Manufacturers often wish to restrict the prices of their products offered by distributors and other entities in the distribution line so as to protect the market and establish a level of perceived quality. Distributors and often the public resist such efforts, wishing a “free market” to set the prices and in many locales, such as the United States, efforts by manufacturers to restrict pricing offered down the distribution line has been held a violation of the various anti trust laws that can impose both civil and criminal penalties on entities who violate the strict provisions.
However, a recent United States Supreme Court decision ruled that it is not an automatic violation of the Sherman Antitrust Act for manufacturers to require that distributors agree to fixed resale prices. Resale price maintenance agreements, often called vertical pricing, have been considered a “per se” (or automatic) antitrust violation since the early Twentieth Century. The ruling may have widespread implications on future pricing agreements between manufacturers and distributors. And the underlying rationale for this new approach? Blame the Internet.
In a case heard in June of 2007 (Leegin Creative Leather Products,Inc. v. PSKS, Inc., No. 06-480, 6/28/07) the Supreme Court ruled that vertical price agreements are not an automatic violation of the Antitrust Act. However, the court did not give a full freedom do set prices in any clauses in a contract that seek to control such pricing. The decision directs lower courts to apply a "rule of reason" with regard to whether similar cases violate antitrust law in the future.
In the Majority Opinion of the Court, the Court pointed out that one of the principal competitive justifications for resale price maintenance is to combat "free riding." In recent years, Internet shopping has made free riding an increasing concern in the traditional retail industry. While consumers can often buy retail items cheaper on the Internet, they cannot hold the products in their hands or mix and match in front of a mirror. To accomplish this type of buying, consumers visit the local stores. However, if the same products are sold for less on the Internet, they will often utilize the services of the local store but then purchase the items online.
This not only hurts potential sales of the unfortunate stores, but can also cost them revenue in terms of wasted time interacting with customers who do not buy. Resale price agreements can effectively negate free riding if all distributors (local stores and Internet retailers) must sell the same item from the same manufacturer for the same price.
Recall that Internet retailers are often able to sell products at lower prices due to their lack of overhead, but if the items were required to have identical sales tags, the playing field would be leveled for offline competitors.
(Would they? Would not the internet companies simply make a larger profit thus have an advantage in that manner? The argument has obvious weaknesses.)
Those on the other side of the argument feel the free market should prevail and Internet retailers should be allowed to sell products at lower prices thereby benefiting consumers
The case involved a manufacturer of leather goods that required distributors to resell its "Brighton" brand products at a set minimum price. The brand became a significant aspect of Kay's Kloset store in Texas, which was owned by PSKS Inc. The retailer promoted Brighton products in its advertising. "Brighton was the store's most important brand and once accounted for 40 to 50 percent of its profits," according to court documents. However, Kay's often discounted Brighton products, which ultimately resulted in the manufacturer canceling its contract and stopping shipments to the store. Revenue from sales at Kay's Kloset plummeted. The retailer then sued the manufacturer, claiming it violated the Sherman Antitrust Act by forcing stores to only charge prices that it fixed. In its case, the retailer relied on a Supreme Court decision from 1911 involving a medicine manufacturer named Dr. Miles Medical Company. The manufacturer sold its products only to distributors who agreed to resell them at set prices. The Court found Dr. Miles' control of resale prices to be unlawful under the Sherman Antitrust Act.
PSKS Inc. was victorious in both the U.S. District Court of East Texas and the U.S. Court of Appeals, which upheld the lower court's finding based on the precedent set by the 1911 case. Both courts ruled that Leegin violated the Sherman Act by requiring that distributors adhere to a price floor when reselling its products. A judgment of nearly $4 million was awarded to PSKS, which included damages, attorney's fees and costs.
Leegin appealed to the Supreme Court maintaining that pricing agreements should only be considered illegal when they can clearly be proven anti-competitive. The retail manufacturer argued that being anti-competitive was not its objective in instituting the price agreements. Leegin argued that it sought only to establish and maintain a certain image that was consistent with higher price points and that discounting items tarnished that image and devalued the brand.
The National Association of Manufacturers filed an amicus brief with the Supreme Court on behalf of Leegin. The organization argued that, "giving manufacturers the flexibility to establish the price at which their products may be sold can provide a variety of pro-competitive benefits." Leegin's counsel argued that a "rule of reason" should determine whether pricing agreements were anti-competitive in nature.
The Supreme Court Overruled the Earlier Decision. After hearing arguments, the Supreme Court ruled in Leegin's favor overturning the Dr. Miles precedent and dictating a "rule of reason" for courts to follow in the future. The decision stated that lower courts can create a "litigation structure" that will "devise rules over time" to ensure that the rule of reason is "fair and efficient" in its application.
Pricing Agreements in the Wake of the Decision:
Leegin Provides Some Freedom of Action, But Remains Restricted. The ruling in the Leegin case is expected to have an impact on pricing agreements in the future. Manufacturers now have some leeway in requiring distributors to meet minimum resale prices but they don't have free reign. Here are some factors to consider:
1. Analyze state and international laws. Some states have laws that may still prevent resale price maintenance agreements. While these laws may change in the wake of the Supreme Court decision, consult with your legal advisers about state laws before establishing a vertical pricing policy. And manufacturers dealing with foreign resellers also must also investigate whether pricing policies violate international antitrust laws.
2. Be careful when setting prices. Under the rule of reason, vertical pricing agreements must be evaluated on a case-by-case basis. Anti-competitive harm is balanced against pro-competitive benefits. Manufacturers should only consider agreements that have reasonable arguments behind them that maintain competitiveness.
3. Avoid agreements with other manufacturers or dealers regarding price. The Supreme Court case deals with vertical pricing. Agreements with other manufacturers or dealers generally constitute horizontal price agreements, which are still illegal.
4. Review your existing contracts. If your company decides to create vertical pricing agreements, be careful. Replace any provisions that allow resellers to set their own prices if that is appropriate but only after consultation with legal counsel and clear identification of the jurisdictions that might apply to the contracts. For example, if your distributor is in Belgium or South Africa, very different laws will apply regardless of the relaxation of the Supreme Court ruling.
Markets change and the law, however slowly, changes with them. As discussed in numerous other articles on this website, the increasing globalization of business and the widespread use of the internet are altering the way all businesses engage in business and the law is scrambling to catch up. The anti trust laws are the newest but not the last area of legal adaptation to the new realities and we can expect the law to be both challenged and altered yet again as the rest of the world seeks to develop a way to integrate this powerful new technology into the pre existing legal and business structures. Stay alert and keep abreast of the new developments.