Law360 is providing free access to its coronavirus coverage to make sure all members of the legal community have accurate information in this time of uncertainty and change. Use the form below to sign up for any of our weekly newsletters. Signing up for any of our section newsletters will opt you in to the weekly Coronavirus briefing.
Sign up for our Competition newsletter
You must correct or enter the following before you can sign up:
Thank You!
Law360 (May 8, 2020, 3:16 PM EDT) --
 |
| Lawrence Silverman |
 |
| Richard Brosnick |
 |
| Sara Mandelbaum |
 |
| Evelina Gentry |
In making these decisions, companies should be aware that, even in times of product shortages, the antitrust laws still apply, and, in fact, such constrained supply conditions could create market power and restrict a supplier's lawful alternatives. As a result, affected suppliers should take precautions to ensure that they do not inadvertently violate antitrust laws.
To the extent that product allocation requires coordination among competitors, suppliers should take advantage of the expedited review processes now offered by the antitrust regulators.
Such precautions are justified, because antitrust enforcement has been enhanced, not relaxed. The Antitrust Division of the United States Department of Justice announced on March 24 its intention to closely scrutinize potential antitrust violations precipitated by changed market conditions, stating that it "stand[s] ready to pursue civil violations of the antitrust laws, which include agreements between individuals and business to restrain competition through increased prices, lower wages, decreased output, or reduced quality as well as efforts by monopolists to use their market power to engage in exclusionary conduct. The DOJ will also prosecute any criminal violations of the antitrust laws, which typically involve agreements or conspiracies between individuals or businesses to fix prices or wages, rig bids, or allocate markets."[1]
To avoid being deemed one of the "bad actors" the DOJ has committed to prosecute, suppliers should consider the following in making allocation decisions during a period of shortage.
UCC 2-615 and "Fair and Reasonable" Product Allocation
The starting place for analysis of product allocation during shortages in most states is the Uniform Commercial Code. As set forth below, the antitrust analysis depends on whether the allocation is different or changed from what is otherwise required under commercial law.
If the supply contract does not contain a force majeure provision or otherwise provide for allocation rights during a shortage, then Section 2-615 of the UCC fills the gap as a defense against a claim of breach for failure to supply goods. This defense is available if the supplier of goods is unable to make delivery under contract.
Under UCC Section 2-615 sub. (a), a party may be excused for whole or partial nonperformance where "performance as agreed has been made impracticable by the occurrence of a contingency, the non-occurrence of which was a basic assumption on which the contract was made." Accordingly, the key is to establish that the nonoccurrence of a problematic event, such as a pandemic causing a shortage, was a basic assumption of the contract and that the occurrence of it rendered performance commercially impracticable.
For example, courts have found in favor of a commercial impracticability defense in situations when a contract required the seller to use a specified supplier but that supplier ceased business operations,[2] when regulatory changes created a cost increase that would have cost the seller to lose more than $75 million during the life of the contract,[3] and when a supplier terminated a seller's dealership rights, thereby making it impossible for the seller to deliver products to the buyer.[4]
In the event the supplier can only make a partial delivery, UCC Section 2-615 sub. (b) mandates that such deliveries be allocated among customers in a "fair and reasonable" manner. While UCC 2-615 does not define "fair and reasonable," official Comment 11 provides some guidance. It does not require strict pro rata allocation but rather mandates fair treatment of all the buyers. It also prohibits the supplier from favoring buyers paying higher prices and, instead, when prices increase the supplier is obligated to "exercise real care in making his allocations, and in case of doubt his contract customers should be favored and supplies prorated evenly among them regardless of price."
