Three Antitrust Bills Are Among First Introduced in New Senate Session

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

Senator Herb Kohl (D, Wis.), chairman of the Judiciary Committee's Antitrust, Competition Policy and Consumer Rights Subcommittee, on January 25 introduced three pieces of legislation that would impact the antitrust laws. Each of the measures has been reintroduced in the 112th Congress, after failing to pass in earlier legislative sessions.

Resale Price Fixing

Senator Kohl introduced a bill to restore the rule of per se illegality for minimum resale price fixing. The proposed “Discount Pricing Consumer Protection Act” (S. 75) would reinstate a rule that was overturned by a 5-4 decision of the U.S. Supreme Court in Leegin Creative Leather Products, Inc. v. PSKS, Inc. (2007-1 Trade Cases ¶75,753). Under Leegin, resale price fixing agreements must be judged under the rule of reason.

The measure is identical to legislation introduced in the last two Congresses. It would amend Sec. 1 of the Sherman Act by adding after the first sentence the following:

“Any contract, combination, conspiracy or agreement setting a minimum price below which a product or service cannot be sold by a retailer, wholesaler, or distributor shall violate this Act.”

Senator Kohl first introduced the legislation in 2007, not long after the Supreme Court decision was handed down. “The experience of the last three years since the Leegin decision has begun to confirm our fears regarding the dangers from permitting vertical price fixing,” Senator Kohl said introducing the measure.

“Pay-for-Delay” Pharmaceutical Settlements

Another antitrust measure introduced on January 25 by Senator Kohl is the proposed “Preserve Access to Affordable Generics Act.” The bill (S. 27) is aimed at so-called “pay-for-delay” agreements between brand name and generic drug companies that delay entry of low-cost generic competition.

Under the proposal, agreements under which brand-name drug companies compensate generic drug companies to delay the entry of generic drugs to the market, a practice known as an “exclusion payment settlement,” would be presumed illegal. The FTC would have the authority to challenge such an agreement as a violation of Sec. 5 of the FTC Act, and the drug companies would have an opportunity to convince a judge why the agreement was not anticompetitive.

If an agreement is found illegal, the FTC could assess civil penalties up to three times the profits gained by the drug companies. The current legislation includes changes made by the Judiciary Committee when it approved similar legislation in the 111th Congress.

Railroad Antitrust Exemption

The proposed “Railroad Antitrust Enforcement Act of 2011” (S. 49) would repeal the antitrust exemption enjoyed by freight railroads. The legislation is identical to a bill that was unanimously approved by the Judiciary Committee in the last Congress. That measure was
never voted on by the full Senate.

“Consolidation in the railroad industry in recent years has resulted in only four Class I railroads providing nearly 90 percent of the Nation's freight rail transportation, as measured by revenue,” according to Senator Kohl. “The ill-effects of railroad industry consolidation are exemplified in the case of ‘captive shippers’—industries served by only one railroad. Over the past several years, these captive shippers have faced spiking rail rates.”

The measure would bring railroad mergers and acquisitions under the purview of the Clayton Act, allowing the federal government, state attorneys general, and private parties to file suit to enjoin anticompetitive mergers and acquisitions. Moreover, it would eliminate the exemption that prevents FTC's scrutiny of railroad common carriers and the antitrust exemption for railroad collective ratemaking.

FTC Revises Thresholds for Merger Filings, Interlocking Directorates

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

The FTC has announced its annual revisions to the thresholds for notifying the antitrust agencies of a proposed acquisition and merger pursuant to the report-and-wait requirements of the Hart-Scott-Rodino (HSR) Act.

The thresholds, which were increased based on the change in the Gross National Product (GNP), will become effective February 24, 2011.

Disclosure Requirements

Pursuant to the HSR Act, plans for large acquisitions and mergers must be disclosed to the Department of Justice and the FTC to enable the federal antitrust enforcement authorities to examine their competitive effects and have an opportunity to challenge them under the antitrust laws prior to consummation. Only the transactions that exceed the jurisdictional thresholds need to be reported on the Notification and Report Form.

However, in light of the recent increase in the number of federal enforcement actions challenging consummated mergers, it must be understood that the antitrust agencies can challenge a merger or acquisition that does not meet the HSR thresholds.

Under the revised thresholds, acquisitions that result in an acquirer holding an aggregate total amount of the voting securities and assets of the acquired party meeting or exceeding $263.8 million will be reportable (up from the current $253.7 million), unless otherwise exempted.

“Size of Person” Test

No transaction resulting in an acquiring person holding $66 million or less (up from $63.4 million or less) of assets or voting securities of an acquired person will need to be reported. The reportability of transactions falling between these boundaries is based on the “size of person” test.

Under the “size of person” test, transactions valued at $66 million or more but less than $263.8 million will be reportable if one party has sales or assets in excess of $131.9 million and the other $13.2 million (up from $126.9 million and $12.7 million, respectively).

Filing Fees

Along with notifying the agencies, parties must pay premerger filing fees. The fees are based on the size of the transaction. Under the revised thresholds, a $45,000 filing fee will be required for reportable transactions valued at less than $131.9 million (up from $126.9 million); a $125,000 filing fee will be required for reportable transactions valued at least $131.9 million but less than $659.5 million (up from $634.4 million); and a $280,000 filing fee will be assessed on the largest transactions.

Interlocking Directorates

The FTC has also released its annual recalculation of profits and sales thresholds applicable in determining whether an individual can serve as an officer or director of two or more competing corporations. Under Sec. 8 of the Clayton Act, the FTC is required to recalculate the figures annually based on changes in the GNP.

Under the new threshold amounts, effective January 25, 2011, interlocking management is prohibited if each of the companies has capital, surplus, and undivided profits in excess of $26,867,000 and the competitive sales of each corporation exceed $2,686,700. These figures are up from last year’s thresholds—$25,841,000 for Clayton Act, Section 8(a)(1), and $2,584,100 for Clayton Act, Section 8(a)(2)(A).

The FTC notice appears here at 76 Federal Register 4349, January 25, 2011.

Light Cigarette Purchasers’ Consumer Class Action Allowed to Proceed

This posting was written by Jody Coultas, Editor of CCH State Unfair Trade Practices Law.

A class of light cigarette purchasers could pursue Minnesota consumer protection claims against Marlboro Light manufacturer Philip Morris based on allegedly deceptive business practices and false advertising, according to a Minnesota appellate court.

The cigarette purchasers sought to recoup money they spent on Marlboro Lights under the Minnesota consumer protection statutes and to represent a class of Minnesota residents that purchased the cigarettes between 1972 and November 2004.

