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July 2, 2007
Resale Price Maintenance Agreements:
Supreme Court Sets a New Standard
Manufacturers and distributors have long been told that resale price maintenance agreements or vertical price restraints — agreements where manufacturers and distributors set the minimum price that a distributor can charge for the manufacturer's product — are off limits. But that thinking and approach to business relationships in the supply channel must now change.
On Thursday, June 28, 2007, in a landmark antitrust opinion, the United States Supreme Court ruled that by a 5-4 vote such agreements are not per se illegal under Section 1 of the Sherman Act. In a departure from prior precedent that dates back almost a century, the Supreme Court announced in Leegin Creative Leather Products, Inc. v. PSKS, Inc. that resale price maintenance agreements between manufacturers and distributors are to be judged under the more pragmatic "rule of reason" test, which takes into account the procompetitive and anticompetitive effects of such agreements. While the full impact of the Supreme Court's decision cannot be measured until it is carried out by the lower courts, there is no doubt that it will fundamentally change the way manufacturers and distributors do business in the future.
Previous Per Se Standard
In 1911, the Supreme Court took up the issue of whether a manufacturer could sell its products only to distributors that agreed to resell them at set prices. Relying more on property law than economic principles, the Supreme Court in Dr. Miles Medical Co. v. John D. Park & Sons Co. ruled that the manufacturer's control of resale prices was unlawful under the antitrust laws. In subsequent decisions, the Supreme Court interpreted the Dr. Miles case as establishing a per se rule against the establishment of minimum resale prices between manufacturers and distributors.
But against the backdrop of changing economic and market realities, it was becoming clear that the basis for the per se prohibition was outdated. As a result, the Supreme Court began to chip away at the scope and rationale of the Dr. Miles case. For example, in Continental TV, Inc. v. GTE Sylvania Inc., the Supreme Court held that vertically imposed nonprice restraints, such as geographic, territorial or customer limits, were not per se illegal. Instead, these types of vertical restraints were to be tested under the rule of reason standard.
Rule of Reason Standard
In Leegin, the Supreme Court finally overruled Dr. Miles and declared that resale price maintenance agreements were not per se illegal. It applied the same reasoning underlying its decisions in the Sylvania case and others, which held that nonprice vertical restraints were subject to the rule of reason standard. With last week's ruling, the Supreme Court finally rejected the outright ban on resale price maintenance agreements.
Under the rule of reason standard, courts assess and weigh the procompetitive and anticompetitive effects of a challenged agreement to determine whether it constitutes an unreasonable restraint on trade. This means looking at whether it is likely to increase or decrease the number of competitors, brands, customer choices and, ultimately, prices.
Practical Pointers Following the Supreme Court's Ruling
While any proposed resale price maintenance agreement must be evaluated on a case-by-case, market-by-market basis, the following factors will be key in determining whether a particular price agreement is likely to hold up under a rule of reason analysis. In any event, courts will now look at the market impact of such agreements.
- Affect on Interbrand Competition. Resale price maintenance agreements necessarily decrease intrabrand competition — competition among firms selling the same product — by preventing price-cutting below a certain pre-set level. However, as the Supreme Court made clear, that will no longer be the end of the story. Courts will now focus on the affect on interbrand competition — competition among manufacturers selling different brands of the same type of product. This will include the likelihood of increased consumer choice through new and existing products that run the spectrum from low-price, low-service to high-price, high-service. The more dynamic the market, the greater the likelihood that resale price maintenance agreements will withstand scrutiny.
- Potential for Anticompetitive Effects. Despite the Supreme Court's announcement of a new standard, courts will continue to assess whether there are anticompetitive effects, such as the facilitation of a cartel. Resale price maintenance agreements could be misused by manufacturers operating in a tightly concentrated industry to identify and discipline price-cutters. Or, such manufacturers could use a resale price maintenance agreement to restrict demand, decrease supply and, consequently, increase prices. Under these circumstances, courts may be skeptical of resale price maintenance agreements and conclude that they are likely to reduce competition and harm consumers. On the other hand, if the market is diffuse, heterogeneous and competitive, then courts will be more likely to conclude that the risks of cartelization are remote and are outweighed by procompetitive effects.
The Supreme Court's decision in Leegin should be welcomed by manufacturers and distributors. It affords them greater flexibility in competing in the marketplace. But the new standard presents challenges as well as opportunities.
We at Much Shelist can help you adapt to the changed legal environment by structuring and implementing price and nonprice vertical agreements in order to compete effectively and legally.
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