Innovation and Competition Policy, Ch. 2 (2d ed)

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4-23-2013
Innovation and Competition Policy, Ch. 2 (2d ed):
Complementary Products and Processes - The Law
of Tying
Herbert J. Hovenkamp
University of Pennsylvania Law School
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Tying" (2013). Faculty Scholarship. 1874.
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INNOVATION AND COMPETITION POLICY, Ch. 2 (2d ed):
COMPLEMENTARY PRODUCTS AND PROCESSES -- THE
LAW OF TYING
Herbert Hovenkamp
This book of CASES AND MATERIALS ON INNOVATION AND COMPETITION
POLICY is intended for educational use. The book is free for all to use subject to an
open source license agreement. It differs from IP/antitrust casebooks in that it
considers numerous sources of competition policy in addition to antitrust,
including those that emanate from the intellectual property laws themselves, and
also related issues such as the relationship between market structure and
innovation, the competitive consequences of regulatory rules governing technology
competition such as net neutrality and interconnection, misuse, the first sale
doctrine, and the Digital Millennium Copyright Act (DMCA). Chapters will be
updated frequently. The author uses this casebook for a three-unit class in
Innovation and Competition Policy taught at the University of Iowa College of
Law and available to first year law students as an elective. The table of contents is
as follows (click on chapter title to retrieve it):
Ch. 1: Competition Policy and the Scope of Intellectual Property Protection
Ch. 2 Complementary Products and Processes: The Law of Tying
Ch. 3 Harm to Competition or Innovation; Remedies
Ch. 4 Competition Policy and the Patent System
Ch. 5 Competition and Innovation in Copyright and the DMCA
Ch. 6 Restraints on Innovation
Ch. 7 Intellectual Property Misuse
Ch. 8 Innovation, Technology, and Anticompetitive Exclusion
Ch. 9 The Innovation Commons
Ch. 10; Post-Sale and Related Distribution Restraints Involving IP Rights
Statutory Supplement and Other Materials
© 2013. Herbert Hovenkamp
License Agreement: The Author hereby grants You a royalty-free, nonexclusive, license to (a) reproduce this Original Work in copies for any purpose
including classroom use; (b) prepare derivative works based upon the Original
Work; and (c) distribute electronic or printed copies of the Original Work and
Derivative Works to others; provided that, acknowledgement of the original author
be made on all distributions of the original or derivative works; and distribution
shall be noncommercial and without charge, except that reasonable costs of
printing and distribution may be passed on. No copyright is claimed in unedited
government or other public domain documents.
Electronic copy available at: http://ssrn.com/abstract=1940927
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INNOVATION AND COMPETITION POLICY
Cases and Materials
Herbert Hovenkamp
CHAPTER 2 (2d ed)
COMPLEMENTARY PRODUCTS AND PROCESSES: THE
LAW OF TYING
HENRY V. A. B. DICK CO.
224 U.S. 1 (1912)
Mr. Justice Lurton delivered the opinion of the court:
The facts and the questions certified, omitting the terms of the
injunction awarded by the circuit court, are these:
“This action was brought by the complainant, an Illinois corporation,
for the infringement of two letters patent, owned by the complainant,
covering a stencil-duplicating machine known as the ‘Rotary Mimeograph.’
The defendants are doing business as copartners in the city of New York.
The complainants sold to one Christina B. Skou, of New York, a Rotary
Mimeograph embodying the invention described and claimed in said patents
under license which was attached to said machine, as follows:
“This machine is sold by the A. B. Dick Company, with the license
restriction that it may be used only with the stencil, paper, ink, and other
supplies made by A. B. Dick Company.
“The defendant Sidney Henry sold to Miss Skou a can of ink suitable
for use upon said mimeograph, with knowledge of the said license
agreement, and with the expectation that it would be used in connection
with said mimeograph. The ink sold to Miss Skou was not covered by the
claims of said patent.”
The meaning and purpose of this restriction was that while the property
in the machine was to pass to the purchaser, the right to use the invention
was restricted to use with other articles required in its practical operation,
supplied by the patentee. It was stated at the bar, and appears fully in the
opinion of Judge Ray (149 Fed. 424), who decided the case in the circuit
court, that the patentee sold its machines at cost, or less, and depended upon
Electronic copy available at: http://ssrn.com/abstract=1940927
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the profit realized from the sale of other nonpatented articles adapted to be
used with the machine, and that it had put out many thousands of such
machines under the same license restriction. Such a sale, while transferring
the property right in the machine, carries with it only the right to use it for
practising the invention according to the terms of the license. To no other or
greater extent does the patentee consent to the use of the machine. When the
purchaser is sued for infringement by using the device, he may defend by
pleading, not the general and unlimited license which is carried by an
unconditional sale, but the limited license indicated by the metal tablet
annexed to the machine. If the use is not one permitted, it is plainly an
infringing use.
If, then, we assume that the violation of restrictions upon the use of a
machine made and sold by the patentee may be treated as infringement, we
come to the question of the kind of limitation which may be lawfully
imposed upon a purchaser.
To begin with, the purchaser must have notice that he buys with only a
qualified right of use. He has a right to assume, in the absence of
knowledge, that the seller passes an unconditional title to the machine, with
no limitations upon the use. Where, then, is the line between a lawful and an
unlawful qualification upon the use? This is a question of statutory
construction. But with what eye shall we read a meaning into it? It is a
statute creating and protecting a monopoly. It is a true monopoly, one
having its origin in the ultimate authority, the Constitution. Shall we deal
with the statute creating and guaranteeing the exclusive right which is
granted to the inventor with the narrow scrutiny proper when a statutory
right is asserted to uphold a claim which is lacking in those moral elements
which appeal to the normal man? Or shall we approach it as a monopoly
granted to subserve a broad public policy, by which large ends are to be
attained, and therefore to be construed so as to give effect to a wise and
beneficial purpose? That we must neither transcend the statute, nor cut
down its clear meaning, is plain. In E. Bement & Sons v. National Harrow
Co. 186 U. S. 70, 89-92, this court quoted with approval the language of
Chief Justice Marshall in Grant v. Raymond, 6 Pet. 218, 241. Concerning
the favorable view which the law takes as to the protection extended to the
exclusive right, the court, through Chief Justice Marshall, said:
“It is the reward stipulated for the advantages derived by the public
for the exertions of the individual, and is intended as a stimulus to those
exertions. The laws which are passed to give effect to this purpose
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ought, we think, to be construed in the spirit in which they have been
made; and to execute the contract fairly on the part of the United States,
where the full benefit has been actually received, if this can be done
without transcending the intention of the statute, or countenancing acts
which are fraudulent or may prove mischievous. The public yields
nothing which it has not agreed to yield, it receives all which it has
contracted to receive. The full benefit of the discovery, after its
enjoyment by the discoverer for fourteen years, is preserved; and for
his exclusive enjoyment of it during that time the public faith is
pledged.”
If the patent be for a machine, the monopoly extends to the right of
making, selling, and using, and these are separable and substantial rights. In
Bloomer v. McQuewan, 14 How. 539, 547, it is said that the grant is of “the
right to exclude everyone from making, using, or vending the thing without
the permission of the owner.” In E. Bement & Sons v. National Harrow Co.
186 U. S. 70, 90, there was involved the legality of certain contracts
between patentees of and dealers in patented harrows. The purpose and
effect of the combination and of the contracts between the parties was to fix
and keep up the prices at which licensees might sell the patented harrows. It
was claimed that the combination and contracts were obnoxious to the
Sherman act; but, upon the other side, it was said that as the contracts
concerned only the sale of patented articles, that that act did not apply. The
character of the monopoly granted under the patent act was therefore
involved….
Now, if this was a suit to recover damages upon the contract not to use
the machine except in connection with other articles proper in its use, made
by the patentee, the only possible defense would be that the agreement was
one contrary to public policy, in that it affected freedom in the sale of such
articles to the user of such machines. But that was the nature of the defense
made to the suit to enforce the agreements under consideration in the
Bement Case. The court in that case found that the contracts did include
interstate commerce within their provisions and restrained interstate trade,
but with reference to the Sherman act:
“But that statute clearly does not refer to that kind of a restraint of
interstate commerce which may arise from reasonable and legal conditions
imposed upon the assignee or licensee of a patent by the owner thereof,
restricting the terms upon which the article may be used and the price to be
demanded therefor. Such a construction of the act, we have no doubt, was
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never contemplated by its framers.”
As to whether the restrictions upon sales imposed by the agreements
were “legal and reasonable conditions,” the court said:
“The provision in regard to the price at which the licensor would
sell the article manufactured under the license was also an appropriate
and reasonable condition. It tended to keep up the price of the
implements manufactured and sold, but that was only recognizing the
nature of the property dealt in, and providing for its value so far as
possible. This the parties were legally entitled to do. The owner of a
patented article can, of course, charge such price as he may choose, and
the owner of a patent may assign it or sell the right to manufacture and
sell the article patented upon the condition that the assignee shall
charge a certain amount for such article.”
If the stipulation in an agreement between patentees and dealers in
patented articles, which, among other things, fixed a price below which the
patented articles should not be sold, would be a reasonable and valid
condition, it must follow that any other reasonable stipulation, not
inherently violative of some substantive law, imposed by a patentee as part
of a sale of a patented machine, would be equally valid and enforceable. It
must also follow that if the stipulation be one which qualifies the right of
use in a machine sold subject thereto, so that a breach would give rise to a
right of action upon the contract, it would be at the same time an act of
infringement, giving to the patentee his choice of remedies.
But it has been very earnestly said that a condition restricting the buyer
to use it only in connection with ink made by the patentee is one of a
character which gives to a patentee the power to extend his monopoly so as
to cause it to embrace any subject, not within the patent, which he chooses
to require that the invention shall be used in connection with. Of course, the
argument does not mean that the effect of such a condition is to cause things
to become patented which were not so without the requirement. The stencil,
the paper, and the ink made by the patentee, will continue to be unpatented.
Anyone will be as free to make, sell, and use like articles as they would be
without this restriction, save in one particular,—namely, they may not be
sold to a user of one of the patentee’s machines with intent that they shall be
used in violation of the license. To that extent competition in the sale of
such articles, for use with the machine, will be affected; for sale to such
users for infringing purposes will constitute contributory infringement. But
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the same consequence results from the sale of any article to one who
proposes to associate it with other articles to infringe a patent, when such
purpose is known to the seller. But could it be said that the doctrine of
contributory infringement operates to extend the monopoly of the patent
over subjects not within it because one subjects himself to the penalties of
the law when he sells unpatented things for an infringing use? If a patentee
says, “I may suppress my patent if I will. I may make and have made
devices under my patent, but I will neither sell nor permit anyone to use the
patented things,” he is within his right, and none can complain. But if he
says, “I will sell with the right to use only with other things proper for using
with the machines, and I will sell at the actual cost of the machines to me,
provided you will agree to use only such articles as are made by me in
connection therewith,”—if he chooses to take his profit in this way, instead
of taking it by a higher price for the machines, has he exceeded his
exclusive right to make, sell, and use his patented machines? The market for
the sale of such articles to the users of his machine, which, by such a
condition, he takes to himself, was a market which he alone created by the
making and selling of a new invention. Had he kept his invention to
himself, no ink could have been sold by others for use upon machines
embodying that invention. By selling it subject to the restriction, he took
nothing from others and in no wise restricted their legitimate market.
For the purpose of testing the consequence of a ruling which will
support the lawfulness of a sale of a patented machine for use only its
connection with supplies necessary for its operation, bought from the
patentee, many fanciful suggestions of conditions which might be imposed
by a patentee have been pressed upon us. Thus it is said that a patentee of a
coffee pot might sell on condition that it be used only with coffee bought
from him, or, if the article be a circular saw, that it might be sold on
condition that it be used only in sawing logs procured from him. These and
other illustrations are used to indicate that this method of marketing a
patented article may be carried to such an extent as to inconvenience the
public and involve innocent people in unwitting infringements. But these
illustrations all fail of their purpose, because the public is always free to
take or refuse the patented article on the terms imposed. If they be too
onerous or not in keeping with the benefits, the patented article will not find
a market. The public, by permitting the invention to go unused, loses
nothing which it had before, and when the patent expires will be free to use
the invention without compensation or restriction. This was pointed out in
the Paper Bag Case, where the inventor would neither use himself nor allow
others to use, and yet was held entitled to restrain infringement, because he
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had the exclusive right to keep all others from using during the life of the
patent. This larger right embraces the lesser of permitting others to use upon
such terms as the patentee chooses to prescribe. It must not be forgotton
[sic] that we are dealing with a constitutional and statutory monopoly. An
attack upon the rights under a patent because it secures a monopoly to
make, to sell, and to use, is an attack upon the whole patent system. We are
not at liberty to say that the Constitution has unwisely provided for granting
a monopolistic right to inventors, or that Congress has unwisely failed to
impose limitations upon the inventor’s exclusive right of use. And if it be
that the ingenuity of patentees in devising ways in which to reap the benefit
of their discoveries requires to be restrained, Congress alone has the power
to determine what restraints shall be imposed. As the law now stands it
contains none, and the duty which rests upon this and upon every other
court is to expound the law as it is written. Arguments based upon
suggestions of Public policy not recognized in the patent laws are not
relevant. The field to which we are invited by such arguments is legislative,
not judicial. The decisions of this court, as we have construed them, do not
so limit the privilege of the patentee, and we could not so restrict a patent
grant without overruling the long line of judicial decisions from circuit
courts and circuit courts of appeal, heretofore cited, thus inflicting
disastrous results upon individuals who have made large investments in
reliance upon them.
The conclusion we reach is that there is no difference, in principle,
between a sale subject to specific restrictions as to the time, place, or
purpose of use, and restrictions requiring a use only with other things
necessary to the use of the patented article purchased from the patentee. If
the violation of the one kind is an infringement, the other is also. That a
violation of any such restriction annexed to a sale by one with notice
constitutes an infringing use has been decided by a great majority of the
circuit courts and circuit courts of appeal, and has come to be a wellrecognized principle in the patent law, in accordance with which vast
transactions in respect to patented articles have been conducted. But it is
now said that the numerous decisions by the lower courts have been
erroneous in respect to the proper construction of the limit of the monopoly
conferred by a patent, and that they should now be overruled. To these
courts has been committed the duty of interpreting and administering the
patent law. There is no power in this court to review their judgments, except
upon a writ of certiorari, or to direct their decisions, save through a certified
interrogatory for direction upon a question of law. This power to review by
certiorari is one which has been seldom exercised in patent cases. A line of
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decisions which has come to be something like a rule of property, under
which large businesses have been conducted, should at least not be
overruled except upon reasons so clear as to make any other construction of
the patent law inadmissible….
Mr. Chief Justice White, with whom concurred Mr. Justice Hughes and
Mr. Justice Lamar, dissenting:
. . . [T]he ink was not covered by the patent; indeed, it is stated in
argument, and not denied, that a prior patent which covered the ink had
expired before the sale in question. It therefore results that a claim for the
ink could not have been lawfully embraced in the patent, and if it had been
by inadvertence allowed, such claim would not have been enforceable. This
curious anomaly, then, results, that that which was not embraced by the
patent, which could not have been embraced therein, and which, if
mistakenly allowed and included in an express claim, would have been
inefficacious, is now, by the effect of a contract, held to be embraced by the
patent and covered by the patent law. …
The exclusive right of use of the invention embodied in the machine
which the patent protected was a right to use it anywhere and everywhere,
for all and every purpose of which the machine, as embraced by the patent,
was susceptible. The patent was solely upon the mechanism which, when
operated, was capable of producing certain results. A patent for this
mechanism was not concerned in any way with the materials to be used in
operating the machine, and certainly the right protected by the patent was
not a right to use the mechanism with any particular ink or other operative
materials. Of course, as the owner of the machine possessed the ordinary
right of an owner of property to use such materials as he pleased in
operating his patented machine, and had the power in selling his machine to
impose such conditions in the nature of covenants not contrary to public
policy as he saw fit, I shall assume that he had the power to exact that the
purchaser should use only a particular character of materials. But as the
right to employ any desired operative materials in using the patented
machine was not a right derived from or protected by the patent law, but
was a mere right arising from the ownership of property, it cannot be said
that the restriction concerning the use of the materials was a restriction upon
the use of the machine protected by the patent law. When I say it cannot be
said, I mean that it cannot be so done in reason, since the inevitable result of
so doing would be to declare that the patent protected a use which it did not
embrace. And this, after all, serves to demonstrate that it is a misconception
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to qualify the restriction as one on the use of the machine, when in truth,
both in form and substance, it was but a restriction upon the use of materials
capable of being employed in operating the machine. In other words, every
use which the patent protected was transferred to Miss Skou, and the very
existence of the particular restriction under consideration presupposes such
right of complete enjoyment, and because of its possession there was
engrafted a contract restriction, not upon the use of the machine, but upon
the materials. And these considerations are equally applicable to the
exercise of the exclusive right to vend protected by the patent unless it can
be said that, by the act of selling a patented machine, and disposing of all
the use of which it is capable, a patentee is endowed with the power to
amplify his patent by causing it to cover in the future things which, at the
time of the sale, it did not embrace.
But the result of this analysis serves at once again to establish, from
another point of view, that the ruling now made in effect is that the patentee
has the power, by contract, to extend his patent rights so as to bring within
the claims of his patent things which are not embraced therein, thus
virtually legislating by causing the patent laws to cover subjects to which,
without the exercise of the right of contract, they could not reach, the result
not only to multiply monopolies at the will of an interested party, but also to
destroy the jurisdiction of the state courts over subjects which, from the
beginning, have been within their authority….
Again, a curious anomaly would result from the doctrine. The law, in
allowing the grant of a patent to the inventor, does not fail to protect the
rights of society; on the contrary, it safeguards them. The power to issue a
patent is made to depend upon considerations of the novelty and utility of
the invention. and the presence of these prerequisites must be ascertained
and sanctioned by public authority; and although this authority has been
favorably exerted, yet, when the rights of individuals are concerned, the
judicial power is then open to be invoked to determine whether the
fundamental conditions essential to the issue of the patent existed. Under
the view now maintained of the right of a patentee by contract to extend the
scope of the claims of this patent, it would follow that the incidental right
would become greater than the principal one, since by the mere will of the
party rights by contract could be created, protected by the patent law,
without any of the precautions for the benefit of the public which limit the
right to obtain a patent…..
For these reasons I therefore dissent.
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NOTES AND QUESTIONS
1.
In Heaton-Peninsular Button-Fastener Co. v. Eureka Specialty Co.,
77 F. 288 (6th Cir. 1896), the Sixth Circuit Court of Appeals refused to
condemn a similar variable proportion tying arrangement involving a
machine that fastened buttons to garments and the “staples” that were used
to do the fastening. Judge Lurton—at the time still on the Sixth Circuit
bench, with later to be Chief Justice Taft sitting on the panel—wrote for the
court:
What we are asked to do is to mark a . . . boundary line
around the patentee’s monopoly, which will debar him from
engrossing the market for an article not the subject of a
patent. To do this, we are asked to say that he cannot license
others to use his invention on condition that they shall use it
only in conjunction with a nonpatentable article made by
himself. The only reason suggested for this limitation upon
his right to define the terms upon which others may use his
invention is that a monopoly in the unpatented article may
thereby be created. Upon what authority are we to
circumscribe the exercise of the privileges awarded a
patentee? In considering any question in respect of restraints
upon the liberty of contracting, imposed by principles of
public policy, we should bear in mind that very high
considerations of public policy are involved in the
recognition of a wide liberty in the making of contracts. This
caution was well expressed by Sir George Jessell in
Registering Co. v. Sampson, L.R. 19 Eq. 462–465, who said:
“It must not be forgotten that you are not to extend arbitrarily
those rules which say that a given contract is against public
policy, because, if there is one thing which, more than
another, public policy requires, it is that men of full age and
competent understanding shall have the utmost liberty of
contracting, and that their contracts, when entered into freely
and voluntarily, shall be held sacred, and shall be enforced
by courts of justice. Therefore you have this paramount
public policy to consider,— that you are not lightly to
interfere with this freedom of contract.”
. . . If the patentee choose to reserve to himself the
exclusive use of his device, and the invention be of a wide
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character, and so radical as to enable him to make and sell an
unpatentable product cheaper than any other competitor, a
practical monopoly of the market for that article will result;
and yet no one could say that a monopoly thus secured was
illegitimate, or obnoxious to public policy. To illustrate: Let
it be supposed that the patents owned by this complainant
were of so wide a character as to cheapen the process of
manufacturing shoes, and to drive from competition all other
modes of manufacture. Then suppose the patentees were of
opinion that they could most profitably enjoy their
inventions by retaining the monopoly of the use, and
engaging in the manufacture of shoes. If content to undersell
all others, they could engross the market for shoes, to the
extent of their capacity to supply the demand during the life
of their patents, or so long as their invention was not
superseded by subsequent inventions still further cheapening
the cost of manufacture. The monopoly thus secured would
be the legitimate consequence of the meritorious character of
their invention. Yet just such monopolies may result
whenever a new and surprising advance is made in some art
of wide and general use. The great consuming public would
be benefited, rather than injured, for the monopoly could
endure so long only as shoes were supplied at a less price
than had prevailed before the invention. Now, if the
patentees, by retaining to themselves the exclusive use of
their invention, are able, legitimately and lawfully, to acquire
a monopoly of the manufacture of shoes, and destroy the
shoe market for those who before had shared it, why may
they not, by a system of restricted licenses, permit others to
use their devices on condition that only some minor part of
the shoe,—the pegs, the tips, the thread, or the buttons, or the
button fasteners,—shall be bought from them? If these
concessions were such as to enable others to compete,
though their use of the mechanism was restricted by the
terms of the license, who could justly complain if the
inventors, content with a monopoly of the market for the
article named in their license, surrendered the opportunity for
a monopoly of the manufacture of the complete shoe? The
device protected by the patents owned by complainant is of
no such wide or radical character as that used for purposes of
illustration. Yet there is no appreciable difference in the legal
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principles applicable to the supposed facts used for
illustration, and those stated on the face of the complainant’s
bill. The fact which has affected the makers of wire staples
for shoe manufacturing is the invention of a machine which,
by its simplicity, superior capabilities, its cheapness and
accuracy, has practically driven all other methods of
fastening buttons to shoes out of use. The older and clumsier
methods, on the allegations of the bill, have been completely
superseded. From this invention there results a large market
for wire staples, adapted in size and shape to use with the
new mechanism, and a second consequence is the complete
cessation of the demand for button fasteners not adapted to
be used with complainant’s machine. To supply staples
adapted to meet this new demand becomes a matter of
moment to those engaged in the business of making wire
button fasteners. The inventions covered by complainant’s
patents are not of such character as to enable them, by
retaining the exclusive use, to absorb either the making of
shoes, or the minor work of fastening buttons to shoes. In the
exercise of the right of exclusive use, they have put on the
market a structure embodying their devices, and licensed the
purchaser to use the invention “only with staples” made by
themselves. In other words, they have chosen to fix the price
for the right of use at the profit resulting from the sale of
staples. As observed by counsel for complainant, “The
fasteners are thus made the counters by which the royalty
proportioned to the actual use of the machine is determined.”
This method of licensing their mechanism may or may not
result in the engrossment of the market for staples. So long
as their invention controls the market for button-fastening
appliances, and to the extent that their machines shall
supersede other modes of clinching staples, just so long will
they be enabled to control the market for staples. Their
monopoly in an unpatented article will depend upon the
merit of their patented device, and the extent to which other
clinching devices are superseded by it. In the last analysis,
the invention destroyed the demand for sizes and shapes of
staples not adapted to use with the machine of complainant,
and the monopoly of the use awarded by the patents
destroyed the market for staples fitted for use in
complainant’s machines. The monopoly in the unpatented
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staple results as an incident from the monopoly in the use of
complainant’s invention, and is therefore a legitimate result
of the patentee’s control over the use of his invention by
others. Depending, as such a monopoly would, upon the
merits of the invention to which it is a mere incident, it is
neither obnoxious to public policy, nor an illegal restraint of
trade.
The Sixth Circuit also rejected the argument that a breach of contract
suit for damages would be an adequate remedy:
The bill discloses that more than 49,000 machines are in
use, and charges a long-continued infringement, and a
purpose to continue therein. Under the circumstances, it must
be evident that, both upon the ground of avoiding a
multiplicity of lawsuits, and upon the general and apparent
inadequacy of a suit at law for damages, either against the
infringer who infringes by an unauthorized use, or those who
actively contribute to that infringement, a court of equity has
jurisdiction. An action at law for the character of continuing
trespass alleged by complainant would be grossly inadequate
to protect the patents from invasion. If the complainant has
the right to reserve a control over the us`e in the manner
stated in its bill, then its machines, to the extent it has
reserved such control, are within the monopoly of the
patents. If its licenses do not infringe public policy, but are
within the privileges awarded by the patents, then it must
follow that the case presented should be accorded relief by
injunction restraining the acts complained of. A court of
equity has the power, independently of any other relief, to
restrain the continuing infringement of a patent.
For further discussion of the problem of breach of contract suits
vs. infringement suits in order to enforce aftermarket restraints such
as ties, see Chapter ten; and CHRISTINA BOHANNAN & HERBERT
HOVENKAMP, CREATION WITHOUT RESTRAINT: PROMOTING LIBERTY
AND RIVALRY IN INNOVATION, Ch. 13 (2011).
