What Lessors Need to Know About Antitrust : Competitors of Copier Equipment Provider Entitled to a 'Kodak Moment' in Alleging a Single Provider Relevant 'Aftermarket'

In the last 50 years, there has been a sea change in the antitrust law relative to monopolization in violation of Section 2 of the Sherman Act, and tying arrangements in violation of Section 1 of the Sherman Act, and Section 3 of the Clayton Act. For example, in United States v. Aluminum Co. of America, 148 F.2d 416 (2d Cir. 1945), Judge Learned Hand, his court sitting as the United States Supreme Court, held that Alcoa had illegally monopolized the market for the production of aluminum ingot, by, among other practices, increasing supply in anticipation of increased consumer demand, and the systematic lowering of prices to levels that could not be competitively matched by new entrant competitors lacking economies of scale efficiency. Other than certain allegations of an above cost 'price squeeze,' there was no evidence of any 'predatory' or unfair or anticompetitive practices. Rather, the court's view at that time was that a monopolist had a duty to regulate his capacity and his pricing to ensure that its smaller and more recently arrived competitors would not be disadvantaged. Currently, the law under Section 2 is that the monopolist has no duty at all: See Verizon Comm., Inc. v. Law Offices of Curtis V. Trinko, LLP, 540 U.S. 398 (2004).

In the arena of tying arrangements, the change in the law can also be described as a sea change. The early opinions of the Supreme Court assumed that 'tying arrangements serve hardly any purpose beyond the suppression of competition.' Standard Oil Co. of California v. United States, 337 U.S. 293, 305-306 (1949). In Fortner Enterprises, Inc. v. United States Steel Corp., 394 U.S. 495, 498-499 (Fortner I), 'sufficient market power' to invoke a per se rule of illegality was found present because of the physically 'unique' attributes of the alleged tying product, which was attractive credit made available for the purchase of prefabricated buildings. The Court held that the 'uniqueness' of the credit offer was sufficient evidence of 'market power' to invoke a per se rule, without any inquiry into what other firms were capable of offering substitutable credit terms.

However, seven years later, the Court, in the same case, held that unless the plaintiff could prove 'market power' in a market consisting of all of the competing products that would be available to consumers who wish to substitute away from the tie, there could be no actionable tie. United States Steel Corp. v. Fortner Enterprises, Inc., 429 U.S. 610, 622 (1977) (Fortner II). Another seven years later, the Supreme Court made it even clearer that in order to determine the presence or absence of 'sufficient economic power' to violate either Section 2 of the Sherman Act or Section 3 of the Clayton Act, there must be an appraisal of 'market power' in a properly defined 'relevant market,' which would consist of all reasonable substitutes confronting the seller's demand curve, that could be readily obtained by consumers. See Jefferson Parish Hosp. Dist. No. 2 v. Hyde, 466 U.S. 2 (1984). Fortner II and Jefferson Parish, taken in conjunction with the Supreme Court's seminal decision in Continental T.V., Inc. v. GTE Sylvania, Inc., 433 U.S. 36 (1977) made it clear that antitrust law must be continually evaluated in light of the increased knowledge in the field of industrial organization economics. See D. Hibner and A. Hasegawa, The Silver Anniversary of an Antitrust Sea-Change: Continental T.V. and Brunswick at Twenty-Five. Competition Magazine 27 (Fall 2002).

Presumption of the Presence of Market Power

However, even with the enlightenment of Continental T.V., Fortner II and Jefferson Parish, early Supreme Court decisions invoked a conclusive presumption of the presence of market power in intellectual property cases. These cases routinely condemned 'requirements ties,' where the seller or lessor of patented systems required the purchase of unpatented parts or service. Pursuant to cases such as International Salt Co. v. United States, 332 U.S. 392 (1947), and United States v. Loew's, Inc., 371 U.S. 38 (1962), 'market power,' or in a Section 2 case 'monopoly power' would be conclusively presumed where the tying product was subject to intellectual property protection. See also, International Business Machines Corp. v. United States, 298 U.S. 131 (1936) (IBM punch card case). This line of cases has also gone to the graveyard of history. In Illinois Tool Works, Inc. v. Independent Ink, Inc., 547 U.S. 281, 126 S. Ct. 1281 (2006), the Supreme Court overruled the earlier cases, which had conclusively presumed 'sufficient economic power' in intellectual property cases involving 'requirements ties.' A full relevant market appraisal is now a requirement in all tying cases.

