Vox Clamantis in Deserto (circa 1966)
Fifty-three years ago today the Supreme Court released its opinion in United States v. Arnold Schwinn & Co., 388 U.S. 365 (1967). The decision banned exclusive territories and other non-price intrabrand restraints as unlawful per se, unless the manufacturer that obtained the restrictions retained title to the products governed by the restraint. Schwinn exemplified the inability of expert enforcement agencies to absorb recent insights from lower court decisions and evolving economic theory necessary to understand the actual economic impact of non-standard contracts. This post describes the jurisprudential background of Schwinn as well as the role (or not) that evolving economic theory played in motivating and informing the decision.
1. The Sherman Act prohibits contracts "in restraint of trade of trade or commerce among the several States." In Standard Oil v. United States, 221 U.S. 1 (1911), the Supreme Court held that the Act prohibits only those agreements that restrain trade "unreasonably." (For a detailed summary of the Standard Oil decision, go here.) A restraint was unreasonable, in turn, if it produced monopoly or the consequences of monopoly. The Court defined these negative consequences as higher prices, reduced output and/or reduced quality. The Court also identified two categories of unreasonable agreements. Those unreasonable because of their "nature or character," and those unreasonable because of the "surrounding circumstances." Modern courts refer to restraints in the first category as "unlawful per se." Courts assess restraints that are not unlawful per se under a fact-intensive Rule of Reason.
2. Contracts are unlawful per se if they are part of a category of agreements that: (1) produce a "pernicious effect on competition" and, in addition, (2) "lack any redeeming virtues." See Northern Pacific Railway Co. v. United States, 356 U.S. 1, 5-6 (1958). When implementing this standard, the Court has effectively equated a pernicious effect on competition with any reduction in rivalry between the parties to the restraint. As a result, the outcome of the application of this standard almost always turns on whether restraints in the given category could produce "redeeming virtues." See Alan J. Meese, Price Theory, Competition and the Rule of Reason, 2003 Illinois L. Rev. 77, 96. Both mergers and naked price fixing extinguish competitive rivalry. But mergers survive per se condemnation because they may produce redeeming virtues.
2. Contracts are unlawful per se if they are part of a category of agreements that: (1) produce a "pernicious effect on competition" and, in addition, (2) "lack any redeeming virtues." See Northern Pacific Railway Co. v. United States, 356 U.S. 1, 5-6 (1958). When implementing this standard, the Court has effectively equated a pernicious effect on competition with any reduction in rivalry between the parties to the restraint. As a result, the outcome of the application of this standard almost always turns on whether restraints in the given category could produce "redeeming virtues." See Alan J. Meese, Price Theory, Competition and the Rule of Reason, 2003 Illinois L. Rev. 77, 96. Both mergers and naked price fixing extinguish competitive rivalry. But mergers survive per se condemnation because they may produce redeeming virtues.
3. During the 1950s and 1960s, the nation's expert enforcement agencies condemned non-price intrabrand restraints, both horizontal and vertical, regardless of the market position of the parties. For instance, the FTC challenged exclusive territories obtained by Sandura, a struggling manufacturer of vinal floor covering products. See Sandura Co. v. FTC, 339 F.2d 847 (6th Cir. 1964). The Department of Justice challenged exclusive territories and reservations of customers obtained by the White Motor Company. See White Motor Co. v. United States, 372 U.S. 253 (1963). Both agencies claimed that such restraints reduced rivalry (as they certainly did) and could not produce redeeming virtues, with the result that both deserved per se condemnation.