2. The court emphasizes that a precondition to contributory
infringement or infringement for failure to follow the tying
condition is that the buyer have actual knowledge of the restriction.
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This is an important difference between contributory infringement
and patent infringement generally, which does not require that the
infringer have notice of the patent being infringed.
NOTE: VARIABLE PROPORTION TIES: PRICE
DISCRIMINATION AND WELFARE EFFECTS
Sellers often use variable proportion ties such as the one in Henry in
order to engage in a kind of price discrimination.1 Such ties benefit some
customers but injure others; on balance they are probably beneficial in most
cases. As a result there is no warrant for condemning them categorically
under the antitrust laws. But price discrimination is not easy. To do it
profitably sellers must (1) have some control over price—i.e., some market
power; (2) separate consumers into discrete groups with different
reservation prices; and (3) prevent arbitrage—low-price consumers
reselling to high-price consumers.
In the standard economic analysis, there are three kinds of price
discrimination. ARTHUR CECIL PIGOU, THE ECONOMICS OF WELFARE §
II.17.5 (4th ed. 1932). First-degree, or ‘perfect,’ price discrimination
involves selling each unit of a good at the highest price any consumer is
willing to pay for that unit.
Perfect price discrimination leaves no
consumer surplus and instead gives all gains to the sellers. Sellers would
love to do this, but first-degree price discrimination is virtually impossible
because there is no practical way for a seller to discover the highest price
each consumer will pay for its goods or services.
By contrast, second- and third-degree price discrimination are common.
In third-degree price discrimination, a seller divides its customers into
discrete groups based on observations about their willingness to pay and
charges each group a unique price. For example, A. B. Dick could divide
its customers into students and nonstudents and sell its mimeographs to
students for $80 and nonstudents for $100. This pricing scheme would
allow A. B. Dick to sell mimeographs to students who would not buy if the
company had to charge all consumers the same monopoly price, which
would probably fall somewhere between $80 and $100. On the other hand,
1
See Herbert Hovenkamp & Erik Hovenkamp, Tying Arrangements and
Antitrust Harm, 52 ARIZ.L.REV. 925, 943-950 (2010). For a contrary
argument, to the effect that variable proportion ties may discourage
innovation in the tied market, see Christopher R. Leslie, Patent Tying, Price
Discrimination, and Innovation, 77 Antitrust L.J. 811 (2011).
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the scheme excludes nonstudents who would pay more than $80 but less
than $100—even nonstudents who would pay more than the
nondiscriminatory monopoly price.
As a result, third-degree price
discrimination tends to take some goods out of the hands of consumers who
value them more and puts them into the hands of consumers who value
them less.
In second-degree price discrimination, sellers offer all consumers the
same price schedule, with different unit prices corresponding to different
quantities or product varieties. Consumers then segregate themselves by
selecting the price and quantity/variety they prefer. A. B. Dick’s
mimeograph tie-in is a classic example of second-degree price
discrimination known as a variable-proportion tie, in which different
consumers use different amounts of the tied product.2 In another case the
defendant sold its patented refrigeration box on the condition that customers
use only the seller’s dry ice.3 These firms are engaging in a type of second
degree price discrimination by dropping the price of the primary, or tying,
good, and increasing the price of a tied good.4 The firm then earns a higher
return from those who purchase a great deal of the tied good than from
those who purchase smaller amounts. Such tying arrangements have
produced voluminous private antitrust litigation.5 These cases are also
ubiquitous in the franchise industry, where variable proportion tying is a
common mechanism for reducing franchisee entry costs and enlarging
franchisor profits through price discrimination. The price of the franchise
(the tying product) is often zero, but is in any event much lower than the
standalone value of the franchise. For example, a nondominant franchisor
2
See 9 PHILLIP E. AREEDA & HERBERT HOVENKAMP, ANTITRUST LAW
¶1711 (3d ed. 2011).
3
Henry v. A.B. Dick & Co., 224 U.S. 1 (1912); Carbice Corp. v. Am.
Patents Dev. Corp., 283 U.S. 27 (1931) (same, tying patented refrigeration
box and dry ice).
4
E.g. Xerox Corp. v. Media Sciences, Inc., 660 F. Supp. 2d 535, 539
(S.D.N.Y. 2009) (printer/ink tie – “As is true of other printer manufacturers,
Xerox generally sells its printers at a low margin or a loss, hoping to earn a
profit through later sales of high margin ink”).
5
See Static Control Components, Inc. v. Lexmark Intern., Inc., 487
F.Supp.2d 861 (E.D.Ky. 2007) (denying summary judgment on claim of
tying printers and print cartridges via technological tie); In re Apple
iPod/iTunes Anttrust Litigation, 2010 WL 2629907 (N.D.Cal. June 29,
2010) (denying summary judgment on claim that Apple unlawfully tied its
iTunes media library to various Apple devices).
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may give franchises to firms at no charge but then tie food products or other
consumables and place an overcharge on these.6 Once again, the franchisor
earns more from higher volume franchises.
Figure One
Figure one illustrates the complex consumer impact of variable
proportion ties. The vertical axis measures consumers’ surplus, while the
horizontal axis measures the number of tied units that the consumer
purchases. The solid line gives consumers’ surplus under tying and the
dotted line without tying. Consumers are divided into three categories
arrayed along the horizontal axis.7 The low preference category consists of
6
E.g., Siegel v. Chicken Delight, 448 F.2d 43, 46-47 (9th Cir. 1971),
cert. denied, 405 U.S. 955 (1972) (franchise fee of zero, tying consumable
products at overcharge).
7
They are actually divided into four categories. At the extreme left next
to the origin the unnamed space consists of consumers who do not even
purchase the tying product at the reduced price under the tying arrangement.
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consumers who would not be in the market at all at standalone pricing, but
who enter the market in response to the tying product price cut. For
example, a firm selling computer printers at a standalone price of $400
might cut the price to $200, but then charge $20 for an ink cartridge that
would otherwise sell for $10. For these low preference consumers the tie is
an unqualified welfare gain, because they would not be in the market at all
under single product pricing. The magnitude of their gains depends on the
size of the printer output increase in response to the price cut, and this can
be very large when the demand curve is convex to the origin and is fairly
shallow in the higher output reaches.
The middle group of customers consists of those who would have
been in the market under standalone pricing, but for them the price decrease
in the printer is greater than the price increase in the cartridges. For
example, if someone in our illustration used fewer than 20 printer cartridges
over the printer’s lifetime he or she would come out ahead under tying.8
The size of this group depends on a number of factors. One factor is the
durability of the tying product and the amount of tied product used during
its lifetime. Another is whether the tie is air tight. For example, many
printer manufacturers attempt to tie cartridges but their success is limited to
the extent that customers or third parties can refill cartridges or produce
generics.9 A third factor is the depth of the tying product price cut and the
height of the tied product price increase.
The third group of “high” intensity buyers are made worse off by the
tie. They are the ones that use more than twenty cartridges in our
illustration. As a result the higher cartridge prices more than offset the
Since they are out of the market under both tying and independent sales,
they are indifferent to the tie.
8
A user of nineteen cartridges over the lifetime of the printer would
spend $190 additional on cartridges but would have saved $200 on the
printer itself.
9
This is a principal issue in the ongoing Lexmark litigation, cited above,
in which Lexmark attempted to use a microprocessor that required the
printer to be able to “read” a particular cartridge before it would work, but
third parties were able to emulate the microprocessor. See Lexmark Intern.,
Inc. v. Static Control Components, Inc., 387 F.3d 522 (6th Cir. 2004) (third
party’s evasion of microprocessor lock very likely did not violate the
Digital Millennium Copyright Act, which can bar the circumvention of
technological locks on copyrighted material).
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lower printer price.
Whether consumers in the aggregate are better or worse off would
be extraordinarily difficult to assess. Further, two additional elements of
consumer benefit may need to be considered. First, for a manufactured
good such as a printer there are likely to be economies of scale in
production that enable the manufacturer to achieve lower costs at higher
volume. Conceivably even the high preference users could be better off if
the tie plus printer price cut brings enough new customers into the market.
Second, if both the tying and tied good are sold in markets that are
not strongly competitive the tie is likely to eliminate a certain amount of
double marginalization, which occurs when two sellers supply vertically
related or complementary goods that are consumed together and each of
them has some market power.10 If the firms are unable to coordinate their
output by selling it together, then each will charge a higher price than a
single firm would charge if it sold both goods together. The elimination of
double marginalization by tying will benefit all consumers if the two goods
are perfect complements -- that is, if each of them has no value without the
other. If they are only imperfect complements, however, then the story is
more complex. For those customers who want both the tying and tied good,
the tie should result in a price reduction and a consumer benefit. However,
customers that do not want the tied good at all will be worse off because
any positive price whatsoever for the tied good injures them. For that
reason a bundled discount may be preferable for tying of imperfect
complements. For example, suppose A & B are imperfect complements.
80% of customers want both, but 20% want only A. The separate prices for
A and B are $10 and $5, but by eliminating double marginalization a seller
can earn more by selling the combination for, say, $12. In that case it can
offer the combination to customers who want it, thus benefitting them and
increasing its own profits. But it can also continue selling good A for the
original price of $10. In this way a bundled discount can benefit the seller
10
On double marginalization in tying, see CHRISTINA BOHANNAN &
HERBERT HOVENKAMP, CREATION WITHOUT RESTRAINT: PROMOTING
LIBERTY AND RIVALRY IN INNOVATION, ch. 2 (2011); Hovenkamp &
Hovenkamp, Tying Arrangements and Antitrust Harm, 52 ARIZ.L.REV. at
958-961. In the case of complementary products the theory of double
marginalization is sometimes referred to as “Cournot Complements,”
because Cournot applied his theory of oligopoly pricing to producers of
complements as well as competitors.
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by permitting it to earn more on the tied combination, and also benefit the
buyers who want both goods by giving them a lower price. The buyers who
want only good A are neither better nor worse off. See Erik Hovenkamp &
Herbert Hovenkamp, Tying Arrangements, OXFORD INTERNATIONAL
HANDBOOK OF COMPETITION POLICY (2012).
MOTION PICTURE PATENTS CO. V. UNIVERSAL FILM
MANUFACTURING CO.
243 U.S. 502 (1917)
Mr. Justice Clarke delivered the opinion of the court:
… Evidence which is undisputed shows that the plaintiff, on June 20,
1912, in a paper styled “License Agreement,” granted to the Precision
Machine Company a right and license to manufacture and sell machines
embodying the inventions described and claimed in the patent in suit….
This agreement contains a covenant … that to each machine sold [the
grantee] will attach a plate showing plainly not only the dates of the letters
patent under which the machine is “licensed,” but also the following words
and figures:
“The sale and purchase of this machine gives only the
right to use it solely with moving pictures containing the
invention of reissued patent No. 12,192, leased by a licensee
of the Motion Picture Patents Company, the owner of the
above patents and reissued patent, while it owns said patents,
and upon other terms to be fixed by the Motion Picture
Patents Company and complied with by the user while it is in
use and while the Motion Picture Patents Company owns
said patents. The removal or defacement of this plate
terminates the right to use this machine.”
. . . On January 18, 1915 … the plaintiff addressed a letter to the
defendant Universal Film Exchange, notifying it that it … was infringing
the same patents by supplying films for use upon the machine of the
Seventy-second street playhouse and elsewhere….
It was admitted at the bar that 40,000 of the plaintiff’s machines are
now in use in this country, and that the mechanism covered by the patent in
suit is the only one with which motion picture films can be used
successfully.
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…. It is obvious that in this case we have presented anew the inquiry,
which is arising with increasing frequency in recent years, as to the extent
to which a patentee or his assignee is authorized by our patent laws to
prescribe by notice attached to a patented machine the conditions of its use
and the supplies which must be used in the operation of it, under pain of
infringement of the patent.
The statutes relating to patents do not provide for any such notice and it
can derive no aid from them…..
The extent to which the use of the patented machine may validly be
restricted to specific supplies or otherwise by special contract between the
owner of a patent and the purchaser or licensee is a question outside the
patent law, and with it we are not here concerned.
The inquiry presented by this record, as we have stated it, is important
and fundamental, and it requires that we shall determine the meaning of
Congress when, in Rev. Stat. § 4884, Comp. Stat. 1913, § 9428, it provided
that “every patent shall contain . . . a grant to the patentee, his heirs or
assigns, for the term of seventeen years, of the exclusive right to make, use,
and vend the invention or discovery throughout the United States, and the
territories thereof.” We are concerned only with the right to “use,”
authorized to be granted by this statute, for it is under warrant of this right
only that the plaintiff can and does claim validity for its warning notice….
In interpreting this language of the statute it will be of service to keep
in mind three rules long established by this court, applicable to the patent
law and to the construction of patents, viz.:
1st. The scope of every patent is limited to the invention described in
the claims contained in it, read in the light of the specification. These so
mark where the progress claimed by the patent begins and where it ends that
they have been aptly likened to the description in a deed, which sets the
bounds to the grant which it contains. It is to the claims of every patent,
therefore, that we must turn when we are seeking to determine what the
invention is, the exclusive use of which is given to the inventor by the grant
provided for by the statute,—“He can claim nothing beyond them.”
2d. It has long been settled that the patentee receives nothing from the
law which he did not have before, and that the only effect of his patent is to
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restrain others from manufacturing, using, or selling that which he has
invented. The patent law simply protects him in the monopoly of that which
he has invented and has described in the claims of his patent.
3d. Since Pennock v. Dialogue, 2 Pet. 1, 7 L. ed. 327, was decided in
1829, this court has consistently held that the primary purpose of our patent
laws is not the creation of private fortunes for the owners of patents, but is
“to promote the progress of science and the useful arts” (Constitution, art. 1,
§ 8),—an object and purpose authoritatively expressed by Mr. Justice Story,
in that decision, saying:
“While one great object [of our patent laws] was, by holding out a
reasonable reward to inventors and giving them an exclusive right to
their inventions for a limited period, to stimulate the efforts of genius,
the main object was ‘to promote the progress of science and useful
arts.’”…
These rules of law make it very clear that the scope of the grant which
may be made to an inventor in a patent, pursuant to the statute, must be
limited to the invention described in the claims of his patent; and to
determine what grant may lawfully be so made we must hold fast to the
language of the act of Congress providing for it, which is found in two
sections of the Revised Statutes. Section 4886 (Comp. Stat. 1913, § 9430)
provides that “any person who has invented or discovered any new and
useful art, machine, manufacture or composition of matter, or any new and
useful improvement thereof, . . . may . . . obtain a patent therefor;” and §
4884 (Comp. Stat. 1913, § 9428), provides that such patent when obtained
“shall contain . . . a grant to the patentee, his heirs or assigns . . . of the
exclusive right to . . . use . . . the invention or discovery.”…
Plainly, this language of the statute and the established rules to which
we have referred restrict the patent granted on a machine, such as we have
in this case, to the mechanism described in the patent as necessary to
produce the described results. It is not concerned with and has nothing to do
with the materials with which or on which the machine operates. The grant
is of the exclusive right to use the mechanism to produce the result with any
appropriate material, and the materials with which the machine is operated
are no part of the patented machine or of the combination which produces
the patented result. The difference is clear and vital between the exclusive
right to use the machine, which the law gives to the inventor, and the right
to use it exclusively with prescribed materials to which such a license notice
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as we have here seeks to restrict it. The restrictions of the law relate to the
useful and novel features of the machine which are described in the claims
of the patent; they have nothing to do with the materials used in the
operation of the machine; while the notice restrictions have nothing to do
with the invention which is patented, but relate wholly to the materials to be
used with it. Both in form and in substance the notice attempts a restriction
upon the use of the supplies only, and it cannot, with any regard to propriety
in the use of language, be termed a restriction upon the use of the machine
itself.
Whatever the right of the owner may be to control by restriction the
materials to be used in operating the machine, it must be a right derived
through the general law from the ownership of the property in the machine,
and it cannot be derived from or protected by the patent law, which allows a
grant only of the right to an exclusive use of the new and useful discovery
which has been made,—this and nothing more….
The construction of the patent law which justifies as valid the
restriction of patented machines, by notice, to use with unpatented supplies
necessary in the operation of them, but which are no part of them, is
believed to have originated in Heaton-Peninsular Button-Fastener Co. v.
Eureka Specialty Co., 77 Fed. 288 (which has come to be widely referred to
as the Button-Fastener Case), decided by the circuit court of appeals of the
sixth circuit in 1896. In this case the court, recognizing the pioneer
character of the decision it was rendering speaks of the “novel restrictions”
which it is considering, and says that it is called upon “to mark another
boundary line around the patentee’s monopoly which will debar him from
engrossing the market for an article not the subject of a patent,” which it
declined to do.
This decision proceeds upon the argument that, since the patentee may
withhold his patent altogether from public use, he must logically and
necessarily be permitted to impose any conditions which he chooses upon
any use which he may allow of it. The defect in this thinking springs from
the substituting of inference and argument for the language of the statute,
and from failure to distinguish between the rights which are given to the
inventor by the patent law and which he may assert against all the world
through an infringement proceeding, and rights which he may create for
himself by private contract, which, however, are subject to the rules of
general, as distinguished from those of the patent, law. While it is true that
under the statutes as they were (and now are) a patentee might withhold his
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patented machine from public use, yet if he consented to use it himself or
through others, such use immediately fell within the terms of the statute,
and, as we have seen, he is thereby restricted to the use of the invention as it
is described in the claims of his patent, and not as it may be expanded by
limitations as to materials and supplies necessary to the operation of it,
imposed by mere notice to the public.
The high standing of the court rendering this decision and the obvious
possibilities for gain in the method which it approved led to an immediate
and widespread adoption of the system, in which these restrictions
expanded into more and more comprehensive forms until at length the case
at bar is reached, with a machine sold and paid for, yet claimed still to be
subject not only to restriction as to supplies to be used, but also subject to
any restrictions or conditions as to use or royalty which the company which
authorized its sale may see fit, after the sale, from time to time to impose.
The perfect instrument of favoritism and oppression which such a system of
doing business, if valid, would put into the control of the owner of such a
patent, should make courts astute, if need be, to defeat its operation. If these
restrictions were sustained, plainly the plaintiff might, for its own profit or
that of its favorites, by the obviously simple expedient of varying its royalty
charge, ruin anyone unfortunate enough to be dependent upon its
confessedly important improvements for the doing of business…..
The exclusive right to “vend” a patented article is derived from the
same clause of the section of the statute which gives the exclusive right to
“use” such an article, and following the decision of the Button-Fastener
Case, it was widely contended as obviously sound, that the right existed in
the owner of a patent to fix a price at which the patented article might be
sold and resold under penalty of patent infringement…. The statutory
authority to grant the exclusive right to “use” a patented machine is not
greater, indeed, it is precisely the same, as the authority to grant the
exclusive right to “vend,” and, looking to that authority, for the reasons
stated in this opinion, we are convinced that the exclusive right granted in
every patent must be limited to the invention described in the claims of the
patent, and that it is not competent for the owner of a patent, by notice
attached to its machine, to, in effect, extend the scope of its patent
monopoly by restricting the use of it to materials necessary in its operation,
but which are no part of the patented invention, or to send its machines forth
into the channels of trade of the country subject to conditions as to use or
royalty to be paid, to be imposed thereafter at the discretion of such patent
owner. The patent law furnishes no warrant for such a practice, and the cost,
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inconvenience, and annoyance to the public which the opposite conclusion
would occasion forbid it.
It is argued as a merit of this system of sale under a license notice that
the public is benefited by the sale of the machine at what is practically its
cost, and by the fact that the owner of the patent makes its entire profit from
the sale of the supplies with which it is operated. This fact, if it be a fact,
instead of commending, is the clearest possible condemnation of, the
practice adopted, for it proves that, under color of its patent, the owner
intends to and does derive its profit, not from the invention on which the
law gives it a monopoly, but from the unpatented supplies with which it is
used, and which are wholly without the scope of the patent monopoly, thus
in effect extending the power to the owner of the patent to fix the price to
the public of the unpatented supplies as effectively as he may fix the price
on the patented machine.
We are confirmed in the conclusion which we are announcing by the
fact that since the decision of Henry v. A. B. Dick Co. supra, the Congress
of the United States, the source of all rights under patents, as if in response
to this decision, has enacted a law making it unlawful for any person
engaged in interstate commerce “to lease or make a sale or contract for sale
of goods, . . . machinery, supplies or other commodities, whether patented
or unpatented, for use, consumption or resale . . . or fix a price charged
therefor, . . . on the condition, agreement or understanding that the lessee or
purchaser thereof shall not use . . . the goods . . . machinery, supplies or
other commodities of a competitor or competitors of the lessor or seller,
where the effect of such lease, sale, or contract for sale, or such condition,
agreement or understanding may be to substantially lessen competition or
tend to create a monopoly in any line of commerce.”
[The patentee’s] restriction is invalid because such a film is obviously
not any part of the invention of the patent in suit; because it is an attempt,
without statutory warrant, to continue the patent monopoly in this particular
character of film after it has expired, and because to enforce it would be to
create a monopoly in the manufacture and use of moving picture films,
wholly outside of the patent in suit and of the patent law as we have
interpreted it…..
Assuming that the plaintiff has been paid an average royalty of $5 on
each machine sold, prescribed in the license agreement, it has already
received over $200,000 for the use of its patented improvement, which
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relates only to the method of using the films which another had invented,
and yet it seeks by this device to collect during the life of the patent in suit
what would doubtless aggregate many times this amount for the use of this
same invention, after its machines have been sold and paid for.
A restriction which would give to the plaintiff such a potential power
for evil over an industry which must be recognized as an important element
in the amusement life of the nation, under the conclusions we have stated in
this opinion, is plainly void, because wholly without the scope and purpose
of our patent laws, and because, if sustained, it would be gravely injurious
to that public interest, which we have seen is more a favorite of the law than
is the promotion of private fortunes.
Mr. Justice Holmes, dissenting:
I suppose that a patentee has no less property in his patented machine
than any other owner, and that, in addition to keeping the machine to
himself, the patent gives him the further right to forbid the rest of the world
from making others like it. In short, for whatever motive, he may keep his
device wholly out of use. Continental Paper Bag Co. v. Eastern Paper Bag
Co. 210 U. S. 405, 422. So much being undisputed, I cannot understand
why he may not keep it out of use unless the licensee, or, for the matter of
that, the buyer, will use some unpatented thing in connection with it.
Generally speaking, the measure of a condition is the consequence of a
breach, and if that consequence is one that the owner may impose
unconditionally, he may impose it conditionally upon a certain event.
No doubt this principle might be limited or excluded in cases where the
condition tends to bring about a state of things that there is a predominant
public interest to prevent. But there is no predominant public interest to
prevent a patented teapot or film feeder from being kept from the public,
because, as I have said, the patentee may keep them tied up at will while his
patent lasts. Neither is there any such interest to prevent the purchase of the
tea or films that is made the condition of the use of the machine. The
supposed contravention of public interest sometimes is stated as an attempt
to extend the patent law to unpatented articles, which of course it is not, and
more accurately as a possible domination to be established by such means.
But the domination is one only to the extent of the desire for the teapot or
film feeder, and if the owner prefers to keep the pot or the feeder unless you
will buy his tea or films, I cannot see, in allowing him the right to do so,
anything more than an ordinary incident of ownership, or, at most, a
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consequence of the Paper Bag Case, on which, as it seems to me, this case
ought to turn. See Grant v. Raymond, 6 Pet. 218, 242, 8 L. ed. 376, 384.
…. I confine myself to expressing my views upon the general and
important questions upon which I have the misfortune to differ from the
majority of the court. I leave on one side the question of the effect of the
Clayton Act, as the court had done, and also what I might think if the Paper
Bag Case were not upheld, or if the question were upon the effect of a
combination of patents such as to be contrary to the policy that I am bound
to accept from the Congress of the United States.
Mr. Justice McKenna and Mr. Justice Van Devanter concur in this
dissent.
CARBICE CORP. OF AMERICA V. AMERICAN PATENTS
DEVELOPMENT CORP.
283 U.S. 27 (1931)
Mr. Justice Brandeis delivered the opinion of the Court:
The American Patents Development Corporation, as owner of United
States Patent No. 1,595,426, and the Dry Ice Corporation, as exclusive
licensee, brought this suit in the federal court for eastern New York to
enjoin contributory infringement by the Carbice Company, for an
accounting of profits, and for damages. The defendant denied both the
validity of the patent and the alleged infringement. The District Court,
without passing upon validity, dismissed the bill on the ground that
infringement had not been shown, 25 F. (2d) 730. The Circuit Court of
Appeals held the patent valid and infringed, 38 F. (2d) 62.
Solid carbon dioxide has a temperature of about 110 below zero. When
it “melts,” it passes directly into a dry gaseous state-the gas having a like
temperature and being in volume about 500 times that of the solid. These
properties makes the solid dioxide an excellent dry refrigerant for
foodstuffs, particularly for the shipment of ice cream. The refrigerating
transportation package, which is the subject of the patent in suit, is made up
in this way: Near the middle of the outer box or carton in which the ice
cream or other foodstuff is to be shipped, there is placed, in a small
container, a quantity of solid carbon dioxide. So placed, this refrigerant is
relatively enduring because it is doubly protected from the exterior heat by
the ice cream which surrounds it and by the evaporating gas which excludes
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air and moisture from the shipping case. The ice cream is kept frozen by
both the solid and the gaseous dioxide. Although the cost of solid dioxide is
about ten times that of water ice, such use is said to have revolutionized the
transportation of ice cream, as in this may shipping and handling charges
are greatly reduced and the messiness incident to the employment of water
ice is eliminated.
