New Congress Can Reshape Antitrust Policy: Antitrust Organization

With new Democratic majorities in both Houses, the New Year presents Congress with an opportunity to reshape the direction of antitrust policy, according to a paper issued December 19 by the American Antitrust Institute (AAI). However, the White House’s veto potential and control over the enforcement agencies suggest that 2007 should be year “to build a record rather than to focus on the passage of new legislation.”

“An Antitrust Agenda for Congress in 2007,” written by AAI President Albert Foer, recommends that Congress hold hearings on antitrust policy and consider an economic summit or special study commission “designed to place antitrust within a national economic policy rather than as a microeconomic specialty.”

The Senate antitrust subcommittee will likely be able to hold about eight hearings (compared to approximately three last year). The House, lacking an antitrust subcommittee, will be able to conduct only “a handful of full committee hearings.” The paper suggested the following hearings topics:

Remedies against cartels. The Justice Department’s leniency program has been a great success and is being replicated around the world. It should be reviewed in a positive way. Important research has shown that sanctions against cartels were based on data substantially understating the magnitude of harm caused by the cartels. Moreover, the Class Action Fairness Act’s impact on class actions to recover cartel overcharges should be examined.

Enforcement of antimonopolization statutes. Congress should decide whether it wants Section 2 of the Sherman Act more vigorously enforced. The federal agencies have almost eliminated monopolization enforcement. Another issue is how effective the remedies in the Microsoft case have proven to be. The growth of “power buyers” (such as Wal-Mart), and the potential antitrust problems caused by such parties, should be studied.

Current merger policies. In light of the new merger wave, the effectiveness of current merger policies should be evaluated. Controversial mergers that have been approved (Whirlpool/Maytag, Wal-Mart/Amigo Supermarkets) should be reviewed, as well as mergers in the telecommunications and airline industries. “We are in an unprecedented period of merger non-enforcement by the agencies,” according to Foer, who pointed out that neither the FTC nor the Department of Justice has litigated a case in almost three years.

Intellectual property. “The misuse of the Intellectual Property laws at the expense of competition has become of increasing concern,” the agenda states. Hearing could “tease out” the difference of opinion between the DOJ (which tends to take a pro-property position) and the FTC (which has criticized the IP laws and institutions).

Petroleum industry. Congress could examine whether the FTC has adequately developed the case for antitrust intervention” in the refining portion of the petroleum industry.

Information to improve enforcement. Hearings could address how the FTC and DOJ can better obtain relevant data to assist in antitrust enforcement.

Text of the antitrust agenda is available on the AAI web site.

Antitrust Division Shows Increased Enforcement Activity in 2006

The year 2006 saw the Department of Justice Antitrust Division obtain its second highest amount of criminal fines in its history, experience a drastic increase in merger filings and challenges, implement an improved merger review process, pursue civil non-merger conduct, participate in a number of U.S. Supreme Court antitrust cases, and remain active in international enforcement and cooperation, according to an announcement issued December 21.

“The Division’s achievements reflect the hard work of its staff, who are committed to aggressive, yet balanced, antitrust enforcement,” said Thomas O. Barnett, Assistant Attorney General in charge of the Antitrust Division.

Cartel Enforcement

The Division continues to give the highest enforcement priority to challenging anticompetitive conduct by criminal cartels. For the fiscal year ending on September 30, 2006, the Division obtained criminal fines totaling more than $473,445, 000. This amount represented a 40 percent increase over the previous year. The Division filed 33 criminal cases, many involving multiple defendants. In fiscal year 2006, there were 5,383 jail days imposed for price fixing, bid rigging, obstruction, fraud, and related anticompetitive conduct.

Merger Enforcement

Premerger transaction filings under the Hart-Scott-Rodino Act increased 8.9 percent over fiscal year 2005 to 1860 filings. Ten merger enforcement actions were initiated, and another six transactions were restructured in response to Division investigations. The percentage in Hart-Scott-Rodino transactions resulting in a “second request” dropped from 1.5 percent to 1 percent, with the duration of the “second request” investigations continuing to decline.

Improved efficiency and transparency in reviewing mergers was attributed to the issuance of the DOJ/FTC joint Commentary on the Horizontal Merger Guidelines (CCH Trade Regulation Reporter ¶50,208) and the amendments to the 2001 Merger Review Process Initiative, which was announced December 15.

U.S. Supreme Court Advocacy

The Division assisted the Solicitor General in submitting the views of the United States as amicus curiae in several cases. In all three antitrust opinions handed down earlier this year, the Supreme Court reached the decision advocated by the United States: Texaco v. Dagher (applying the rule of reason to pricing decisions by joint venturers); Illinois Tool Works Inc. v. Independent Ink, Inc. (holding that market power is not presumed in a patented product for tying purposes); and Volvo Trucks North America, Inc. v. Reeder-Simco GMC, Inc. (clarifying standards for secondary-line price discrimination under the Robinson-Patman Act).

The Division also assisted in briefs filed in pending Supreme Court cases: Weyerhaeuser Co. v. Ross Simmons Hardwood Lumber Co. Inc. (the standard for predatory pricing claims); Bell Atlantic Corp. v. Twombly (pleading standards for antitrust conspiracy claims); and Credit Suisse First Boston Ltd. v. Billing (the standard for implying antitrust immunity to conduct in the securities industry).

International

The Division continues to be active on the international front by participating in international cooperative efforts in competition law, according to the announcement.

United Gets Tentative Antitrust Immunity for Alliances with Foreign Air Carriers

United Airlines and a number of its international Star Alliance partners received tentative approval on December 19 from the Department of Transportation(DOT) to add three carriers to their immunized alliance and to permit expanded cooperation between United and alliance member Air Canada.

The action, if made final, will provide the carriers with immunity from U.S. antitrust laws to the extent necessary to enable them to plan and coordinate services over their entire international route systems, as well as pave the way for implementation of the U.S.-Canada Open Skies air transport agreement.

The DOT tentatively decided to allow Swiss International Air Lines, LOT Polish Airlines, and TAP Air Portugal to join the alliance with antitrust immunity. It also would expand the current grant of immunity between United and Air Canada to all of their international operations. The European members of the Star Alliance with imunity are Austrian Airlines, Lufthansa German Airlines, and Scandanavian Airlines. All of the airlines will contune to be independent companies and retain their separate coporate and national identities.

In its December 19 show-cause order, the DOT tentatively concluded that the proposed alliance was in the public interest because the partners' increased ability to cooperate would allow them to provide consumers with additional service options, such as more nonstop flights, expanded code-sharing, and new online services. Interested parties were given 21 days to show why the tentative decision should not be made final, with replies due seven days afterward. After a review of these filings, the DOT will issue a final decision.