Such restraints would later become known as non-standard contracts, because they did more than just mediate passage of title between buyer and seller. See Oliver E. Williamson, Assessing Contract, 1 J. L., Econ. & Org. 177, 185-188 (1985) (distinguishing "classical market contracting" from "nonstandard contracts" such as tying, franchise restrictions, customer and territorial restrictions, minimum rpm and exclusive dealing). The agencies' condemnation of these and other non-standard contracts flowed naturally from the dominant economic framework of the time, so-called Neoclassical Price Theory. As the late Oliver Williamson explained, Price Theory only recognized technological efficiencies. By their nature, these efficiencies, such as economies of scale, arose solely within the boundaries of a firm. This incomplete and erroneous account of efficiencies precluded economists from recognizing that non-standard contracts that limited the discretion of trading partners after passage of title could produce cognizable benefits. Such agreements all reduce competitive rivalry one way or the other. Because economists and others could not imagine any beneficial consequences of such restraints, they naturally inferred that firms entered such agreements in an effort to obtain or exercise market power. Put in legal terms, such agreements had a pernicious effect on competition and lacked any redeeming virtues. See Northern Pacific Railway Co. The result was the so-called "Inhospitality Tradition" of antitrust law, whereby courts and agencies presumed all non-standard agreements unlawful and very rarely allowed rebuttal of this presumption. See Oliver E. Williamson, The Economics of Governance, 95 Amer. Econ. Rev. 1, 5 n. 8 (2005) (describing origins of this term) (citing Alan J. Meese, Intrabrand Restraints and the Theory of the Firm, 83 N.C. L. Rev. 5 (2004))
Such restraints would later become known as non-standard contracts, because they did more than just mediate passage of title between buyer and seller. See Oliver E. Williamson, Assessing Contract, 1 J. L., Econ. & Org. 177, 185-188 (1985) (distinguishing "classical market contracting" from "nonstandard contracts" such as tying, franchise restrictions, customer and territorial restrictions, minimum rpm and exclusive dealing). The agencies' condemnation of these and other non-standard contracts flowed naturally from the dominant economic framework of the time, so-called Neoclassical Price Theory. As the late Oliver Williamson explained, Price Theory only recognized technological efficiencies. By their nature, these efficiencies, such as economies of scale, arose solely within the boundaries of a firm. This incomplete and erroneous account of efficiencies precluded economists from recognizing that non-standard contracts that limited the discretion of trading partners after passage of title could produce cognizable benefits. Such agreements all reduce competitive rivalry one way or the other. Because economists and others could not imagine any beneficial consequences of such restraints, they naturally inferred that firms entered such agreements in an effort to obtain or exercise market power. Put in legal terms, such agreements had a pernicious effect on competition and lacked any redeeming virtues. See Northern Pacific Railway Co. The result was the so-called "Inhospitality Tradition" of antitrust law, whereby courts and agencies presumed all non-standard agreements unlawful and very rarely allowed rebuttal of this presumption. See Oliver E. Williamson, The Economics of Governance, 95 Amer. Econ. Rev. 1, 5 n. 8 (2005) (describing origins of this term) (citing Alan J. Meese, Intrabrand Restraints and the Theory of the Firm, 83 N.C. L. Rev. 5 (2004))
4. Beginning in 1960, economists and law professors began to push back against Price Theory's account of non-standard contracts. In 1960, Lester Telser famously argued that minimum resale price maintenance could prevent a manufacturer's dealers from free riding on each others' promotional expenditures and thus ensuring appropriate expenditures on advertising and promotion. Six years later, Robert Bork (pictured above) contended that exclusive territories were properly understood as ancillary restraints. See The Rule of Reason and the Per Se Concept: Price Fixing and Market Division II, 75 Yale L. J. 373 (1966). This under-appreciated article rehabilitated William Howard Taft's doctrine of ancillary restraints, giving the doctrine economic content within a normative framework of wealth maximization. See United States v. Addyston Pipe & Steel Co., 85 F. 271 (6th Cir. 1899). Bork also invoked Ronald Coase's conclusion that business firm are simply a particular form of contractual integration and opined that partial contractual integration could perform the same function as complete integration. See Bork, Price Fixing and Market Division, 75 Yale L. J. at 384, n. 29 (citing Ronald H. Coase, The Nature of the Firm, 4 Economica (n.s.) 318 (1937)). See also Alan J. Meese, Robert Bork's Forgotten Role in the Transaction Cost Revolution, 79 Antitrust L. J. 953 (2014). Fully-integrated manufacturers naturally engaged in profit-maximizing advertising and promotion without incurring antitrust liability. However, some manufacturers might choose to rely upon independent dealers to distribute their products. Granting such dealers an exclusive territory, Bork said, would allow dealers to capture the benefits of their promotional investments, thereby inducing such dealers to engage in the same amount and type of promotion as a fully-integrated firm. (For additional elaboration of Bork's contributions to Antitrust thinking, see here).
5. Even before Bork's breakthrough lawyers were making similar arguments about the propensity of such restraints to produce redeeming virtues. In White Motors, for instance, the defendants contended that exclusive territories would ensure that "dealers who have spent valuable time 'pre-selling' a customer --- i.e., softening him up for a White sale instead of a GM or Ford sale --- will not lose the legitimate reward of their labor to another White dealer who jumps territorial boundaries at a strategic moment and snatches away the pre-sold customer." Sandura echoed these contentions in an amicus brief filed in White Motors. The company described its efforts to recruit new distributors in an effort to reverse competitive failure. Such distributors, it said, would have to do "an extensive job of promoting [the product]" and "pay for the bulk of advertising and other promotional expenditures." (p. 8) Exclusive territories, the company said, would ensure that dealers could capture the benefits of such investments. Id.