The patent in suit is not for solid carbon dioxide. That article and its
properties as a refrigerant have been long known to the public. The patent is
not for a machine for making solid carbon dioxide. Nor is it for a process
for making or using that substance. The Patent Office rejected an
application for a process patent. The patent is said to be for a manufacture.
The specifications outline the method of construction and use; and a typical
claim (6) is for a “transportation package consisting of a protective casing
of insulating material having packed therein a quantity of frozen carbon
dioxide in an insulating container and a quantity of freezable product in
freezing proximity to said frozen carbon dioxide and the gas evaporated
therefrom, arranged so that said frozen carbon dioxide is less accessible for
exterior heat than said freezable products.”
The sole business of the Dry Ice Corporation is the manufacture of
solid carbon dioxide which it sells under the name of “DryIce.” It does not
make or sell transportation packages in which solid carbon dioxide is used
as a refrigerant. It does not issue to other concerns licenses to make such
packages upon payment of a stipulated royalty. It does not formally license
buyers of its dry ice to use the invention in suit. But each invoice for solid
dioxide sold by it bears this notice. “The merchandise herein described is
shipped upon the following condition: That DryIce shall not be used except
in DryIce cabinets or other containers or apparatus provided or approved by
the DryIce Corporation of America; and the DryIce Cabinets or other
containers or apparatus provided or approved by the DryIce Corporation of
America shall be refrigerated or used only with DryIce. These uses of
DryIce are fully covered by our Basic Method and Apparatus Patent No.
1,511,306. Granted October 14th, 1924, and other Patents Pending.” The
patent in suit, No. 1,595,426, issued August 10, 1926, is not named in the
invoice; but it has been assumed that thereby the Dry Ice Corporation
extends to each of its customers, buyers of solid carbon dioxide, a license to
use the invention without the payment of royalty. The restrictions as to the
purchase of cartons set forth in the invoices of the corporation appear not to
have been insisted upon by it.
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The Carbice Corporation also manufactures solid carbon dioxide. It is
charged with contributory infringement because it sells its product to
customers of the Dry Ice Corporation with knowledge that the dioxide is to
be used by the purchaser in transportation packages like those described in
the patent. The Carbice Corporation challenges the validity of the patent
and denies infringement. Whether the transportation package described is a
patentable invention we need not determine. For even if it is, no relief can
be granted.
The invention claimed is for a particular kind of package employing
solid carbon dioxide in a new combination. If the patent is valid the owner
can, of course, prohibit entirely the manufacture, sale, or use of such
packages, Continental Paper Bag Co. v. Eastern Paper Bag Co., 210 U. S.
405. Or it can grant licenses upon terms consistent with the limited scope of
the patent monopoly, United States v. General Electric Co., 272 U. S. 476,
489. It may charge a royalty or license fee. But it may not exact as the
condition of a license that unpatented materials used in connection with the
invention shall be purchased only from the licensor; and if it does so, relief
against one who supplies such unpatented materials will be denied. The
limited monopoly to make, use, and vend an article may not be “expanded
by limitations as to materials and supplies necessary to the operation of it.”
Motion Picture Patents Co. v. Universal Film Manufacturing Co., 243 U. S.
502, 515.
The relief here sought is indistinguishable from that denied in the
Motion Picture Case. There, it was held that to permit the patent-owner to
“derive its profit, not from the invention on which the law gives it a
monopoly, but from the unpatented supplies with which it is used” is
“wholly without the scope of the patent monopoly.” Page 517 of 243 U. S.
If a monopoly could be so expanded, the owner of a patent for a product
might conceivably monopolize the commerce in a large part of unpatented
materials used in its manufacture. The owner of a patent for a machine
might thereby secure a partial monopoly on the unpatented supplies
consumed in its operation. The owner of a patent for a process might secure
a partial monopoly on the unpatented material employed in it. The owner of
the patent in suit might conceivably secure a limited monopoly for the
supplying not only of solid carbon dioxide, but also of the ice cream and
other foods, as well as the cartons in which they are shipped. The attempt to
limit the licensee to the use of unpatented materials purchased from the
licensor is comparable to the attempt of a patentee to fix the price at which
the patented article may be resold. Bauer & Cie v. O’Donnell, 229 U. S.
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1…. [C]ourts deny relief against those who disregard the limitations sought
to be imposed by the patentee beyond the legitimate scope of its monopoly.
Plaintiffs seek to distinguish the Motion Picture Case from that at bar,
by pointing out that there, as in Henry v. A. B. Dick Co., 224 U. S. 1, the
unpatented supplies, over which the licensor sought to extend its monopoly,
were merely used in the patented machines, whereas here the unpatented
refrigerant is one of the necessary elements of the patented product. And to
distinguish the case at bar from Morgan Envelope Co. v. Albany Perforated
Wrapping Paper Co., 152 U. S. 425, 433, it is pointed out that the Carbice
Corporation is furnishing not a passive element in the combination, like the
paper in the Morgan Envelope fixture, but the dynamic element which
produces refrigeration. These distinctions are without legal significance.
Infringement, whether direct or contributory, is essentially a tort, and
implies invasion of some right of the patentee. The Dry Ice Corporation has
no right to be free from competition in the sale of solid carbon dioxide.
Control over the supply of such unpatented material is beyond the scope of
the patentee’s monopoly; and this limitation, inherent in the patent grant, is
not dependent upon the peculiar function or character of the unpatented
material or on the way in which it is used. Relief is denied because the Dry
Ice Corporation is attempting, without sanction of law, to employ the patent
to secure a limited monopoly of unpatented material used in applying the
invention. The present attempt is analogous to the use of a patent as an
instrument for restraining commerce which was condemned, under the
Sherman Anti-Trust Law, in Standard Sanitary Mfg. Co. v. United States,
226 U. S. 20.
Reversed.
NOTES AND QUESTIONS
1. Anticompetitive ties have been illegal since the Supreme Court’s
decision in Motion Picture Patents Co.
But what makes a tie
“anticompetitive”? How exactly do ties harm consumers? How do they
harm competition?
Nearly all the competitive harm that courts have claimed to see in
tying cases can be divided into two types: leverage and foreclosure.
Under the leverage theory, a firm with a monopoly in one good can
create a monopoly in a second good by tying sales of the second good
to the first. In other words, the firm uses its market power in the tying
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good to “leverage” monopoly profits in the tied good. Consumers are
harmed because the tie forces them to pay more for the tied good than
they would if there were no tie. HERBERT HOVENKAMP, FEDERAL
ANTITRUST POLICY: THE LAW OF COMPETITION AND ITS PRACTICE §
10.6a (4th ed. 2011). Although courts still occasionally condemn tieins under this theory, leveraging has largely been discredited. A buyer
who needs both the tying and tied products is indifferent as to how the
price is allocated between the two. Its willingness to pay is determined
by the value it places on the combination. For example, if the
purchasers of a printer and ink generally value the combination at $100,
then a printer monopolist charging $90 for the printer alone cannot
profitably tie ink for more than $10, regardless of its market power in
the printer. Moreover, so long as the purchasers can get the
combination for $100, they will be indifferent as to whether they pay
$100 for the printer and $0 for the ink, or $90 for the printer and $10
for the ink, or some other price allocation. Thus, the critique of
leveraging theory shows that a seller does not gain any additional
monopoly over an unpatented product by tying it to the patented
product, even if the seller enjoys market power in the market for the
patented product. See Ward S. Bowman, Jr., Tying Arrangements and
the Leverage Problem, 67 YALE L.J. 19 (1957); Richard S. Markovits,
Tie-ins, Leverage, and the American Antitrust Laws, 80 YALE L.J. 195
(1970); Richard A. Posner, The Chicago School of Antitrust Analysis,
127 U. PA. L. REV. 925 (1979).
While leverage theory has lost traction over the last several
decades, foreclosure remains apt. Foreclosure occurs when a tying
arrangement unreasonably limits the opportunities of rivals, typically in
the tied product market. While power in the tying product may be
necessary under a foreclosure theory, the real gravamen of the offense is
exclusion in the tied product market. To that end, are there important
differences between the effects of the tie in Motion Picture Patents from
those in Carbice? The tie in the first case threatened to monopolize the
motion picture industry, while no one could ever have obtained a
monopoly of dry ice.
2. To what extent have the antitrust laws been implicated in the tying cases
up to this point? Carbice was decided 17 years after the Clayton Act
was passed, and more than 40 years after the Sherman Act.
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3. Neither Motion Picture Patents Co. nor Carbice mentions patent
misuse, but the doctrine underlies both decisions. Patent misuse is an
affirmative defense to an infringement claim. It allows infringement
defendants to avoid liability by showing that the patent holder is using
the patent in a way that violates patent or antitrust law. See Chapter 7.
If the court finds misuse, the patent will be unenforceable until “the
patent holder can show that the misuse has been purged, or that ‘the
improper practice has been abandoned and that the consequences of the
misuse of the patent have been dissipated.’” Morton Salt Co. v. G.S.
Suppiger Co., 314 U.S. 488, 493 (1942)). A. B. Dick Co., Motion
Pictures Patent Co., and Carbice illustrate the doctrine’s development.
The late 1800s and early 1900s were a good time for American
patent holders. They “enjoyed unrestrained exploitation of their
patents,” and there was no misuse defense. Richard Calkins, Patent
Law: The Impact of the 1988 Patent Misuse Reform Act and Noerr–
Pennington Doctrine on the Misuse Defenses and Antitrust
Counterclaims, 38 DRAKE L. REV. 175, 178 (1988–1989). Recall that A.
B. Dick sold its patented mimeograph machines on the condition that
they could be used only with only its unpatented paper, ink, and stencils.
A. B. Dick sued Sidney Henry for patent infringement after Henry sold
his mimeograph to a third party along with a can of non-A. B. Dick ink.
The Court rejected the argument that A. B. Dick was using the tie to
extend its mimeograph monopoly to its unpatented stencils, paper, and
ink—or, to look at it another way, the Court held that A. B. Dick did not
misuse its patent.
In overruling A. B. Dick but not applying the antitrust laws, the
MPPC decision implicitly recognized patent misuse as an infringement
defense. Just as A. B. Dick, Motion Picture Patents Co. sold its patented
good (film projectors) on the condition that they be used only with its
unpatented goods (films). But unlike the stencils, ink, and paper in A. B.
Dick, MPPC’s unpatented films couldn’t be used without its patented
projectors. This is important because a tie cannot create a second
monopoly in the tied product unless the tied product has no untied
uses.” Erik Hovenkamp & Herbert Hovenkamp, Tying Arrangements
and Antitrust Harm, 92 ARIZ. L. REV. 925, 932 (2010). The fact that
MPPC’s films had no untied uses could have allowed the company “to
monopolize the movie market by prohibiting anyone other than [MPPC]
from showing its films through [MPPC’s] projector.”
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Given this distinction between A. B. Dick’s stencils, ink, and paper
and MPPC’s films, the Court could have left A. B. Dick intact in cases
where the tied goods had untied uses. Instead the Court tilted its head
toward section 3 of the Clayton Act—an antitrust provision that
outlawed tie-ins like those in A. B. Dick Co. and MPPC when they
“substantially lessen competition or tend to create a monopoly”—and
announced that A. B. Dick was dead. MPPC, 243 U.S. at 517–18. See
HOVENKAMP, FEDERAL ANTITRUST POLICY, supra, § 5.5b.
After MPPC, the Supreme Court continued to find patent misuse in
cases where patent holders tied sales of patented inventions to
unpatented goods. In addition to Carbice, in Leitch Manufacturing Co.
v. Barber Co., 302 U.S. 458, 460-463 (1938), the Court found misuse
where the plaintiff tied licensing of a patented process used in road
building to sales of an unpatented emulsion used in the process. Citing
Carbice, the Court stated that the plaintiff’s patent did not give it “the
right to be free from competition in supplying unpatented material to be
used in practicing the invention.”
Notice that the tied goods in Carbice and Leitch were not just
unpatented—they were “common commodit[ies] produced by many
competitors” and “used for many purposes.” It was therefore unlikely
that these tie-ins could give the plaintiff–patent holders a second
“monopoly.”. But the Supreme Court was clear: “[E]very use of a patent
as a means of obtaining a limited monopoly of unpatented material is
prohibited.” 302 U.S. at 463.
MPPC, Carbice, and Leitch involved accusations of contributory
infringement. In each, the patent holder sued its competitors for selling
unpatented goods to the patent holder’s licensees. In allowing the
defendants to assert patent misuse as a defense, the Supreme Court
essentially held that a patent holder could not stop its rivals from
“selling goods not covered by the scope of the patent.”
But in Morton Salt Co. v. G.S. Suppiger Co., 314 U.S. 488, 493
(1942), the Court went a step further. Suppiger and Morton Salt
manufactured and sold salt tablets. Both also made and leased machines
that deposited the tablets into canned foods. Suppiger’s machines were
patented, and it prohibited its licensees from using any other salt tablets
with its machines. Unlike the plaintiffs in the earlier cases, Suppiger
accused Morton Salt of direct infringement: Suppiger alleged that
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Morton’s machines violated Suppiger’s patent. The trial court dismissed
the complaint, but the Seventh Circuit Court of Appeals reversed
because it found that Suppiger had not used its patent in a way that
violated section 3 of the Clayton Act. 314 U.S. at 490. That is, the
Seventh Circuit in effect held that misuse would not apply unless the
defendant had violated the antitrust laws.
The Supreme Court reversed, stating that Suppiger had sued for
patent infringement, and that the issue was not whether Morton Salt
violated the antitrust laws but whether a court of equity would “lend its
aid to protect the patent monopoly when [the patent holder] is using it as
the effective means of restraining competition with its sale of an
unpatented article.”. The Court held that patent holders cannot sue even
for direct infringement of their patents when they tie their inventions to
unpatented goods. To hold otherwise would “aid[] in the creation of a
limited monopoly . . . not granted by the patent.” Morton Salt, 314 U.S.
at 491. Morton Salt therefore prevents patent holders from enforcing
any of their basic patent rights where “enforcement might contribute to
[their] attempt to control the market for unpatented goods”—in other
words, when they misuse their patents.
INTERNATIONAL SALT CO. V. UNITED STATES
332 U.S. 392 (1947)
Mr. Justice Jackson delivered the opinion of the Court.
The Government brought this civil action to enjoin the International
Salt Company, appellant here, from carrying out provisions of the leases of
its patented machines to the effect that lessees would use therein only
International’s salt products. The restriction is alleged to violate § 1 of the
Sherman Act, and § 3 of the Clayton Act. Upon appellant’s answer and
admissions of fact, the Government moved for summary judgment. . . .
Judgment was granted and appeal was taken directly to this Court.
It was established by pleadings or admissions that the International Salt
Company is engaged in interstate commerce in salt, of which it is the
country’s largest producer for industrial uses. It also owns patents on two
machines for utilization of salt products. One, the “Lixator,” dissolves rock
salt into a brine used in various industrial processes. The other, the
“Saltomat,” injects salt, in tablet form, into canned products during the
canning process. The principal distribution of each of these machines is
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under leases which, among other things, require the lessees to purchase
from appellant all unpatented salt and salt tablets consumed in the leased
machines.
Appellant had outstanding 790 leases of an equal number of “Lixators,”
all of which leases were on appellant’s standard form containing the tying
clause11 and other standard provisions; of 50 other leases which somewhat
varied the terms, all but 4 contained the tying clause. It also had in effect 73
leases of 96 “Saltomats,” all containing the restrictive clause. In 1944,
appellant sold approximately 119,000 tons of salt, for about $500,000, for
use in these machines.
The appellant’s patents confer a limited monopoly of the invention they
reward. From them appellant derives a right to restrain others from making,
11
“It is further mutually agreed that the said Lixate Process Dissolver
shall be installed by and at the expense of said Lessee and shall be
maintained and kept in repair during the term of this lease by and at the
expense of said Lessee; that the said Lixate Process Dissolver shall be used
for dissolving and converting into brine only those grades of rock salt
purchased by the Lessee from the Lessor at prices and upon terms and
conditions hereafter agreed upon, provided:
“If at any time during the term of this lease a general reduction in price
of grade of salt suitable for use in the said Lixate Process Dissolver shall be
made, said Lessee shall give said Lessor an opportunity to provide a
competitive grade of salt at any such competitive price quoted, and in case
said Lessor shall fail or be unable to do so, said Lessee, upon continued
payments of the rental herein agreed upon, shall have the privilege of
continued use of the said equipment with salt purchased in the open market,
until such time as said Lessor shall furnish a suitable grade of salt at the said
competitive price.”
It further provides as follows:
“Should said Lessee fail to pay promptly the aforesaid rental, or shall at
any time discontinue purchasing its requirement of salt from said Lessor, or
otherwise breach any of the terms and conditions of this lease, said Lessor
shall have the right, upon 30 days’ written notice of intention to do so, to
remove the said Lixate Process Dissolver from the possession of said
Lessee.”
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vending or using the patented machines. But the patents confer no right to
restrain use of, or trade in, unpatented salt. By contracting to close this
market for salt against competition, International has engaged in a restraint
of trade for which its patents afford no immunity from the anti-trust laws.
Morton Salt Co. v. G.S. Suppiger Co., 314 U.S. 488.
Appellant contends, however, that summary judgment was
unauthorized because it precluded trial of alleged issues of fact as to
whether the restraint was unreasonable within the Sherman Act or
substantially lessened competition or tended to create a monopoly in salt
within the Clayton Act. We think the admitted facts left no genuine issue.
Not only is price-fixing unreasonable, per se, United States v. SoconyVacuum Oil Co., 310 U.S. 150, but also it is unreasonable, per se, to
foreclose competitors from any substantial market. Fashion Originators’
Guild of America v. Federal Trade Commission, 2 Cir., 114 F.2d 80,
affirmed, 312 U.S. 457. The volume of business affected by these contracts
cannot be said to be insignificant or insubstantial and the tendency of the
arrangement to accomplishment of monopoly seems obvious. Under the
law, agreements are forbidden which “tend to create a monopoly,” and it is
immaterial that the tendency is a creeping one rather than one that proceeds
at full gallop; nor does the law await arrival at the goal before condemning
the direction of the movement.
Appellant contends, however, that the “Lixator” contracts are saved
from unreasonableness and from the tendency to monopoly because they
provided that if any competitor offered salt of equal grade at a lower price,
the lessee should be free to buy in the open market, unless appellant would
furnish the salt at an equal price; and the “Saltomat” agreements provided
that the lessee was entitled to the benefit of any general price reduction in
lessor’s salt tablets. The “Lixator” provision does, of course, afford a
measure of protection to the lessee, but it does not avoid the stifling effect
of the agreement on competition. The appellant had at all times priority on
the business at equal prices. A competitor would have to undercut
appellant’s price to have any hope of capturing the market, while appellant
could hold that market by merely meeting competition. We do not think this
concession relieves the contract of being a restraint of trade, albeit a less
harsh one than would result in the absence of such a provision. The
“Saltomat” provision obviously has no effect of legal significance since it
gives the lessee nothing more than a right to buy appellant’s salt tablets at
appellant’s going price. All purchases must in any event be of appellant’s
product.
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Appellant also urges that since under the leases it remained under an
obligation to repair and maintain the machines, it was reasonable to confine
their use to its own salt because its high quality assured satisfactory
functioning and low maintenance cost. The appellant’s rock salt is alleged
to have an average sodium chloride content of 98.2%. Rock salt of other
producers, it is said, “does not run consistent in sodium chloride content and
in many instances runs as low as 95% of sodium chloride.” This greater
percentage of insoluble impurities allegedly disturbs the functioning of the
“Lixator” machine. A somewhat similar claim is pleaded as to the
“Saltomat.”
Of course, a lessor may impose on a lessee reasonable restrictions
designed in good faith to minimize maintenance burdens and to assure
satisfactory operation. We may assume, as matter of argument, that if the
“Lixator” functions best on rock salt of average sodium chloride content of
98.2%, the lessee might be required to use only salt meeting such a
specification of quality. But it is not pleaded, nor is it argued, that the
machine is allergic to salt of equal quality produced by any one except
International. If others cannot produce salt equal to reasonable
specifications for machine use, it is one thing; but it is admitted that, at
times, at least, competitors do offer such a product. They are, however, shut
out of the market by a provision that limits it, not in terms of quality, but in
terms of a particular vendor. Rules for use of leased machinery must not be
disguised restraints of free competition, though they may set reasonable
standards which all suppliers must meet . . . .
NOTES AND QUESTIONS
1. What was the competitive harm that prompted the government to bring
this action under the antitrust laws? Surely the defendant was not
threatening to create a monopoly in salt. Could tying salt create a
monopoly in the patented machine?
2. International Salt’s observation that a patent confers a “limited
monopoly” effectively migrated the law of tying arrangements from patent
doctrine (misuse) to antitrust, and for the next sixty years the Supreme
Court “presumed” sufficient market power to make a tying arrangement
anticompetitive when the tying product was patented. How sensible is that
presumption?
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3. Take another look at the lease agreement in the Court’s footnote.
International Salt required buyers of its patented Saltomats and Lixators
(the tying products) to purchase its unpatented salt (the tied product) only if
International Salt matched the market price for salt. This was certainly a
tying arrangement—but did it allow International Salt to engage in price
discrimination? See John L. Peterman, The International Salt Case, 22 J.L.
& ECON. 351, 356 (1979) (“[C]harging the competitive price would at most
cover International’s cost of supplying salt. There would be no margin on
salt through which International might be said to charge amounts for
Lixators which vary according to intensity of use.”). This tends to support
the defendant’s argument that its real purpose was to guarantee the quality
of the salt used in the machine.
SIEGEL V. CHICKEN DELIGHT, INC.
448 F.2d 43 (9th Cir. 1971)
MERRILL, Circuit Judge:
This antitrust suit is a class action in which certain franchisees of
Chicken Delight seek treble damages for injuries allegedly resulting from
illegal restraints imposed by Chicken Delight’s standard form franchise
agreements. The restraints in question are Chicken Delight’s contractual
requirements that franchisees purchase certain essential cooking equipment,
dry-mix food items, and trade-mark bearing packaging exclusively from
Chicken Delight as a condition of obtaining a Chicken Delight trade-mark
license. These requirements are asserted to constitute a tying arrangement,
unlawful per se under § 1 of the Sherman Act, 15 U.S.C. § 1.
Over its eighteen years existence, Chicken Delight has licensed several
hundred franchisees to operate home delivery and pick-up food stores. It
charged its franchisees no franchise fees or royalties. Instead, in exchange
for the license granting the franchisees the right to assume its identity and
adopt its business methods and to prepare and market certain food products
under its trade-mark, Chicken Delight required its franchisees to purchase a
specified number of cookers and fryers and to purchase certain packaging
supplies and mixes exclusively from Chicken Delight. The prices fixed for
these purchases were higher than, and included a percentage markup which
exceeded that of, comparable products sold by competing suppliers.
In order to establish that there exists an unlawful tying arrangement
plaintiffs must demonstrate First, that the scheme in question involves two
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distinct items and provides that one (the tying product) may not be obtained
unless the other (the tied product) is also purchased. Times-Picayune
Publishing Co. v. United States, 345 U.S. 594, 613-614 (1953). Second, that
the tying product possesses sufficient economic power appreciably to
restrain competition in the tied product market. Northern Pacific R. Co. v.
United States, 356 U.S. 1, 6 (1958). Third, that a “not insubstantial” amount
of commerce is affected by the arrangement. International Salt Co. v.
United States, 332 U.S. 392 (1947). Chicken Delight concedes that the third
requirement has been satisfied. It disputes the existence of the first two.
Further it asserts that, even if plaintiffs should prevail with respect to the
first two requirements, there is a fourth issue: whether there exists a special
justification for the particular tying arrangement in question. United States
v. Jerrold Electronics Corp., 187 F.Supp. 545 (E.D.Pa.1960), aff’d per
curiam, 365 U.S. 567 (1961).
Two Products
The District Court ruled that the license to use the Chicken Delight
name, trade-mark, and method of operations was “a tying item in the
traditional sense,” 311 F.Supp. at 849, the tied items being the cookers and
fryers, packaging products, and mixes.
The court’s decision to regard the trade-mark or franchise license as a
distinct tying item is not without precedent. In Susser v. Carvel Corp., 332
F.2d 505 (2d Cir. 1964), all three judges regarded as a tying product the
trade-mark license to ice cream outlet franchisees, who were required to
purchase ice cream, toppings and other supplies from the franchisor. See
also Baker v. Simmons Co., 307 F.2d 458, 466–469 (1st Cir. 1962).
Nevertheless, Chicken Delight argues that the District Court’s conclusion
conflicts with the purposes behind the strict rules governing the use of tying
arrangements.
The hallmark of a tie-in is that it denies competitors free access to the
tied product market, not because the party imposing the arrangement has a
superior product in that market, but because of the power or leverage
exerted by the tying product. Northern Pac. R. Co. v. United States, supra.
Rules governing tying arrangements are designed to strike, not at the mere
coupling of physically separable objects, but rather at the use of a dominant
desired product to compel the purchase of a second, distinct commodity.
