The Federal Trade Commission Should Reconsider its Proposed Ban on Employee Noncompete Agreements

        In January, 2023, the Federal Trade Commission issued a Notice of Proposed Rulemaking ("NPRM"), proposing to ban all employee noncompete agreements ("NCAs"), with the exception of a small portion of those that arise out the sale of a business.      The proposed rule would ban even those agreements that state courts have found to be reasonable, after employers demonstrate that the agreement is necessary to produce significant benefits that exceed harms.  The Commission issued the proposed ban more than three years after receiving a 2019 petition from Chair Khan's former employer requesting that the Commission ban all NCAs as unfair methods of competition and thus violations of Section 5 of the FTC Act.  The Commission, in existence since 1914, has never assessed an NCA in an on-the-record adjudication. 

            This blogger filed lengthy comments with the Commission in April, 2023 identifying various errors of fact and analysis in the NPRM.  Among other things, the NPRM:

• Overstated the extent of labor market concentration; 

•  Understated the extent to which such agreements are disclosed to employees in advance;

• Mischaracterized state court opinions describing the prevalence of employer bargaining power;

• Ignored advances in economic theory relating to the voluntary formation of contracts that produce cognizable benefits;

• Misapplied the less restrictive alternative standard; 

• Erroneously rejected the regulatory alternative, proposed by this blogger and others, that would mandate pre-agreement disclosure of such contracts and thus reduce the information imbalance that the NPRM identified;

• Incorrectly concluded that mandate disclosure would have no impact on the number and content of NCAs.     

• Relied on "aggregate" or "average" effects of NCAs and refusing to discriminate between those that produce benefits and those that are harmful.

•  Incorrectly assumed that fully disclosed and beneficial NCAs are the result of a coercive process of contract formation with the result that any benefits necessarily coexist with coercive harm.  

        In addition to the Comments mentioned above, this blogger has also authored four publications on this subject between 2022 and 2024.   The first replied to a 2019 Petition requesting that the Commission ban all NCAs, including those that are reasonable. See Don't Abolish Employee Noncompete Agreements, 57 Wake Forest L. Rev. 631 (2022).  The three more recent publications criticize various aspects of the reasoning of the NPRM.  See New Vision Old Model: How the FTC Exaggerated Harms When Assessing Business Justifications for Employee Noncompete Agreements, 109 Cornell L. Rev. Online _____ (2024) (forthcoming); Regulation by (bad) Proxy: How Selective Application of Transaction Cost Economics Tainted the FTC’s Proposed Ban of Employee Noncompete Agreements, 100 Indiana L. J. Supp. _____ (2024)  (forthcoming); Are Employee Noncompete Agreements Coercive?  Why the FTC's Wrong Answer Disqualifies It from Rulemaking (For Now), 18 Va Law & Bus. Rev. 245 (2024).   Like the 2022 article in the Wake Forest Law Review, these papers draw on my prior work regarding the intersection of Transaction Cost Economics (TCE) and antitrust policy.  See e.g.:

• The Market Power Model of Contract Formation: How Outmoded Economic Theory Still Distorts Antitrust Doctrine, 88 Notre Dame L. Rev. 1291 (2013);

• Reframing Antitrust in Light of Scientific Revolution: Accounting for Transaction Costs in Rule of Reason Analysis, 62 Hast. L. J. 457 (2010) 

• Market Failure and Non-Standard Contracting: How the Ghost of Perfect Competition Still Haunts Antitrust, 1 J. Competition L & Econ. 21 (2005);

• Price Theory, Competition and the Rule of Reason, 2003 Illinois L. Rev. 77; 

• Tying Meets the New Institutional Economics: Farewell to the Chimera of Forcing, 146 U. Penn. L. Rev. 1 (1997);

    The four recent articles (2022-2024) cited above identify various errors and shortcomings in the case for abolishing NCAs.  Perhaps most notably, these papers take issue with the claim, made by the 2019 Petition and the NPRM, that NCAs, whether or not they produce benefits, are the result of a coercive process of contract formation.  The Petition contended that NCAs are always the result of unequal bargaining power and thus contracts of adhesion and can never produce cognizable benefits.  To its credit, the NPRM implicitly rejected the second contention, instead finding that NCAs could protect trade secrets and facilitate employer investments in employee training.  Unfortunately, the Commission embraced the claim that all NCAs result from employers' use of a "particularly acute" bargaining power advantage coercively to impose NCAs on unwilling employees.  (The only exception was for the tiny category of "Senior Executives.").   