Substantial progress in the application of advances in economic knowledge to antitrust principles continue at an increasing pace. See Leegin Creative Leather Products, Inc. v. PSKS, Inc., 127 S. Ct. 2705 (2007) (per se rule against vertical resale price maintenance overruled.)

But Then, There Is Still Kodak

In Eastman Kodak Co. v. Image Technical Services, Inc., 504 U.S. 451 (1992) the Supreme Court affirmed a reversal of summary judgment for Kodak against charges that Kodak illegally tied the sale of replacement parts for its photocopiers and micrographic equipment to the purchase of its repair services. After holding that a genuine issue of fact existed as to whether parts and repair services constituted distinct product markets, the Court considered whether a seller without market power in the market for the sale of original equipment could possess market power in the aftermarket for the sale of parts and services. The Supreme Court accepted the lower court's conclusion that Kodak was one of a number of competing sellers of photocopiers and micrographic equipment, and that it lacked market power in any original equipment market. Kodak argued that this alone was dispositive of the tying issue, as it clearly lacked market power in the copier and micrographic equipment market, and thus could not compel or coerce the purchase of unwanted parts. If it attempted to charge supra-competitive prices for parts, it would lose new placements of original equipment to purchasers who would avoid the tie by substituting to suppliers who offered equipment with lower total life-cycle costs.

The Supreme Court rejected this argument for basically two reasons. First, the Court found that the difficultly of obtaining meaningful 'life-cycle cost data' would create a substantial pool of exploitable equipment purchasers. While sophisticated buyers might be able to protect themselves by obtaining life-cycle cost information, others might not. Second, the cost of switching would disincentivize existing owners of Kodak equipment from buying competing equipment from competitors, and would thus be 'locked in' to Kodak's ability to charge higher than 'competitive' prices for its aftermarket replacement parts. This would be particularly so, if the percentage of locked-in users was high relative to potential new purchasers.

The Court emphasized that it was reviewing the case to determine whether, on a motion for summary judgment, there was a genuine issue of fact that could support the allegations of the complaint. At trial, a trier of fact, whether judge or jury, could find that the relevant market for the determination of the presence or absence of substantial market power was Kodak copiers themselves, and not the array of substitutable equipment available to a potential customer who was not 'locked in,' and was not a captive to Kodak because of the information asymmetry which would enable Kodak to charge non-competitive prices in the aftermarket for its parts.

In the wake of Kodak, several courts of appeal applied it to tying cases, and limited the relevant market to the defendant's equipment sales alone, thus insuring that the defendant would be found to have 'monopoly power' over its own sales. At first, the Kodak decision was heralded as a throwback to an earlier era, where franchise antitrust claims would be more sustainable by plaintiffs. See, e.g., Janet L. McDavid and Richard M. Steuer, The Revival of Franchise Antitrust Claims. 67 Antitrust L.J. 209 (1999). However, the vast majority of court decisions have limited the Kodak aftermarket analysis to Kodak-specific facts. The analysis has been generally limited to situations where the alleged tied products requirement is first disclosed to the purchaser after the customers are 'locked-in' by virtue of previous purchase of the tying product. Such courts have generally limited Kodak of situations where the defendant has changed its aftermarket sales and pricing policy after a significant number of customers have made their purchase, or a significant number of purchasers can actually show that they were misinformed about aftermarket prices, at the time of contract formation. See, e.g., David A.J. Goldfine and Kenneth M. Vorrasi, The Fall of the Kodak Aftermarket Doctrine: Dying a Slow Death in the Lower Courts. 72 Antitrust LJ 209 (2004).