Times-Picayune Publishing Co. v. United States, supra, 345 U.S. at 614. In
effect, the forced purchase of the second, tied product is a price exacted for
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the purchase of the dominant, tying product. By shutting competitors out of
the tied product market, tying arrangements serve hardly any purpose other
than the suppression of competition. Standard Oil Co. v. United States, 337
U.S. 293, 305–306 (1949).
Chicken Delight urges us to hold that its trade-mark and franchise
licenses are not items separate and distinct from the packaging, mixes, and
equipment, which it says are essential components of the franchise system.
To treat the combined sale of all these items as a tie-in for antitrust
purposes, Chicken Delight maintains, would be like applying the antitrust
rules to the sale of a car with its tires or a left shoe with the right. Therefore,
concludes Chicken Delight, the lawfulness of the arrangement should not be
measured by the rules governing tie-ins. We disagree.
In determining whether an aggregation of separable items should be
regarded as one or more items for tie-in purposes in the normal cases of
sales of products the courts must look to the function of the aggregation.
Consideration is given to such questions as whether the amalgamation of
products resulted in cost savings apart from those reductions in sales
expenses and the like normally attendant upon any tie-in, and whether the
items are normally sold or used as a unit with fixed proportions.
Where one of the products sold as part of an aggregation is a trademark or franchise license, new questions are injected. In determining
whether the license and the remaining (“tied”) items in the aggregation are
to be regarded as distinct items which can be traded in distinct markets
consideration must be given to the function of trade-marks.
The historical conception of a trade-mark as a strict emblem of source
of the product to which it attaches has largely been abandoned. The
burgeoning business of franchising has made trade-mark licensing a
widespread commercial practice and has resulted in the development of a
new rationale for trade-marks as representations of product quality. This is
particularly true in the case of a franchise system set up not to distribute the
trade-marked goods of the franchisor, but, as here, to conduct a certain
business under a common trade-mark or trade name. Under such a type of
franchise, the trade-mark simply reflects the goodwill and quality standards
of the enterprise which it identifies. As long as the system of operation of
the franchisees lives up to those quality standards and remains as
represented by the mark so that the public is not misled, neither the
protection afforded the trade-mark by law nor the value of the trade-mark to
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the licensee depends upon the source of the components.
This being so, it is apparent that the goodwill of the Chicken Delight
trade-mark does not attach to the multitude of separate articles used in the
operation of the licensed system or in the production of its end product. It is
not what is used, but how it is used and what results that have given the
system and its end product their entitlement to trade-mark protection. It is to
the system and the end product that the public looks with the confidence
that established goodwill has created.
Thus, sale of a franchise license, with the attendant rights to operate a
business in the prescribed manner and to benefit from the goodwill of the
trade name, in no way requires the forced sale by the franchisor of some or
all of the component articles. Just as the quality of a copyrighted creation
cannot by a tie-in be appropriated by a creation to which the copyright does
not relate, United States v. Paramount Pictures, Inc., 334 U.S. 131 (1948),
so here attempts by tie-in to extend the trade-mark protection to common
articles (which the public does not and has no reason to connect with the
trade-mark) simply because they are said to be essential to production of
that which is the subject of the trade-mark, cannot escape antitrust scrutiny.
Chicken Delight’s assertions that only a few essential items were
involved in the arrangement does not give us cause to reach a different
conclusion. The relevant question is not whether the items are essential to
the franchise, but whether it is essential to the franchise that the items be
purchased from Chicken Delight. This raises not the issue of whether there
is a tie-in but rather the issue of whether the tie-in is justifiable, a subject to
be discussed below.
We conclude that the District Court was not in error in ruling as matter
of law that the arrangement involved distinct tying and tied products.
Economic Power
Under the per se theory of illegality, plaintiffs are required to establish
not only the existence of a tying arrangement but also that the tying product
possesses sufficient economic power to appreciably restrain free
competition in the tied product markets.
Chicken Delight points out that while it was an early pioneer in the fast
food franchising field, the record establishes that there has recently been a
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dramatic expansion in this area, with the advent of numerous firms,
including many chicken franchising systems, all competing vigorously with
each other. Under the circumstances, it contends that the existence of the
requisite market dominance remained a jury question.
The District Court ruled, however, that Chicken Delight’s unique
registered trade-mark, in combination with its demonstrated power to
impose a tie-in, established as matter of law the existence of sufficient
market power to bring the case within the Sherman Act.
We agree. In Fortner Enterprises, Inc. v. United States Steel Corp., 394
U. S. 495, 502-503 (1969), it is stated:
“The standard of ‘sufficient economic power’ does not,
as the District Court held, require that the defendant have a
monopoly or even a dominant position throughout the
market for the tying product. Our tie-in cases have made
unmistakably clear that the economic power over the tying
product can be sufficient even though the power falls far
short of dominance and even though the power exists only
with respect to some of the buyers in the market.”
Later, at page 504, it is stated:
“Accordingly, the proper focus of concern is whether the
seller has the power to raise prices, or impose other
burdensome terms such as a tie-in, with respect to any
appreciable number of buyers within the market.”
In United States v. Loew’s, Inc., 371 U.S. 38, 45 (1962), it is stated:
“Even absent a showing of market dominance, the
crucial economic power may be inferred from the tying
product’s desirability to consumers or from uniqueness in its
attributes.”
It can hardly be denied that the Chicken Delight trade-mark is
distinctive; that it possesses goodwill and public acceptance unique to it and
not enjoyed by other fast food chains.
It is now clear that sufficient economic power is to be presumed where
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the tying product is patented or copyrighted. United States v. Loew’s, Inc.,
supra; United States v. Paramount Pictures, Inc., supra; International Salt
Co. v. United States, supra.
In Fortner, 394 U.S. at page 505, it is stated:
“Uniqueness confers economic power only when other
competitors are in some way prevented from offering the
distinctive product themselves. Such barriers may be legal,
as in the case of patented and copyrighted products, e.g.,
International Salt; Lowe’s, or physical, as when the product
is land, e. g., Northern Pacific.”
Just as the patent or copyright forecloses competitors from offering the
distinctive product on the market, so the registered trade-mark presents a
legal barrier against competition. It is not the nature of the public interest
that has caused the legal barrier to be erected that is the basis for the
presumption, but the fact that such a barrier does exist. Accordingly we see
no reason why the presumption that exists in the case of the patent and
copyright does not equally apply to the trade-mark.
Thus we conclude that the District Court did not err in ruling as matter
of law that the tying product-the license to use the Chicken Delight trademark -possessed sufficient market power to bring the case within the
Sherman Act.
Justification
Chicken Delight maintains that, even if its contractual arrangements are
held to constitute a tying arrangement, it was not an unreasonable restraint
under the Sherman Act. Three different bases for justification are urged.
First, Chicken Delight contends that the arrangement was a reasonable
device for measuring and collecting revenue. There is no authority for
justifying a tying arrangement on this ground. Unquestionably, there exist
feasible alternative methods of compensation for the franchise licenses,
including royalties based on sales volume or fees computed per unit of time,
which would neither involve tie-ins nor have undesirable anticompetitive
consequences.
Second, Chicken Delight advances as justification the fact that when it
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first entered the fast food field in 1952 it was a new business and was then
entitled to the protection afforded by United States v. Jerrold Electronics
Corp., supra, 187 F.Supp. 545. As to the period here involved—1963 to
1970—it contends that transition to a different arrangement would be
difficult if not economically impossible.
We find no merit in this contention. Whatever claim Chicken Delight
might have had to a new business defense in 1952-a question we need not
decide- the defense cannot apply to the 1963-70 period. To accept Chicken
Delight’s argument would convert the new business justification into a
perpetual license to operate in restraint of trade. See Id., 187 F.Supp. at 558,
561.
The third justification Chicken Delight offers is the “marketing
identity” purpose, the franchisor’s preservation of the distinctiveness,
uniformity and quality of its product.
In the case of a trade-mark this purpose cannot be lightly dismissed.
Not only protection of the franchisor’s goodwill is involved. The licensor
owes an affirmative duty to the public to assure that in the hands of his
licensee the trade-mark continues to represent that which it purports to
represent. For a licensor, through relaxation of quality control, to permit
inferior products to be presented to the public under his licensed mark
might well constitute a misuse of the mark. 15 U.S.C. §§ 1055, 1127; See
Note, “Quality Control and the Antitrust Laws in Trade-mark Licensing,”
supra.
However, to recognize that such a duty exists is not to say that every
means of meeting it is justified. Restraint of trade can be justified only in
the absence of less restrictive alternatives. In cases such as this, where the
alternative of specification is available, the language used in Standard Oil
Co. v. United States, supra, 337 U.S. at 306, in our view states the proper
test, applicable in the case of trade-marks as well as in other cases:
“* * * the protection of the good will of the manufacturer of the tying
device-fails in the usual situation because specification of the type and
quality of the product to be used in connection with the tying device is
protection enough. * * * The only situation, indeed, in which the protection
of good will may necessitate the use of tying clauses is where specifications
for a substitute would be so detailed that they could not practicably be
supplied.”
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The District Court found factual issues to exist as to whether effective
quality control could be achieved by specification in the case of the cooking
machinery and the dip and spice mixes. These questions were given to the
jury under instructions; and the jury, in response to special interrogatories,
found against Chicken Delight.
As to the paper packaging, the court ruled as matter of law that no
justification existed. It stated, 311 F. Supp. at page 851:
“Defendants’ showing on paper packaging is nothing
more than a recitation of the need for distinctive packaging
to be used uniformly by all franchisees in identifying the hot
foods. This was not contested. However, the admissions in
evidence clearly demonstrate that the tied packaging was
easily specifiable. In fact, the only specifications required
were printing and color. Moreover, defendants have admitted
that any competent manufacturer of like products could
consistently and satisfactorily manufacture the packaging
products if defendants furnished specifications. Those
suppliers could have sold to the franchisees through normal
channels of distribution.”
We agree. One cannot immunize a tie-in from the antitrust laws by
simply stamping a trade-mark symbol on the tied product—at least where
the tied product is not itself the product represented by the mark.
We conclude that the District Court was not in error in holding as
matter of law (and upon the limited jury verdict) that Chicken Delight’s
contractual requirements constituted a tying arrangement in violation of § 1
of the Sherman Act. Upon this aspect of the case, judgment is affirmed.
The Measure of Damages
Section 4 of the Clayton Act, 15 U.S. C. § 15, provides that anyone
“injured in his business or property” by reason of a violation of the antitrust
laws “shall recover threefold the damages by him sustained.” In
determining what damages plaintiffs incurred, the District Court noted that
the contracts and all written representations by Chicken Delight stated that
there were no franchise fees or royalty payments and from that fact
concluded that the entire price paid by the franchisees was allocable to the
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tied items. Thus, the court ruled that the fact of damages equal in amount to
the overcharge on the tied items (the amount by which the contract price
exceeded the market price for comparable items) was established as a
matter of law.
It stated, 311 F.Supp. at page 852:
“On the issue of fact of damage, this Court has
determined as a matter of law that the fact of damage is
established. Defense counsel persists in his argument that the
upcharge in the tied products should be offset by a
‘reasonable value’ assessed for the Chicken Delight license.
* * * This Court will not attempt to restructure the system of
defendants into one which is legally constituted and then
allow an offset for imaginary or suppositious royalty fees.
Such would be directly contrary to the avowed policy of the
Sherman Act.”
In this we feel the court erred.
It is by no means clear that any of the parties to the tying arrangements
understood that the tying items were to be given free of charge. Indeed, the
more reasonable reading of the contracts and of Chicken Delight’s
representations is that they stated simply that the contract prices for the tied
items were to be the full compensation asked by Chicken Delight for both
those items and the franchise licenses.
By its own terms, Clayton Act recovery is available only where actual
injury has been suffered. Winckler & Smith Citrus Products Co. v. Sunkist
Growers, Inc., 346 F.2d 1012, 1014 (9th Cir. 1965). The question here is
whether the plaintiffs have suffered injury by virtue of the unlawful
arrangement to which they were subjected. That arrangement of necessity
involved both tying and tied products. To ascertain whether an unlawful
arrangement for the sale of products has caused injury to the purchaser, the
cost or value of the products involved, free from the unlawful arrangement,
must first be ascertained.
Appellants contend that since the value of the tying items must be taken
into account, as matter of law appellees have suffered no injury. They
reason that the value of the tying items has been conclusively evidenced by
what the franchisees were willing to pay (in overcharges for the tied items)
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in order to get them.
We cannot agree. The franchisees’ apparent willingness to pay the
ultimate cost of the arrangement is clouded by the fact that they may well
have been unaware of what that cost would come to in practice. Had the full
amount of the over-charge on the tied items been openly specified as the
cost of the tying items, agreement might not have been forthcoming. We
can hardly rule as matter of law that it would have been.
We conclude that neither the existence of damage nor its lack of
existence has been established as matter of law; that factual issues remain as
to the value of both tying and tied products, free from the tying
arrangement; that remand for the resolution of these issues is necessary.
Upon the issue of damages, judgment is reversed and the case
remanded for limited new trial.
NOTES AND QUESTIONS
1. Franchise ties like the one in Chicken Delight are similar to the product
ties you saw in A. B. Dick Co., Motion Picture Patents Co., Carbice, and
International Salt. The major difference is that in the franchising context,
the tying good is typically the franchisor’s trademark, which it licenses to
its franchisees. See Roger D. Blair & Francine Lafontaine, The Economics
of Franchising 139 (2005); Benjamin Klein & Lester F. Saft, The Law and
Economics of Franchise Tying Contracts, 28 J.L. & ECON 345, 355 (1985).
The tied goods, meanwhile, are often supplies and inputs the franchisees
need to run the business. Steven C. Michael, The Extent, Motivation, and
Effect of Tying in Franchise Contracts, 21 MANAGERIAL & DECISION ECON.
191, 191 (2000).
2. Just like tying firms in other contexts, franchisors want to capture as
much of the consumer surplus as they can (only here, the “consumers” are
the businesspeople that operate the franchises). Franchisors frequently do
this through the use of variable-proportion ties. Developing a trademark can
be extremely expensive, and in the absence of a tying arrangement, a
franchisor might have to charge large upfront fees to cover these sunk costs.
HERBERT HOVENKAMP, FEDERAL ANTITRUST POLICY: THE LAW OF
COMPETITION AND ITS PRACTICE § 10.6e (4th ed. 2011). On the other hand,
once the trademark and business method are established, the cost of
licensing the trademark to an additional franchisee may be very low and in
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some cases may approach zero. If the franchisor charged the same
“monopoly” price to all franchisees, it would probably set the price higher
than many franchisees would be willing to pay, and franchises that would
be profitable at a lower entry price would never come about. See id. So
instead the franchisor reduces the price of the tying product (the franchise
license) and raises the price of the tied products (in Chicken Delight, the
spices, dips, batter, paper packaging, etc). Doing this allows the franchisor
to earn a high return from higher-volume franchisees, who purchase more
of the tied goods, and at least some profit from lower-volume—but still
profitable—franchisees.
Capturing consumer surplus is not the only reason franchisors tie their
trademarks. Quality control is a major concern for franchisors. Consumers
usually cannot tell how good or bad an individual franchisee’s product is
before they purchase it, so franchisees have incentives to cut costs by using
lower-quality inputs. Klein & Saft, supra, at 349. Because the franchise’s
products are standardized, consumers blame the entire franchise for, say, a
bad chicken leg. See id. The individual franchisee benefits from selling lessthan-delightful chicken, while the losses from lower future demand—
assuming the unhappy customer does not come back—are spread across the
entire Chicken Delight franchise. Id. at 349–50. A franchisor can prevent
“free riding” on its trademark by requiring franchisees to purchase inputs
from the franchisor or from suppliers the franchisor trusts. See id. at 352–
53. Empirical research on tying suggests that quality control is in fact a big
reason franchisors tie goods to their trademarks. Michael, supra, at 195.
But even franchisors who appear to be doing quality control are
probably also—if not only—trying to capture as much of their franchisees’
surplus as they can. For instance:
Chicken Delight diligently monitored purchase of the
packaging items, but it paid little attention to inputs that
could be expected to affect quality more significantly.
Chicken, for example, could be purchased by franchisees
from any source, as long as specifications set by the
franchisor were met. Chicken Delight did have an interest in
assuring that customers would not purchase chicken in a
bucket that leaked, but this did not seem to be a problem. In
fact, to detect franchisees that were using unauthorized
(“counterfeit”) packaging materials, Chicken Delight at one
point employed an invisible dye that could be observed only
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under ultraviolet light. This is an odd technique if buckets
from other sources are clearly inferior.
Chicken Delight monitored purchase of the paper
products not because of quality control considerations but
because it collected the franchise fee as a profit on these
items . . . .
Klein & Saft, supra, at 348 (footnotes omitted). On the other hand,
Chicken Delight may have been half-right. See Edward M. Iacobucci,
Tying as Quality Control, 32 J. LEGAL STUDIES 435 (2003) (arguing
that “inferior tied goods may not harm, and indeed may enhance, the
tying good’s reputation”). For an argument that empirical evidence
suggests franchise ties increase the likelihood of leaky buckets, see Uri
Benoliel, The Behavioral Law and Economics of Franchise Tying
Contracts, 41 RUTGERS L.J. 527 (2010).
Finally, to the extent that tying reduces the upfront costs of
acquiring a franchise, does it also lower the likelihood that franchisees
will irrationally continue to run unprofitable businesses? See Gillian K.
Hadfield, Problematic Relations: Franchising and the Law of
Incomplete Contracts, 42 STAN. L. REV. 927, 952 (1990) (“A business
with sunk costs, on the other hand, will continue to operate even though
it has never recovered its investments in fixed costs, and it will not shut
down until the amount it is losing exceeds what it would lose by simply
abandoning the investment.”). This would almost certainly benefit
franchisees. See PAUL KRUGMAN & ROBIN WELLS, ECONOMICS 238–39
(2d ed. 2009). Probably not, because while the franchisee’s fixed costs
are reduced by the tie, its variable costs are increased, and shutting
down is more likely to be responsive to high variable costs.
3. Tying Requirements. In determining whether Chicken Delight’s
franchise agreement violated the antitrust laws, the Ninth Circuit Court
applied a three-part test under which plaintiffs could prevail only if:
First, . . . the scheme in question involves two distinct
items and provides that one (the tying product) may not be
obtained unless the other (the tied product) is also purchased.
Second, . . . the tying product possesses sufficient economic
power appreciably to restrain competition in the tied product
market. Third, . . . a “not insubstantial” amount of commerce
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is affected by the arrangement.
Siegel v. Chicken Delight, Inc., 448 F.2d at 47 (citations omitted).
4. What was the basis for Chicken Delight’s claim that there was no
illegal tie-in? Does it strike you as plausible? Were the terms of the
licensing agreement no different from “the sale of a car with its tires or a
left shoe with the right,” as Chicken Delight argued? Chicken Delight
claimed that its trademark and franchise agreements were not “separate and
distinct from the packaging, mixes, and equipment” it claimed were
“essential components” of the Chicken Delight franchising system. Chicken
Delight, 448 F.2d at 47–48. The Ninth Circuit Court of Appeals disagreed,
stating that “the goodwill of the Chicken Delight trade-mark does not attach
to the multitude of separate articles used in the operation of the licensed
system or in the production of its end product.”
Cf. Rick-Mik Enters., Inc. v. Equilon Enters. LLC, 532 F.3d 963, 974
n.3 (9th Cir. 2008), which concluded that the “method of doing business
(the franchise) is not sold separately from the ingredients that go into the
method of business.” Rick-Mik, 532 F.3d at 974 (emphasis added). Would
these “ingredients” include the barbecue-rib seasoning Chicken Delight
“forced” on its franchisees? Chicken Delight’s special batter mix? What
about the packaging that bore Chicken Delight’s trademark? The fryers its
franchisees would use to make Chicken Delight chicken?
5. Damages—overcharge in the tied product alone? On the sum of the two
products? The district court found that Chicken Delight didn’t charge its
franchisees royalties or fees for using its trademark but instead made its
money by “overcharg[ing]” for its non-trademarked tied products. 311 F.
Supp. at 852. The lower court ruled that the plaintiffs had established
damages equal to the overcharge on the tied products, but Chicken Delight
argued that the overcharges on the tied products “should be offset by a
‘reasonable value’ assessed for the Chicken Delight license.” On appeal the
chain apparently claimed that the “value of the tying items” totally offset
the overcharge on the tied products and that the plaintiffs had therefore
suffered no harm. See 448 F.3d at 52. The district court, however, refused to
“allow an offset for imaginary or suppositious royalty fees,” The Ninth
Circuit rejected the contention that the “value of the tying items [was]
conclusively evidenced by what the franchisees were willing to pay (in
overcharges for the tied items) in order to get them.” But the Ninth Circuit
bought Chicken Delight’s proposed framework for calculating damages in
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illegal-tying cases, which basically required the court to take the sum of (a)
the plaintiffs’ gains from licensing the tying products and (b) the plaintiffs’
losses from paying overcharges on the tied products. See id. The parties
settled before the lower court had to do the math, but it’s possible—maybe
even “likely”—that Chicken Delight’s franchisees suffered no injury from
the tie. See PHILLIP E. AREEDA & HERBERT HOVENKAMP, ANTITRUST LAW
¶340c (3d ed. 2008).
6. The first Chicken Delight opened in Illinois in 1952, and at one point
there were more than a thousand Chicken Delights in the United States. But
by the time the Siegels first sued the fast-food chain, that number had
dropped to about 650. See Chicken Delight, 271 F. Supp. at 725. After the
Ninth Circuit’s decision in Siegel v. Chicken Delight, Inc., Chicken
Delight’s “main source of revenue”—the packaging and equipment it sold
its franchisees—“dried up.” See History, Chicken Delight,
http://www.chickendelight.com/about.htm (last visited Sept. 18, 2011).
There are currently less than a dozen Chicken Delights left in the U.S. See
id.
QUEEN CITY PIZZA, INC. V. DOMINO’S PIZZA, INC.
124 F.3d 430 (3d Cir. 1997)
SCIRICA, Circuit Judge.
In this appeal, we must decide whether certain franchise tying
restrictions support a claim for violation of federal antitrust laws. Eleven
franchisees of Domino’s Pizza stores and the International Franchise
Advisory Council, Inc. filed suit against Domino’s Pizza, Inc., alleging
violations of federal antitrust laws, breach of contract, and tortious
interference with contract. The district court dismissed the antitrust claims
under Fed.R.Civ.P. 12(b)(6)….
Domino’s Pizza, Inc. is a fast-food service company that sells pizza
through a national network of over 4200 stores. Domino’s Pizza owns and
operates approximately 700 of these stores. Independent franchisees own
and operate the remaining 3500. Domino’s Pizza, Inc. is the second largest
pizza company in the United States, with revenues in excess of $1.8 billion
per year.
A franchisee joins the Domino’s system by executing a standard
franchise agreement with Domino’s Pizza, Inc. Under the franchise
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agreement, the franchisee receives the right to sell pizza under the
“Domino’s” name and format. In return, Domino’s Pizza receives franchise
fees and royalties.
The essence of a successful nationwide fast-food chain is product
uniformity and consistency. Uniformity benefits franchisees because
customers can purchase pizza from any Domino’s store and be certain the
pizza will taste exactly like the Domino’s pizza with which they are
familiar. This means that individual franchisees need not build up their own
good will. Uniformity also benefits the franchisor. It ensures the brand
name will continue to attract and hold customers, increasing franchise fees
and royalties.
For these reasons, section 12.2 of the Domino’s Pizza standard
franchise agreement requires that all pizza ingredients, beverages, and
packaging materials used by a Domino’s franchisee conform to the
standards set by Domino’s Pizza, Inc. Section 12.2 also provides that
Domino’s Pizza, Inc. “may in our sole discretion require that ingredients,
supplies and materials used in the preparation, packaging, and delivery of
pizza be purchased exclusively from us or from approved suppliers or
distributors.” Domino’s Pizza reserves the right “to impose reasonable
limitations on the number of approved suppliers or distributors of any
product.” To enforce these rights, Domino’s Pizza, Inc. retains the power to
inspect franchisee stores and to test materials and ingredients. Section 12.2
is subject to a reasonableness clause providing that Domino’s Pizza, Inc.
must “exercise reasonable judgment with respect to all determinations to be
made by us under the terms of this Agreement.”
Under the standard franchise agreement, Domino’s Pizza, Inc. sells
approximately 90% of the $500 million in ingredients and supplies used by
Domino’s franchisees. These sales, worth some $450 million per year, form
a significant part of Domino’s Pizza, Inc.’s profits. Franchisees purchase
only 10% of their ingredients and supplies from outside sources. With the
exception of fresh dough, Domino’s Pizza, Inc. does not manufacture the
products it sells to franchisees. Instead, it purchases these products from
approved suppliers and then resells them to the franchisees at a markup.
The plaintiffs in this case are eleven Domino’s franchisees and the
International Franchise Advisory Council, Inc. (“IFAC”), a Michigan
corporation consisting of approximately 40% of the Domino’s franchisees
in the United States, formed to promote their common interests. The
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plaintiffs contend that Domino’s Pizza, Inc. has a monopoly in “the $500
million aftermarket for sales of supplies to Domino’s franchisees” and has
used its monopoly power to unreasonably restrain trade, limit competition,
and extract supra-competitive profits. Plaintiffs point to several actions by
Domino’s Pizza, Inc. to support their claims.
