Distribution, Competition, and Antitrust / IP Law

Third Circuit Rejects Single-Product Bundling Claim – But Holds Its Fire on What Test to Apply

English: A CG rendering of a deoxygenated Red ...

Red Blood Cell (Photo credit: Wikipedia)

In Eisai, Inc. v. Sanofi Aventis U.S., LLC, No. 14-2017 (3d Cir. May 4, 2016), the Third Circuit addressed a mix of allegedly exclusionary conduct, including the defendant’s discounting of its anti-coagulant drug Lovenox, and held that the discounting was not unlawful.

The defendant offered discounts, including up to 30% of a customer’s total Lovenox purchases if the customer bought some 90% of its anti-coagulant drugs from Sanofi.  Eisai argued that Sanofi was effectively foreclosing competition by “bundling” the different types of demand for Lovenox – the “uncontestable” demand for the product (i.e., the inelastic and always-present demand) with the “contestable” portion for which Eisai would like to compete.

The Third Circuit declined to extend its Rule of Reason bundled-product discounting analysis in LePage’s Inc. v. 3M, 324 F.3d 141 (3d Cir. 2003) (en banc), cert. denied, 542 U.S. 953 (2004), to a single-product market.  And “[e]ven if bundling of different types of demand for the same product could, in the abstract, foreclose competition, nothing in the record indicates that an equally efficient competitor was unable to compete with Sanofi,” the Court held.

While rejecting application of LePage’s, in analyzing the evidence of competitive harm, the Third Circuit nevertheless engaged in an exclusive dealing-type analysis, focusing on the relatively mild consequences of not obtaining the defendant’s discounts.  In the Court’s view, Eisai failed to demonstrate that hospitals were foreclosed from purchasing competing drugs as a result of Sanofi’s discounting.

However, the Court also refused to apply a price-cost screen to Sanofi’s conduct.  When pricing “predominates over other means of exclusivity, the price-cost test applies.  This is usually the case when a firm uses a single-product loyalty discount or rebate to compete with similar products.”  In that situation, “an equally efficient competitor can match the loyalty price and the firms can compete on the merits.  More in-depth factual analysis is unnecessary because we know that ‘the balance always tips in favor of allowing above-cost pricing practices to stand.’”  However, Eisai alleged that Sanofi, having obtained a unique FDA indication, offered a discount that bundled incontestable and contestable demand.  “On Eisai’s telling, the bundling – not the price – served as the primary exclusionary tool.”  The Third Circuit therefore did not apply a price-cost screen, and declined to opine “on when, if ever, the price-cost test applies to this type of claim.”

Whether the distinction between bundling and discounting the Third Circuit sought to draw makes sense is less than clear – the only real effect of the bundling was to enable a discount, and the discount was offered in connection with the bundling.  They are two sides of the same coin.  Eisai continues the tension between the Third Circuit and others on the treatment of bundled discounts.  See, e.g., Cascade Health Solutions v. PeaceHealth, 515 F.3d 883 (9th Cir. 2008) (applying price-cost screen to bundled discounts).

Speaking About Discounted Pricing Clauses

I’m happy to be speaking on “Discounted Pricing Clauses: Drafting Enforceable and Compliant Provisions After Collins.”  We’ll be addressing potential pitfalls in drafting discounted pricing clauses in commercial contracts, particularly in light of the Sixth Circuit’s decision in Collins Inkjet Corp. vs. Eastern Kodak, 14-3306 (6th Cir. 2015). The panel will review the efficacy of bundled pricing provisions, minimum requirements contracts, and tiered or volume-based pricing schemes and provide best practices for drafting compliant clauses.

The presentation is on Tuesday, May 17, 2016.  Information can be found here.  I wrote about Collins previously.

