Regulation of the distribution relationship

Competing products

Are restrictions on the distribution of competing products in distribution agreements enforceable, either during the term of the relationship or afterwards?

In the absence of market power, a supplier generally is free to restrict a distributor’s sales of competing products, although some state laws limit this ability. Where exclusive dealing requirements are so broad as to foreclose a substantial portion of the market, they may be found unlawful as an unreasonable restraint of trade under the antitrust (competition) laws. Restrictions that extend beyond the term of a distribution agreement are disfavoured in some states and generally must be ancillary to the contract and in furtherance of its lawful purposes, as well as reasonable as to the products restricted, the geographical scope of the restriction and the duration. Where a supplier provides a turnkey operation, as in a classic franchise, and discloses all the details of how to operate the business, such post-term restrictions may be more broadly permitted, particularly if they are short in duration and cover a limited geographical area.

Prices

May a supplier control the prices at which its distribution partner resells its products? If not, how are these restrictions enforced?

In general, US antitrust laws, such as section 1 of the Sherman Act, in the absence of monopoly power, address concerted action, not unilateral conduct. Thus, if the supplier itself is making the sale, as is the case with owned outlets, a controlled subsidiary or, in most jurisdictions, through a true agent, the pricing is unilateral and usually not problematic. However, an agreement between independent entities in which the supplier regulates the resale prices of a distributor, franchisee or licensee raises antitrust concerns. Even in the case of a purported unilateral policy (eg, an announced supplier policy to deal only with retailers that maintain the manufacturer’s suggested resale price), care must be taken to enforce the policy strictly. Lax enforcement together with ultimate compliance by the customer can be construed as evidence of a resale price maintenance (RPM) agreement rather than mere establishment of a unilateral policy.

In 2007, the US Supreme Court held, in Leegin Creative Leather Products, Inc v PSKS, Inc, that all vertical agreements (ie, agreements between the buyer and seller), even with respect to resale prices, are judged under federal law by the rule of reason, under which the court must determine whether the anticompetitive harm from the conduct is outweighed by the potential competitive benefits rather than by the per se rule, which makes conduct unlawful without regard to any claimed justifications. In Leegin, the Supreme Court noted a variety of situations in which such RPM may be anticompetitive, and suggested several factors relevant to the rule of reason inquiry, including the number of suppliers using RPM in the industry (the more manufacturers using RPM, the more likely it could facilitate a supplier or dealer cartel), the source of the restraint (if dealers are the impetus for a vertical price restraint, it is more likely to facilitate a dealer cartel or support a dominant, inefficient dealer) and where either the supplier or dealer involved has market power.

Importantly, the states do not always follow federal precedent in enforcing their own antitrust laws and so may not follow Leegin. Indeed, some states have antitrust statutes that explicitly bar RPM programmes. Thus, some state authorities will apply the per se rule to RPM under state law. The result is a patchwork of states accepting or rejecting the Leegin approach in enforcing state antitrust laws. Consequently, before implementing any RPM programme, counsel must carefully examine each relevant state’s treatment of RPM, especially as state law continues to develop, review all the facts and determine whether any of the factors described by the Supreme Court in Leegin are present or whether there are other indications that the proposed programme will have anticompetitive effects rather than enhancing interbrand competition.

May a supplier influence resale prices in other ways, such as suggesting resale prices, establishing a minimum advertised price policy, announcing it will not deal with customers who do not follow its pricing policy, or otherwise?

It is lawful in the US for a supplier to suggest resale prices so long as there is no enforcement mechanism and the customer remains truly free to set its own prices. In addition, under the rule announced in 1919 by the US Supreme Court in United States v Colgate & Co, a supplier may establish a unilateral policy against sales below the supplier’s stated resale price levels and unilaterally choose not to do business with those that do not follow that policy, because only agreements on resale pricing may be unlawful, at least in the absence of market power. But care must be taken not to take steps that would convert such a unilateral policy into an agreement. When a supplier’s actions go beyond mere announcement of a policy, and it employs other means to obtain adherence to its resale prices, an RPM agreement can be created. Colgate policies can be notoriously difficult to administer in practice because salespeople often try to persuade a customer to adhere to the policy instead of simply terminating sales upon a violation (with the resulting loss of sales to the salesperson), and such efforts can be enough to take the seller out of the Colgate safe harbour and into a potentially unlawful RPM situation.

