Franchisor Price Fixing: What Does Leegin Really Mean for Franchising?

Do Franchisors Have Market Power?

Why can we franchise lawyers be so bold in our advice? The answer lies in the concept of market power in the relevant market. But first, more about the Leegin case itself.

Cynthia M. Klaus and Sejal Desai Winkelman identified the significant Leegin facts in their article, 'Supreme Court Considers Price Fixing Agreements,' published in the July 2007 issue of LJN's Franchising Business & Law Alert. For our purposes, the relevant facts are these: Leegin suspended shipment of its Brighton line of women's accessories when Kay's Kloset sold products at less than Leegin's suggested retail prices. Relying on precedent going back to 1911, Dr. Miles Medical Co. v. John D. Park & Sons Co., 220 U.S. 373 (1911), the Fifth Circuit upheld a lower court finding that Leegin committed a per se violation of Sherman Section One. The Supreme Court reversed, sending the case back to the lower courts, presumably for evaluation of the legality of Leegin's actions under the rule of reason.

Franchisors should have little fear of antitrust liability for vertical price fixing under the rules of reason because few, if any, have market power in any relevant market. As a result of Leegin, retail price maintenance is not unlawful unless it unreasonably restrains competition. Before a court will allow a jury to evaluate the reasonableness of a restraint, the court must first identify the relevant product and geographic markets within which the supplier competes. The relevant product market consists of products that are interchangeable or substitutable by the consumer by reason of their characteristics, prices, and intended use. The relevant geographic market is the area where conditions of competition apply equally to all traders.

Market power is essentially the ability of a supplier to control prices in a relevant market. If the consumer will readily substitute a competitor's product in response to efforts of a supplier to control price in the relevant market, the supplier does not have market power.

Because franchisors operate in highly competitive markets, they cannot control the prices paid for products by the ultimate consumer. If a franchisor establishes a super-competitive price for its franchisee's hamburger or its franchisee's hotel room, the consumer will purchase the hamburger or rent the room from the competition. The ability of a franchisor to capture a premium for its product through product differentiation (typically through advertising) is not the same as market power. As long as the franchisor does not have market power in an antitrust sense, the 'reasonableness' of its pricing practices is beyond attack under Sherman Section One.

But what about the 'baby Sherman Antitrust law' present in all but four states?

There does remain a risk that some states will not follow Leegin in the application of these statutes. My firm has categorized the proclivity of states to apply Sherman Antitrust Act precedent to their baby acts into four categories. We identified 24 states as having strong adherence to the Sherman Act precedence; 12 as moderately strong; five as 'permissive' to the extent they allow, but do not require adherence; and nine as unclear in their degree of adherence. In almost all states, federal precedence is at least a guide in the interpretation of a state antitrust law. The odds are not great that the states will essentially make Leegin meaningless by how they interpret their own statutes.

The Bottom Line

The bottom line is that every franchisor should consider the following in light of Leegin:

1) Determine what limitation your franchise agreement places on your ability to set prices. Franchise agreements often reserve to the franchisee the right to establish minimum prices, given the concern of franchisors prior to Leegin that minimum price setting is unlawful per se. Franchisors should amend their new and renewal franchise agreements to reserve the right to establish both minimum and maximum retail prices ' regardless of any desire to control prices at this stage. Things change over time. A franchisor's ability to fix prices for such things as national accounts and systemwide promotions may be essential to the system's ability to compete with other franchisors and integrated companies.

2) Still consider the safest course. Until some of the bigger states rule on whether they will apply Leegin to their antitrust statutes, a franchisor will face a risk (perhaps remote) of liability for establishing minimum resale prices. Establishing a maximum price may accomplish the same result. The Supreme Court Kahn decision subjecting maximum price setting to the rule of reason has existed for 11 years now without any serious state attack on the practice under baby Sherman Acts.

3) Identify your pro-competitive objectives. Without market power, franchisors cannot use vertical price fixing for anticompetitive ends. The legitimate franchisor is driven by a desire to increase overall sales in its franchise system when setting a floor on franchisee prices. Its objective will be to take business from its competitors by increased service, uniformity in pricing expectations of consumers, effective national sales programs, and the like. The upshot will be increased interbrand competition. Decision makers within the franchisor organization must be ready to recite these pro-competitive objectives if called to account in a court of law.

4) If you have a choice, limit your minimum price setting, at least initially, to the states most disposed to follow Sherman Act precedent in the interpretation of their state acts. The Florida statute, for example, says that 'it is the intent of the Legislature that, in construing this chapter, due consideration and great weight be given to the interpretation of the federal courts relating to comparable federal antitrust statutes.' On the other hand, the California Supreme Court has said that the Sherman Act is not directly probative of its antitrust statute (the Cartwright Act), although federal judicial interpretations are helpful. In decisions predating Kahn and Leegin, California courts have declared minimum and maximum price maintenance unlawful per se. Given California's sometimes-liberal leanings, the wise franchisor may not choose this as its first state to test the legality of price setting under state law. The smaller franchisor might choose to preserve the right to set prices in its franchise agreement and let bigger franchisors test the state waters.

