Competition News, June 2015
Unilateral Price Policies in the Contact Lens Industry: Can Manufacturers Be Forced to Sell to Every Retailer?
It is a cardinal rule of antitrust that – absent very limited exceptions – parties can do business, or refuse to do business, with whomever they choose. The Supreme Court solidified that premise in United States v. Colgate & Co., 250 U.S. 300, 307 (1919), and has reiterated it time and again. See, e.g., Monsanto Co. v. Spray-Rite Service Co., 465 U.S. 752, 761 (1984). Recent state legislation and lawsuits arising in the contact lens industry are threatening to dismantle that bedrock principle of antitrust law. The State of Utah—home to 1-800 Contacts, a prominent discount reseller—has enacted a statute making it unlawful for a contact lens manufacturer to refuse to sell to a discount reseller. The manufacturers are fighting back by challenging the constitutionality of this legislation, which, if upheld, would chip away at the nearly 100-year-old doctrine that gives a manufacturer the freedom to choose the resellers with which it does business.
Under the Colgate doctrine, a seller is allowed "freely to exercise his own independent discretion as to the parties with whom he will deal." Accordingly, a seller may unilaterally refuse to deal with any buyer for any reason, price-related or otherwise, so long as the action is unilateral and not a bilateral "agreement." 250 U.S. at 307. The Colgate doctrine is now being threatened to its very core in a dispute in the contact lens industry.
It all started in the summer of 2014, when the Senate Judiciary Committee conducted a hearing about pricing and competition in the contact lens industry. The hearing inspired the non-profit American Antitrust Institute (AAI) to write a ten-page letter to the Federal Trade Commission and the U.S. Department of Justice advocating for enforcement action against contact lens manufacturers, and hashing out a possible litigation strategy.
The letter began with a stark fact: since the Supreme Court decided Leegin Creative Leather Products, Inc. v. PSKS, Inc., 551 U.S. 877 (2007), eight years ago, holding that vertical resale price maintenance is not per se illegal but subject to the antitrust balancing test called the rule of reason, the Obama administration has not challenged a single resale price maintenance (RPM) policy. The AAI then proposed that the relatively concentrated contact lens industry—four manufacturers account for 97% of sales—effectively serve as a test case for challenge. The AAI asserted that the contact lens manufacturers' unilateral price policies (UPPs) that announce refusals to deal with price-cutting resellers were anticompetitive under the rule of reason. The AAI also argued that the UPPs were actually agreements between the manufacturers and the resellers, and thus not truly unilateral. Even more boldly, the AAI said that even if the UPPs were unilateral, UPPs should not be protected under the Colgate doctrine. The AAI asserted that because now that RPM is subject to the rule of reason under federal law, the antitrust analysis should not turn entirely on a formal distinction between unilateral conduct and bilateral conduct. Instead, according to the AAI, a pricing policy should be judged based on its economic effects.
The AAI's theories of liability are about to be tested in court. In March, discount retailer Costco sued contact lens manufacturer Johnson & Johnson over its UPP. Costco Wholesale Corp. v. Johnson & Johnson Vision Care Inc., no. 15-cv-00941 (N.D. Cal.). Within a week of that suit, consumers challenging UPPs brought a proposed class action against the four leading contact lens manufacturers. John Machikawa et al. v. Cooper Vision Inc. et al., no. 15-cv-01001 (N.D. Cal.). Those cases are pending, and in early stages. Although the plaintiffs allege that the UPPs are not actually unilateral—because, plaintiffs assert, contact lens resellers contributed to the development of the UPPs—the cases also pose an interesting question: can there be liability for a unilateral pricing policy, notwithstanding Colgate?
It's a question that the State of Utah has answered with a resounding "yes." In late March, the Utah legislature passed a statute that makes it unlawful for a contact lens manufacturer to take any action—even unilateral action—that has the effect of controlling the price charged by a retailer. Utah Code § 58-16a-905.1. In other words, the statute requires a manufacturer to continue to sell to every retailer, even those with which it unilaterally decides not to do business. Indeed, even if a seller decided to stop selling to a retailer for reasons unrelated to price and based on sound business judgment – such as credit-worthiness, timely payment of invoices or responsiveness to customer complaints – that decision would be subject to challenge as allegedly related to resale prices. According to Costco, which has intervened in suits by manufacturers challenging the Utah legislation, similar laws have been proposed in other states, including New York and California.
