The focus of the Sherman Act is to prohibit only “unreasonable” restraints of interstate trade and commerce. Okay, that sounds simple enough, but what does that mean? How would the average business or commercial lawyer respond to the question, “What is an unreasonable restraint of trade?” In response, lawyers bandy about standards get bantered such as, the “rule of reason” and the “per se rule.” The application of those standards is further convoluted by terms like, “horizontal restraints” and “vertical restraints.” What do these standards and terms really mean and, more importantly, how do they all fit together so that the antitrust laws seem more approachable? This article will help explain these standards and terms used in antitrust law by tracing their historical development.
The development of the rule of reason and per se rule
By the time of the enactment of the Sherman Act in 1890, the common law on restraints of trade had been well developed in England and had, to lesser extent, been developed in the states. The Sherman Act was the first step in establishing a comprehensive federal scheme on restraints of trade in the U. S. The Supreme Court, however, was sharply divided on the issue of its proper interpretation. While the English common law had previously set forth standards to distinguish between “reasonable” and “unreasonable” restraints of trade such as monopolies, the Sherman Act had not used the word “unreasonable” at all. Moreover, because the Sherman Act was both a civil and criminal statute, there was a constitutional (due process) component to its interpretation.The Supreme Court wrestled with this interpretive quagmire: Should the Sherman Act be interpreted consistent with the English common law (from which it developed) or should it be interpreted expressly as written in the statute?”
English common law on monopolies.
The English common law did not use the term “antitrust,” rather, the English common law used terms such as “monopoly” to broadly describe public and private attempts to restrain trade and commerce. Like the Sherman Act in the U.S., many English common law rules on restraints of trade became codified by statute. English common law restraints of trade, monopolies for example, were divided into two classes:
- Involuntary restraints (i.e., those restraints imposed on private trade by the Crown in the form of letters patent, grants and charters)
- Voluntary restraints (i.e., those restraints imposed on private trade by private citizens, usually in the form of two-party agreements)
Involuntary restraints typified a power struggle between the Crown and parliament which was largely put to rest by the enactment of the Statute of Monopolies in 1624. A far more complex battle, played out in the English courts, was to determine what types of private restraints of trade would be permitted.
The English courts took the position that voluntary restraints were presumptively “unreasonable” as they had deleterious effect on free trade by:
- Artificially raising prices
- Artificially reducing quality
- Keeping able-bodied workers from employment
These effects were bad for the individual subject to the restraint as well as society as a whole. Voluntary restraints were void as against public policy and thereby unenforceable unless the party that sought to enforce the restraint could prove that it was “reasonable” by showing:
- There was good and valuable consideration offered and received between the parties
- There was a legitimate purpose behind the restraint
- The restraint was limited in terms of duration and scope
In sum, under English common law on monopolies, private-party (voluntary) restraints were presumptively unreasonable, unless that presumption could be overcome by proof of reasonableness.
h common law (from which it developed) or should it be interpreted as expressly written in the statute?
The “all contracts” standard under the Sherman Act
The early Supreme Court decisions rejected any notion that the Sherman Act applied only to unreasonable restraints, but rather broadly condemned all restraints of interstate trade and commerce, reasonable or not. Under the “all contracts” standard, the Supreme Court condemned all contracts whose main purpose was to directly interfere with the free flow of interstate trade and commerce. No distinction was made between reasonable and unreasonable restraints because the express language of the Sherman Act did not limit its reach only to unreasonable restraints. In practice, of course, the “all contracts” standard proved unworkable and over-inclusive because every business contract restrained trade or commerce to one degree or another.
The “rule of reason” standard under the Sherman Act
The growing dissatisfaction with the “all contracts” standard in the business community as well as within the ranks of the Supreme Court led to the adoption of the “rule of reason” in 1911 in Standard Oil Co. v. United States By 1911, the Supreme Court had limited the reach of the Sherman Act to “unreasonable” restraints of interstate trade and commerce. Under the rule of reason standard, federal courts were required to consider a host of competitive variables to decide whether the restraint—in practice—was unreasonable (i.e., produced more competitive harm than good). Competitively harmful restraints were unreasonable and unlawful under the Sherman Act. The advantage to the rule of reason, from the defendant’s perspective, was that it permitted a defendant to submit evidence that the restraint, on balance, produced more pro-competitive than anti-competitive effects.