Purchaser of Janitorial Business Franchise Was “Employee”

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

The purchaser of a janitorial business franchise, whose relationship with a franchisor differed in key respects from the typical franchise relationship, was not an independent contractor or even a franchisee, but was an “employee” under the meaning of the Massachusetts unemployment compensation law, the Massachusetts Supreme Court has ruled. Thus, the franchisor, Coverall North America, Inc., was required to pay contributions for the purchaser’s reported earnings, pursuant to the unemployment insurance statute. A Massachusetts trial court’s ruling—upholding a determination by what was then the Massachusetts Division of Employment and Training’s Review Board—was affirmed.

BACKGROUND

In the “start-up phase” of a franchise relationship, Coverall typically provided new franchisees with extensive training. In addition, new franchisees were given an initial customer base and allowed to solicit prospective customers directly, according to the court. If a franchisee established a new customer, that customer was required to sign a contract with Coverall. Every month, Coverall directly billed all customers and paid its franchisees for the services rendered to those customers, taking deductions for finance charges, royalties, and management fees.

The claimant originally began working at a Massachusetts nursing home under the direction of another of Coverall’s franchisees. Shortly thereafter, the franchisee lost its account with the nursing home, although Coverall retained its contract with the home. The claimant then inquired into the possibility of becoming a franchise owner with Coverall in order to continue her position there and became a franchise owner. The claimant purchased a franchise from Coverall, paying the franchisor $3,800 in cash and agreeing to pay an additional $6,700 towards the cost of the franchise. The claimant was then given the nursing home’s account, which required her to work at the home for 25 hours each week and for which she would receive $1,485 per month, subject to deductions for management fees, royalties, and costs.

Pursuant to its usual practices, the franchisor negotiated the contract with the nursing home directly and billed it directly, without any involvement of the claimant. If the nursing home had a complaint about the claimant’s service, it would be submitted directly to the franchisor. The claimant lacked any of her own business cards and failed to solicit any new customers of her own, the court noted. Additionally, the claimant’s daily tasks were given to her by a representative of the nursing home who closely supervised both her work and her arrivals and departures. In addition, the claimant was supervised by one of the franchisor’s field consultants.

After a dispute arose over the amount of work assigned to the claimant and the lack of additional pay for additional duties, the claimant refused to perform additional tasks that were periodically assigned to her. An examiner from the Division of Employment and Training subsequently found that the franchisor “discharged” the claimant over this dispute and the claimant filed for unemployment benefits.

UNEMPLOYMENT LAW

In order to be exempted from the requirement of contributions to the unemployment compensation fund, an employer was required to establish under Massachusetts law that the individual providing services was an independent contractor. To meet that burden, the employer was required to show “that the services at issue are performed: (a) free from control or direction of the employing enterprise; (b) outside of the usual course of business, or outside of all the places of business, of the enterprise; and (c) as part of an independently established trade, occupation, profession, or business of the worker."

ANALYSIS AND DECISION

Coverall could not satisfy its burden of proving the third prong of the test because the claimant did not operate an independent business apart from Coverall, the court ruled. Therefore, it was not necessary to determine whether or not Coverall could satisfy the first two prongs of the test.

The parties’ agreement required the claimant to allow Coverall to negotiate contracts and pricing directly with clients, bill clients, and provide a daily cleaning plan to which the claimant was required to adhere, the court commented. Thus, the claimant was compelled to rely heavily on Coverall, the court decided.

In support of its conclusion that the claimant did not operate a business independent from Coverall, the Review Board found that the claimant cleaned only at locations specified by Coverall and was given a plan and directions by Coverall supervisors. The franchisor contended that the agency incorrectly focused on what the claimant actually did with her franchise instead of what she was capable of doing. Essentially, Coverall argued that, even though the claimant did not take advantage of the entrepreneurial opportunities afforded her by her agreement such as soliciting new customers and hiring employees, she was still an independent contractor by virtue of her capability to expand her business.

However, even if the claimant was capable of expanding her business, it was undisputed that the growth of her business inevitably expanded Coverall’s business, as each new client became a Coverall client, the court observed. Even though Coverall argued that the claimant was not compelled to depend on it because she had been in the cleaning business for six years prior to becoming a “franchise owner,” the claimant testified that her business subsequently ended once Coverall “discharged” her. Because the agency’s decision incorporated all of these facts, there was substantial evidence supporting its conclusion that the franchisor failed to establish that claimant’s business was independent of it under the third prong of the test, the court held.

Finally, although the Supreme Court specifically stated in a footnote that the claimant was not a franchisee, it added in another footnote that its conclusion did not reflect a determination concerning the nature of other Coverall contracts beyond the agreement at issue between the parties in the instant dispute.

The December 12, 2006 opinion in Coverall North America, Inc. v. Commissioner of the Division of Unemployment Assistance, will appear in a forthcoming issue of the CCH Business Franchise Guide.

FTC Extends Forbearance Policy for Prerecorded Telemarketing Calls

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

The FTC has extended its previously-announced forbearance policy in enforcement of the prohibition of prerecorded calls in the Telemarketing Sales Rule (16 CFR Part 310, CCH Trade Regulation Reporter ¶38,058). The policy had been set to expire January 2, 2007.

The Direct Marketing Association and three other organizations petitioned the government for an extension of the revocation date. In response, the Commission determined that the forbearance policy should remain in effect until the conclusion of proceedings on a proposed new safe harbor to the call-abandonment provision of the rule, which would have permitted telemarketers to deliver prerecorded messages to consumers with whom the seller had an “established business relationship.” As a result, telemarketers may continue to use prerecorded messages to consumers with whom the seller had “an established business relationship,” until the proceedings are completed.

In October, the FTC denied a request for creation of the new safe harbor. The agency instead proposed an amendment to the rule that would make explicit the prohibition of prerecorded calls that is now implicit in the rules “call abandonment” provisions. The amendment would explicitly prohibit sellers and telemarketers from delivering a pre-recorded message when the person answers the telemarketing call, except in the very limited circumstances permitted in the call-abandonment safe harbor or when a consumer has consented in writing to receive such calls. At that time, the Commission also announced the revocation of its policy of refraining from enforcement of the call-abandonment prohibition.

DOJ Attempts to Streamline Merger Review Process, Reduce Burdens

The Department of Justice Antitrust Division has amended its 2001 Merger Review Process Initiative in order to streamline its investigation process, improve efficiency, reduce costs, and lessen burdens on parties to transactions, according to the December 15 announcement by the Department of Justice.

The 2001 Merger Review Process Initiative was intended to help the Division identify critical legal, factual, and economic issues regarding proposed mergers more quickly; to facilitate more efficient and focused investigative discovery; and to provide an effective process for the evaluation of evidence.

The new amendments include a voluntary option enabling companies to reduce the duration and costs of merger investigations. The option would limit the document search required by a Division information request (known as a “second request”) to particular files and a targeted list of 30 employees whose files must be searched for responsive documents. This option will be conditioned on timing and procedural agreements that protect the Division’s ability to obtain appropriate discovery should it decide to challenge the deal in district court.

The Antitrust Division is also changing its model second request to reduce compliance burdens further by (1) reducing the default search period to two years prior to the date of the issuance of an information request and (2) limiting the volume of materials that companies must collect, review, and produce in response to a second request.

