Supreme Court Changes the Rules on Vertical Price Fixing

by Lee Gesmer on June 29, 2007

As recently as 1977 virtually all “vertical restraints” were per se illegal under the federal antitrust laws. This included “nonprice” restraints, which are agreements between firms operating at different levels than the manufacturer that restrict the conditions under which firms may resell goods. An example might be a restriction on the locations from which a retailer may sell a manufacturer’s product.

Supreme Court precedent also restricted both vertical “maximum” price restrictions (example: “you may not price this product higher than $12/unit”) and vertical “minimum” price restraints (example: “you may not price this produce at less than $10/unit”).

However, over the last 30 years the Supreme Court has, in effect, withdrawn each of these antitrust prohibitions, holding that these restraints must be subject to the “rule of reason” (requiring an economic examination in every case to determine whether the harms outweigh the benefits), rather than the per se doctrine (per se illegal = automatically illegal; no excuse will do).

In 1977 the Supreme Court dropped the per se rule on “nonprice” restraints in the case of Continental T.V., Inc. v. GTE Sylvania, Inc. I had the pleasure (is there an emoticon for sarcasm?) of writing a Law Review Note on that case: Sylvania and Vertical Restraints on Distribution, 19 Boston College Law Rev. 751 (1978).

Twenty years later, in State Oil Co. v. Khan, the second leg of this three-legged stool was removed when the Supreme Court held that maximum vertical price restraints should not be subject to the per se rule of illegality. In and of itself this was not a big deal, since manufacturers rarely set maximum prices. The real battle, all antitrust lawyers knew, lay with the third, and most controversial, leg of the chair: minimum vertical price-fixing.

Since the 1997 Khan ruling left the per se rule against minimum price restraints intact, for the last ten years it has remained per se illegal for a manufacturer to dictate the minimum price at which a product may be sold. In other words, it has remained per se illegal for a distributor (or a manufacturer that sells directly to retailers) to prevent distributors and retailers from price cutting. Hence, the phrase “manufacturer’s suggested retail price” or “MSRP.” Most likely, you have never seen the phrase “manufacturer’s required retail price.”

Yesterday, in a five to four decision written by Justice Kennedy (often seen as the swing vote on this Court), the Supreme Court overruled the per se rule on vertical minimum price fixing that almost every living American has lived with his or her entire life. In Leegin v. PSKS, Inc., the Court swept away the almost 96-year old per se rule against vertical minimum price fixing, holding that henceforth this practice, too, will be judged under the “rule of reason.”

The rationale behind this ruling? In a nutshell, the Court was convinced that “interbrand” (as opposed to “intrabrand”) competition is sufficient to protect consumers. This leaves the possibility, therefore, that a monopolist, or a manufacturer with overwhelming market power, will still be prevented from vertical minimum price fixing. However, because the practice no longer is per se illegal, proving the harmful impact on competition in any given case will be far more costly, difficult and unpredicatable. It has been observed by one commentator that litigating a rule of reason case is one of the most costly procedures in antitrust law (H. Hovenkamp, The Antitrust Enterprise 105 (2005)). As a result of the Leegin decision, far fewer cases will be brought.

Will this make business happy? Almost certainly it will. We have had countless clients express their dismay over the rule that prevented them from imposing minimum prices on their dealers. This has been even more true as the Internet marketplace has emerged, since sellers can advertise price cuts so easily on the Web. Why should a retailer maintain a storefront and an experienced on-site sales staff when it can be undercut so easily online?

Will this change in the law be good for consumers in the long run, as the Supreme Court majority believes? Measuring the benefits and detriments of a rule such as this in an economy as complex as ours is well near impossible. The Supreme Court’s decision was based entirely on economic theory rather than empirical economic evidence. When considering this one must, of course, recall the oft-quoted comment of John Kenneth Galbraith: “The only function of economic forecasting is to make astrology look respectable.”

What is clear, however, is that a generation of antitrust lawyers will have to learn to change their tune when a client asks: “Can I tell all my distributors (or retailers) that they cannot sell below a specific price?” And keep an eye out for that label – “manufacturer’s required retail price.”

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