In a December 14, 1998 decision, the Supreme Court resolved a conflict among the circuits on the question of whether a single purchaser's decision to buy from one seller rather than another may constitute a per se violation of the antitrust laws. In NYNEX Corp. v. Discon, Inc., No. 96-1570, the Court held that the rule of reason test must be applied in analyzing the purchaser's decision. In so doing, it reaffirmed the right of companies to switch suppliers for any reason which is not anticompetitive.
Background
Most allegations of antitrust violations are assessed under the "rule of reason." The rule of reason is a balancing test which weighs the procompetitive effect or intent of a particular conduct or agreement against its harm to competition. A party claiming a violation of the antitrust laws under the rule of reason must prove both (1) the existence of the alleged anticompetitive agreement or conduct, and (2) that the agreement or conduct complained of is, in fact, anticompetitive.
The Supreme Court has found some categories of conduct or agreements, however, to be so contrary to the antitrust laws that no proof of competitive harm is needed. Such conduct or agreements are said to constitute per se violations of the antitrust laws. One offense which falls within this per se category is the group boycott. (1) A key characteristic distinguishing the group boycott from other concerted refusals to deal is its horizontal makeup. (2)
Determining whether a trade restraint is horizontal or vertical in nature can sometimes be difficult. This fact is perhaps best illustrated by Klor's, Inc. v. Broadway-Hale Stores, Inc. (3) In that case, several appliance manufacturers agreed with a retailer either not to sell to the retailer's competitor, or to do so only at discriminatory prices. Neither the District Court or Ninth Circuit recognized the case as a horizontal conspiracy. The Supreme Court, however, reasoned that the agreement, although vertical in appearance, amounted to a "group boycott" because it involved "a wide combination consisting of manufacturers, distributors, and a retailer." (4)
Despite the fact that the concerted refusal to deal present in Klor's included a horizontal agreement between a group of competing appliance manufacturers, three circuits chose to extend Klor's group boycott analysis to situations involving a conspiracy between a single retailer and a single manufacturer. (5) Other courts expressly declined to extend Klor's in such a manner, however, for fear of confusing such two-firm boycotts with exclusive distributorship agreements, which are evaluated under the rule of reason. (6)
NYNEX Corp. v. Discon, Inc.
Discon was a company formed following the breakup of AT&T to provide "removal services" -- that is, to remove obsolete telephone equipment -- for companies in the New York area. Discon entered into a contract with NYNEX Materiel Enterprises Company ("MECo"), a wholly-owned subsidiary of NYNEX, to provide removal services for New York Telephone Company ("NYTC"), another NYNEX subsidiary. MECo subsequently decided to drop Discon as a supplier of removal services for NYTC in favor of more expensive removal services provided by AT&T Technologies.
Discon sued. It alleged, among other things, that NYNEX and AT&T Technologies had conspired to eliminate Discon from the market for removal services because Discon had refused to participate in a scheme to defraud NYTC customers by overcharging MECo for its services, and then sharing the excess profits through a secret year-end "rebate" to MECo. (7) Discon claimed that this conduct violated the antitrust laws. The trial court disagreed and dismissed Discon's complaint.
The Second Circuit reversed. Pointing to its decision in Oreck Corp. v. Whirlpool Corp., (8) which expanded upon Klor's, the Second Circuit reasoned that two-firm vertical conspiracies without any pro-competitive rationale may constitute group boycotts. (9) Because NYNEX's decision to choose the more costly AT&T Technologies removal services over Discon was allegedly for an improper purpose -- e.g. to overcharge rate-paying customers -- the Second Circuit concluded that Discon had possibly "alleged a cause of action . . . under the per se rule applied to group boycotts in Klor's, if the restraint of trade 'has no purpose except stifling competition.'" (10)
The Supreme Court granted certiorari solely on the question of whether the per se rule applied. Reversing the Second Circuit, the Supreme Court held that a lack of procompetitive rationale does not make a non-price vertical restraint per se violative of the Sherman Act. The Court cited two fundamental reasons for its holding. First, the Court ruled that "precedent limits the per se rule in the boycott context to cases involving horizontal agreements among direct competitors." Specifically, the Court noted that it held in Business Electronics Corp. v. Sharp Electronics Corp. that a vertical agreement between a supplier and a customer cannot be per se illegal unless there is "some agreement on price or price levels." (11)
In Discon, the alleged restraint does not involve pricing.
Second, the Court cited the lack of "any special feature of this case that could distinguish it from" precedent. While the alleged conduct may have injured consumers, the Court held that the injury "flowed not so much from a less competitive market for removal services, as from the [improper] excercise of market power that is lawfully in the hands of a monopolist." Applying the per se rule to regulatory fraud could open the door to using the antitrust laws to attack other improper -- but not necessarily anticompetitive -- business behavior such as nepotism or personal pique. Such a per se rule "would discourage firms from changing suppliers" -- a "freedom" that "lies close to the heart of the competitive process that the antitrust laws seek to encourage." Moreover, victims of improper business behavior have other remedies at their disposal and do not need the antitrust laws to win compensation for their injury.