“The amendments to the Division’s already successful Merger Review Process Initiative are part of our ongoing efforts to reduce enforcement burdens, while at the same time preserve our ability to conduct thorough investigations and protect consumers from anticompetitive transactions,” said Thomas O. Barnett, Assistant Attorney General in charge of the Antitrust Division.

The 2001 initiative has resulted in an average decrease in the number of days that pass from the opening of a preliminary investigation to the early termination or closing of the investigation from 93 days to 57 days.

The amended initiative and a model second request appear on the Division’s web site.

Failure to Disclose Payment for Word-of-Mouth Marketing Can Violate FTC Act

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

A marketer could violate the Federal Trade Commission Act by paying a consumer to praise a product or service to others, if the consumer’s relationship with the marketer is undisclosed or otherwise unclear from the context, according to a Federal Trade Commission Staff Opinion Letter dated December 7.

The practice could be deceptive because those hearing the consumer’s favorable comments are likely to give them greater weight and credibility than would be the case if the marketer’s sponsorship were disclosed. The relationship between the “word-of-mouth” marketer and the endorser should be disclosed if consumers hearing the message would not reasonably expect the existence of the relationship, according to the FTC staff.

Because children and teens are more vulnerable to marketing messages than adults, the Commission would consider consumer expectations from the standpoint of an “ordinary child or teenager” in determining whether to launch an enforcement action in cases of marketing to children, the FTC staff added.

The staff letter was issued in response to a letter from Commercial Alert, a nonprofit marketing watchdog group, requesting that the FTC investigate companies that engage in “buzz marketing” and that the FTC issue new guidelines requiring disclosure of paid marketing relationships. FTC staff concluded that issuance of guidelines was unnecessary at this time and that the staff would determine on a case-by-case basis whether law enforcement action is appropriate. Members of the public were encouraged to submit information and recommend that the Commission take law enforcement action.

As an example of conduct viewed as improper, Commercial Alert’s letter referred to a 2002 Sony/Ericsson marketing campaign in which 60 trained actors reportedly were employed to prowl tourist attractions in New York and Seattle, behaving like tourists and asking passersby to take their pictures with a camera phone. In another example, Procter & Gamble reportedly assembled in 2004 a marketing task force of 250,000 teens compensated with coupons, product samples, and other items.

The FTC Staff Opinion Letter and the petitioning letter from Commercial Alert will be published in the December report of the CCH Advertising Law Guide.

Franchisor Barred from Making Unregistered Franchise Sales in California

This posting was written by Peter Reap, editor of CCH Business Franchise Guide.

A franchisor of edible fruit bouquet businesses was preliminarily enjoined from making further franchise sales in California until it registered a fully-compliant Uniform Franchise Offering Circular with the state.

The federal district court in Los Angeles found a likelihood that the franchisor violated the California Unfair Competition Law through its violations of California franchise laws and regulations. The franchisor, which did not oppose the motion for injunctive relief, was alleged to have (1) failed to disclose in its UFOC that there was a lawsuit pending in Connecticut against one of its principal; (2) misrepresented in its California franchise registration application that an independent auditor prepared the financial statements, and (3) offered to sell franchises in California before registering.

Although a franchise disclosure/registration law claim is usually brought by a franchisee or prospective franchisee, this action was maintained by a competing franchisor, who contended that the alleged violations caused it irreparable harm by giving the franchisor an unfair competitive advantage in the market for edible fruit bouquet business franchises.

The franchisor’s failure to disclose the litigation in Connecticut was material because the lawsuit involved allegations of deceptive practices and was premised on claims that representatives of the defending franchisor posed as prospective franchise purchasers in order to gain access to competitor’s proprietary information, the court held. A prospective purchaser of a franchise would consider information regarding the suit— and the defending franchisor’s alleged use of the competitor’s proprietary information to create a competing franchise system—important.

The financial statements that the franchisor submitted with its franchise registration application were not prepared by an independent auditor, as required by California Code of Regulations Title 10, Section 310.111.2(a), according to the court. Evidence showed that the accounting firm preparing the statements was run by the father of the franchisor’s principal and employed the principal for 10 years prior to his entering the franchise business. Furthermore, the defending franchisor was shown to have offered to sell franchises in California prior to completing the franchise registration process.

The decision is Edible Arrangements International, Inc. v. Notaris, U.S. District Court for the Central District of California, Case No. CV 06-5945 FMC (PJWx), filed October 19, 2006, CCH Business Franchise Guide ¶13,487.

Acquisition of Manufacturer, Rebranding Was Not Cause for Dealership Termination

A jury in the federal district court in Chicago has awarded $2.1 million to a construction equipment dealer whose dealership was terminated pursuant to the acquisition of its manufacturer and the rebranding of the acquired product line.

The dealer, FMS, Inc., sold Samsung construction equipment products, including excavators, in the State of Maine. In 1998, Volvo Construction Equipment of North America purchased Samsung and assumed its dealership agreement with FMS. In 1999, Volvo notified FMS that it would terminate its dealership as part of an initiative to rebrand the Samsung excavators as Volvo.

FMS and six other dealers filed suit in Arkansas state court in March 2000, alleging breach of contract and violation of various state franchise and trade practice laws. Eventually, the case was transferred to the federal district court in Chicago.

In January 2005, the parties filed cross motions for summary judgment on a claim that Volvo terminated the dealership without cause in violation of the Maine power equipment, machinery, and appliances dealer law. The court denied the motions and required the case to proceed to trial, since issues of fact existed about whether the rebranding constituted a discontinuation of the excavator product law—an enumerated cause for termination under the law (CCH Business Franchise Guide ¶13,011).

After a six-day trial, the jury found that the rebranding did not constitute a discontinuation of the excavator product line because there was no substantial change in the excavators. In a special verdict, the jury found that Volvo “had not discontinued the manufacture or distribution of the franchise goods,” that Volvo’s termination of the franchise relationship “proximately caused damages to FMS,” and that FMS was entitled to $2.1 million in damages.

Scott Korzenowski, counsel for FMS, said the jury verdict awarded the dealer every dollar it sought.

The case is FMS, Inc. v. Volvo Construction Equipment of North America, Inc., U.S. District Court for the Northern District of Illinois, Case No. 00 C 8143, November 30, 2006.

High Court to Consider Resale Price Maintenance, Implied Antitrust Immunity

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

The U.S. Supreme Court on December 7 agreed to review two plaintiff-friendly antitrust decisions. The Court will review an unpublished decision of the U.S. Court of Appeals in New Orleans (2006-1 Trade Cases ¶75,166) upholding a multi-million-dollar award to a retailer that was terminated by a manufacturer of women’s accessories for refusing to comply with the manufacturer’s resale pricing policy. Citing the High Court’s 1911 decision in Dr. Miles Medical Co. v. John D. Park & Sons Co. (220 U.S. 373), the appellate court said that it was bound by precedent to apply the per se rule to the agreement. The manufacturer calls on the Court to overturn the “anachronistic per se rule and to bring the law of resale price maintenance into step with the law governing other vertical restraints.” The case is Leegin Creative Leather Products, Inc. v. PSKS, Inc., Dkt. 06-480.