The most influential article, however, that has been instrumental in limiting Kodak to a 'Kodak moment' is Benjamin Klein and Lester F. Saft, The Law and Economics of Franchise Tying Contracts. 28 J.L. & Econ 345 (1985). In their pre-Kodak article, economists Klein and Saft demonstrate that absent an aftermarket change or misrepresentation, the market power component in a franchise or requirements tie case should be determined by an analysis of the competitive inputs available to a potential purchaser at the time of contract formation. If the potential purchaser is reasonably apprised of the potential of downstream 'installed base opportunism,' he or she may substitute away from the proposed tie, and make competitive market decisions. Thus, absent aftermarket policy changes, subsequent to contract formation, and absent fraudulent or deceptive practices that could prevent the potential purchaser from obtaining the necessary product or service life-cycle information, the relevant market for determining 'market power' should be all of the substitutes confronting the demand curve.

The Klein & Saft Analysis

Numerous courts have adopted the Klein & Saft analysis, as cited with approval in Queen City Pizza v. Domino's Pizza, 124 F.3d 430 (3d Cir. 1997). Queen City held that the relevant market for determining the presence or absence of market power in a pizza franchise was all available franchise opportunities for pizza and fast food operations. One commentator has opined that the denial of certiorari in Queen City Pizza 'started the 'death knell' for tying claims in business format franchise cases. Absent after the fact changes in parts of services distribution policy, all competing products available to the purchaser at the time of contract formation should be included.

The recent IKON decision in the Ninth Circuit confirms that while Kodak is not 'dead,' and remains a viable decision of the United States Supreme Court, it will be limited by lower courts to its specific facts. In IKON, the court reasoned that the allegations of the complaint presented a closer factual analogy to Kodak than to Queen City Pizza. Thus, there was a genuine issue of fact whether the alleged market power flowed from the contractual terms between the defendant and its customers, or from traditional acts of exclusionary conduct, that differentiated a single product market from a broader market of interchangeable competing products.

In an enigmatic of somewhat metaphysical analysis, the IKON court held that allegations of fraudulent contract opportunism warranted the conclusion that the defendant's market power could be a function of market imperfections and the lack of substitutability, rather than from the contract itself. Noting that the 'new lease on life' of the complaint may be somewhat fleeting, the court also noted that nothing in its decision guaranteed that ' or even speaks of whether ' Newcal's complaint will 'survive' a motion for summary judgment. Thus, the application of Kodak in IKON may indeed be a 'Kodak moment.' An issue that may be decided on summary judgment is whether the contract opportunism allegations are such that they could not have been anticipated at the time of formation.

Conclusion

The moral of this story? A seller or lessor of a product that wishes to mandate or encourage the sale of its proprietary aftermarket parts or service in a 'requirements tie' situation will be well advised to include appropriate recitals in the Sale or Lease Agreement as to the obligation of the potential purchaser to investigate and assimilate product life-cycle information, and to agree that there may well be changes in the seller's aftermarket parts and service policies, depending on a number of business factors, which should be identified and quantified, wherever practicable. This may do much to mutate a Kodak moment into a Queen City Pizza experience.

Don T. Hibner, Jr. is a partner in the Los Angeles office of Sheppard, Mullin, Richter & Hampton. Mr. Hibner has specialized in antitrust litigation and counseling since admission to the Bar and has been a frequent contributor to programs of the Antitrust Section, its National Institutes, PLI and other programs, as well as a contributor to various Law Reviews. He may be reached at [email protected].

The Ninth Circuit recently examined an antitrust issue with significant relevance to the equipment leasing industry. In Newcal v. IKON Office Solution , 513 F.3d 1038 (9th Cir., Jan. 23, 2008), competitors of a copier equipment provider, IKON Office Solution ('IKON'), alleged that defendant IKON used 'fraudulent practices' to secure and lengthen its customer contracts, thus reducing the ability of competing copier equipment providers to contest for 'aftermarket' business.'