    This finding of what I call "procedural coercion" informed several other aspects of the NPRM's rationale.  For instance, the NPRM treated such procedural coercion as a necessary condition for "substantive coercion," which it treated as an independent source of harm.  The Commission also assumed that, even if NCAs are fully disclosed in advance, employers will still use coercive bargaining power to impose them, with the result that disclosure will not impact the number and content of NCAs.  Finally, the NPRM invoked the supposed near-universal presence of procedural and substantive coercion to justify imposing a "high bar" on efforts to establish business justifications for NCAs, over and above the requirement that defendants bear the burden of proving the factual basis for such justifications.

     Each of the papers authored between 2022 to 2024 refutes the claim that NCAs are necessarily the result of unequal bargaining power.  The NPRM adduced no evidence that all or even most employees subject to NCAs work in concentrated markets.  Moreover, evidence in the record the NPRM ignored established the opposite, namely, that most employees work in unconcentrated markets.  Also, the Commission ignored several decades of economic learning to the effect that firms with market power generally will not use such power to impose a fully-disclosed nonstandard agreement, including an NCA but will instead exercise that power to increase prices or reduce wages.  While such exercises of power are cognizable harms, they are inconsistent with the use of such power coercively to impose NCAs.

      As noted above, the Commission found that NCAs sometimes produce cognizable benefits.  Evidence in the record also reported that 61 percent of employees subject to NCAs know of such agreements in advance, a figure generated before several states mandated pre-agreement disclosure of NCAs.  These facts raise the prospect that a significant proportion of NCAs are both beneficial and known to employees in advance, thereby refuting the finding that such agreements are always coercive in either respect.  Such refutation also undermines that Commission's assertion that mandatory disclosure will have no impact on the number and content of NCAs, undermining the Commission's rationale for rejection of the mandatory disclosure requirement.  Finally, such refutation undermines the Commission's assumption that benefits of NCAs always coexist with coercive harms, thereby eliminating the basis for applying a "high bar" to efforts to justify all NCAs.  The Commission's erroneous assumption that harms and benefits coexist, which echoed price theory's partial equilibrium trade-off model, resulted in a distorted assessment of business justifications that was unduly biased against NCAs.

        More fundamentally, the various errors identified above suggest to this blogger that, regardless of legal authority to issue such rules, the Commission lacks the capacity to gather and evaluate information regarding the impact of the entire universe of NCAs.  The Commission should thus withdraw the NPRM and start over.

Requiem for a Lightweight: How NCAA Continues to Distort Antitrust Doctrine, 56 Wake Forest L. Rev. _____ (2021) (forthcoming)

To download the latest version of this paper, go to this link.  

Abstract

The Supreme Court speaks rarely about the meaning of the Sherman Act.  When the Court does speak, its pronouncements have particular resonance and staying power among jurists, scholars and enforcers.  NCAA v. Board of Regents of the University of Oklahoma was such a case.  There the Court assessed agreements reducing the output and increasing the prices of televised college football games.  After announcing that restraints imposed by sports leagues are exempt from per se condemnation, the Court went on to invalidate the challenged agreements under the Rule of Reason because they produced significant economic harm without offsetting benefits.  In so doing the Justices also addressed restraints not before the Court, opining that members of the NCAA may collectively restrict the level of compensation that universities provide student athletes. 

Announced almost four decades ago, NCAA and its rationale have exerted substantial influence on Sherman Act doctrine, enforcement policy and scholarly discourse well beyond the context of sports leagues.  Later this term, in NCAA v. Alston, the Court will revisit the antitrust propriety of collective limitations on the compensation schools pay student athletes.  There the Court will review the Ninth Circuit’s condemnation of NCAA regulations restricting the value of education-related benefits, such as post-graduation scholarships, that schools provide student athletes in addition to tuition, room, board and other costs of attendance. 