Sixth Circuit Applies Cost Screen to Tying by Differential Pricing

English: Eastman Kodak model B

Eastman Kodak model B (Photo credit: Wikipedia)

In Collins Inkjet Corp. v. Eastman Kodak Co., No. 14-3306 (6th Cir. March 16, 2015), the U.S. Court of Appeals for the Sixth Circuit held that differential pricing – charging more for one product when the customer does not also purchase a second product – can constitute an unlawful tying arrangement only when the price differential in effect discounts the second product below the seller’s cost.

Eastman Kodak sells refurbished printer components for industrial printers. It also sells ink. Its competitor, Collins, competes for the sale of ink. In 2013, Kodak announced a new pricing policy – it discounted print heads for customers that also buy Kodak ink. Collins sought, and obtained in the district court, a preliminary injunction against the pricing policy.

The Sixth Circuit affirmed the grant of the preliminary injunction, but clarified the test for what it termed “non-explicit tying via differential pricing.” In the Court’s view, differential pricing becomes equivalent to an unlawful tying arrangement when the price discount, as applied to the original price of the second (or “tied”) product, in effect lowers the price of the tied product below the seller’s cost. “[D]ifferential pricing . . . is unlawful only if it might [force] a more efficient competitor out of business.” The below-cost test is required because

differential pricing, unlike other forms of indirect coercion, can be employed legitimately without illegal anticompetitive influence from the defendant’s control over the tying product market . . . . [I]f the defendant merely offers a discount on the tying good to buyers who also purchase the tied good, then buyers are only ‘forced’ to buy the tied good elsewhere at a price low enough to offset the forgone discount for the tying product. The defendant uses its market power over the tying good to shift the discount from the tied good to the tying good, but this in itself does not ‘force’ buyers to purchase the tied product any more than a discount on the tied product would.

In applying a below-cost screen, the Sixth Circuit followed the Ninth Circuit’s approach to bundled discounts in Cascade Health Solutions v. PeaceHealth, 515 F.3d 883, 906 (9th Cir. 2008), and criticized the Third Circuit’s approach in LePage’s, Inc. v. 3M, 324 F.3d 141, 154-57 (3d Cir. 2003 (en banc).

Application of a cost screen has the obvious advantage of providing a relatively bright line test that firms can apply themselves to avoid potential violations in the first instance.

Is the California Unfair Practices Act a Free Pass on Motions to Dismiss?

Probably not, but UPA claims can be tough to defeat at the motion to dismiss stage. Witness Rheumatology Diagnostics Laboratory, Inc. v. Aetna, Inc., 2013 U.S. Dist. LEXIS 151128 (N.D. Cal. Oct. 18, 2013) (Orrick, J.), where the court dismissed many of the plaintiffs’ Sherman Act Section 1 and Section 2 claims. However, the court refused to dismiss the plaintiffs’ below-cost pricing claims against Quest Diagnostics under the UPA, reasoning:

The UPA “appears to be a painstaking endeavor by the legislature to combat the abuses which the business interests have deemed unfair practices in the competitive field.” To require the plaintiffs to plead with an unreasonable degree of specificity would undermine the UPA’s admonition that the statute “shall be liberally construed that its beneficial purposes may be subserved.” Cal. Bus. & Prof. Code § 17002. Much of the information that must be pleaded—Quest’s costs and the prices it charges by product—is in Quest’s hands and not easily accessed by the plaintiffs. The Court does not “forget that proceeding to [ ] discovery can be expensive” or that the plaintiffs must meet their burden under Federal Rule of Civil Procedure 8. However, even in a case where the plaintiff “fail[ed] to allege a definite cost of doing business,” the California Court of Appeal held that “it would serve no useful purpose to require a speculative allegation of cost which adds nothing to the notice given by the pleadings in their present state. Accordingly, we view the present pleadings as sufficient under section 17043 and find error in sustaining the demurrer thereto.”

In sum, “the determination of cost is best approached on a case-by-case basis.” So long as the method used was not “arbitrary or irrational,” it is sufficient for pleading purposes. Finding that the plaintiffs adequately plead their UPA claim based on the information alleged in the [complaint] does not mean that the information or calculations provided are necessarily correct or even that the plaintiffs are likely to succeed in proving their claim. Quest may dispute the details of the calculation method later to the trier of fact. However, the purpose of pleading is to put a defendant on sufficient notice of its alleged wrongdoing, and the plaintiffs have done so here.

