First published in LES Insights
In a recent Second Circuit case, a USB connector manufacturer alleged that a number of its competitors engaged in anticompetitive behavior in violation of the Sherman Act's Foreign Trade Antitrust Improvements Act (FTAIA) by ignoring their patent-licensing obligations as part of a standard-setting organization. Specifically, the plaintiff alleged that the defendants injured the plaintiff by attempting to exclude them from the market and that the effect of this injury was increased prices for USB devices in the U.S. But the court affirmed the judgment of the district court, which dismissed the plaintiff's antitrust claim, because the alleged domestic effect did not cause the plaintiff's injury and thus could not give rise to a Sherman Act claim.
Prohibiting unreasonable restraints on trade, the Sherman Act is one of the core U.S. antitrust laws. Section 6a of the Act, known as the Foreign Trade Antitrust Improvements Act (FTAIA), generally excludes all foreign conduct from the Act's reach, unless it has a direct, substantial, and reasonably foreseeable effect on U.S. domestic, import, or certain export commerce, and that effect gives rise to a claim under the provisions of sections 1-7 of the Act. Thus, Congress designed the FTAIA to clarify, but not expand, the scope of the Sherman Act as it applies to foreign commerce. In a recent case,Lotes Co. v. Hon Hai Precision Indus. Co.,1 the Second Circuit rejected plaintiff Lotes's claim for relief under the FTAIA, because Lotes failed to show that a domestic effect of defendants' allegedly anticompetitive conduct proximately caused Lotes's injury of being excluded from the market for USB 3.0 connectors.
Lotes, a Taiwanese company, designs and manufactures electronic computer parts, including USB connectors. Lotes manufactures the USB connectors in China and sells them to Original Design Manufacturers in China, which assemble computer products incorporating USB connectors for computer brands such as Acer, Dell, HP, and Apple. Consumers and businesses around the world, including in the United States, purchase these computer products. The defendants, Hon Hai Precision Industry, and a number of Foxconn entities, compete with Lotes in the manufacturing and sale of USB connectors. They also produce and distribute electronics products that incorporate USB connectors.
The dispute between Lotes and the defendants resulted from USB 3.0, the latest industry standard for USB connectors. Technological standards like USB 3.0 carry procompetitive advantages because they enable different companies to produce compatible products, thereby promoting innovation and competition. Common standards can also stimulate increased investment from manufacturers, reduce the need for customization, promote price competition, and drive down costs—all to the benefit of consumers. There are, however, anticompetitive risks accompanying standards like USB 3.0. For example, developing standards demands cooperation among competitors, which can lead to anticompetitive behavior. Additionally, technological standardization may give rise to "patent hold-ups," whereby patent holders of technologies essential to implement a given standard can "hold up" industry participants unless they agree to pay supracompetitive royalties.
To protect against these anticompetitive risks, standard-setting organizations often secure from their members an agreement to license any technology necessary to the standard on reasonable and nondiscriminatory (RAND) terms. In exchange for granting a RAND license, the contributing member receives the benefit of industry-wide acceptance of their patented technology. One specific type of RAND license is a RAND-Zero license, under which patented technology is licensed on a royalty-free basis.
USB Implementers Forum, Inc. (USB-IF) is the USB standard-setting organization. USB-IF required all members that contributed to the USB 3.0 standard, including Lotes and the defendants, to sign a Contributors Agreement. That agreement requires signatories whose patented technology is necessary to the USB 3.0 standard to provide a RAND-Zero license to other members of the organization that adopt the standard. The Agreement also includes provisions specifically aimed at curtailing antitrust violations. For example, one provision prohibits any communications about the exclusion of competitors or any other topic that could be construed as a violation of antitrust laws.
Lotes filed suit in October 2012 under sections 1 and 2 of the Sherman Act, alleging that the defendants engaged in anticompetitive behavior and disregarded their obligations under the Contributors Agreement to provide RAND-Zero licenses. Specifically, Lotes alleged that the defendants threatened to sue Lotes's customers and distributors unless they purchased USB connectors from Foxconn. Additionally, Hon Hai never provided Lotes with a draft agreement to secure a RAND-Zero license, as required under the Contributors Agreement. And Foxconn filed patent-infringement suits in China to enjoin two of Lotes's manufacturing facilities from making USB 3.0 connectors, despite Foxconn's having sent a letter to the USB-IF's president to reaffirm their commitments under the Contributors Agreement.
Lotes argued that if defendants' conduct continued, Lotes would be eliminated as a major USB 3.0 connector competitor, which would deter other competitors and make defendants the dominant supplier. Lotes further argued that restricting competition in China would result in downstream anticompetitive effects worldwide because any price increases would ultimately be passed on to consumers, including U.S. consumers.
