In one of its rare opinions in the antitrust field and the first ever by Chief Judge Jonathan Lippman, the Court of Appeals recently clarified important points about the Donnelly Act regarding the pleading of a claim under the “rule of reason” and the limited extraterritorial scope of the statute. The court’s approach in Global Reinsurance Corp. v. Equitas Ltd., ___ N.Y.2d ___, 2012 WL 995268 (March 27, 2012), may also give defense counsel a basis to encourage the lower courts to more closely scrutinize the pleading of Donnelly Act claims in the future.

Background

The dispute arose in the esoteric business of retrocessionary reinsurance, which is essentially reinsurance for reinsurers, spreading a risk among a third level of underwriters. Lloyd’s of London, which filed an amicus brief in the case, issued through its independent syndicates substantial policies for retrocessional coverage of “non-life” risks such as environmental, asbestos, and catastrophic. Many of the policies are of the “long tail” variety, meaning that claims surface long after the policy period.

The underwriters of these policies misjudged their potential liability and were facing huge pay-outs in the early 1990s. Part of the problem was that it was the practice of the syndicates to pay claims “without haggling and without imposing onerous administrative burdens on their insureds.” In 1996, with government approval, the syndicates agreed to create a new entity known as Equitas to reinsure their otherwise uninsurable retrocessionary obligations. The investors in the Lloyd’s syndicates transferred to Equitas some $14.7 billion in premium assets and agreed to give up all control over such funds. Because it was set up to conclude obligations under existing coverage, but not to solicit new business, Equitas was then free to be more aggressive in handling claims made by the ceding reinsurers.

Plaintiff Global Reinsurance purchased certain coverage from Lloyd’s syndicates, which policies subsequently were ceded to Equitas. Plaintiff asserted that Equitas’ “hard nosed” approach to handling claims included various abusive practices. Plaintiff commenced arbitration proceedings under the governing insurance treaties, but in 2007 also filed a complaint under the Donnelly Act, General Business Law §340 et seq., and for tortious interference with contractual relations. The antitrust claim was that the agreement among the syndicates at Lloyd’s to concentrate claims management decision-making power in Equitas suppressed competition in the delivery of claims management services within the Lloyd’s marketplace. Equitas moved to dismiss.

The Supreme Court, New York County, dismissed the tortious interference claim, but not the original Donnelly Act claim. Plaintiff then amended its claim to allege an anticompetitive effect in the world market, not just the Lloyd’s market.

Equitas moved to dismiss the second amended complaint, which motion was granted on the basis that plaintiff had not identified a relevant market in which there was an anticompetitive effect. The Appellate Division, First Department, reversed with one justice dissenting. That court found that the complaint adequately pled a worldwide market in which defendants had market power. The Appellate Division also rejected the argument that the Donnelly Act did not reach the alleged London-based conspiracy to restrain trade because there was no allegation of an anticompetitive effect in New York. The Appellate Division did grant leave to appeal, and the Court of Appeals reversed and held that the claim should be dismissed.

Market Power

There are a number of noteworthy aspects to the Court of Appeals’ opinion for counsel who are asserting or attacking a Donnelly Act claim.

First, the court adopted a description of the elements of a Donnelly Act claim consistent with most recent lower court opinions: The complaint “must allege both concerted action by two or more entities and a consequent restraint of trade within an identified relevant product market.” In a footnote, Chief Judge Lippman acknowledged that while the Court of Appeals had never recognized the need to identify a relevant market, “it is logically necessary to a coherent allegation of a trade restraint….” One cannot evaluate whether there have been anticompetitive effects of a particular restraint without defining a market within which to evaluate such effects.

Equitas challenged the pleading of both elements of the Donnelly Act claim, so the court first dealt with whether concerted activity had been alleged. It held that the “pertinent inquiry…is one of substance and not form; what is important is how the parties to the alleged anticompetitive conduct actually operate.” The court assumed without deciding that concerted action was alleged, noting that Equitas exercised consolidated decision-making authority in place of and on behalf of the independent Lloyd’s’ syndicates.

Next, the court turned to the first major issue on appeal, involving the second element of the offense, the allegation of an anticompetitive effect in a relevant market. Chief Judge Lippman made a number of important observations regarding this issue. For one thing, he seemed to challenge plaintiff’s reliance on a distinct submarket confined to Lloyd’s within a broader world market, dismissing it as “not a legally viable allegation.” He simply stated, without any discussion of this complex topic, that product markets are defined by whether the products are “reasonably interchangeable,” apparently the first time that the Court of Appeals has specifically adopted this test. The federal courts have followed this general standard under the Sherman Act since at least the Brown Shoe decision in 1962, though nowadays some economists and regulators would apply more sophisticated economic tests.1

Some economists and federal courts have contended that analytically the concept of a submarket adds little; either a product or service is in a separate market or it is not. In any event, the Court of Appeals found that the Lloyd’s submarket theory was not “plausible” in light of the allegation that the Lloyd’s product is interchangeable with retrocessional reinsurance products available worldwide.

Next, after noting that the claim alleged was under the rule of reason, not a per se violation,2 the court held that a plaintiff “must minimally allege that conspirators possessed power within the relevant market to produce a market-wide anticompetitive effect.” The opinion then defines market power as “the ability to raise prices significantly without losing business, but more generally may be understood as the capacity to impose onerous economic terms without suffering competitive detriment.” Stating that a complaint may be dismissed where it does not allege “a conspirator’s basic capacity to inflict marketwide anticompetitive injury,” the court concluded that the complaint did not allege the requisite power within the relevant worldwide market.

