Athletes, Ivies and the NCAA

By Alexandros Kazimirov

On June 29, 2023, a student class action was filed against educational institutions that form the Ivy League, asserting that their agreement to restrict athletic scholarships for student athletes competing in Division I of the National Collegiate Athletic Association (NCAA) is a form of price-fixing, incompatible with antitrust law, under a per se and rule of reason analysis. The complaint echoes criticism of what is claimed as “procompetitive justification” for imposing limits on education-related expenses in National Collegiate Athletic Association v. Alston.

The question of compensation of student athletes has long permeated public discourse and the U.S. courts. At its core it is a matter of balancing between the interests of student athletes and the concept of amateurism, which constitutes intercollegiate sports under the NCAA. Some hold that refusing compensation to student athletes when the NCAA’s product is worth billions, is preposterous. The view that there is great disparity between the NCAA’s earnings and the student athletes’ compensation is one shared by Justice Kavanaugh, who laid out his separate opinion in Alston: “Those enormous sums of money flow to seemingly everyone except the student athletes. College presidents, athletic directors, coaches, conference commissioners, and NCAA executives take in six- and seven-figure salaries. Colleges build lavish new facilities. But the student athletes who generate the revenues end up with little or nothing”.

The NCAA on its part has historically focused on the premise of amateurism. According to the NCAA, amateurism defines college athletics, and the sport derives its value from it. Subsequently, the NCAA has been at arms with every court decision limiting NCAA’s discretion on how to address the issue.

A fundamental principle in all relevant cases so far, is that the courts discern between education-related expenses and education-unrelated expenses, such as endorsement deals based on a student-athlete’s name, image or likeness (NIL). What is more, education-related expenses can be in the form of tuition discounts or athletic scholarships.

The issue of whether college athletes should receive additional compensation beyond tuition, room and board, and other educational expenses has not been fully settled. In O’Bannon v. NCAA [802 F.3d 1049 (9th Cir. 2015)] the Ninth Circuit Court of Appeals lifted caps on education-related compensation, but allowed some discretion to the NCAA on limiting students’ earnings based on NIL deals which are unrelated to their education expenses. In Alston, the NCAA appealed the loss of their ability to cap educational-related expenses. And lost.

The Court described that just because the NCAA’s arrangement was not found to be illegal per se in a previous case (NCAA v. Board of Regents of the University of Oklahoma) this does not preclude the Court from examining it under the rule of reason.

And under the rule of reason, the Court laid out the process that the District Court employed to reach its conclusions. First, the students argued that the restraints on education-related expenses and additional compensation were anti-competitive measures by a party enjoying monopsony. Then, letting the NCAA rebut the argument by reiterating the pro-competitive aspects of the arrangement, such as retaining “amateurism”, i.e. the collegiate non-professional nature of sports. Third, carefully considering whether the consumer market can be attained using substantially less restrictive means.

The Court found in Alston that the District Court struck a good balance by condemning the restraints on educational-related expenses, but still leaving some discretion to the NCAA on how to manage such expenses, without having judges second-guess every decision they take.

Justice Kavanaugh’s concurring opinion is worthy of mention. He reminded the Court that NCAA’s appeal pertained only to caps on cost of attendance, which the Court unanimously rejected. But he went beyond this, saying he didn’t find the NCAA’s procompetitive justification for its rules limiting athletic scholarships or even NIL compensation persuasive either. In a nod to a future class of petitioners, Justice Kavanaugh indicated that there is more to be gained. His remarks were noticed and his call was answered in Choh v. Brown University.

From here on, with O’Bannon and Alston as precedent, it will be a tough road for the defendants to keep restrictions on athletic scholarships or NIL deals.

Franchise Agreements: The Case for Limited Non-Compete Clauses

By Alexandros Kazimirov

In early 2023, the Federal Trade Commission proposed a rule under the notice-and-comment process arguing that non-compete clauses constitute an unfair method of competition and therefore violate Section 5 of the Federal Trade Commission Act. The Commission’s intent is to absolve the labor force from binding clauses that impose restrictions on its movement in the market, which in turn harms competition in the country. In the Commission’s enclosed fact sheet, the widespread use of non-competes is highlighted through grossly disproportionate instances, such as the case of a security guard being prevented from getting a job with a new employer by virtue of a two-year non-compete with his previous employer. The Commission’s view is that such over- broad use of non-competes at all levels of employment, cannot be justified to protect trade secrets in light of the fact that some states like California do not enforce such clauses anymore. In the rule proposal, the FTC recognizes that some cases may require deeper inquiry and asks feedback on whether franchisees should be covered by the rule.