The Court also agreed to consider the appropriate standard for implying antitrust immunity in an action involving conduct in the securities industry. At issue is a decision of the U.S. Court of Appeals in New York City (2005-2 Trade Cases ¶74,943), holding that an antitrust action against the nation’s leading underwriters for engaging in anticompetitive conduct with respect to initial public offerings (IPOs) should not have been dismissed on implied immunity grounds. The U.S. Solicitor General had asked the U.S. Supreme Court to grant the petition by investment banks that underwrite IPOs to “resolve the continuing confusion in the lower courts about the proper manner in which to reconcile the antitrust laws and the securities laws.”

The underwriters asked the Court whether— in a private damages action under the antitrust laws challenging conduct that occurs in a highly regulated securities offering—the standard for implying antitrust immunity is the potential for conflict with the securities laws, or a specific expression of congressional intent to immunize such conduct and a showing that the Securities Exchange Commission (SEC) has power to compel the specific practice.

In its brief, the government contended that, although “the court of appeals failed to give adequate protection to collaborative conduct that is permitted under the securities laws, the district court and petitioners are also wrong in their view that all conduct connected with initial public offerings is impliedly immune from antitrust liability because the SEC exercises ‘pervasive’ regulatory authority over it.” The case is Credit Suisse First Boston Ltd., Dkt. 05-1157.

Arbitration Clause in Franchise Agreement Unconscionable Under California Law

This posting was written by Peter Reap, editor of CCH Business Franchise Guide.

In a long-awaited en banc decision, the U.S. Court of Appeals in San Francisco has ruled that an arbitration provision in a franchise agreement was both procedurally and substantively unconscionable under California law and was therefore unenforceable. A federal district court ruling that the provision was valid and enforceable (Business Franchise Guide 2002-2004 New Developments Transfer Binder ¶12,559) was reversed.

The arbitration provision at issue in the agreement between the Massachusetts franchisor and the California franchisee provided in part:

35.1 Arbitration. Any controversy or claim arising out of or relating to this Agreement, or any breach thereof, including, without limitation, any claim that this Agreement or any portion thereof is invalid, illegal, or otherwise voidable or void, shall be submitted to arbitration before and in accordance with the rules of the American Arbitration Association (AAA) or successor organization.

After two years of unprofitable operation, the franchisee unilaterally terminated the parties’ agreement. The franchisor sought arbitration of its claim for more than $80,000 in unpaid fees it claimed the franchisee owed. The franchisee then brought suit against the franchisor in a California state court (later removed to federal court by the franchisor), alleging violations of California franchise law, misrepresentation, and challenging the validity of the arbitration provision.

Validity for Court, Not Arbitrator, to Determine

The appellate court reached its conclusion that the provision was unenforceable after first determining that a court, not an arbitrator, was required to decide the issue of whether the arbitration provision in the parties’ agreement was valid and enforceable. In an earlier, now-withdrawn opinion (Business Franchise Guide 2004-2005 New Developments Transfer Binder ¶13,034), a three-judge panel of the appellate court determined that the unconscionability of the arbitration provision was for an arbitrator to decide. However, considering the issue en banc, the appellate court decided that the franchisee did not seek invalidation of the parties’ agreement as a whole on the grounds of unconscionability; instead, the franchisee challenged only the arbitration provision. In light of the recent ruling of the U.S. Supreme Court in Buckeye Check Cashing, Inc. v. Cardegna (126 S. Ct. 1204, 2006), a court was required to determine the provision’s enforceability.

The franchisee’s complaint made it “abundantly clear” that the franchisee challenged only the arbitration provision, according to the appellate court. The franchisee did not allege a single ground for invalidation of the entire agreement. Although the franchisee did contend that the provision was procedurally unconscionable, based in part on the fact that the entire agreement was a contract of adhesion, the franchisee did not allege that the entire agreement was invalid or seek any relief from the agreement as a whole. Indeed, the franchisee’s four other causes of action provided relief only if the agreement between the parties was a valid and binding one, the court observed.

Unconscionability

The federal district court erred when it “sidestepped the requisite procedural unconscionability analysis” under California law, finding it “nondispositive.” Under California law, the critical factor in procedural unconscionability was the manner in which the disputed provision was presented and negotiated, according to the appellate court. In the instant dispute, the franchisee was in a substantially weaker bargaining position than the franchisor. The franchisor drafted the franchise agreement, and presented it to the franchisee on a take-it-or-leave-it basis. Although the evidence of procedural unconscionability appeared minimal, it was sufficient to require an analysis of whether, under the sliding scale approach employed under California law in a weighing of procedural and substantive unconscionability, the provision was unconscionable.

Two particulars in the arbitration provision exhibited a lack of mutuality supporting a finding of substantive unconscionability, the appellate court ruled. First, the provision gave the franchisor access to a judicial forum to obtain provisional remedies for the protection of its intellectual property, while affording the franchisee only the arbitral forum to resolve her claims. Second, the designation of Boston as the arbitral forum was a location considerably more advantageous to the franchisor than to the franchisee.

The December 4, 2006 opinion in Nagrampa v. Mailcoups, Inc., is posted at the Ninth Circuit web site:

">http://www.ca9.uscourts.gov/ca9/newopinions.nsf/
C2FA43604F5CB31A8825723A005ACAC0/$file/0315955.pdf?openelement">

The decision will appear in a forthcoming issue of the CCH Business Franchise Guide.

High Court Considers Proper Standard in Predatory Buying Case

This posting was written by John Scorza, CCH Washington, D.C. Correspondent.

In oral arguments November 28, the U.S. Supreme Court considered the question of what standard a plaintiff alleging predatory buying must meet to prevail under Section 2 of the Sherman Act.

The case involves Ross-Simmons Hardwood Lumber Co., a pioneer in the alder lumber industry that went out of business in 2001, and lumber products giant Weyerhaeuser Co. Ross-Simmons sued Weyerhaeuser, claiming Weyerhaeuser purchased more logs than it needed at an inflated price in an effort to eliminate competition. Ross-Simmons prevailed in a jury trial of its monopolization and attempted monopolization claims and was awarded nearly $79 million in damages.

On appeal, the Ninth Circuit (2005-1 TRADE CASES ¶74,817), upheld the jury verdict, ruling that the standard for a predatory pricing claim articulated by the Supreme Court in Brooke Group Ltd. v. Brown & Williams Tobacco Corp. (1993-1 TRADE CASES ¶70,277) did not apply to a case that alleged “predatory bidding” in violation of Section 2 of the Sherman Act.

The Brooke Group decision maintained that a plaintiff asserting predatory pricing must prove that the defendant suffered a short-term loss from the pricing and had a dangerous probability of recouping its loss through “supracompetitive” pricing after the elimination of competition. The appeals court upheld instructions that allowed a jury to find a Section 2 violation based on factors such as “fairness” and “necessity.”