Accordingly, this subsection permits but does not require favoring of contracted customers over spot buyers, and leaves a reasonable business leeway to the supplier. Courts generally favor an allocation based on some objective standard based on the parties' prior purchasing practices.[5]
The supplier must also "seasonably notify" the buyer that there will be a delay or nondelivery and, when an allocation is required under subsection (b), also provide a quantification of the estimated quota that will be available for the buyer.[6] The UCC defines "seasonable notice" as "within the time agreed" or "if no time is agreed, within a reasonable time."[7]
In a pandemic situation, "seasonable notice" should probably mean days and not weeks, although what counts as "seasonable notice" will inevitably depend on the facts of the situation. Receipt of the notice triggers a "reasonable" period (typically no more than 30 days) for the customer to either terminate the contract or accept the allocation and modified contract, with acceptance being the default if the customer does not act/respond within a reasonable period.
Antitrust Limitations on Coordinated Responses to Shortages
While coordinating with competing suppliers to make fair and reasonable allocations of scarce supply may initially appeal to a supplier concerned about acting on its own, doing so could entail significant antitrust risk. Section 1 of the Sherman Antitrust Act prohibits agreements in restraint of trade, such as price-fixing, refusals to deal, bid-rigging, and market allocation, and a joint decision to allocate scarce supply to one customer over or at the expense of another could be construed to constitute a violation, particularly from the perspective of the disfavored customer. The parties involved in such a joint decision might be competing suppliers, customers, or a combination of the two.[8]
For example, when the demand is high, suppliers may be approached by competitors to limit supply, boycott certain customers or divide the market in order to drive up prices. When the demand is low, competitors might agree to split the market by remaining in their geographic areas or serving only their existing customers. Notably, an agreement need not be formal or in writing to violate the antitrust laws; unlawful arrangements may be inferred from circumstantial evidence, such as the exchange of competitively sensitive information concerning pricing, customers, or markets.
To avoid inadvertent violations of Section 1, suppliers are strongly counselled to take the following precautions:
1. Any decisions concerning which customers and markets to continue serving or which customers or contracts to prioritize, must be made unilaterally, that is, wholly independently of any third party. "Unilateral activity by a defendant, no matter the motivation, cannot give rise to a section 1 [antitrust] violation."[9]
2. Avoid discussions with competitors, potential competitors or other customers even about seemingly innocuous subject matter related to allocation of scarce supply, but especially refrain from discussing, coordinating or agreeing with third parties as to the following:
- geographical areas, territories, specific customers, or plans for allocating customers or product supply with any third parties;
- limiting areas of service or customers served, or amount of supply/output, even in response to emergency situations; and
- allocation of one customer's supply with another customer, which could be construed to support boycott and/or exclusion claims.
Even if such exchanges of information or agreements have the legitimate, pro-competitive purpose of seeking an efficient allocation of goods during a time of shortage, they could lead to antitrust claims by disfavored or disgruntled would-be customers, which might argue that the agreement or information exchanged went beyond what was necessary to address the shortages occasioned by the current market conditions. In other words, even apparently legitimate pro-competitive justifications will not necessarily insulate a supplier from scrutiny of its decisions concerning customer or market allocation.[10]
Product allocation decisions in times of shortages might legitimately require suppliers to refrain from dealing with certain customers, and such refusals to deal will not constitute a violation of the antitrust laws where the supplier can show that the agreement made or action taken was not anti-competitive in nature. However, making that showing will be easier where the supplier at issue made its decisions unilaterally.[11] As the U.S. Supreme Court has repeatedly emphasized, there is "no duty to deal under the terms and conditions preferred by [a competitor's] rivals … there is only a duty not to refrain from dealing where the only conceivable rationale or purpose is "to sacrifice short-term benefits in order to obtain higher profits in the long run from the exclusion of competition."[12]