Challengers are arguing that Utah's law is contrary to the Commerce Clause's bar on extraterritorial state regulation. In denying the challengers' application for a preliminary injunction, the District Court has ruled that the law is likely constitutional. See, Alcon Laboratories Inc. v. Reyes, no. 15-cv-00252 (D. Utah).The Tenth Circuit has temporarily enjoined enforcement of the law pending appeal of the District Court's decision. Johnson & Johnson Vision Care v. Reyes, no. 15-4701 (10th Cir.). The Utah law, if it is upheld, would present a rare instance of unilateral conduct not being protected by the Colgate doctrine, and may yet prove to be a test case for rolling back upstream dealers' freedom to influence downstream pricing. If Utah can require contact lens manufacturers to do business with all resellers, then other states may follow with similar legislation in the contact lens industry and beyond.
North Carolina State Board of Dental Examiners v. FTC – The Aftermath
As we previously reported in a recent article discussing the likely significant implications of the February 25, 2015 U.S. Supreme Court decision, North Carolina State of Dental Examiners v. FTC -- see http://www.wiggin.com/15877 --
The Court's decision creates significant uncertainty from both a legal and practical perspective. It remains to be seen how long it will take for subsequent litigation to clarify what the Court has intentionally left for another day.
NC Dental held that a state occupational licensing board comprised primarily of "active market participants" is not entitled to antitrust immunity unless the decisions of that board are subsequently reviewed prior to being finalized by another government official who is not an active market participant. Needless to say, occupational licensing boards throughout the country are for the most part comprised of active market participants, such as the dentists who comprised a majority of members of the NC Dental Board.
As we suspected, lawsuits are beginning to be filed against state boards and, unless corrective measures are taken promptly by state legislatures, we predict that the current trickle will quite quickly turn into a veritable flood. We are aware of at least two recent suits which challenge the actions of state boards. In Teladoc, Inc., et al. v. Texas Medical Board, et al., filed on April 29, 2015 in the United States District Court, Western District of Texas, the antitrust complaint asserts that the Texas Medical Board ("TMB") is comprised of a majority of active market participants that "has been waging a war for years against telehealth providers." The allegations of the complaint concern a rule adopted by the TMB that would require a physician to "conduct an in-person physical examination of a patient before telephonic diagnosis or treatment is allowed, regardless of whether such an examination is medically necessary under the circumstances." An application for a temporary restraining order and preliminary injunction was granted by the court on May 29, 2015.
In Axcess Medical Clinic, Inc. et al. v. Mississippi State Board of Medical Licensure, et al., filed on April 24, 2015 in the United States District Court, Southern District of Mississippi, the complaint alleges that a rule adopted by the Mississippi State Board of Medical Licensure ("Board") that requires any pain management clinic to "be owned by a hospital or licensed physician, and excludes non-physicians from owning such clinics" violates the antitrust laws. The complaint further asserts that the Board is comprised of "market participants [who receive] no supervision from a politically accountable state supervisor with veto power who is not a market participant."
The aforesaid rules in the Texas and Mississippi matters may or may not be sound public policy. However, the fact that these challenges to agency action are premised upon an alleged deficiency in the state's statutory framework leads to the obvious conclusion that both rules and adjudicatory decisions issued by state agencies predominately comprised of those who are actively practicing in the field that they are also regulating will become fodder for antitrust claims. Inevitably, such lawsuits will drain limited governmental resources and, in some instances, delay, or even block entirely, substantive rules and adjudicatory actions that may well be in the public interest.
Whether the NC Dental decision, itself, is sound jurisprudence is, at this stage, beside the point. It is incumbent on states to act promptly to adjust their respective occupational licensing laws to comport with NC Dental. If that does not occur, we predict that the occupational licensing systems in those states that do ignore the structural problems identified in NC Dental will cease to function effectively -- if at all.
The U.S. Supreme Court Reminds Us Once Again: Don't Forget About State Antitrust Law!
In Oneok, Inc. v. Learjet, Inc., 135 S. Ct. 1591 (2015), the Supreme Court addressed the issue of whether state antitrust laws were preempted by the federal Natural Gas Act. In a 7-2 decision, the Court found that even though the Natural Gas Act gives the Federal Energy Regulatory Commission ("FERC") the authority to regulate certain kinds of interstate natural gas sales and transport, states retain the authority to regulate—through their antitrust laws—aspects of the natural gas industry outside of FERC's purview. The ruling reaffirmed the power of state antitrust laws. The Court demonstrated its reluctance to interfere with state antitrust laws absent a clear conflict between those laws and federal law.