The issue before the Supreme Court revolves around the jury instructions. The jury was told it could find that an anticompetitive act occurred if Weyerhaeuser purchased more logs “than it needed” or paid a higher price “than necessary” to prevent competitors from obtaining the logs they needed at a fair price.

Representing Weyerhaeuser, Andrew J. Pincus said that the question was “whether the standards adopted in Brooke Group to determine whether a seller’s prices violate the antitrust laws because they are too low also should apply in assessing the claim that the buyer’s purchase prices are illegally high.”

Weyerhaeuser maintains that the proper standard is the stricter one established by the court in Brooke Group. A predatory pricing case, Brooke Group would require Ross-Simmons to show that Weyerhaeuser paid so much for the raw materials that (1) the price at which it sold its products did not cover its costs and (2) the company had a “dangerous probability” of recouping its losses. Weyerhaeuser claims the stricter standard is a much clearer test.

Chief Justice John G. Roberts Jr. appeared hesitant to apply the Brooke Group standard to this case. The alleged anticompetitive activity in Brooke Group was low pricing, which benefits consumers. But that situation was not present in this case, he said. “So isn’t that a reason not to think that we should apply to Brooke Group test to this situation?” he asked.

Pincus responded that when competition drives up the prices of logs, the sellers of those logs benefit. Consumers too may benefit, he said, because of the expectation that a buyer bidding more can make more efficient use of the product and generate more output, ultimately resulting in lower prices for consumers. Weyerhaeuser, he said, had achieved such efficiencies. Pincus noted that the court in past cases has said that “price competition generally, a free and open price competition, will produce lower prices and better goods and services.”

Arguing for the federal government, in support of Weyerhaeuser, Kannon K. Shanmugam urged the court to adopt the Brooke Group test. Shanmugam said a claim of predatory bidding is the “flip side” of a claim of predatory pricing, so the Brooke Group standard for predatory pricing claims should apply to predatory bidding claims as well.

On behalf of Ross-Simmons, Michael E. Haglund countered that the Brooke Group test is not the proper standard in predatory buying cases. It is not justified “because raising input prices, unlike cutting output prices, is moving prices in the wrong direction for consumers,” Haglund told the court.

While acknowledging that the jury instructions may not have been perfect, Haglund said “the instructions on the whole” provided sufficient guidance to the jury. To improve the instructions, Haglund suggested the following language: “Paid a higher price than necessary to move the log market to higher levels than otherwise would have prevailed in order to injure competition.”

The case is Weyerhaeuser Co. v. Ross-Simmons Hardwood Lumber Co. Inc., No. 05-381, cert. granted June 26, 2006. A transcript of the oral argument appears at:

http://www.supremecourtus.gov/oral_arguments/
argument_transcripts/05-381.pdf

Rest Easy, McDonald’s Isn’t Trying to Stop You from Making a Sandwich

A story about how McDonald’s Corp. is seeking a patent on the “method and apparatus for making a sandwich” seems to have caught the fancy of newspapers, blogs, and legal listservs in the U.S. and England.

The item has prompted overly-broad statements like “McDonald’s wants to own the right to how a sandwich is made” (U.K Metro) and “The next time you’re stacking a pastrami hero, better make sure McDonald’s isn’t watching—they’re [sic] trying to claim rights on how to make a sandwich” (The New York Post).

The Wall Street Journal’s “Law Blog” wasn’t above poking fun at McDonald’s U.S. and British patent application and its claims relating to the “simultaneous toasting of a bread component” and the insertion of condiments into the sandwich with a “sandwich delivery tool.”

Even members of the ABA Forum on Franchising’s listserv took the occasion to bemoan the expansion of “business method patents,” the examination backlog at the Patent and Trademark Office, and the lack of proper training of patent examiners.

This is all good fun, but a close reading of the Abstract of the 55-page patent application indicates that McDonald’s patent claims are not that unusual. The claimed invention relates to (1) “the pre-assembly of sandwich components and simultaneous preparation of different parts of the same sandwich” and (2) a sandwich assembly tool “useful in the preparation of a made-to-order sandwich.” The tool has one or two cavities for garnish. Under the claimed method, the “bread component” is placed over the tool, and the tool and bread component together are inverted to deposit the sandwich garnish onto the bread component. The strangely-shaped tool is described in great detail.

Methods for making a variety of sandwiches—from subs and deli-style sandwiches to “cocktail sandwiches” and hamburgers—are expressed in painstakingly-specific terms.

Despite media reports, McDonald’s is not intending to prevent anyone from using previous methods for making sandwiches, the franchisor told Metro. Such a patent would not retroactively apply to previous methods in any event.

“They might have a novel device, but it could be quite easy for someone to make a sandwich in a similar way without infringing their claims,” a spokesman for the British Patent Office pointed out.

Supreme Court Hears Arguments in Antitrust Pleading Case

This posting was written by Jeffrey May, editor of CCH Trade Regulation Reports, and John W. Arden.

The U.S. Supreme Court heard oral argument November 27 on the pleading requirements in an antitrust case. The Court is reviewing Bell Atlantic Corp. v. Twombley, a decision of the U.S. Court of Appeals in New York City (2005-2 TRADE CASES ¶74,951) that the customers of a telecommunications company did not have to plead so-called “plus factors” to sufficiently allege that telecommunications providers conspired to refrain from competing against one another. In vacating the dismissal of the conspiracy claim, the appeals court held that a heightened pleading standard should not have been applied.

The customers had brought a putative class action, alleging that the Incumbent Local Exchange Carriers—Bell Atlantic Corp., Bellsouth Corp., QWEST Communications International, Inc., SBS Communications, Inc., and Verizon Communications, Inc.—conspired to exclude Competitive Local Exchange Carriers and to refrain from competing against one another in their respective geographic markets for local telephone and high-speed Internet services.

Arguing for the petitioning telecommunications companies, Michael Kellogg of Kellogg, Huber, Hansen, Todd & Evans in Washington, D.C. told the court that it was “faced with the question of what a plaintiff needs to plead in order to state a claim and show an entitlement to relief under the antitrust laws.” Kellogg argued that an agreement could not be inferred from allegations of parallel conduct and that it was insufficient to “merely to recite a legal conclusion, and claim an entitlement to relief therefore.”

As a matter of substantive antitrust law, there is a “range of permissible inferences that can be drawn from parallel conduct,” he said. “And if all you have is parallel conduct that’s consistent, on one hand, with conspiracy, or on the other hand, with ordinary business judgment, you cannot draw an inference of the sort that the plaintiffs depend upon in this case.”

Assistant Attorney General Thomas O. Barnett of the Department of Justice, Antitrust Division, argued on behalf of the government in support of the petitioners. The antitrust chief said that a “fundamental concern of the United States is that the decision of the Second Circuit can be read to hold that a Section 1 Sherman Act complaint will survive a motion to dismiss merely by alleging parallel action or inaction in attaching the bare assertion of an agreement. Such a result fails to appreciate that parallel action or inaction is ubiquitous in our economy and often reflects beneficial competitive forces.”