First, plaintiffs allege that Domino’s Pizza, Inc. has restricted their
ability to purchase competitively priced dough. Most franchisees purchase
all of their fresh dough from Domino’s Pizza, Inc. Plaintiffs here attempted
to lower costs by making fresh pizza dough on site. They contend that in
response, Domino’s Pizza, Inc. increased processing fees and altered quality
standards and inspection practices for store-produced dough, which
eliminated all potential savings and financial incentives to make their own
dough. Plaintiffs also allege Domino’s Pizza, Inc. prohibited stores that
produce dough from selling their dough to other franchisees, even though
the dough-producing stores were willing to sell dough at a price 25% to
40% below Domino’s Pizza, Inc.’s price.
Next, plaintiffs object to efforts by Domino’s Pizza, Inc. to block
IFAC’s attempt to buy less expensive ingredients and supplies from other
sources. In June 1994, IFAC entered into a purchasing agreement with
FoodService Purchasing Cooperative, Inc. (FPC). Under the agreement,
FPC was appointed the purchasing agent for IFAC-member Domino’s
franchisees. FPC was charged with developing a cooperative purchasing
plan under which participating franchisees could obtain supplies and
ingredients at reduced cost from suppliers other than Domino’s Pizza, Inc.
Plaintiffs contend that when Domino’s Pizza, Inc. became aware of these
efforts, it intentionally issued ingredient and supply specifications so vague
that potential suppliers could not provide FPC with meaningful price
quotations.
Plaintiffs also allege Domino’s Pizza entered into exclusive dealing
arrangements with several franchisees in order to deny FPC access to a pool
of potential buyers sufficiently large to make the alternative purchasing
scheme economically feasible. In addition, plaintiffs contend Domino’s
Pizza, Inc. commenced anti-competitive predatory pricing to shut FPC out
of the market. For example, they maintain that Domino’s Pizza, Inc.
lowered prices on many ingredients and supplies to a level competitive with
FPC’s prices and then recouped lost profits by raising the price on fresh
dough, which FPC could not supply. Further, plaintiffs contend Domino’s
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Pizza, Inc. entered into exclusive dealing arrangements with the only
approved suppliers of ready-made deep dish crusts and sauce. Under these
agreements, the suppliers were obligated to deliver their entire output to
Domino’s Pizza, Inc. Plaintiffs allege the purpose of these agreements was
to prevent FPC from purchasing these critical pizza components for resale
to franchisees.
Finally, plaintiffs allege Domino’s Pizza, Inc. refused to sell fresh
dough to franchisees unless the franchisees purchased other ingredients and
supplies from Domino’s Pizza, Inc. As a result of these and other alleged
practices, plaintiffs maintain that each franchisee store now pays between
$3000 and $10,000 more per year for ingredients and supplies than it would
in a competitive market. Plaintiffs allege these costs are passed on to
consumers.
As noted, eleven Domino’s franchisees and IFAC filed an amended
complaint in United States District Court for the Eastern District of
Pennsylvania against Domino’s Pizza, Inc. seeking declaratory, injunctive,
and compensatory relief under §§ 1 and 2 of the Sherman Act, 15 U.S.C. §§
1 and 2. The plaintiffs also sought damages for breach of contract, breach of
implied covenants of good faith and fair dealing, and tortious interference
with contractual relations.
Domino’s Pizza, Inc. moved to dismiss the antitrust claims for failure
to state a claim, contending the plaintiffs failed to allege a “relevant
market,” a basic pleading requirement for claims under both § 1 and § 2 of
the Sherman antitrust act. They maintained that the relevant market defined
in the complaint—the “market” in Domino’s-approved ingredients and
supplies used by Domino’s Pizza franchisees—was invalid as a matter of
law because the boundaries of the proposed relevant market were defined
by contractual terms contained in the franchise agreement, and not
measured by cross-elasticity of demand or product interchangeability.
The district court granted defendant’s motion to dismiss with prejudice
plaintiffs’ federal antitrust claims…. Noting that plaintiffs did “not
explicitly identify the relevant product and geographic markets in their
amended complaint,” the court said that “it is clear from the context, and
confirmed in their memorandum in opposition to the instant motion, that
Plaintiffs consider the relevant product market to be the market for
ingredients and supplies among Domino’s franchisees.” Rejecting this
concept of the relevant market, the court held that “antitrust claims
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predicated upon a ‘relevant market’ defined by the bounds of a franchise
agreement are not cognizable.” The court noted that Domino’s Pizza, Inc.’s
power to force plaintiffs to purchase ingredients and supplies from them
stemmed “not from the unique nature of the product or from its market
share in the fast food franchise business, but from the franchise agreement.”
For that reason, plaintiffs’ claims “implicate principles of contract, and are
not the concern of the antitrust laws.” The district court also held plaintiffs
had failed adequately to allege harm to competition, “a bedrock premise of
antitrust law.” Because plaintiffs failed to assert a cognizable antitrust claim
and there was neither diversity among the parties nor special circumstances
justifying exercise of supplemental jurisdiction, the court dismissed without
prejudice plaintiffs’ common law claims for lack of subject matter
jurisdiction.
. . . Plaintiffs assert six distinct antitrust claims on appeal. First,
plaintiffs allege Domino’s Pizza, Inc. has monopolized the market in pizza
supplies and ingredients for use in Domino’s stores, in violation of § 2 of
the Sherman Act, 15 U.S.C. § 2. In support of this contention, plaintiffs
allege Domino’s Pizza, Inc. has sufficient market power to control prices
and exclude competition in this market. Second, plaintiffs contend
Domino’s Pizza, Inc. has attempted to monopolize the market for Domino’s
pizza supplies and ingredients, in violation of § 2 of the Sherman Act.
Third, plaintiffs allege Domino’s Pizza, Inc.’s exclusive dealing
arrangements have unreasonably restrained trade in violation of § 1 of the
Sherman Act, 15 U.S.C. § 1. Fourth, plaintiffs allege Domino’s Pizza, Inc.
imposed an unlawful tying arrangement by requiring franchisees to buy
ingredients and supplies from them as a condition of obtaining fresh dough,
in violation of the Sherman Act § 1, 15 U.S.C. § 1. Fifth, plaintiffs allege
Domino’s Pizza, Inc. imposed an unlawful tying arrangement by requiring
franchisees to buy ingredients and supplies “as a condition of their
continued enjoyment of rights and services under their Standard Franchise
Agreement,” in violation of § 1 of the Sherman Act, 15 U.S.C. § 1. Sixth,
plaintiffs allege Domino’s Pizza, Inc. has monopoly power in a relevant
“market for reasonably interchangeable franchise opportunities facing
prospective franchisees,” in violation of § 2 of the Sherman Act, 15 U.S.C.
§ 2. This last claim was not raised before the district court.
As we have noted, the district court held that none of the plaintiffs’
antitrust claims was cognizable under federal law. We will analyze each
claim in turn.
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As a threshold matter, plaintiffs argue that “relevant market
determinations are inherently fact intensive, and therefore are inappropriate
for disposition on a Rule 12(b)(6) motion.” 16). It is true that in most cases,
proper market definition can be determined only after a factual inquiry into
the commercial realities faced by consumers. See Eastman Kodak Co. v.
Image Technical Services, Inc., 504 U.S. 451, 482 (1992). Plaintiffs err,
however, when they try to turn this general rule into a per se prohibition
against dismissal of antitrust claims for failure to plead a relevant market
under Fed.R.Civ.P. 12(b)(6).
Plaintiffs have the burden of defining the relevant market. “The outer
boundaries of a product market are determined by the reasonable
interchangeability of use or the cross-elasticity of demand between the
product itself and substitutes for it.” Brown Shoe Co. v. U.S., 370 U.S. 294,
325. Where the plaintiff fails to define its proposed relevant market with
reference to the rule of reasonable interchangeability and cross-elasticity of
demand, or alleges a proposed relevant market that clearly does not
encompass all interchangeable substitute products even when all factual
inferences are granted in plaintiff’s favor, the relevant market is legally
insufficient and a motion to dismiss may be granted. See, e.g.,… Tower Air,
Inc. v. Federal Exp. Corp., 956 F.Supp. 270 (E.D.N.Y.1996) (“Because a
relevant market includes all products that are reasonably interchangeable,
plaintiff’s failure to define its market by reference to the rule of reasonable
interchangeability is, standing alone, valid grounds for dismissal.”).
Plaintiffs allege Domino’s Pizza, Inc. has willfully acquired and
maintained a monopoly in the market for ingredients, supplies, materials
and distribution services used in the operation of Domino’s stores, in
violation of § 2 of the Sherman Act, 15 U.S.C. § 2. Section 2 sanctions
those “who shall monopolize, or attempt to monopolize, or combine or
conspire with any other person or persons, to monopolize any part of the
trade or commerce among the several states, or with foreign nations.” “The
offense of monopoly under § 2 of the Sherman Act has two elements: (1)
the possession of monopoly power in the relevant market and (2) the willful
acquisition or maintenance of that power as distinguished from growth or
development as a consequence of a superior product, business acumen, or
historic accident.” Aspen Skiing Co. v. Aspen Highlands Skiing Corp., 472
U.S. 585, 596 n. 19 (1985) (quoting United States v. Grinnell Corp., 384
U.S. 563, 570-71 (1966)).
The district court dismissed plaintiffs’ § 2 monopoly claims for failure
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to plead a valid relevant market. Plaintiffs suggest the “ingredients,
supplies, materials, and distribution services used by and in the operation of
Domino’s pizza stores” constitutes a relevant market for antitrust purposes.
We disagree.
… “Interchangeability implies that one product is roughly equivalent
to another for the use to which it is put; while there may be some degree of
preference for the one over the other, either would work effectively. A
person needing transportation to work could accordingly buy a Ford or a
Chevrolet automobile, or could elect to ride a horse or bicycle, assuming
those options were feasible.” Allen-Myland, Inc. v. International Business
Machines Corp., 33 F.3d 194, 206 (3d Cir.1994) (internal quotations
omitted). When assessing reasonable interchangeability, “[f]actors to be
considered include price, use, and qualities.” Tunis Brothers, 952 F.2d at
722. Reasonable interchangeability is also indicated by “cross-elasticity of
demand between the product itself and substitutes for it.” Brown Shoe Co. v.
U.S., 370 U.S. 294, 325 (1962). As we explained in Tunis Brothers Co., Inc.
v. Ford Motor Co., 952 F.2d 715, 722 (3d Cir.1991), “products in a relevant
market [are] characterized by a cross-elasticity of demand, in other words,
the rise in the price of a good within a relevant product market would tend
to create a greater demand for other like goods in that market.” Tunis
Brothers, 952 F.2d at 722.
Here, the dough, tomato sauce, and paper cups that meet Domino’s
Pizza, Inc. standards and are used by Domino’s stores are interchangeable
with dough, sauce and cups available from other suppliers and used by other
pizza companies. Indeed, it is the availability of interchangeable ingredients
of comparable quality from other suppliers, at lower cost, that motivates this
lawsuit. Thus, the relevant market, which is defined to include all
reasonably interchangeable products, cannot be restricted solely to those
products currently approved by Domino’s Pizza, Inc. for use by Domino’s
franchisees. For that reason, we must reject plaintiffs’ proposed relevant
market.
Of course, Domino’s-approved pizza ingredients and supplies differ
from other available ingredients and supplies in one crucial manner. Only
Domino’s-approved products may be used by Domino’s franchisees without
violating section 12.2 of Domino’s standard franchise agreement. Plaintiffs
suggest that this difference is sufficient by itself to create a relevant market
in approved products. We disagree. The test for a relevant market is not
commodities reasonably interchangeable by a particular plaintiff, but
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“commodities reasonably interchangeable by consumers for the same
purposes.” United States v. E.I. du Pont de Nemours & Co., 351 U.S. 377,
395 (1956); Tunis Brothers, 952 F.2d at 722. A court making a relevant
market determination looks not to the contractual restraints assumed by a
particular plaintiff when determining whether a product is interchangeable,
but to the uses to which the product is put by consumers in general. Thus,
the relevant inquiry here is not whether a Domino’s franchisee may
reasonably use both approved or non-approved products interchangeably
without triggering liability for breach of contract, but whether pizza makers
in general might use such products interchangeably. Clearly, they could.
Were we to adopt plaintiffs’ position that contractual restraints render
otherwise identical products non-interchangeable for purposes of relevant
market definition, any exclusive dealing arrangement, output or requirement
contract, or franchise tying agreement would support a claim for violation
of antitrust laws. Perhaps for this reason, no court has defined a relevant
product market with reference to the particular contractual restraints of the
plaintiff….
Plaintiffs argue that the Supreme Court’s decision defining relevant
markets in Eastman Kodak Co. v. Image Technical Services, Inc., 504 U.S.
451 (1992) requires a different outcome. We disagree.
In Kodak, the Supreme Court observed that a market is defined with
reference to reasonable interchangeability. Kodak, 504 U.S. at 482. The
Court held that the market for repair parts and services for Kodak photocopiers was a valid relevant market because repair parts and services for
Kodak machines are not interchangeable with the service and parts used to
fix other copiers. Id. Plaintiffs suggest that Kodak supports its proposed
relevant market because it indicates that in some circumstances, a single
brand of a product or service may constitute a relevant market. This is
correct where the commodity is unique, and therefore not interchangeable
with other products. But here, it is uncontested that contractual restraints
aside, the sauce, dough, and other products and ingredients approved for use
by Domino’s franchisees are interchangeable with other items available on
the market.
Plaintiffs contend that they face information and switching costs that
“lock them in” to their position as Domino’s franchisees, making it
economically impracticable for them to abandon the Domino’s system and
enter a different line of business. They argue that under Kodak, the fact that
they are “locked in” supports their claim that an “aftermarket” for
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Domino’s-approved supplies is a relevant market for antitrust purposes. We
believe plaintiffs misread Kodak.
The defendants in Kodak argued that there was no relevant market in
Kodak repair parts, even if they were unique and non-interchangeable with
other repair parts, because of cross-elasticity of demand between parts
prices and copier sales. If the price of parts were raised too high, defendants
contended, it would decrease demand for copiers. The Court held that
whether there was cross-elasticity of demand between parts and copiers
was, in this case, a factual question that could not be determined as a matter
of law. The Court reached this conclusion because switching and
information costs arise when one purchases an expensive piece of
equipment like a copier. In some circumstances, these costs might create an
economic lock-in that could reduce or eliminate the cross-elasticity of
demand between copiers and the repair parts for those copiers.
Kodak, we believe, held that a plaintiff’s proposed relevant market in a
unique and non-interchangeable derivative product or service cannot be
defeated on summary judgment by a defendant’s assertion that the proposed
derivative market is cross-elastic with the primary market, if there is a
reasonable possibility that the defendant’s assertion about cross-elasticity is
factually incorrect. But Kodak does not hold that the existence of
information and switching costs alone, such as those faced by the Domino’s
franchisees, renders an otherwise invalid relevant market valid. In Kodak,
the repair parts and service were unique and there was a question of fact
about cross-elasticity. Judgment as a matter of law was therefore
inappropriate. Here, it is uncontroverted that Domino’s approved supplies
and ingredients are fully interchangeable in all relevant respects with other
pizza supplies outside the proposed relevant market. For this reason,
dismissal of the plaintiffs’ claim as a matter of law is appropriate.
Kodak is distinguishable from the present appeal in other important
respects. The Kodak case arose out of concerns about unilateral changes in
Kodak’s parts and repairs policies. When the copiers were first sold, Kodak
relied on purchasers to obtain service from independent service providers.
Later, it chose to use its power over the market in unique replacement parts
to squeeze the independent service providers out of the repair market and to
force copier purchasers to obtain service directly from Kodak, at higher
cost. Because this change in policy was not foreseen at the time of sale,
buyers had no ability to calculate these higher costs at the time of purchase
and incorporate them into their purchase decision. In contrast, plaintiffs
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here knew that Domino’s Pizza retained significant power over their ability
to purchase cheaper supplies from alternative sources because that authority
was spelled out in detail in section 12.2 of the standard franchise agreement.
Unlike the plaintiffs in Kodak, the Domino’s franchisees could assess the
potential costs and economic risks at the time they signed the franchise
agreement. The franchise transaction between Domino’s Pizza, Inc. and
plaintiffs was subjected to competition at the pre-contract stage. That cannot
be said of the conduct challenged in Kodak because it was not authorized by
contract terms disclosed at the time of the original transaction. Kodak’s sale
of its product involved no contractual framework for continuing relations
with the purchaser. But a franchise agreement regulating supplies,
inspections, and quality standards structures an ongoing relationship
between franchisor and franchisee designed to maintain good will. These
differences between the Kodak transaction and franchise transactions are
compelling….
Were we to accept plaintiffs’ relevant market, virtually all franchise
tying agreements requiring the franchisee to purchase inputs such as
ingredients and supplies from the franchisor would violate antitrust law.
Courts and legal commentators have long recognized that franchise tying
contracts are an essential and important aspect of the franchise form of
business organization because they reduce agency costs and prevent
franchisees from freeriding-offering products of sub-standard quality
insufficient to maintain the reputational value of the franchise product while
benefitting from the quality control efforts of other actors in the franchise
system. Franchising is a bedrock of the American economy. More than one
third of all dollars spent in retailing transactions in the United States are
paid to franchise outlets. We do not believe the antitrust laws were designed
to erect a serious barrier to this form of business organization.
The purpose of the Sherman Act “is not to protect businesses from the
working of the market; it is to protect the public from the failure of the
market.” Spectrum Sports, Inc. v. McQuillan, 506 U.S. 447, 458 (1993).
Here, plaintiffs’ acceptance of a franchise package that included purchase
requirements and contractual restrictions is consistent with the existence of
a competitive market in which franchises are valued, in part, according to
the terms of the proposed franchise agreement and the availability of
alternative franchise opportunities. Plaintiffs need not have become
Domino’s franchisees. If the contractual restrictions in section 12.2 of the
general franchise agreement were viewed as overly burdensome or risky at
the time they were proposed, plaintiffs could have purchased a different
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form of restaurant, or made some alternative investment. They chose not to
do so. Unlike the plaintiffs in Kodak, plaintiffs here must purchase products
from Domino’s Pizza not because of Domino’s market power over a unique
product, but because they are bound by contract to do so. If Domino’s
Pizza, Inc. acted unreasonably when, under the franchise agreement, it
restricted plaintiffs’ ability to purchase supplies from other sources,
plaintiffs’ remedy, if any, is in contract, not under the antitrust laws. For
these reasons, we agree with the district court that plaintiffs have not
pleaded a valid relevant market….
[The court applied the same reasoning in condemning a claim for
unlawful tying under §1 of the Clayton Act; a dissenting opinion by Judge
Lay is omitted.]
NOTES AND QUESTIONS
Contract lock-in. As courts began to recognize that the legal monopolies
created by patents and trademarks don’t necessarily amount to economic
monopolies, dissatisfied franchisees needed a “new angle” from which to
allege illegal tying. ROGER D. BLAIR & FRANCINE LAFONTAINE, THE
ECONOMICS OF FRANCHISING 150, 152 (2005). The “lock-in” theory that
sprang out of Eastman Kodak appeared to offer franchisees a way to show
that franchisors had market power. Id. at 152. But the Supreme Court
decided Eastman Kodak in 1992, and despite nearly twenty years and
millions of dollars spent litigating “lock-in” claims, “not a single decision
has correctly found market power based on Kodak-style lock-in.” HERBERT
HOVENKAMP, FEDERAL ANTITRUST POLICY: THE LAW OF COMPETITION AND
ITS PRACTICE § 3.3a2 (4th ed. 2011).
The lock-in problem works like this: While Chrysler competes with
Chevy, Ford, Toyota, and a slew of other automobile manufacturers, many
of the repair parts for Chryslers are unique. So people who buy Chryslers
are “locked in” to Chrysler repair parts. The issue, however, is whether the
lock-in enables Chrysler to take advantage of its automobile owners, and if
any such advantage amounts to ‘monopoly.’” Usually it does not. For
instance, if Chrysler jacked up repair-part prices for its locked-in Chrysler
owners, it would soon find itself out of business—word of the upcharges
would spread, and people would very quickly stop buying Chryslers. But in
Kodak, the Supreme Court found that high information and switching costs
could enable firms to lock in consumers:
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For the service-market price to affect equipment demand,
consumers must inform themselves of the total cost of the
“package”—equipment, service, and parts—at the time of purchase;
that is, consumers must engage in accurate lifecycle pricing.
Lifecycle pricing of complex, durable equipment is difficult and
costly. . . .
A second factor undermining Kodak’s claim that
supracompetitive prices in the service market lead to ruinous losses
in equipment sales is the cost to current owners of switching to a
different product. If the cost of switching is high, consumers who
already have purchased the equipment, and are thus “locked in,” will
tolerate some level of service-price increases before changing
equipment brands. Under this scenario, a seller profitably could
maintain supracompetitive prices in the aftermarket if the switching
costs were high relative to the increase in service prices, and the
number of locked-in customers were high relative to the number of
new purchasers.
Eastman Kodak Co. v. Image Tech. Servs., Inc., 504 U.S. 451, 473, 476
(1992) (citations and footnotes omitted).
Plaintiffs in recent franchise-tying case—including Queen City—have
repeatedly claimed to be victims of asymmetric information. Blair &
Lafontaine, supra, at 162. But this is a tough sell, as state and federal law
require franchisors to disclose such information as what supplies
franchisees must purchase and whether they must buy them from designated
suppliers, as well as information about the expected costs of supplies.
The switching-costs argument does no better. While the relatively
higher upfront costs of licensing a franchise might suggest that franchisees
are “every bit as locked in . . . as a Kodak copier owner is to Kodak repair
parts,” there is a crucial difference: unlike Kodak copier owners, who own a
“durable good with rapidly declining resale value,” franchisees “have a
revenue-generating asset that has a significant resale value.” Id. at 161–62.
Dissatisfied franchisees can sell their franchises. Id. Switching costs may
therefore pose less of a problem to franchisees, suggesting that lock-in
theory is inappropriate in the usual franchise-tying case.
Finally, as you saw in Queen City, courts are extremely unwilling to
limit the market-power question to the four corners of the franchise
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contract. In Queen City, the Third Circuit drew a line between “precontract” and “post-contract” market power. While the court acknowledged
that post-contract Domino’s could require the plaintiffs to buy its pizza
dough at above-market prices, it held that this “‘power’ to ‘force’ plaintiffs
to purchase the alleged tying product stems not from [market power] but
from plaintiffs’ contractual agreement to purchase the tying product.”
Queen City, 124 F.3d at 443. If the plaintiffs did not like Domino’s terms,
they could have picked another franchise. Furthermore, Domino’s terms
were spelled out clearly in the franchising agreement, and the plaintiffs
knew about it when they signed it. Under these circumstances, there could
be no “lock-in,” could there?
UNITED STATES V. LOEW'S, INC.
371 U.S. 38 (1962)
Mr. Justice GOLDBERG delivered the opinion of the Court.
These consolidated appeals present as a key question the validity
under § 1 of the Sherman Act of block booking of copyrighted feature
motion pictures for television exhibition. We hold that the tying agreements
here are illegal and in violation of the Act.
The United States brought separate civil antitrust actions in the
Southern District of New York in 1957 against six major distributors of pre1948 copyrighted motion picture feature films for television exhibition,
alleging that each defendant had engaged in block booking in violation of §
1 of the Sherman Act. The complaints asserted that the defendants had, in
selling to television stations, conditioned the license or sale of one or more
feature films upon the acceptance by the station of a package or block
containing one or more unwanted or inferior films. No combination or
conspiracy among the distributors was alleged; nor was any monopolization
or attempt to monopolize under § 2 of the Sherman Act averred. The sole
claim of illegality rested on the manner in which each defendant had
marketed its product. The successful pressure applied to television station
customers to accept inferior films along with desirable pictures was the
gravamen of the complaint.
… [T]he several defendants have each, from time to time and to the
extent set forth in the specific findings of fact, licensed or offered to license
one or more feature films to television stations on condition that the
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licensee also license one or more other such feature films, and have, from
time to time and to the extent set forth in the specific findings of fact,
refused, expressly or impliedly, to license feature films to television stations
unless one or more other such feature films were accepted by the licensee.’
The [trial] judge recognized that there was keen competition
between the defendant distributors, and therefore rested his conclusion
solely on the individual behavior of each in engaging in block booking. In
reaching his decision he carefully considered the evidence relating to each
of the 68 licensing agreements that the Government had contended involved
block booking. He concluded that only 25 of the contracts were illegally
entered into. Nine of these belonged to defendant C & C Super Corp.,
which had an admitted policy of insisting on block booking that it sought to
justify on special grounds.
Of the others, defendant Loew's, Incorporated, had in two
negotiations that resulted in licensing agreements declined to furnish
stations KWTV of Oklahoma City and WBRE of Wilkes-Barre with
individual film prices and had refused their requests for permission to select
among the films in the groups. Loew's exacted from KWTV a contract for
the entire Loew's library of 723 films, involving payments of $314,725.20.
The WBRE agreement was for a block of 100 films, payments to total
$15,000.
Defendant Screen Gems, Inc., was also found to have block booked
two contracts, both with WTOP of Washington, D.C., one calling for a
package of 26 films and payments of $20,800 and the other for 52 films and
payments of $40,000. The judge accepted the testimony of station officials
that they had requested the right to select films and that their requests were
refused….