Taking as an example a fictional restaurant chain called Big Kahuna Burger (BKB). BKB is in the business of selecting locations, building restaurants, then selling the restaurants and franchising the buyers to allow them to become individually owned and operated BKB restaurants. Let’s assume that all individual BKB restaurants are owned and operated by franchisees. The potential franchisee enters into a standardized franchise agreement which governs many aspects of the franchise operations. BKB franchisees do not receive an exclusive territory, and prospective franchisees are told that franchisees may face competition from other BKB restaurants as well as, of course, from restaurants of other chains. The franchise agreement includes a non-compete clause, which states that: “No employee may seek employment at a different BKB franchise within six months after their termination of employment with their initial BKB franchise.”

It would be an uphill battle to make the case that such a noncompete clause is per se illegal. The reason is because:

(i) it is fairly narrow in scope, i.e. it applies only to BKB franchises and for a limited time,

(ii) does not prescribe price-fixing on its face and

(iii) may retain a pro-competitive effect vis-a-vis other chain restaurants.

The bench is more comfortable in declaring something per se unlawful when the restraint is clearly restrictive on its face. When it is less obvious, the bench may exercise its discretion and review a restraint under the rule of reason theory. It is therefore worth considering whether limited non-competes between franchises can be considered as an unreasonable restraint of trade under a rule of reason analysis.

Would it survive a rule of reason analysis?

In this analysis, the judge would identify two forces: an intrinsic anti-competitive force and an extrinsic pro-competitive force. The intrinsic force concerns the restraint viewed between one franchise and another. In this intrinsic market of employment, the employees are indeed restricted and the clause functions as a brazenly anti-competitive feature because it limits the post-employment options of a franchise employee. The extrinsic force concerns the restraint as viewed between the franchise and the competing restaurants. In this extrinsic market, the employees are not restricted and taken holistically this feature functions more as a pro-competitive feature, because it enhances labor security between franchises and the employees retain an “out” to competing chains.

Next, the analysis would turn to facts and circumstances, i.e. how many opportunities of an “out” the employees of a particular franchise actually have. For example, the judge can select a designated area around a BKB franchise and ask how many competing chains have presence versus BKB franchises. By having an approximate understanding of the market, a judge can determine how broad or narrow the restrictive character of the clause is. For example, if there are more BKB franchises within a designated area than other restaurants, then the intrinsic force of the clause is stronger and therefore it may be interpreted as an unreasonable restraint on competition. Alternatively, if there are more competing chain restaurants than BKB franchises, then the extrinsic force of the clause is stronger and therefore it may be interpreted as a reasonable restraint on competition.

Perhaps weighing the limitations of non-compete covenants and then rewriting them to an acceptable standard is a task that should not burden the courts, some may argue. Traditionally, courts in Delaware and New York (where until recently state law has tolerated non-competes, although state legislatures have indicated to adopt a more hostile stance), have required that restrictions be reasonable in duration, geographic scope and in kind of the business restrained.

However, in Kodiak v. Adams the Court of Chancery admonished parties seeking to have the bench “blue pencil” restrictive covenants to a reasonable and enforceable scope, echoing the growing hesitancy not only to enforce but also to correct non-competes.

Conclusion

Whether the FTC decides to carve out an exception for post-termination non-competes in franchise agreements or moves to include them in its ban, remains unknown so far. Between the hesitation of courts to review non-competes and the lack of flexibility for franchises that a total ban may entail, the former may be the lesser evil.

Law School Boycotts and the Sherman Act

By Alexandros Kazimirov

In April of 2023, U.S. News & World Report (USNWR) released its first rankings of law schools after a boycott initiated by Yale, Harvard and UC Berkeley Law Schools, which first cut ties with USNWR in November 2022 claiming the magazine used a flawed methodology. Soon after their announcement, the trio’s boycott was joined by several other prominent schools.

Could the boycott of the U.S. News ranking of law schools be a violation of antitrust law?

As a start, it is prudent to address the root causes which led Law Schools to cease dissemination of information related to test scores to the USNWR journal. At the core of this decision are two conflicting motives. Some believe that rankings published by USNWR do not reflect the efforts undertaken by the Law Schools on promoting a diverse body of students. At the same time, Law Schools are not comfortable with the prospect of test score ambiguity (since under the current system, their ranking depends on the test scores they set as requirements for admission) which entails loss of prestige and therefore potentially losing access to other resources as well.

To avoid a compromise between high academic thresholds and bad reputation in diversity efforts, Law Schools may have collectively agreed not to disclose data to the USNWR, which compiles an annual ranking list. Hence, the issue turns on whether this agreement is a restraint that distorts competition under Section 1 of the Sherman Act.

