By Elinor R. Hoffmann

In the most important antitrust decision by the Supreme Court since 1992, the Court unanimously voted to change the law on vertical maximum price-fixing this week.

State Oil Company v. Khan, (No. 96-871) (decided November 4, 1997) started as a lawsuit by a gasoline dealer against his supplier. The gasoline dealer complained that his supplier had imposed a maximum resale price at which the dealer could sell gasoline to its customers. The supplier did this by requiring the dealer to rebate to the supplier amounts charged by the retailer in excess of a specified price (3.25 cents per gallon). In a decision remarkable for its invitation to the Supreme Court to reverse, the Seventh Circuit reluctantly applied existing law and held that a vertical agreement fixing a maximum resale price was still a per se violation of the antitrust laws. The Supreme Court vacated the Seventh Circuit's decision.

At least since 1968, it has been clear that an agreement to set vertical maximum prices (that is, an agreement between a supplier and a distributor setting a ceiling on the price that may be charged by the distributor to its customers) was automatically illegal. Albrecht v. Herald Co., 390 U.S. 145 (1968). This put maximum price-fixing into the same category of per se illegality as minimum price-fixing (agreeing on a price floor that may be charged by a retailer) and horizontal price-fixing (agreements on price made by competitors). Albrecht has been widely criticized in the past three decades, both in judicial opinions and in antitrust/economics literature. In Khan, the Court found Albrecht's "conceptual foundations gravely weakened," and agreed with the critics that under some circumstances, vertical maximum price-fixing may be more procompetitive than anticompetitive. In situations where suppliers have set up exclusive territories for distributors, for example, maximum resale prices, aimed at increasing volume, may enhance interbrand competition. On the other hand, maximum resale prices may actually mask price floors, harmful to consumers. The Court acknowledged that vertical maximum price-fixing might have a variety of different effects, but concluded that they could be dealt with more appropriately by a "rule of reason" analysis of the facts of each case.

The importance of the Khan case to pricing in the vertical chain of distribution was underscored by the large number of amicus briefs filed by interested parties. The Justice Department, represented at argument by Joel Klein, Assistant Attorney General for Antitrust, urged adoption of a rule of reason standard in maximum price-fixing cases. A group of state attorneys general opposed a change in the law. Industry groups, such as the Business Roundtable and associations of manufacturers, newspaper publishers and oil companies, argued in favor of change while associations of retailers argued against abandoning a categorical prohibition on maximum resale price-fixing.

It is important to recognize what the Khan decision did not do. First, the Khan decision left intact the rule that vertical price-fixing other than setting maximum prices is still per se illegal, as are horizontal agreements on price. And perhaps most significantly for routine business operations, Khan did not hold that vertical maximum price-fixing is always legal. Khan simply said that vertical maximum price-fixing arrangements will be tested on a case-by-case basis under a rule of reason standard, like the majority of restraints on trade. In each case, the particular conduct at issue will be analyzed to see whether on balance, it is more procompetitive than anticompetitive. Finally, a predicate to every price-fixing violation is that there has been a contract, combination or conspiracy - some sort of agreement - to engage in the challenged conduct. Although a contract requiring a distributor to charge a particular price is an agreement, a true suggested resale price is not.

The Khan case is likely to have a meaningful impact on pricing arrangements between manufacturers and distributors. Manufacturers now may enter into contracts with their distributors, limiting the price at which the distributors may resell a product. In some cases, these agreements may still violate the antitrust laws. Whether the Khan case will have a beneficial impact on consumer welfare has yet to be seen. It will create greater flexibility, but also increase legal uncertainty, in pricing arrangements adopted by manufacturers and distributors.
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