The court entered separate final judgments against the defendants,
wherein each was enjoined from
‘(A) Conditioning or tying, or attempting to condition or tie, the
purchase or license of the right to exhibit any feature film over any
television station upon the purchase or license of any other film;
‘(B) Conditioning the purchase or license of the right to exhibit
any feature film over any television station upon the purchase or
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license for exhibition over any other television station of that feature
film, or any other film;
‘(C) Entering into any agreement to sell or license the right to
exhibit any feature film over any television station in which the
differential between the price or fee for such feature film when sold
or licensed alone and the price or fee for the same film when sold or
licensed with one or more other film (sic) has the effect of
conditioning the sale or license of such film upon the sale or license
of one or more other films.’
This case raises the recurring question of whether specific tying
arrangements violate § 1 of the Sherman Act. This Court has recognized
that ‘(t)ying agreements serve hardly any purpose beyond the suppression
of competition,’ Standard Oil Co. of California v. United States, 337 U.S.
293, 305-306. They are an object of anti-trust concern for two reasons-they
may force buyers into giving up the purchase of substitutes for the tied
product, see Times-Picayune Pub. Co. v. United States, 345 U.S. 594, 605,
and they may destroy the free access of competing suppliers of the tied
product to the consuming market, see International Salt Co. v. United
States, 332 U.S. 392, 396. A tie-in contract may have one or both of these
undesirable effects when the seller, by virtue of his position in the market
for the tying product, has economic leverage sufficient to induce his
customers to take the tied product along with the tying item. The standard
of illegality is that the seller must have ‘sufficient economic power with
respect to the tying product to appreciably restrain free competition in the
market for the tied product * * *.’ Northern Pacific R. Co. v. United States,
356 U.S. 1, 6. Market dominance-some power to control price and to
exclude competition-is by no means the only test of whether the seller has
the requisite economic power. Even absent a showing of market dominance,
the crucial economic power may be inferred from the tying product's
desirability to consumers or from uniqueness in its attributes.
The requisite economic power is presumed when the tying product
is patented or copyrighted, International Salt Co. v. United States, 332 U.S.
392; United States v. Paramount Pictures, Inc., 334 U.S. 131. This principle
grew out of a long line of patent cases which had eventuated in the doctrine
that a patentee who utilized tying arrangements would be denied all relief
against infringements of his patent. Motion Picture Patents Co. v. Universal
Film Mfg. Co., 243 U.S. 502; Carbice Corp. v. American Patents Dev.
Corp., 283 U.S. 27. These cases reflect a hostility to use of the statutorily
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granted patent monopoly to extend the patentee's economic control to
unpatented products. The patentee is protected as to his invention, but may
not use his patent rights to exact tribute for other articles.
Since one of the objectives of the patent laws is to reward
uniqueness, the principle of these cases was carried over into antitrust law
on the theory that the existence of a valid patent on the tying product,
without more, establishes a distinctiveness sufficient to conclude that any
tying arrangement involving the patented product would have
anticompetitive consequences. In United States v. Paramount Pictures, Inc.,
334 U.S. 131, 156-159 [1948], the principle of the patent cases was applied
to copyrighted feature films which had been block booked into movie
theaters. The Court reasoned that
‘The copyright law, like the patent statutes, makes reward to the
owner a secondary consideration. In Fox Film Corp. v. Doyal, 286
U.S. 123, Chief Justice Hughes spoke as follows respecting the
copyright monopoly granted by Congress. ‘The sole interest of the
United States and the primary object in conferring the monopoly lie
in the general benefits derived by the public from the labors of
authors.’ It is said that reward to the author or artist serves to induce
release to the public of the products of his creative genius. But the
reward does not serve its public purpose if it is not related to the
quality of the copyright. Where a high quality film greatly desired is
licensed only if an inferior one is taken, the latter borrows quality
from the former and strengthens its monopoly by drawing on the
other. The practice tends to equalize rather than differentiate the
reward for the individual copyrights. Even where all the films
included in the package are of equal quality, the requirement that all
be taken if one is desired increases the market for some. Each stands
not on its own footing but in whole or in part on the appeal which
another film may have. As the District Court said, the result is to add
to the monopoly of the copyright in violation of the principle of the
patent cases involving tying clauses.' 334 U.S., at 158.
Appellants attempt to distinguish the Paramount decision in its
relation to the present facts: the block booked sale of copyrighted feature
films to exhibitors in a new medium-television. Not challenging the District
Court's finding that they did engage in block booking, they contend that the
uniqueness attributable to a copyrighted feature film, though relevant in the
movie-theater context, is lost when the film is being sold for television use.
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Feature films, they point out, constitute less than 8% of television
programming, and they assert that films are ‘reasonably interchangeable’
with other types of programming material and with other feature films as
well. Thus they argue that their behavior is not to be judged by the principle
of the patent cases, as applied to copyrighted materials in Paramount
Pictures, but by the general principles which govern the validity of tying
arrangements of nonpatented products, e.g., Northern Pacific R. Co. v.
United States, 356 U.S. 1, 6. They say that the Government's proof did not
establish their ‘sufficient economic power’ in the sense contemplated for
nonpatented products.
Appellants cannot escape the applicability of Paramount Pictures. A
copyrighted feature film does not lose its legal or economic uniqueness
because it is shown on a television rather than a movie screen.
The district judge found that each copyrighted film block booked by
appellants for television use ‘was in itself a unique product’; that feature
films ‘varied in theme, in artistic performance, in stars, in audience appeal,
etc.,’ and were not fungible; and that since each defendant by reason of its
copyright had a ‘monopolistic’ position as to each tying product, ‘sufficient
economic power’ to impose an appreciable restraint on free competition in
the tied product was present, as demanded by the Northern Pacific decision.
We agree. These findings of the district judge, supported by the record,
confirm the presumption of uniqueness resulting from the existence of the
copyright itself.
Moreover, there can be no question in this case of the adverse
effects on free competition resulting from appellants' illegal block booking
contracts. Television stations forced by appellants to take unwanted films
were denied access to films marketed by other distributors who, in turn,
were foreclosed from selling to the stations. … These anti-competitive
consequences are an apt illustration of the reasons underlying our
recognition that the mere presence of competing substitutes for the tying
product, here taking the form of other programming material as well as
other feature films, is insufficient to destroy the legal, and indeed the
economic, distinctiveness of the copyrighted product. Standard Oil Co. of
California v. United States, 337 U.S. 293, 307; Times-Picayune Pub. Co. v.
United States, 345 U.S. 594, 611 and n. 30. By the same token, the
distinctiveness of the copyrighted tied product is not inconsistent with the
fact of competition, in the form of other programming material and other
films, which is suppressed by the tying arrangements.
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It is therefore clear that the tying arrangements here both by their
‘inherent nature’ and by their ‘effect’ injuriously restrained trade. United
States v. American Tobacco Co., 221 U.S. 106, 179. Accommodation
between the statutorily dispensed monopoly in the combination of contents
in the patented or copyrighted product and the statutory principles of free
competition demands that extension of the patent or copyright monopoly by
the use of tying agreements be strictly confined. There may be rare
circumstances in which the doctrine we have enunciated under § 1 of the
Sherman Act prohibiting tying arrangements involving patented or
copyrighted tying products is inapplicable. However, we find it difficult to
conceive of such a case, and the present case is clearly not one….
The United States contends that the relief afforded by the final
judgments is inadequate and that to be adequate it must also: (1) require the
defendants to price the films individually and offer them on a picture-bypicture basis; (2) prohibit noncost-justified differentials in price between a
film when sold individually and when sold as part of a package; (3)
proscribe ‘temporary’ refusals by a distributor to deal on less than a block
basis while he is negotiating with a competing television station for a
package sale.
Under the final judgments entered by the court, a distributor would
be free to offer films in a package initially, without stating individual prices.
If, however, he delayed at all in producing individual prices upon request,
he would subject himself to a possible contempt sanction. The
Government's first request would prevent this ‘first bite’ possibility, forcing
the offer of the films on an individual basis at the outset (but, as we view it,
not precluding a simultaneous package offer, United States v. Paramount
Pictures, Inc., supra, 334 U.S., at 159….
The final judgments as entered only prohibit a price differential
between a film offered individually and as part of a package which ‘has the
effect of conditioning the sale or license of such film upon the sale or
license of one or more other films.’ The Government contends that this
provision appearing by itself is too vague and will lead to unnecessary
litigation. Differentials unjustified by cost savings may already be
prohibited under the decree as it now appears. Nevertheless, the addition of
a specific provision to prevent such differentials will prevent uncertainty in
the operation of the decree. To ensure that litigation over the scope and
application of the decrees is not left until a contempt proceeding is brought,
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the second requested modification should be added. The Government,
however, seeks to make distribution costs the only saving which can
legitimately be the basis of a discount. We would not so limit the relevant
cost justifications. To prevent definitional arguments, and to ensure that all
proper bases of quantity discount may be used, the modification should be
worded in terms of allowing all legitimate cost justifications.
The Government's third request is, like the first, designed to prevent
distributors from subjecting prospective purchasers to a ‘run-around’ on the
purchase of individual films. No doubt temporary refusal to sell in broken
lots to one customer while negotiating to sell the entire block to another is a
proper business practice, viewed in vacuo, but we think that if permitted
here it may tend to force some stations into buying pre-set packages to
forestall a competitor's getting the entire group. In recognition of this the
Government seeks a blanket prohibition against all temporary refusals to
deal. We agree in the main, except that the modification proposed by the
Government fails to give full recognition to that part of this Court's holding
in Paramount Pictures which said,
‘We do not suggest that films may not be sold in blocks or groups,
when there is no requirement, express or implied, for the purchase of
more than one film. All we hold to be illegal is a refusal to license
one or more copyrights unless another copyright is accepted.’
The modifications we have specified will bring about a greater
precision in the operation of the decrees. We have concluded that they will
properly protect the interest of the Government in guarding against
violations and the interest of the defendants in seeking in good faith to
comply.
The judgments are vacated and the causes are remanded to the District
Court for further proceedings in conformity with this opinion.
Vacated and remanded.
NOTES AND QUESTIONS
1. Does block booking necessarily decrease consumer welfare? What if
different costumers do not value separate products the same? Suppose that
Loew’s values movie A at $1,000 and movie B at $10,000. Suppose further
that C & C values movie A at $8,000 and movie B at $1,200. Does
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requiring the rights-holder to offer the movies individually rather than in a
block always increase consumer welfare? See Erik Hovenkamp & Herbert
Hovenkamp, Tying Arrangements and Antitrust Harm, 52 ARIZ. L. REV.
925, 956–59 (2010).
2. Are there other explanations for why a firm would want to sell its
products in blocks? If a firm charges different customers different prices,
the customers may perceive this discrepancy as unfair, even though the
customers value the same product differently. See Barak Y. Orbach,
Antitrust and Pricing in the Motion Picture Industry, 21 YALE J. REG. 317,
353–55 (2004). Another reason a firm may want to block book is to prevent
oversearching. By not allowing a customer to pick from individual films,
the rights-holders do not have to spend the resources to price each film
individually. See F. Andrew Hanssen, The Block Booking of Films
Reexamined, 43 J.L. & ECON. 395, 398–99. Can you think of any other
reasons a firm would engage in block booking? See generally id.; Bruce H.
Kobayashi, Does Economics Provide a Reliable Guide to Regulating
Commodity Bundling by Firms?A Survey of the Economic Literature, 1 J.
COMPETITION L. & ECON. 707, 714–27 (2005).
3. Note that the Court’s decree permitted “cost justified” bundling. That is,
if the costs of licensing a block of films is lower than of licensing each film
separately, the defendant could pass on the cost savings but no more. Of
course, if cost savings fully explained the blocks, then the decree effectively
permitting blocking in any event.
UNITED STATES v. MICROSOFT CORP.
253 F.3d 34 (D.C. Cir.) cert. denied, 534 U.S. 952 (2001)
Per Curiam
The action against Microsoft arose pursuant to a complaint filed by the
United States and separate complaints filed by individual States. The
District Court determined that Microsoft had maintained a monopoly in the
market for Intel-compatible PC operating systems in violation of § 2;
attempted to gain a monopoly in the market for internet browsers in
violation of § 2; and illegally tied two purportedly separate products,
Windows and Internet Explorer (“IE”), in violation of § 1. United States v.
Microsoft Corp., 87 F.Supp.2d 30 (D.D.C.2000) (“ Conclusions of Law”).
The District Court then found that the same facts that established liability
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under §§ 1 and 2 of the Sherman Act mandated findings of liability under
analogous state law antitrust provisions….
As a general rule, courts are properly very skeptical about claims that
competition has been harmed by a dominant firm's product design
changes. See, e.g., Foremost Pro Color, Inc. v. Eastman Kodak Co., 703
F.2d 534, 544-45 (9th Cir.1983). In a competitive market, firms routinely
innovate in the hope of appealing to consumers, sometimes in the process
making their products incompatible with those of rivals; the imposition of
liability when a monopolist does the same thing will inevitably deter a
certain amount of innovation. This is all the more true in a market, such as
this one, in which the product itself is rapidly changing. Judicial deference
to product innovation, however, does not mean that a monopolist's product
design decisions are per se lawful. See Foremost Pro Color, 703 F.2d at
545; see also Cal. Computer Prods., 613 F.2d at 739, 744; In re IBM
Peripheral EDP Devices Antitrust Litig., 481 F.Supp. 965, 1007-08
(N.D.Cal.1979).
[Commingling of Code, Under §2 of the Sherman Act]
… [T]he District Court condemned Microsoft's decision to bind IE to
Windows 98 “by placing code specific to Web browsing in the same files as
code that provided operating system functions.” Putting code supplying
browsing functionality into a file with code supplying operating system
functionality “ensure[s] that the deletion of any file containing browsingspecific routines would also delete vital operating system routines and thus
cripple Windows....” [P]eventing an OEM from removing IE deters it from
installing a second browser because doing so increases the OEM's product
testing and support costs; by contrast, had OEMs been able to remove IE,
they might have chosen to pre-install [Netscape] Navigator alone.****
[T]he District Court condemned Microsoft's decision to bind IE to
Windows 98 “by placing code specific to Web browsing in the same files as
code that provided operating system functions.” Putting code supplying
browsing functionality into a file with code supplying operating system
functionality “ensure[s] that the deletion of any file containing browsingspecific routines would also delete vital operating system routines and thus
cripple Windows....” As noted above, preventing an OEM from removing
IE deters it from installing a second browser because doing so increases the
OEM's product testing and support costs; by contrast, had OEMs been able
to remove IE, they might have chosen to pre-install Navigator alone.
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Microsoft denies, as a factual matter, that it commingled browsing
and non-browsing code, and it maintains the District Court's findings to the
contrary are clearly erroneous. According to Microsoft, its expert “testified
without contradiction that ‘[t]he very same code in Windows 98 that
provides Web browsing functionality’ also performs essential operating
system functions-not code in the same files, but the very same software
code.”
Microsoft's expert did not testify to that effect “without
contradiction,” however. A Government expert, Glenn Weadock, testified
that Microsoft “design [ed] [IE] so that some of the code that it uses coresides in the same library files as other code needed for Windows.”
Another Government expert likewise testified that one library file,
SHDOCVW.DLL, “is really a bundle of separate functions. It contains
some functions that have to do specifically with Web browsing, and it
contains some general user interface functions as well.” One of Microsoft's
own documents suggests as much. See Plaintiffs' Proposed Findings of Fact
¶ 131.2.vii (citing GX 1686 (under seal) (Microsoft document indicating
some functions in SHDOCVW.DLL can be described as “IE only,” others
can be described as “shell only” and still others can be described as
providing both “IE” and “shell” functions)).
In view of the contradictory testimony in the record, some of which
supports the District Court's finding that Microsoft commingled browsing
and non-browsing code, we cannot conclude that the finding was clearly
erroneous. See Anderson v. City of Bessemer City, 470 U.S. 564, 573-74
(1985) (“If the district court's account of the evidence is plausible in light of
the record viewed in its entirety, the court of appeals may not reverse it
even though convinced that had it been sitting as the trier of fact, it would
have weighed the evidence differently.”). Accordingly, we reject
Microsoft's argument that we should vacate Finding of Fact 159 as it relates
to the commingling of code, and we conclude that such commingling has an
anticompetitive effect; as noted above, the commingling deters OEMs from
pre-installing rival browsers, thereby reducing the rivals' usage share and,
hence, developers' interest in rivals' APIs as an alternative to the API set
exposed by Microsoft's operating system.
Microsoft's justifications for integration
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… Although Microsoft does make some general claims regarding the
benefits of integrating the browser and the operating system, see,
e.g., Direct Testimony of James Allchin ¶ 94,reprinted in 5 J.A. at 3321
(“Our vision of deeper levels of technical integration is highly efficient and
provides substantial benefits to customers and developers.”), it neither
specifies nor substantiates those claims. Nor does it argue that either
excluding IE from the Add/Remove Programs utility or commingling code
achieves any integrative benefit. Plaintiffs plainly made out a prima facie
case of harm to competition in the operating system market by
demonstrating that Microsoft's actions increased its browser usage share and
thus protected its operating system monopoly from a middleware threat and,
for its part, Microsoft failed to meet its burden of showing that its conduct
serves a purpose other than protecting its operating system monopoly.
Accordingly, we hold that Microsoft's exclusion of IE from the
Add/Remove Programs utility and its commingling of browser and
operating system code constitute exclusionary conduct, in violation of §
2….
IV. TYING * * * * [Mainly under § 1 of the Sherman Act]
The District Court concluded that Microsoft’s contractual and
technological bundling of the IE web browser (the “tied” product) with its
Windows operating system (“OS”) (the “tying” product) resulted in a tying
arrangement that was per se unlawful. We hold that the rule of reason,
rather than per se analysis, should govern the legality of tying arrangements
involving platform software products. ...
The key District Court findings are that (1) Microsoft required licensees
of Windows 95 and 98 also to license IE as a bundle at a single price, (2)
Microsoft refused to allow OEMs to uninstall or remove IE from the
Windows desktop, (3) Microsoft designed Windows 98 in a way that
withheld from consumers the ability to remove IE by use of the
Add/Remove Programs utility, and (4) Microsoft designed Windows 98 to
override the user’s choice of default web browser in certain circumstances.
... Although the District Court also found that Microsoft commingled
operating system-only and browser-only routines in the same library files, it
did not include this as a basis for tying liability despite plaintiffs’ request
that it do so. ...
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Microsoft does not dispute that it bound Windows and IE in the four
ways the District Court cited. Instead it argues that Windows (the tying
good) and IE browsers (the tied good) are not “separate products,” ...
The first case to give content to the separate-products test was Jefferson
Parish, 466 U.S. 2. That case addressed a tying arrangement in which a
hospital conditioned surgical care at its facility on the purchase of
anesthesiological services from an affiliated medical group. The facts were
a challenge for casual separate-products analysis because the tied service anesthesia - was neither intuitively distinct from nor intuitively contained
within the tying service - surgical care. A further complication was that,
soon after the Court enunciated the per se rule for tying liability in
International Salt Co. v. United States, 332 U.S. 392, 396 (1947), and
Northern Pacific Railway Co. v. United States, 356 U.S. 1, 5-7 (1958), new
economic research began to cast doubt on the assumption, voiced by the
Court when it established the rule, that “tying agreements serve hardly any
purpose beyond the suppression of competition.”
The Jefferson Parish Court resolved the matter in two steps. First, it
clarified that “the answer to the question whether one or two products are
involved” does not turn “on the functional relation between them. ...” In
other words, the mere fact that two items are complements, that “one ... is
useless without the other,” does not make them a single “product” for
purposes of tying law. ... Second, reasoning that the “definitional question
[whether two distinguishable products are involved] depends on whether the
arrangement may have the type of competitive consequences addressed by
the rule [against tying],” the Court decreed that “no tying arrangement can
exist unless there is a sufficient demand for the purchase of
anesthesiological services separate from hospital services to identify a
distinct product market in which it is efficient to offer anesthesiological
services separately from hospital service. ...”
To understand the logic behind the Court’s consumer demand test,
consider first the postulated harms from tying. The core concern is that
tying prevents goods from competing directly for consumer choice on their
merits, i.e., being selected as a result of “buyers’ independent judgment,” ...
With a tie, a buyer’s “freedom to select the best bargain in the second
market [could be] impaired by his need to purchase the tying product, and
perhaps by an inability to evaluate the true cost of either product. ...” Direct
competition on the merits of the tied product is foreclosed when the tying
product either is sold only in a bundle with the tied product or, though
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offered separately, is sold at a bundled price, so that the buyer pays the
same price whether he takes the tied product or not. ...
But not all ties are bad. Bundling obviously saves distribution and
consumer transaction costs. 9 Areeda, Antitrust Law ¶ 1703g2 (1991). This
is likely to be true, to take some examples from the computer industry, with
the integration of math co-processors and memory into microprocessor
chips and the inclusion of spell checkers in word processors. ... Indeed, if
there were no efficiencies from a tie (including economizing on consumer
transaction costs such as the time and effort involved in choice), we would
expect distinct consumer demand for each individual component of every
good. ...
Before concluding our exegesis of Jefferson Parish’s separate-products
test, we should clarify two things. First, Jefferson Parish does not endorse a
direct inquiry into the efficiencies of a bundle. Rather, it proposes easy-toadminister proxies for net efficiency. In describing the separate-products
test we discuss efficiencies only to explain the rationale behind the
consumer demand inquiry. ...
Second, the separate-products test is not a one-sided inquiry into the
cost savings from a bundle. Although Jefferson Parish acknowledged that
prior lower court cases looked at cost-savings to decide separate products,
the Court conspicuously did not adopt that approach in its disposition of
tying arrangement before it. Instead it chose proxies that balance costs
savings against reduction in consumer choice.
... [T]here is merit to Microsoft’s broader argument that Jefferson
Parish’s consumer demand test would “chill innovation to the detriment of
consumers by preventing firms from integrating into their products new
functionality previously provided by standalone products - and hence, by
definition, subject to separate consumer demand.”
In light of the monopoly maintenance section, obviously, we do not find
that Microsoft’s integration is welfare-enhancing or that it should be
absolved of tying liability. Rather, we heed Microsoft’s warning that the
separate-products element of the per se rule may not give newly integrated
products a fair shake.
The Supreme Court has warned that “‘[i]t is only after considerable
experience with certain business relationships that courts classify them as
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per se violations. ...’” Broadcast Music, 441 U.S. at 9. ... Yet the sort of
tying arrangement attacked here is unlike any the Supreme Court has
considered. ...
In none of [the earlier Supreme Court] cases was the tied good
physically and technologically integrated with the tying good. Nor did the
defendants ever argue that their tie improved the value of the tying product
to users and to makers of complementary goods. In those cases where the
defendant claimed that use of the tied good made the tying good more
valuable to users, the Court ruled that the same result could be achieved via
quality standards for substitutes of the tied good. ...Here Microsoft argues
that IE and Windows are an integrated physical product and that the
bundling of IE APIs with Windows makes the latter a better applications
platform for third-party software. It is unclear how the benefits from IE
APIs could be achieved by quality standards for different browser
manufacturers. We do not pass judgment on Microsoft’s claims regarding
the benefits from integration of its APIs. We merely note that these and
other novel, purported efficiencies suggest that judicial “experience”
provides little basis for believing that, “because of their pernicious effect on
competition and lack of any redeeming virtue,” a software firm’s decisions
to sell multiple functionalities as a package should be “conclusively
presumed to be unreasonable and therefore illegal without elaborate inquiry
as to the precise harm they have caused or the business excuse for their
use.” ...
...The failure of the separate-products test to screen out certain cases of
productive integration is particularly troubling in platform software markets
such as that in which the defendant competes. Not only is integration
common in such markets, but it is common among firms without market
power. We have already reviewed evidence that nearly all competitive OS
vendors also bundle browsers. Moreover, plaintiffs do not dispute that OS
vendors can and do incorporate basic internet plumbing and other useful
functionality into their OSs. ...
... [B]ecause of the pervasively innovative character of platform
software markets, tying in such markets may produce efficiencies that
courts have not previously encountered and thus the Supreme Court had not
factored into the per se rule as originally conceived. For example, the
bundling of a browser with OSs enables an independent software developer
to count on the presence of the browser’s APIs, if any, on consumers’
machines and thus to omit them from its own package. ...
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We do not have enough empirical evidence regarding the effect of
Microsoft’s practice on the amount of consumer surplus created or
consumer choice foreclosed by the integration of added functionality into
platform software to exercise sensible judgment regarding that entire class
of behavior.
Our judgment regarding the comparative merits of the per se rule and
the rule of reason is confined to the tying arrangement before us, where the
tying product is software whose major purpose is to serve as a platform for
third-party applications and the tied product is complementary software
functionality. While our reasoning may at times appear to have broader
force, we do not have the confidence to speak to facts outside the record. ...
Should plaintiffs choose to pursue a tying claim under the rule of
reason, we note the following for the benefit of the trial court:
...[O]n remand, plaintiffs must show that Microsoft’s conduct unreasonably
restrained competition. Meeting that burden “involves an inquiry into the
actual effect” of Microsoft’s conduct on competition in the tied good
market, Jefferson Parish, 466 U.S. at 29, the putative market for browsers.
[However, given its loss on market-power questions of the browser-attempt
claim the court forbad the government from relying on any theory that
required the definition of a browser market and a showing of high entry
barriers there - ed.]