To begin with, the relevant market for this case would be law school education. While Law Schools have agreed to withhold data from USNWR, which is the consumer of this information, the ultimate recipient of the product that USNWR creates is the pool of prospective student applicants. Law Schools are anxious to attract graduates with high test scores, because this perpetuates their reputational preeminence among their peer competitors. Furthermore, Law Schools are highly motivated to project such reputational preeminence because they are also competing for donations and gifts by individual benefactors.

Law Schools may be susceptible to reputational harm but they are not immune from antitrust violations. An agreement not to participate in the ranking list publication resembles a horizontal restraint seeking to curb competition among Law Schools for student admissions. This action is in fact a group boycott, which under U.S. v. General Motors Corp. is unlawful per se, however like in FTC v. Indiana Federation of Dentists, a more deferential judge would emulate the court’s discretion and examine it under the rule of reason instead.

Afterall, like in Indiana Federation of Dentists, the agreement does not prescribe price-fixing on its face, but seeks to withhold from their customer a particular service that they desire. To reach a conclusion on whether this agreement is an unreasonable restraint on competition, courts would avoid embarking on a journey into “the sea of doubt” in accordance with Addyston. Here, this temptation would be to consider whether diversity concerns justify a collective withdrawal from what may be a flawed ranking system.

Instead, a court would focus on the agreement’s pro-competitive or anti-competitive propensities. When considering the pro-competitive and the anti-competitive propensities of this restraint, it leans to the latter. In National Society of Professional Engineers, the court held “the assumption that competition is the best method of allocating resources in a free market recognizes that all elements of a bargain — quality, service, safety, and durability — and not just the immediate cost, are favorably affected by the free opportunity to select among alternative offers.” Similarly, Law Schools have no obligation to submit their data on student admissions to USNWR, but they cannot collectively agree to foreclose the possibility of doing so, in an attempt to prevent competition among themselves, and reduce the risk of either reputational harm or lower revenues from donations.

Like in Indiana Federation of Dentists, “a refusal to compete with respect to the package of services offered to customers impairs the ability of the market to advance social welfare by ensuring the provision of desired goods and services to consumers at a price approximating the marginal cost of providing them.” In this instance, the consumer – USNWR – would be less informed about the test scores of the admitted students. In turn, this would result in greater ambiguity in the decision-making process of admissions, i.e. what criteria are used and to what effect. In other words, less information leads to less competition.

Without a feature which enhances its pro-competitive efficiencies, this restraint cannot be viewed as legal. It is plausible that Law School may dislike the rankings publication on the premise that it distorts or misinforms their efforts on attracting a diverse body of students. That does not mean that law schools are precluded from withdrawing from the rankings publication on their own initiative; rather it confirms that to do it in a concerted manner would distort competition.

In sum, concerns of diversity and inclusion may be a legitimate worry, but not one that makes a restraint on competition reasonable. Like the court’s reasoning in National Society of Professional Engineers, “we may assume that competition is not entirely conducive to ethical behavior, but that is not a reason, cognizable under the Sherman Act, for doing away with competition.”

What if there was never an agreement to begin with?

Rather, a case where Yale took the lead, and the rest followed in what constitutes parallel conduct. Parallel conduct can be explained as conduct which is sound on its own, regardless of actions of competitors, or it can be so suspicious that it raises an inference of a conspiracy.

An express agreement of a restraint of a trade is the best evidence one can hope for, however direct evidence of conspiracy is not a sine qua non. Circumstantial evidence can establish an antitrust conspiracy under Interstate Circuit. Circumstantial evidence can be shown through price exchange, regular peer contacts, stating shared concerns so that “knowing that concerted action was contemplated and invited, the distributors gave their adherence to the scheme and participated in it.”

The first requirement is an atypical behavior. By initiating the boycott, Yale is undertaking a highly risky move, which if not followed by others could be harmful for its reputation. Is it a rational decision? Would Yale commit to its decision if not sure that others would follow? Well, others joined the boycott. Perhaps, the bench could interpret this as a series of reasonable independent initiatives or someone more inquisitive could infer a conspiracy. But inference alone is not dispositive. It simply gives the bench reason to consider circumstantial evidence. Therefore, it would ask whether the law school deans consulted among themselves, exchanged information on resources allocated to diversity or formulated appropriate courses of action. Such evidence would be holistically considered before concluding whether there was a tacit accord to partake in a boycott. And if the bench concluded in the affirmative, it would find it illegal per se or apply the aforementioned rule of reason analysis, where absent any pro-competitive features, a conspiracy to distort competition would be a violation of the antitrust law.

Selective Distribution and Online Marketplace Restrictions: the EU Coty Prestige case

By Giuseppe Colangelo

The online sales phenomenon – and all the issues deriving from vertical restraints – has attracted significant attention in recent years in several EU Member States. This attention arises mainly from a question regarding the extent to which restrictions limiting the ability of retailers to sell via online marketplaces are compatible with competition rules.

