United States v. Dentsply: the Third Circuit bites down on the 'alternative distribution channels' defense.

• Author: Novak, Joshua J.

1. INTRODUCTION II. BACKGROUND A. Applicable Law B. The History of Dentsply International C. Dealer Criterion 1. Facts 2. Alternative Distribution Channels 3. The District Court's Decision E. The District Court's Decision Overturned by the Third Circuit 1. Applicability of Section 2 2. Alternative Distribution Channels III. DISCUSSION/ANALYSIS A. The Microsoft Case 1. The Government's Section 1 Claim 2. Microsoft's Section 2 Argument B. Section 3 of the Clayton Act C. An Analysis of Dentsply 1. The Relevant Market and Foreclosure 2. Harm to Consumers a. "Harm" to Laboratories b. "Harm" to Dealers 3. Length of Agreements with the Foreclosed Dealer s IV. RECOMMENDATIONS V. CONCLUSION I. INTRODUCTION

   The United States Congress first passed antitrust laws more than 125 years ago in an effort to protect competition in the marketplace. (1) Protecting competition in the marketplace also helps to protect the consumer, who is meant to be the ultimate beneficiary of antitrust enforcement. (2) Today, three of the principal statutes courts use to achieve that goal are section 3 of the Clayton Act, (3) section 1 of the Sherman Act, (4) and section 2 of the Sherman Act. (5)

   In 1999, federal prosecutors charged Dentsply International, a leading manufacturer of dental materials, under all three of these statutes, but in February 2005, Dentsply was ultimately found guilty only of violating section 2 of the Sherman Act. (6) However, several factors in the case could have led the Third Circuit to reach a different conclusion. Part II of this Comment lays out the background leading up to this case, including the applicable law and a brief history of antitrust law, as well as a discussion of some of the key cases that the Third Circuit relied on in reaching its conclusion. Part II also includes the history of Dentsply International, including a look at Dealer Criterion 6, the contractual clause that Dentsply imposed on its dealers that led to the claims of antitrust violations.

   Part III of this Comment discusses the case of United States v. Microsoft, in which the software giant was found guilty of violating section 2 of the Sherman Act. (7) In its discussion of Microsoft's alleged violation of section 1 of the Sherman Act, the Microsoft district court held that because there were alternative distribution channels for competitors of Microsoft to market their software, there was no section 1 violation. (8) Part III also looks at how courts have dealt with the presence of alternative distribution channels in section 3 Clayton Act claims. This Comment contends that because courts have treated section 1 Sherman Act and section 3 Clayton Act claims more critically than section 2 Sherman Act claims, analyses done under those claims can be, and should have been, used to guide the analysis in the section 2 claim against Dentsply. Part III concludes with an analysis of the Third Circuit's decision in Dentsply, and reaches the ultimate conclusion that the Third Circuit erred in its decision.

   Part IV suggests four steps the Third Circuit should have taken when determining whether Dentsply was guilty of violating section 2. The first step is to define the relevant market and formulate a foreclosure rate, which this Comment contends the Third Circuit properly did. Step two involves determining whether consumers have been significantly harmed by the practices of Dentsply. Based on the factual records presented in the lower court, it appears that the consumers in the Dentsply case suffered little or no injury because of Dentsply's practices. Third, the court must also look at the length of the agreement in question, with shorter agreements being less anticompetitive. Because Dentsply's agreements with dealers were terminable at will, they were, for purposes of antitrust law, theoretically of short duration. After finding this, the court should have then turned to the presence of alternative distribution channels. If such alternatives are present and viable, there should be no violation of section 2. To understand these intricacies, however, one must first have knowledge of the background that has given rise to this case.

2. BACKGROUND

   1. Applicable Law

      Congress passed the Sherman Act more than a century ago because it was "concerned about those activities of trusts and monopolies that unduly restrained trade or caused a monopolization of interstate commerce." (9) The purpose of antitrust law was, and still is, to protect competition and prevent monopolization. (10) The three main laws that are applied in antitrust cases today are sections 1 and 2 of the Sherman Act and section 3 of the Clayton Act.