NOTES AND QUESTIONS
1. The Microsoft decision produced an enormous variety of commentary.
See, e.g., Andrew Chin, Decoding Microsoft: A First Principles Approach,
40 WAKE FOREST L. REV. 1, 137–38 (2005) (“[T]he Microsoft tying claim
satisfied all of the generally required elements of a per se illegal tying
arrangement. . . . [T]he plaintiffs would still have been able to prevail on
their tying claim . . . where the residual rule of reason was the only
available basis for liability.”); Keith N. Hylton & Michael Salinger, Tying
Law and Policy: A Decision-Theoretic Approach, 69 ANTITRUST L.J. 469,
520 (2001) (“[W]e see no reason to treat software bundling as less
deserving of the non-interventionist standard than other types of product
integration.”). For an example of support, see Harry First & Andrew I.
Gavil, Re-Framing Windows: The Durable Meaning of the Microsoft
Antitrust Litigation, 2006 UTAH L.REV. (2006)(noting that “. . . opponents
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of the government’s prosecution of Microsoft . . . [charged that] antitrust
enforcement was a crude and slow tool, ill-suited for the fast-paced and
changing markets of the information age . . . [but that] [t]oday, more than a
decade after the Justice Department reached its first consent decree with
Microsoft, Microsoft’s share of the Intel-compatible PC operating system
market remains above ninety percent,” and that “Excess caution by
enforcers and courts . . . inherently favors the incumbent at the expense of
competition.”).
2. The D.C. Circuit vacated the district court's conclusion that the per se
rule governed Microsoft's contractual and technological tying of Internet
Explorer to its Windows operating system. Rather, the court concluded, the
rule of reason should be applied to a tie in which the tying product is a
software computer platform and the tied product is an application. The
court reached this conclusion, not by purporting to overrule the Supreme
Court's highly generalized per se rule governing tying arrangements, but
rather by stressing the novelty of the arrangement before it given that only a
few previous cases had involved ties of computer software. This suggestion
that the per se tying rule is "market specific" is unprecedented and seems
quite inconsistent with Supreme Court precedent, which has applied the per
se rule to ties in new markets by generalizing from older cases that arose in
different markets. Indeed, it is inconsistent with the jurisprudence of the
per se rule generally, which is not product specific, although the nature of
the product or service in question may affect the disposition of particular
issues.
In creating this market specific rule, the court took rather extreme
liberties with this statement from the Supreme Court's Jefferson Parish
decision: "[i]t is far too late in the history of our antitrust jurisprudence to
question the proposition that certain tying arrangements pose an
unacceptable risk of stifling competition and therefore are unreasonable 'per
se." The D.C. Circuit italicized the word "certain" in the Jefferson Parish
statement -- as if what the Supreme Court had meant to say was that some
ties required per se treatment but others required rule of reason treatment
and it was up to the lower courts to decide which was which. While that is
true, the lower court's liberty to reject the per se rule had never been related
to the particular market in which tying occurred. Rather, The Supreme
Court had used the word "certain" to indicate that the per se rule for tying
applied only where its doctrinal requirements were established. That is, a
court might conclude that the defendant lacked tying product power, and
thus that its tie was not one of those arrangements posing an unacceptable
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risk of stifling competition. The lower courts were not given a warrant to
slice and dice the world of tying arrangements depending on the type or
product or service that was at issue.
ILLINOIS TOOL WORKS, INC. V. INDEPENDENT INK, INC.
547 U.S. 28 (2006)
JUSTICE STEVENS delivered the opinion of the Court.
In Jefferson Parish Hospital Dist. No. 2 v. Hyde, 466 U.S. 2 (1984), we
repeated the well-settled proposition that “if the Government has granted
the seller a patent or similar monopoly over a product, it is fair to presume
that the inability to buy the product elsewhere gives the seller market
power.” This presumption of market power, applicable in the antitrust
context when a seller conditions its sale of a patented product (the “tying”
product) on the purchase of a second product (the “tied” product), has its
foundation in the judicially created patent misuse doctrine. See United
States v. Loew's Inc., 371 U.S. 38, 46 (1962). In 1988, Congress
substantially undermined that foundation, amending the Patent Act to
eliminate the market power presumption in patent misuse cases. See 102
Stat. 4674, codified at 35 U.S.C. § 271(d). The question presented to us
today is whether the presumption of market power in a patented product
should survive as a matter of antitrust law despite its demise in patent law.
We conclude that the mere fact that a tying product is patented does not
support such a presumption.
Petitioners, Trident, Inc., and its parent, Illinois Tool Works Inc.,
manufacture and market printing systems that include three relevant
components: (1) a patented piezoelectric impulse ink jet printhead; (2) a
patented ink container, consisting of a bottle and valved cap, which attaches
to the printhead; and (3) specially designed, but unpatented, ink. Petitioners
sell their systems to original equipment manufacturers (OEMs) who are
licensed to incorporate the printheads and containers into printers that are in
turn sold to companies for use in printing barcodes on cartons and
packaging materials. The OEMs agree that they will purchase their ink
exclusively from petitioners, and that neither they nor their customers will
refill the patented containers with ink of any kind.
Respondent, Independent Ink, Inc., has developed an ink with the same
chemical composition as the ink sold by petitioners. After an infringement
action brought by Trident against Independent was dismissed for lack of
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personal jurisdiction, Independent filed suit against Trident seeking a
judgment of noninfringement and invalidity of Trident's patents. In an
amended complaint, it alleged that petitioners are engaged in illegal tying
and monopolization in violation of §§ 1 and 2 of the Sherman Act. 15
U.S.C. §§1, 2.
After discovery, the District Court granted petitioners' motion for
summary judgment on the Sherman Act claims. It rejected respondent's
submission that petitioners “necessarily have market power in the market
for the tying product as a matter of law solely by virtue of the patent on
their printhead system, thereby rendering [the] tying arrangements per se
violations of the antitrust laws.” Finding that respondent had submitted no
affirmative evidence defining the relevant market or establishing petitioners'
power within it, the court concluded that respondent could not prevail on
either antitrust claim. The parties settled their other claims, and respondent
appealed.
After a careful review of the “long history of Supreme Court
consideration of the legality of tying arrangements,” 396 F.3d 1342, 1346
(2005), the Court of Appeals for the Federal Circuit reversed the District
Court's decision as to respondent's § 1 claim. Placing special reliance on our
decisions in International Salt Co. v. United States, 332 U.S. 392 (1947),
and Loew's, 371 U.S. 38, as well as our Jefferson Parish dictum, and after
taking note of the academic criticism of those cases, it concluded that the
“fundamental error” in petitioners' submission was its disregard of “the duty
of a court of appeals to follow the precedents of the Supreme Court until the
Court itself chooses to expressly overrule them.” 396 F.3d, at 1351. We
granted certiorari to undertake a fresh examination of the history of both the
judicial and legislative appraisals of tying arrangements. Our review is
informed by extensive scholarly comment and a change in position by the
administrative agencies charged with enforcement of the antitrust laws.
American courts first encountered tying arrangements in the course of
patent infringement litigation. See, e.g., Heaton-Peninsular Button-Fastener
Co. v. Eureka Specialty Co., 77 F. 288 (6th Cir 1896). Such a case came
before this Court in Henry v. A.B. Dick Co., 224 U.S. 1 (1912), in which, as
in the case we decide today, unpatented ink was the product that was “tied”
to the use of a patented product through the use of a licensing agreement.
Without commenting on the tying arrangement, the Court held that use of a
competitor's ink in violation of a condition of the agreement--that the rotary
mimeograph “‘may be used only with the stencil, paper, ink and other
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supplies made by A.B. Dick Co.’”--constituted infringement of the patent
on the machine. Chief Justice White dissented, explaining his disagreement
with the Court's approval of a practice that he regarded as an “attempt to
increase the scope of the monopoly granted by a patent ... which tend[s] to
increase monopoly and to burden the public in the exercise of their common
rights.” Two years later, Congress endorsed Chief Justice White's
disapproval of tying arrangements, enacting § 3 of the Clayton Act. See 38
Stat. 731 (applying to “patented or unpatented” products); see also Motion
Picture Patents Co. v. Universal Film Mfg. Co., 243 U.S. 502, 517-518
(1917) (explaining that, in light of § 3 of the Clayton Act, A.B. Dick “must
be regarded as overruled”). And in this Court's subsequent cases reviewing
the legality of tying arrangements we, too, embraced Chief Justice White's
disapproval of those arrangements. See, e.g., Standard Oil Co. of Cal. v.
United States, 337 U.S. 293, 305-306 (1949); Mercoid Corp. v. MidContinent Investment Co., 320 U.S. 661, 664-665 (1944).
In the years since A.B. Dick, four different rules of law have supported
challenges to tying arrangements. They have been condemned as improper
extensions of the patent monopoly under the patent misuse doctrine, as
unfair methods of competition under § 5 of the Federal Trade Commission
Act, 15 U.S.C. § 45, as contracts tending to create a monopoly under § 3 of
the Clayton Act, 15 U.S.C. § 13a, and as contracts in restraint of trade under
§ 1 of the Sherman Act. In all of those instances, the justification for the
challenge rested on either an assumption or a showing that the defendant's
position of power in the market for the tying product was being used to
restrain competition in the market for the tied product. As we explained in
Jefferson Parish, 466 U.S., at 12, “[o]ur cases have concluded that the
essential characteristic of an invalid tying arrangement lies in the seller's
exploitation of its control over the tying product to force the buyer into the
purchase of a tied product that the buyer either did not want at all, or might
have preferred to purchase elsewhere on different terms.”
Over the years, however, this Court's strong disapproval of tying
arrangements has substantially diminished. Rather than relying on
assumptions, in its more recent opinions the Court has required a showing
of market power in the tying product. Our early opinions consistently
assumed that “[t]ying arrangements serve hardly any purpose beyond the
suppression of competition.” Standard Oil Co., 337 U.S., at 305-306. In
1962, in Loew's, 371 U.S., at 47-48, the Court relied on this assumption
despite evidence of significant competition in the market for the tying
product. And as recently as 1969, Justice Black, writing for the majority,
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relied on the assumption as support for the proposition "that, at least when
certain prerequisites are met, arrangements of this kind are illegal in and of
themselves, and no specific showing of unreasonable competitive effect is
required." Fortner Enterprises, Inc. v. United States Steel Corp., 394 U.S.
495, 498-499 (Fortner I). Explaining the Court's decision to allow the suit to
proceed to trial, he stated that “decisions rejecting the need for proof of
truly dominant power over the tying product have all been based on a
recognition that because tying arrangements generally serve no legitimate
business purpose that cannot be achieved in some less restrictive way, the
presence of any appreciable restraint on competition provides a sufficient
reason for invalidating the tie.”
Reflecting a changing view of tying arrangements, four Justices
dissented in Fortner I, arguing that the challenged “tie”--the extension of a
$2 million line of credit on condition that the borrower purchase
prefabricated houses from the defendant--might well have served a
legitimate purpose. In his opinion, Justice White noted that promotional tieins may provide “uniquely advantageous deals” to purchasers. And Justice
Fortas concluded that the arrangement was best characterized as “a sale of a
single product with the incidental provision of financing.”
The dissenters' view that tying arrangements may well be
procompetitive ultimately prevailed; indeed, it did so in the very same
lawsuit. After the Court remanded the suit in Fortner I, a bench trial resulted
in judgment for the plaintiff, and the case eventually made its way back to
this Court. Upon return, we unanimously held that the plaintiff's failure of
proof on the issue of market power was fatal to its case--the plaintiff had
proved “nothing more than a willingness to provide cheap financing in
order to sell expensive houses.” United States Steel Corp. v. Fortner
Enterprises, Inc., 429 U.S. 610, 622 (1977) (Fortner II).
The assumption that “[t]ying arrangements serve hardly any purpose
beyond the suppression of competition,” rejected in Fortner II, has not been
endorsed in any opinion since. Instead, it was again rejected just seven
years later in Jefferson Parish, where, as in Fortner II, we unanimously
reversed a Court of Appeals judgment holding that an alleged tying
arrangement constituted a per se violation of § 1 of the Sherman Act. 466
U.S., at 5. Like the product at issue in the Fortner cases, the tying product in
Jefferson Parish--hospital services--was unpatented, and our holding again
rested on the conclusion that the plaintiff had failed to prove sufficient
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power in the tying product market to restrain competition in the market for
the tied product--services of anesthesiologists.
In rejecting the application of a per se rule that all tying arrangements
constitute antitrust violations, we explained:
“[W]e have condemned tying arrangements when the seller has
some special ability--usually called ‘market power’--to force a
purchaser to do something that he would not do in a competitive
market....
.....
Per se condemnation--condemnation without inquiry into actual
market conditions--is only appropriate if the existence of forcing is
probable. Thus, application of the per se rule focuses on the
probability of anticompetitive consequences....
For example, if the Government has granted the seller a patent or
similar monopoly over a product, it is fair to presume that the
inability to buy the product elsewhere gives the seller market
power.” United States v. Loew's Inc., 371 U.S., at 45-47. Any effort
to enlarge the scope of the patent monopoly by using the market
power it confers to restrain competition in the market for a second
product will undermine competition on the merits in that second
market. Thus, the sale or lease of a patented item on condition that
the buyer make all his purchases of a separate tied product from the
patentee is unlawful.”
Notably, nothing in our opinion suggested a rebuttable presumption of
market power applicable to tying arrangements involving a patent on the
tying good. Instead, it described the rule that a contract to sell a patented
product on condition that the purchaser buy unpatented goods exclusively
from the patentee is a per se violation of § 1 of the Sherman Act.
Justice O'Connor wrote separately in Jefferson Parish, concurring in the
judgment on the ground that the case did not involve a true tying
arrangement because, in her view, surgical services and anesthesia were not
separate products. 466 U.S., at 43. In her opinion, she questioned not only
the propriety of treating any tying arrangement as a per se violation of the
Sherman Act, but also the validity of the presumption that a patent always
gives the patentee significant market power, observing that the presumption
was actually a product of our patent misuse cases rather than our antitrust
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jurisprudence. It is that presumption, a vestige of the Court's historical
distrust of tying arrangements, that we address squarely today.
Justice O'Connor was, of course, correct in her assertion that the
presumption that a patent confers market power arose outside the antitrust
context as part of the patent misuse doctrine. That doctrine had its origins in
Motion Picture Patents Co. v. Universal Film Mfg. Co., 243 U.S. 502
(1917), which found no support in the patent laws for the proposition that a
patentee may "prescribe by notice attached to a patented machine the
conditions of its use and the supplies which must be used in the operation of
it, under pain of infringement of the patent," Although Motion Picture
Patents Co. simply narrowed the scope of possible patent infringement
claims, it formed the basis for the Court's subsequent decisions creating a
patent misuse defense to infringement claims when a patentee uses its
patent “as the effective means of restraining competition with its sale of an
unpatented article.” Morton Salt Co. v. G.S. Suppiger Co., 314 U.S. 488,
490 (1942); see also, e.g., Carbice Corp. of America v. American Patents
Development Corp., 283 U.S. 27, 31 (1931).
Without any analysis of actual market conditions, these patent misuse
decisions assumed that, by tying the purchase of unpatented goods to the
sale of the patented good, the patentee was “restraining competition,”
Morton Salt, 314 U.S., at 490, or “secur[ing] a limited monopoly of an
unpatented material,” Mercoid, 320 U.S., at 664; see also Carbice, 283
U.S., at 31-32. In other words, these decisions presumed “[t]he requisite
economic power” over the tying product such that the patentee could
“extend [its] economic control to unpatented products.” Loew's, 371 U.S., at
45-46.
The presumption that a patent confers market power migrated from
patent law to antitrust law in International Salt Co. v. United States, 332
U.S. 392 (1947). In that case, we affirmed a District Court decision holding
that leases of patented machines requiring the lessees to use the defendant's
unpatented salt products violated § 1 of the Sherman Act and § 3 of the
Clayton Act as a matter of law. Although the Court's opinion does not
discuss market power or the patent misuse doctrine, it assumes that “[t]he
volume of business affected by these contracts cannot be said to be
insignificant or insubstantial and the tendency of the arrangement to
accomplishment of monopoly seems obvious.”
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The assumption that tying contracts “ten[d] ... to accomplishment of
monopoly” can be traced to the Government's brief in International Salt,
which relied heavily on our earlier patent misuse decision in Morton Salt.
The Government described Morton Salt as “present[ing] a factual situation
almost identical with the instant case,” and it asserted that “although the
Court in that case did not find it necessary to decide whether the antitrust
laws were violated, its language, its reasoning, and its citations indicate that
the policy underlying the decision was the same as that of the Sherman
Act.” Brief for United States in International Salt Co. v. United States,
O.T.1947, No. 46, p. 19 (United States Brief). Building on its assertion that
International Salt was logically indistinguishable from Morton Salt, the
Government argued that this Court should place tying arrangements
involving patented products in the category of per se violations of the
Sherman Act.
Our opinion in International Salt clearly shows that we accepted the
Government's invitation to import the presumption of market power in a
patented product into our antitrust jurisprudence. While we cited Morton
Salt only for the narrower proposition that the defendant's patents did not
confer any right to restrain competition in unpatented salt or afford the
defendant any immunity from the antitrust laws, International Salt, 332
U.S., at 395-396, given the fact that the defendant was selling its unpatented
salt at competitive prices, the rule adopted in International Salt necessarily
accepted the Government's submission that the earlier patent misuse cases
supported the broader proposition “that this type of restraint is unlawful on
its face under the Sherman Act,” United States Brief 12.
Indeed, later in the same Term we cited International Salt for the
proposition that the license of “a patented device on condition that
unpatented materials be employed in conjunction with the patented device”
is an example of a restraint that is “illegal per se.” United States v.
Columbia Steel Co., 334 U.S. 495, 522-523, and n. 22 (1948). And in
subsequent cases we have repeatedly grounded the presumption of market
power over a patented device in International Salt. See, e.g., Loew's, 371
U.S., at 45-46; Times-Picayune Publishing Co. v. United States, 345 U.S.
594, 608 (1953); Standard Oil Co., 337 U.S., at 304.
Although the patent misuse doctrine and our antitrust jurisprudence
became intertwined in International Salt, subsequent events initiated their
untwining. This process has ultimately led to today's reexamination of the
presumption of per se illegality of a tying arrangement involving a patented
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product, the first case since 1947 in which we have granted review to
consider the presumption's continuing validity.
Three years before we decided International Salt, this Court had
expanded the scope of the patent misuse doctrine to include not only
supplies or materials used by a patented device, but also tying arrangements
involving a combination patent and “unpatented material or [a] device [that]
is itself an integral part of the structure embodying the patent.” Mercoid,
320 U.S., at 665; see also Dawson Chemical Co. v. Rohm & Haas Co., 448
U.S. 176, 188-198 (1980) (describing in detail Mercoid and the cases
leading up to it). In reaching this conclusion, the Court explained that it
could see “no difference in principle” between cases involving elements
essential to the inventive character of the patent and elements peripheral to
it; both, in the Court's view, were attempts to “expan[d] the patent beyond
the legitimate scope of its monopoly.” Mercoid, 320 U.S., at 665.
Shortly thereafter, Congress codified the patent laws for the first time.
At least partly in response to our Mercoid decision, Congress included a
provision in its codification that excluded some conduct, such as a tying
arrangement involving the sale of a patented product tied to an “essential”
or “nonstaple” product that has no use except as part of the patented product
or method, from the scope of the patent misuse doctrine. § 271(d); see also
Dawson, 448 U.S., at 214. Thus, at the same time that our antitrust
jurisprudence continued to rely on the assumption that “tying arrangements
generally serve no legitimate business purpose,” Fortner I, 394 U.S., at 503,
Congress began chipping away at the assumption in the patent misuse
context from whence it came.
It is Congress' most recent narrowing of the patent misuse defense,
however, that is directly relevant to this case. Four years after our decision
in Jefferson Parish repeated the patent-equals-market-power presumption,
466 U.S., at 16, Congress amended the Patent Code to eliminate that
presumption in the patent misuse context, 102 Stat. 4674. The relevant
provision reads:
“(d) No patent owner otherwise entitled to relief for infringement or
contributory infringement of a patent shall be denied relief or
deemed guilty of misuse or illegal extension of the patent right by
reason of his having done one or more of the following: ... (5)
conditioned the license of any rights to the patent or the sale of the
patented product on the acquisition of a license to rights in another
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patent or purchase of a separate product, unless, in view of the
circumstances, the patent owner has market power in the relevant
market for the patent or patented product on which the license or
sale is conditioned.” 35 U.S.C. § 271(d)(5) (emphasis added)
The italicized clause makes it clear that Congress did not intend the
mere existence of a patent to constitute the requisite “market power.”
Indeed, fairly read, it provides that without proof that Trident had market
power in the relevant market, its conduct at issue in this case was neither
“misuse” nor an “illegal extension of the patent right.”
While the 1988 amendment does not expressly refer to the antitrust
laws, it certainly invites a reappraisal of the per se rule announced in
International Salt. A rule denying a patentee the right to enjoin an infringer
is significantly less severe than a rule that makes the conduct at issue a
federal crime punishable by up to 10 years in prison. See 15 U.S.C. § 1. It
would be absurd to assume that Congress intended to provide that the use of
a patent that merited punishment as a felony would not constitute “misuse.”
Moreover, given the fact that the patent misuse doctrine provided the basis
for the market power presumption, it would be anomalous to preserve the
presumption in antitrust after Congress has eliminated its foundation. Cf. 10
P. Areeda, H. Hovenkamp, & E. Elhauge, Antitrust Law ¶1737c (2d
ed.2004) (hereinafter Areeda).
After considering the congressional judgment reflected in the 1988
amendment, we conclude that tying arrangements involving patented
products should be evaluated under the standards applied in cases like
Fortner II and Jefferson Parish rather than under the per se rule applied in
Morton Salt and Loew's. While some such arrangements are still unlawful,
such as those that are the product of a true monopoly or a market wide
conspiracy, see, e.g., United States v. Paramount Pictures, Inc., 334 U.S.
131, 145-146 (1948), that conclusion must be supported by proof of power
in the relevant market rather than by a mere presumption thereof.
Rather than arguing that we should retain the rule of per se illegality,
respondent contends that we should endorse a rebuttable presumption that
patentees possess market power when they condition the purchase of the
patented product on an agreement to buy unpatented goods exclusively
from the patentee. Respondent recognizes that a large number of valid
patents have little, if any, commercial significance, but submits that those
that are used to impose tying arrangements on unwilling purchasers likely
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do exert significant market power. Hence, in respondent's view, the
presumption would have no impact on patents of only slight value and
would be justified, subject to being rebutted by evidence offered by the
patentee, in cases in which the patent has sufficient value to enable the
patentee to insist on acceptance of the tie.
Respondent also offers a narrower alternative, suggesting that we
differentiate between tying arrangements involving the simultaneous
purchase of two products that are arguably two components of a single
product--such as the provision of surgical services and anesthesiology in the
same operation, Jefferson Parish, 466 U.S., at 43 (O'Connor, J., concurring
in judgment), or the licensing of one copyrighted film on condition that the
licensee take a package of several films in the same transaction, Loew's, 371
U.S. 38--and a tying arrangement involving the purchase of unpatented
goods over a period of time, a so-called “requirements tie.” According to
respondent, we should recognize a presumption of market power when
faced with the latter type of arrangements because they provide a means for
charging large volume purchasers a higher royalty for use of the patent than
small purchasers must pay, a form of discrimination that “is strong evidence
of market power.” Brief for Respondent 27; see generally Jefferson Parish,
466 U.S., at 15, n. 23 (discussing price discrimination of this sort and citing
sources).
The opinion that imported the “patent equals market power”
presumption into our antitrust jurisprudence, however, provides no support
for respondent's proposed alternative. In International Salt, it was the
existence of the patent on the tying product, rather than the use of a
requirements tie, that led the Court to presume market power. 332 U.S., at
395 (“The appellant's patents confer a limited monopoly of the invention
they reward”). Moreover, the requirements tie in that case did not involve
any price discrimination between large volume and small volume
purchasers or evidence of noncompetitive pricing. Instead, the leases at
issue provided that if any competitor offered salt, the tied product, at a
lower price, “the lessee should be free to buy in the open market, unless
appellant would furnish the salt at an equal price.”
As we have already noted, the vast majority of academic literature
recognizes that a patent does not necessarily confer market power.
Similarly, while price discrimination may provide evidence of market
power, particularly if buttressed by evidence that the patentee has charged
an above-market price for the tied package, it is generally recognized that it
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also occurs in fully competitive markets, see, e.g., Baumol & Swanson, The
New Economy and Ubiquitous Competitive Price Discrimination:
Identifying Defensible Criteria of Market Power, 70 ANTITRUST L.J. 661,
666 (2003); 9 Areeda ¶ 1711; Landes & Posner 374-375. We are not
persuaded that the combination of these two factors should give rise to a
presumption of market power when neither is sufficient to do so standing
alone. Rather, the lesson to be learned from International Salt and the
academic commentary is the same: Many tying arrangements, even those
involving patents and requirements ties, are fully consistent with a free,
competitive market. For this reason, we reject both respondent's proposed
rebuttable presumption and their narrower alternative.