Light cigarettes were marketed as having less tar and nicotine than regular cigarettes and were less likely to cause lung cancer.

Benefit to Public

Minnesota allows a private person injured by a violation of a Minnesota consumer protection statute to bring a civil action and recover damages, together with costs and disbursements including attorney’s fees and other equitable relief. However, the statute only allows claims that are shown to benefit the public.

Because Philip Morris made the allegedly deceptive statements to the public at large for a long period of time, the cigarette purchasers’ claim met the benefit of the public requirement.

Philip Morris argued that the claims should be dismissed because any benefit to the public that the case could possibly confer was already distributed to the public.

The Minnesota Attorney General had already pursued the same claims based on the same alleged deceptive business practices and obtained a permanent injunction against Philip Morris. Thus, the public had already been benefited, according to Philip Morris.

Private Suits After Attorney General

However, the court was unwilling to narrow the Minnesota Duties of the Attorney General statute to prohibit consumers from bringing private suits after the Attorney General. The statute allows private citizens to recover damages in addition to other remedies available by law, including the injunction the Attorney General was awarded in the previous case.

Consumers may meet the public benefit requirement even after the government acts to address the same misrepresentations.

Finally, the court rejected Philip Morris’ argument that the consumer protection claims were barred by the Tobacco Settlement release signed after the Attorney General received the injunction. Because the purchasers were not agents or representatives of the state, they were not barred from bringing the claims.

The decision is Curtis v. Altria Group, Inc., Minn. App. Ct., CCH State Unfair Trade Practices Law ¶32,180.

Further information regarding CCH State Unfair Trade Practices Law is available here.

New York Fails to Enjoin Mattress Maker’s Restrictions on Discounting

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

The State of New York was not entitled to an order enjoining mattress manufacturer Tempur-Pedic International, Inc. from restricting discounting by its authorized retailers, a New York state court has ruled.

The New York Attorney General alleged that Tempur-Pedic violated New York General Business Law Sec. 369-a, which renders minimum resale price agreements unenforceable.

These alleged violations, according to the state, constituted repeated and persistent illegal and fraudulent conduct in violation of New York Executive Law Sec. 63(12), which permits the state attorney general to seek an order enjoining such acts.

Dictating Reseller Prices

The state's investigation into Tempur-Pedic's retail pricing policies began after the attorney general received a letter in February 2007 from an unidentified customer stating that—while shopping for a Tempur-Pedic mattress—a number of stores had informed him that Tempur-Pedic dictates the resellers' prices for its mattresses and does not allow discounts. The letter stated, “[t]his sounds like illegal price fixing to me.”

It did not, however, sound like illegal price fixing to the court.

The state failed to allege an illegal act or repeated or persistent fraud, the court held. Under General Business Law Sec. 369-a, contracts for resale price restraints were unenforceable and not actionable, but they were not illegal. In addition, the pricing restraints did not amount to fraudulent conduct that deceived retailers or consumers.

The court rejected the attorney general's allegations that the company “misleads retailers into believing that restraints on discounting are enforceable, thus ensuring compliance to its demands” and that customers were deceived into believing that the retailer cannot discount the defending manufacturer's products, when retailers did have that right under the law.

The state also unsuccessfully argued that it had the power to enjoin the mattress maker's price restraints as unenforceable contracts under Executive Law Sec. 63(12). The court ruled that no contract provision to restrain discounting was established.

Contract to Adhere to Minimum Prices

Without demonstrating, by some evidence, that a contract to adhere to suggested minimum resale prices or prohibit discounting existed, the attorney general failed to plead all of the elements required to show a violation of General Business Law Sec. 369-a.

The evidence presented by the attorney general failed to demonstrate that the interactions between Tempur-Pedic and its retailers amounted to a meeting of the minds or consisted of harassment, threats to harm business, or concerted acts between the manufacturer and its retailers to harass other noncompliant retailers.

Unilateral Refusal to Deal

Tempur-Pedic had informed retailers that it would suspend shipments to an account if it discovered that the account was substantially deviating from suggested retail prices and that the policy was the manufacturer's unilateral decision and not negotiable.

While there were a number of instances in which Tempur-Pedic was communicating with its retailers regarding compliance with its set minimum prices, the communications did not demonstrate coercive tactics or threats to achieve compliance, in the court's view. Moreover, the manufacturer never ceased doing business with a New York retailer due to the retailer's refusal or failure to sell the manufacturer's products at recommended or suggested retail prices.

Advertising Restrictions

Tempur-Pedic’s Retail Partner Obligations and Advertising Policies (RPOAP) also was not found to violate General Business Law Sec. 369-a. The RPOAP restrained the retailers from advertising certain coupons, rebates, and promotional items; however, it was not a contract to restrain discounting, only advertising of discounting.

The January 14 decision is People of the State of New York v. Tempur-Pedic International, Inc., N.Y. Sup. Ct., 2011-1 Trade Cases ¶77,311.

Injunction Preserves McDonald’s Franchises Pending Trial of Renewal Claims

This posting was written by Pete Reap, Editor of CCH Business Franchise Guide.

A franchisee of several McDonald’s restaurants was reasonably likely to succeed on the merits of his claim that the franchisor had agreed to renew his three franchises with fewer than five years remaining on the agreements, a California trial court has decided. Moreover, the balance of the harms tipped strongly in favor of a preliminary injunction allowing the franchisee to continue operating the three McDonald’s franchises pending a full adjudication on his claims. Accordingly, the franchisee’s request for a preliminary injunction was granted.

A concurrent request by McDonald’s for a preliminary injunction to prevent the franchisee’s “unauthorized use” of its trademarks at the three restaurants was denied.

Offer to Extend Franchises

Shortly after purchasing seven existing restaurants from another franchisee (including the three at issue), the franchisee alleged that McDonald’s had made a written offer to extend the agreements for the three restaurants for a 20-year term and that the franchisee had mailed McDonald’s an acceptance.

A McDonald’s employee admitted that she sent a letter offering a new 20-year term for one of the franchises, but testified that she never received a response. She further alleged that she left a voicemail with the franchisee about the offer and sent a follow-up letter after the offer expired, but never received any reply.

At trial, a jury could interpret the assignment agreement by which the franchisee acquired the seven additional franchises in accordance with a broader understanding between the parties under which McDonald’s had agreed to grant the franchisee franchise extensions for those that were due to expire soon, the court determined.

In fact, the evidence indicated it would have been "extraordinary, harsh and unjust" if the franchisee had been expected to invest the $10.5 million that he invested in the acquired franchises only to have several of them expire without extension within five years.

