bidding against one another. (13)

Beware: There exists a wide range of conduct which, when agreed to by competitors, has been held to constitute unlawful price fixing even though no literal fixing of the product's price is discernible. Here are some examples:

1. an agreement to standardize credit terms offered to purchasers;
2. an agreement to use uniform or standard trade-in allowances;
3. an agreement to use uniform cash down payment requirements;
4. an agreement to limit discounts;
5. an agreement to discontinue free service;
6. an agreement to use a specific method of quoting prices;
7. an agreement establishing uniform costs and markups;
8. an agreement specifying price differentials among grades of products;
9. an agreement adopting common classifications of customers entitled to discounts;
10. an agreement to use specified accounting methods;
11. an agreement to use a uniform price list as a common starting point for bargaining with customers;
12. agreements limiting production or setting quotas;
13. an agreement to set standards that stabilize price or suppress competition;
14. an agreement that no sales will be made below cost;
15. an agreement to discontinue a product;
16. an agreement to limit business hours.

Note that this list, while lengthy, is not exhaustive.

A perfectly understandable reaction by a business person would be: "My God! How am I supposed to know when I'm doing something unlawful?" It's not as bad as that, however. Remember, a necessary condition for these violations is an agreement between firms that compete with one another. If you haven't reached an understanding with your competitor, either expressly or by a wink and a nod, then there is no issue under Section 1.

But suppose your client wants to agree with a competitor to do something. How can you tell whether the something they want to agree to do is price fixing? One answer, of course, is to not make agreements with competitors until you have conferred with competent antitrust counsel. If you insist on doing your own "horseback" analysis, here is a rule of thumb: If, when being truly honest with themself, your client admits that the rationale for the agreement they are considering is to raise prices (or keep them from falling), then they've got a problem.

Besides "price fixing" in its many guises, there are other agreements among competing firms that raise issues under Section 1. One example is an agreement to allocate markets. This can involve an agreement with a competitor to limit sales activity to a particular geographic territory, to particular customers, or to a particular product. Such an agreement to divide up markets will generally be illegal per se. An important exception is this: If the agreement is ancillary to the sale of a business it will be evaluated under the so-called rule of reason. In other words, the agreement will not be condemned out of hand as per se unreasonable, but will be examined for possible beneficial effects. For example, in some cases, the positive impact of an agreement by the seller of a business not to compete, provided that it is reasonable in scope and duration, has been judged to outweigh the negative, anticompetitive effects. Such reasonable agreements are lawful under Section 1.

Besides reasonable agreements not to compete that are ancillary to the sale of a business, some other horizontal arrangements that affect price competition have been exempted from the per se rule and examined under the rule of reason.(14) The analysis of these exceptions is subtle and we will not undertake it here.

Finally, a "group boycott" or "concerted refusal to deal" can violate Section 1. A Supreme Court case from the mid-80s provides a good summary of the law on such boycotts:

Cases to which this Court has applied the per se approach have generally involved joint efforts by a firm or firms to disadvantage competitors by "either directly denying or persuading or coercing suppliers or customers to deny relationships the competitors need in the competitive struggle." In these cases, the boycott often cut off access to a supply, facility, or market necessary to enable the boycotted firm to compete, and frequently the boycotting firm possessed a dominant position in the relevant market. In addition, the practices were generally not justified by plausible arguments that they were intended to enhance overall efficiency and make markets more competitive. Under such circumstances the likelihood of anticompetitive effects is clear and the possibility of countervailing procompetitive effects is remote.(15)

Boycotts that have the characteristics enumerated by the Court are sometimes called "classic boycotts" and they are unlawful per se. Conduct that falls short of a classic boycott will be reviewed according to the rule of reason, that is, the court will weigh its anticompetitive effects against any procompetitive effects before deciding whether the boycott is an unreasonable restraint on trade.

Vertical Agreements in Restraint of Trade

While horizontal agreements that fix prices or allocate markets are generally unlawful per se under Section 1, "vertical" agreements are more likely to be analyzed under the rule of reason. A vertical agreement is an agreement between firms at different levels in the production/ distribution chain. An agreement between a manufacturer and his distributor is a vertical agreement as is an agreement between a manufacturer and a firm that supplies it with raw materials.

