Supreme Court Overturns Dr. Miles, Per Se Scrutiny of Vertical Price Restraints

This posting was written by Jeffrey May, editor of CCH Trade Regulation Reporter.

The U.S. Supreme Court, in a five-to-four decision, overturned a 96-year-old precedent applying the per se rule to vertical price fixing—Dr. Miles Medical Co. v. John D. Park & Sons Co. (220 U.S. 373 (1911))—and held that vertical agreements between a manufacturer and its distributor to set minimum resale prices were to be judged under rule of reason analysis.

A decision of the U.S. Court of Appeals in New Orleans (2006-1 Trade Cases ¶75,166) applying the per se rule to uphold an award of $3,975,000 to a Texas retailer that was terminated by the manufacturer of Brighton leather goods and fashion accessories for discounting was reversed, and the case was remanded.

Factual Background

The manufacturer, which sold its Brighton brand primarily through small boutiques and specialty stores, announced a retail pricing policy in 1997, under which it refused to sell to retailers that discounted Brighton goods below suggested prices. A year after instituting the pricing policy, the manufacturer introduced a marketing strategy known as the "Heart Store Program." Under that program, the manufacturer offered incentives to retailers in exchange for their pledge, among other things, to sell at the manufacturer's suggested prices.

The complaining retailer heavily promoted the Brighton line, and Brighton eventually became the store's most important brand, accounting for 40 to 50 percent of its profits. The manufacturer terminated the complaining retailer in 2002, however, when it discovered the retailer had been marking down Brighton's entire line by 20 percent

At trial, the retailer argued that the "Heart Store Program," among other things, demonstrated an agreement to fix resale prices. Relying on the per se rule established by Dr. Miles, the court excluded the manufacturer's expert testimony describing the procompetitive effects of its pricing policy. A jury returned a verdict in favor of the retailer.

On appeal, the manufacturer did not dispute that it had entered into vertical price fixing agreements with its retailers. Rather, it contended that the rule of reason should have applied to those agreements.

Rule of Reason Analysis

In a decision by Justice Anthony M. Kennedy, the Court held that vertical agreements between a manufacturer and its distributor to set minimum resale prices, such as the one at issue, were to be judged under rule of reason analysis because they could have procompetitive or anticompetitive effects.

Minimum resale price maintenance could stimulate interbrand competition—the competition among manufacturers selling different brands of the same type of product. On the other hand, it could lead to collusion among manufacturers or retailers or to a stifling of competition or innovation by dominant manufacturers or retailers.

Nevertheless, it could not be said that resale price maintenance was the type of conduct subject to the per se rule, i.e., conduct that always or almost always tended to restrict competition and decrease output.

The Court rejected the retailer's argument that the administrative convenience of the per se rule or the threat of higher prices resulting from vertical price restraints justified subjecting vertical price agreements to per se scrutiny. Rather, the economic dangers of resale price maintenance were to be taken into account in the rule of reason inquiry.

Careful Scrutiny

However, the Court provided some instruction on how to proceed. According to the Court, resale price maintenance should be subject to careful scrutiny if many competing manufacturers adopted the practice or if there were evidence retailers were the impetus for the restraint.

In addition, whether a dominant manufacturer or retailer could abuse resale price maintenance for anticompetitive purposes might be dependent upon the existence of market power. If a retailer lacked market power, manufacturers likely could sell their goods through rival retailers, the Court observed. If a manufacturer lacked market power, there was less likelihood it could use the practice to keep competitors away from distribution outlets, the Court explained.

Doctrine of Stare Decisis

The Court also decided that the doctrine of stare decisis did not compel continued adherence to the per se rule against vertical price restraints. The Court based its decision on the trend in the case law and suggested that it made little sense to condemn maintaining suggested retail prices though vertical price agreements as per se illegal when a manufacturer could accomplish the same goal through nonprice conduct that would be reviewed under rule of reason analysis.

"It is a flawed antitrust doctrine that serves the interests of lawyers—by creating legal distinctions that operate as traps for the unwary—more than the interests of consumers—by requiring manufacturers to choose second-best options to achieve sound business objectives," the Court explained.

Per Se Analysis Still Viable

The Court stated that "the rule of reason is the accepted standard for testing whether a practice restrains trade in violation of Sec. 1 of the Sherman Act." However, it reaffirmed the viability of the per se rule, noting that horizontal agreements among competitors to fix prices remain unlawful per se.

Dissent

According to a dissenting opinion by Justice Stephen G. Breyer, the majority did not “show new or changed conditions sufficient to warrant overruling a decision of such long standing.” The dissent also predicted that the effect of the decision was likely to “raise the price of goods at retail and create considerable legal turbulence as lower courts seek to develop workable principles.”

The text of the June 28, 2007, decision in Leegin Creative Leather Products, Inc. v. PSKS, Inc., No. 06-480, will appear at 2007-1 Trade Cases ¶75,753.