While acknowledging that some evidence could be considered as supporting either side, the court found a reasonable likelihood that the trier of fact would accept the franchisee’s view of the evidence.

Balance of Harms

The franchisor argued that allowing the franchisor to continue operating the franchises after expiration of the franchise agreements would be “potentially damaging” to its business model, goodwill, and trademarks. However, there was no showing that the McDonald’s brand was suffering from the franchisee’s operations. The franchisee had a long history of protecting the brand and had no interest in damaging it at this point.

In contrast, there was a real possibility of serious and possibly catastrophic results for the franchisee if the three franchises were turned over to McDonald’s. Thus, the balance of harms clearly favored the franchisee, the court ruled.

The decision is Husain v. McDonald’s Corp., Superior Court, Marin County, California, CCH Business Franchise Guide ¶14,530.

California Class Certified in Suit Over Dell Price Advertising

This posting was written by William Zale, Editor of CCH Advertising Law Guide.

In a suit against Dell Inc. under California consumer protection laws, a class was certified consisting of all citizens of the State of California who on or after March 23, 2003 purchased Dell-branded products advertised with a “Slash-Thru” price—a discount from a former sales price—via the Home & Home Office segment of Dell's website, the federal district court in San Jose has ruled.

Reliance

A key question was whether class members' reliance on Dell's allegedly false representations was susceptible to common proof.

In California, “a presumption, or at least an inference, of reliance arises wherever there is a showing that a misrepresentation was material,” under the California Supreme Court's 2009 decision In re: Tobacco II Cases (CCH Advertising Law Guide ¶63,423).

There was no dispute that the alleged misrepresentations were communicated to all class members, because the representations were made at the point of sale as part of a standardized online purchasing process, the court observed.

Dell's marketing expert contended that while some purchasers might attach importance to a discount off Dell's list price, others would base their decision on wholly unrelated factors. But, under California law, the purchasers did not need to establish that each and every class member based his or her decision on the represented discounts.

The purchasers' common evidence that the representations were material satisfied California's reliance presumption, as well as the federal class action requirement that issues of law and fact common to class members predominate over individual issues, the court determined.

Exclusions from Class

The court excluded from the class purchasers exposed only to Dell's starting “Starting Price” promotions and purchasers through the Small and Medium Business (SMB) segment of Dell's website.

The two named plaintiffs' exposure to alleged misrepresentations regarding a former sales price were not typical of the purchases made after Dell changed to “Starting Price” promotions in mid-2007, the court found. The named plaintiffs failed to satisfy the class action typicality requirement with respect to the later purchases.

As to purchases made through Dell's SMB segment, a purchaser of a large number of computers for a business, or even the purchaser of a single $20,000 commercial server, was unlikely to have a substantially similar purchasing experience as the purchaser of a single laptop for personal use.

It would be difficult to make the same inference of reliance regarding the relevant offers and alleged falsity in the context of Dell's SMB segment, the court said.

The opinion in Brazil v. Dell Inc. will be reported at CCH Advertising Law Guide ¶64,130.

Choice of Florida Law Barred Minnesota Franchise Act Claims

This posting was written by Pete Reap, Editor of CCH Business Franchise Guide.

Minnesota Franchise Act claims asserted by a Florida franchisee of two hockey-training businesses and its principal against a Minnesota franchisor and several of its officers were barred by the valid and enforceable choice of Florida law provision in the parties’ agreements, the federal district court in St. Paul, Minnesota, has decided.

After hearing about the franchise opportunity, the corporate franchisee’s principal traveled to Minnesota and met with three officers of the franchisor there. Provided with a Uniform Franchise Offering Circular, the franchisee and principal entered into two franchises for territories in Florida. The franchisee opened only one of the franchises, closing it after one year due to financial losses.

The franchisee and principal filed suit, alleging that the franchisor violated the Minnesota Franchise Act by failing to register the franchise and making several false representations that induced them to purchase the franchises. As a result of these violations, the franchisee and principal lost more than $800,000.

Specifically, the plaintiffs alleged that, contrary to the franchisor’s representations:

(1) The franchises did not generate anywhere near the gross total sales that the franchisor claimed they could;

(2) It was imperative that a franchise be located in or near a hockey rink;

(3) It was highly unlikely that all of the hockey facilities of the franchisor were financially successful;

(4) The owner of the franchise needed to have significant hockey experience to operate profitably; and

(5) The franchisor did not experience the growth that had been represented or have an established business plan for running hockey facilities.

Waiver of Rights

The franchisee and principal argued that, despite the choice of law provision, the franchisor was liable for violations under the Minnesota Franchise Act (MFA) because Minnesota law did not permit the waiver of any rights secured by the Act.

However, the statute’s anti-waiver provision prohibited the waiver of rights secured by the MFA through a choice of law provisions only if the waiver purported to bind (1) a person who was a Minnesota resident (or Minnesota corporation) at the time the that person or organization acquired a franchise or (2) a person (regardless of residence) who was acquiring a franchise that would operate in Minnesota.

In this case, the principal was not a resident of Minnesota, the franchisee was not was not organized or incorporated in Minnesota, and the franchises at issue were to be operated in Florida, not Minnesota, the court found. Accordingly, the Minnesota Franchise Act’s anti-waiver provision did not void the parties’ choice of law provision.

Although the statutory anti-waiver provision was to be construed broadly, it was also to be construed in favor of protecting Minnesota franchisees, the court observed.

Fraud, negligent misrepresentation, and Florida Franchise Act claims brought by the franchisee and its principal withstood a motion for dismissal. The court held that the issues could not be decided at such an early stage of litigation.

The January 10 decision is Hockey Enterprises, Inc. v. Total Hockey Worldwide, LLC, CCH Business Franchise Guide ¶14,531.

Snapple Purchasers’ “All Natural” Claims Meet Fraud Pleading Standards

This posting was written by William Zale, Editor of CCH Advertising Law Guide.

Purchasers of Snapple drink products pleaded with particularity that “all natural” labeling of beverages containing high fructose corn syrup (HFCS) was deceptive and fraudulent under California consumer protection laws, the federal district court in Sacramento has ruled.

The purchasers' broader allegations regarding unspecified “commercial advertisements” and “other promotional materials” were dismissed.

Labeling Claims

The purchasers alleged that between March 4, 2005 and March 4, 2009, Snapple used “All Natural” and other similar terms in labeling its drink products. The purchasers submitted examples of the labels from bottles of each of the sixty drink products, all of which contain the term “All Natural” or “100% Natural.”