The findings of the recent E-commerce Sector Inquiry [COM (2017) 229 final] indicate that absolute marketplace bans should not be considered to be hardcore restrictions within the meaning of Article 4(b) and Article 4(c) of the Vertical Block Exemption Regulation (330/2010). However, as recalled by the Commission, this approach has been affirmed pending the CJEU’s decision in the Coty Prestige case.^[1] Indeed, the Higher Regional Court of Frankfurt am Main essentially asked the EU Court of Justice (CJEU) whether a ban on using third party platforms in a selective distribution agreement is compatible with Article 101(1) TFEU and whether such a restriction constitutes a restriction of competition by object.

No wonder Coty was so anticipated. The judgment is expected to shape the future of EU e-commerce affecting online markets, the luxury industry and Internet platforms.

The request for a preliminary ruling has been submitted in the context of a dispute between a supplier of luxury cosmetics (Coty Germany) and its authorized distributor (Parfümerie Akzente), concerning the prohibition, under the selective distribution agreement, of the use of third-party undertakings for Internet sales. In particular, Parfümerie Akzente distributes Coty goods both at its brick-and-mortar locations and over the Internet. In the latter case, sales are carried out partly through its own online store and partly via the Amazon platform.

According to Coty, the selective distribution system is required in order to support the luxury image of its brands. In this respect, the selective distribution agreement, as it pertains to Internet sales, provides that the authorized retailer is not permitted to use a different name or to engage a third-party undertaking which has not been authorized. The dispute at issue arose when Parfümerie Akzente refused to sign amendments regarding Internet sales activity. They prohibited the use of a different business name and the recognizable engagement of a third-party undertaking which is not an authorized retailer of Coty Prestige. Thus, according to these amendments, the authorized retailer is prohibited from collaborating with third parties if such collaboration is directed at the operation of the website and is affected in a manner that is discernible to the public.

In response to the action brought by Coty to prohibit Parfümerie Akzente from distributing products via Amazon, the German court of first instance found that, in accordance with Pierre Fabre ruling (C-439/09), the objective of maintaining a prestigious image of the mark could not justify the introduction of a selective distribution system which restricts competition. Further, according to the national court, the contractual clause at issue constituted a hardcore restriction under Article 4(c) of the Regulation. It did not meet the conditions for an individual exemption, since it has not been shown that the general exclusion of Internet sales via third-party platforms entails efficiency gains that offset the disadvantages for competition that result from the clause. Moreover, the court considered such a general prohibition unnecessary, since there were other equally appropriate but less restrictive means, such as the application of specific quality criteria for the third-party platforms.

In these circumstances, the Oberlandesgericht Frankfurt am Main requests a preliminary ruling asking: (i) whether selective distribution networks aimed at preserving the image of luxury goods are caught by the prohibition laid down in Article 101(1) TFEU; (ii) whether, in the same context, Article 101(1) precludes a contractual clause which prohibits authorized distributors from using, in a discernible manner, third-party platforms for Internet sales, without consideration of whether there is any actual breach of the legitimate requirements of the manufacturer in terms of quality; (iii and iv) whether Article 4(b) and (c) of the Regulation must be interpreted as meaning that such a third-party platform ban constitutes a restriction by object of the retailer’s customer group or of passive sales to end users.

The questions reflect the diverging interpretations of Pierre Fabre by the national competition authorities and courts. Thus, the case provides the CJEU with the opportunity to clarify the meaning of Pierre Fabre.

 

Sidestepping Pierre Fabre

By answering the first question, the CJEU recalls that since Metro (C-26/76 and C-75/84), the Court has recognized the legality of selective distribution networks based on qualitative criteria. Notably, according to the conditions set by the case law to ensure the compatibility of a selective distribution network with Article 101(1) TFEU, resellers must be chosen on the basis of objective criteria of a qualitative nature, which are determined uniformly for all potential resellers and applied in a non-discriminatory manner; the characteristics of the product necessitate such a selective distribution network in order to preserve its quality and ensure its proper use; the criteria defined must not go beyond what is necessary.

In the context of luxury goods, it follows from the case law that, due to their characteristics and their nature, those goods may require the implementation of a selective distribution system in order to preserve their quality and to ensure that they are used properly. Indeed, as highlighted by the Copad judgment (C-59/08), the quality of luxury goods is not just the result of their material characteristics, but also of their allure and prestige. As prestige goods are high-end goods, the aura of luxury they emanate is essential in that it enables consumers to distinguish them from similar goods and, therefore, an impairment to that aura is likely to affect the actual quality of those goods. For these reasons, the characteristics and conditions of a selective distribution system may  preserve the quality and ensure the proper use of luxury goods. The CJEU in Copad held that the establishment of a selective distribution system which seeks to ensure that the goods are displayed in sales outlets in a manner that enhances their value contributes to the reputation of the goods, and therefore contributes to sustaining the aura of luxury surrounding them.