5) Realize that there are downsides to price setting, independent of the antitrust laws. If nothing else, plaintiffs will cite resale price maintenance by a franchisor as one more piece of evidence that the franchisor controls day-to-day operations of its franchisees and should therefore be liable for its franchisees' acts under theories of vicarious liability. Also, top-down price setting deprives franchisees of an ability to meet local pricing pressures and can lead to franchisee frustration over undue franchisor interference. In fact, controlling franchisee pricing is best left to special programs like national accounts, national marketing programs, and similar activities with systemwide impact. Finally, some state franchise relationship laws (Minnesota, for example) do prohibit franchisors from placing unreasonable standards of conduct on franchisees, and unreasonable pricing restraints might fall within this prohibition.

William L. Killion is a partner in the Minneapolis office of Faegre & Benson LLP. He can be contacted by phone at 612-766-7671 or by e-mail at [email protected].

By now, everyone seriously involved in the practice of franchise law is aware of Leegin Creative Leather Products, Inc. v. PSKS, Inc., 2007 WL 1835892 (S. Ct. June 28, 2007). The Supreme Court in Leegin held that vertical resale price maintenance is no longer unlawful in and of itself. Although hailing the decision as overruling a nearly 100-year prohibition on minimum price fixing, the pundits writing in the wake of Leegin have nevertheless hedged their bets on just how revolutionary the decision is. Their constant mantra is this: Leegin does not open the door to unrestrained resale price maintenance, but rather changes the rules under which courts will evaluate sales agreements setting minimum prices. No longer will courts treat them as unlawful per se; they will now evaluate their legality under something called 'the rule of reason.' If a court (or jury) concludes that an agreement establishing a minimum price is an 'unreasonable restraint of trade,' then the supplier has violated the antitrust laws. If the threat of treble damages from such a finding isn't sobering enough, writers warn us that courts may interpret state 'baby Sherman Acts' as still making resale price maintenance unlawful per se, regardless of what the U.S. Supreme Court says.

These warnings are sage advice coming from authors trying to generalize on the broad application of Leegin to a wide variety of suppliers and purchasers of products. After all, the Supreme Court itself warns that 'if the rule of reason were to apply to vertical price restraints, courts would have to be diligent in eliminating their anticompetitive uses from the market.' The problem with carrying this warning to the extreme is that it defeats one of the Supreme Court's very purposes in abandoning the per se rule, namely, to create a degree of certainty for sellers of products rather than serve 'the interests of lawyers … by creating legal distinctions that operate as traps for the unwary ' '

The point of this article is that we franchise lawyers do our clients a disservice when we hedge our bets unduly in this area. We should call a spade a spade when it comes to minimum resale price maintenance by a franchisor: The practice may be a breach of a contract, but it is no longer a federal antitrust violation in light of Leegin. And franchisors should begin to take full advantage of the door now opened by Leegin. Ultimately, Leegin levels the playing field between franchising and integrated supply systems as methods of distributing a product or service (as did decisions like Sylvania, Jefferson Parish, and Kahn before it). Now franchisors, like their competitors that own the entire chain of distribution, can set retail prices (both minimum and maximum) in order to compete in the marketplace. And that is good for franchisors, franchisees, and consumers alike.

Do Franchisors Have Market Power?

Why can we franchise lawyers be so bold in our advice? The answer lies in the concept of market power in the relevant market. But first, more about the Leegin case itself.

Cynthia M. Klaus and Sejal Desai Winkelman identified the significant Leegin facts in their article, 'Supreme Court Considers Price Fixing Agreements,' published in the July 2007 issue of LJN's Franchising Business & Law Alert. For our purposes, the relevant facts are these: Leegin suspended shipment of its Brighton line of women's accessories when Kay's Kloset sold products at less than Leegin's suggested retail prices. Relying on precedent going back to 1911, Dr. Miles Medical Co. v. John D. Park & Sons Co. , 220 U.S. 373 (1911), the Fifth Circuit upheld a lower court finding that Leegin committed a per se violation of Sherman Section One. The Supreme Court reversed, sending the case back to the lower courts, presumably for evaluation of the legality of Leegin's actions under the rule of reason.