The purchasers alleged that this labeling deceived consumers because the drink products contained HFCS, which they asserted is not a natural product. The purchasers further alleged that if they had not been deceived by the labels on the products, they would not have purchased the products, but would have purchased alternative drink products.

These allegations satisfied the heightened standard for specifying the who, what, where, and how of fraud, under Rule 9(b) of the Federal Rules of Civil Procedure, the court held.

Advertisements, Promotional Materials

The purchasers' allegations regarding unspecified “commercial advertisements” and “other promotional materials” were dismissed because they failed to (1) identify any specific advertisements or promotional materials; (2) allege when plaintiffs were exposed to each advertisements or materials; or (3) explain how such advertisements or materials were false or misleading, according to the court.

The January 6 opinion in Von Koenig v. Snapple Beverage Corp. will be reported at CCH Advertising Law Guide ¶64,116.

Antitrust Division, FCC Conditionally Approve Comcast/NBC Universal Joint Venture

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

The Department of Justice Antitrust Division and the Federal Communications Commission yesterday conditionally approved a joint venture between Comcast Corp. and NBC Universal Inc., a subsidiary of General Electric Co.

The joint venture, which was announced in December 2009, combines Comcast–the nation’s largest cable operator and Internet service provider–and NBC Universal’s cable networks, filmed entertainment, and television programming, including the NBC broadcast network. It will be managed and 51 percent owned by Comcast, with GE holding 49 percent ownership.

Antitrust Concerns

Comcast’s control of the NBC Universal programming raised antitrust concerns, since Comcast’s rivals could face difficulties obtaining access to valuable content now controlled by the joint venture.

The Antitrust Division and five state attorneys general filed a civil antitrust lawsuit in the federal district court in Washington, D.C., alleging that the transaction would allow Comcast to limit competition from its cable, satellite, telephone, and online competitors.

At the same time, a proposed consent decree was filed that, if approved by the court, would resolve the competition concerns of the U.S. Department of Justice, as well as California, Florida, Missouri, Texas, and Washington.

Proposed Consent Decree

According to the Department of Justice, the proposed consent decree and an FCC order require the joint venture to make available to online video distributors (OVDs), like Netflix, the same package of broadcast and cable channels that it sells to traditional video programming distributors. In addition, the joint venture must offer an OVD broadcast, cable, and film content that is similar to, or better than, the content the distributor receives from any of the joint venture’s programming peers.

The FCC order requires the joint venture to license NBC Universal content to Comcast’s cable, satellite, and telephone competitors.

In a press release, announcing the settlement, Christine Varney, Assistant Attorney General in charge of the U.S. Justice Department Antitrust Division, said that the Antitrust Division and FCC “consulted extensively to coordinate their reviews and create remedies that were both consistent and comprehensive.”

Programming Benefits

According to an FCC news release, the joint venture will increase local news coverage to viewers; expand children’s programming; enhance the diversity of programming available to Spanish-speaking viewers; offer broadband services to low-income Americans at reduced monthly prices; and provide high-speed broadband to schools, libraries and underserved communities, among other public benefits.

Text of the complaint, proposed final judgment, and stipulation and order appear on the Antitrust Division’s website.

Further details regarding the conditional approval appear here on the Wolters Kluwer Law & Business AntitrustConnect blog.

Merged Health Insurers Did Not Illegally Collude on Pharmacy Rates

This posting was written by Darius Sturmer, Editor of CCH Trade Regulation Reporter.

Now-merged health insurers UnitedHealth Group and PacifiCare did not illegally conspire to depress the rate of reimbursement paid to the nation's largest institutional pharmacy, Omnicare, Inc., for prescription drugs it provided to senior citizens under the Medicare Part D plan, the U.S. Court of Appeals in Chicago has ruled.

UnitedHealth and PacifiCare—both sponsors of the Medicare Part D plan—began merger talks while each was developing an individual Part D plan proposal, and finalized their merger shortly before Plan D's 2006 launch.

According to Omnicare, the insurers conspired to coordinate their negotiations with it while their merger was pending, with UnitedHealth encouraging PacifiCare to use PacifiCare's in-house pharmacy benefits manager (PBM) "as a stalking horse to obtain the best service and contracts."

PacifiCare eventually entered into a contract with Omnicare that had terms significantly less favorable to the pharmacy than UnitedHealth's contract. Then, shortly after the merger became final, UnitedHealth concocted allegedly pretextual reasons to exit its own contract with Omnicare and promptly joined PacifiCare's. Omnicare contended that this course of conduct reflected a buyer's cartel that was per se violative of the Sherman Act.

Anticompetitive Agreement?

The appellate court agreed with the trial court, however, that the evidence on record in the case did not create a genuine issue of material fact as to the existence of an anticompetitive agreement between the insurers.

A granting of summary judgment against Omnicare's federal and Kentucky antitrust claims was therefore affirmed, as was the denial of Omnicare's motion for partial summary judgment on the issue of the insurers' affirmative defenses.

Though Omnicare produced an "extraordinary amount of evidence" to prove the existence of an illegal agreement between UnitedHealth and PacifiCare, it was ambiguous evidence that was at least as consistent with permissible independent action by the insurers as it was with an unlawful agreement, the court stated.

The merger agreement by its own terms, which restricted the ability of PacifiCare to enter into certain contracts without approval of UnitedHealth before the merger was completed, did not establish the existence of a conspiracy in restraint of trade.

The bargaining strategy adopted by PacifiCare, which ultimately resulted in the better deal with the pharmacy, was not shown to be economically irrational in the absence of a conspiracy, the court added.

Pre-Merger Communications

The communications that took place between the insurers prior to the completion of their merger also did not create substantial evidence from which a jury could find the existence of a conspiracy, in the court's view.

In particular, the pricing information they disclosed to each other was not so competitively sensitive that it was inappropriate to disclose before the signing of the merger agreement. Rather, this information exchange was a necessary part of the due diligence process in a merger and appeared to have been conducted in a reasonably sensitive manner, the court observed.

Inference of Independent Action

Even viewing the evidence all together, it still did not tend to negate the reasonable inference of independent action, the court explained. Without sufficient support for a conspiratorial information exchange, Omnicare's claims detailing how the insurers put that information to use was less plausible as well.

The conspiracy theory was further impugned when all of the alleged acts comprising the conspiracy were mapped sequentially and superimposed on a chronological timeline, the court noted. For example, a strategic options memo that was purportedly a blueprint for the insurer's scheme was not drafted until the alleged collusion was well underway, after UnitedHealth already had a contract with Omnicare and before the pharmacy took the initiative to reopen negotiations with PacifiCare.

