Are Exclusive Distribution Agreements Lawful?

Distributorship agreements where the distributor agrees to deal exclusively with a particular supplier
are generally viewed as lawful under the antitrust laws. There are some exceptions.

Are Exclusive Distribution Agreements Lawful?

In an exclusive distributor agreement, the supplier and wholesaler-distributor agree that the wholesaler-distributor will deal exclusively with the supplier for certain products. Such agreements foreclose the supplier's competitors from accessing the marketplace through the exclusive distribution network. The antitrust laws view these agreed-to restrictions between non-competitors as vertical non-price restrictions. The restrictions are classified as "vertical" because the agreement is between non-competitors (the supplier and its wholesaler-distributor).

Since 1977 the courts have held that vertical non-price restrictions - - such as exclusive distributorship agreements - - are not per se (or always) illegal under the antitrust laws. Instead, these arrangements violate the antitrust laws if their effect may be to substantially lessen interbrand competition or tend to create a monopoly in any line of commerce. This requires an analysis of several factors, including:

• whether the supplier has substantial market power to unreasonably restrain trade in the relevant market (i.e., the power to raise prices significantly above the competitive level without losing all of one's business);

• the effects of the restrictions on interbrand competition; and

• the justification for imposing the restrictions.

The Department of Justice (“DOJ”) sued Dentsply International, Inc., a dominant manufacturer of artificial teeth, claiming that the manufacturer’s distribution policies violated the antitrust laws. Specifically at issue were Dentsply’s policy that (1) an authorized dealer will lose their Dentsply account if the dealer adds a product line that competes with Dentsply, and (2) in order to become an authorized Dentsply dealer, the prospective dealer had to agree to drop some or all competing lines. The DOJ charged that Dentsply’s exclusive-dealing agreements with its 23 dealers in the U.S., coupled with its monopoly power, was unlawful because they substantially lessened competition in the artificial teeth market. (U.S. v. Dentsply International, Inc., Del. Dist. Ct., No. 99-005).

Following a district court bench trial, judgment was entered in favor of the manufacturer. In finding the absence of the necessary level of anticompetitive effect, the court noted that rival manufacturers were not prevented from competing with Dentsply because hundreds of dealers, other than the 23 exclusive dealers used by Dentsply, were available to market competing product lines. The court added that even these 23 exclusive dealers were free to leave Dentsply at any time and go with another manufacturer who offered the dealer a more financially attractive product line. In addition, the court found that direct distribution by a manufacturer was an optional market channel for the sale of artificial teeth.

The Justice Department appealed the district court’s ruling on the monopolization charge to the U.S. Court of Appeals for the Third Circuit. The appeal court reversed, and found Dentsply had monopoly power and had engaged in conduct to foreclose competition that is impermissibly exclusionary when practiced by a monopolist. (U.S. v. Dentsply International, Inc., 399 F3d 181, 3rd Cir.)

Dentsply possessed monopoly power because it had 80% market share based on revenue, 67% on a unit basis, it was 15 times larger than its next closest competitor, and it had held this dominant position for over 10 years. It also exercised that power with aggressive price increases and growing profit margins, showing little concern with its competitors’ pricing.

According to the court, Dentsply’s monopoly power was maintained in large part by its exclusive dealing arrangements with its dealer network. Although not illegal in themselves, such exclusive dealing arrangements, when orchestrated by a monopolist, can be an unlawful means to maintain a monopoly. Dentsply was motivated by an explicitly anticompetitive intent - - reserve for itself the key dealers in the industry thus foreclosing its competitors from also using this vital market channel to reach customers. The same type of arrangement with dealers may pass antitrust scrutiny where the manufacturer does not have monopoly power.

The Dentsply case illustrates how difficult it can be to distinguish between lawful and unlawful conduct. After all, Dentsply prevailed in the trial court only to lose on appeal. At least one of the Federal judges involved in the case thought that Dentsply did not do anything wrong.

 

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