Franchisors should have little fear of antitrust liability for vertical price fixing under the rules of reason because few, if any, have market power in any relevant market. As a result of Leegin, retail price maintenance is not unlawful unless it unreasonably restrains competition. Before a court will allow a jury to evaluate the reasonableness of a restraint, the court must first identify the relevant product and geographic markets within which the supplier competes. The relevant product market consists of products that are interchangeable or substitutable by the consumer by reason of their characteristics, prices, and intended use. The relevant geographic market is the area where conditions of competition apply equally to all traders.

Market power is essentially the ability of a supplier to control prices in a relevant market. If the consumer will readily substitute a competitor's product in response to efforts of a supplier to control price in the relevant market, the supplier does not have market power.

Because franchisors operate in highly competitive markets, they cannot control the prices paid for products by the ultimate consumer. If a franchisor establishes a super-competitive price for its franchisee's hamburger or its franchisee's hotel room, the consumer will purchase the hamburger or rent the room from the competition. The ability of a franchisor to capture a premium for its product through product differentiation (typically through advertising) is not the same as market power. As long as the franchisor does not have market power in an antitrust sense, the 'reasonableness' of its pricing practices is beyond attack under Sherman Section One.

But what about the 'baby Sherman Antitrust law' present in all but four states?

There does remain a risk that some states will not follow Leegin in the application of these statutes. My firm has categorized the proclivity of states to apply Sherman Antitrust Act precedent to their baby acts into four categories. We identified 24 states as having strong adherence to the Sherman Act precedence; 12 as moderately strong; five as 'permissive' to the extent they allow, but do not require adherence; and nine as unclear in their degree of adherence. In almost all states, federal precedence is at least a guide in the interpretation of a state antitrust law. The odds are not great that the states will essentially make Leegin meaningless by how they interpret their own statutes.

The Bottom Line

The bottom line is that every franchisor should consider the following in light of Leegin:

1) Determine what limitation your franchise agreement places on your ability to set prices. Franchise agreements often reserve to the franchisee the right to establish minimum prices, given the concern of franchisors prior to Leegin that minimum price setting is unlawful per se. Franchisors should amend their new and renewal franchise agreements to reserve the right to establish both minimum and maximum retail prices ' regardless of any desire to control prices at this stage. Things change over time. A franchisor's ability to fix prices for such things as national accounts and systemwide promotions may be essential to the system's ability to compete with other franchisors and integrated companies.

2) Still consider the safest course. Until some of the bigger states rule on whether they will apply Leegin to their antitrust statutes, a franchisor will face a risk (perhaps remote) of liability for establishing minimum resale prices. Establishing a maximum price may accomplish the same result. The Supreme Court Kahn decision subjecting maximum price setting to the rule of reason has existed for 11 years now without any serious state attack on the practice under baby Sherman Acts.

3) Identify your pro-competitive objectives. Without market power, franchisors cannot use vertical price fixing for anticompetitive ends. The legitimate franchisor is driven by a desire to increase overall sales in its franchise system when setting a floor on franchisee prices. Its objective will be to take business from its competitors by increased service, uniformity in pricing expectations of consumers, effective national sales programs, and the like. The upshot will be increased interbrand competition. Decision makers within the franchisor organization must be ready to recite these pro-competitive objectives if called to account in a court of law.

4) If you have a choice, limit your minimum price setting, at least initially, to the states most disposed to follow Sherman Act precedent in the interpretation of their state acts. The Florida statute, for example, says that 'it is the intent of the Legislature that, in construing this chapter, due consideration and great weight be given to the interpretation of the federal courts relating to comparable federal antitrust statutes.' On the other hand, the California Supreme Court has said that the Sherman Act is not directly probative of its antitrust statute (the Cartwright Act), although federal judicial interpretations are helpful. In decisions predating Kahn and Leegin, California courts have declared minimum and maximum price maintenance unlawful per se. Given California's sometimes-liberal leanings, the wise franchisor may not choose this as its first state to test the legality of price setting under state law. The smaller franchisor might choose to preserve the right to set prices in its franchise agreement and let bigger franchisors test the state waters.

5) Realize that there are downsides to price setting, independent of the antitrust laws. If nothing else, plaintiffs will cite resale price maintenance by a franchisor as one more piece of evidence that the franchisor controls day-to-day operations of its franchisees and should therefore be liable for its franchisees' acts under theories of vicarious liability. Also, top-down price setting deprives franchisees of an ability to meet local pricing pressures and can lead to franchisee frustration over undue franchisor interference. In fact, controlling franchisee pricing is best left to special programs like national accounts, national marketing programs, and similar activities with systemwide impact. Finally, some state franchise relationship laws (Minnesota, for example) do prohibit franchisors from placing unreasonable standards of conduct on franchisees, and unreasonable pricing restraints might fall within this prohibition.

William L. Killion is a partner in the Minneapolis office of Faegre & Benson LLP. He can be contacted by phone at 612-766-7671 or by e-mail at [email protected].