During argument for the complaining customers by J. Douglas Richards of Milberg Weiss Bershad Hynes & Lerach LLP in New York City, Chief Justice Roberts asked whether there was any allegation of an agreement apart from the parallel conduct. Richards maintained that the “leading plus factor” is “action that would have been against the self-interest of the conspirators in the absence of a conspiracy.” In this case, the complaint alleges “that the conduct of not entering into one another’s territories and competing among the [Incumbent Local Exchange Carriers] as a [Competitive Local Exchange Carriers]” was contrary to the defendants’ self-interest. Justice Breyer suggested that the complaining customers’ interpretation of the antitrust pleading requirements could require a “major restructuring of the economy.”

Richards further contended that the defending telecommunications companies were expected to compete, in light of the Telecommunications Act of 1996. Their decision not to compete created an inference of conspiracy, he maintained. Justice Scalia responded by saying that, based on his past experience in the field of telecommunications, the customers’ case was very weak if it were based on what Congress expected to happen when it passed the Act.

A transcript of the oral arguments appears at:

http://www.supremecourtus.gov/oral_arguments/
argument_transcripts/05-1126.pdf

“Medspa” Explosion a Headache for Some Franchisees

This posting was written by Peter Reap, editor of the CCH Business Franchise Guide.

In the past three years, the number of “medspas” (businesses offering medical treatments in a spa environment) has more than tripled to about 1,500, according to Rhonda L. Rundle, writing in the Wall Street Journal. However, the fast-growing industry has turned into a financial and legal pain for some unsuspecting medspa franchisees

Medspas offer services such as laser hair removal and botox injections in an upscale, comfortable environment very different from a doctor’s office. Licensing rules vary, but many states do not specifically regulate medical facilities that provide relatively routine treatments.

Two years after opening his medspa franchise in St. Louis, Jeff Nebot, a franchisee of Sona Medspa International, Inc., thought he had struck gold when his business’ annual revenue hit $3 million. Soon thereafter, however, Nebot realized that his revenue lagged behind his payouts for marketing staff and franchise fees. The gold was gone for good when Mr. Nebot sold the assets of his business for only $2 last April, the Journal reports.

Nebot lays the bulk of the blame on his franchisor. He complains that the marketing, advertising, and support services provided by the franchisor in exchange for roughly one-fourth of his revenue were inadequate, forcing him to develop his own marketing. He also says that he was misled as to the efficacy of Sona’s laser hair removal treatments.

Several of Sona’s franchisees, though not Mr. Nebot, are currently in arbitration with the franchisor. The franchisees claim that the franchisor represented a complicated business as a “turnkey operation” and failed to provide adequate support.

Some franchisees of another franchisor—Radiance MedSpa Franchise Group, PLLC—have alleged that their franchisor overestimated revenue and underestimated initial start-up costs in its financial projections. According to the Journal, the president of Radiance, Charles L. Engelmann, recently acknowledged that some franchisees are attempting to get their money back, but also claimed that the number of Radiance businesses was expanding and none of them have closed.

While there is no official tracking of medspa businesses, interviews with industry consultants, franchisees, and others indicates numerous failures, according to Ms. Rungle. Medspas “are coming up like mushrooms and then they are gone,” states Hannelore Leavy, executive director of the International Medical Spa Association. Leavy says that many of the struggling businesses are affiliated with a franchise system that has a flawed business model, which may require that too much of a franchisee’s revenue to go for marketing, among other problems.

The regulatory environment for medspas is changing as states react to complaints about burns and other serious mishaps. In the wake of a recent law change in Florida, some medspas are required to spend an extra $60,000 a year to hire a dermatologist or plastic surgeon to oversee their operations.

Stricter enforcement of existing laws has also begun. In February 2005, the California Corporations Commissioner denied registration of a franchise offering of HealthWest, Inc., a California-based medspa franchisor with approximately 20 franchisees around the country. According to the agency, HealthWest had offered and sold unregistered franchises within California and had “falsely represented” that prospective franchisees could legally own a medspa in the state without a medical background.
http://www.corp.ca.gov/enf/info/dr/05pdf/HealthWest.pdf

Ms. Rungle’s article, “Medspa Boom Has Become A Bust for Some,” appears on page B1 of the Tuesday, November 21, 2006, Wall Street Journal.

Children’s Food Advertising Guidelines Getting Sweet and Sour Reactions

Imagine starting a program promoting the advertising of healthy food and beverage choices among children. Then attract a former director of the FTC Bureau of Consumer Protection to head up the development of the program. After months of study, convince 10 of the largest food and beverage companies to join the self-regulatory program. Sounds all good, right? Not necessarily, say food and consumer advocacy groups.

The new Children’s Food and Beverage Advertising Initiative, announced by the Council of Better Business Bureaus (CBBB) and the National Advertising Review Council (NARC) on November 15, has received decidedly mixed reviews from government and health advocacy goups.

The Initiative is designed to shift the mix of advertising to children to encourage healthier dietary choices and healthy lifestyles, according to the CBBB and the NARC. Ten companies, which account for more than two-thirds of food advertising to children, have publicly committed to follow the initiative’s core principles. These companies—which include McDonald’s, Kraft Foods, General Mills, and Coca-Cola—agreed to:

(1) Devote at least 50% of their advertising directed to children to promoting healthier dietary choices and/or to messages that encourage good nutrition or healthy lifestyles;

(2) Limit products shown in interactive games to healthier dietary choices or incorporate healthy lifestyle messages into the games;

(3) Refrain from advertising food or beverage products in elementary schools;

(4) Refrain from engaging in product placement in editorial and entertainment content; and

(5) Reduce the use of third-party licensed characters in advertising that does not meet the Initiative’s product or messaging criteria.

The Initiative resulted from a review of the Guidelines of the Children’s Advertising Review Unit (CARU), undertaken by NARC and led by Joan Z. (Jodie) Bernstein, former Director of the FTC Bureau of Consumer Protection. The review process brought together more than 40 leading children’s advertisers. In addition to the Initiative, the review produced a revision of the CARU Guidelines to cover (1) advertising that is “unfair” in addition to advertising that is misleading, (2) advertising that obscures the line between editorial content and (3) advertising messages in interactive games. http://www.cbbb.org/initiative/

The Initiative was welcomed by FTC Chairman Deborah Platt Majoras. “I am highly encouraged by the Council of Better Business Bureaus’ initiative on children’s food and beverage advertising, and I commend the Council for taking these important steps,” Majoras said. The new program “shows real promise and I hope will encourage more competition in developing and marketing healthier products that are attractive to kids and their parents.” http://www.ftc.gov/opa/2006/11/majorasstatement.htm


Others have not been so positive. “Any junk food advertiser who feared that a rewrite of the Children’s Advertising Review Unit’s voluntary guidelines would force a significant change in the way companies do business can rest easy,” said Michael F. Jacobson, executive director for the Center for Science in the Public Interest. “While the Council of Better Business Bureaus labored like an elephant, it came forth with a mouse.”

