- Dentsply: Exclusive Dealing Policy Maintained a Monopoly in Violation of Section 2 of the Sherman Act
- June 15, 2005 | Author: Sharon E. Selby
- Law Firm: Weil, Gotshal & Manges LLP - New York Office
The Third Circuit decision on February 24, 2005, in United States v. Dentsply, 399 F.3d 181 (3rd Cir. 2005), continues the judicial trend of invalidating under Section 2 of the Sherman Act exclusive dealing and similar contracts entered into by dominant suppliers.
In 1999 the Department of Justice ("DOJ") instituted a civil suit against Dentsply International, Inc. ("Dentsply"), a manufacturer of prefabricated artificial teeth, for alleged violations of Sections 1 and 2 of the Sherman Act as well as Section 3 of the Clayton Act. The DOJ claimed that Dentsply adopted formal, written criteria prohibiting its existing dealers from adding competing lines to their product offerings, and requiring new dealers to drop some or all competing lines in order to obtain Dentsply's products ("Dealer Criterion 6"). Existing dealers were permitted to continue to sell competing brands, commonly called "grandfathered brands," they were carrying as of the date the criteria were announced.1
District Court Decision
The district court found that the express purposes of the challenged provisions were exclusionary: to "block competitive distribution points," prohibit competition from achieving "toeholds in dealers," and to generally "tie-up dealers."2 Further, the evidence demonstrated that Dentsply had a persistently high revenue market share of 75-80% (and a 67% unit share) for at least ten years, which was 15 times higher than its next closest competitor. The remaining competitors had 2% or less of the market.3
Nevertheless, the district court held that the DOJ had failed to prove that Dentsply violated Sherman Act Section 1 or Section 3 of the Clayton Act, because Dentsply's exclusive arrangements with dealers did not foreclose a substantial share of the market or present an unreasonable restraint on competition.4 Other dealers were available to competing manufacturers, and Dentsply's dealers were free to terminate their agreements with Dentsply at any time. The trial court found that "the fact that no dealer has deemed leaving the Dentsply network a financially viable alternative is not surprising given Dentsply's competitors' failure to compete," and was not a result of Dentsply's market power.5 Moreover, the court found that direct distribution between manufacturers and dental laboratories (bypassing dealers) was a "viable and, in some ways, advantageous method of distribution," which was unaffected by Dentsply's exclusive arrangements with dealers.6
In its Section 2 analysis, the district court held that although monopoly power could be inferred from Dentsply's predominant market share, the DOJ failed to prove that Dentsply actually had the power to exclude competition or to control prices.7 The trial court found that Dentsply's two main rivals "failed to gain market share as a result of their own business decisions, not Dentsply's exclusionary practices."8 The court also held that the DOJ provided no evidence that Dentsply sold at supra-competitive prices, and that its high profit margin was comparable to manufacturers in similar markets in which "significant pre-sale promotion is employed."9 The district court also noted that even if Dentsply did possess monopoly power, it would violate Section 2 "only when it acquired or maintains, or attempts to acquire or maintain, a monopoly by engaging in exclusionary conduct 'as distinguished from growth or development as a consequence of a superior product, business acumen, or historic accident.'"10 Finally, the court ruled that the DOJ had failed to prove that Dentsply's actions "have been or could be successful in preventing 'new or potential competitors from gaining a foothold in the market.'"11
The Third Circuit's Reversal
The DOJ appealed the lower court's decision only with respect to the claims under Section 2 of the Sherman Act. The Third Circuit reversed, holding that Dentsply did possess monopoly power and had excluded competition through anticompetitive conduct.