Although the district court had granted a motion to dismiss pursuant to FRCP 12(b)(6) on the ground that IKON did not have market power over a 'unique' product or service, and that any control that it had acquired over its customers was a function of contract, and not market power, the Ninth Circuit reversed. The following article is an analysis of the relevant law of antitrust and a discussion of applicable issues that counsel should consider when marketing proprietary aftermarket equipment.

Antitrust Law

In the last 50 years, there has been a sea change in the antitrust law relative to monopolization in violation of Section 2 of the Sherman Act, and tying arrangements in violation of Section 1 of the Sherman Act, and Section 3 of the Clayton Act. For example, in United States v. Aluminum Co. of America , 148 F.2d 416 (2d Cir. 1945), Judge Learned Hand, his court sitting as the United States Supreme Court, held that Alcoa had illegally monopolized the market for the production of aluminum ingot, by, among other practices, increasing supply in anticipation of increased consumer demand, and the systematic lowering of prices to levels that could not be competitively matched by new entrant competitors lacking economies of scale efficiency. Other than certain allegations of an above cost 'price squeeze,' there was no evidence of any 'predatory' or unfair or anticompetitive practices. Rather, the court's view at that time was that a monopolist had a duty to regulate his capacity and his pricing to ensure that its smaller and more recently arrived competitors would not be disadvantaged. Currently, the law under Section 2 is that the monopolist has no duty at all: See Verizon Comm., Inc. v. Law Offices of Curtis V. Trinko, LLP , 540 U.S. 398 (2004).

In the arena of tying arrangements, the change in the law can also be described as a sea change. The early opinions of the Supreme Court assumed that 'tying arrangements serve hardly any purpose beyond the suppression of competition.' Standard Oil Co. of California v. United States , 337 U.S. 293, 305-306 (1949). In Fortner Enterprises, Inc. v. United States Steel Corp. , 394 U.S. 495, 498-499 ( Fortner I ), 'sufficient market power' to invoke a per se rule of illegality was found present because of the physically 'unique' attributes of the alleged tying product, which was attractive credit made available for the purchase of prefabricated buildings. The Court held that the 'uniqueness' of the credit offer was sufficient evidence of 'market power' to invoke a per se rule, without any inquiry into what other firms were capable of offering substitutable credit terms.

However, seven years later, the Court, in the same case, held that unless the plaintiff could prove 'market power' in a market consisting of all of the competing products that would be available to consumers who wish to substitute away from the tie, there could be no actionable tie. United States Steel Corp. v. Fortner Enterprises, Inc. , 429 U.S. 610, 622 (1977) ( Fortner II ). Another seven years later, the Supreme Court made it even clearer that in order to determine the presence or absence of 'sufficient economic power' to violate either Section 2 of the Sherman Act or Section 3 of the Clayton Act, there must be an appraisal of 'market power' in a properly defined 'relevant market,' which would consist of all reasonable substitutes confronting the seller's demand curve, that could be readily obtained by consumers. See Jefferson Parish Hosp. Dist. No. 2 v. Hyde , 466 U.S. 2 (1984). Fortner II and Jefferson Parish , taken in conjunction with the Supreme Court's seminal decision in Continental T.V., Inc. v. GTE Sylvania, Inc. , 433 U.S. 36 (1977) made it clear that antitrust law must be continually evaluated in light of the increased knowledge in the field of industrial organization economics. See D. Hibner and A. Hasegawa, The Silver Anniversary of an Antitrust Sea-Change: Continental T.V. and Brunswick at Twenty-Five. Competition Magazine 27 (Fall 2002).