While antitrust scholars and practitioners disagree about the merits of the Ninth Circuit’s decision, all hope the Court will clarify the extent to which the NCAA may limit student athlete compensation.  This essay contends that Alston also presents the Court with an opportunity to address more fundamental questions.  That is, the case offers the Court a chance to correct NCAA’s erroneous application of the per se standard and derivative errors the Court committed when conducting rule of reason analysis, errors that reverberate throughout Sherman Act jurisprudence.

  In particular, the essay demonstrates that NCAA’s sports league exemption from the ordinary per se standard contradicts basic antitrust principles.  Moreover, the rationale for the exemption turned partly on the Court’s (correct) assertion that some horizontal restraints can overcome market failures and enhance interbrand competition.  Recognition of these potential benefits undermined the Court’s otherwise broad articulation of the per se rule that purportedly created the need for such an exemption in the first place. 

  Failure to condemn the restraints before it as unlawful per se also distorted the Court’s pronouncements regarding how to conduct rule of reason analysis.  For instance, the requirements for establishing a prima facie case should depend upon the nature of redeeming virtues a restraint might produce.  However, courts, agencies and scholars have read NCAA as holding that proof that a restraint produces prices exceeding the non-restraint baseline necessarily establishes such a case, even when the restraint may overcome a market failure.  Moreover, lower courts, agencies and the Court itself have read NCAA as endorsing a “Quick Look” approach in some rule of reason cases, allowing plaintiffs to bypass any requirement to establish anticompetitive harm.  Finally, the Court’s approach to rule of reason analysis lent credence to the dubious assumption that benefits produced by challenged restraints necessarily coexist with harms, bolstering the equally dubious less restrictive alternative test.  Hopefully, the Court will take this opportunity in Alston to correct these errors and ensure a more coherent Section 1 jurisprudence that better reflects the teachings of modern economic theory.

Happy National Lighthouse Day!

Today is National Lighthouse Day!   In 1989 Congress designated this day for annual celebration of the "Act for the Establishment and Support of Lighthouses, Beacons, Buoys and Public Piers," enacted into law on August 7, 1789.  (Go here for the text of the original Act.)   To help celebrate the occasion, here are some photos of Ram Island Ledge Light, in Casco Bay, Maine.  An earlier post on this blog recounts some history behind the creation of this lighthouse and includes some additional photographs.

Winston Churchill Inspects Coastal Defenses, July 31, 1940

Winston Churchill inspected British coastal defenses several times during the summer of 1940.   France had capitulated on June 25, 1940, and many Britons expected a German invasion by autumn or before.  This visit took place 80 years ago, on July 31, 1940, just two weeks after Adolph Hitler issued Directive 16, ordering the German military to prepare an invasion of England.   Here Churchill examines a U.S.-made Thompson submachine gun, also known as a "Chicago Typewriter," because of the weapon's popularity with Chicago gangsters.  Nazi propagandists tried to exploit the image as evidence that Churchill was himself a gangster and reckless warmonger, dropping leaflets on England featuring the image. (See here)  The effort apparently failed, along with Hitler's attempt to convince the British People to pressure their government to make a separate peace.  

Happy Birthday to Continental T.V. v. G.T.E. Sylvania, 433 U.S. 36 (1977)!

Got his way! 

Today is the 43rd anniversary of the Supreme Court's decision in Continental T.V. v. GTE Sylvania, 433 U.S. 36 (1977).  The decision overruled United States v. Arnold Schwinn & Co., 388 U.S. 365 (1967).  Sylvania also reflected a sea change in both the Supreme Court's normative account of the Sherman Act and the type of economic theory the Court would employ to implement that vision when determining whether challenged agreements were "in restraint of trade" within the meaning of the Sherman Act.   While the decision dealt with a garden variety non-price vertical restraint, Sylvania's rationale had potentially major implications for various facets of antitrust law and policy.  This post discusses what was at stake in Sylvania, the Court's resolution of the dispute as well as the potential implications of that resolution.  