The per se standard under the Sherman Act.
Because the rule of reason standard relied upon an elaborate, expensive and time-consuming process of examining a host of competitive variables particular to an industry to determine whether a particular restraint was unreasonable, the process produced inconsistent outcomes across the federal court system. The rule of reason standard presumed that all federal court judges had the appropriate background and business acumen to effectively weigh all of the complex competitive variables at play. Moreover, “reasonableness” is itself a rather vague concept: What may be reasonable to one judge is utterly unreasonable to another. The standard was, and continues to be, susceptible to inconsistent outcomes. Consequently, during the 1940s and 1950s, the Supreme Court began to carve out certain classes of restraints that could escape a full-blown rule of reason analysis. These classes of restraints were presumptively (or per se) unlawful because historically they had no other purpose but to restrain interstate trade and commerce (referred to as “naked restraints”). Naked restraints had a deleterious effect on the machinery of competition. As to them, there was no need for an expensive and time-consuming rule of reason analysis, since the outcome would (or should) be same. Such per se restraints included price-fixing, market divisions, supply restrictions, group boycotts and certain forms of tying arrangements. The significant drawback to the per se standard, from the defendant’s perspective, is that it does not permit the defendant to submit evidence demonstrating pro-competitive affects—no competitive justifications were permitted.
The erosion of the per se standard
The distinction between horizontal and vertical restraints
Of course, no standard is perfect. The essential predicate to the application of the per se standard to certain classes of restraints was that history had taught the Supreme Court that these classes of restraints always or almost always restrained interstate trade or commerce. Beginning in the 1960s, however, the Supreme Court started to re-evaluate the breadth of the per se standard. A distinction emerged between horizontal and vertical restraints and, specifically, whether any practical differences between them should justify in a departure from the per se standard. Horizontal restraints are those imposed between competitive rivals (firms in the same level of commerce, otherwise referred to as “direct competitors”). Horizontal restraints are perceived to be more dangerous to the economy as they have the effect of reducing inter-brand competition (thus affecting a broad width of commerce). Historically, the per se standard had been applied only to horizontal restraints. Vertical restraints, by contrast, are restraints imposed by one level of commerce onto another line of commerce (i.e., a manufacturer to a distributor to a retailer). As such, vertical restraints pose less of a competitive threat to the economy as a whole because they reduce only intra-brand competition (thus affecting a far narrower band of commerce) (arguably, only a single column of commerce).
The elimination of the per se standard applied to vertical restraints.
When faced with this important economic distinction, the Supreme Court balked and began to take measured steps to erode the application of the per se standard to vertical restraints. The erosion began with vertical non-price restraints and slowly led to vertical price restraints. Today, all vertical restraints, non-price and price alike, are judged by the rule of reason Only limited classes of horizontal restraints (price-fixing, bid rigging, supply restrictions, market divisions and group boycotts) are judged under the per se standard; all other horizontal restraints are judged under the rule of reason.
While the standards to determine whether a particular restraint violates the Sherman Act have varied over time (maybe flip-flopped would be a better word), the purpose of these standards (since at least 1911) has not. The purpose behind each standard has always been to determine whether a particular restraint, or class of restraints, is unreasonable. Only unreasonable restraints violate the Sherman Act. Today, the standards are fairly straight forward: Only certain classes of horizontal restraints (price-fixing, bid rigging, supply restrictions, market divisions and group boycotts) are unlawful per se. All remaining restraints (horizontal and vertical) are judged under the rule of reason. If history repeats itself, and it might, it would not be surprising to see a further erosion of the per se standard in the years to come, leaving the rule of reason as the exclusive standard by which to judge whether a restraint is unreasonable under the Sherman Act. 1911 here we come (again).