Even where a supplier makes its allocation decisions unilaterally, disappointed customers may claim that their being disfavored was part of the supplier's effort to obtain or maintain a monopoly position. Monopolization under Section 2 of Sherman Act requires the possession of monopoly power in a relevant market and the willful acquisition or maintenance of that power.[13] Attempted monopolization occurs when a company uses anti-competitive conduct with the specific intent to monopolize, and there is a dangerous likelihood that the company will achieve monopoly power if it is successful in its scheme.[14]
The existence of monopoly power ordinarily may be inferred from the predominant share of the market.[15] While courts typically require a market share of greater than 50% to find the monopoly power, some courts have found that it is possible for a defendant to possess monopoly power with a market share of less than 50%.[16] These courts provide for the possibility of establishing monopoly power through non-market-share evidence, such as direct evidence of an ability profitably to raise price or exclude competitors. Additionally, the minimum showing of market share required in an attempt case is a lower than that required in an actual monopolization case.[17]
Companies possessing or approaching monopoly (or market) power are usually aware of their position. However, shortage conditions can create market power — even if temporary — as alternative sources of supply become unavailable. Suppliers must be aware that there are no exemptions from antitrust laws during a crisis, and that the same rules apply regardless of how market power is obtained.[18] Conversely, the courts have also held that the fair allocation of supplies among all fabricators during a shortage by a vertically integrated producer without favoritism for the producer's own subsidiary demonstrates the absence of a specific intent to monopolize.[19]
Suppliers must therefore remember that Section 2 applies regardless of how the supplier came to have market power. In order to minimize the risk of being accused of monopolization or attempted monopolization, a supplier finding itself in a position of increased market share or pricing power should avoid actions that could be construed as taking advantage of the product shortage to entrench that market power — for example, by seeking to sign long-term, requirements or bulk contracts, particularly as a condition of continued supply.
Additionally, while a pro rata general allocation is generally reasonable, a vertically integrated supplier should not favor its own downstream subsidiaries because it could be construed as an attempt to monopolize the downstream market — i.e., starve out competitors and nonintegrated independents so that downstream subsidiaries can gain share and become dominant post-shortage. Instead, suppliers should allocate their supplies objectively as discussed above.
Further, suppliers selling products that are in high demand during the pandemic should not increase their prices to maximize short-term profit, lest they potentially violate state anti-gouging laws.
Practical Advice in Making Product Allocation Decisions
To summarize, any supply allocation decisions made under shortage conditions must have a legitimate business purpose and should steer clear of any actions that may be construed as anti-competitive.
Step one is for suppliers to work with their contract coordinators to determine what types of contracts the supplier has, differentiating spot purchase orders from long-term contracts. The latter may include requirements contracts (also sometimes referred to as "output contracts"), wherein the supplier has already committed contractually to selling all the products that the buyer needs during a given period of time (in contrast to spot purchase orders where the obligation to perform does not arise until the order is accepted). Therefore, as part of a fair and reasonable allocation plan, a supplier would be permitted to prioritize such long-term requirements agreements over any uncommitted spot orders.
Another type of allocation plan that would likely be deemed objective and reasonable is a pro rata allocation based on the percentage of inventory against purchase orders. Where a product is of particular relevance to combating the current pandemic — for example, masks and rubber gloves — a supplier might fairly and reasonably decide to increase the allocation percentages for hot-zone areas, without fear of running afoul of the antitrust laws.
However, unless approved by antitrust regulators in advance, suppliers should avoid coordination or collaboration with competitors or other third parties in making allocation decisions in response to a shortage induced by the COVID-19 crisis. Similarly, suppliers that find themselves in a position of having a high market share or otherwise having new-found pricing power due to the shortage must take care not to undertake even unilateral actions to entrench that position or benefit themselves or their affiliates in an adjacent market.
Suppliers facing such decisions or seeking to enter into new supply agreements while shortage conditions continue should seek the advice of antitrust counsel.
Lawrence Silverman and Richard Brosnick are partners, and Sara Mandelbaum and Evelina Gentry are associates, at Akerman LLP.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
[1] DOJ Joint Antitrust Statement Regarding Covid-19, https://www.justice.gov/atr/joint-antitrust-statement-regarding-covid-19.
