December 18, 2014

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The Third Circuit Does It Again: A Monopolist Violates the Antitrust Laws By Offering Conditional Above -Cost Market Share Discounts That Constitute "De Facto Partial Exclusive Dealing"

In ZF Meritor, LLC v. Eaton Transmission Corporation, [1] (hereinafter "Meritor"), the Third Circuit has issued its third decision within the past 10 years concluding that above-cost vertical restraints imposed by a supplier with market power violate the antitrust laws. The first, LePage's Inc. v. 3M, [2] ruled that a supplier with market power's above-cost, bundled discounts that excluded competition violate the Sherman Act. The second, United States v. Dentsply Int'l, [3] struck down a monopolist's exclusive dealing arrangements with fewer than 25 percent of the distributors in the applicable market. Now in Meritor, the Third Circuit has determined, in a 2-1 decision, that a monopolist offering above-cost market share discounts conditioned upon the acceptance by four major buyers of additional non-price restrictions, violates both the Sherman and Clayton Acts if the restraints constitute "de facto partial exclusive dealing," a term that essentially is new to antitrust.

Background Facts

The Meritor case involves the heavy-duty "Class 8" truck transmission market ("HD Transmissions"). The parties' customers for HD transmissions are manufacturers of heavy-duty trucks used to travel long distances on highways, and "performance" vehicles such as cement mixers and dump trucks. Eaton, the defendant, long had a monopolistic share of the market, and in fact was the only significant manufacturer until Meritor entered the market in 1989. By 1999 Meritor had obtained about 17 percent of the market. Nevertheless, Eaton HD transmissions remained a "must have" product. No other significant competitor had entered the market in 20 years.

There are only four direct purchasers of HD transmissions in the US—the original equipment manufacturers (OEMs) of heavy-duty trucks. Buyers of such trucks largely select their truck components including HD transmissions, from the OEMs' catalogs called "data books." The data books list alternative component choices, with one listed as the "standard" or "preferred" option — typically the lowest priced component. Thus, positioning in the data book is a form of advertising—apparently the key form.

From 1999 through early 2000, the trucking industry experienced a 40-50 percent decline in demand for new heavy-duty trucks. In response, Eaton offered new long-term agreements (LTAS) to the four OEMs. While long-term supply agreements were not uncommon, and Meritor itself had utilized them, the new Eaton LTAs were unprecedented in duration—at least five years.

Additionally, the LTAs accepted by the four OEMs included provisions under which an OEM would receive rebates from Eaton that varied by the percentage of the OEM's requirements for HD transmissions purchased from Eaton, with the highest discount made available if the OEM purchased about 90 percent of the OEM's requirements from Eaton. All or most of the following conditions had to be met by the OEM in order to obtain the rebates: (i) listing Eaton's transmissions as the "preferred" HD transmission in its data book—but not in other forms of advertising; (ii) pricing Eaton's transmissions as the lowest priced HD transmission; (iii) removing competitive products from the data book; and (iv) giving Eaton the opportunity to match the price and quality of HD transmissions offered by a competitor.

Key undisputed facts were that Eaton's HD transmissions always had been priced lower than Meritor's; the prices for Eaton's products after the highest market share rebate always remained above-cost; and by the time the suit was filed Meritor's market share had declined to 13 percent from the 16 percent share it had when the LTAs were first made available in 2000. Additionally, there was evidence that Meritor had refused OEM requests to lower its prices to remain competitive, and at the end of 2003 it actually raised the price of its flagship line of HD transmissions by 25 percent. There also was evidence that Meritor HD transmissions required frequent repairs. In fact, in 2002 and 2003 it faced millions of dollars in warranty claims.

Meritor's market share continued to drop, and in 2007 it exited the market. It brought suit in 2006 against Eaton, claiming that the LTA program violated Sections 1 and 2 of the Sherman Act, as well as Section 3 of the Clayton Act, which in part addresses the validity of exclusive dealing arrangements. The jury found for Meritor, and while entering an injunction, the judge rejected Meritor's damage claim on the ground that the data on which it was based was uncertain and faulty.