There is one type of vertical agreement that is unlawful per se, namely an agreement to fix the minimum resale price of a product ("resale price maintenance"). An agreement between a manufacturer and a retailer, or between the manufacturer and the wholesaler, that the party buying the product will charge at least X when that party resells it would be a per se violation of Section 1.

(Recall that without an agreement there can be no violation of Section 1. Therefore, it is perfectly legal, for example, for a manufacturer to tell his distributors that he expects them to charge X and that he will terminate any distributor who charges less than X -- provided the manufacturer acts unilaterally. In concrete cases it can be difficult to distinguish unilateral action from concerted action; competent antitrust counsel should be consulted to design appropriate policies and procedures for terminating distributors.)

Vertical agreements on the maximum price to charge used to be unlawful per se, but have been subject to rule of reason analysis since the Supreme Court's decision in Khan, three years ago.(16) Likewise, vertical non-price restraints are also evaluated under the rule of reason. Examples of such non-price restraints would be an agreement between a manufacturer and a distributor that the distributor will only sell the manufacturer's products within a certain geographic market. Not only are vertical territorial and customer restrictions evaluated under the rule of reason, but, upon such evaluation, the courts have found nearly all such agreements reasonable, i.e., lawful. The reason for that result is a belief by courts (and economists) that the most important kind of competition is interbrand competition (GM vs. Ford), not intrabrand competition (Ford dealer X vs. Ford dealer Y). Because exclusive distributorships and similar arrangements are perceived to encourage interbrand competition, they are considered on balance to be procompetitive and thus lawful under the rule of reason.

Tying Arrangements

A "tying arrangement" has been defined as "an agreement by a party to sell one product but only on the condition that the buyer also purchases a different (or tied) product, or at least agrees that he will not purchase that product from any other supplier."(17) The Supreme Court has explained that "the essential characteristic of an invalid tying arrangement lies in the seller's exploitation of its control over the tying product to force the seller into the purchase of a tied product that the buyer either did not want at all, or might have preferred to purchase elsewhere on different terms."(18)

A tying arrangement may be unlawful under Section 1 of the Sherman Act as an agreement that unreasonably restrains trade. It may also be unlawful under Section 3 of the Clayton Act which makes it unlawful for a seller of goods to require, as a condition of the sale, that the buyer not purchase from the seller's competitors, if the effect may be to substantially lessen competition or tend to create a monopoly. A tying arrangement is a violation of both of those statutes if these four elements are shown:

(1) There are indeed two separate products or services;
(2) The buyer must purchase the tied product if he wishes to purchase the tying product;
(3) The seller has sufficient economic power in the market for the tying product to enable it to restrain trade in the market for the tied product; and
(4) A "not insubstantial" amount of commerce in the market for the tied product is foreclosed.

Exclusive Dealing Arrangements and Requirements Contracts

An exclusive dealing arrangement is an agreement -- express or implied -- that a buyer will for an extended period of time purchase a product or service exclusively from one seller. A "requirements contract" is an agreement that a buyer will take all his "requirements" from the seller for a specified period of time. Another version of the same kind of arrangement is an agreement to buy a large dollar amount from a particular seller, an amount so large in fact that for all practical purposes the buyer ends up dealing exclusively with that seller.

As one court put it, "[t]he antitrust problem that courts have found lurking in [these] contracts grows out of their tendency to 'foreclose' other sellers from the market by 'tying up' potential purchases of the buyer."(19) However, as the Supreme Court noted over 50 years ago, contracts such as these "may well be of economic advantage to buyers as well as to sellers."(20) As the First Circuit put it in the Barry Wright case, the facts may often suggest "the existence of legitimate business justifications for the agreements from the perspectives of both buyer and seller."

Because the foreclosure effects of such agreements may often be offset by "legitimate business justifications," the courts examine them under the rule of reason. A variety of factors will be looked at, depending on the facts of the case, to determine the agreement's likely impact on competition in the affected market. These factors include:

(a) The extent to which the affected market is foreclosed to other sellers. For example, if an exclusive dealing arrangement only "locks up" 30 percent of the sales in a market, so that sellers can compete for the other 70 percent, the arrangement is less likely to be found unlawful.
(b) The duration of the exclusive arrangement. The Seventh Circuit has held, for example, that a contract of one year duration or less is presumed lawful. The longer the duration the more likely is a finding of unreasonable foreclosure.
(c) The business justification for the arrangement. For example, an agreement by a buyer to deal exclusively with a seller for several years may be reasonable if the seller had to make buyer-specific investments that can only be recovered that way.
(d) Ease of entry. For example, an agreement by a distributor to handle only products of manufacturer X may not be an unreasonable foreclosure if competing manufacture Y can set up his own distributors or sell directly to end-users.

