The European Union's first tier court, the General Court, has upheld the record €1.06 billion fine imposed on Intel for entering into illegal rebate schemes with major customers.(1)
Intel is an allegedly dominant supplier of central processing unit chips for computers and servers. It agreed with its main desktop customers (Dell, HP, Lenovo and NEC) that it would pay them substantial rebates in return for exclusivity or near exclusivity, amounting to between 80% and 100% of their needs. The rebates in some cases totalled hundreds of millions of dollars. In addition, Intel paid additional amounts to these customers and to a PC retailer not to:
- stock competitor-chip-based PCs;
- delay the introduction of rival chips; or
- confine the competitor chips to non-strategic products.
The European Union found this to be abuse of a dominant position and imposed fines of €1.06 billion.
|No economic defence to exclusivity-linked rebate schemes||For a dominant company, a rebate scheme linked to exclusivity is presumptively illegal. It is no defence to show that the scheme had little or no effect on competition, or that the schemes affected only a small proportion of the market. Similarly, it is irrelevant that the schemes were of short duration, were asked for by customers or that those customers were powerful buyers.|
|Volume targets can be justified on the facts||The court distinguished exclusivity-linked rebates from volume-target-linked rebates, and suggested that a more nuanced approach is required. All case circumstances should be considered to determine whether a volume-linked scheme is legal. Showing that the rebate scheme survives an as efficient competitor (AEC) cost-based test (that a smaller but equally efficient competitor could remain positive margin while matching the value of the rebate over a smaller contestable sales base) does not demonstrate legality. Article 102 of the European Commission's Guidance prohibits schemes that make competitors' access to the market economically impossible and those that simply make it more difficult. What constitutes 'difficult market access' is not explained.|
|Article 102 not overruled, but application is circumscribed||The court did not say that the commission's enforcement guidance is wrong. Formal proceedings began before the guidance was issued, so the commission was not bound to follow it. However, the judgment rewrites the guidance for exclusivity-linked schemes, swapping the guidance's economics-lead approach for a near per se illegality rule. For quantity-linked schemes, it is not wrong to conduct an AEC test, but it is also important to assess other factors:
Exclusivity-linked rebates in high market share lines will almost never be defensible. This is also true of schemes that link rebates to 75% to 80% or higher customer requirements.
Volume-target-linked rebate schemes require an assessment in the round. The commission's guidance as to the economic test was not overruled and is likely to remain the starting point for compliance counselling. If a scheme fails an AEC test, it is likely to be illegal. Other important factors include:
- the scheme's coverage;
- the rebate's affect on customers' finances;
- the strategic nature of customers; and
- the fragility of competition (are there new entrants or struggling rivals?).
The broader strategic rationale and business documents surrounding the deal should not show illegitimate intent.
Rebate schemes which are 'pure quantity' schemes – an objective volume applicable to all customers – which generate scale economies or other efficiencies are legitimate where the dominant company seeks to pass through the cost saving by way of discount or rebate. In practice, few companies can show a direct effect of a cost saving on price.
The court set out its stall on rebates in the opening paragraphs of its substantive review. Though assuring the reader that the analysis rests on impeccably established case law, the court offered a mini-revolution in rebates analysis in a few short paragraphs (Paragraphs 72 to 94).
The court distinguished three rebate categories:
- quantity (Paragraph 75);
- exclusivity (Paragraphs 76 and 77); and
- the third category (Paragraph 78).
Pure quantity rebates
Rebates linked to the quantity of supply alone are "generally considered not to have the foreclosure effect prohibited by Article [102 TFEU]". The court explained:
"[i]f increasing the quantity supplied results in lower costs for the supplier, the latter is entitled to pass on that reduction to the customer in the form of a more favourable tariff. Quantity rebates are therefore deemed to reflect gains in efficiency and economies of scale made by the undertaking in a dominant position."
Economists advise that it is near impossible to show a link between saved costs and the rebate offered. Each customer is too small to have an individual costs impact, so it is almost impossible to rely on a cost pass through defence. In passing, the court spoke of such rebates as being "deemed" lawful. If by that the court meant that provided the scheme is a pure quantity one, no detailed costs analysis is required, it would be a welcome development.
The court found that exclusivity was the category at issue in Intel. Linking exclusivity or near exclusivity was, on its face, illegal for a dominant company. Near exclusivity is present where the scheme requires between 80% and 100% requirements (Intel), but it could also be lower (75% in Hoffmann La-Roche (Paragraph 135)). It does "not require proof of a capacity to restrict competition depending on the circumstances of the case" (Paragraphs 80 and 81). To the contrary, exclusivity schemes are likely to be per se abusive, as they "are by their very nature capable of restricting competition" (Paragraph 85).
The court justified this strict approach by the fact of the company's dominance – competition is already fragile in markets where there are dominant incumbents – and the nature of an exclusivity scheme is such that it makes market access if not impossible, then substantially more difficult for competitors. The penalty for a customer breaching exclusivity is loss of the entire rebate. It loses not just the portion covering the rival's supplies, but also the quantities which the customer must continue to take from the dominant "unavoidable trading partner" (Paragraphs 86 to 93).
The court also offered a belt-and-braces analysis, saying that had it been required to show that the scheme was capable of restricting competition based on all circumstances – it was satisfied the commission met that test. The customers were strategic ones and their internal documents showed that their purchasing decisions were influenced. There was evidence of a broader exclusionary intent by Intel. The scale, scope and duration of the schemes made exclusion likely (Paragraphs 178 to 197).