The Third Circuit Opinion

In a 2-1 decision, the Third Circuit (in a massive opinion, and an even longer dissent) affirmed the jury verdict, but dismissed the injunction because Meritor was no longer in business. The court remanded the damage claim to the district court to consider alternative methodology that apparently had been contained in Meritor's damage report. (Otherwise it would have been a pyrrhic victory for Meritor, with the only recovery being its attorneys' fees.)

At the very outset of the legal discussion, Judge Fisher, writing for the two-judge majority, rejected Eaton's argument that because its prices always were above cost, the challenged practices were per se lawful under the price-cost test established by the Supreme Court in Brooke Group Ltd. v. Brown & Williamson Tobacco Corp. [4] Under that test, above-cost prices cannot violate the Sherman Act in a predatory pricing case. According to the Third Circuit majority, however, the Brooke Group standard applies only when "price is the clearly predominant method of exclusion," and the LTAs had exclusionary elements besides price that could be challenged even if the prices were above cost. Specifically, Meritor had "consistently argued that the LTAs in their entirety constituted de facto exclusive dealing contracts, which improperly foreclosed a substantial share of the market, and thereby harmed competition." [5]

The court added that an express exclusivity requirement is not necessary if exclusivity is the effect of an agreement that does not require exclusivity by its terms—de facto exclusive dealing. [6] Exclusive dealing arrangements are forbidden if a defendant with significant market power forecloses competition in a substantial share of the relevant market through such an arrangement. [7] According to the majority decision:

Where, as here, a dominant supplier enters into de facto exclusive dealing arrangements with every customer in the market, other firms may be driven out not because they cannot compete on a price basis, but because they are never given an opportunity to compete, despite their ability to offer products with significant customer demand. [8]

The court then explained the reasons for its view that "de facto partial exclusive dealing" by a monopolist could violate both the Sherman and Clayton Acts. Although the LTAs did not cover 100 percent of an OEM's purchases, the evidence at trial persuaded the jury and the Third Circuit majority that the purchase requirements necessary to obtain Eaton's market share discounts were as effective as total exclusivity. For example, the LTAs with two of the four OEMs gave Eaton the right to terminate the agreements if the market-share targets were not met, and "no OEM could satisfy customer demand without at least some Eaton products, and therefore no OEM could afford to lose Eaton as a supplier." [9] The court did not specifically state that Eaton would terminate dealings with an OEM that failed to comply with an LTA's requirements, as distinguished from simply terminating the LTA. It did declare, however, that there was evidence "that Eaton leveraged its position as a supplier of necessary products to coerce the OEMs into entering the LTAs . . . because without Eaton's transmissions, the OEMs would be unable to satisfy customer demand." [10]

Summing up the anticompetitive effects of the LTAs, the majority declared:

Here, Eaton entered into long-term agreements with every direct purchaser in the market , and under each agreement, imposed what could be viewed as mandatory purchase requirements. . . . The OEMs generally met these targets, which . . . resulted in approximately 15% of the market remaining open to Eaton's competitors by 2003 . . . . [By] 2005, Plaintiff's market share had dropped to 4%. [11]

Because "there was considerable evidence from which a jury could infer that the primary purpose of the LTAs was not to meet customer demand, but to take preemptive steps to block potential competition , . ." the majority concluded that the jury could properly find that the cumulative effect of Eaton's conduct was to adversely affect competition in violation of both the Sherman and Clayton Acts. [12]