Monopolization

So far, all of the antitrust issues we've discussed arise out of concerted action by a plurality of actors. However, Section 2 of the Sherman Act makes unlawful certain conduct engaged in by a single firm acting on its own. Here is what Section 2 says:

Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other person or persons, to monopolize any part of the trade or commerce among the several States, or with foreign nations, shall be deemed guilty of a felony....

Of course, conspiring or combining to monopolize requires a plurality of actors but monopolization does not. Neither does attempted monopolization.

What is monopolization? It is not simply having a monopoly. A firm may have a monopoly over a particular product or service but, if it acquired that monopoly through legitimate means, it has committed no offense. In the words of a landmark decision, "[a] single producer may be the survivor out of a group of active companies, merely by virtue of his superior skill, foresight, and industry.... The successful competitor, having been urged to compete, must not be turned upon when he wins."(21) And if a firm has become a monopoly by legitimate means, e.g., by superior skill, foresight and industry, it is not illegal for that monopoly firm to charge a profit maximizing price, a price that by definition will exceed what the price would have been with competition.

Unlawful monopolization occurs when two conditions are satisfied: (1) a firm has monopoly power, typically defined as a large enough share of a market to be able to successfully raise the price of the product; and (2) the firm achieved or is maintaining its monopoly power by means of "exclusionary" or "predatory" conduct. Such conduct consists of practices by the monopoly firm that keep would-be competitors out of the market other than by "competition on the merits." Modern Section 2 cases have tended to focus on a handful of such practices.

One such practice is predatory pricing, although the recent trend is for courts to be highly skeptical of claims that a firm's pricing behavior is "predatory." For a price to count as predatory it has to be below "cost." What measure of cost? The Supreme Court has not answered that question definitively yet, but a price below average variable cost (or marginal cost) raises concerns. The logic is pretty straightforward. Basic economics teaches us that if a firm has to lower its prices below average variable cost to get business, it would be better off without the business. Thus, the only explanation for such seemingly irrational behavior as charging less than average variable cost is that the firm has an ulterior motive: it is trying to drive out its competition, at which point it will recoup its short-run losses by raising prices to monopoly levels. This ability to recoup is the second element required for a finding of predatory pricing. In fact, some courts start with recoupment and work backwards. If barriers to entry are low, so that recoupment seems highly unlikely, these courts will not find predatory pricing.

Another type of behavior that may be considered predatory or exclusionary and support a finding of monopolization is a "refusal to deal." As a general rule, a business firm has the right to sell or not to sell to whomever it chooses. However, a firm with monopoly power may be required to sell to other firms if a refusal to sell is calculated to maintain monopoly power.

The test is whether the monopolist's refusal to deal has a "legitimate business justification." If it does, the refusal is not unreasonably exclusionary. On the other hand, if a monopolist refuses to deal with a competitor merely "to maintain a monopoly market share or thwart the entry of competitors,"(22) the refusal to deal may be unlawful.

A special case of the exclusionary refusal to deal is a refusal to deal by a firm that owns "essential facilities." The essential facilities doctrine comes into play if these conditions are satisfied: (1) a monopolist controls an "essential" or "bottleneck" facility; (2) a competitor is unable reasonably or practically to duplicate the essential facility; (3) it is feasible for the monopolist to provide the competitor with access to the facility; but (4) the monopolist denies access to the facility.(23) In the MCI case, AT&T refused to allow MCI to connect its long distance lines to AT&T's local network, despite the fact that without such interconnection MCI could not compete with AT&T for long distance business and despite the fact that it was technically and economically feasible to permit interconnection. According to the 7th Circuit:

A monopolist's refusal to deal under these circumstances is governed by the so-called essential facilities doctrine. Such a refusal may be unlawful because a monopolist's control of an essential facility (sometimes called a "bottleneck") can extend monopoly power from one stage of production to another, and from one market into another. Thus, the antitrust laws have imposed on firms controlling an essential facility the obligation to make the facility available on non-discriminatory terms.(24)

The courts have generally taken the adjective "essential" seriously. A facility is not essential merely because the party seeking access to it would be inconvenienced or incur higher costs if denied access. Only if denial of access would impose a "severe handicap" is the facility "essential."