Moreover, it was difficult to reconcile the theory of an affirmative, ongoing conspiracy to use the PBM as a stalking horse alongside evidence showing that the very target of that conspiracy was the party that made overtures toward it, the court concluded.

The January 10 decision is Omnicare, Inc. v. UnitedHealth Group, Inc., 2011-1 Trade Cases ¶77,304.

Cosmetics Company Settles California Vertical Price Fixing Charges

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

Cosmetics company Bioelements, Inc. has agreed to settle a complaint brought by the State of California, alleging that the company engaged in vertical price fixing in per se violation of the California Cartwright Act.

The state alleged that Bioelements had entered into dozens of contracts with other companies that required them to sell Bioelements’ products online for at least as much as the retail prices prescribed by Bioelements.

Under a consent decree signed by a state court judge on January 12, Bioelements agreed to refrain from fixing resale prices for its merchandise, to inform distributors and retailers that it will not enforce the challenged contracts, and to pay a total of $51,000 in civil penalties and attorney fees.

State Ban of Vertical Price Fixing

In a January 14 statement, the California Attorney General’s office said that the settlement “is one of the first applications of California’s strict, pro-consumer antitrust law banning vertical price-fixing in the wake of a controversial 2007 U.S. Supreme Court decision that weakened federal law in this area.”

In 2007, the U.S. Supreme Court in Leegin Creative Leather Products v. PSKS, Inc. (2007-1 Trade Cases ¶75,753) overruled the long-standing per se prohibition on resale price maintenance under the Sherman Act and held that resale price maintenance was instead subject to a more lenient standard, the rule of reason.

Previous Settlement

Bioelements is not the first cosmetics company to face vertical price fixing allegations from the State of California in recent years. Last February, DermaQuest, Inc. agreed under the terms of a consent decree to settle charges that it entered into distribution agreements with distributors and retailers containing resale price maintenance components, including prohibitions on pricing below suggested retail prices (2010-1 Trade Cases ¶76,922).

Bioelement is an Illinois corporation with its physical headquarters in Colorado. The company’s founder and president is domiciled in California. In its complaint, California also alleged that the company regularly sells and delivers cosmetics in the state. The complaint points to dozens of contracts between Bioelements and third party sellers.

Further information regarding the settlement appears here on the California Attorney General’s website.

The final judgment in People of the State of California v. Bioelements, Inc., Case No. 10011659, will appear at 2011-1 Trade Cases ¶77,306.

FTC’s Light Bulb Complaint Fails to Meet Fraud Pleading Standards

This posting was written by William Zale, Editor of CCH Advertising Law Guide.

The Federal Trade Commission failed to satisfy the fraud pleading standards of Rule 9(b) of the Federal Rules of Civil Procedure in a complaint alleging that a light bulb manufacturer and its principals misrepresented the light output and life expectancy of the company’s Light Emitting Diode (LED) bulbs, the federal district court in Santa Ana, California has ruled.

The court rejected the FTC's contention that Rule 9(b) did not apply to actions for violation of Sec. 5 of the Federal Trade Commission Act.

The FTC alleged that the manufacturer's two sole shareholders distributed promotional materials that made specific representations about the watt equivalency, lumen output, and life spans of their LED lamps; that these representations were false or unsubstantiated; and that the principals knew or should known knew or should have known that their conduct was unfair or deceptive.

The claim sounded in fraud because it alleged a unified course of fraudulent conduct and relied entirely on that course of conduct as the basis of the claim, the court held. Precedents applying Rule 9(b) to claims of negligent misrepresentation and violation of California consumer protection statutes were persuasive, the court found.

The FTC did not argue that the complaint met Rule 9(b)'s requirements for pleading the who, what, when, where, and how of the alleged course of conduct. The complaint did not differentiate between conduct of the company and its two principals and failed to explain when or where the alleged misrepresentations took place, the court noted.

Leave to replead was granted.

The decision in Federal Trade Commission v. Lights of America, Inc. will be reported at CCH Advertising Law Guide ¶64,117.

Canada Enacts Anti-Spam, Phishing, Spyware Legislation

This posting was written by Thomas A. Long, Editor of CCH Privacy Law in Marketing.

New Canadian anti-spam law legislation was approved by Parliament and received Royal Assent on December 15, 2010. The “Fighting Internet and Wireless Spam Act” (Statutes of Canada 2010, c. 23; Bill C-28) prohibits the sending of commercial electronic messages without the prior consent of the recipient. The legislation also addresses threats from other types of unsolicited electronic contact, including identity theft, phishing, spyware, viruses, and botnets.

The law grants a right of civil action to businesses and consumers targeted by the perpetrators of such activities. It will come into force on a day or days to be fixed by order of the Governor in Council.

Spam

Along with the prior consent requirement, the legislation provides that commercial e-mail messages must:

(1) Identify the person who sent the message and the person on whose behalf it is sent,

(2) Provide accurate contact information for these parties, and

(3) Set out an unsubscribe mechanism as outlined in the legislation.

The prohibition on spam does not apply to messages that facilitate, complete, or confirm a commercial transaction that has already been agreed to by the recipient, or that provides warranty, product recall, safety, or security information about a product, good, or service that the recipient has used or purchased.

Phishing

The same consent requirement for spam also applies to phishing messages. Phishing is described as e-mail that is sent from what appears to be an organization the recipient knows, such as a bank, requiring the recipient to send back personal information or confirm the information via a link.

Alterations of Transmissions

The legislation prohibits certain activities regarding electronic communications between two parties that have been intercepted. Such transmissions may not be altered so that the message is sent or copied anywhere other than where the sender thinks it is going.

All alterations to the transmission data require the express consent of the sender, with the ability to withdraw that consent at will. Service providers are exempt from this requirement, because they sometimes need to alter transmission data for technical reasons.

Unauthorized Software

The statute provides that no one may, in the course of a commercial activity, install or cause to be installed a computer program on any other person’s computer system, nor may anyone use any installed program to cause an electronic message to be sent from another person’s computer, without the owner’s express consent. This provision is aimed particularly at the surreptitious installation of spyware and malware.

Enforcement and Penalties

The law designates the Canadian Radio-television and Telecommunications Commission as the main regulatory agency responsible for pursuing administrative penalties against violators. The CRTC is given investigative powers by the statute, including the power to require production of documents.

The maximum penalty for an individual is $1 million and the maximum penalty for a corporation or other organization is $10 million. These penalties are to be imposed per violation.