Minimum advertised price (MAP) policies that control the prices a supplier advertises, but not the actual sales price, are also generally permitted, although the issue of what constitutes an advertised price for online sales can have almost metaphysical dimensions. To avoid classification as RPM, the MAP policy must not control the actual resale price but only the advertised price. The closer to the point of sale that advertising is controlled, the greater the risk. Thus, in the bricks-and-mortar world, policies restricting advertising in broadcast and print media are more likely to be permitted; restrictions on in-store signage would be riskier, and restrictions on actual price tags on merchandise most likely would be deemed a restriction on actual, rather than advertised, price. Online, sellers have most often restricted banner ads and the price shown when an item is displayed. Restrictions on the price shown once a consumer places an item in his or her shopping cart carry a greater risk, which explains why some items are displayed with the legend ‘Place item in cart for lower price’. Where the supplier does not prohibit an advertised price inconsistent with the supplier’s policy, but instead, as part of a cooperative advertising programme, conditions reimbursement of all or a portion of the cost of an advertisement on compliance with a supplier’s MAP policy, the risk is reduced, although not eliminated.

May a distribution contract specify that the supplier’s price to the distributor will be no higher than its lowest price to other customers?

In general, yes. Most favoured customer clauses are widespread, and courts generally have applied the rule of reason and found that they do not unreasonably restrain trade.

In 2010, however, the US Department of Justice filed an action in federal court in Michigan against health insurer Blue Cross Blue Shield (BCBS), claiming its use of these clauses thwarted competition, in violation of antitrust laws. The Department asserted that, because of its market power, BCBS harmed competition by requiring hospitals to agree to charge other insurers as much as 40 per cent more than they charged BCBS. (The case was voluntarily dismissed by the Department of Justice after the state of Michigan passed a law prohibiting health insurers from using most favoured customer clauses.) In the Apple e-books case, a federal district court found that a most favoured customer provision in Apple’s contracts with publishers that required the publishers to lower the price at which they sold e-books in Apple’s store if the books were sold for less elsewhere – notably by Amazon.com – violated the antitrust laws. The decision was affirmed on appeal by the US Court of Appeals for the Second Circuit. Apple sought Supreme Court review; however, the Court declined to review the decision.

The presence of most favoured customer clauses may also lead a supplier to reject an otherwise attractive offer from a customer to take surplus inventory at a lower price, because the discounted price would have to be offered to all customers with a most favoured customer clause. Contract drafters should therefore examine whether a most favoured customer clause raises antitrust risks in the context of their client’s particular market share and pricing practices, with particular caution advisable where market power is present.

Are there restrictions on a seller’s ability to charge different prices to different customers, based on location, type of customer, quantities purchased, or otherwise?

Yes. The federal Robinson–Patman Act prohibits, with certain exceptions, price differences (as well as discrimination in related services or facilities) in contemporaneous interstate sales of commodities of like grade and quality for use or resale within the US that causes antitrust injury. The basic principle is that big purchasers may not be favoured over small ones. The Robinson–Patman Act also requires promotional programmes to be available to customers on a proportionally equal basis. The Act does not apply to services, leases or export sales.

The statute is often criticised, and is honoured more in the breach than the observance, as quantity discounts are commonplace and government enforcement actions are rare. Private damage actions, however, are still brought with some frequency, although the requirement of showing antitrust injury is often an obstacle to success. To prevail under the statute, a plaintiff must show that the price difference had a reasonable possibility of causing injury to competition or competitors, a standard that has been tightened by recent case law.