Therefore, once the Metro criteria are met, a selective distribution system designed primarily to preserve the luxury image of those goods is compatible with Article 101(1) TFEU. This outcome is not challenged by Pierre Fabre. The assertion contained in paragraph 46 of that case (“The aim of maintaining a prestigious image is not a legitimate aim for restricting competition and cannot therefore justify a finding that a contractual clause pursuing such an aim does not fall within Article 101(1) TFEU”) is confined to the context of that judgment and consequently does not alter the settled case law. Notably, that assertion is related solely to the goods at issue (“the goods covered by the selective distribution system at issue in that case were not luxury goods, but cosmetic and body hygiene goods”) and to the contractual clause in question in Pierre Fabre (a general and absolute ban on Internet sales). Therefore, the selective distribution system in its entirety was not at issue.

The same line of reasoning guides the CJEU’s answer to the second question, which is related to the lawfulness of a specific clause prohibiting authorized retailers from using, in a discernible manner, third-party platforms for Internet sales of luxury products.

The contractual clause must be evaluated in light of the Metro criteria. The CJEU recalls that it indisputable that the clause at issue: i) pursues the objective of preserving the image of luxury and prestige of the contractual goods; ii) is objective and uniform; iii) is applied without discrimination to all authorized retailers. Therefore, the lawfulness of the third-party platforms prohibition is a matter of proportionality. Hence, an assessment is required as to whether such a prohibition is appropriate for preserving the luxury image of the contractual goods and whether it goes beyond what is necessary to achieve that objective.

As regards the appropriateness of the prohibition at issue, the CJEU considers the contractual clause justified by the need to preserve the luxury image of the products in light of three arguments. Indeed, the third-party platforms ban is coherent with the aim of: i) guaranteeing that the contract goods will be exclusively associated with authorized distributors; ii) monitoring the qualitative criteria according to which the products are sold (the absence of a contractual relationship between the supplier and third-party platforms prevents the former from being able to require compliance with the quality conditions imposed on the authorized retailers); iii) contributing to the high-end image among consumers (those platforms constitute a sales channel for goods of all kinds, while the chief value of a luxury good lies in the fact that it is not too common).

With regard to the question of whether the prohibition goes beyond what is necessary to achieve the objective pursued, the clause at issue is clearly distinguished from the one sanctioned in Pierre Fabre, since it does not contain an absolute prohibition on online sales. Indeed, authorized retailers are allowed to distribute the contract goods online via their own websites and third-party platforms, when the use of such platforms is not discernible to consumers.

The CJEU also relies on this argument to answer the third and fourth questions raised by the referring court. Even if the clause at issue restricts a specific kind of Internet sale, it does not amount to a restriction within the meaning of Article 4(b) and (c) of the Regulation, since it does not preclude all online sales, but only one of a number of ways of reaching customers via the Internet. Indeed, the contractual clause even allows, under certain conditions, authorized retailers to advertise on third-party platforms and to use online search engines. Moreover, it is not possible ex ante to identify a customer group or a particular market to which users of third-party platforms would correspond. Therefore, the content of the clause does not have the effect of partitioning territories or of limiting access to certain customers.

In summary, in line with the position expressed by the Commission in the Sector Inquiry, the CJEU states that absolute marketplace bans should not be considered as hardcore restrictions since, contrary to the restriction at stake in Pierre Fabre, they do not amount to prohibition on selling online and do not restrict the effective use of the Internet as a sales channel.

 

Some open issues

Despite the clarity of the CJEU’s findings, there is a matter of interpretation related to the potential limitation of the judgment solely to genuine luxury products. Indeed, the CJEU also distinguishes Coty from Pierre Fabre on the grounds that the latter did not concern a luxury product: “the goods covered by the selective distribution system at issue in [Pierre Fabre] were not luxury goods, but cosmetic and body hygiene goods. … The assertion in paragraph 46 of that judgment related, therefore, solely to the goods at issue in the case that gave rise to that judgment and to the contractual clause in question in that case”.

In that respect, the wording of the CJEU is unfortunate. First, the proposed exclusion of cosmetic and body hygiene products from the luxury landscape is far from convincing. Further, the uncertainty about the scope of the ruling may generate litigation over the prestige of some goods, since national enforcers may adopt different approach and manufacturers would seek protection against online marketplace sales for products whose luxury features are questionable. Indeed, the CJEU does not define the notion of luxury, but relies on Copad, stating that the quality of such goods is not just the result of their material characteristics, but also of the allure and prestigious image which bestow on them an aura of luxury. That aura is essential in that it enables consumers to distinguish them from similar goods.

