In its final set of opinions for the 2006-07 term, the U.S. Supreme Court overruled a century-old rule against minimum resale price maintenance – and businesses may now want to reconsider their distribution policies as a result. Until the Supreme Court’s June 28 decision in Leegin Creative Leather Products, Inc. v. PSKS, Inc., any agreement permitting a manufacturer, supplier, or licensor to control the minimum price at which others would resell its products had been illegal “per se” – that is, automatically illegal, with no possible defense. Ten years ago, the Supreme Court eliminated that rule for maximum prices, and now the Supreme Court has done the same for minimum resale price agreements. Instead, all resale price agreements will now be judged by looking at their actual effects on competition.
Background. Back in 1911, the Supreme Court said in the Dr. Miles case that it was illegal for a supplier to restrain a reseller’s pricing. But in the Colgate case eight years later, the Supreme Court also confirmed that there was no antitrust violation unless there was an “agreement” between the supplier and its reseller – because the Sherman Act only forbids agreements that restrain trade, not unilateral practices that may have the same practical effect. So a mere suggestion of a resale price – with no evidence of agreement – was not an “agreement” in restraint of trade; manufacturers were free to provide Manufacturer’s Suggested Resale Prices (MSRPs) and other market intelligence to their resellers, as long as they didn’t “agree” on a reselling price. Many manufacturers took this a step further and adopted what came to be called “Colgate policies”: the manufacturer announced the minimum resale prices that it wanted to see and announced a policy that it would not deal with discounters. In other words, at any given time the reseller would be free to sell its existing inventory at whatever price it chose, but the manufacturer could refuse to resupply a reseller whom it discovered to be discounting below MSRP.
The Dr. Miles rule of per se illegality originally applied to nonprice vertical agreements that could have a significant effect on price, but the Supreme Court’s 1977 GTE Sylvania case changed that. A nonprice restraint could provide a direct benefit to consumers (e.g., a requirement that a store have a minimum space devoted to the manufacturer’s product, or that the store have a certain number of on-floor personnel trained in the manufacturer’s product and able to provide information). Or it could simply provide an incentive for the reseller to provide a higher level of pre-sale services (for example, granting a reseller an exclusive territory might give the reseller a sufficient assurance that consumers would buy from that reseller, rather than going down the street to the discounter who had not borne the expense of providing pre-sale services). So the Supreme Court decided that nonprice vertical restraints should be evaluated under the “Rule of Reason.” The Rule of Reason requires courts to examine the specific agreement and evaluate its actual effects on competition (in contrast to the per se approach, which conclusively presumes that the condemned conduct always or almost always has a net negative effect on competition – for example, a price-fixing agreement between competing manufacturers). Under the Rule of Reason, an agreement is unlawful only if it has a net negative effect on competition.
In its 1997 State Oil v. Khan case, the Supreme Court chipped more directly at the Dr. Miles rule. In Khan, the Court held that maximum vertical price agreements – that is, fixing the maximum price at which the manufacturer’s products could be resold – would no longer be judged as illegal per se but would instead be judged under the Rule of Reason. But the case did not involve minimum resale price agreements.
Leegin v. PSKS. The Leegin case arose because a company that started with a Colgate policy ended up with reseller agreements. Leegin was a small, start-up manufacturer of women’s accessories such as handbags, shoes, and jewelry, and it was trying to compete with larger, established manufacturers and with department stores and other retail chains. Leegin adopted a Retail Pricing and Promotion Policy stating that it would sell its Brighton-branded products only to retailers that followed Leegin’s MSRPs. But then Leegin took one step too many and crossed the line separating unilateral announcement from bilateral agreement. Leegin demanded that all of its retailers “pledge” their compliance with the pricing policy. PSKS (d/b/a Kay’s Kloset) pledged, then broke its promise by discounting the entire Brighton line. Leegin suspended shipments to Kay’s, Kay’s sales plunged, and Kay’s sued. A jury found for Kay’s, but only after the trial court excluded Leegin’s proffer of expert testimony that the Leegin policy was actually pro-competitive.
