On 29 April 2013, the Supreme Court declined to review a recent Third Circuit ruling, ZF Meritor, LLC v. Eaton Corporation (Meritor), 696 F.3d 254 (3d Cir. 2012), which implicated the ability of dominant manufacturers to provide loyalty or market share discounts to customers. The Court’s decision to let the Third Circuit ruling stand could lead to uncertainty for manufacturers interested in using such discounts. Combined with the Federal Trade Commission’s (FTC) recent focus on exclusive dealing arrangements, the Meritor case suggests a measure of caution when analyzing arrangements that involve full or partial exclusivity or could be characterized as such.

Meritor decision

The Meritor case arose out of a series of long-term supply agreements between Eaton Corporation, a manufacturer of transmissions for heavy duty trucks and the major manufacturers (OEMs) of heavy duty trucks in the United States. ZF Meritor, a competitor to Eaton, alleged that these agreements contained substantial discounts tied to market-penetration and purchasing targets, which caused the OEMs to buy most of their transmissions from Eaton and effectively locked Meritor out of the market. In October 2009, a jury found that Eaton violated Sections 1 and 2 of the Sherman Act and Section 3 of the Clayton Act, and in June 2012, a divided Third Circuit panel upheld the verdict, characterizing Eaton’s agreements as “de facto” exclusive dealing contracts rather than supply agreements with pricing provisions. As a result, in order to prevail under the traditional exclusive dealing framework, ZF Meritor needed to demonstrate that the “probable effect” of the agreements was to substantially lessen competition, which the jury so found. Had the agreements been considered supply agreements with pricing provisions the standard as articulated by the Supreme Court in Brooke Group Ltd. V. Brown & Williamson Tobacco Corp., 509 U.S. 209 (1993), and acknowledged by the Third Circuit in Meritor would have been whether Eaton was selling its transmissions below cost.

In its petition for certiorari before the Supreme Court, Eaton argued that the lower court’s characterization of conditional loyalty discounts as “de facto partial exclusive dealing contracts” subject to rule of reason analysis was incorrect as a matter of law and put the Third Circuit in conflict with other circuits—many of which have concluded that conditional loyalty discounts are acceptable so long as the resulting pricing remains above cost.1 Eaton’s position was supported by a group of 18 well-known antitrust and economics scholars who filed an amicus brief urging the Supreme Court to overrule the Third Circuit’s decision.2 The scholars cautioned that the Third Circuit decision, if allowed to stand, could “chill sellers from offering conditional nonpredatory discounts and rebates, reward less efficient producers, diminish price competition, and harm consumer welfare.”3

For dominant companies offering conditional loyalty discounts, the Third Circuit’s opinion suggests that two separate lines of analysis are needed when considering the antitrust risk of these discounts. First, companies should take the traditional step of considering whether discounts cause their pricing to fall below their costs. As a result of Meritor, companies must now also consider whether an aggrieved competitor or customer could characterize the discounts as de facto exclusive dealing and argue that the practical effects of the discounts are to substantially exclude competition. While determining whether pricing is below cost is a measurable metric lending itself to straightforward analysis, deliberation on the anticompetitive effects that an agreement could have is a much more involved process that requires consideration of a myriad of factors.

Other exclusive dealing developments

Given current uncertainty, companies that utilize loyalty discounts should keep up-to-date with developments in the exclusive dealing landscape. The FTC recently obtained consent decrees limiting exclusive dealing arrangements in two cases alleging market foreclosure. 

In April, the FTC obtained a proposed consent decree stemming from Graco, Inc.’s acquisition of two competitors in fast-set equipment used to apply polyurethane foams and coating.4 Although the FTC’s complaint focused on the consolidation of the market through past acquisitions, it specifically discussed Graco’s use of discount and inventory threshold requirements and Graco’s threats to distributors that they would be terminated if they carried competitors’ products as decreasing competition in the relevant market. While there were no allegations about the use of exclusive dealing contracts, these actions were alleged to substantially reduce prospective competitors’ access to the relevant distributor market.

Among other things, the proposed consent order prohibits Graco from entering into exclusive dealing contracts and limits the purchase and inventory levels upon which Graco may condition distributor loyalty discounts. While a majority of FTC commissioners recognized the procompetitive benefits that exclusive dealing arrangements could have, they were also wary of these agreements’ potential to cement monopoly power and to prevent or deter entry.5 Commissioner Joshua Wright disagreed with the restrictions placed on Graco’s ability to use exclusive dealing contracts and loyalty discounts, asserting that the weight of evidence suggests that “exclusive dealing arrangements [ and loyalty discounts ] are much more likely to be procompetitive than anticompetitive.”6

In February, the FTC settled charges that a dominant manufacturer of veterinary point-of-care (POC) diagnostic testing products used its 70 per cent market share to force national distributors to enter into exclusive dealing arrangements, thus foreclosing a substantial portion of the market.7 As a result of the consent order, IDEXX is prohibited from maintaining concurrent exclusive dealing agreements with the three major national POC diagnostic testing product distributors and from retaliating against non-exclusive distributors for distributing competitor products. IDEXX also must show any future agreements to the FTC 30 days before they are signed. 

As Meritor, Graco, and IDEXX show, the treatment of exclusive dealing and loyalty discounts is in a state of flux. Companies with significant market power should not only analyze the formal structure of their agreements (i.e. exclusive or non-exclusive), but also look at the practical effects that these agreements can have on their competitors and customers. Until the contours of exclusive dealing and loyalty discount jurisprudence come into focus, caution should be exercised when negotiating both categories of agreements.