NY Federal Judge Holds Market Power Unnecessary for Violation of Section 1 of Sherman Antitrust Act

Diana Uhimov, June 11, 2014.

Eastern District Judge Nicholas Garaufis’ decision last month in United States v. American Express held that a plaintiff is not required to establish a defendant’s market power to prove a vertical restraint in violation of Section 1 of the Sherman Act.  A firm with market power has the ability to influence the price of an item by exercising control over its demand, supply, or both.  The U.S. Department of Justice brought this action against American Express, among other credit card companies, disputing their practice of prohibiting merchants from “steering” customers to use less expensive payment cards.  Visa and MasterCard settled the lawsuit, but American Express refused to settle.  Instead, it moved for summary judgment and was defeated.

Vertical restraints are agreements between entities at different levels of the production and distribution chain to restrict competition, as opposed to agreements between competitors, which are horizontal restraints. There are numerous types of vertical restraints, from a requirement that dealers accept consumer returns of a manufacturer’s product, to resale price maintenance agreements that set the minimum or maximum price that seller’s can charge for a product, and exclusive dealing arrangements.

Vertical restraints are prohibited under federal law pursuant to Section 1 of the Sherman Act.  The Sherman Act challenges anticompetitive activity and monopolies with the aim of protecting the public by preventing the artificial raising of prices. Three elements must be present to establish a Section 1 violation:

1.     An agreement

2.     which unreasonably restrains competition

3.     and which affects interstate commerce.

Historically, courts were opposed to most vertical restraints, practically declaring them unlawful per se, or automatically illegal.  More recently, however, courts have reversed this rigid precedent, analyzing such restraints under the “rule of reason” in accordance with the 2007 U.S. Supreme Court case Leegin Creative Leather Products v. PSKS.  The rule of reason evaluates the reasonableness of a restriction of competition.  It involves a fact-specific inquiry into the restraint’s overall competitive effect, taking into account facts particular to the business, the history of the restraint, and the reasons why it was imposed.

In American Express, the defendant argued that the plaintiffs failed to establish an essential element in proving a Section 1 violation—market power in the relevant market.  But the plaintiffs prevailed based on their argument that Leegin allowed a plaintiff to satisfy its burden in a Section 1 claim by either: (1) proving that the defendant has market power, or (2) proving that the defendant’s challenged behavior had actual detrimental effects on competition. They demonstrated that the anti-steering rules could have an actual adverse effect on competition by positing that given the high fees that American Express imposed on merchants, competition would exist if these rules were not in place.

Circuit courts are currently split on this issue of market power.  The Fifth, Seventh, and Eighth circuits uphold American Express’ position that a defendant’s market power is essential to establishing that a vertical restraint is unlawful.  However, Judge Garaufis’ decision confirmed the Second Circuit’s view that while market power is a factor, an actual negative effect on competition is enough to demonstrate a vertical restraint. The Fourth and Eleventh circuits also take this approach.

Additionally, Judge Garaufis’ decision provided that market power can exist even absent market share, subjecting to suit defendants who are not dominant in a market, but hold enough power to adversely impact competition. Thus, this decision is advantageous for plaintiffs in the Second Circuit because it sets forth various ways to prove a Section 1 violation, and eases the burden of proving market power.  As of now, American Express has not appealed this decision.  However, further monitoring is suggested to see if the issue comes before the Second Circuit or Supreme Court to further clarify the standard for vertical restraint cases.