1.  Readers will recall from a recent post that Schwinn had condemned as unlawful per se vertical exclusive territories and reservations of customers.  The decision had announced an exception, however, in those cases in which such limitations appeared in a consignment agreement, pursuant to which the manufacturer retained title to the product until its distribution to a purchaser.  The Court had also affirmed the district court's finding that Schwinn's consignment agreements including such restrictions were not unreasonable restrictions on competition.  The Court concluded that Schwinn faced significant rivalry from other brands and that the firm had adopted such restrictions as part of a larger effort to fend off such interbrand rivalry.  Unfortunately the Court did not explain how such restrictions could advance interbrand rivalry or why the legality of such restrictions should turn on the passage of title.  Finally, the Court did not mention the foundational decision in Northern Pacific Railway Co. v. United States, 356 U.S. 1 (1958), which had articulated the standard governing when courts should condemn a given category of restraint.  Northern Pacific Railway had held that per se condemnation was only appropriate if the category of restraint in question both produced a pernicious effect on competition and, in addition, lacked redeeming virtues.

2.   Schwinn's per se rule was a manifestation of the so-called "inhospitality tradition" of antitrust.  During this era, courts and the enforcement agencies were greatly suspicious of so-called "non-standard contracts," that is, agreements that constrained the discretion of purchasers after passage of title.  As previously explained, neoclassical price theory had no efficiency-based explanation for such agreements.  Thus, scholars, courts and agencies naturally concluded that such agreements, which undeniably restricted competitive rivalry, were efforts to obtain or exercise market power.  Moreover, the Court also saw antitrust regulation as a tool for enhancing the "freedom" of traders from contractual limitations on their autonomy.  In Albrecht v. Herald Co., 390 U.S. 145 (1968), for instance, the Court condemned as unlawful per se maximum vertical price fixing, which reduced consumer prices, because such agreements would "'cripple[] the freedom of traders and thereby restrain their ability to sell in accordance with their own judgment.''" Id. at 152 (quoting Kiefer-Stewart Co. v. Seagram & Sons, Inc., 340 U.S. 211, 213 (1951)).  See also Alan J. Meese, Economic Theory, Trader Freedom and Consumer Welfare: State Oil v. Khan and the Continuing Incoherence of Antitrust Doctrine, 84 Cornell L. Rev. 763 (1999)   Taken together, neoclassical price theory and a normative commitment to trader freedom combined to drive judicial expansion of various per se bans condemning conduct previously analyzed under a fact-intensive and forgiving rule of reason.   See Alan J. Meese, Price Theory, Competition and the Rule of Reason, 2003 Illinois L. Rev. 77, 124-34.

3.  The inhospitality approach was not confined to vertical cases   In United States v. Topco, 405 U.S. 596 (1972), the Court condemned horizontal restrictions that were ancillary to the formation of a joint venture among independent grocery chains.  The joint venture created numerous private label products which it distributed to member stores, which competed against large national chains who had created and advertised their own private label products.  The agreement creating the venture assigned each member an exclusive territory within which only it could distribute the venture product.  Relying on the work of Robert Bork, the defendants contended that such exclusivity could allow members to recapture the benefits of investments they made promoting the venture's product and thus enhanced interbrand competition vis a vis the giant chains.  As a result, they said, such restrictions could produce redeeming virtues, thereby thwarting per se condemnation under the Northern Pacific Railway standard.  The Supreme Court rejected  this argument. however.  Although the Court quoted the Northern Pacific Railway standard with approval, it opined that the Sherman Act was the "Magna Carta of Free Enterprise," and that the restrictions before it interfered with each member's "freedom to compete" however it saw fit.  Thus, concern over the autonomy of traders precluded the Court from recognizing the promotion of interbrand competition as a redeeming virtue.

4.  Before Schwinn, Sylvania, which at the time had a one percent share of the market, revamped its system of distribution in an effort to reverse flagging T.V. sales.  Among other things the firm included so-called "location clauses" in its distribution agreements. These clauses specified the location(s) from which dealers could sell Sylvania products after title had passes and precluded such dealers from employing a different location without Sylvania's consent.  Sylvania terminated Continental T.V. after the latter opened a new store in Sacramento over Sylvania's objection.  Continental challenged this termination, claiming that the agreement limiting the locations from which it could sell was unlawful per se.  The district court agreed, and instructed the jury to find for Continental if it found the existence of such an agreement governing products whose title had passed, without regard to whether the agreement was reasonable.