NATURAL GAS REGULATION
The Court's decision was strongly influenced by the history of natural gas regulation, which it described as "less than perfect." 135 S. Ct at 1597. Originally, the states regulated natural gas prices. Then, in the 1930s, based on a series of unfavorable Supreme Court decisions, the federal government stepped in. Congress passed the Natural Gas Act, giving FERC the authority to regulate the interstate shipment and sale of gas to distributors for resale. Until the 1970s, FERC set the wholesale rates for interstate pipelines. Then, FERC deregulated the industry. Sellers and buyers negotiated prices based on privately published price indices. Sellers, however, manipulated these price indices, sometimes simply making up reported information or using "wash trades" (or false trades). Id. at 1598. According to a 2003 FERC report, the end result was that prices climbed to "extraordinary levels" for both gas sales for resale and direct sales to consumers.
The plaintiffs in Oneok were all direct sale customers; they bought gas directly from interstate pipelines. They sued the pipelines for manipulating gas prices under several state antitrust statutes. A number of similar suits were filed in different states, and all were removed to federal court, and then consolidated for pretrial purposes. The pipelines then successfully moved for summary judgment on the basis that even though FERC did not regulate these direct sale customers, their state antitrust claims were preempted under the doctrine of "field preemption." That doctrine applies when Congress intends to occupy the whole "field" of a particular area of regulation, even when there are no direct conflicts between state and federal law. The pipelines argued that Congress intended that only the federal government (and not the states) should be able to regulate interstate natural gas sales – and so, direct sale customers could not use state antitrust statutes to sue them for their alleged manipulation of price indices. Id. at 1594-95.
THE COURT'S HOLDING
The Court found that under these facts, states could use antitrust laws to regulate the natural gas price indices. The Natural Gas Act regulates interstate sales to resellers, but does not regulate direct sales. Even though the price indices affected both resellers and direct sales customers, here only direct sale customers sued. The Court emphasized that because the Natural Gas Act "was drawn with meticulous regard for the continued exercise of state power," it would not find preemption unless the state regulation was aimed directly at protecting the resellers (in other words, aimed at protecting "things over which FERC has comprehensive authority"). Id. at 1599. These antitrust regulations were not. Indeed, as the Court noted, state antitrust laws are broadly applicable to all businesses in the marketplace. "This broad applicability of state antitrust law," the Court noted, "supports a finding of no pre-emption here." Id. at 1601.
IMPLICATIONS FOR ANTITRUST LAW
Oneok indicates that the Court will be unlikely to find state antitrust suits are preempted in the absence of a direct conflict between state antitrust laws and federal regulation. The Court signaled it was reluctant to find the doctrine of field preemption bars antitrust suits. Although the decision is limited to the Court's reading of the Natural Gas Act, the holding could be read as applicable to antitrust suits in other areas. In the context of antitrust laws, it will be difficult to meet the Supreme Court's test for preemption here: whether the state law is aimed at something that the federal government directly regulates. After all, as the Supreme Court noted, antitrust laws are not targeted. Rather, they are a broad tool.
Ironically, the Court did not address the many decisions in which field preemption has been held to bar state antitrust suits in other areas of law. E.g., Flood v. Kuhn, 443 F.2d 264, 268 (2d Cir. 1971) (barring antitrust suit involving sports leagues) aff'd, 407 U.S. 258 (1972); Smart v. Local 702 Int'l Bhd. of Elec. Workers, 562 F.3d 798, 808 (7th Cir. 2009) (field preemption bars antitrust suit in the same arena as federal labor law). The question now is whether any of this prior case law is suspect in light of Oneok – must preemption of state antitrust claims now be based only on a direct conflict?
The Court concluded its opinion by noting that it was not addressing the doctrine of conflict preemption. According to the majority, "[t]o the extent any conflicts arise between state antitrust law proceedings and the federal rate-setting process, the doctrine of conflict pre-emption should prove sufficient to address them." 135 S. Ct. at 1602. That issue wasn't raised in Oneok, however, and so the Court left "conflict pre-emption questions for the lower courts to resolve in the first instance." Id.