(Citations omitted). This liberal standard – coupled with the fact that a UPA plaintiff probably need not prove a dangerous probability of recoupment after the predatory period, a requirement under federal law – makes it difficult to target these claims on a motion to dismiss.

The Top Nine Things You Need to Know About Below-Cost Pricing Law in California : Part II

This is the second of two posts on California below-cost pricing law.  The first post is here.

5. What does it mean to sell below “cost?”

Unlike federal law, California law expressly defines the concept of below-cost sales (although there remain many questions about how California law applies in practice and in detail). Under California law, the cost referred to in the UPA is a fully allocated cost or fully distributed cost.

For distribution, cost means the invoice or replacement cost, whichever is lower, of the article or product to the distributor and vendor, plus the cost of doing business by the distributor and vendor. So here’s an example: if you are a distributor and you are selling product X, the cost will be the invoice/replacement cost of X, plus an appropriate allocation to product X of a portion of your overhead costs (including lease costs, depreciation, maintenance costs, insurance and advertising costs, administrative costs, labor costs, etc.). Developing proof of the appropriate cost allocation can be time-consuming and complex.

In the absence of proof of cost of doing business, a markup of six percent on such invoice or replacement cost is prima facie proof of such cost of doing business. Thus, absent actual evidence, a plaintiff can still make out a case by establishing that your pricing is below invoice cost plus six percent. This is another relatively unique feature of California law that makes it more difficult to secure early dismissals of below-cost claims.

6. What if I lower my prices temporarily – can’t I average them over time?

Although there are good arguments that you should be able to average out temporary price reductions, the case law in this area is somewhat conflicting and unclear. Therefore, you should not simply assume that you can lower prices for a few days or weeks and enjoy immunity because over a period of months or years your prices are above cost. Before deciding on such a pricing strategy, you should consider its legal implications more closely.

7. Does California law average costs over time?

Here, the answer is a bit better for sellers. At least one California appellate court has held that the costs of selling items should be measured as the average costs over a reasonable time, rather than the cost of the item on a particular occasion. Thus, if your costs happen to temporarily increase, you may be able to argue that the costs should be measured over a longer period of time (and thus are lower than the dip prices). This is important, because you want your pricing to be above your cost.

8. Are there defenses to below-cost pricing claims?

Yes. Both Section 17043 and Section 17044 are subject to an affirmative defense for sales made in good faith in an endeavor to meet the legal prices of a competitor selling the same article or product, in the same locality or trade area and in the ordinary channels of trade. This is the so-called “meeting competition” defense. Note that the defense allows you to meet (not beat) competitive pricing, and it only applies when you meet the legal prices of a competitor. Thus, if two sellers know they are each selling below cost and nevertheless pursue a price war, the defense will probably not apply.

There are other less important defenses as well. For example, you can engage in below cost sales of perishable goods to close out your stock, or price below cost when goods are damaged or deteriorated in quality.

9. What are the remedies for a violation of California’s below-cost pricing statute?

For violations of the UPA’s pricing provisions, a plaintiff can recover treble damages, attorney’s fees, and costs. A plaintiff can also secure injunctive relief against the pricing practices at issue. Violations can also amount to criminal misdemeanors and subject violators to fines and imprisonment, but the UPA is almost never enforced in this manner.

Conclusion

It may be surprising to some that companies cannot price as they wish, but that is in fact the case. In California, below-cost pricing remains actionable, and below-cost pricing suits are filed almost every year. Because California does not require proof of the possibility of recoupment, because it provides plaintiffs with powerful (but rebuttable) presumptions, and because the defenses to a below-cost claim under California law are limited, companies that do business in California should make sure that aggressive promotions, discounts, or rebates do not violate California’s below-cost pricing law.

