Time to Check Your Distribution Agreements?

Stack of filesYour company is doing well – perhaps through invention, innovation, historical accident, or a well-timed decision.  As a result, you may have come up with a niche product that has placed your company in its own marketplace.  Market share is increasing and your company has acquired a substantial position in the market.  If this sounds like you, it might be time to review your company’s distribution agreements to ensure they comport with antitrust laws.

Of special note, Section 2 of the Sherman Act prohibits the willful acquisition or maintenance of monopoly power through exclusionary conduct.  The use of exclusivity provisions by a monopolist may violate Section 2 if the provisions are employed to restrict competition and foreclose rivals from the marketplace.

IDEXX Laboratories (“IDEXX”), a manufacturer of point of care diagnostic products used mainly by veterinarians, recently found itself in the cross-hairs of the Federal Trade Commission (“FTC”) for its use of exclusivity provisions in contracts with its distributors.  As alleged by the FTC, IDEXX had approximately 70% of the point of care diagnostic market.  More than 75% of veterinarians used the point of care diagnostic products of IDEXX and its competitors, purchasing the products primarily through distributors.  The products lack close substitutes and were distributed by a handful of distributors.

According to the FTC, IDEXX’s contracts with its distributors had exclusivity provisions that barred the distributors from carrying competing point of care diagnostic products, and IDEXX was considered by distributors as a must-carry product.  These facts enabled IDEXX to foreclose its competitors from effectively reaching the marketplace, leading to higher prices.

The FTC recently settled its claim against IDEXX with IDEXX agreeing to a consent order.  The consent order essentially requires IDEXX to renegotiate its distribution agreements to comply with the terms of the consent order.

While not necessarily required for every company’s distribution agreements for the reasons stated below, the requirements placed upon IDEXX’s distribution agreements are illustrative of what might be considered a safe harbor from antitrust liability.  On a going forward basis, IDEXX distribution agreements were required to have the following terms:

  • An initial term of no less than two years, with renewal for one or more additional terms;
  • Provision of IDEXX products on a non-exclusive basis;
  • Absence of terms requiring (or inducing, coercing, threatening or pressuring) the distributor to refuse or limit the purchase or sale of products to persons other than IDEXX, including based upon the distributors intention to sell products competing with IDEXX; and
  • Absence of penalty, volume limits or other retaliatory provisions preventing the distributor from distributing products competing with IDEXX products.

The consent order also requires IDEXX to submit for FTC review notifications relating to the non-renewal, termination or breach of any distribution agreements.

Of course, not every manufacturer with strong market share has exclusive distribution provisions that violate the antitrust laws.  The facts of IDEXX make that situation distinguishable from many other exclusive distribution arrangements.  That distributors had to carry the IDEXX product and that consumers purchased their requirements primarily through distribution channels were significant enablers of IDEXX’s ability to foreclose competition.  IDEXX also engaged in more distribution than it needed, a fact which the FTC claimed signaled that it was violating the antitrust laws with its use of exclusivity.

Companies may have legitimate purposes for their exclusivity provisions.  A monopolist may rebut a Section 2 claim by proving that the challenged provision is reasonably necessary to achieve some procompetitive benefit.  Of course, using after-the-fact, lawyer-created arguments is not a particularly credible means of accomplishing this.  Companies should document the procompetitive reasons for the use of exclusivity provisions contemporaneously with their inclusion in distribution agreements.  And companies should be as detailed as possible in this documentation.

But, complying with a government investigation, even where the challenged conduct is legal at the end of the day, can be a costly endeavor.  Exclusivity provisions are adjudged under the rule of reason – an examination of the marketplace in which the conduct occurs balancing the anticompetitive harm against the procompetitive benefits.  Such an examination often requires volumes of documents, interviews and expert opinions, as well as business disruption.  That is not to say that companies should avoid the use of exclusivity provisions, but rather companies should appreciate the risks they involve.  And, companies reaching significant share of their marketplace should consider whether their use of exclusivity provisions changes their risk profile.

About the Author

Timothy Cornell

timothy-cornell-clifford-chanceAbout the Author
Timothy Cornell, counsel in Clifford Chance's U.S. Antitrust Practice, advises clients on antitrust issues in government civil and criminal investigations, the regulatory review of mergers and acquisitions, intellectual property and technology licensing, supply and distribution agreements, joint venture formation, retail pricing issues, horizontal and vertical restraints, private party civil litigation, and the adoption of antitrust best practices.

Mr. Cornell has advocated on behalf of more than two dozen clients before the U.S. Federal Trade Commission and U.S. Department of Justice, representing transacting parties and parties opposing transactions between their competitors. Mr. Cornell brings significant experience in assisting clients through government antitrust investigations, representing targets of governmental investigations and non-parties cooperating with the government. He has litigated antitrust and other high profile cases before arbitration panels, and in federal and state courts across the U.S.

Mr. Cornell obtained his JD from Georgetown, cum laude, and his BS in political science from the United States Naval Academy.

Contact information:

Timothy J. Cornell
Clifford Chance
2001 K Street, NW
Washington, DC 20006
+1 202 912 5220
+1 201 519 7959