Dentsply's Exclusionary Exercise of Monopoly Power:
The Third Circuit held that Dentsply had exhibited the power to exclude rivals and, combined with its ten year dominant market share, that it had demonstrated monopoly power.12 The appellate court disagreed with the district court's attribution of Dentsply's competitors' poor business practices as a cause for their failure to secure more of the market, and found that the real reason for their lack of success was Dentsply's "blocking of access to the key dealers," which was "not a matter of apathy, but a reflection of the effectiveness of Dentsply's exclusionary policy."13
Emphasizing economic realities over a formalistic approach, the Third Circuit cited testimony from former Dentsply managers about eliminating competitive product options for dealers as "clear expressions of a plan to maintain monopolistic power."14 The Third Circuit also found the district court's emphasis on the "ultimate consumer" to be misplaced and, comparing the fact pattern to that in its earlier LePage's decision and the DC Circuit Microsoft case, held that antitrust scrutiny should focus on the dealers and laboratories as the "customers" who purchased artificial teeth.15 Moreover, the Third Circuit found that Dentsply's ability to set prices with "little concern for its competitors" was "something a firm without a monopoly would have been unable to do."16
The Third Circuit then found that Dentsply used its market power to foreclose competitors from the market, focusing on sales to dealers, not direct sales to laboratories, as the preferred source for artificial teeth. The court believed that direct sales were "viable" only in the sense that they were "'possible,' not that it is practical or feasible in the market as it exists and functions." Thus, the court found the district court's conclusion of "viability" to "run counter to the facts" and to be "clearly erroneous."17
Further, the Third Circuit declared that record testimony showed that Dentsply's Dealer Criterion 6 "created a strong economic incentive for dealers to reject competing lines in favor of Dentsply's teeth. As in LePage's, rivals simply could not provide dealers with a comparable economic incentive to switch."18 The court compared Dentsply's authorized dealers to the high volume retailers at issue in LePage's, stating that "[t]here are other ways across the 'river' to consumers, but high volume retailers provided the most effective bridge," with the same being true in the market for artificial teeth.19
Similarly, the court considered the "at-will" nature of the arrangement meaningless; even though dealers theoretically could easily terminate the relationships, "dealers have a strong economic incentive to continue carrying Dentsply's teeth," concluding that "Dealer Criterion 6 is not edentulous."20
Finally, the Third Circuit ruled, as had the district court, that Dentsply's alleged justification for Dealer Criterion 6 was pretextual and did not excuse its exclusionary practices.21
Counseling Implications of Dentsply
Section 2 Sherman Act Enforcement Trend:
The current administration has not brought any vertical restraint cases. Moreover, Dentsply, originallybrought by the Clinton Administration, was appealed only under Section 2 of the Sherman Act. Similarly, when the D.C. Circuit affirmed in part Judge Jackson's finding of Section 2 liability for illegal monopoly maintenance in Microsoft, and remanded his finding of Section 1 liability for unlawful tying, the DOJ opted not to pursue the tying claim on remand and focused instead on the Section 2 claims.
Courts Are Tough on Monopolists:
This focus by the DOJ on Section 2 has proven significant, as the federal courts traditionally have been tough on monopolists. In Dentsply, the Third Circuit referred to the duration of Dentsply's monopoly share, and emphasized that such a persistent dominant share in the market evidences the ability to control prices and exclude competitors. Similarly, in Microsoft, the DC Circuit ruled that Microsoft's high market share, combined with barriers to entry in the relevant market, demonstrated that Microsoft displayed "power to stave off even superior new rivals."22Further, the court held that Microsoft "set the price of Windows without considering rivals' prices ... something a firm without a monopoly would have been unable to do."23 In United States v. Visa USA,24 the Second Circuit held that similar evidence demonstrated that the defendants had excluded their rivals from the marketplace.
Monopolists have also been subject to a lower "foreclosure" test than under Section 1 of the Sherman Act when courts evaluate exclusives. As the DC Circuit held in Microsoft, a monopolist's use of exclusive contracts may violate Section 2 "even though the contracts may foreclose less than the roughly 40% or 50% share usually required under A41."25
While the Supreme Court afforded more leeway in its treatment of a monopolist's refusal to deal with competitors in Verizon Communica tions, Inc. v. Law Offices of Curtis V. Trinko, LLP,26 the decisions noted above caution firms with high market shares to scrutinize carefully from an antitrust standpoint vertical restraints as distinguished from refusing to deal with competitors with whom they have not previously dealt voluntarily.