There are two principal defences to a Robinson–Patman Act claim. First, showing that the price difference was justified by cost differences is a defence. This defence, however, is notoriously difficult to establish, requiring detailed data as to the cost differences applicable to the different sales at different prices. Second, under the ‘meeting competition’ defence, prices may be lowered to meet (but not beat) a competitor’s price, where there is a good faith basis for believing the competitor actually made a lower offer. If a copy of the competitor’s invoice or price quotation cannot be obtained, the company should gather as much information as possible to support the belief that the competitor offered the lower price. The lower price must not, however, be confirmed with the competitor, which could provide evidence supporting a horizontal price-fixing conspiracy by the suppliers. Rather, the supplier should obtain that information through other sources, such as customer documentation or market surveys.

There are also state laws that restrict price discrimination. Some are generally applicable and modelled on the Robinson–Patman Act, but apply to intrastate sales instead of or in addition to interstate sales. Others restrict locality discrimination, charging different prices in different parts of a state. Some states, such as California, have unfair competition laws that prohibit below-cost pricing (which in certain circumstances may also violate federal law) and the provision of secret and unearned rebates to only some competing buyers. Other state laws apply to specific industries, such as motor vehicles or alcoholic beverages, and prohibit discrimination in pricing to dealers.

Geographic and customer restrictions

May a supplier restrict the geographic areas or categories of customers to which its distribution partner resells? Are exclusive territories permitted? Is there a distinction between active sales efforts and passive sales that are not actively solicited, and how are those terms defined?

As a general rule, yes. Non-price vertical restraints are judged by the rule of reason in the United States and are generally permitted, in the absence of market power. Customer and territory restrictions, such as exclusive territories, pursuant to which a distributor is allocated a specific territory outside of which it may not sell and within which no other distributor may sell the supplier’s goods, thus are governed by the rule of reason. Exclusive territories necessarily reduce intrabrand competition between distributors of the same products. But by eliminating a competing distributor that could ‘free-ride’ on the promotional and service efforts of another and undercut its price, and thus making it feasible for the remaining distributor to sustain those efforts, exclusive territories can enhance interbrand competition between suppliers of competing products, and so are generally viewed as pro-competitive on balance.

The distinction between active and passive selling applicable in Europe is not generally relevant under US antitrust law. Another distinction from the European approach is that restrictions on online sales are viewed as a non-price vertical restraint and so are judged by the rule of reason and generally permitted, in the absence of market power. Courts have upheld prohibitions on mail order and telephone sales under the rule of reason, and restrictions on internet sales – even an absolute prohibition – should be judged no differently.

However, customer allocation by competitors is a horizontal arrangement rather than a vertical one and is per se illegal. It is thus critical that the impetus for exclusive territories come from the supplier in a vertical arrangement and not from dealers or distributors making a horizontal allocation of territories.

Many US cases apply a ‘market power screen’ in rule of reason cases, and uphold non-price vertical restraints whenever the defendant lacks market power. These restraints, including exclusive territories, will be viewed more sceptically if market power exists.

Online sales

May a supplier restrict or prohibit e-commerce sales by its distribution partners?

Restrictions on online sales are a non-price vertical restraint, judged by the rule of reason and generally permitted, in the absence of market power. Courts have upheld prohibitions on mail order and telephone sales under the rule of reason, and restrictions on internet sales – even an absolute prohibition – should be judged no differently.

Refusal to deal

Under what circumstances may a supplier refuse to deal with particular customers? May a supplier restrict its distributor’s ability to deal with particular customers?

In general, a business that does not have market power is free to choose its customers and do or not do business with whomever it wishes. This can include restricting a distributor’s ability to do business with particular customers or classes of customers, a vertical restraint that will be judged by the rule of reason. A supplier with market power will be more limited in its ability to engage in such practices if an adverse effect on competition can be shown. In certain circumstances, courts have found that a monopolist may have an obligation to deal, or to continue dealing, with its competitors.

Note that an agreement among competitors at the same level of distribution not to deal with certain customers, or to restrict with whom customers may deal, will be treated as a horizontal and per se illegal restraint rather than as a vertical restraint governed by the rule of reason. Thus where a restriction on dealing with certain customers originates with a group of competing distributors, a supplier may be at risk of being found to be an illegal participant in that horizontal conspiracy, even though the same restraint originated by the supplier might well be lawful.