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The Top Nine Things You Need to Know About Below-Cost Pricing Law in California : Part I

Fair Pricing

Fair Pricing (Photo credit: Wikipedia)

As of 2012 (at least according to Wikipedia), California was the 12th largest economy in the world. Most national and international firms do at least some business in the Golden State. Like other states, California has laws prohibiting the below-cost pricing of goods and services. Although below-cost pricing claims are not filed with great frequency, they are indeed filed, and they can become a trap for those who are unfamiliar with the law in this area.

In fact, California’s below-cost pricing law features some unique plaintiff-friendly provisions that can, at least in theory, expose your company to more potential liability than the analogous laws of other states. You might unwittingly find yourself on the wrong side of California law, especially if your firm at least on occasion uses discounts, promotions, or rebates. In the next few posts, I will briefly review California’s below-cost pricing law and the top nine things you need to know about it to minimize your exposure to below-cost pricing claims.

1. What statute is at issue?

California Business & Professions Code section 17043 prohibits “sell[ing] any article or product at less than the cost thereof to [a] vendor, or . . . giv[ing] away any article or product, for the purpose of injuring competitors or destroying competition.” Section 17043 is part of California’s Unfair Practices Act, or “UPA.”

California law also expressly prohibits the use of loss leaders. Section 17044 prohibits “sell[ing] or us[ing] any article or product as a ‘loss leader’ as defined in Section 17030 of this chapter.” Section 17030 defines “loss leader” as “any article or product sold at less than cost: (a) Where the purpose is to induce, promote or encourage the purchase of other merchandise; or (b) Where the effect is a tendency or capacity to mislead or deceive purchasers or prospective purchasers; or (c) Where the effect is to divert trade from or otherwise injure competitors.” Although the loss leader provision was probably designed to protect small retailers, the statute is not expressly limited to retailers and it could apply to other links in the distribution chain. For most purposes, you can safely think of a loss leader claim as a specific type of below-cost pricing claim.

2. Why would a statute address below-cost pricing?

California developed the below-cost sections of the UPA during the Great Depression to, among other things, protect existing firms against market price erosion as a result of distress sales, bankruptcy liquidations, and unscrupulous practices. The UPA is in some ways similar to, and in some ways significantly different from, the federal Robinson-Patman Act, 15 U.S.C. § 13, which also concerns itself with, among other things, below-cost pricing. Some of the notable differences between California and federal law are discussed below.

3. What products does the statute cover?

The UPA defines “article or product” broadly to include “any article, product, commodity, thing of value, service or output of a service trade.” Section 17024. One court has written that this definition is “remarkably open-ended.” As such, the UPA may apply to technology or software licensing – which usually does not fall under the federal Robinson-Patman Act because such licensing involves neither commodities nor sales.

4. Do sales below cost themselves violate the statute? Isn’t harm to competition also required?

Proof of harm to competition is one of the major differences between federal law and California law. Under federal law, below-cost sales are only actionable when the seller is likely to recoup the losses at a later time period (e.g., after the seller has driven its competitors out of the market and jacks up the prices). Because likelihood of recoupment is so difficult to prove, below-cost pricing claims under federal law have become relatively rare. California law, however, imposes no such requirement, and so considerably lowers the bar for below-cost pricing claims.

That said, to violate the statute, the seller must act with the purpose, i.e., the desire, of injuring competitors or destroying competition. Such intent could be shown through the seller’s internal documents, which might be obtained in discovery. Often, of course, no such documents exist. Some courts have also indicated, citing Section 17071 of the UPA, that proof of one or more acts of selling or giving away any article or product below cost or at discriminatory prices, together with proof of the injurious effect of such acts, is presumptive evidence of the purpose or intent to injure competitors or destroy competition. Although such evidence can be rebutted, the presumption may make it more difficult for a seller to dismiss at an early stage a below-cost pricing claim.

Up next: What does it mean to sell below “cost?”

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