6. These arguments thwarted the agencies' efforts to extend the per se rule to these restraints. In White Motor the Court refused to the declare the challenged restraints unlawful per se. Although the Court did not expressly mention the problem of free riding, it did opine that such restraints "may be allowable protections against aggressive competitors or the only practicable means a small company has for breaking into a staying in business." Id. at 263. The Court thus rejected the Department's claim that such restraints could never produce redeeming virtues, because it did "not know enough about the economic and business stuff out of which these arrangements emerge to be certain." Id. at 263. Instead, it remanded to the district court for additional findings on this question. Shortly thereafter, in Sandura, the Sixth Circuit rejected the FTC's contentions. The court observed that "distributors are unwilling to engage in extensive advertising and promotion of a product if the final sales may be made by another distributor." As a result, it said, the "closed territories made for the vigor and health of Sandura, increasing the competitive good that flows from interbrand competition, without any showing of detriment to intrabrand competition." Thus, the court said, the Commission's finding that the practice was "without justification or redeeming virtue," was "without support in the evidence." In his 1966 article, Bork instanced Sandura as the lower court decision that "came nearer to the mark" at understanding the rationale of such restraints than other lower courts that had also rejected per se condemnation. See Bork, Rule of Reason and the Per Se Concept, 75 Yale L. J. at 433.
7. A neutral observer in 1967 may have reasonably predicted that the Supreme Court would soon expressly adopt the reasoning of Sandura and hold that non-price intrabrand restraints were subject to rule of reason scrutiny. But then came Schwinn. The government claimed that Schwinn had imposed exclusive territories on its wholesalers and also prevented retailers from reselling Schwinn's products to unapproved dealers. The trial court found that exclusive territories at least were unlawful per se with respect to those products to which Schwinn no longer retained title. By contrast, when Schwinn did retain title, as with a consignment agreement, such restraints survived per se condemnation and were instead analyzed under the Rule of Reason. After conducting such an analysis, the court held that the United States had failed to prove that Schwinn's consignment agreements were unreasonable.
The United States appealed, hoping to overturn the trial court's determination that the consignment restraints were not unreasonable. Schwinn did not cross-appeal, thereby leaving in place the district court's per se condemnation of exclusive territories governing the disposition of products after title had passed. Two antitrust all stars helped draft the government's brief: Donald Turner, a Yale-educated economist on leave from Harvard Law School and leading the Antitrust Division, and Richard Posner, a recent Harvard Law School graduate in the Solicitor General's office. The brief claimed that the restrictions were unreasonable because they limited price competition between wholesalers and retailers without producing any offsetting benefits. To bolster the claim that no benefits were present, the brief contended that: "integration into distribution may sometimes benefit the economy by leading to cost savings, agreements to retail prices or impose territorial restrictions of limited duration or outlet limitations of the type involved here have never been shown to produce comparable economies." (p. 50).
8. It should be noted that the opinion of the Antitrust Division of the Department of Justice was not unanimous. Instead, Oliver Williamson, a young economist serving as a special assistant to Donald Turner, objected to the Turner/Posner position. In 1999, Williamson conceded that, despite his objection, he did not have an alternative theory that explained such restraints. See Oliver E. Williamson, Some Reflections, in Firms, Markets and Hierarchies, 32, 32 (Glenn R. Carrol and David E. Teece, Editors) (1999). It thus does not seem that Williamson invoked the reasoning of Bork's very recent article on the subject. Unfortunately Turner and Posner persisted despite Williamson's objection.
9. Schwinn's own brief asserted that it adopted its system so as to "encourage local sales effort by small retailers, including local advertising, salemanship and all forms of promotional advertising, as a competitive weapon against the heavy competitive advertising of large, well-financed mass merchandisers (i.e., Sears, Wards, etc.)." (p. 94). It did not, however, contend that dealers would refuse to promote Schwinn's products without exclusivity. Schwinn mentioned Sandura once in its 114 page brief, and then only as part of a long string cite of decisions that had declined to condemn non-price restraints as unlawful per se.
