Knew Something About The Sherman Act
A previous post on this blog celebrated the birthday of Standard Oil Co. v. United States, 221 U.S. 1 (1911). As explained in that post, Standard Oil articulated the "Rule of Reason" that courts apply when determining whether an agreement between two or more firms is a "contract, combination or conspiracy in restraint of trade or commerce among the several states" and thus contrary to Section 1 of the Sherman Act. Recognizing that all agreements restrain trade in some sense, the Standard Oil Court read Section 1 narrowly, so as not to offend liberty of contract. Thus, the Court held that Section 1 bans only those restraints that produce "the consequences of monopoly," namely, prices above the competitive level, output below the competitive level, and/or quality below the competitive level.
Standard Oil was controversial at the time, with Justice Harlan (in dissent) and various commentators claiming that the Court's Rule of Reason contravened two key Supreme Court precedents, including United States v. Joint Traffic Association, 171 U.S. 505 (1898), and United States v. Trans Missouri Freight Association, 166 U.S. 290 (1897). Harlan and others also invoked Addyston Pipe and Steel Co. v. United States, 85 F. 271 (6th Cir. 1898), which the Supreme Court unanimously affirmed. See 175 U.S. 211 (1899). According to Harlan, for instance, the Sixth Circuit's Addyston Pipe decision had read Section 1, as interpreted by Trans-Missouri Freight, to ban every contract that restrained trade, without regard to reasonableness. Harlan issued a similar dissent in American Tobacco v. United States, 221 U.S. 106, 180 (1911), which reiterated Standard Oil's Rule of Reason when interpreting and applying Section 2 of the Sherman Act.
Whether he knew it or not, Harlan's charge was potentially embarrassing for then-President William Howard Taft, who, as an appellate judge, had authored the Sixth Circuit's decision in Addyston Pipe and appointed Edmund White, then an Associate Justice, as Chief Justice upon the death of Melvin Fuller.
112 years ago today, President Taft responded to this critique of Standard Oil, without mentioning Harlan by name, in his Third Annual message to Congress. Some of Taft's remarks, found here on the website of the University of Virginia's Miller Center, are worth re-reading:
"In two early cases, where the statute was invoked to enjoin a transportation rate agreement between interstate railroad companies, it was held that it was no defense to show that the agreement as to rates complained of was reasonable at common law, because it was said that the statute was directed against all contracts and combinations in restraint of trade whether reasonable at common law or not. It was plain from the record, however, that the contracts complained of in those cases would not have been deemed reasonable at common law. In subsequent cases the court said that the statute should be given a reasonable construction and refused to include within its inhibition, certain contractual restraints of trade which it denominated as incidental or as indirect.
These cases of restraint of trade that the court excepted from the operation of the statute were instances which, at common law, would have been called reasonable. In the Standard Oil and Tobacco cases, therefore, the court merely adopted the tests of the common law, and in defining exceptions to the literal application of the statute, only substituted for the test of being incidental or indirect, that of being reasonable, and this, without varying in the slightest the actual scope and effect of the statute. In other words, all the cases under the statute which have now been decided would have been decided the same way if the court had originally accepted in its construction the rule at common law.
It has been said that the court, by introducing into the construction of the statute common-law distinctions, has emasculated it. This is obviously untrue. By its judgment every contract and combination in restraint of interstate trade made with the purpose or necessary effect of controlling prices by stifling competition, or of establishing in whole or in part a monopoly of such trade, is condemned by the statute. The most extreme critics can not instance a case that ought to be condemned under the statute which is not brought within its terms as thus construed.
The suggestion is also made that the Supreme Court by its decision in the last two cases has committed to the court the undefined and unlimited discretion to determine whether a case of restraint of trade is within the terms of the statute. This is wholly untrue. A reasonable restraint of trade at common law is well understood and is clearly defined. It does not rest in the discretion of the court. It must be limited to accomplish the purpose of a lawful main contract to which, in order that it shall be enforceable at all, it must be incidental. If it exceed the needs of that contract, it is void.
The test of reasonableness was never applied by the court at common law to contracts or combinations or conspiracies in restraint of trade whose purpose was or whose necessary effect would be to stifle competition, to control prices, or establish monopolies. The courts never assumed power to say that such contracts or combinations or conspiracies might be lawful if the parties to them were only moderate in the use of the power thus secured and did not exact from the public too great and exorbitant prices. It is true that many theorists, and others engaged in business violating the statute, have hoped that some such line could be drawn by courts; but no court of authority has ever attempted it. Certainly there is nothing in the decisions of the latest two cases from which such a dangerous theory of judicial discretion in enforcing this statute can derive the slightest sanction."
In short, Taft rejected claims that Chief Justice White's Standard Oil opinion departed from Supreme Court precedent and his own Addyston Pipe decision. As Taft noted, subsequent decisions had imposed upon Section 1 a "reasonable construction," holding that the statute did not reach incidental or indirect restraints. See United States v. Joint Traffic Association, 171 U.S. 505 (1898) and Hopkins v. United States, 171 U.S. 578 (1898). In so doing, the Court avoided claims that the statute was so broad as to offend liberty of contract. (See here). Standard Oil, Taft said, simply employed a different verbal formulation, "The Rule of Reason," to describe the very same standard that courts, including Addyston Pipe, had been applying since the late 1890s. If anything, Taft actually understated his case. After all, decisions such as Joint Traffic and Hopkins had announced that indirect restraints, including mergers and the formation of partnerships, were beyond the scope of the Sherman Act altogether, regardless of their impact upon prices or output. Standard Oil, by contrast, contemplated that at least some such transactions could be unreasonable, ironically expanding the scope of the Act to condemn welfare-reducing conduct previously beyond its reach. (See pp. 796-97 of this source). Moreover, the decision suggested that some agreements were automatically unreasonable, if the "nature and character" of such conduct established that they necessarily produced the consequences of monopoly. The resulting rule, then replicated, in substance, but not in form, the distinction between "naked" and "ancillary" restraints announced by then-judge Taft in Addyston Pipe. Like the Rule of Reason itself, this distinction has stood the test of time.