The district court dismissed Lotes's suit with prejudice under Rule 12(b)(1) for lack of subject-matter jurisdiction. According to the court, the FTAIA's requirements are jurisdictional in nature, and Lotes failed to plausibly allege a "direct, substantial, and reasonably foreseeable effect" on U.S. domestic or import commerce. Thus, the court ruled, it lacked subject-matter jurisdiction over the suit. Lotes appealed to the U.S. Court of Appeals for the Second Circuit.
The Lotes Co. Decision
The court addressed four issues on appeal: (1) whether the FTAIA's requirements are jurisdictional in nature, or substantive, (2) whether defendants had waived the FTAIA's requirements by signing the Contributors Agreement, (3) whether Lotes plausibly alleged that defendants' conduct had a "direct substantial, and reasonably foreseeable effect" on U.S. domestic or import commerce, and (4) whether the alleged domestic conduct proximately caused Lotes's alleged injury.
In an earlier case, Filetech S.A. v. France Telecom S.A., 157 F.3d 922 (2d Cir. 1998), the court found that the FTAIA's requirements were jurisdictional in nature, meaning the requirements present a threshold inquiry that could prevent a court from presiding over the case. The U.S. Supreme Court's intervening decision in Arbaugh v. Y&H Corp., 546 U.S. 500 (2006), which considered the same issue under a different statute, compelled the court to abandon its prior ruling and conclude that the FTAIA's requirements are not jurisdictional. The FTAIA's requirements therefore go to the merits of the plaintiff's antitrust claim, not the court's authority to hear the claim.
The court then addressed Lotes's argument that the defendants contractually waived the requirements of the FTAIA and agreed to subject their conduct to U.S. antitrust scrutiny by signing the Contributors Agreement. Even if the substantive requirements of the FTAIA were waivable by contract—an issue the court assumed to be true for purposes of its ruling but did not actually consider—nothing in the Contributors Agreement suggested that the defendants waived the requirements. Rather, at most, the Contributors Agreement affirms that the signatories must abide by the Sherman Act, to the extent it applies. The court therefore held that Lotes's waiver argument lacked merit and that the defendants had not waived any defenses under the FTAIA.
The court next considered whether Lotes plausibly alleged the first FTAIA requirement—that defendants' conduct has a "direct, substantial, and reasonably foreseeable effect" on U.S. domestic or import commerce. Disagreeing with the district court, which construed "direct" to require an immediate consequence, the court construed "direct" to require only a reasonably proximate causal nexus between the defendant's alleged conduct and the effect. The court observed that complex manufacturing processes through multilayered supply chains are increasingly common in the global economy. Requiring "direct" to mean "immediate consequence" would essentially vitiate the FTAIA's purpose. Ultimately, the court found it unnecessary to determine whether the defendants' alleged anticompetitive conduct had a reasonably proximate causal nexus to an effect on U.S. domestic or import commerce.
Instead, the court turned to the second requirement—whether the domestic effect gives rise to the plaintiff's claim under the Sherman Act. To "give rise to" the plaintiff's claim, the court explained, the effect must proximately cause the plaintiff's injury. According to Lotes, the "effect" of defendants' foreign, anticompetitive conduct was increasing prices of U.S. consumer electronics using USB 3.0 connectors. Lotes's alleged injury, however, was exclusion from the USB 3.0 connectors market because of defendants' threatening Lotes's customers with legal action and suing to enjoin Lotes's manufacturing facilities. Thus, there was no nexus between the alleged effect and injury.
To the contrary, the court noted, causation ran in the wrong direction. Lotes's alleged injury—exclusion from the USB 3.0 connectors market—precedes the alleged effect of higher prices passed on to U.S. consumers. In an attempt to overcome this causation problem, Lotes argued that the defendants also failed to license necessary U.S. patent claims, which effectively foreclosed competition in the U.S., and proximately caused Lotes's injury. The court, however, disagreed, noting that Lotes never alleged that it does any business in the United States, raising the question of why Lotes had any need for licenses to U.S. patents. Moreover, even if Lotes had a U.S. license, it could still be excluded from the USB 3.0 market based on separate infringement suits filed by the defendants in China. The court therefore affirmed the district court's decision, albeit on alternative grounds, to dismiss Lotes's complaint.
Strategy and Conclusion
This decision confirms that foreign conduct may proximately cause harmful, anticompetitive effects in the U.S., sufficient to meet the "direct, substantial, and reasonably foreseeable" requirement of the first prong of the FTAIA. In light of the court's reasoning, it is important for litigants seeking relief under the FTAIA to identify the appropriate causal chain, by showing not only that a defendant's conduct caused a direct, substantial, and reasonably foreseeable domestic effect, but also that the domestic effect proximately caused the plaintiff's injury. This case also illustrates that while a RAND license on U.S. patents through a standard-setting organization may insulate those that import into or sell in the U.S. covered products, it does not necessarily provide the ability to manufacture and sell covered products outside the United States, where the patent holder has foreign counterpart patents.