10. In a lengthy and sometimes confusing opinion, the Court abandoned White Motors and implicitly rejected the logic of Sandura. Even though Schwinn had conceded the issue, the Court reached out to opine that exclusive territories are unlawful per se. The Court did not mention the Northern Pacific Railway test for per se illegality or the concept of redeeming virtues. Nor did it take issue or even allude to arguments made in White Motor and Sandura that such restraints could encourage dealers to expend sufficient resources on promotion. Instead, the Court's brief analysis of the question invoked Dr. Miles v. John D. Park & Sons, 220 U.S. 373 (1911), which had banned minimum resale price maintenance. Exclusive territories and other limits on resale, the Court said, were analogous to minimum rpm and should suffer the same fate. See Schwinn, 388 U.S. at 378.
11. It may be difficult to fault the Schwinn Court for failing to recognize and incorporate Bork's analysis. At the same time, decisions such as Sandura pointed in the right direction. Moreover, the Court would subsequently expressly ignore Bork's analysis in United States v. Topco, 405 U.S. 596 (1972).
12. Nonetheless, Schwinn still prevailed. After a lengthy exegesis, the Court finally turned to the question actually before it, viz., whether the intrabrand restrictions obtained via consignment agreements were unreasonable. In three paragraphs, the Court affirmed the district court's holding rejecting the government's rule of reason case. See Schwinn, 388 U.S. at 380-82. Among other things, the Court noted that Schwinn's market share was declining in the face of stiff competition, including from mass merchandisers, the agreements allowed dealers to carry competing brands of bicycles, and consumers had access to bicycles sold to numerous competitors. At the same time, the Court's analysis left the reader wondering how, exactly, the restraints themselves helped bolster Schwinn's competitive position vis a vis rivals.
13. The Schwinn opinion sowed the seeds for future critiques. For instance, the Court did not articulate the methodology it employed to determine whether restraints are unlawful per se. Nor did the Court explain why that (unexplained) methodology treated the passage of title as dispositive. Finally, the Court's rule of reason analysis rested in part on an assumption that furthering interbrand competition is a redeeming virtue, thus raising the possibility that other restraints that might produce such benefits would thereby avoid per se condemnation.
5. Even before Bork's breakthrough lawyers were making similar arguments about the propensity of such restraints to produce redeeming virtues. In White Motors, for instance, the defendants contended that exclusive territories would ensure that "dealers who have spent valuable time 'pre-selling' a customer --- i.e., softening him up for a White sale instead of a GM or Ford sale --- will not lose the legitimate reward of their labor to another White dealer who jumps territorial boundaries at a strategic moment and snatches away the pre-sold customer." Sandura echoed these contentions in an amicus brief filed in White Motors. The company described its efforts to recruit new distributors in an effort to reverse competitive failure. Such distributors, it said, would have to do "an extensive job of promoting [the product]" and "pay for the bulk of advertising and other promotional expenditures." (p. 8) Exclusive territories, the company said, would ensure that dealers could capture the benefits of such investments. Id.
6. These arguments thwarted the agencies' efforts to extend the per se rule to these restraints. In White Motor the Court refused to the declare the challenged restraints unlawful per se. Although the Court did not expressly mention the problem of free riding, it did opine that such restraints "may be allowable protections against aggressive competitors or the only practicable means a small company has for breaking into a staying in business." Id. at 263. The Court thus rejected the Department's claim that such restraints could never produce redeeming virtues, because it did "not know enough about the economic and business stuff out of which these arrangements emerge to be certain." Id. at 263. Instead, it remanded to the district court for additional findings on this question. Shortly thereafter, in Sandura, the Sixth Circuit rejected the FTC's contentions. The court observed that "distributors are unwilling to engage in extensive advertising and promotion of a product if the final sales may be made by another distributor." As a result, it said, the "closed territories made for the vigor and health of Sandura, increasing the competitive good that flows from interbrand competition, without any showing of detriment to intrabrand competition." Thus, the court said, the Commission's finding that the practice was "without justification or redeeming virtue," was "without support in the evidence." In his 1966 article, Bork instanced Sandura as the lower court decision that "came nearer to the mark" at understanding the rationale of such restraints than other lower courts that had also rejected per se condemnation. See Bork, Rule of Reason and the Per Se Concept, 75 Yale L. J. at 433.
7. A neutral observer in 1967 may have reasonably predicted that the Supreme Court would soon expressly adopt the reasoning of Sandura and hold that non-price intrabrand restraints were subject to rule of reason scrutiny. But then came Schwinn. The government claimed that Schwinn had imposed exclusive territories on its wholesalers and also prevented retailers from reselling Schwinn's products to unapproved dealers. The trial court found that exclusive territories at least were unlawful per se with respect to those products to which Schwinn no longer retained title. By contrast, when Schwinn did retain title, as with a consignment agreement, such restraints survived per se condemnation and were instead analyzed under the Rule of Reason. After conducting such an analysis, the court held that the United States had failed to prove that Schwinn's consignment agreements were unreasonable.