5.  Sylvania appealed to the Ninth Circuit, which reversed in an en banc decision.  See 537 F.2d 980 (9th Cir. 1976) (en banc).  The court did not dispute that Schwinn condemned vertical exclusive territories or restrictions on the customers to whom dealers would sell.  However, it sought to distinguish Schwinn on two grounds.  First, the court emphasized that compared to Schwinn, Sylvania was a relatively small participant in the relevant market, with a market share that grew from one percent to five percent after it adopted the challenged restraints.  Second, the court claimed that a location clause was less restrictive of competitive rivalry than the restrictions condemned in Schwinn, thereby suggesting a different application of the per se rule.

6.   The Ninth Circuit's decision was not unanimous.  Judge Browning, among others, dissented.  Among other things, he contended that Schwinn rested upon concern for the autonomy of dealers, independent of the economic impact of the restraints.  As a result, he said, the majority's effort to distinguish Schwinn was not successful, because location clauses limited dealer autonomy as well.  To bolster this argument, he quoted Topco's assertion that the Sherman Act was the Magna Carta of Free Enterprise and thus protected the freedom of individual traders to ignore agreements limiting their economic autonomy.  See 537 F.2d at 1015.

7.    Continental T.V. sought review of the Ninth Circuit's decision in the Supreme Court.  The Court almost said no.  A grant of certiorari requires four votes.  Justice Rehnquist was recused, leaving only eight available votes.  Initially the Court balked, with only three justices (Brennan, Powell and Stevens) voting to grant review.  However, Justice Powell (pictured above) asked that the case be relisted and then lobbied two colleagues --- Justices White and Stewart --- for the necessary fourth vote.  He also threatened to issue a dissent if his colleagues voted to deny certiorari.  Andrew Gavil's excellent historical work details this process, based upon a review of Justice Powell's papers.   See Sylvania and the Process of Change in the Supreme Court, 17 Antitust 8 (Fall 2017).  Among other things Professor Gavil concludes that it is unclear "why Powell became such an active, persistent and vocal advocate for using Sylvania to reconsider Schwinn."

8.  The case featured a dispute between leading members of the Harvard School of Antitrust.  For instance, Lawrence Sullivan co-authored Continental T.V.'s brief in the Supreme Court.  Sullivan's credentials were impeccable.  He received his J.D. from Harvard in 1951 and held a Chair at the University of California at Berkeley.  His leading treatise on antitrust would appear that same year.  See Lawrence Anthony Sullivan, Antitrust (1977).   This work was a classic manifestation of the Harvard School approach to antitrust  The book acknowledged Sullivan's intellectual debt to Joe Bain, Donald Turner and Philip Areeda, all faculty at Harvard and members of the Harvard School.  Turner, of course, had authorized the case again Schwinn and had co-authored the government's brief in the Supreme Court.  The book's four page survey of the "Literature of Antitrust" did not mention the work of Chicagoans Robert Bork, Harold Demsetz, Yale Brozen or Lester Telser.  Instead, these pages invoked the work of Joe Bain, Donald Turner, Phillip Areeda and Carl Kaysen   While Sullivan mentioned Richard Posner's 1974 casebook, he attributed its content to "an economic point of view and, indeed, a very particular one, representative of the 'Chicago School," a point of view which is narrower, especially in its approach to vertical issues, than either the law itself or most industrial organization economists would countenance."  See id. at 14-15.   Sullivan also cited work by scholars who advocated more interventionist antitrust policy than the Harvard School.

9.  Petitioner's brief sought reversal of the decision below, relying unapologetically on Scwhinn.   In so doing, the brief emphasized the importance of the freedom of traders.

"Independent small businessmen who have made an investment of capital, energy and hope in their own enterprises, ought to be able to make their crucial decisions as to where to sell and what price to charge for their own merchandise, free of coercion, collusion or exclusionary practices.  That is what the free enterprise system, which the Sherman Act protects, is all about."