Implications of Discon
The Supreme Court's decision in Discon has two significant implications for the corporate or antitrust counselor. First, it puts an end to the inter-circuit confusion concerning circumstances under which a company may choose or drop a supplier. Because of the split authority on the question of whether one buyer and one seller could form a group boycott, a lawyer advising a seller or buyer of goods or services in most jurisdictions was well-advised to assume per se treatment for two-firm vertical combinations lacking a clear pro-competitive rationale. In light of the Discon decision, this is no longer the case.
Second, the Discon ruling appears clearly to reject a recent theory propounded by some antitrust regulators and commentators that, if there is no legitimate business reason for conduct, it can be condemned with only a minimal inquiry into competitive effects. (12) As the Supreme Court points out in its opinion, obligating businesses to articulate a pro-competitive motive for their buying or selling decisions infringes on their freedom of choice and could impact their conduct "even where the competitive process itself [would not otherwise] suffer harm." Accordingly, Discon has implications well beyond the specific facts presented by this case and appears to reject the "minimal inquiry" approach. (13)
The Supreme Court's ruling does not, however, create an antitrust "safe-harbor" for buyers or suppliers wishing to engage in anticompetitive exclusionary conduct. An exclusive agreement between a single buyer and a single supplier may still violate Section 1 of the Sherman Act if the agreement harms competition. Vertical agreements which (i) exclude or materially harm competitors, (ii) create or preserve the market power of either party, or, (iii) where either party has market power, is unreasonable exclusionary, may fail the rule of reason test. Accordingly, buyers' freedom choice is not unlimited; both buyers and sellers must continue to review proposed exclusive purchasing arrangements for possible anticompetitive effects in their market and in upstream or downstream markets.
Notes:
1. See Northwest Wholesale Stationers v. Pacific Stationery & Printing Co., 472 U.S. 284 (1985).
2. See P. Areeda, Antitrust Law 61644, p. 469 (1989).
3. 359 U.S. 207 (1959).
4. 359 U.S. at 213.
5. See, e.g., Com-Tel, Inc. v. DuKane Corp., 669 F.2d 404, 411-13 & nn.13, 16 (6th Cir. 1982); Cascade Cabinet Co. v. Western Cabinet & Millwork Inc., 710 F.2d 1366, 1370-71 (9th Cir. 1983).
6. See, e.g., Construction Aggregate Transp., Inc. v. Florida Rock Industries, Inc., 710 F.2d 752, 776-78 (11th Cir. 1983).
7. The alleged scheme to overcharge NYTel customers was the focus of proceedings before the Federal Communications Commission which culminated with NYTel agreeing "to refund over $35 million to customers for 'for unreasonable rates reflecting improper capital costs and expense charges.'" Discon, Inc. v. NYNEX Corp., 93 F.3d 1055, 1058 (2nd Cir. 1996).
8. 579 F.2d 126 (2nd Cir.) (en banc), cert. denied, 439 U.S. 946 (1978).
9. 93 F.3d 1061, citing Com-Tel, Inc. v. DuKane Corp., 669 F.2d 404, 411-413 & nn.13, 16 (6th Cir. 1982); Cascade Cabinet Co. v. Western Cabinet & Millwork Inc., 710 F.2d 1366, 1370-71 (9th Cir. 1983).
10. Id., quoting Oreck, 579 F.2d at 131 (citations omitted).
11. See 485 U.S. 717, 735-36 (1988).
12. See, e.g., Jonathan B. Baker, "Promoting Innovation Competition Through the Aspen/Kodak Rule," Prepared Remarks Presented Before the George Mason University Law Review Antitrust Symposium: The Changing Face of Efficiency, October 16, 1998. See also A. Douglas Melamed, Principal Deputy Assistant Attorney General, Antitrust Division, U.S. Department of Justice, "Exclusionary Vertical Agreements," Speech to the Antitrust Section of the American Bar Association, April 2, 1998.
13. For instance, the Federal Trade Commission has brought a regulatory action against Intel for its refusal to provide three of its customers continuing access to technical information necessary to develop computer systems based on Intel microprocessors. All three of these companies -- Digital Equipment Corporation, Intergraph Corporation, and Compaq Computer Corporation -- are also competitors to Intel. The FTC's claim seems to be based upon the notion that, absent a legitimate rationale for its conduct, a monopolist's refusal to deal with a customer who is also a competitor requires only a showing of harm to the customer/competitor but no showing of harm to competition or consumers.