There may be some industries in some states where a supplier is required to deal with all customers. For example, in many states, alcoholic beverage wholesalers must sell to all licensed retailers.

Competition concerns

Under what circumstances might a distribution or agency agreement be deemed a reportable transaction under merger control rules and require clearance by the competition authority? What standards would be used to evaluate such a transaction?

Acquisitions of businesses or interests in businesses, including a supplier’s purchase of an ownership interest in a distributor, may be subject to filing requirements and federal antitrust agency review if certain thresholds are met as to the size of the transaction (more than US$94 million) and the size of the parties. Regarding the latter, if the value of the proposed transaction is more than US$376 million, it is reportable; however, if the value is more than US$94 million but less than US$376 million, it is reportable if one party to the transaction has total assets or net sales of US$188 million or more and the other has total assets or net sales of US$18.8 million or more. These dollar amounts are adjusted annually for inflation. New dollar thresholds are expected to be announced in the first quarter of 2021. In the absence of an ownership interest, however, distribution relationships are not generally subject to antitrust reporting requirements or agency clearance procedures.

Do your jurisdiction’s antitrust or competition laws constrain the relationship between suppliers and their distribution partners in any other ways? How are any such laws enforced and by which agencies? Can private parties bring actions under antitrust or competition laws? What remedies are available?

Vertical agreements between suppliers and distributors are generally governed by the rule of reason, under which the anticompetitive effects of the restraint are weighed against any possible pro-competitive effects, and in the absence of market power, will usually be found lawful. In contrast, horizontal agreements among competitors at the same level of distribution relating to matters such as pricing, allocation of customers or territories, or production levels, are prohibited by the per se rule.

Accordingly, it is important for suppliers and distributors not only to avoid such agreements with their competitors, but also to avoid putting themselves or their distribution partners into a position where they might be deemed participants in a horizontal conspiracy at either distribution partner’s level of distribution. Thus, suppliers should not exchange current or future pricing or production information with their competitors, should not use their common distributors to facilitate such information exchanges, should not share one distributor’s pricing information with other distributors, and should not agree to territorial allocations made by their distributors rather than imposed by the supplier. Distributors should not share with one supplier pricing or production information received from another. Similarly, suppliers should not share information with each other about their common distributors as such exchanges could support a claim of a concerted refusal to deal should both suppliers then decide to terminate their relationships with the distributor.

Returning to purely vertical relationships, a supplier may not require its customers to purchase one product (the tied product) to be able to purchase another product (the tying product) if the supplier has substantial economic power in the tying product market, and a ‘not insubstantial’ amount of interstate or international commerce in the tied product is affected. One of the difficult questions in a tying analysis is whether there are in fact two distinct products, one of which is forced on customers who would not otherwise purchase it as a result of market power with respect to the other.

The antitrust laws are enforced both by government action and by private party litigation. At the federal level, both the US Department of Justice and the Federal Trade Commission (FTC) enforce the antitrust laws. They may seek criminal or civil enforcement penalties. Jail terms are not uncommon for antitrust violations, especially horizontal ones. Maximum fines for each violation are US$1 million for individuals and US$100 million for corporations, subject to being increased to twice the amount gained from the illegal acts or twice the money lost by the victims of the crime if either of those amounts is over US$100 million. In addition, both federal agencies can bring civil actions to enjoin violations of the antitrust laws, disgorge profits, impose structural remedies and recover substantial civil penalties. The federal agencies often cooperate with foreign antitrust and competition authorities in investigating violations.

State attorneys general also actively prosecute antitrust cases and have similar authority to the federal agencies within their own states. State antitrust laws also provide civil and criminal penalties, and the states frequently cooperate with each other and with the federal agencies in multistate investigations and prosecutions.

Last, but certainly not least, private plaintiffs may bring civil actions under the antitrust laws and recover treble damages – that is, three times the actual damages caused by the violation – and attorneys’ fees (not the usual rule in the US, where each party generally pays its own legal fees, regardless of who prevails). The exposure in an antitrust action can thus be extremely high, as can the costs of litigation.

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7 February 2020