The court then refined its analysis on this point by invoking the distinction in the federal jurisprudence between injury to an individual competitor versus injury to competition in the relevant market, a concept sometimes referred to as antitrust injury. In the words of the court, “it is marketwide effect that is crucial to an antitrust claim under the Sherman or Donnelly Act, not the existence of otherwise compensable individual injury.” Even though the complaint contained allegations about the stature and power of Lloyd’s in the marketplace, the court found that that did not justify the inference that Lloyd’s could at will engage in anticompetitive claims management behavior but retain its business in a global market.

Extraterritorial Reach

The second major ground on which the court based its decision—the “immovable obstacle to the action’s maintenance”—concerned the extraterritorial application of the Donnelly Act. This is the first time that the Court of Appeals has addressed this issue, and its approach may inform the construction of other New York statutes. Chief Judge Lippman noted that the court was not “placing some new limitation on the reach of the Donnelly Act,” but that this was simply “a rare instance” that exceeded the outer jurisdictional limits of the statute. While the court used the word “jurisdiction,” its analysis really speaks in terms of the substantive reach of the statute rather than the power of the court to entertain the dispute, a distinction the Supreme Court drew in Morrison v. National Australia Bank, 130 S.Ct. 2869 (2010) and that was applied to the Sherman Act in Animal Science Products, Inc. v. China MinMetals Corp., 654 F.3d 462, 468-69 (3d Cir. 2011), cert. denied, __ U.S. __ (2012).

In a somewhat convoluted analysis, the Court of Appeals made several points. First, it reiterated, the “established presumption” is against the extraterritorial operation of New York law, citing McKinney’s Laws of N.Y., Book 1, Statutes §149 (1971). Then the court opined that “the Donnelly Act’s reach must be understood as part of a jurisdictional continuum whose outermost extension is defined by federal antitrust law,” but that the reach of the Donnelly Act is not necessarily coextensive with that of the Sherman Act.

Next, the court held that the Donnelly Act “cannot reach foreign conduct deliberately placed by Congress beyond the Sherman Act’s jurisdiction.” The court reasoned that the power to regulate foreign commerce is essentially a federal power, which would be “undone” if the states were free to entertain claims that went beyond the federal limitation upon the reach of the Sherman Act.3 The Court of Appeals did not reference the supremacy or foreign commerce clauses of the U.S. Constitution, nor the 1989 Supreme Court decision that federal antitrust law does not automatically preempt state law.4 (Several lower courts have held that the federal law will preempt the Donnelly Act where the alleged conduct has little or no impact on intrastate commerce within New York).

The Court of Appeals next conducted a brief analysis of the claims to see whether they were beyond the extraterritorial reach of the Sherman Act as limited by the Foreign Trade Antitrust Improvements Act, 15 U.S.C. §6a. The FTAIA requires that, except in the case of import commerce, in order for U.S. law to apply the conduct must have a “direct, substantial, and reasonably foreseeable effect” on U.S. commerce, which effect gives rise to the alleged claim. The court found that the complaint before it involved the purchase of retrocessional coverage in a London marketplace by the New York branch of a German reinsurer, and the subsequent elimination of competition for management services within that marketplace. The court concluded that such conduct was not within the reach of either the Sherman Act or the Donnelly Act, noting that any arguable injury in New York occurred “only by reason of the circumstance that plaintiff’s purchasing branch happens to be situated here….”

The court characterized the assertion of jurisdiction over purely extraterritorial conduct as a “highly intrusive international projection of state regulatory power.” The court went on to point out that “there is nothing in the pleadings to justify an inference that [defendants] targeted United States commerce specially or that its effect upon commerce in this country was substantial.” Looking to the future, the court summed up the point by stating that “for a Donnelly Act claim to reach a purely extra-territorial conspiracy, there would, we think, have to be a very close nexus between the conspiracy and injury to competition in this state.”

Future Pleading Practice

One last noteworthy point is the undercurrent that the court was willing to scrutinize the factual allegations of a complaint to a greater degree than may previously have been the case. The influence of Bell Atlantic Co. v. Twombly, 550 U.S. 544 (2007), can be discerned throughout the opinion in Global Reinsurance. Twombly raised the bar for federal pleadings, demanding plausible allegations of fact beyond conclusions and mere recitation of the elements of a claim. In at least two places, Chief Judge Lippman referred to the need for pleadings to be “factually plausible,” which is the linchpin for analysis under Twombly. More generally, the opinion in Global Reinsurance reflects the willingness of the Court of Appeals to carefully analyze at the pleading stage the non-conclusory allegations of the key elements of a claim.

Global Reinsurance would therefore seem to give defense counsel support for urging the lower courts to more carefully evaluate pleadings under the Donnelly Act that do not tell a plausible story. Plaintiffs’ counsel, on the other hand, must use care in drafting their pleadings to be sure that each element of the claim is supported by reasonably detailed factual allegations that all hang together in a plausible manner. This can sometimes be hard to do prior to discovery.

Richard E. Donovan is a partner and co-chair of the antitrust and competition law group at Kelley Drye & Warren. He is author of the antitrust litigation chapter in the treatise ‘Commercial Litigation in New York State Courts’ (West 3d ed. 2010).

Endnotes:

1. See ABA Section of Antitrust, Market Definition in Antitrust (2012).

2. Per se offenses under both the Sherman Act and Donnelly Act are those that over time the courts have recognized to always be without any procompetitive value, so they are per se illegal without the need to show that they unreasonably restrain trade in the specific situation. These include agreements among competitors regarding price, output or terms of dealing.

3. See Cavanagh, “The FTAIA and Claims by Foreign Plaintiffs Under State Law,” 26 Antitrust 43 (Fall 2011).

4. California v. Arc America Corp., 490 U.S. 93 (1989).