Supreme Court Decision. Leegin squarely presented the question of whether the Dr. Miles per se ban on minimum resale price agreements should continue to be the law, and the Supreme Court said no. First, the Court found that were it to write on a clean slate, without the Dr. Miles precedent, it would have held that resale price agreements should be judged under the “Rule of Reason” approach that looks at an agreement’s actual effects on competition. Agreements should fall into the “per se” category only if the type of agreement at issue would always or almost always be judged illegal under the Rule of Reason – such as price-fixing agreements between competitors. In contrast, minimum resale price agreements can have pro-competitive benefits that outweigh the anticompetitive harms. The Court had held in Khan that the primary purpose of antitrust is to protect “interbrand” competition – for example, competition between the Pepsi® and Coke® brands of cola. Minimum resale price agreements can increase “interbrand” competition precisely because they reduce “intrabrand” competition among retailers selling the same brand. By assuring resellers that they won’t face price competition from other resellers of the same brand (at least not through prices below the MSRP), resale pricing agreements encourage retailers to invest in services or promotional efforts to sell that brand against competing brands. Moreover, by eliminating the risk that one reseller might “free ride” on another reseller’s provision of these services, minimum resale price agreements can give consumers more choices among low-price, low-service brands; high-price, high-service brands; and brands falling in between. And resale price maintenance can also help new brands enter the market by enabling resellers to provide the pre-sale services necessary to compete with entrenched brands.
Second, the Court found that principles of stare decisis – judicial reluctance to overrule earlier decisions – did not require the Court to adhere to the Dr. Miles rule, even though it had stood for nearly a century. The doctrinal basis for the decision had been undermined by decisions like Sylvania and Khan, and its economic basis has been shown to be flawed. Moreover, Congress had intended the antitrust laws to evolve much like the common law has evolved as courts gain knowledge and experience.
Risks and Unresolved Questions. The Leegin case was decided on a 5-4 vote, and even the majority opinion recognized the risks that minimum resale price agreements create – and a resale price agreement could still be found illegal under the Rule of Reason. Companies with significant market power and companies in concentrated industries would be most at risk. For example, seven years ago the Federal Trade Commission challenged the Minimum Advertised Price (MAP) policies that record companies had imposed on music CD retailers – policies that, according to the FTC’s then-chairman, had “no plausible business justification . . . other than to get prices up.” Furthermore, minimum resale pricing agreements can be used to help police a horizontal price-fixing agreement among competitors – and that, of course, remains a per se violation with serious criminal penalties as well as civil exposure.
Leegin expressly left undecided one important question – the significance of dual distribution. Leegin’s president had an ownership interest in some Leegin resellers – and the plaintiff said this meant the case really was a horizontal price-fixing case, because Leegin was competing against its own independent resellers in the retail sale of Leegin products. The Court declined to address this argument because it had not been made in the lower courts.
State laws present another set of potential challenges. Leegin decided only what federal law provides – most of the 50 states have their own antitrust laws, and Leegin did not interpret any of them and did not (at least not expressly) prohibit states from reaching a different result. Many states have policies of construing their antitrust laws the same as federal law, but a number of state attorneys general had filed an amicus brief supporting the Dr. Miles rule. How state AGs (and private plaintiffs, such as terminated resellers) will seek to enforce state laws remains to be seen. Moreover, some state laws may prohibit material changes in existing distribution agreements, making it difficult to adopt a new policy, at least in those states.
The remedies for breach of a Leegin agreement may not be terribly attractive; every argument that the manufacturer makes about its reseller’s breach of contract and free-riding on the promotional efforts of other distributors will be countered with an argument that the reseller was just trying to bring lower prices to consumers – and which of those arguments is a jury going to buy?
Some Practical Suggestions for Suppliers. Still, the Leegin decision removes some significant legal risk and thus opens up a range of business possibilities that the Dr. Miles rule had foreclosed for a century. So what are those opportunities, and what should businesses be considering? Here are some thoughts.
1. Do Nothing (Discounting Encouraged). For some suppliers, discounting is not a problem. For example, for companies selling commoditized products with little brand equity (or at least not enough to give them any significant pricing power), discounting may be encouraged. For such suppliers, adopting a “Colgate Policy” (of cutting off discounters) is not necessary or effective.
