march 2, 2009

"Price Squeeze" Claims Not Actionable Absent Antitrust Duty to Deal

The Supreme Court unanimously held in Pacific Bell Telephone Co. v. Linkline Communications, Inc. (decided February 25, 2009) that price squeeze claims are not cognizable absent a duty-to-deal under the antitrust laws.

The plaintiffs were internet service providers, which leased DSL facilities from AT&T at wholesale and used them to provide retail DSL service to customers.  As a condition for a recent merger, the Federal Communications Commission (“FCC”) required AT&T to provide wholesale DSL transport service to independent firms at a rate no greater than the retail price of AT&T’s own DSL service.  AT&T controls most of the “last mile” – the lines that connect individual homes and businesses to a telephone network.  In order to provide competing DSL service to residential and business customers, independent firms, such as the plaintiffs, must lease AT&T’s last mile facilities. 

Plaintiffs alleged that AT&T squeezed their profits by simultaneously raising its wholesale prices for facility access and decreasing its own retail DSL service prices.  As a result, plaintiffs claimed that these two pressures of input pricing increases and retail price discounts “excluded and unreasonably impeded competition” and allowed AT&T to “maintain its monopoly control of DSL access to the Internet.”

The Ninth Circuit held that the plaintiffs stated a potentially valid antitrust claim for price squeezing.  It distinguished a 2004 Supreme Court holding (Verizon Communications Inc. v. Law Offices of Curtis V. Trinko, 540 U.S. 398) that a firm with no antitrust duty to deal with its rivals is not obligated to offer those rivals a sufficient level of service, on the grounds that “Trinko did not involve a price squeezing theory,” which theory “formed part of the fabric of traditional antitrust law prior to Trinko.”  In Trinko, Verizon was required by statute to lease certain elements of its telecommunications network to rival firms at wholesale rates.  The plaintiffs, in that case, alleged that the poor quality of Verizon’s interconnection service prevented them from effectively competing.

In reversing the Ninth Circuit, the Supreme Court analyzed separately the upstream wholesale pricing and downstream retail pricing components of the price-squeezing claim.

First, it held that, like Trinko, the duty to deal with rivals arose from other regulation, and not from the Sherman Act.  Without any duty to deal mandated by the antitrust laws, the wholesale DSL access rates AT&T charged its rivals were no more actionable than the “insufficient assistance” Verizon provided to its rivals.  Said the Court:  “There is no reason to distinguish between price and nonprice components of a transaction.”

Further, without a duty to deal, AT&T could have simply stopped leasing its facilities and (putting the FCC order aside) not run afoul of the antitrust laws.

Second, it stated that the claim that AT&T’s retail prices were “too low” would be actionable only if its pricing was “predatory” under the standard set forth in Brooke Group v. Brown & Williamson Tobacco Corp., 509 U.S. 209 (1993):  below-cost retail prices that drive rivals out of the market and allow the monopolist to raise prices later and sufficiently recoup the temporary losses that were suffered from the earlier below-cost pricing.

Plaintiffs asserted that defendants must, nevertheless, leave them a “fair” price or “adequate margin.”  But the court dismissed such a standard as completely unworkable.  First, the relative certainty of the Brooke Group standard “avoid[s] chilling aggressive price competition.”  To the contrary, the Sherman Act encourages aggressive price competition.  Second, adopting a duty of “fairness” in dealing would force courts into the role of a regulatory agency, and they would be unable to effectively supervise such a duty.

The Court’s decision makes clear that allegations of “price-squeezing” against a vertically integrated wholesaler/retailer cannot constitute an independent antitrust violation without a duty to deal under the antitrust laws.

Finally, Plaintiffs also asked the Court for leave to amend their complaint to assert a Brooke Group predatory pricing claim.  The Court did not address this issue.  (The grant of cert in Linkline was limited to the question of whether price squeeze claims are actionable without an antitrust duty to deal.)

Plaintiffs also filed an amended complaint, which the district court concluded could be read to satisfy the Brooke Group requirements.  However, the Court noted that the district court applied a pleading standard since rejected in the case of Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007), which case calls for presentation of “enough fact to raise a reasonable expectation that discovery will reveal evidence of illegal agreement,” and should apply the Twombly standard to the amended complaint.  The Linkline case thus seems to confirm that the Twombly standard, which has been widely applied outside the antitrust context, applies in antitrust cases under Section 2 of the Sherman Act.

Federal Trade Commission Intervenes in Closed Transaction Not Subject to HSR Reporting

On February 26, 2009, the Federal Trade Commission (“FTC”) announced that it had filed a complaint against, and entered into a consent agreement with, Lubrizol Corporation (“Lubrizol”) in connection with Lubrizol’s purchase in February 2007 of certain specialty chemical assets from The Lockhart Company (“Lockhart”).  The asset purchase was not subject to the reporting and waiting period requirements under the Hart-Scott-Rodino Act (“HSR Act”).

The HSR Act requires that, subject to any applicable exemption, mergers or acquisitions that exceed a minimum jurisdictional threshold value (currently $65.2 million) be reported to the FTC and the Department of Justice (“DOJ”), and that a waiting period be observed, prior to closing.  The $15.6 million value of the Lubrizol transaction fell below that initial threshold.

Challenges to transactions valued below the minimum HSR Act threshold had been exceedingly rare until recently.  After having not challenged such a transaction since July 2006, the FTC filed a complaint on December 16, 2008 challenging Ovation Pharmaceuticals, Inc.’s January 2006 acquisition of the drug NeoProfen.  Three days later, the DOJ filed a civil antitrust lawsuit against Microsemi Corporation in connection with its acquisition of assets from Semicoa Inc., which closed in July of 2008.

The FTC complaint alleged that Lubrizol’s purchase from Lockhart of oxidates – specialty chemicals used to prevent rust or corrosion during the manufacture of metal products – violated Section 7 of the Clayton Act and Section 5 of the Federal Trade Commission Act by lessening competition in the market for rust preventatives containing oxidates.  The FTC explained that, “prior to the acquisition, Lubrizol and Lockhart dominated the market for oxidates, and, together accounted for over 98% of sales in the U.S. market for oxidates.”

The FTC took issue with a non-compete clause in the asset purchase agreement that prohibited Lockhart, from a period of five years from the date of the asset purchase, from directly or indirectly competing against the business sold to Lubrizol.  According to the complaint, Lubrizol subsequently indicated that the provision barred Lockhart from leasing its plant – the only one in the United States, other than Lubrizol’s, capable of producing quality oxidizing products – to another oxidate manufacturer.

Under the terms of the consent agreement, Lubrizol is required to transfer certain assets to Additives International LLC (“AI”), including a non-exclusive license to manufacture certain oxidates whose formulas Lubrizol had acquired from Lockhart and the right to use Lockhart’s trademarks and trade name for two years.  In addition, Lockhart must lease a portion of its plant to AI, and Lubrizol must execute a waiver of any non-compete agreements that would prevent such a lease.

This complaint provides another reminder that transactions not subject to HSR notification may still be challenged, even after they are consummated.

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If you have any questions regarding the matters covered in this Antitrust Update, please contact any of the lawyers listed below or your regular Davis Polk contact:

Paul W. Bartel, II, Partner
212-450-4760 | paul.bartel@dpw.com

Arthur J. Burke, Partner
212-450-4352 | arthur.burke@dpw.com

Joel M. Cohen, Partner
212-450-4592 | joel.cohen@dpw.com

Ronan P. Harty, Partner
212-450-4870 | ronan.harty@dpw.com

Stephen M. Pepper, Counsel
212-450-4108 | stephen.pepper@dpw.com