A few days after the Coty judgement, the German Federal Court of Justice, in evaluating ASICS’s online restrictions, stated that sports and running shoes are not luxury goods.^[2] Previously, on 4 October 2017 the District Court of Amsterdam, referring to the Opinion of Advocate General Wahl in Coty, reached a different conclusion about Nike shoes and ruled in favor of Nike in an action against a distributor (Action Sport), which had not complied with the selective distribution policy.^[3]

A narrow interpretation of the Coty judgement would be at odds with the settled case law, which holds that it is the specific characteristics or properties of the products concerned that may be capable of rendering a selective distribution system compatible with Article 101(1) TFEU. As pointed out by the Advocate General, the CJEU has already made clear that irrespective even of whether the products concerned are luxury products, a selective distribution system may be necessary in order to preserve the quality of the product. In the same vein, according to the Commission’s Guidelines, qualitative and quantitative selective distribution is exempted regardless of both the nature of the product concerned and the nature of the selection criteria as long as the characteristics of the product necessitate selective distribution or require the applied criteria. It is the properties of the products concerned, whether they lie in the physical characteristics of the products (such as high-quality products or technologically advanced products) or in their luxury or prestige image, that must be preserved.

However, the mentioned ambiguity does not seem to have a significant impact in practice. Indeed, whether or not an online marketplace ban should be considered as hardcore restrictions within the meaning of Article 4(b) and (c) of the Regulation does not depend on the nature of products. Since, according to the CJEU’s finding, absolute marketplace bans are not hardcore restrictions, a case-by-case analysis of effects will be required for both luxury and non-luxury goods.

[1] Coty Germany GmbH v. Parfümerie Akzente GmbH (C-230/16).

[2] Case KVZ 41/17.

[3] Case C/13/615474 / HA ZA 16-959.

Teva Contests EU Charges at Antitrust Hearing

By Nicole Daniel

On 13 March 2018 Teva appeared at a closed-doors antitrust hearing in Brussels to contest EU pay-for-delay charges (COMP/39.686).

In April 2011 the European Commission opened an investigation against Teva and Cephalon, both pharmaceutical companies, for a 2005 pay-for-delay agreement. This investigation was a consequence of the 2009 sector inquiry of the pharmaceutical sector which had resulted in an EU policy of penalizing pay-for-delay settlements. This sector inquiry identified structural issues and companies’ practices that led to competition distortions. The Commission also recommend a stronger enforcement of patent settlements. Accordingly, these settlements are now monitored by the Commission on an annual basis.

Furthermore, this is the fourth pay-for-delay antitrust case opened after the sector inquiry. In Lundbeck (COMP/39.226), Servier (COMP/39.612) and Johnson & Johnson (COMP/39.685), the respective pharmaceutical companies were fined by the Commission. On 8 September 2016 the General Court upheld the Lundbeck Commission decision, thereby confirming the Commission’s finding that pay-for-delay agreements are a restriction by object, i.e. treating such an arrangement as infringement regardless of whether it has an anticompetitive effect. In the Servier case, the appeal to the General Court is still pending. The Johnson & Johnson case was not appealed.

The Teva case regards modafinil, a sleep-disorder drug. The patents for modafinil and its manufacture were owned by Cephalon but after certain patents expired, Teva entered the market with its generic version for a few months. A lawsuit for alleged patent infringement followed and the litigation in the UK and the U.S. was settled with a world-wide pay-for-delay agreement. In 2005 Teva received $ 125 million to delay the sale of generic modafinil. The agreement saw Teva taking modafinil off the market until October 2012. In the meantime, Cephalon became a subsidiary of Teva.

In the U.S. the same deal was also investigated by the authorities; this probe, however; was concluded with a $ 1.2 billion settlement.

On 17 July 2018 Teva received a Statement of Objections from the Commission. At that time Teva commented that it “strongly disagreed” with the Commission’s approach to patent settlements in the pharmaceutical industry. The Commission’s view is that substantial harm to health service budgets and EU patients may have been caused by the agreement, since it led to higher prices for modafinil.

It is possible for companies to respond in writing and in person to a Statement of Objections. On 13 March 2018 Teva therefore attended a closed-doors hearing in Brussels to respond to the allegations above.

It should be noted that since Teva had already started marketing its generic version of modafinil, this aspect could be an important element in deciding whether the market suffered due to that agreement. In other pay-for-delay cases, the pharmaceutical companies often argued that there was no anticompetitive intent or effect since no generic version, i.e. a rival product, had launched. However, this line of defense might not be applicable here.

It remains to be seen how the Commission will respond to Teva’s arguments.