The law also amends the Personal Information Protection and Electronic Documents Act (CCH Privacy Law in Marketing ¶42,200) to expand the Privacy Commissioner’s discretion and permit the Office of the Privacy Commissioner to take measures against the unauthorized collection of personal information through hacking or illicit trading of lists of electronic addresses.

In addition, the law amends the Competition Act, giving the Competition Bureau and the Commissioner of Competition a role in investigating and enforcing the new anti-spam provisions. Under the anti-spam legislation, the Competition Act’s existing regime on misleading and deceptive practices has been expanded to include online activity.

Private Right of Action

Persons affected by violations are able to bring a private action for actual damages. Courts may also award statutory damages of $200 for each violation, up to a maximum of $1 million per day.

Text of the legislation will appear in CCH Privacy Law in Marketing. More information on the law is available here at the Canadian Parliament’s website.

Paper Purchasers' Price Fixing Claims Rejected

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

The federal district court in Bridgeport, Connecticut, has rejected price fixing claims brought by direct purchasers of commercial grade paper used for printing catalogues and magazines against paper company Stora Enso.

The complaining direct purchasers failed to create a genuine issue of material fact that an agreement between Stora Enso and rival UPM-Kymmene Corp. (UPM) affected the prices charged for publication paper in the United States. Summary judgment was granted in favor of Stora Enso.

Justice Department Investigation

The purchasers brought suit shortly after the Department of Justice made public that it was investigating the publication paper industry in 2004. In 2006, a federal grand jury in Connecticut issued a one-count indictment charging Stora Enso North America Corp. and other unnamed co-conspirators with price fixing from August 2002 to June 2003. Charges were not brought against UPM, which had entered into a full immunity agreement with the Justice Department.

The case against Stora Enso proceeded to trial in July 2007. At trial, a UPM executive testified about conversations with a Stora Enso executive. The jury ultimately acquitted Stora Enso (See U.S. No. 4855, ¶45,106).

Private Suit

In the private direct purchaser litigation, Stora Enso moved for summary judgment on the ground that the plaintiffs failed to proffer any evidence, direct or circumstantial, that Stora Enso and UPM, through their executives, agreed to engage in an illegal price fixing conspiracy.

The direct purchasers offered the criminal trial testimony of the UPM executive as direct evidence. However, the testimony could not reasonably be interpreted as direct evidence or proof of an agreement to raise, fix, or stabilize future prices of publication paper.

The testimony could be characterized as an exchange of information that each entity had already independently decided to follow price increase announcements, the court explained.

The court also determined that the circumstantial evidence offered by the purchasers was not enough to overcome Stora Enso's motion for summary judgment.

Parallel Price Increases, Capacity Reduction

Three industry-wide, parallel price increases and a capacity reduction were insufficient to demonstrate a conspiracy, the court held. In order to establish a conspiracy, the complaining purchasers had to come forward with additional facts that tended to exclude the possibility that the paper companies acted independently, in their own self-interest, when engaging in the parallel conduct.

The susceptibility of the market to illegal collusion and suspect communications between paper industry executives did not, without more, exclude the possibility of independent action. The complaining purchasers’ evidence did not tend to exclude the possibility that Stora Enso acted in accordance with independent, permissible business justification when following a rival’s price increase, the court decided.

The decision is In Re: Publication Paper Antitrust Litigation, 2010-2 Trade Cases ¶77,293.

States Urge High Court to Take Up “Pay-for-Delay” Drug Patent Case

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

Attorneys general from 32 states have filed a friend-of-the-court brief with the U.S. Supreme Court, urging the Court to accept for review a case that seeks to end reverse-payment or "pay-for-delay" settlement agreements. Under these patent litigation settlements, a drug company pays competitors not to market generic versions of its brand-name drug.

The states contend that they "need guidance as to the legality of reverse payment agreements that clearly eliminate generic competition and impact our States’ budgets and citizens."

Direct purchasers of the antibiotic ciprofloxacin hydrochloride (Cipro)—including large drug wholesalers, pharmacies, unions and health care plans—have asked the U.S. Supreme Court to review a decision of the U.S. Court of Appeals in New York City (2010-1 Trade Cases ¶76,989), rejecting their antitrust challenge to settlements in a patent infringement lawsuit involving Cipro.

The direct purchasers had sued drug makers Bayer Corporation, Barr Laboratories, and others, alleging that the exclusion payment agreement in the patent settlements violated the antitrust laws. Bayer allegedly paid its competitors $400 million in exchange for agreements not to market generic versions of Cipro, which is used to prevent and treat a variety of bacterial infections.

The Second Circuit rejected the purchasers' claims, after determining that it was bound by an earlier decision—Joblove v. Barr Labs., Inc. (In re Tamoxifen Citrate Antitrust Litig.), 2006-2 Trade Cases ¶75,382. In Tamoxifen, a divided court held that a reverse payment settlement of a patent lawsuit involving a drug used to treat breast cancer did not violate the antitrust laws.

Under Tamoxifen, a settlement agreement did not exceed the scope of the patent and was valid where:

(1) There was no restriction on marketing noninfringing products;

(2) A generic version of the branded drug would necessarily infringe the branded firm’s patent; and

(3) The agreement did not bar other generic manufacturers from challenging the patent.

In their petition, the drug purchasers asked whether, absent patent fraud or sham litigation, a brand drug maker’s substantial payment to a competing generic drug maker to forgo judicial testing of the patent and restrict entry is per se lawful under the Sherman Act.

The states contend that the Cipro decision, by "allowing courts to conclusively presume that patents are valid and infringed renders most, if not all, reverse payment agreements per se legal." The states reject the standard as too lax.

The petition is Louisiana Wholesale Drug Co., Inc. v. Bayer AG, Dkt. 10-762. California Attorney General Kamala D. Harris is the lead on the amicus brief.

“Truth in Caller ID Act” Signed by President Obama

This posting was written by Thomas A. Long, Editor of CCH Privacy Law in Marketing.

A law that amends the Telephone Consumer Protection Act to prohibit the transmission of misleading or inaccurate caller identification information with the intent to defraud, cause harm, or wrongfully obtain anything of value was signed by President Obama on December 22, 2010.

The “Truth in Caller ID Act of 2009” (Public Law No. 111-331, Senate Bill 30) is intended to combat “spoofing,” which occurs when a telephone caller alters the number or other information that appears on a recipient’s caller ID to conceal his or her identity.

Transmissions are exempted if they are made in connection with authorized activities of law enforcement agencies or a court order specifically authorizing the use of caller ID manipulation.