“The industry’s definition of ‘healthy’ includes sugary breakfast cereals, for instance,” he said in a statement posted on the health advocacy group’s website. “If a ‘healthy lifestyle message’ means that Ronald McDonald is pedaling a bike while peddling junk food, that message still does more harm than good. It’s a joke.”

Mr. Jacobson expressed hope that Congress will take a fresh look at the industry’s advertising practices. “In the meantime, junk food marketers should expect more lawsuits—not praise—from health advocates.” http://www.cspinet.org/new/200611141.html

In a November 17 news release, the group lauded the efforts of British regulators, who have recently prohibited junk-food marketers from advertising on programming aimed at kids under 16.

Commercial Alert, a consumer group, agreed with those sentiments. “Self-regulation is just another word for letting the fox regulate the chicken coop, which of course leads to dead chickens,” said Executive Director Gary Ruskin. “Self-regulation has been a key ingredient in the childhood obesity epidemic. It is the problem, not the solution. The childhood obesity epidemic will continue until Congress passes tough new laws against marketing to children. Self-regulation is no substitute.” http://www.commercialalert.org/news/news-releases/2006/11/
food-companies-launch-yet-another-phony-effort-against-childhood-obesity

Senator Tom Harkin (D, Iowa) took a stance somewhere between the FTC and the advocacy groups. “If employed successfully, this could be a good first step,” he said. “But the program leaves companies significant leeway to continue marketing unhealthy foods to kids. And, ultimately, the new initiative is only as good as the enforcement.”

While supporting the effort, Harkin encourage more companies to “go beyond the 50 percent benchmark and use all of their creativity, resources, and marketing practices to help improve the health of our nation’s children,” Harkin said. “Ultimately, Congress will examine this issue closely. As the Institute of Medicine urged in its report last year, government has a responsibility to foster the development and promotion of healthful diets and lifestyles for our kids.” http://harkin.senate.gov/news.cfm?id=265855

Web Publisher Not Liable for Discriminatory Housing Ads Posted by Third Party

This posting was written by Cheryl Montan, editor of CCH Guide to Computer Law.

Publishing company Craigslist was not liable for Fair Housing Act violations resulting from allegedly discriminatory advertisements posted on its website, the federal district court in Chicago has ruled. The Communications Decency Act operated to immunize the publisher from liability for content posted on its website by third parties. (Chicago Lawyers’ Committee for Civil Rights Under the Law, Inc. v. Craigslist, Case No. 06 C 0657, November 14, 2006).

The Chicago Lawyers' Committee for Civil Rights Under Law, Inc. (CLC), a public interest consortium of Chicago law firms, sought to hold Craigslist liable for discriminatory housing advertisements appearing on its website. Craigslist requested dismissal of the suit, arguing that, as an interactive computer service provider, the Communications Decency Act shielded it from liability for the third-party ads. Craigslist operates a website (accessible at “chicago.craigslist.org,” as well as other web addresses), that allows third-party users to post and read notices for, among other things, housing sale or rental opportunities. In a typical month, more than 10 million items of user-supplied information are posted on the Craigslist website.

The Fair Housing Act prohibits discrimination in the sale or rental of housing, including publishing and printing advertisements that discriminate or indicate a preference based on race, color, religion, sex, handicap, familial status, or national origin. 42 U.S.C. § 3604(c). http://www4.law.cornell.edu/uscode/html/uscode42/
usc_sec_42_00003604----000-.html

Courts have held that Section 3604(c) applies to a variety of media, including newspapers and print publishers. CLC contended that Internet publishers like Craigslist should be held to the same standard of liability as print publishers under the Fair Housing Act.

Craigslist asserted that the Communications Decency Act operated to immunize it from liability for content, including housing ads, posted on its website by third parties. The CDA provides that "[n]o provider . . . of an interactive computer service shall be treated as a publisher for information provided by another information content provider." 47 U.S.C. § 230(c)(1).

The court agreed with Craigslist. While the CDA does not grant immunity per se to website operators, it does prohibit causes of action based on the website operator’s status as a publisher. The CLC’s Fair Housing Act cause of action depended on Craigslist’s actions as a publisher of content provided by third parties. Thus, the court dismissed the complaint as barred by the CDA.

Culligan's New Franchise Agreement Reflects "True Partnership"

This posting was written by Peter Reap, editor of CCH Business Franchise Guide.

The new franchise agreement between Culligan International and its water-treatment franchisees could become a model for other franchise systems, according to an article by Richard Gibson in the November 13 issue of The Wall Street Journal. The new agreement features shared commitments, responsibilities, and rewards, a departure from many franchise agreements designed to give the franchisor firm control over the business, Mr. Gibson reports.

Under the revised terms, franchisees who previously had little clout – something common in many franchise systems – now must be consulted on critical changes to the brand and hold some veto power. In addition, the new agreements grant the franchisees exclusive territories, caps on wholesale costs, the right to select a qualified successor, and longer franchise terms of 20 years, among other changes.

The new agreement was negotiated after the private equity firm Clayton, Dubilier & Rice purchased the franchisor in 2004. According to the franchisees, the firm said it was prepared to consider a significantly revised agreement. The goal was to align interests and remove troublesome issues that had strained franchisee relationships with the previous owners. However, the initial draft submitted by the firm contained few of the franchisee’s suggestions.

The franchisee association of approximately 650 members called an emergency meeting in May 2005, during which the franchisees made a fateful decision, Mr. Gibson observes. If they could not persuade their new franchisor to make significant concessions, they would leave the franchise system en masse and found a rival water treatment company of their own. “When they realized we weren’t bluffing, they snapped around pretty fast,” says one of the franchisees involved in the negotiations.

Within a few days, both sides returned to the bargaining table, and “things got ironed out.” The resulting new agreement “reflects more of a true partnership, with shared decision-making, mutually supportive financial goals and, perhaps most importantly, mutual respect,” according to Mr. Gibson. Among the significant points:

-- The franchisor collects a royalty payment on every dollar of franchisee revenue. Previously, the company made money only on equipment sales.

-- The duration of the agreement is 20 years, twice the length of previous agreements.

-- Franchisees have a right to renew their agreements on then-current terms.

-- Franchises are required to be consulted on major changes to the business. They previously had almost no say in such matters.

-- Prices on current equipment are reduced and future equipment prices are capped.

- Except in connection with certain promotions, the franchisor will not advertise suggested retail prices without dealer approval.

-- Franchisees are now paid for all warranty work and receive a royalty on sales by the franchisor to large retailers.

-- The franchisor may no longer examine franchisees’ customer lists.

-- Franchisees are now granted exclusive territories for residential business.

-- Franchisees can now select a successor to their businesses, with the franchisor having no right of first refusal.

-- Franchisees are entitled to purchase as much as 10% of the franchisor’s privately held stock.

