Summary

The Supreme Court has delivered its much anticipated[1] decision in Leegin v. PSKS, Inc.[2] and overruled the 96 year-old rule established in Dr. Miles Medical Co. v. John D. Park & Sons Co.[3] that made agreements between manufacturers and their distributors on the minimum resale price of the manufacturer’s products, "per se" or automatically unlawful.  The Court held that the appropriate standard for testing the lawfulness of minimum resale price agreements, also known as resale price maintenance or RPM, is the rule of reason, not the per se standard.  Under the rule of reason, the courts evaluate the effects of a trade restraint on competition in the relevant antitrust market.  If a restraint’s effects benefit competition between rival firms more than they injure competition, the restraint will be upheld.  Thus, the Leegin decision means that courts will now review RPM practices on a case-by-case basis.  Federal and state law enforcers and private plaintiffs will have the burden of proving that a RPM practice is anticompetitive, while manufacturers and distributors will need to show that their RPM practice is procompetitive.

Introduction

            For 96 years, the rule established by the Supreme Court in Dr. Miles made RPM practices per se unlawful under Section 1 of the Sherman Act.  A person who engaged in RPM was thus exposed to federal and state prosecution as well as private actions, criminal penalties including imprisonment, automatic treble damages, and liability for litigation costs and attorneys fees.  But on June 28^th 2007, in a 5-4 decision, the Court overruled its decision in Dr. Miles and held that RPM is not the kind of practice that fits the per se rule.  RPM does not "always or almost always tend[] to restrain competition and decrease output" and so the per se rule is not the appropriate standard for RPM.  In reaching this conclusion, the Court found that the reasons given in Dr. Miles did not justify the per se rule; that RPM can stimulate interbrand competition (competition among manufacturers selling different brands of competing goods) which is the antitrust laws’ primary purpose; and that the legal doctrine of stare decisis did not compel adherence to Dr. Miles because the Sherman Act is treated in the manner of the common law, not statutory law.  Because the per se rule no longer applies, the Court held that the RPM should be subject to the rule of reason, "the accepted standard for testing whether a practice restrains trade in violation of § 1 of the Sherman Act".  Under this approach, the courts will consider all of the circumstances including the relevant business, the restraint’s history, nature and effect, and especially, whether the businesses involved have market power.

The District Court Decision

            Leegin, like many manufacturers concerned with brand image and product merchandising, had established MSRP policies where the manufacturer in advance announces the terms and conditions upon which it will deal and the circumstances under which it will refuse to deal.  MSRP policies are lawful under United States v. Colgate & Co., 250 U.S. 300 (1919).  Colgate created a lawful alternative to the per se rule against resale price agreements in Dr. Miles.  Under Colgate, a purely unilateral MSRP policy escapes the per se rule in Dr. Miles because it lacks the element of "agreement" essential under § 1.

            Plaintiff PSKS, Inc., a women’s clothing and accessories store doing business as Kay’s Kloset, sued Leegin, a manufacturer of women’s accessories, for engaging in RPM with other retailers in violation of § 1.[1]  PSKS, Inc. demonstrated that Leegin’s MSRP policy went beyond the lawful boundaries of Colgate by suggesting joint, not unilateral action, that Leegin solicited agreement from retailers by asking them to "pledge" to follow the policy, and that Leegin assured retailers that others were following the policy.  The district court refused to allow any expert testimony on behalf of the defense which asserted that MSRP can be pro-competitive and was so here.  Instructed pursuant to Dr. Miles, the jury found that defendant Leegin engaged in RPM with retailers and therefore violated § 1 of the Sherman Act.  Leegin was ordered to pay PSKS, Inc. $3.6 million in trebled damages as well as $375,000 in attorney’s fees and costs.

The Fifth Circuit Decision

            On appeal, Leegin did not challenge the jury’s finding that it entered into RPM agreements with retailers.  Rather, Leegin challenged the per se standard.  The Fifth Circuit rejected Leegin’s arguments, explaining it was bound by Dr. Miles to apply the per se rule.  The court noted the length of time that the rule has stood since Dr. Miles was decided and the Supreme Court’s consistency in applying it. [2]  The court also rejected Leegin’s argument that the jury should be permitted to consider either that Leegin’s pricing practices were procompetitive or its expert economic testimony.  Neither, the court held, were relevant where the per se rule applies because the rule presumes competitive harm.[3]

