Customer and territorial restraints

A. Introduction
This chapter considers restrictions manufacturers or other suppliers
may impose on where or to whom dealers or distributors may sell their
goods and how the restrictions are evaluated for legality.
1. Historical Context and Adoption of the Rule of Reason
When manufacturers decide to use independent firms to distribute
their products, they frequently create a network of dealers or distributors
and limit the scope of an individual dealer’s or distributor’s sales and
service activities. Restrictions such as assigned or “national” accounts,
exclusive territories, or “primary areas of responsibility” are
commonplace. Corporate staffs responsible for distribution, and even their
in-house counsel, may be confused about how far they can go in imposing
distribution restraints, and, for many years, there was uncertainty as to
whether it was legal to impose restrictions on distribution.1 The outright
opposition to these vertical restraints is perhaps best illustrated by the
Justice Department’s prosecution and the Supreme Court’s decision in
United States v. Arnold, Schwinn & Co.2
In the early 1950s, the Schwinn company was the leading bicycle
manufacturer in the United States, commanding a substantial share of the
market. For the most part, Schwinn’s sales were made through a network
of 22 distributors to a large number of bike shops and small specialty
retailers. Other bicycle manufacturers sold directly to large retail
powerhouses, such as Sears and Montgomery Ward. As the market power
of these retail chains grew in relation to neighborhood bike shops,
1. See, e.g., White Motor Co. v. United States, 372U.S. 253, 263 (1963) (“A
vertical territorial limitation may or may not have that purpose or effect [i.e.,
to stifle competition]. We do not know enough of the economic and business
stuff out of which these arrangements emerge to be certain.”).
2. 388U.S. 365 (1967).
124 Antitrust Law and Economics of Product Distribution
Schwinn’s national market share began to drop. To stem the tide, Schwinn
adopted the “Schwinn Plan”—a classic system of territorial and customer
restrictions at both the distributor and dealer levels. In essence, Schwinn
reduced the number of distributors and retailers handling its products,
awarded them exclusive territories, and required that they promote the
Schwinn brand at least as vigorously as any competing brands carried.3
In 1958 the Justice Department brought suit against Schwinn for
violation of Section 1 of the Sherman Act, alleging the “Schwinn Plan” to
be an illegal restraint of trade. The trial lasted 70 days4 and cost Schwinn
roughly $400,000—approximately $3.3 million in 2016 dollars—to
defend.5 Upon its conclusion, the United States District Court for the
Northern District of Illinois found that the Schwinn Plan was “reasonable,
fair and good business procedure under all the circumstances existing in
the bicycle industry” and, indeed, was necessary for Schwinn to compete
more effectively against the large retail stores carrying competitive brands:
By franchising the local cycle outlets and dealing with them only,
Schwinn has remained in business and is still furnishing the best grade
bicycle at prices now below those of 1951 and still making a profit.
Schwinn has increased its sales and so have its distributors and retailers.6
The Justice Department appealed the decision directly to the Supreme
Court under the Expediting Act.7 Richard A. Posner, later Chief Judge of
the United States Court of Appeals for the Seventh Circuit, argued the case
for the government. Before the Supreme Court, the government
abandoned its contention that the territorial and customer restraints
imposed by Schwinn were per se unlawful; rather, it contended they
should be evaluated under the rule of reason.8 That did not dissuade the
Court from declaring that “where a manufacturer sells products to his
distributor subject to territorial restrictions upon resale, a per se violation
3. Id. at 368-71.
5. United States v. Arnold, Schwinn Co., 237F. Supp. 323, 332 (N.D. Ill.
1965), rev'd, 388U.S. 365 (1967).
6. Id. at 335.
7. 15U.S.C. § 29.
8. Schwinn, 388 U.S. at 368, 380.
Customer and Territorial Restraints 125
of the Sherman Act results” and that “the same principle applies to
restrictions of outlets with which the distributors may deal. . .”9
The basis for the Court’s declaration of per se illegality of customer
and territorial restraints had nothing to do with perceived effects on
competition but, rather, derived from a claimed historical hostility towards
restraints on alienation:
[T]o allow. . . [territory and customer restrictions] where the
manufacturer has parted with dominion over the goodsthe usual
marketing situationwould violate the ancient rule against restraints on
alienation and open the door to exclusivity of outlets and limitation of
territory further than prudence permits.10
Without explaining why, the Court declared territorial and customer
restraints to be “so obviously destructive of competition that their mere
existence is enough”11 to constitute a per se violation of the Sherman Act.12
A firestorm of criticism followed, beginning with a biting dissent by
Justice Potter Stewart (“problems involved are difficult and complex, and
our response should be more reasoned and sensitive than the simple
acceptance of a hoary formula”13) and continuing with a wave of lower
court decisions struggling to confine Schwinn to its facts.14 Commenting
on Schwinn, Judge Posner observed later that the Supreme Court’s
decisions in restricted distribution cases as of 1967 “constituted an
intellectual failure of imposing dimensions.”15 This would have been
small comfort to Arnold, Schwinn & Co., which, after remand and the
entry of injunctive relief, continued to lose market share to larger,
vertically-integrated competitors and, ultimately, filed for bankruptcy.16
9. Id. at 379.
10. Id. at 380.
11. Id. at 379.
12. Id. at 382.
13. Id. at 392 (Stewart, J., dissenting).
14. A number of these cases are collected at Cont’l T.V., Inc. v. GTE Sylvania
Inc., 433U.S. 36, 48-49 n.14 (1977). For an exhaustive review of the post
Schwinn case law and commentary, see generally MONOGRAPH NO. 2, supra
note 4, at 14-71.
15. RICHARD A. POSNER, ANTITRUST LAW 188 (2d ed. 2001).

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