The law calls for the Federal Communications Commission to prescribe implementing regulations no later than six months after enactment.

Further details will appear in an upcoming issue of CCH Privacy Law in Marketing.

Federal/State Antitrust Cooperation Continued in 2010

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

In 2010, the states joined with the federal antitrust agencies to challenge anticompetitive conduct in some of the year's most high profile antitrust enforcement actions.

Restrictive Credit Card Rules

A total of 20 states have now joined the Department of Justice Antitrust Division in challenging the allegedly restrictive rules of the three largest credit and charge card transaction networks in the United States. The Department of Justice and seven states originally filed their civil antitrust suit against Visa, MasterCard and American Express in October 2010. The complaint was amended in December to add the additional states. Visa and MasterCard have entered into proposed settlements; however, American Express has announced its intention to defend itself in court.

Acquisitions and Mergers

Illinois, Michigan, and Wisconsin also joined forces with the U.S. Department of Justice in an action against Dean Foods Company—the nation’s largest dairy processor—to undo the company's 2009 acquisition of Dean Foods and Foremost Farms USA's Consumer Products Division. The case is ongoing.

In other merger news, Ohio Attorney General Richard Cordray, co-chair of the Antitrust Committee of the National Association of Attorneys General, announced in September plans to open a preliminary review of the combination of Southwest Airlines and AirTran Airlines.

Health Care

The State of Michigan and the U.S. Justice Department filed suit in October against Blue Cross Blue Shield of Michigan, the largest provider of commercial health insurance in Michigan, over its use of “most favored nation” (MFN) clauses in contracts with hospitals across the state. The suit alleges that Blue Cross’s contracting practices violated Sec. 1 of the Sherman Act and Sec. 2 of the Michigan Antitrust Reform Act.

Also in the health care area, the State of Nevada reached a settlement with Universal Health Services, one of the nation’s largest hospital management companies, over its proposed acquisition of Psychiatric Solutions, Inc. Under a final judgment resolving the state's antitrust concerns, Universal Health Services was required to divest two local psychiatric hospitals, which also had to be divested under a separate FTC consent order.

Price Fixing

In 2010, the states resolved a number of price fixing actions. In September, a $25 million multi-state settlement involving an alleged price fixing conspiracy in the vitamins industry was announced. The suit, brought in 2009, asserted that 12 vitamin manufacturers had schemed to inflate the prices of 16 vitamins, causing government health care programs to overpay for those vitamins. Resolution of a long-running price fixing action brought by 33 states was announced in June. Six of the world’s top manufacturers of dynamic random access memory (DRAM) computer chips agreed to a $173 million settlement. The proposed settlement would resolve both of these litigations, as well as lawsuits by private plaintiffs

Antitrust Division Active in Health Care, Financial Sectors in 2010

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

With the nation focused on government efforts to overhaul the health care and financial services sectors in 2010, it is not surprising that two of the Department of Justice Antitrust Division's most notable enforcement actions last year were in these industries.

In October, the U.S. Justice Department and the Michigan Attorney General filed a civil action in the federal district court in Detroit against Blue Cross Blue Shield of Michigan, the largest provider of commercial health insurance in Michigan, over its use of “most favored nation” clauses in contracts with hospitals across the state.

Also in October, the U.S. Justice Department and seven states filed a civil antitrust suit in the federal district court in Brooklyn, New York, against the three largest credit and charge card transaction networks in the United States, challenging rules that allegedly restrict price competition at the point of sale.

MasterCard and Visa agreed to settle the charges under the terms of a proposed consent decree; however, American Express announced that it had no intention of settling the case.

The government’s investigation into anticompetitive and fraudulent conduct in the municipal bond industry continued in 2010 as well. Among the most recent developments in the investigation, the Justice Department announced in December that Bank of America agreed to pay a total of $137.3 million in restitution to federal and state agencies for its participation in a conspiracy to rig bids in the municipal bond derivatives market. The restitution was a condition of the bank’s admission into the Justice Department’s antitrust corporate leniency program.

Employee Recruiting, Agriculture

Jobs were also a major issue for Americans in 2010, and the Department of Justice took action to prohibit a number of high-tech companies from conspiring to restrict employee recruiting. In September, the Justice Department announced a settlement with six firms that allegedly agreed not to cold call any employee at the other company, a practice which prevented the companies from directly soliciting each other’s employees. In late December, a seventh company agreed under a proposed U.S. consent decree to refrain from engaging in similar practices.

The livelihood of farmers, ranchers, and other participants in the agricultural industry were considered at a series of workshops exploring competition issues in agriculture. The workshops, which were announced in August 2009 and held throughout 2010, included Department of Justice and Department of Agriculture leadership.

Merger Enforcement, Review

As at the FTC, the issuance of the revised joint Horizontal Merger Guidelines (CCH Trade Regulation Reporter ¶13,100) in August was among the major 2010 merger review and enforcement developments for the Antitrust Division. In addition, a number of high profile mergers were reviewed by the Justice Department in 2010.

In January 2010, the Antitrust Division approved the Ticketmaster/Live Nation acquisition, subject to structural and behavioral remedies. Another merger challenge that was filed at the start of the year remains ongoing. Last January, the Antitrust Division, along with state attorneys general from Illinois, Michigan and Wisconsin, challenged Dean Foods Company's April 2009 acquisition of Dean Foods and Foremost Farms USA's Consumer Products Division.

In August, the Justice Department approved the proposed merger of UAL Corporation, the parent of United Airlines, after the parties agreed to transfer slots at Newark Airport to Southwest Airlines. Now pending before the agency is Southwest's proposed acquisition of low-cost rival AirTran.

The Antitrust Division is also currently reviewing the proposed acquisition of U.S. global media and entertainment giant NBC Universal by Comcast Corporation. Regulatory approval of the Comcast-NBC combination was anticipated in January 2011.

Issuance of New Merger Guidelines Highlighted FTC's Accomplishments in 2010

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

The FTC’s efforts to substantially revise the Horizontal Merger Guidelines for the first time since 1992 were among the agency’s major accomplishments of 2010.

Working with the Department of Justice Antitrust Division, the FTC issued new joint guidelines in August (CCH Trade Regulation Reporter ¶13,100). The issuance of the guidelines marked the culmination of a process that began in September 2009.

Merger Enforcement Actions

Last year also saw a number of notable merger enforcement actions brought by the Commission. The agency resolved more than a dozen merger challenges in 2010 through consent decrees. Among these was an administrative challenge to Dun & Bradstreet’s consummated acquisition of Quality Educational Data, its nearest rival in the education marketing business.