Full-work Licensing Requirement 100 Percent Rejected: Second Circuit Rules in Favor of Fractional Licensing

By Martin Miernicki

On 19 December 2017, the Second Circuit handed down a summary order on the BMI Consent Decree in the dispute between the Department of Justice (DOJ) and Broadcast Music, Inc. (BMI). The court ruled that the decree does not oblige BMI to license the works in its repertoire on a “full-work” basis.

 

Background^[1]

ASCAP and BMI are the two largest U.S. collective management organizations (CMOs) which license performance rights in musical works. Both organizations are subject to so-called consent decrees which entered into force 2001 and 1994, respectively. In 2014, the DOJ’s Antitrust Division announced a review of the consent decrees to evaluate if these needed to be updated. The DOJ concluded the review in August 2016, issuing a closing statement. The DOJ declared that it did not intend to re-negotiate and to amend the decrees, but rather stated that it interpreted these decrees as requiring ASCAP and BMI to license their works on a “full-work” or “100 percent” basis. Under this rule, the CMOs may only offer licenses that cover all performance rights in a composition; thus, co-owned works to which they only represent a “fractional” interest cannot be licensed. In reaction to this decision, BMI asked the “rate court” to give its opinion on this matter. In September 2016, Judge Stanton ruled against the full-work licensing requirement, stating that the decree “neither bars fractional licensing nor requires full-work licensing.”

 

Decision of the court

On appeal, the Second Circuit affirmed Judge Stanton’s ruling and held that fractional licensing is compatible with the BMI Consent Decree. First, referencing the U.S. Copyright Act – 17 U.S.C. § 201(d) –, the court highlighted that the right of public performance can be subdivided and owned separately. Second, as fractional licensing was common practice at the time the decree was amended in 1994, its language does indicate a prohibition of this practice. Third, the court rejected the DOJ’s reference to Pandora Media, Inc. v. ASCAP, 785 F. 3d 73 (2d Cir. 2015) because this judgment dealt with the “partial” withdrawal of rights from the CMO’s repertoire and not with the licensing policies in respect of users. Finally, the Second Circuit considered it to be irrelevant that full-work licensing could potentially advance the procompetitive objectives of the BMI Consent Decree; rather, the DOJ has the option to amend the decree or sue BMI in a separate proceeding based on the Sherman Act.

 

Implications of the judgement

The ruling of the Second Circuit is undoubtedly a victory for BMI, but also for ASCAP, as it must be assumed that ASCAP’s decree – which is very similar to BMI’s decree – can be interpreted in a similar fashion. Unsurprisingly, both CMOs welcomed the decision. The DOJ’s reaction remains to be seen, however. From the current perspective, an amendment of the decrees appears to be more likely than a lengthy antitrust proceeding under the Sherman Act; the DOJ had already partly toned down its strict reading of the decree in the course of the proceeding before the Second Circuit. Yet, legislative efforts might produce results and influence the further developments before a final decision is made. A recent example for the efforts to update the legal framework for music licensing is the “Music Modernization Act” which aims at amending §§ 114 and 115 of the U.S. Copyright Act.

[1] For more information on the background see Transatlantic Antitrust and IPR Developments Issue No. 3-4/2016 and Issue No. 5/2016.

 

U.S. Appeals Court for the Ninth Circuit Finds Per Se Treatment Inapplicable to Tying Arrangement in the Premium Cable Services Market

By Valerio Cosimo Romano

On 19 September 2017, the U.S. Court of Appeals for the Tenth Circuit (“Appeals Court”) affirmed with a split decision the tossing by the U.S. District Court For the Western District of Oklahoma of a jury verdict in a suit alleging that a telecommunications company had illegally tied the rental of set-top boxes to its premium interactive cable services.

 

Parties and procedural history of the case

Cox Communications, Inc. (“Defendant”) operates as a broadband communications and entertainment company for residences and businesses in the United States. Its subscribers cannot access premium cable services unless they also rent a set-top box from Cox. A class of subscribers in Oklahoma City (“Plaintiffs”) sued Defendant under antitrust law, alleging that Defendant had illegally tied cable services to set-top-box rentals in violation of § 1 of the Sherman Act, which prohibits illegal restraints of trade.

The jury found that Plaintiffs had proven the necessary elements to establish a tying arrangement. However, the District Court disagreed, and determined that Plaintiffs had offered insufficient evidence for a jury to find that Cox’s tying arrangement had foreclosed a substantial volume of commerce in Oklahoma City to other sellers or potential sellers of set-top boxes in the market for set- top boxes. The District Court also concluded that Plaintiffs had failed to show anticompetitive injury.

 

Tying theory

A tie exists when a seller exploits its control in one product market to force buyers in a second market into purchasing a tied product that the buyer either didn’t want or wanted to purchase elsewhere. Usually, courts apply a per se rule to tying claims, under which plaintiffs can prevail just by proving that a tie exists. In this case, there is no need for further market analysis.

