The Meaning of Vertical Agreement and the Structure of Competition Law

• Author: Louis Kaplow
• Position: Finn M.W. Caspersen and Household International Professor of Law and Economics, Harvard Law School, and Research Associate, National Bureau of Economic Research
• Pages: 563-630

THE MEANING OF VERTICAL AGREEMENT AND THE

STRUCTURE OF COMPETITION LAW

L

OUIS

K

APLOW

*

Competition law is aimed primarily at agreements, mergers, and the actions

of dominant firms. Of course, in each category, most acts are permissible. For

agreements, the prohibition in the United States applies only to those that are

unreasonable, interpreted as involving a suppression of competition.

1

But

what constitutes an agreement? This question is most important in the hori-

zontal context, particularly with regard to price fixing, which is per se illegal

and subject to competition law’s strongest sanctions. In that setting, the agree-

ment requirement plays an important role and has generated some

controversy.

2

Regarding vertical agreements, such as between a manufacturer and its dis-

tributors, much of the scholarly debate and doctrinal evolution has centered on

* Finn M.W. Caspersen and Household International Professor of Law and Economics,

Harvard Law School, and Research Associate, National Bureau of Economic Research. I am

grateful to the editors, the referees, Jonathan Baker, Aaron Edlin, and participants at the Ameri-

can Law and Economics Association 2015 annual meeting for helpful discussions and com-

ments; Britt Cramer, Iacopo Lash, Daniel Marcet, and Isaac Park for research assistance; and

Harvard Law School’s John M. Olin Center for Law, Economics, and Business for financial

support. I formulated some of the ideas in this article in the early 1980s, hints of which are

reflected in P

HILLIP

A

REEDA

& L

OUIS

K

APLOW

, A

NTITRUST

A

NALYSIS

(4th ed. 1988) (and also in

the 1988 Teacher’s Manual), and in subsequent editions thereof. Refinements that derive from

the analysis of horizontal agreements draw on Louis Kaplow, On the Meaning of Horizontal

Agreements in Competition Law, 99 C

ALIF

. L. R

EV

. 683 (2011), and L

OUIS

K

APLOW

, C

OMPETI-

TION

P

OLICY AND

P

RICE

F

IXING

(2013). Disclaimer: I occasionally consult on antitrust cases, and

my spouse is in the legal department of a financial services firm.

1

See Standard Oil Co. v. United States, 221 U.S. 1, 49–68 (1911); Chicago Bd. of Trade v.

United States, 246 U.S. 231, 238 (1918); Nat’l Soc’y of Prof’l Eng’s v. United States, 435 U.S.

679, 690–91, 693–96 (1978).

2

For a detailed analysis, with extensive discussion of the literature, see L

OUIS

K

APLOW

,

C

OMPETITION

P

OLICY AND

P

RICE

F

IXING

, pt. I (2013), and Louis Kaplow, On the Meaning of

Horizontal Agreements in Competition Law, 99 C

ALIF

. L. R

EV

. 683 (2011). Interestingly, the

policy problem in the two rather different realms is much the same: the agreement requirement is

used to distinguish behavior with the same economic consequences. As it turns out, for price

fixing, the distinction more often has a negative correlation with competitive consequences,

rather than the typical mere lack of correlation for vertical arrangements (see infra Section III.A).

563

564

A

NTITRUST

L

AW

J

OURNAL

[Vol. 80

which agreements should be deemed illegal, in particular, per se illegal. In

recent decades in the United States, per se rules against vertical nonprice re-

straints (such as customer and territorial restrictions), maximum resale prices,

and minimum resale prices have each, in turn, been overruled, so that the rule

of reason now governs all vertical agreements.

3

In other jurisdictions, notably

the European Union, vertical agreements are treated more strictly.

4

Before, during, and after this period over which the U.S. Supreme Court

reversed the applicable precedents, one would have expected that the question

of what constitutes a vertical agreement would have become well settled.

Moreover, there is reason to suppose that this question would usually yield a

straightforward, affirmative answer. In the horizontal setting, there are impor-

tant contexts, such as price fixing, where the firms involved are not otherwise

in contractual relationships, and they also hope to keep their actions secret; as

a consequence, defining and demonstrating the existence of an agreement can

be difficult.

5

But in the vertical setting, where one firm is supplying goods or

services to another, there ordinarily exist supply contracts, ranging from for-

mal to imputed, so it might appear that an agreement always exists.

In 1919, however, the Supreme Court famously held in Colgate

6

that this

was not necessarily so. Under some circumstances, a supplier’s policies in

connection with a contractual arrangement are deemed to be unilateral. These

policies may be insisted upon and de facto accepted by the downstream firm,

but they do not necessarily constitute an agreement on that account. Although

subsequent cases had interpreted this unilateral action defense narrowly,

7

it

was given some degree of new life in the Court’s 1984 Monsanto decision.

8

Ever since Colgate, the vertical agreement requirement and the unilateral

action defense have proved enigmatic.