The Supreme Court Decision

            In overruling Dr. Miles, the Supreme Court first noted that the per se rule is confined, and should only apply, to trade restraints that "always or almost always" tend to restrict competition and decrease output, such as horizontal agreements among competitors to fix prices or divide markets.[4]  A restraint condemned by the per se rule must have manifestly anticompetitive effects and lack any redeeming value, the Court added.[5]  The per se rule, the Court said, is only appropriate after courts have had considerable experience with the type of restraint at issue.[6]  A departure from the rule of reason and the application of the per se rule should only be based on a demonstrable economic effect rather than formalistic line drawing.[7]

            For all these reasons, the Court held that the per se rule established in Dr. Miles was wrong.  Dr. Miles, the Court noted, was decided not long after the Sherman Act was enacted, when the Court had little experience with antitrust analysis.  Furthermore, the Court in Dr. Miles did not rely on any demonstrable economic effect.  Instead, it relied upon a formalistic legal doctrine, the common-law rule that a general restraint upon alienation is ordinarily invalid.  The common-law rule against restraints on alienation, especially in the age that Dr. Miles was decided, the Court observed, was usually associated with land, not chattels, and involved policy concerns that are not relevant to the use of vertical distribution restraints in the American economy today.[8] 

            In addition, the Court recognized that "economics literature is replete with procompetitive justifications for a manufacturer’s use of resale price maintenance."[9]  Thus, RPM is not "manifestly anticompetitive" and does not always injure competition.  Manufacturers may have procompetitive justifications for RPM, such as to enhance efficiency, encourage retailers to invest in consumer services or promotional efforts that aid the manufacturer’s position against rival manufacturers, help retailers develop a quality reputation encouraging consumers to buy from such sellers, and induce retailers to perform by discouraging free-riding.[10]  The Court stated that RPM may facilitate market entry for new firms and brands.  Thus, while resale price maintenance may reduce intrabrand competition (competition among distributors selling the same manufacturer’s products), it might simultaneously stimulate interbrand competition (competition among rival manufacturers).  Interbrand, not intrabrand, competition is the primary purpose of the antitrust laws, the Court held.

            The Court likewise determined that stare decisis did not compel it to uphold Dr. Miles, a key difference with the dissent.  Stare decisis is not as significant in this case, the majority said, because this case concerns the Sherman Act and "the general presumption that legislative changes should be left to Congress has less force with respect to the Sherman Act".[11]  "Congress intended," the Court said, "§ 1 of the Sherman Act to give courts the ability ‘to develop governing principles of law’ in the common-law tradition".[12]  The Sherman Act’s prohibition of  "restraints of trade" in § 1 should "evolve to meet the dynamics of present economic conditions."[13]<

Applying the Rule of Reason to RPM, and What Now?

            Although the Court abandoned the per se rule of illegality, it did not make RPM per se lawful.  Instead, the Court established a rule of reason standard for RPM, meaning that each RPM practice will be evaluated on a case-by-case basis.  This approach is appropriate, the Court explained, because while RPM can have procompetitive effects in some cases, it can have anticompetitive effects in others.  RPM could discourage manufacturers, the Court noted, from lowering prices to retailers, discourage retailers from offering lower prices to consumers, facilitate price fixing among competing manufacturers or competing retailers, or be abused by a powerful manufacturer or retailer.[14]

            The Court provided some guidance on how the lower courts should treat vertical price restraints.  It advised the lower courts to be diligent in eliminating anticompetitive uses of vertical price restraints[15] and to take into account certain factors.  These factors include the number of manufacturers using vertical price restraints in a given industry (few manufacturers with little market power or a single manufacturer with market power would not likely facilitate a manufacturer cartel); the source of the restraint (if the restraint is retailer driven, it may be more likely that the restraint facilitates a retailer cartel); the nature of the restraint; and especially important, whether the manufacturer or retailer has market power (a manufacturer with market power could, for example, use RPM to give retailers an incentive not to sell the products of smaller rivals or new entrants).  Although this could involve a lengthy investigation, the Court suggested that a "quick-look" analysis or presumptions might suffice once the courts gain experience in applying the rule of reason to RPM.[16] 

Manufacturers that have market power, that operate in a mature, highly concentrated industry, or that could be pressured to participate in  a manufacturer cartel or facilitate a retailer cartel, may find it prudent to stick to unilateral MSRP policies rather than test the post-Leegin waters at the risk that a court could find that its RPM practice is injuring competition and therefore violates § 1.  Some manufacturers may also want to wait and see whether the States, as in the case of Illinois Brick,[17] move to adopt Leegin "repealers" and retain the per se rule.[18]  Manufacturers should thus consult antitrust counsel to help determine whether their use of RPM would pass the applicable legal test.

Authored By:

Heather M. Cooper

(213) 617-5457

hcooper@sheppardmullin.com

Michael W. Scarborough

(415) 774-2963

mscarborough@sheppardmullin.com