2. Do Nothing (Keep Colgate Policy). If your company already has a Colgate Policy, one option is to continue what you’ve been doing all along. Leegin has eliminated the risk that your unilateral policy becomes (or is perceived as becoming) an agreement, and you may decide not to take your practices any further.
3. Adopt a Colgate Policy. If your company never adopted a Colgate Policy because the perceived risk was too great, then now is the time to reconsider that decision. The Leegin decision has clearly eliminated the largest legal risk factor (but again, the remaining risk under state laws and the federal Rule of Reason must still be considered). A unilateral Colgate Policy will still not constitute an “agreement” for antitrust purposes, but Leegin greatly reduces the legal risks if the unilateral policy slips into becoming an agreement.
4. Revisit Co-Op Advertising Policies. Some companies that don’t have a Colgate Policy do have a co-op advertising program that provides full or partial reimbursement for resellers’ advertising, but only if the advertisement either mentions only prices at or above an MSRP or no price at all. Leegin did not address such programs directly, but if agreements on selling price are now judged under the Rule of Reason, then agreements on advertised price (as opposed to actual sales price) clearly will be too. (This had been brought into question in the FTC’s Music CD investigation.)
5. Revise Your Dealer, Franchise, or IP License Agreements. One of the major defects of the Colgate doctrine has always been that compliance with a manufacturer’s unilateral Colgate Policy cannot be made a condition of dealer agreements – otherwise, the policy would be an agreement. Many suppliers have dealer agreements with longer terms and no right for the supplier to terminate without good cause before the end of the term, making Colgate Policies effective only at the end of the term (i.e., in deciding whether to renew or terminate the agreement). Companies that have previously chosen not to have a Colgate Policy because they could not effectively enforce it should now reconsider.
6. Preserve Flexibility. Many distribution, franchise, and IP license agreements expressly provide that the reseller has the right to set its own selling price. If you think your agreement is going to continue for some time into the future, you should consider different options, for example: simply dropping the existing provision (and being silent on the point); expressly requiring the reseller to sell at (or above) your minimum prices; or reserving the right to impose that requirement (but permitting the reseller to terminate if you exercise the right).
Some Thoughts for Resellers. The Leegin decision may well cause more manufacturers to create or strengthen minimum resale pricing programs, and this will present challenges and opportunities for resellers, including dealers, licensees, and franchisees. Resellers should consider the implications for their own business models – how much pre-sale service should the reseller provide and how many competing brands should it carry. Resellers should also start thinking about the types of programs and agreements that Leegin will cause manufacturers to want, and the types of manufacturers that the reseller wants to deal with.
Conclusion. Your company’s distribution model is a basic business decision. Leegin has removed some substantial legal risk (and thus provided a better legal toolset for your business), but it does not change business realities. Some resellers may simply refuse to sign a Leegin agreement, and if they are large buyers that account for a significant percentage of your business, you may decide not to press either them or anyone else for such agreements. Even if you think you can get agreement, however, you should consider what you will do if a large customer decides not to honor it; having a policy or agreement that you are not prepared to enforce is worse than having no program at all. Finally, even after Leegin, the strongest defense against free-riding discounters may well be the same as it has always been: not dealing with discounters in the first place.
About the Author: Michael Lindsay is a partner at Dorsey & Whitney LLP and is the co-chair of the firm’s Antitrust Practice Group. He is a 1983 graduate of the University of Chicago Law School, where he served as Managing Editor of the law review, and a 1980 graduate of Marquette University, and he also studied at the London School of Economics. He served as law clerk for Judge Richard Posner at the U.S. Court of Appeals for the Seventh Circuit. Mr. Lindsay’s practice focuses on antitrust matters, both in litigation and in client counseling. Mr. Lindsay has taught antitrust as an adjunct professor at the University of St. Thomas Law School and Hamline Law School, and he is a frequent lecturer at continuing legal education programs on antitrust issues. He was the Chair (2005-06) of the Minnesota State Bar Association’s Antitrust Section, and he is Vice-Chair of the ABA Antitrust Section’s Trial Practice Committee. He was the publication co-chair for the ABA Antitrust Section’s Indirect Purchaser Litigation Handbook (2007).