9

Part I of this article analyzes the un-

3

See Continental T.V., Inc. v. GTE Sylvania Inc., 433 U.S. 36 (1977); State Oil Co. v. Khan,

522 U.S. 3 (1997); Leegin Creative Leather Prods., Inc. v. PSKS, Inc., 551 U.S. 877, 897–98

(2007).

4

See, e.g., C

OMMISSION

R

EGULATION

(EU) No. 330/2010 of 20 April 2010 on the Applica-

tion of Article 101(3) of the Treaty on the Functioning of the European Union to Categories of

Vertical Agreements and Concerted Practices, 2010 O.J. (L 102) 1, 5 (Article 4 on Hardcore

Restrictions, including resale price maintenance).

5

See sources cited supra note 2.

6

United States v. Colgate & Co., 250 U.S. 300 (1919).

7

Much of a volume of Areeda and Hovenkamp’s treatise is devoted to a detailed elaboration

of these cases. 7 P

HILLIP

E. A

REEDA

& H

ERBERT

H

OVENKAMP

, A

NTITRUST

L

AW

, ch. 14D (3d ed.

2010). For a succinct summary, see Glen O. Robinson, Explaining Vertical Agreements: The

Colgate Puzzle and Antitrust Method, 80 V

A

. L. R

EV

. 577, 583–86 (1994).

8

Monsanto Co. v. Spray-Rite Serv. Corp., 465 U.S. 752 (1984).

9

Phillip Areeda and Herbert Hovenkamp’s treatise suggests that the law and lower courts’

analyses of vertical agreements are tangled. See A

REEDA

& H

OVENKAMP

,supra note 7, at 7.

Most other treatments advance a similar view. See, e.g., 1 ABA S

ECTION OF

A

NTITRUST

L

AW

,

A

NTITRUST

L

AW

D

EVELOPMENTS

23 (7th ed. 2012) [hereinafter A

NTITRUST

L

AW

D

EVELOP-

2016]

V

ERTICAL

A

GREEMENT AND

C

OMPETITION

L

AW

565

derlying phenomenon in order to elucidate why this is the case. It begins with

a series of examples showing that the distinction between vertical agreement

and unilateral action is even more difficult to draw than is generally thought.

A central reason for this is that supply contracts are, after all, contracts, and

this point extends to vertical restraints related to such contracts. Since con-

tracts are named in Sherman Act Section 1’s prohibition, it is difficult not to

see them as agreements.

10

Another term in Section 1, and the one most often

mentioned in courts’ opinions, is conspiracy, but it too readily encompasses

the vertical restrictions in question, even when they are said to involve unilat-

eral action by the upstream supplier. Some formulations of the vertical agree-

ment doctrine, including the one in Monsanto’s famous footnote,

11

require

something akin to offer and acceptance, but this too is arguably present in

most if not all cases of unilateral action in the vertical realm. Rather than

seeking to interpret the statute directly, many commentators have essentially

thrown up their hands in attempting to summarize the cases—which in any

event seem to allow only a fairly narrow unilateral action defense—and assert

that just about anything more than simple unilateral action crosses the bound-

ary into vertical agreement. This formulation is obviously difficult to rational-

ize. Its explanatory and predictive power is also limited because there exists

neither a clear definition of the baseline—which, if exceeded even modestly,

leads to a judgment of agreement—nor an indication of how much more, and

along what dimensions, is required.

Part II turns to the law on vertical agreement, mainly focusing on the

United States but briefly describing how the situation in the European Union

is fairly similar. Sherman Act Section 1’s statement of the agreement require-

ment, which has received less attention from courts and commentators than

one might have expected, is examined, and it is found to offer little support

MENTS

] (“[L]ower courts have continued to struggle with the issue of what additional evidence is

necessary to permit the factfinder to infer a conspiracy.”); Edward H. Levi, The Parke, Da-

vis–Colgate Doctrine: The Ban on Resale Price Maintenance, 1960 S

UP

. C

T

. R

EV

. 258, 326

(“[I]t is a matter of concern that the law should have failed to provide itself with a meaningful

structure of theory.”); Donald F. Turner, The Definition of Agreement Under the Sherman Act:

Conscious Parallelism and Refusals to Deal, 75 H

ARV

. L. R

EV

. 655, 686 (1962) (“Can these

cases be fitted together in any rational way? The answer is clearly ‘no.’” Turner proceeds to

describe the cases as “hopelessly irreconcilable.”); id. at 688 (“[O]nce Dr. Miles was applied to

tacit as well as express agreements, any tenable line between ‘agreements’ and compliance with

a manufacturer’s stated wishes wholly disappeared.”); see also Warren S. Grimes, The Path

Forward after Leegin: Seeking Consensus Reform of the Antitrust Law of Vertical Restraints, 75

A

NTITRUST

L.J. 467, 490 (2008) (“[T]he Colgate defense requires ‘legal gymnastics’ that are

costly, disruptive to dealer-manufacturer relations, and have no relevance to the procompetitive

or anticompetitive effects of the underlying practice.”).

10

As explained in Section II.A, the term agreement does not actually appear in the statute

itself (although it does in the European Union’s provision, see infra Section II.E) but has been

used as a summary of the terms that do appear.

11

See infra Subsection II.B.2.