Though exclusivity schemes might nominally be objectively justified, no justification was put forward in this case.
Third category 'fidelity-building' rebates
The third category, by contrast, requires no case-by-case assessment. Third category schemes include those based on individualised targets, but without exclusivity or near exclusivity. In which case, it may be appropriate to consider an economic assessment of the kind advocated by Article 102. The court was clear that the guidance's AEC test is not endorsed by case law. Even in circumstances where that test has not been undertaken or has a positive result, it may still be possible to demonstrate that the scheme is capable of restricting competition (Paragraphs 144 and 145).
Once defined as an exclusivity rebate, the court denied any effects-based defence. Evidence of lack of impact was irrelevant. A rebate scheme is illegal if it is "capable of restricting competition" (Paragraph 103). The court found that an exclusivity rebate plainly satisfies that threshold: "When such a trading instrument exists, it is unnecessary to undertake an analysis of the actual effects" (Paragraph 103). The court was equally unmoved by evidence that customers were not influenced by Intel's exclusivity rebates, and would have purchased the same quantities in any event (Paragraphs 95 to 105).
The duration or amount of the rebate was also irrelevant. A 30-day notice period in the supply contracts could not excuse schemes that lasted between one and five years. This was notwithstanding that the period consisted of a series of successive short-term supply agreements (Paragraphs 108, 112, 113 and 195).
That the scheme covered only a small proportion of the market was also not a defence (Paragraphs 114 to 124). Exclusivity applied to certain applications only (corporate desktops, but not consumer PCs or servers). This meant that the scheme covered far less than 80% of total chip requirements. The court held the scheme to be illegal even if it applied exclusivity to a limited segment only (Paragraphs 129 to137). Even if - contrary to the court's view - the proportion of the market affected was a relevant criterion, the court held that the 14% of the market allegedly affected was a sufficiently significant proportion of demand (Paragraph 194).
The rebate granted at the request of, and under significant pressure from, powerful buyers was also unsuccessful (Paragraph 139).
Whether the commission had correctly applied an AEC test to assess whether a competitor could match the rebate's value over its smaller sales volume to the customer (the contestable part of the customer's demand) and remain above the dominant company's cost was also irrelevant. Exclusivity-linked schemes are illegal regardless of such an assessment (Paragraph 143).
That Intel's rival AMD experienced substantial growth and market penetration during the alleged exclusionary scheme was in operation was also no defence. The court stated that the "fact that that capability [of restricting competition] does not produce actual effects cannot suffice to prevent the application of Article ".
The court sidestepped direct commentary on Article 102. Since Intel, initiation of proceedings pre-dated the guidance and the commission was not bound to apply it. Arguments that the commission had repeatedly stated that it was applying the approach specified in the guidance did not, according to the court, give Intel any legitimate expectation. According to the court, the commission had proven amply that the rebate schemes were capable of restricting competition. A cost test was not required; hence, the many errors alleged by Intel in that test could not change the result (Paragraphs 173 to 175).
Since it found exclusivity alone was sufficient to found abuse, the court did not review the commission's cost-based analysis. The allegations that this was erroneous were left unexamined.
Just as Tomra before it, Intel makes discomfiting reading for practitioners seeking a clear line for counselling. Offering better prices for customers meeting sales targets is a near daily business occurrence, yet it has attracted contradictory analysis and unsatisfactory case law.
The commission's much-vaunted AEC test – complex though it can be to apply – at least offered a coherent theory to underpin rebates antitrust analysis. The court refused to analyse the commission's application of the test in Intel and remained adamant that cost-based tests alone offer no legal assurance. Exclusivity-linked schemes will be near per se illegal. Pure quantity schemes which pass through cost savings are presumptively lawful. Between those extremes the elusive third category is left in the uncomfortable position of an all-the-circumstances analysis, but there is no clear guide as to what those circumstances are.
The commission(3) and national regulators(4) remain wedded to the economic approach to rebate schemes for now. They utilise analysis similar to Article 102's AEC test. However, Intel makes clear that the court is not prepared to develop case law in the same direction. The old per se form-based analysis of 30 years ago is being repeated in the current generation of rebates case law. The result is legal uncertainty for a key feature of business life. It remains to be seen whether an appeal will encourage the European Court of Justice (ECJ) to define a clearer standard. That opportunity will soon be at hand in the second Post Danmark case(5) on referral to the ECJ.
While the European Union maintains its strict stance, rebate schemes remain a significant area of divergence in European and US antitrust. In the United States, different circuits are still in search of a unified standard for monopolistic rebate schemes. Intel's outcome has parallels with two recent cases(6) in the Third Circuit and the District of New Jersey. There the courts held "market-share discounts" – similar to Intel's "exclusivity-linked rebates" – requiring a rule of reason "exclusive dealing" analysis. Conversely, quantity-linked rebates are more likely to be subject to a price-cost test. ZF Meritor used the exclusive dealing approach and Eisai a price-cost test. On June 23 2014 the Federal Trade Commission and the Department of Justice held a workshop on rebate schemes, highlighting that this line of case law is still a work in progress.
For further information on this topic please contact Bill Batchelor at Baker & McKenzie by telephone (+32 2 639 36 11), fax (+32 2 639 36 99) or email (email@example.com). The Baker & McKenzie website can be accessed at www.bakermckenzie.com.