Presumption of the Presence of Market Power

However, even with the enlightenment of Continental T.V., Fortner II and Jefferson Parish, early Supreme Court decisions invoked a conclusive presumption of the presence of market power in intellectual property cases. These cases routinely condemned 'requirements ties,' where the seller or lessor of patented systems required the purchase of unpatented parts or service. Pursuant to cases such as International Salt Co. v. United States , 332 U.S. 392 (1947), and United States v. Loew's, Inc ., 371 U.S. 38 (1962), 'market power,' or in a Section 2 case 'monopoly power' would be conclusively presumed where the tying product was subject to intellectual property protection. See also, International Business Machines Corp. v. United States, 298 U.S. 131 (1936) (IBM punch card case). This line of cases has also gone to the graveyard of history. In Illinois Tool Works, Inc. v. Independent Ink, Inc. , 547 U.S. 281, 126 S. Ct. 1281 (2006), the Supreme Court overruled the earlier cases, which had conclusively presumed 'sufficient economic power' in intellectual property cases involving 'requirements ties.' A full relevant market appraisal is now a requirement in all tying cases.

Substantial progress in the application of advances in economic knowledge to antitrust principles continue at an increasing pace. See Leegin Creative Leather Products, Inc. v. PSKS, Inc. , 127 S. Ct. 2705 (2007) ( per se rule against vertical resale price maintenance overruled.)

But Then, There Is Still Kodak

In Eastman Kodak Co. v. Image Technical Services, Inc. , 504 U.S. 451 (1992) the Supreme Court affirmed a reversal of summary judgment for Kodak against charges that Kodak illegally tied the sale of replacement parts for its photocopiers and micrographic equipment to the purchase of its repair services. After holding that a genuine issue of fact existed as to whether parts and repair services constituted distinct product markets, the Court considered whether a seller without market power in the market for the sale of original equipment could possess market power in the aftermarket for the sale of parts and services. The Supreme Court accepted the lower court's conclusion that Kodak was one of a number of competing sellers of photocopiers and micrographic equipment, and that it lacked market power in any original equipment market. Kodak argued that this alone was dispositive of the tying issue, as it clearly lacked market power in the copier and micrographic equipment market, and thus could not compel or coerce the purchase of unwanted parts. If it attempted to charge supra-competitive prices for parts, it would lose new placements of original equipment to purchasers who would avoid the tie by substituting to suppliers who offered equipment with lower total life-cycle costs.

The Supreme Court rejected this argument for basically two reasons. First, the Court found that the difficultly of obtaining meaningful 'life-cycle cost data' would create a substantial pool of exploitable equipment purchasers. While sophisticated buyers might be able to protect themselves by obtaining life-cycle cost information, others might not. Second, the cost of switching would disincentivize existing owners of Kodak equipment from buying competing equipment from competitors, and would thus be 'locked in' to Kodak's ability to charge higher than 'competitive' prices for its aftermarket replacement parts. This would be particularly so, if the percentage of locked-in users was high relative to potential new purchasers.

The Court emphasized that it was reviewing the case to determine whether, on a motion for summary judgment, there was a genuine issue of fact that could support the allegations of the complaint. At trial, a trier of fact, whether judge or jury, could find that the relevant market for the determination of the presence or absence of substantial market power was Kodak copiers themselves, and not the array of substitutable equipment available to a potential customer who was not 'locked in,' and was not a captive to Kodak because of the information asymmetry which would enable Kodak to charge non-competitive prices in the aftermarket for its parts.

In the wake of Kodak, several courts of appeal applied it to tying cases, and limited the relevant market to the defendant's equipment sales alone, thus insuring that the defendant would be found to have 'monopoly power' over its own sales. At first, the Kodak decision was heralded as a throwback to an earlier era, where franchise antitrust claims would be more sustainable by plaintiffs. See, e.g., Janet L. McDavid and Richard M. Steuer, The Revival of Franchise Antitrust Claims. 67 Antitrust L.J. 209 (1999). However, the vast majority of court decisions have limited the Kodak aftermarket analysis to Kodak-specific facts. The analysis has been generally limited to situations where the alleged tied products requirement is first disclosed to the purchaser after the customers are 'locked-in' by virtue of previous purchase of the tying product. Such courts have generally limited Kodak of situations where the defendant has changed its aftermarket sales and pricing policy after a significant number of customers have made their purchase, or a significant number of purchasers can actually show that they were misinformed about aftermarket prices, at the time of contract formation. See, e.g., David A.J. Goldfine and Kenneth M. Vorrasi, The Fall of the Kodak Aftermarket Doctrine: Dying a Slow Death in the Lower Courts. 72 Antitrust LJ 209 (2004).