[2] Selland Pontiac-GMC, Inc v King
, 384 NW2d 490 (Minn App, 1986).[3] Aluminum Company of America v Essex Group Inc
, 499 F Supp 53 (WD Pa, 1980).[4] Federal Pants, Inc v Stocking
, 762 F2d 561 (CA 7, 1985).[5] See., e.g., Cliffstar Corp. v. Riverbend Prod., Inc.
, 750 F. Supp. 81, 87 (W.D.N.Y. 1990) (tomatoes allocation based on prior dealings); Intermar, Inc v Atlantic Richfield Co , 364 F Supp. 82 (ED Pa, 1973) (percentage gasoline supply allocation based on comparable data from the same month prior year); Terry v Atlantic Richfield Co , 72 Cal App 3d 962 (1977) (same and also holding in accord with Comment 11 that allocating to both pre-existing contractual customers and regular customers not under contract did not make the allocation scheme unfair or unreasonable).[6] See U.C.C. § 2-615(c).
[7] See U.C.C. § 1-205.
[8] See generally, Leegin Creative Leather Products, Inc. v. PSKS, Inc.
v. 551 U.S. 877 (2007).[9] InterVest, Inc. v. Bloomberg, L.P.
, 340 F.3d 144, 159 (3d Cir. 2003).[10] See Graphic Prod. Distributors, Inc. v. ITEK Corp.
, 717 F.2d 1560, 1577 (11th Cir. 1983) ("The goal of adequate and efficient service in territories beyond the branch office location was legitimate and pro-competitive, but there was no showing—nor any serious attempt to show—that the territorial restrictions were reasonably necessary to achieve that legitimate purpose."). See also In re Ins. Brokerage Antitrust Litig. , 618 F.3d 300, 318 (3d Cir. 2010). There, the defendant brokers argued that their agreement to consolidate the pool of insurers to which they referred business was intended, among other things, to improve efficiency. The court held that the information disclosed did not suggest that there was a conspiracy in restraint of trade, stating that even where the defendant offers sound pro-competitive justifications "… the court must proceed to weigh the overall reasonableness of the restraint using a full-scale rule of reason analysis."[11] See Aerotec Int'l, Inc. v. Honeywell Int'l, Inc.
, 836 F.3d 1171, 1184 (9th Cir. 2016).[12] Aerotec, 836 F.3d at 1184 (citations omitted).
[13] United States v. Grinnell Corp.
, 384 U.S. 563 (1966).[14] Image Tech. Servs., Inc. v. Eastman Kodak Co.
, 125 F.3d 1195, 1202 (9th Cir. 1997).[15] United States v. Grinnell Corp.
, 384 U.S. 563, 571, 86 S. Ct. 1698, 1704 (1966).[16] See, e.g., Hayden Publ'g Co., Inc. v. Cox Broad. Corp.
, 730 F.2d 64, 69 n.7 (2d Cir. 1984).[17] See, e.g. Domed Stadium Hotel, Inc. v. Holiday Inns, Inc.
, 732 F.2d 480, 490 (5th Cir. 1984).[18] See, e.g. Mullis v. ARCO Petroleum Corp.
, 502 F.2d 290, 298 (7 Cir. 1974).[19] See White Bag Co. v. International Paper Co.
, 5 Trade Reg. Rep. (1974-2 Trade Cas.) ¶ 75,188, at 97,356-57 (4th Cir. Aug. 8, 1974) (paper shortage); Independent Iron Works, Inc. v. United States Steel Corp. , 322 F.2d 656, 667 (9th Cir.), cert. denied, 375 U.S. 922 (1963) (steel shortage); cf. Harlem River Consumers Cooperative, Inc. v. Associated Grocers, Inc. , 371 F. Supp. 701, 713 (S.D.N.Y.), aff'd per curiam, 493 F.2d 1352 (2d Cir. 1974) (food shortage).For a reprint of this article, please contact reprints@law360.com.