The FTC's focus on consummated mergers was evidenced by another administrative complaint issued in November. The agency challenged Laboratory Corporation of America’s already-completed acquisition of rival clinical laboratory testing company Westcliff Medical Laboratories, Inc. An administrative trial is set for May 2011.

Before the year ended, the Commission ordered complete divestiture in another administrative action involving a consummated merger. In December, the Commission announced that Polypore International, Inc. must divest assets of a rival manufacturer of battery components acquired in 2008.

The FTC's decision not to take action against Google with respect to the search engine's acquisition of the mobile advertising company AdMob was also a notable development. The Commission unanimously closed its investigation in May after determining that Apple was in a position to nullify any anticompetitive effects of the merger.

The agency also suffered a tough loss in a federal district court challenge to an acquisition in the pharmaceuticals industry in 2010. The federal district court in Minneapolis rejected an action brought by the agency along with the State of Minnesota against global pharmaceutical company Lundbeck, Inc., challenging its predecessor’s acquisition of drugs used to treat premature infants with a heart condition known as patent ductus arteriosus (PDA) (2010-2 Trade Cases ¶77,160). In October 2010, the FTC and State of Minnesota appealed the decision to the U.S. Court of Appeals in St. Louis.

Non-Merger Enforcement Efforts

Also in the pharmaceutical sector, the FTC continued its efforts to target “pay-for-delay” drug patent settlements in 2010. FTC Chair Jon Leibowitz has said that ending these settlements, under which a branded drug company compensates a generic competitor for not bringing its lower-cost drug to market for a certain period of time, is one of the agency's highest priorities.

Legislative efforts to address the conduct failed in 2010. However, the agency will likely weigh in again as private litigants seek U.S. Supreme Court review of a decision of the U.S. Court of Appeals in New York City (2010-1 Trade Cases ¶76,989) rejecting an antitrust challenge to a settlement in a patent infringement lawsuit involving the antibiotic ciprofloxacin hydrochloride (Cipro).

A number of other important non-merger enforcement efforts were highlights of 2010. The agency's August settlement with computer chip giant Intel Corporation after eight months of litigation over the company's alleged monopolistic conduct was one of the them. Last year, Transitions Optical, Inc., the maker of photochromic treatments that darken corrective lenses used in eyeglasses, also agreed to settle FTC charges that it used anticompetitive practices to maintain a monopoly.

Consumer Protection

On the consumer protection front, the FTC in 2010 continued to focus on deceptive practices aimed at financially-distressed consumers. It also proposed revised “green” marketing guides. As the year came to a close, the staff of the agency threw their support behind the implementation of a “do-not-track” mechanism for Internet users that would provide them with a method to opt-out from having their online activity tracked by data-gathering firms.

Iowa May Tax Royalties to Out-of-State Franchisor Having No Physical Presence in State

This posting was written by John W. Arden.

The State of Iowa could impose corporate income taxes on royalties paid by Iowa franchisees to Louisville-based KFC, which owned no restaurant properties within Iowa and had no employees within the state, according to the Supreme Court of Iowa.

In 2001, the Iowa Department of Revenue issued an assessment of more than $284,000 for KFC’s unpaid corporate income taxes, penalties, and interest for 1997, 1998, and 1999. KFC filed a protest of the assessment, contending that the royalty income was not subject to taxation by Iowa because it was a foreign corporation that had no physical presence within the state. Such taxation would violate the Commerce Clause and the Iowa tax code, according to KFC.

An administrative law judge disagreed with KFC, holding:

(1) that physical presence is not required to tax corporate income,

(2) that KFC had a sufficient nexus with Iowa to support the tax assessment, and

(3) that the Iowa statute requiring “situs in this state” did not require physical situs, but merely required Iowa to be the place where a right is held to be located in law.

The director of the Department of Revue affirmed the administrative law judge, noting that several states had held that an economic presence satisfied the “substantial nexus” requirement for corporate income tax purposes.

On appeal, the state district court affirmed, finding that “physical presence” was not required under the Commerce Clause and that the income derived from the use of KFC’s intellectual property was taxable under Iowa law.

Dormant Commerce Clause

On review, the state supreme court explained that physical presence “in the narrow sense does not appear as an important factor in cases involving state income taxation.”

However, the U.S. Supreme Court has endorsed the requirement of physical presence in the area of state sales and use taxes, as held in the 1992 decision Quill Corp. v. North Dakota (504 U.S. 298).

Nevertheless, the Iowa high court argued that—in addressing due process questions—the U.S. Supreme Court has eviscerated the formalistic physical presence test in favor of a flexible multifactor minimum contacts test. It maintained that such analysis should extend to Commerce Clause analysis.

Since Quill, the U.S. Supreme Court has “generally avoided Commerce Clause cases involving the authority of states to impose taxes other than sales and use taxes on out-of-state entities with or without ‘physical presence,’” according to the Iowa court.

Geoffrey Case

The court found support for its position in Geoffrey, Inc. v. S.C. Tax Commission (CCH Business Franchise ¶10,319). In Geoffrey, the South Carolina Supreme Court held that state income taxes could be imposed on out-of-state franchisors who earned income from franchisee activities within the state based on the notion that the franchisor’s intangible property had acquired a “business situs” when used by local franchisees.

In making its decision, the South Carolina Supreme Court concluded that the franchisor’s physical presence in the state was not required. It held that “any corporation that regularly exploits the markets of a state should be subject to its jurisdiction to impose an income tax even though not physically present.”

This decision, which was denied review by the U.S. Supreme Court in 1993, has been cited in many state courts considering whether the licensing of intangible property (such as trademarks and business methods) provides sufficient nexus for the imposition of state income tax. These state courts tend to limit Quill to the context of sales and use taxes, the court noted.

In attempting to determine how the U.S. Supreme Court would rule on this case, the Iowa high court held that the dormant Commerce Clause would not be offended by the imposition of state income tax on royalties paid by KFC’s Iowa franchisees. It based its ruling on findings that:

(1) Franchisees' use of the franchisor’s intangible property within Iowa to produce the royalty income was the functional equivalent of “physical presence” under Quill; and

(2) The Court would not have extended the “physical presence” test beyond its “established moorings” in Quill to prevent a state from imposing an income tax based on revenue generated from intangibles within the taxing jurisdiction in light of subsequent developments in the law.

The December 30, 2010 decision is KFC Corp. v. Iowa Department of Revenue. The 40-page opinion will appear in CCH Business Franchise Guide.