See Brief for Petitioner in Continental T.V. v. G.T.E. Sylvania, 433 U.S. 36 (1977), No. 76-15 at 38-39.

The challenged restriction was not collusive or exclusionary, thereby suggesting that Sullivan and his co-authors believed the location clause was coercive.  Indeed, the same brief asserted 20 pages later that rule of reason scrutiny of such restraints would countenance "administered judgement about the ideal development of outlets across the nation" and result in "paternalistic overreaching."  (Id. at 58.)

10.  Sullivan's was not the only voice of the Harvard School, however.  Donald Turner also co-authored a brief, this time on behalf of the Motor Vehicle Manufacturer's Association as Amicus Curiae.   The brief contended that Schwinn's per se rule was not justified and should be overruled.  Among other things the brief recognized what the government and Court had ignored in Schwinn, namely, that such restraints could counteract the propensity of dealers to free ride on each others' promotional efforts and help ensure optimal promotion by a manufacturer's dealers.  

11.  In an opinion by Justice Powell, the Court chose Turner's version of the Harvard School over Sullivan's.   The Court could have simply affirmed on the basis articulated by the Ninth Circuit.  Indeed, Justice White's concurrence advocated just such an approach.  See Sylvania, 433 U.S. at 59-71 (White, J. concurring).  However, the Court, per Justice Powell, rejected the Ninth Circuit's logic.  Among other things he agreed with Continental T.V. that there was no meaningful economic distinction between location clauses, on the one hand, and the restrictions invalidated in Schwinn, on the other.  As a result, he said, the Court could only affirm the judgment below if it overruled Schwinn.

12.  The Court also criticized the distinction Schwinn had drawn between vertical restraints that were part of consignment agreements and those that accompanied outright sales.  Both restraints, the Court said, had identical effects on competitive rivalry, and there was no reason the Sherman Act should treat one restraint more favorably than the other merely because of the form of the transaction.  Thus, the Court said, the Sherman Act should either condemn all such restraints outright or subject all to  fact-intensive rule of reason scrutiny.

13.  The Court then proceeded to determine which unified standard should apply.  The Court chided Schwinn for its abupt and unexplained departure from United States v. White Motors, 372 U.S. 253 (1963), which had declined to condemn similar restraints because it know too little about their economic impact, including the propensity to produce redeeming virtues.  The Court also chided Schwinn for failing to mention or apply the Northern Pacific Railway test for per se condemnation.  Rule of reason was the default position, Justice Powell said, and the Court could only condemn a type of restraint as unlawful per se if the proponent of such treatment met the "demanding standards" of the Northern Pacific Railway test.  The plaintiffs could not satisfy these standards, he said.  

14.  The Court recognized, of course, that location clauses and exclusive territories reduced intrabrand competition.  During the inhospitality era, such realization would have sufficed to condemn a type of restraint.  However, partly due to Turner's amicus brief, the Court rejected price theory's account of such restraints.  See Gavil, Sylvania and the Process of Change, 17 Antitrust at 16-17  Instead, the Court turned to what modern scholars call Transaction Cost Economics.  Invoking Robert Bork's 1966 article on horizontal and vertical ancillary restraints, the Court noted that manufacturers wished to maintain intrabrand competition as needed to distribute their products.  See Robert H. Bork, The Rule of Reason and the Per Se Concept: Price Fixing and Market Division, 75 Yale L. J. 373 (1966).  The Court also noted that, "because of market imperfections such as the 'free rider effect,'" a "purely competitive market" might not produce various services necessary to protect the manufacturer's goodwill and ensure proper distribution of its product.  See Sylvania, 433 U.S. at 55.  The Court also rejected the plaintiff's claim that expenditures on advertising were socially wasteful because they simply accentuated product differentiation and thus enhanced manufacturers' market power.  See Sylvania, 433 U.S. at 57, n. 25 (rejecting contention that "a large part of the promotional efforts resulting from vertical restrictions does not socially valuable information about product availability, price, quality, and services").   Such restraints could overcome such market imperfections, ensure a more efficient level of promotional expenditures and thus enhance interbrand competition.  This reasoning, of course, replicated the Chicago School's account of such restraints found in Bork's 1966 work, Richard Posner's 1976 monograph as well as a 1975 article by Posner.  See Richard A. Posner, Antitrust: An Economic Perspective (1976); Richard A Posner, Antitrust Policy and the Supreme Court: An Analysis of the Restricted Distribution, Horizontal Merger and Potential Competition Decisions, 75 Columbia L. Rev. 282 (1975).  (See also here) (describing how Sylvania Court embraced Bork's economic account of such restraints).  The transaction cost account of such restraints also undermined the petitioner's claim that such restraints were necessarily coercive, given that non-standard agreements the overcome market failures are presumptively voluntary.    See Alan J. Meese, The Market Power Model of Contract Formation: How Outmoded Economic Theory Still Distorts Antitrust Doctrine, 88 Notre Dame L. Rev. 1291 (2013).