      Section 1 of the Sherman Act makes illegal every contract that restrains trade or commerce among the individual states. (11) Section 3 of the Clayton Act makes it unlawful to engage in exclusive dealing for the purpose of lessening competition or creating a monopoly. (12) For a section 3 claim to succeed, a plaintiff must prove that "the probable effect of [a company's] restrictive dealing agreements is to decrease competition." (13)

      However, in the Dentsply case under analysis in this Comment, the government chose only to pursue on appeal a claim under section 2 of the Sherman Act. Section 2 creates liability for a person who either attempts to monopolize or actually does monopolize a trade. (14) To violate section 2 of the Sherman Act, a defendant must possess monopoly power and must also willfully maintain "that power as distinguished from growth or development as a consequence of a superior product, business acumen, or historic accident." (15) One such way section 2 can be violated is through an exclusive dealing arrangement. (16)

      Even though exclusive dealing clauses are not per se illegal, they can be ruled illegal if they aide a company in either achieving or maintaining monopoly status. (17) For exclusive dealing to be illegal, monopoly power must exist and the exclusionary conduct must be anti-competitive. (18) Harm to actual competition, and not just harm to competitors, is a "sine qua non for a [s]ection 2 violation." (19) Once this is established, the monopolizing party may attempt to defend itself by showing a "valid business justification" for the action(s) taken. (20)

   2. The History of Dentsply International

      Dentsply International is a health care corporation founded more than 100 years ago, specializing in the manufacture of dental products ranging from anesthesia to false teeth. (21) The company is incorporated in Delaware with its principal place of business in York, Pennsylvania. (22) Since its inception, Dentsply has opened facilities in 22 countries, and it sells its products in more than 100 countries. (23) The company proclaims itself to be "the largest manufacturer of dental prosthetics and consumable dental products in the world." (24)

      Dentsply sells its products to a network of 23 dealers, who in turn sell the false teeth and other materials to dental laboratories. (25) These laboratories then provide dentists with the supplies they need, including dentures. (26) Excluding false teeth, Dentsply supplies its dealers with approximately $400 million of products. (27) Dentsply dominated the artificial teeth market, holding a 75%-80% market share at the time the Third Circuit handed down its decision in February 2005. (28) According to a 1996 report, between 1990 and 1996, Dentsply saw an increase in profits from false teeth of 32% (29) and at the time of its trial in 2003, the company made 1.1 million teeth per week. (30) Dealers who purchase from Dentsply do so by filling out purchase orders; other than these purchase orders, no long-term contract is signed, which makes the relationship between Dentsply and its dealers "essentially terminable at will." (31)

      Since 1993, Dentsply has stipulated that dealers it supplies its products with must deal almost exclusively with Dentsply. (32) This exclusionary policy, known as "Dealer Criterion 6," made many dealers unhappy. (33) Dealer Criterion 6 was also the reason for the antitrust action the government brought against Dentsply.

   3. Dealer Criterion 6

      Dealer Criterion 6 prevented dealers that carried Dentsply products from "add[ing] further tooth lines to their product offering." (34) Dealer Criterion 6 applied to all dealers, except those who were already carrying competing products prior to 1993. (35) Dentsply also rejected attempts by dealers who were already carrying rival brands to "expand their lines of competing products." (36) If a dealer refused to follow this stipulation, Dentsply could refuse to fill any more orders for that dealer. (37)

      Even though Dentsply's relationship with dealers was terminable at will, none of the dealers subject to Dealer Criterion 6 opted to carry a competitor's line and drop Dentsply. (38) Nonetheless, dealers were not pleased about having to abide by Dealer Criterion 6. (39) They claimed that Dealer Criterion 6 allowed Dentsply to "exert too much control over the products [dealers] may sell." (40)

      Dentsply offered a business justification for its decision to move forward with Dealer Criterion 6 by arguing that, the greater the number of competing tooth lines carried, the less likely that a dealer will be able to sustain all of

      the desired service and promotional elements at a high, competitive level.... [S]ervice and promotional support for a particular line is likely to suffer [with] the greater number of lines carried. (41) Dentsply also attempted to justify Dealer Criterion 6 by using a "pro-competitive free riding" rationale. (42) Parts II.D and II.E of this Comment will discuss how the district court and Third Circuit rejected both justifications. (43)

   4. The District Court: A Victory for Dentsply

      In January 1999, the United States charged Dentsply with violating sections 1 and 2 of the Sherman Act and section 3 of the Clayton Act, (44) citing Dealer Criterion 6 as the reason. The result of this lower court case was a "surprising...