Focus on Market Realities:
The Third Circuit held that the "at-will" nature of Dentsply's relationships with its dealers was only theoretical, and found the district court's holding that direct sales were a competitive alternative also as theoretical, focusing instead on the realities of competition in the relevant market. Indeed, because the ease with which dealers could terminate the Dentsply agreements was considered illusory in view of their need for Dentsply's line, there may not even have been a business need for the exclusive provisions at all.
Risks of Attempted Monopolization Claims:
Even dominant firms with less than monopoly-level market shares should keep in mind the elements of a claim for attempted monopolization when they consider imposing vertical restraints. To establish a Section 2 violation for attempted monopolization, "a plaintiff must prove (1) that the defendant has engaged in predatory or anticompetitive conduct with (2) a specific intent to monopolize and (3) a dangerous probability of achieving monopoly power." Spectrum Sports, Inc. v. McQuillan.27 The probability of achieving such a market share with substantially anticompetitive effect through exclusive agreements or otherwise could augment the risk of violating Section 2 of the Sherman Act, even if the restraints pass muster under Section 1.
- United States v. Dentsply Int'l, Inc., 277 F. Supp. 2d 387, 412-13 (D. Del. 2003), rev'd, 399 F.3d 181 (3rd Cir. 2005).
- F. Supp. 2nd at 419.
- Id. at 423, 451.
- Id. at 449.
- Id. at 450.
- Id. at 449.
- The court acknowledged that the Third Circuit has held that "if the [exclusive dealing agreements] do not infringe upon the stiffer standards of anti-competitiveness under the Clayton Act, they will also be lawful under the less restrictive provisions of the Sherman Act," but nevertheless conducted an independent analysis under Section 2 of the Sherman Act. Id. at 451, citing Barr Labs, Inc. v. Abbott Labs, 978 F.2d 98, 110 (3rd Cir. 1992), and Tampa Electric Co. v. Nashville Coal Co., 365 U.S. 320, 335 (1961).
- F. Supp. 2nd at 451.
- Id. at 452-53, quoting United States v. Microsoft, 253 F.3d 34, 58 (D.C. Cir. 2001) (quoting U.S. v. Grinnell Corp., 384 U.S. 563, 571 (1966)).
- Id. at 453 (quoting LePage's, Inc. v. 3M, 324 F.3d 141, 159 (3rd Cir. 2003).
- 399 F.3d 181, 188-89 (3rd Cir. 2005).
- Id. at 189.
- Id. at 189-90.
- Id. at 190
- Id. at 191, citing U.S. v. Microsoft, 253 F.3d at 58.
- Id. at 195
- Id. at 196.
- Id. at 193-194. The Third Circuit also distinguished case law holding that exclusive dealing contracts of short duration do not violate the antitrust laws, including CDC Techs., Inc. v. IDEXX Labs., Inc., 186 F.3d 74, 81 (2d Cir. 1999), Omega Envtl., Inc. v. Gilbarco, Inc., 127 F.3d 1157, 1163 (9th Cir. 1997), and Ryko Mfg. Co. v. Eden Servs., 823 F.2d 1215 (8th Cir. 1987). Dentsply, 399 F.3d at 194 fn 2.
- Id. at 196. Referencing its decision in LePage's, the Third Circuit also declared that "a finding in favor of the defendant under Section 1 of the Sherman Act and Section 3 of the Clayton Act [does] not 'preclude the application of evidence of...exclusive dealing to support the [Section] 2 claim.'" Id. at 196.
- 253 F.3d at 56.
- Id. at 58.
- 344 F.3d at 229, 239-40 (2d Cir. 2003).
- United States v. Microsoft, 253 F.3d at 70.
- 540 U.S. 398 (2004).
- 506 U.S. 447, 456 (1993).