15.  At this point one might be tempted to conclude that changed economic theory alone accounted for the reversal of Schwinn.  Certainly such a change was necessary.  However, it was not sufficient.  After all, Bork's work had been in the public domain for over a decade.  As noted above, the Topco defendants had expressly contended that the challenged restraints were ancillary and might produce redeeming virtues because they could encourage members of the venture to invest sufficient resources in promotion, invoking Bork's 1966 article.  But of course the Court had rejected that argument, reasoning that the autonomy of individual traders was of paramount concern, regardless of the potential favorable impact of such restraints on interbrand competition.  As noted above, Judge Browning had invoked Topco to support his view that Schwinn rested upon a strong concern for the autonomy of traders.   

The Sylvania Court expressly rejected Judge Browning's argument, however.  According to the Court:

"Competitive economies have social, political as well as economic advantages, but an antitrust policy divorced from market considerations would lack any objective benchmarks.  As Mr. Justice Brandeis reminded us: 'Every agreement concerning trade, every regulation of trade, restrains.  To bind, to restrain, is of their very essence.'"

Sylvania, 433 U.S. at 53, n. 21 (quoting Chicago Board of Trade v. United States, 246 U.S. 231, 238 (1918)).

16.  Of course, the Sherman Act had remained unchanged since 1967, when the Court announced Schwinn.   But the composition of the Court had changed considerably.  Chief Justice Warren and Justices Douglas, Fortas, Clark and Black, who were members of Schwinn's 5-2 majority, had left the Court, as had Justice Harlan.  Chief Justice Burger, and Justices Marshall, Rehnquist, Powell, Blackmun and Stevens had since joined the Court.  All but Marshall had been appointed by Republican Presidents. All but Marshall and Rehnquist, the latter of whom had recused himself, joined the majority opinion overruling Schwinn.  These five justices apparently embraced a different normative conception of the Sherman Act than those who had joined Schwinn, Topco and Albrecht, for instance.

17.  Like all decisions, no matter how momentous, Sylvania left several questions open.  Indeed, the Court qualified its holding in two important respects.  For instance, the Court purported to distinguish the non-price restraints before it from horizontal restraints such as those condemned in Topco.  The Court also distinguished non-price vertical restraints from minimum resale price maintenance, purporting at least to reaffirm the per se rule against the latter.  According to Professor Gavil, Justice Powell had to grant such concessions to retain five votes for his majority opinion.  Shortly after the decision, however, contemporary commentators wondered if these distinctions would survive future cases.  For instance, if the propensity of a restraint to overcome a market failure and induce promotion qualified as a redeeming virtue in the vertical context, there was no apparent reason to reject a similar conclusion simply because a restraint is, like so many beneficial restraints, horizontal.  See Martin Louis,  Restraints Ancillary to Joint Ventures and Licensing Agreements: Do Seally and Topco Logically Survive Sylvania and Broadcast Music?. 66 Virginia L. Rev. 897 (1980).  Only time would tell whether whether the Court would take Sylvania's rationale to its logical conclusions in other doctrinal contexts.  

Happy Birthday to United States v. Arnold Schwinn & Co., 388 U.S. 365 (1967)!

     

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.

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))

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.

Stay tuned for "the rest of the story."