Another example of conduct that may constitute monopolization if engaged in by a firm with monopoly power is predatory innovation. An innovation might be deemed predatory if the innovation does not genuinely improve the product or service but serves merely to exclude competitors.

Recall that monopolization requires predatory conduct plus monopoly power. Even without monopoly power, predatory conduct can support a claim of attempted monopolization if the firm engaging in predatory conduct has a "specific intent" to obtain monopoly power in a market and there is a "dangerous probability" the firm will achieve that goal .(25)

Price Discrimination

Section 2 of the Clayton Act, as amended by the Robinson Patman-Act, may under certain circumstances make it unlawful to sell goods of like grade and quality to different purchasers at different prices. The key issue (assuming a number of so-called "jurisdictional" elements have been satisfied) is whether the price differences may harm competition.

Consider this scenario. Firm A sells its product in a number of geographic markets. In one of those markets, firm A competes with firm B, and in that market firm A charges a lower price than in its other markets. Firm B alleges price discrimination because firm A is charging different prices for the same goods. When, as in this example, a competitor of the price discriminator is the one alleging injury due to the price differences, the courts have said that, even though the competitor himself may have been injured, there is no injury to competition, and thus no unlawful act, unless: (1) the firm engaged in price discrimination was pricing below its cost; and (2) the firm had a reasonable prospect of recovering the losses it incurred as a result of its below-cost prices. (26) In effect, demonstrating unlawful price discrimination in such "primary line" cases requires a showing of predatory pricing (and we explained above how skeptical modern courts are about claims that prices are predatory).

Consider a different scenario. Firm A sells to a number of customers including retailer B and retailer C. Firm A charges B a lower price than it charges C for the very same product. B and C are competitors and C alleges that A's price discrimination gives B an unfair competitive advantage. In such so-called "secondary line" cases, the courts have been willing to find a violation of the Robinson-Patman Act based on injury to a competitor without the need to show injury to the competitive process. To show such injury, firm C needs to prove a "substantial" difference in the price firm A charged it and the price that A charged C's competitor B. In addition, C must show that the substantial price difference continued for a "significant" period of time. The theory is that under such circumstances C must certainly have lost business (and profits) to B, thereby establishing injury.

Note, also, that in cases where the seller has unlawfully discriminated the buyer may be liable under the law if that buyer has knowingly induced or received the discriminatory price.

Even where a plaintiff can make out a prima facie case of unlawful price discrimination, there are several defenses an alleged price discriminator can make use of. These are (1) the "meeting competition" defense; (2) the "cost justification" defense; (3) the "changing conditions" defense; and (4) the "functional availability" defense.

The "meeting competition" defense permits a seller to argue that the lower price charged to some customers was a good faith effort to meet an equally low price charged by one of his competitors.

The "cost justification" defense permits a seller to charge a lower price to a customer or class of customers where the lower price makes "only due allowance for differences in the cost of manufacture, sale or delivery resulting from the differing methods or quantities" involved in supplying those customers. Note, however, that not all types of cost differences have been recognized by the courts for purposes of the defense. In one case, for example, a firm justified a lower price to "incremental" customers on the grounds that additional goods could be produced for them with no increase in fixed cost. Existing customers were charged a higher price based on fully-allocated cost. The court rejected the argument, holding that the cost-justification defense was not intended to apply to those kinds of cost differences.(27)

The third defense to a price discrimination claim involves "changing conditions affecting the market" for the good in question. One such changing condition specifically enumerated in the statute is the "obsolescence of seasonal goods." At least one court has extended the concept to technological obsolescence. In a case involving telephones, the 10th Circuit stated:

Although the statute speaks of obsolescence of seasonal goods, price differences as a result of technological obsolescence or the introduction of a new product model are circumstances sufficiently similar to the examples named in the statue that they fall within the general scope of the statute.(28)

The fourth defense, "functional availability," applies when the lower price was in fact made available to the purchasers complaining of discrimination, but they did not avail themselves of it. The adjective "functional" indicates that the defense is not valid if the lower price was only available to the complaining purchasers in theory, but as a practical matter they could not take advantage of it.

The author would like to thank Darryl S. Bell, chair of the Quarles & Brady antitrust and trade regulation group, for his valuable comments. Any remaining errors are the responsibility of the author.