The Dissent

Judge Greenberg, in a strongly worded dissent, contended that judgment should have been entered for Eaton on all aspects of the case as a matter of law. He declared that "the general principle that above-cost pricing practices are not anticompetitive. . . is a cornerstone of antitrust jurisprudence that applies regardless of whether the plaintiff focuses its claims on the price or non-price aspects of the defendant's pricing program." [13] Deriding "de facto partial exclusive dealing" as a term never recognized, or even identified, by the Supreme Court or any court of appeals, Judge Greenberg declared that nothing that Eaton did was "coercive" because: (i) the LTAs by their terms were not exclusive nor mandatory; (ii) the above-cost prices could have been matched by Meritor; and (iii) there was no evidence "that Eaton would have refused to supply transmissions to the OEMs" had they failed to meet the LTAs' market-share targets. . . ." [14] He stressed that the non-price aspects of the LTAs would not have existed without the reduced prices that Eaton offered as an incentive for the OEMs to enter the agreements, declaring that the "Brooke Group price-cost test should apply and be given persuasive effect "regardless of whether a plaintiff identifies non-price elements of a defendant's conduct that it alleges were anticompetitive. [15]

Referring to the totality of the evidence at trial, the dissenter observed that Eaton was able to maintain its dominant position for myriad reasons, including a number that were procompetitive—its offering of a full product line to the OEMs, favorable pricing, its long-standing positive reputation , as well as the market forces favoring an established, successful market player. He listed a number of factors unfavorable to Meritor, including the fact that it offered only a limited product line, its market share was falling before the adoption of the LTAs, and it charged a high price for its flagship HD transmission. [16]

Judge Greenberg concluded that erroneous judgments in cases like this one can come at a great social cost, because market-share discounts can result in lower prices by rewarding loyal customers regardless of their size, and because corporate counsel for a dominant firm presented with a proposed discount program that might be challenged by competitors may now play it safe by counseling against its adoption, with the result that prices may remain too high and competition may be stifled—a perverse outcome. [17]

Looking Ahead

The Third Circuit has remanded the Meritor case to the district court for further proceedings relating to the damage award. Perhaps Eaton will seek certiorari at this time or after a damages decision—if favorable to Meritor—on the ground that this decision is contrary to the views of other circuits, including the Second, [18] Sixth [19] and Eighth. [20] Or the case may be settled. In any event, the Meritor decision is another reminder to the antitrust plaintiffs' bar that the Third Circuit may be the most hospitable venue for a failing company that believes its business losses were caused by the unlawful conduct of a dominant competitor rather than what actually might have been tough, lawful competition and/or its own business mismanagement and inadequate competitive reactions to external market forces. [1]


[1] 696 F.3d 254 (3d Cir. 2012).

[2] 324 F.3d 142 (3d Cir. 2003). cert. denied, 542 U.S. 953 (2004).

[3] 399 F.3d 181 (3d Cir. 2005).

[4] 509 U.S. 209 (1993).

[5] Meritor . 966F.3d at 269.

[6] Id. at 270 .

[7] Id. at 271-72 .

[8] Id. at 281. 

[9] Id. at 283 .

[10] Id. at 286 .

[11] Id.

[12] Id. at 289 .

[13] Meritor dissent, at 311-12.

[14] Id. at 312.

[15] Id. at 324.

[16] Id. at 350.

[17] Id. at 351.

[18] See Virgin Atlantic Airway Ltd. V. British Airways plc, 257 F.3d 256 (2d Cir. 2001).

[19] See Nicsand Inc. v. 3M Company, 507 F.3d 768 (6thCir. 2002).

[20] See Concord Boat Corp. v. Brunswick Corp., 207 F.3d 1039 (8th Cir.), cert. denied, 531 U.S. 979 (2000).

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About this Author

Senior Counsel

Irving Scher is senior counsel in Greenberg Traurig's New York office. He focuses his practice on antitrust, marketing and unfair and deceptive trade practice litigation and counseling. Mr. Scher has wide-ranging experience in antitrust, marketing and advertising matters across a broad spectrum of products and services. He counsels and represents clients in virtually all phases of government investigations and litigation, including national coordination of cases and trial and appellate work. He has served as lead defense counsel in a multitude of major antitrust, marketing and unfair...

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