It is no doubt the virtual consensus among economists that has
persuaded the enforcement agencies to reject the position that the
Government took when it supported the per se rule that the Court adopted in
the 1940's. In antitrust guidelines issued jointly by the Department of
Justice and the Federal Trade Commission in 1995, the enforcement
agencies stated that in the exercise of their prosecutorial discretion they
“will not presume that a patent, copyright, or trade secret necessarily
confers market power upon its owner.” U.S. Dept. of Justice and FTC,
Antitrust Guidelines for the Licensing of Intellectual Property § 2.2 (Apr. 6,
1995), available at http://www.usdoj.gov/atr/public/guidelines/. While that
choice is not binding on the Court, it would be unusual for the Judiciary to
replace the normal rule of lenity that is applied in criminal cases with a rule
of severity for a special category of antitrust cases.
Congress, the antitrust enforcement agencies, and most economists have
all reached the conclusion that a patent does not necessarily confer market
power upon the patentee. Today, we reach the same conclusion, and
therefore hold that, in all cases involving a tying arrangement, the plaintiff
must prove that the defendant has market power in the tying product.
NOTES AND QUESTIONS
1. In the Illinois Tool Works opinion, Justice Stevens notes that there is a
“virtual consensus” among economists that a patent should not be assumed
to confer market power. This view is not unanimous, however. Professor
Katz argues that the price a rights-holder charges for intellectual property—
including patents— is nearly always significantly higher than the marginal
cost. This means that, under a traditional definition of market power,
because the owner of the intellectual property has the ability to charge a
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price substantially higher than marginal cost, the rights-holder will almost
always have market power. See Ariel Katz, Making Sense of Nonsense:
Intellectual Property, Antitrust, and Market Power, 49 ARIZ. L. REV. 837
(2007) (arguing that “the relationship between [intellectual property] and
market power are more than coincident. Market Power is the intended result
of [intellectual property]”).
2. In Chicken Delight, supra, the defendant, a struggling relatively small
franchisor, argued that the plaintiffs could not establish market power
because the fast-food industry was “vigorously” competitive. The Ninth
Circuit acknowledged that hungry consumers had “many chicken
franchising systems” to choose from. See 448 F.2d at 49. But taking a page
or two from the Supreme Court’s decisions in Loew’s and Paramount
Pictures, the Ninth Circuit presumed market power because Chicken
Delight’s tying product—its “name, symbols, and system of operation”—
was trademarked. Id. at 50 (“[W]e see no reason why the presumption [of
market power] that exists in patent and copyright does not apply equally to
[Chicken Delight’s] trade-mark.”). Query: virtually every business that
deals in a manufactured product or has a business name also has one or
more trademarks. Does that mean that all of them are monopolists?
Following Illinois Tool, the lower courts wasted little time applying the
new rule to trademarks. See, e.g., Sheridan v. Marathon Petroleum Co., 530
F.3d 590 (7th Cir. 2008). In Sheridan the plaintiffs ran Marathon gas
dealerships. The franchise agreements required the dealers to process all
sales made with Marathon’s proprietary credit card through a special system
the company set up. Dealers were free to process non-Marathon credit card
sales through any system they liked—but they had a “powerful incentive to
route all [their] credit card transactions through the Marathon system, as
otherwise [they] would have to duplicate the processing equipment that
Marathon supplies.” Sheridan, 530 F.3d at 596. The dealers argued that the
agreements violated the Sherman Act because they tied credit-card
processing to its trademark.
The trial court dismissed the complaint and the Seventh Circuit
affirmed. In his opinion for the Seventh Circuit, Judge Posner eventually
explained that there was no tie, Sheridan, 530 F.3d at 596 (“To call this
tying would be like saying that a manufacturer of automobiles who sells
tires with his cars is engaged in tying because, although the buyer is free to
buy tires from someone else, he is unlikely to do so, having paid for the
tires supplied by the car’s manufacturer.”), but first he gave the parties a
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grand tour of the market-power requirement:
The Court has not discarded the tying rule, and we have
no authority to do so. But it has modified the rule by
requiring proof that the seller has “market power” in the
market for the tying product. . . .
So “market power” is key, but its meaning requires
elucidation. Monopoly power we know is a seller’s ability to
charge a price above the competitive level (roughly
speaking, above cost, including the cost of capital) without
losing so many sales to existing competitors or new entrants
as to make the price increase unprofitable. The word
“monopoly” in the expression “monopoly power” was never
understood literally, to mean a market with only one seller; a
seller who has a large market share may be able to charge a
price persistently above the competitive level despite the
existence of competitors. Although the price increase will
reduce the seller’s output (because quantity demanded falls
as price rises), his competitors, if they are small, may not be
able to take up enough of the slack by expanding their own
output to bring price back down to the competitive level;
their costs of doing so would be too high-that is doubtless
why they are small.
As one moves from a market of one very large seller
plus a fringe of small firms to a market of several large
firms, monopoly power wanes. Now if one firm tries to
charge a price above the competitive level, its competitors
may have the productive capacity to be able to replace its
reduction in output with an increase in their own output at no
higher cost, and price will fall back to the competitive level.
Eventually a point is reached at which there is no threat to
competition unless sellers are able to agree, tacitly or
explicitly, to limit output in order to drive price above the
competitive level. The mere possibility of collusion cannot
establish monopoly power, even in an attenuated sense to
which the term “market power” might attach, because then
every firm, no matter how small, would be deemed to have
it, since successful collusion is always a possibility.
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The plaintiffs in drafting their complaint were at least
dimly aware that they would have to plead and prove that
Marathon had significant unilateral power over the market
price of gasoline and so could charge a supracompetitive
price (folded into the price for gasoline that it charges its
dealers) for credit card processing. But all that the complaint
states on this score is that Marathon is “the fourth-largest
United States-based integrated oil and gas company and the
fifth-largest petroleum refiner in the United States” and sells
“petroleum products to approximately 5,600 Marathon and
Speedway branded direct-served retail outlets and
approximately 3,700 jobber-served retail outlets.” Marathon
and Speedway’s alleged annual sales of six billion gallons of
gasoline (improperly swollen by inclusion of Speedway’s
sales) are only 4.3 percent of total U.S. gasoline sales per
year . . . . That is no one’s idea of market power.
Marathon does of course have a “monopoly” of
Marathon franchises. But “Marathon” is not a market; it is a
trademark; and a trademark does not confer a monopoly; all
it does is prevent a competitor from attaching the same name
to his product. “Not even the most zealous antitrust hawk has
ever argued that Amoco gasoline, Mobil gasoline, and Shell
gasoline”—or, we interject, Marathon gasoline—“are three
[with Marathon, four] separate product markets.” Generac
Corp. v. Caterpillar, Inc., 172 F.3d 971, 977 (7th Cir.1999).
The complaint does not allege that there are any local
gasoline markets in which Marathon has monopoly (or
market) power. No market share statistics for Marathon
either locally or nationally are given, and there is no
information in the complaint that would enable local shares
to be calculated.
What is true is that a firm selling under conditions of
“monopolistic competition”—the situation in which minor
product differences (or the kind of locational advantage that
a local store, such as a barber shop, might enjoy in
competing for some customers) limit the substitutability of
otherwise very similar products—will want to trademark its
brand in order to distinguish it from its competitors’ brands.
But the exploitation of the slight monopoly power thereby
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enabled does not do enough harm to the economy to warrant
trundling out the heavy artillery of federal antitrust law. And
anyway in this case monopolistic competition is not alleged
either. So we are given no reason to doubt that if Marathon
raises the price of using the Marathon name above the
competitive level by raising the price of the credit card
processing service that it offers, competing oil companies
will nullify its price increase simply by keeping their own
wholesale gasoline prices at the existing level. . . . [T]he
plaintiffs’ naked assertion of Marathon’s “appreciable
economic power”—an empty phrase—cannot save the
complaint.
530 F.3d 592–95 (citations omitted).
BRANTLEY V. NBC UNIVERSAL, INC.
675 F.3d 1192 (9th Cir. 2012),
cert. denied, ___ S.Ct. ___ (Nov. 5, 2012)
IKUTA, Circuit Judge:
Plaintiffs allege that Programmers' practice of selling multi-channel
cable packages violates Section 1 of the Sherman Act, 15 U.S.C. § 1. In
essence, plaintiffs seek to compel programmers and distributors of
television programming to sell each cable channel separately, thereby
permitting plaintiffs to purchase only those channels that they wish to
purchase, rather than paying for multi-channel packages, as occurs under
current market practice. Plaintiffs appeal the dismissal with prejudice of
their complaint for failure to state a claim. We affirm.
The television programming industry can be divided into upstream
and downstream markets. In the upstream market, programmers such as
NBC Universal and Fox Entertainment Group own television programs
(such as “Law and Order”) and television channels (such as NBC's Bravo
and MSNBC, and Fox Entertainment Group's Fox News Channel and FX)
and sell them wholesale to distributors. In the downstream retail market,
distributors such as Time Warner and Echostar sell the programming
channels to consumers.
According to plaintiffs' third amended complaint, Programmers have
two categories of programming channels: “must-have” channels with high
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demand and a large number of viewers, and a group of less desirable, lowdemand channels with low viewership. Plaintiffs allege that “[e]ach
programmer defendant, because of its full or partial ownership of a
broadcast channel and its ownership or control of multiple important cable
channels, has a high degree of market power vis-a-vis all distributors,” and
that Programmers exploit this market power by requiring distributors, “as a
condition to purchasing each programmer's broadcast channel and its ‘must
have’ cable channels,” to “also acquire and resell to consumers all the rest
of the cable channels owned or controlled by each programmer” and “agree
they will not offer unbundled [i.e., individual] cable channels to
consumers.” “As a consequence,” plaintiffs contend, “distributors can offer
consumers only prepackaged tiers of cable channels which consist of each
programmer's entire offering of channels.”…
The district court dismissed plaintiffs' first amended complaint
without prejudice on the ground that plaintiffs failed to show that their
alleged injuries were caused by an injury to competition. In their second
amended complaint, plaintiffs alleged that Programmers' practice of selling
packaged cable channels foreclosed independent programmers from
entering and competing in the upstream market for programming channels.
The district court subsequently denied defendants' motion to dismiss,
holding that plaintiffs had adequately pleaded injury to competition.
After preliminary discovery efforts on the question whether the
Programmers' practices had excluded independent programmers from the
upstream market, the plaintiffs decided to abandon this approach.12 Pursuant
to a stipulation among the parties, plaintiffs filed their third amended
complaint, which deleted all allegations that the Programmers and
Distributors' contractual practices foreclosed independent programmers
from participating in the upstream market, along with a motion requesting
the court to rule that plaintiffs did not have to allege foreclosure in the
upstream market in order to defeat a motion to dismiss…. The district court
entered an order on October 15, 2009 granting Programmers and
Distributors' motion to dismiss the third amended complaint with prejudice
because plaintiffs failed to allege any cognizable injury to competition. The
district court also denied plaintiffs' motion to rule on the question whether
allegations of foreclosed competition are required to state a Section 1 claim.
Plaintiffs timely appeal….
12
Programmers and Distributors claim that plaintiffs decided to discontinue discovery
after preliminary review showed there was no evidence to support their claim that the
packaging of channels foreclosed competition in the upstream market.
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The parties do not dispute that the rule of reason applies in this case,
and the pleading requirements for a rule of reason case therefore apply.13
… In order to plead injury to competition … sufficiently to
withstand a motion to dismiss, “a section one claimant may not merely
recite the bare legal conclusion that competition has been restrained
unreasonably.” Les Shockley Racing, Inc. v. Nat'l Hot Rod Ass'n, 884 F.2d
504, 507–08 (9th Cir.1989). “Rather, a claimant must, at a minimum, sketch
the outline of [the injury to competition] with allegations of supporting
factual detail.” Such allegations must “raise a reasonable expectation that
discovery will reveal evidence of” an injury to competition. Bell Atl. Corp.
v. Twombly, 550 U.S. 544, 556, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007)….
Courts have also concluded that agreements between firms operating
at different levels of a given product market (referred to as “vertical
agreements”), such as agreements between a supplier and a distributor, may
or may not cause an injury to competition. Vertical agreements that
foreclose competitors from entering or competing in a market can injure
competition by reducing the competitive threat those competitors would
pose. Some types of vertical agreements can also injure competition by
facilitating horizontal collusion. …
The complaint in this case focuses on a type of vertical agreement
that creates a restraint known as “tying.” Tying is defined as an arrangement
where a supplier agrees to sell a buyer a product (the tying product), but
“only on the condition that the buyer also purchases a different (or tied)
product....” N. Pac. Ry. Co. v. United States, 356 U.S. 1, 5, 78 S.Ct. 514, 2
L.Ed.2d 545 (1958). The potential injury to competition threatened by this
practice is that the tying arrangement will either “harm existing competitors
or create barriers to entry of new competitors in the market for the tied
product,” Jefferson Parish Hosp. Dist. No. 2 v. Hyde, 466 U.S. 2, 14 (1984),
13
In the case of “tying” claims, a per se rule is applied in some circumstances. A tying
arrangement will constitute a per se violation of the Sherman Act if the plaintiff proves “(1)
that the defendant tied together the sale of two distinct products or services; (2) that the
defendant possesses enough economic power in the tying product market to coerce its
customers into purchasing the tied product; and (3) that the tying arrangement affects a not
insubstantial volume of commerce in the tied product market.” Cascade Health Solutions v.
PeaceHealth, 515 F.3d 883, 913 (9th Cir.2008) (quoting Paladin Assocs., Inc. v. Mont.
Power Co., 328 F.3d 1145, 1159 (9th Cir.2003)) (internal quotation marks omitted). The
parties have disclaimed any contention that the tying practices in this case are per se
antitrust violations.
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abrogated in part on other grounds by Ill. Tool Works Inc. v. Indep. Ink,
Inc., 547 U.S. 28 (2006); Cascade, 515 F.3d at 912, or will “force buyers
into giving up the purchase of substitutes for the tied product,” United
States v. Loew's, 371 U.S. 38, 45 (1962), abrogated in part on other grounds
by Ill. Tool Works, 547 U.S. 28.
But courts distinguish between tying arrangements in which a
company exploits its market power by attempting “to impose restraints on
competition in the market for a tied product” (which may threaten an injury
to competition) and arrangements that let a company exploit its market
power “by merely enhancing the price of the tying product” (which does
not). Jefferson Parish, 466 U.S. at 14….
…. As the Supreme Court has noted, “when a purchaser is ‘forced’
to buy a product he would not have otherwise bought even from another
seller in the tied product market, there can be no adverse impact on
competition because no portion of the market which would otherwise have
been available to other sellers has been foreclosed.” Jefferson Parish, 466
U.S. at 16….
Therefore, a plaintiff bringing a rule of reason tying case cannot
succeed … merely by alleging the existence of a tying arrangement, because
such an arrangement is consistent with pro-competitive behavior….
There is no dispute that the complaint alleges the existence of a
tying arrangement. In fact, according to the plaintiffs' complaint, the
Programmer–Distributor agreements at issue consist of two separate tying
arrangements. First, in the upstream market, each Programmer requires each
Distributor that wishes to purchase that Programmer's high-demand
channels (the tying product) to purchase all of that Programmer's lowdemand channels (the tied product) as well.14 Second, in the downstream
market, Distributors sell consumers cable channels only in packages
consisting of each Programmer's entire offering of channels. Thus,
consumers, like Distributors, are allegedly required to purchase each
Programmer's low-demand channels, which they do not want (the tied
product), in order to gain access to that Programmer's high-demand
channels, which they do want (the tying product).
14
We assume for purposes of this opinion, without deciding, that high-demand and
low-demand channels are actually separate products, and do not address the question
whether it is more apt to view each Programmer's block of channels as a single product,
which would preclude any argument that there was an illegal tying arrangement.
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But as explained above, tying arrangements, without more, do not
necessarily threaten an injury to competition. Therefore, the complaint's
allegations regarding the two separate tying arrangements do not, by
themselves, constitute a sufficient allegation of injury to competition.
Rather, plaintiffs must also allege facts showing that an injury to
competition flows from these tying arrangements. We conclude that such
allegations are not present in the complaint.
First, it is clear that the complaint does not allege the types of
injuries to competition that are typically alleged to flow from tying
arrangements. The complaint does not allege that Programmers' practice of
selling “must-have” and low-demand channels in packages excludes other
sellers of low-demand channels from the market, or that this practice raises
barriers to entry into the programming market.15 Nor do the plaintiffs allege
that the tying arrangement here causes consumers to forego the purchase of
substitutes for the tied product. Loew's, 371 U.S. at 45. Nothing in the
complaint indicates that the arrangement between the Programmers and
Distributors forces Distributors or consumers to forego the purchase of
alternative low-demand channels. Indeed, Plaintiffs disavow any intent to
allege that the practices engaged in by Programmers and Distributors
foreclosed rivals from entering or participating in the upstream or
downstream markets. Cf. Jefferson Parish, 466 U.S. at 14; Cascade, 515
F.3d at 912 (“Tying arrangements are forbidden on the theory that, if the
seller has market power over the tying product, the seller can leverage this
market power through tying arrangements to exclude other sellers of the
tied product.”). Nor does the complaint allege that the tying arrangements
pose a threat to competition because they facilitate horizontal collusion.
Instead of identifying such standard-issue threats to competition, the
complaint alleges that the injury to competition stems from Programmers'
requirement that channels must be sold to consumers in packages.
According to the complaint, the required sale of multi-channel packages
harms consumers by (1) limiting the manner in which Distributors compete
with one another in that Distributors are unable to offer a la carte
programming, which results in (2) reducing consumer choice, and (3)
increasing prices. These assertions do not sufficiently allege an injury to
competition for purposes of stating a Section 1 claim. First, because Section
1 does not proscribe all contracts that limit the freedom of the contracting
parties, a statement that parties have entered into a contract that limits some
15
Thus, there is effectively “zero foreclosure” of competitors.
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freedom of action (in this case, by circumscribing the distributors' ability to
offer smaller packages or channels on an unbundled basis) is not sufficient
to allege an injury to competition.16
Second, allegations that an agreement has the effect of reducing
consumers' choices or increasing prices to consumers does not sufficiently
allege an injury to competition. Both effects are fully consistent with a free,
competitive market….
Plaintiffs disagree, and argue that under the rule in Loew's, 371 U.S.
38, and Ross v. Bank of America, N.A. (USA), 524 F.3d 217 (2d Cir.2008),
they have sufficiently alleged an injury to competition by alleging that the
agreements have the effect of reducing choice and increasing prices. This
argument is unavailing. In Loew's, the United States brought antitrust
actions against six major film distributors, alleging that the defendants had
conditioned the license or sale of one or more feature films upon the
acceptance by television stations of a package or block containing one or
more unwanted or inferior films. The Court observed that the restraint
injured competition because the movie studios' block booking forced the
television stations to forego purchases of movies from other distributors.
The relevant injury in Loew's was to competition, not to the ultimate
consumers, because the challenged practice forced television stations to
forego the purchase of other movies, and therefore created barriers to entry
for competing movie owners. Cf. Jefferson Parish, 466 U.S. at 14. Here,
Plaintiffs have not alleged that the contracts between Programmers and
Distributors forced either Distributors or consumers to forego the purchase
of other low-demand channels (a result analogous to the competitive injury
in Loew's ), but only that consumers could not purchase programs a la carte
and they did not want all of the channels they were required to buy from
Distributors. “[C]ompelling the purchase of unwanted products” is not itself
an injury to competition. We have explained why this is so:
In order to obtain desired product A, let us suppose, the
defendant's customer is forced to take product B, which it does not
want, cannot use, and would not have purchased from anyone. This
is typically the equivalent of a higher price for product A. From the
16
A rule to the contrary could cast doubt on whether musicians would be free to sell
their hit singles only as a part of a full album, or writers to sell a collection of short stories.
Indeed, such a rule would call into question whether Programmers and Distributors could
sell cable channels at all, since such channels are themselves packages of separate
television programs.
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viewpoint of the defendant seller, its revenue on product A consists
of the A price plus the excess of the B price over B's cost to the
seller. From the viewpoint of the customer, the cost of obtaining the
desired product A is the nominal A price plus the excess of the B
price over its salvage value. This has nothing to do with gaining
power in the B market or upsetting competition there.
Blough, 574 F.3d at 1089–90 (quoting IX Phillip E. Areeda & Herbert
Hovenkamp, Antitrust Law ¶ 1724b, at 270 (2004 & Supp. 2009)); see also
Jefferson Parish, 466 U.S. at 14 (“When the seller's power is just used to
maximize its return in the tying product market, where presumably its
product enjoys some justifiable advantage over its competitors, the
competitive ideal of the Sherman Act is not necessarily compromised.”).
Nor does plaintiffs' citation to Ross support their argument; that case
involved allegations of horizontal collusion, which has not been alleged by
plaintiffs in this case, and pertained to standing, not injury to competition.
Plaintiffs also contend that because most or all Programmers and
Distributors engage in the challenged practice, we should hold that in the
aggregate, the practice constitutes an injury to competition. We cannot rule
out the possibility that competition could be injured or reduced due to a
widely applied practice that harms consumers. See Leegin, 551 U.S. at 897
(indicating that vertical restraints, such as resale price maintenance, “should
be subject to more careful scrutiny” if the practice is adopted by many
competitors). But the plaintiffs here have not alleged in their complaint how
competition (rather than consumers) is injured by the widespread practice of
packaging low- and high-demand channels. The complaint did not allege
that Programmers' sale of cable channels in packages has any effect on
other programmers' efforts to produce competitive programming channels
or on Distributors' competition as to cost and quality of service. Nor is there
any allegation that any programmer's decision to offer its channels only in
packages constrained other programmers from offering their channels
individually if that practice was competitively advantageous. In sum, the
complaint does not include any allegation of injury to competition, as
opposed to injuries to the plaintiffs.
Injury to competition must be alleged to state a violation of Sherman
Act § 1. Kendall, 518 F.3d at 1047. Plaintiffs' complaint does not allege
facts that “raise a reasonable expectation that discovery will reveal evidence
of” injury to competition. Twombly, 550 U.S. at 566. Thus, plaintiffs'
complaint did not allege facts that, taken as true, “state a claim to relief that
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is plausible on its face.” Id. at 570. Dismissal was proper.
AFFIRMED
NOTES AND QUESTIONS
1. The monopoly “leverage theory” is the theory that a monopolist in one
market can leverage its monopoly market to reap an advantage in a separate
market. Courts have begun to reject this theory, reasoning that a monopolist
“can take its monopoly profits just once.” Schor v. Abbott Labs., 457 F.3d
608, 611 (7th Cir. 2006), cert. denied, 549 U.S. 1205 (2007). Suppose a
firm with monopoly power in one market is able to tie its monopoly product
with a non-monopoly product.
For example, suppose that a firm has a patent-granted monopoly in
Widgets, and the profit-maximizing price is $10 per Widget. Suppose
further that Widgets are used in conjunction with Flidgets, a non-patented
product in a competitive market. If the firm tries to increase the price of
Flidgets, the effect is the same as charging more for Widgets—which would
decrease the firm’s monopoly profits, as the profit-maximizing strategy in
the patented product is to charge the monopoly price. The effect of
increasing the price would be to raise prices and reduce output—something
the antitrust laws are designed to protect. However, since this strategy
would actually reduce the firm’s profits, its profit-maximizing strategy
would actually be to keep the price of Flidgets as low as possible, allowing
more consumers to have access to Widgets. The more consumers who
purchase Widgets at the monopoly price, the higher Firm A’s monopoly
profits will be.
2. Why would a cable television firm bundle stations rather than selling
them ala carte? One possibility is that it is engaged in a type of price
discrimination in which it takes advantage of the fact that different
customers have different preferences for channels. See the notes following
the Loew’s decision, supra.
A more likely possibility is that the transaction costs of block
pricing are much lower than the transaction costs of ala carte pricing. One
television programming is produced and assembled onto a particular station
the cost of transmitting that station to a view who is already wired up with
cable is fairly close to zero. As a result in may cost very little more in real
resources to transmit a large offering of cable channels than a smaller one.
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However, ala carte pricing would require dividing up offerings according to
individual consumers’ tastes and putting a price on each channel. Further,
the cost of the system for delivery (cable, maintenance, set-top box, and the
like) is the same whether the customers buys five channels or 200.
3. Why did the plaintiffs plead their tying case only under the rule of
reason? Foreclosure of competitors is not an articulated requirement of the
per se tying rule? Does the Ninth Circuit’s decision effectively require
foreclosure in all tying cases, even those brought under the per se rule?
4. With Brantley, compare In re Cox Enterprises, Inc. Set-Top Cable
Television Box Antitrust Litigation, No. 09-ML-2048-C, 2011 WL 6826813
(W.D. Okla. Dec. 28, 2011). Cox was accused of permitting certain
interactive features of its cable television subscriptions to be used only with
its own set top boxes. If a customer wanted to use a third party box, such as
TiVo, the interactive features would not work. While set-top boxes are no
longer necessary for receiving content on newer televisions, customers need
them in order to interact with their televisions and use “pay-per-view,”
video on demand, and interactive programming guide features. Cox permits
its subscribers to purchase third-party set-top boxes like TiVO or Moxi, but
these third-party boxes cannot access the interactive features like video on
demand or interactive programming guides The district court denied class
certification of the user's tying claim because the plaintiffs could not
demonstrate that they could prove market power and antitrust injury with
common evidence. What would be the downstream market from which
rivals or potential rivals were foreclosed?
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