The opinion could provide useful guidance for participants in two-sided markets, like the credit card industry and the health care industry, where separate interests of insurers and patients are often implicated by the same services.

On September 26, the U.S. Court of Appeals for the Second Circuit reversed a district court decision that held American Express (Amex) liable for violating the antitrust laws because it prevented merchants that accepted Amex from encouraging cardholders to use other credit cards with lower fees.1 Generally, the Second Circuit opinion sends the message that steering, tiering, exclusive dealing and other contractual arrangements that appear to suppress competition in one part of the market may be legitimate if they facilitate lower prices and better access to services in another part of the market.

The Credit Card Industry – A Two-Sided Market

For a credit card to facilitate commerce, a consumer must choose to carry a particular card and a merchant must agree to accept payment from the same credit card network. The consumer typically pays an annual fee for the card and, in return, receives the ability to engage in easy credit-based transactions and various perks, like airline miles, hotel points and cash back. The merchant also pays a fee to the credit card network to participate in the transaction and, in exchange, receives the benefit of increased sales and the ability to avoid extending merchant-based credit. “[C]ardholders benefit from holding a card only if that card is accepted by a wide range of merchants, and merchants benefit from accepting a card only if a sufficient number of cardholders use it.”2

The merchant fees are used to fund cardholder rewards, and higher rewards cards are generally subject to higher merchant fees. That said, Visa and MasterCard derive more than half of their revenues from the interest charged to cardholders for credit balances that extend past a billing period. Amex, by contrast, does not use intermediaries and relies primarily on higher merchant fees to maximize its profits. Merchants do not uniformly reject Amex because of the higher fee, though, because Amex offers merchants access to its “marquee” cardholders, who tend to spend more.

In response to ad campaigns highlighting Amex’s smaller merchant-acceptance network, Amex began including strong “nondiscriminatory provisions” in its merchant contracts to ensure that merchants could not state a preference for another method of payment at the point of sale. These provisions, and similar contractual language in Visa and MasterCard merchant contracts, prompted the instant dispute.

Procedural History

In October 2010, the United States and 17 states sued Amex, Visa and MasterCard, claiming that nondiscrimination provisions in their merchant agreements violate section 1 of the Sherman Antitrust Act. The plaintiffs alleged that these anti-steering provisions suppressed interbrand competition by reducing competition at the point of sale and removing incentives for credit card companies to reduce card fees. In 2011, Visa and MasterCard entered into settlements voluntarily restricting the use of anti-steering provisions.

Amex, by contrast, proceeded to a bench trial in the Eastern District of New York. The district court concluded that Amex’s nondiscrimination provisions violate the U.S. antitrust laws and “create an environment in which there is nothing to offset credit-card networks’ incentives . . . to charge merchants inflated prices for their services.”3 Amex appealed.

Second Circuit’s Decision

Under the Sherman Act, when the challenged restriction involves a restraint between firms at different levels of distribution — here, between the credit card network and the merchant — the restraint qualifies as a vertical restraint and is generally evaluated under the “rule of reason.”4 Under the rule-of-reason framework, “a plaintiff bears the initial burden of demonstrating that a defendants’ challenged behavior ‘had an actual adverse effect on competition as a whole in the relevant market.’”5 A plaintiff can show anticompetitive effects by providing evidence of “reduced output, decreased quality, and supracompetitive pricing.”6

Although the district court concluded that the plaintiffs had established anticompetitive effects, the Second Circuit reversed and remanded with instructions to enter judgment in favor of Amex. Dooming the district court’s finding was its definition of the relevant market. In the district court’s view, the relevant market consisted of services offered by credit card companies to merchants, while excluding services offered to cardholders. The Second Circuit rejected that narrow definition, holding instead that, because the functions provided by the credit card industry are interdependent, the relevant market must necessarily encompass the entire multisided platform.7

The Second Circuit explained that, once the cardholder side of the market was taken into account, the plaintiffs had not put forth evidence that the Amex merchant contract provisions had anticompetitive effects within the market as a whole. Although “merchants may desire lower fees, those fees are necessary to maintaining cardholder satisfaction — and if a particular merchant finds that the cost of Amex fees outweighs the benefit it gains by accepting Amex cards, then the merchant may choose to not accept Amex cards.”8 Unless the plaintiffs could show “either that cardholders engaged in fewer credit-card transactions (i.e., reduced output), that card services were worse than they might otherwise have been (i.e., decreased quality), or that Amex’s pricing was set above competitive levels within the credit-card industry (i.e., supracompetitive pricing),” the plaintiffs could not prevail.9

Because the plaintiffs had not put forth evidence that showed harm to the market as a whole, the court next evaluated whether it could infer such harm from Amex’s market power. “Market power is the power to force a purchaser to do something that he would not do in a competitive market.”10 The district court looked to a series of merchant fee increases between 2005 and 2010 “without any meaningful merchant attrition” and concluded that such a pattern was “‘compelling evidence’ of [Amex’s] power in the network service market.”11 But, as the Second Circuit noted, the district court failed to acknowledge that increased fees on the merchant side in the short term could very well yield increased demand on the cardholder side and expand the value on the merchant side in the long term.12

The Second Circuit also took issue with the lower court’s reliance on the idea of “cardholder insistence” to conclude that Amex had market power. “Cardholder insistence” refers to the segment of Amex’s cardholders who insist on paying with their Amex cards in order to make a purchase. The district court found that this phenomenon prevents merchants from dropping Amex and shows that Amex has market power. The Second Circuit roundly criticized this conclusion, explaining that “[c]ardholder insistence results not from market power, but instead from competitive benefits on the cardholder side of the platform and the concomitant competitive benefits to the merchants who chose to accept Amex cards.”13 Put differently, “evidence showing that Amex must compete” to maintain cardholders “does not show that Amex has the power to increase prices to supracompetitive levels.”14

Because the plaintiffs failed to show anticompetitive effects that took both the merchant and cardholder sides of the market into account, the Second Circuit found that the district court erred when it held Amex liable under the Sherman Act.

Impact of the Decision

The deadline for the plaintiffs to ask for en banc review of the panel decision has not yet lapsed. Some pundits predict that the plaintiffs will file such a petition because the panel opinion parts ways with an earlier Second Circuit case, United States v. Visa, which defined the relevant market as the market in which Visa, MasterCard, Amex and Discover compete to sell network services to merchants, just as the district court did in the Amex case.15 The Amex panel opinion dismissed the Visa panel’s test for two reasons: (1) in the Visa case, the anticompetitive effects harmed both the merchants and the cardholders, whereas in the Amex case, cardholders may benefit from higher merchant fees in the form of rewards programs; and (2) whereas the restraints at issue in the Visa case were horizontal agreements between competing payment-card networks, the restraints at issue in the Amex case were vertical agreements between Amex and merchants.16 Some commentators suggest that these two distinguishing factors are insufficient, making this case ripe for reconsideration because the panel decision has effectively created an intracircuit conflict.

If the Amex opinion stands, it provides some useful guidance for participants in two-sided markets, like the credit card industry and the health care industry, where separate interests of insurers and patients are often implicated by the same services. Rather than focusing solely on the impact of particular conduct on one facet of such a market, companies seeking to use anti-steering or other similar restraints should take care to understand the potential anticompetitive effects of them, as well as to explain the procompetitive benefits that will flow from them with respect to each side of the market. Even so, until the scope of the Amex decision becomes clearer and other circuit courts weigh in, it would be risky for businesses to rely too heavily on the decision’s principles to engage in any behavior that has anticompetitive effects on any portion of an integrated market, no matter the overall market impact.