The Supreme Court determined that tying two products together disrupted the natural functioning of the markets and violated antitrust law per se. However, the Supreme Court has declared that the per se rule for tying arrangements demands a showing that the tie creates a substantial potential for impact on competition.

On the basis of Supreme Court’s precedents, lower courts have defined the elements needed to prove per se tying claims. In particular, in the Tenth Circuit, a plaintiff must show that (1) two separate products are involved; (2) the sale or agreement to sell one product is conditioned on the purchase of the other; (3) the seller has sufficient economic power in the tying product market to enable it to restrain trade in the tied product market; and (4) a ‘not insubstantial’ amount of interstate commerce in the tied product is affected. If a plaintiff fails to prove an element, the court will not apply the per se rule to the tie, but then may choose to analyze the merits of the claim under the rule of reason.

 

Legal precedents

According to the Appeals Court, legal precedents (Eastman Kodak, Microsoft) show that in some industries a per se treatment might be inappropriate.

In this regard, the Court cited a recent case from Second Circuit (Kaufman), concerning the same kind of tie by a different cable company. In Kaufman, the court thoroughly explained the reasons why the tying arrangement at issue didn’t trigger the application of the per se rule.

To start, the court explained that cable providers sell their subscribers the right to view certain contents. The contents’ producers, however, require the cable companies to prevent viewers from stealing their content. This problem is solved by set-top boxes, which enable cable providers to code their signals. However, providers do not share their codes with cable box manufacturers. Therefore, to be useful to a consumer, a cable box must be cable-provider specific.

After explaining the function of set-top boxes, the Second Circuit turned to the regulatory environment and the history of the cable industry’s use of set-top boxes. The court described the Federal Communication Commission’s (“FCC”) attempts to disaggregate set-top boxes from the delivery of premium cable, and stated that the FCC’s failure is at least partly attributable to shortcomings in the new technologies designed to make premium cable available without set-top boxes. The court also pointed out that one FCC regulation actually caps the price that cable providers can charge customers who rent set-top boxes. Under the regulation, cable companies must calculate the cost of making such set-top boxes functional and available for consumers, and must charge customers according to those costs, including only a reasonable profit in their leasing rates.

On this basis, the Second Circuit concluded that the plaintiffs’ factual allegations because they didn’t trigger the application of the per se tying rule.

 

Analysis

In our case, the discussion relates to the fourth element (affection of a ‘not insubstantial’ amount of interstate commerce in the tied product). Plaintiffs claim that this element only requires consideration of the gross volume of commerce affected by the tie, and that they met this requirement presenting undisputed evidence that Cox obtained over $200 million in revenues from renting set-top boxes during the class period. On the other side, Defendant maintains that this element requires a showing that the tie actually foreclosed some amount of commerce, or some current or potential competitor, in the market for set-top boxes.

According to the Appeals Court, recent developments in tying law validate the district court’s order and support Cox’s interpretation of tying law’s foreclosure element. Based on the Supreme Court’s tying cases and other precedents, the Appeals Court therefore concluded that Plaintiffs had failed to show that the tie has a substantial potential to foreclose competition.

The Appeals Court’s reasoning is based on four points. First, Cox does not manufacture the set-top boxes that it rents to customers. Rather, it acts as an intermediary between the set-top-box manufacturers and the consumers that use them. This means that what it does with the boxes has little or no effect on competition between set-top-box manufacturers in the set-top-box market, as they must continue to innovate and compete with each other to maintain their status as the preferred manufacturer for as many cable companies as possible. Second, because set-top-box manufacturers choose not to sell set-top boxes at retail or directly to consumers, no rival in the tied market could be foreclosed by Cox’s tie, and therefore the alleged tie does not fall within the realm of contracts in restraint of trade or commerce proscribed by § 1 of the Sherman Act. Third, all cable companies rent set-top boxes to consumers. This suggests that tying set-top-box rentals to premium cable is simply more efficient than offering them separately. Fourth, the regulatory environment of the cable industry precludes the possibility that Cox could harm competition with its tie, as the regulatory price control on the tied product makes the plaintiffs’ tying claim implausible as a whole.

The Appeals Court also argued that it does not have to apply the rule of reason unless Plaintiffs also argued that the tie was unlawful under a rule of reason analysis. However, as Plaintiffs had expressly argued that tying arrangements must be analyzed under the per se rule, the court did not address whether Defendant’s tie would be illegal under a rule of reason analysis.

 

Final outcome

The Appeals Court therefore agreed with the District Court that Plaintiffs had failed to show that Defendant’s tying arrangement foreclosed a substantial volume of commerce in the tied-product market, and therefore the tie did not merit per se condemnation. Thus, the Appeals Court affirmed the district court’s order.