Connecticut Supreme Court to Decide Whether CUTPA Reaches Conduct Occurring Entirely Outside of Connecticut
How far does the Connecticut Unfair Trade Practices Act ("CUTPA") reach? That is the question pending before the Connecticut Supreme Court in Western Dermatology Consultants, P.C. v. VitalWorks, Inc., et al. (S.C. 19248). The case involves a dispute over allegedly faulty software sold to a New Mexico medical practice by a company headquartered in Connecticut, from which it directed its product development, marketing, sales and delivery operations. The twist in this case is that the defendant's software operations were located in Alabama, it demonstrated the product to the plaintiff in California and New Mexico, and it installed the software and accompanying hardware and trained the plaintiff's staff in New Mexico. Is it enough that the defendant is headquartered in and directed the company's business practices from Connecticut? The trial court said yes, but the Appellate Court said no. The Supreme Court soon will have the last word.
CUTPA forbids "unfair methods of competition and unfair or deceptive acts or practices in the conduct of any trade or commerce." Conn. Gen. Stat. § 42-110b(a). The statute defines "trade" and "commerce" to mean "the advertising, the sale or rent or lease, the offering for sale or rent or lease, or the distribution of any services and any property, tangible or intangible, real, personal or mixed, and any other article, commodity, or thing of value in this state." Id. § 42-110a(4) (emphasis added). The central question before the Supreme Court is what it means to sell, offer to sell, or distribute services and property "in this state."
The trial court found for the plaintiff on its CUTPA claim. Relying in part on a choice of law analysis, the trial court concluded that Connecticut law should apply to the parties' dispute: "‘[T]he acts which gave rise to [the] plaintiff's claims occurred in Connecticut. . . . The location of the party responsible for the wrongful, tortious conduct toward [the] plaintiff is Connecticut. . . . Applying Connecticut law to all [the] plaintiff's claims . . . provides for the most consistent, rational and fair application of law to the facts of this case.'" 146 Conn. App. 169, 197-98 (2013) (summarizing and quoting trial court decision). On appeal, the defendants argued that even if Connecticut law applied, the plaintiff's CUTPA claim failed because the defendants' conduct did not constitute trade or commerce in Connecticut. The Appellate Court agreed.
After quoting CUTPA's definition of "trade and commerce," the Appellate Court concluded: "The meaning of § 42-110b(a) is plain and unambiguous; it proscribes only unfair trade practices occurring within the state of Connecticut." Id. at 199. Noting that the plaintiff was in New Mexico, the product demonstrations were in California and New Mexico, the software and hardware were installed in New Mexico, the services were performed in New Mexico, and the plaintiff dealt with the defendants' Alabama employees, the court concluded there had been no sale, offer to sell or distribution of property or services in Connecticut. Id. at 200. Echoing CUTPA's definition of trade and commerce, the Appellate Court held: "While VitalWorks admits to being a Delaware corporation and the court found that Ridgefield, Connecticut was its corporate headquarters, the complained about activities did not involve the advertising, sale, rent, lease, offering for sale, rent or lease or distribution of any services and any property, tangible or intangible, real, personal or mixed, and other article commodity or thing of value in Connecticut." Id. The court explained further: "Connecticut only served as the corporate headquarters at the time of the execution of the contract and for about a year after until VitalWorks was acquired by Cerner. We decline to give extraterritorial effect to § 42-110a(4) for actions taken in the pursuit of trade or commerce occurring wholly outside the state." Id. at 201.
The Appellate Court then addressed the choice of law analysis in which some courts, including the trial court below, have engaged to decide whether CUTPA applies to particular facts. In framing the issue, the court revealed its evident skepticism about the merit of engaging in such an analysis to determine CUTPA's reach: "Despite the clear words of the statute, some decisions involving CUTPA claims stemming from multistate activities have employed choice of law principles to determine whether CUTPA applies to the defendant's conduct." Id. at 201-02. The Appellate Court concluded that a choice of law analysis led to the same result: CUTPA did not apply. Unlike the trial court, the Appellate Court placed little weight on the fact that defendant VitalWorks was headquartered in Connecticut, describing that fact as "a circumstance merely incidental to the alleged tortious conduct." Id. at 206.
The Supreme Court soon will weigh in. What remains to be seen is whether the Court will tackle head on the issue of CUTPA's applicability to persons located in Connecticut whose actions occur mostly if not wholly outside of this State, or whether it will see a narrower path forward, such as concluding that the record supports the trial court's finding that some of the defendant's unfair acts emanated from its Connecticut headquarters. The Supreme Court has not issued a definitive ruling on this precise issue in the more than 40 years of CUTPA's existence. Its decision could have significant ramifications. Before the Appellate Court's ruling in Western Dermatology, courts generally had considered CUTPA's reach to be far more expansive than what the Appellate Court concluded. Where the Supreme Court comes down on the issue could have profound implications for private litigants and the state's enforcement efforts.