The most influential article, however, that has been instrumental in limiting Kodak to a 'Kodak moment' is Benjamin Klein and Lester F. Saft, The Law and Economics of Franchise Tying Contracts. 28 J.L. & Econ 345 (1985). In their pre-Kodak article, economists Klein and Saft demonstrate that absent an aftermarket change or misrepresentation, the market power component in a franchise or requirements tie case should be determined by an analysis of the competitive inputs available to a potential purchaser at the time of contract formation. If the potential purchaser is reasonably apprised of the potential of downstream 'installed base opportunism,' he or she may substitute away from the proposed tie, and make competitive market decisions. Thus, absent aftermarket policy changes, subsequent to contract formation, and absent fraudulent or deceptive practices that could prevent the potential purchaser from obtaining the necessary product or service life-cycle information, the relevant market for determining 'market power' should be all of the substitutes confronting the demand curve.

The Klein & Saft Analysis

Numerous courts have adopted the Klein & Saft analysis, as cited with approval in Queen City Pizza v. Domino's Pizza , 124 F.3d 430 (3d Cir. 1997). Queen City held that the relevant market for determining the presence or absence of market power in a pizza franchise was all available franchise opportunities for pizza and fast food operations. One commentator has opined that the denial of certiorari in Queen City Pizza 'started the 'death knell' for tying claims in business format franchise cases. Absent after the fact changes in parts of services distribution policy, all competing products available to the purchaser at the time of contract formation should be included.

The recent IKON decision in the Ninth Circuit confirms that while Kodak is not 'dead,' and remains a viable decision of the United States Supreme Court, it will be limited by lower courts to its specific facts. In IKON, the court reasoned that the allegations of the complaint presented a closer factual analogy to Kodak than to Queen City Pizza. Thus, there was a genuine issue of fact whether the alleged market power flowed from the contractual terms between the defendant and its customers, or from traditional acts of exclusionary conduct, that differentiated a single product market from a broader market of interchangeable competing products.

In an enigmatic of somewhat metaphysical analysis, the IKON court held that allegations of fraudulent contract opportunism warranted the conclusion that the defendant's market power could be a function of market imperfections and the lack of substitutability, rather than from the contract itself. Noting that the 'new lease on life' of the complaint may be somewhat fleeting, the court also noted that nothing in its decision guaranteed that ' or even speaks of whether ' Newcal's complaint will 'survive' a motion for summary judgment. Thus, the application of Kodak in IKON may indeed be a 'Kodak moment.' An issue that may be decided on summary judgment is whether the contract opportunism allegations are such that they could not have been anticipated at the time of formation.

Conclusion

The moral of this story? A seller or lessor of a product that wishes to mandate or encourage the sale of its proprietary aftermarket parts or service in a 'requirements tie' situation will be well advised to include appropriate recitals in the Sale or Lease Agreement as to the obligation of the potential purchaser to investigate and assimilate product life-cycle information, and to agree that there may well be changes in the seller's aftermarket parts and service policies, depending on a number of business factors, which should be identified and quantified, wherever practicable. This may do much to mutate a Kodak moment into a Queen City Pizza experience.

Don T. Hibner, Jr. is a partner in the Los Angeles office of Sheppard, Mullin, Richter & Hampton. Mr. Hibner has specialized in antitrust litigation and counseling since admission to the Bar and has been a frequent contributor to programs of the Antitrust Section, its National Institutes, PLI and other programs, as well as a contributor to various Law Reviews. He may be reached at [email protected].