The United States appealed, hoping to overturn the trial court's determination that the consignment restraints were not unreasonable. Schwinn did not cross-appeal, thereby leaving in place the district court's per se condemnation of exclusive territories governing the disposition of products after title had passed. Two antitrust all stars helped draft the government's brief: Donald Turner, a Yale-educated economist on leave from Harvard Law School and leading the Antitrust Division, and Richard Posner, a recent Harvard Law School graduate in the Solicitor General's office. The brief claimed that the restrictions were unreasonable because they limited price competition between wholesalers and retailers without producing any offsetting benefits. To bolster the claim that no benefits were present, the brief contended that: "integration into distribution may sometimes benefit the economy by leading to cost savings, agreements to retail prices or impose territorial restrictions of limited duration or outlet limitations of the type involved here have never been shown to produce comparable economies." (p. 50).
8. It should be noted that the opinion of the Antitrust Division of the Department of Justice was not unanimous. Instead, Oliver Williamson, a young economist serving as a special assistant to Donald Turner, objected to the Turner/Posner position. In 1999, Williamson conceded that, despite his objection, he did not have an alternative theory that explained such restraints. See Oliver E. Williamson, Some Reflections, in Firms, Markets and Hierarchies, 32, 32 (Glenn R. Carrol and David E. Teece, Editors) (1999). It thus does not seem that Williamson invoked the reasoning of Bork's very recent article on the subject. Unfortunately Turner and Posner persisted despite Williamson's objection.
9. Schwinn's own brief asserted that it adopted its system so as to "encourage local sales effort by small retailers, including local advertising, salemanship and all forms of promotional advertising, as a competitive weapon against the heavy competitive advertising of large, well-financed mass merchandisers (i.e., Sears, Wards, etc.)." (p. 94). It did not, however, contend that dealers would refuse to promote Schwinn's products without exclusivity. Schwinn mentioned Sandura once in its 114 page brief, and then only as part of a long string cite of decisions that had declined to condemn non-price restraints as unlawful per se.
10. In a lengthy and sometimes confusing opinion, the Court abandoned White Motors and implicitly rejected the logic of Sandura. Even though Schwinn had conceded the issue, the Court reached out to opine that exclusive territories are unlawful per se. The Court did not mention the Northern Pacific Railway test for per se illegality or the concept of redeeming virtues. Nor did it take issue or even allude to arguments made in White Motor and Sandura that such restraints could encourage dealers to expend sufficient resources on promotion. Instead, the Court's brief analysis of the question invoked Dr. Miles v. John D. Park & Sons, 220 U.S. 373 (1911), which had banned minimum resale price maintenance. Exclusive territories and other limits on resale, the Court said, were analogous to minimum rpm and should suffer the same fate. See Schwinn, 388 U.S. at 378.
11. It may be difficult to fault the Schwinn Court for failing to recognize and incorporate Bork's analysis. At the same time, decisions such as Sandura pointed in the right direction. Moreover, the Court would subsequently expressly ignore Bork's analysis in United States v. Topco, 405 U.S. 596 (1972).
12. Nonetheless, Schwinn still prevailed. After a lengthy exegesis, the Court finally turned to the question actually before it, viz., whether the intrabrand restrictions obtained via consignment agreements were unreasonable. In three paragraphs, the Court affirmed the district court's holding rejecting the government's rule of reason case. See Schwinn, 388 U.S. at 380-82. Among other things, the Court noted that Schwinn's market share was declining in the face of stiff competition, including from mass merchandisers, the agreements allowed dealers to carry competing brands of bicycles, and consumers had access to bicycles sold to numerous competitors. At the same time, the Court's analysis left the reader wondering how, exactly, the restraints themselves helped bolster Schwinn's competitive position vis a vis rivals.
13. The Schwinn opinion sowed the seeds for future critiques. For instance, the Court did not articulate the methodology it employed to determine whether restraints are unlawful per se. Nor did the Court explain why that (unexplained) methodology treated the passage of title as dispositive. Finally, the Court's rule of reason analysis rested in part on an assumption that furthering interbrand competition is a redeeming virtue, thus raising the possibility that other restraints that might produce such benefits would thereby avoid per se condemnation.
Stay tuned for "the rest of the story."
