Jason Lee is an associate of the Firm. His practice focuses on corporate transactions, including mergers and acquisitions, private equity transactions, and general corporate matters for both public and private clients, focusing on middle-market and emerging growth companies. In addition, Jason counsels companies in connection with company formation process, SEC reporting requirements and registrations, federal and state securities laws and compliance, corporate governance matters, joint ventures, employee incentive plans and executive employment agreements. Below, Jason evaluates exclusive dealing arrangements under Section 1 of the Sherman Act.
Q. What does Section 1of the Sherman Act seek to prevent?
A. Section 1 of the Sherman Act prohibits unreasonable restraints on trade. Section 1 of the Sherman Act prohibits any contract, combination or conspiracy that unreasonably restrains trade. Restraints are typically analyzed by two standards: per se or the rule of reason. Certain restraints are so unreasonably harmful that they are per se illegal. Others require court analysis under the rule of reason.
Q. What are the elements a plaintiff must establish to prove a violation under Section 1 of the Sherman Act for an exclusive dealing contract?
A. A plaintiff bringing a claim of violation of Section 1 must establish that an agreement between two or more parties exists, there is an effect on interstate or foreign commerce and the agreement places an unreasonable restraint on trade. The agreement between the parties can made among competitors or among parties at different levels within a certain distribution chain. In addition, an agreement can exist even if there is no written contract.
Under the rule of reason, a plaintiff must define the relevant market restrained by the challenged agreement, show that the defendant has market power in the relevant market and establish that such agreement adversely effects competition in the relevant market. For exclusive dealing agreements, courts examine the effects of competition on a relevant market by determining if such an arrangement forecloses a substantial portion of any competing supplier’s distribution channels.
Q. What factors do courts use to review the impact of foreclosure of competitors to distribution channels?
A. To assess the competitive impact of foreclosure, courts measure the percentage of foreclosure and several qualitative factors listed below.
- Percentage of foreclosure. Courts generally find that an arrangement that forecloses 20% or less of the relevant market presumptively does not adversely affect competition. However, the percentage of foreclosure is not a definitive factor. Under the qualitative substantiality standard, courts evaluate agreements and the percentage of foreclosure in light of conditions in the market.
- Market position of the seller imposing the restraint. Courts will require that the seller and party to the agreement has a dominant position.
- Duration and terminability of the exclusive arrangement. Courts generally hold agreements that have a term of one year do not have substantial anticompetitive effects and are presumptively legal. Likewise, if agreements are easily terminated by the distributor, even if its term is longer than one year, courts are likely to find the agreement reasonable.
- Level in the distribution chain where restraint is imposed and whether alternative methods of distribution exist. Courts review the level of the distribution chain where the restraint exists. If the restraint involves a middleman distributor, as opposed to consumers, courts tend to require a higher amount of foreclosure percentage because it is less obvious the restraint will affect competition at the consumer level. Courts will also look to see if there are alternative outlets for competitors to reach consumers. If such alternative outlets exist, courts are reluctant to find an exclusive dealing arrangement illegal.
- Whether there has been entry into or withdrawal from the supplier market. If there is a successful recent entry into the supplier’s market, courts are less likely to find that an exclusive dealing arrangement substantially foreclosed competition. Conversely, if there is evidence competitors have not been able to enter the market because of an exclusive dealing arrangement, the agreement is more likely to be found anticompetitive and illegal.
- Prevalence of exclusive dealing arrangements in the industry. Courts will review how prevalent exclusive dealing arrangements are in the relevant market.
- Whether the exclusive dealing arrangement was the product of competition. Courts also consider whether exclusive dealing arrangements result from vigorous competition as opposed to anticompetitive behavior. If there is a bidding process where a retailer or distributor sought exclusivity, courts are unlikely to find that agreement unreasonable because courts generally view a buyer seeking exclusivity obligations to be an indicator that the arrangement is procompetitive. If the arrangement exists because the defendant offers a better product or better price to the distributor than competitors, courts tend to uphold the agreement as legal.
Ultimately, a plaintiff must show that the supplier’s action forecloses competitors in such a way that allows the supplier to either raise prices, restrict output or otherwise harm consumers.
For more information about the Sherman Act and other corporate matters, contact Jason Lee at (818) 444-4506 or firstname.lastname@example.org.