Susan P. Kezios, president of the American Franchisee Association, praised the agreement as “definitely a step in the right direction, on a number of levels.” One of them is that the franchisor has no right of first refusal on transferred franchises, she commented. Extending the duration of the agreements to 20 years has the similar effect of encouraging new franchisees looking for long-term investments, she noted. The full text of Mr. Gibson’s article appears on page R11 of the Monday, November, 13, 2006, Wall Street Journal.

Illinois Beer Distribution Law Blamed in Microbrewer’s Market Withdrawal

The Illinois Beer Industry Fair Dealing Act is being blamed for a popular Michigan microbrewery’s withdrawal from the Illinois market, according to a story in the November10 issue of the Chicago Tribune.

Bell’s Brewery, Inc. of Kalamazoo, Michigan has decided to stop shipping product to Illinois, after a dispute arose between the microbrewery and Chicago Beverage Systems, which recently purchased the Illinois distribution rights for Bell brands from another distributor.

Apparently, microbrewery owner Larry Bell feared that his highly-regarded, but relatively modest, product line would not be fully serviced by the new distributor, one of the largest liquor distributors in the Midwest. A meeting with the distributor did not ease his fears that his brands would get short shrift in light of the distributor’s representation of Miller, Coors, and other national and foreign brands. Under the Illinois Beer Industry Fair Dealing Act (815 Illinois Compiled Statutes 720/1-10), Bell’s Brewery had to distribute its product in Illinois through Chicago Beverage Systems or not at all.

“My choice was to be sold to [Chicago Beverage Systems], to be sued, or pull out,” Bell was quoted as saying in the Tribune. “I saw the lesser evil as pulling out.”

These choices apparently were dictated by the law’s prohibition of termination, cancellation, or nonrenewal of wholesalers and distributors except with good cause and 90 days’ written notice. Brewers that terminate or refuse to renew a wholesaler or distributor without good cause must pay reasonable compensation. Like liquor distribution laws in other states (and distribution laws affecting other industries), the Illinois statute was intended to remedy the inequality in bargaining power between large manufacturers or suppliers and smaller distributors.

However, this dispute—between a brewer with annual revenues of $12 million and one of the largest beer distributorships in the Midwest—stands the legislative intent of such laws on its head. In fact, Chicago Beverage Systems is owned by Reyes Holdings, L.L.C., the largest privately-held company based in Chicago, with 2005 revenues of $7.27 billion.

This conceptual flaw is only one criticism of beer and liquor distribution laws, which have been enacted, in some form, in 45 states. When the Illinois legislature considered enacting a similar law for wine and spirits distribution in 1999, the Director of the Chicago Regional Office of the Federal Trade Commission warned that the legislation would (1) make permanent existing agreements between suppliers and distributors by prohibiting a supplier from canceling, failing to renew, or terminating any such agreement without good cause; (2) shield the business of liquor distribution from market forces; and (3) deter the entry of new distributors and new products. http://www.ftc.gov/be/v990005.htm

The FTC wrote a similar letter in 2005 to a California state senator regarding a proposed beer “Franchise Act.” According to the letter, the proposal was likely to increase the cost of beer distribution and reduce competition among wholesalers, resulting in higher retail prices and a possible reduction in the variety of beers available to consumers. http://www.ftc.gov/os/2005/08/050826beerfranchiseact.pdf

There is speculation on BeerAdvocate.com (a web site for beer aficionados) that Bell’s will sit out for a period of 12 to 18 months and then re-enter the market with another distributor. http://beeradvocate.com/forum/read/841604/?start=0

Network Consolidation Was Cause for Termination Under New York Beer Distribution Law

This posting was written by Peter Reap, editor of CCH Business Franchise Guide.

The U. S. importer of a Canadian brewer’s products could terminate its agreement with a New York wholesaler—pursuant to its national policy of consolidation of its wholesaler network—without violating the New York beer law, an arbitrator in New York City has decided. (Molson USA, LLC v. John G. Ryan, Inc., AAA Case No. 15 181 00640 05, November 6, 2006.)

As required by Section 55-c-7 of the New York Alcoholic Beverage Control Law, the importer would be required to pay the wholesaler the fair market value of the distribution rights that would be lost or diminished by reason of the termination, together with the fair and reasonable compensation for other damages suffered. The importer’s policy was "reasonable, nondiscriminatory and essential" as required by the statute and the distributor acted in "good faith" regarding the proposed termination, the arbitrator determined.

Under a mandatory arbitration clause in the parties’ agreement, the importer sought (1) a declaratory judgment that it had the right to terminate the agreement and appoint a wholesaler of its own choosing and (2) a determination of the amount of compensation due the wholesaler by virtue of the termination. In the event the parties were unable to reach an agreement about the amount of such compensation, the amount would be determined during the second phase of the arbitration proceeding, according to the arbitrator.

The beer distribution section of the New York Alcoholic Beverage law provided that a brewer (or its agent, such as the importer) could terminate a wholesaler only for "good cause." The good cause requirement established standards that had to be met by a brewer in order to justify termination as part of a national or regional policy of consolidation. In relevant part, the statute specified that good cause for termination pursuant to such a policy was limited to: "[t]he implementation by a brewer of a national or regional policy of consolidation which is reasonable, nondiscriminatory and essential. Such policy shall have been previously disclosed, in writing, in reasonable detail to the brewer's wholesalers, and shall result in a contemporaneous reduction in the number of a brewer's wholesalers not only for a brand in this state, but also for a brand in contiguous states or in a majority of the states in which the brewer sells the brand." http://public.leginfo.state.ny.us/menugetf.cgi?COMMONQUERY=LAWS

Amendments to the beer law that changed the statute’s definition of good cause for termination as part of policy of consolidation were made in 2001, during the pendency of the parties’ agreement. These amendments were applicable to the agreement, despite a claim that they would impair an existing contract in violation of the Contracts Clause, the arbitrator ruled. Following the rationale of Garal Wholesalers, Ltd. V. Miller Brewing Co. (751 N.Y.S.2d 679, 2002), the statute and the 2001 amendments were remedial in nature and should be applied retroactively to avoid undermining its remedial purpose, the arbitrator determined. The changes were not drastic and did not rise to the level of substantial impairment.

The importer’s proposed termination of the wholesaler was "nondiscriminatory" within the meaning of the statute, according to the arbitrator, because the national plan of consolidation had been in effect since 2001 and had been pursued steadily since that date. The distributor’s efforts to stage its consolidation efforts consistent with the limitations of state law and the need to operate its business did not constitute discrimination, the arbitrator reasoned.

Factors such as cost savings to the importer and its corporate parent, avoidance of financial losses, increases in efficiency, and focus on the brands that contributed to increased revenues satisfied the statutory requirements that a plan be reasonable and essential, the arbitrator ruled.

Finally, the distributor acted in "good faith" under the meaning of the statute with regard to its proposed termination of the wholesaler, according to the arbitrator. A brewer did not fail to act in good faith by implementing a policy of consolidation over time. State law and the need to run a business permitted a brewer to achieve its consolidation in stages, the arbitrator reasoned.