Claim Against the “Hub” but not the “Spokes”

Recent California Federal District Court Decision, in Alleged “Hub-and-Spoke” Antitrust Conspiracy, Allows Plaintiff to Aggregate Competitive Effects of Separate Vertical Agreements to Show Antitrust Injury in Claim Against the “Hub” but not the “Spokes”

By James M. Mulcahy on October 28, 2013

In the antitrust context, a “rimless wheel” – or “hub-and-spoke” – conspiracy is not a general conspiracy but instead amounts to multiple conspiracies between the common defendant – e.g., a distributor – and each of the other defendants – e.g., multiple suppliers.

This means that, absent allegations establishing a “rim” between the spokes, a hub-and-spoke conspiracy is not a single conspiracy, but rather consists of separate conspiracies for each spoke. Nevertheless, in a case of first impression, the United States District Court for the Northern District of California recently held that it is appropriate to aggregate the cumulative anticompetitive effects of multiple independent vertical agreements for the purpose of showing that a common distributor’s conduct was anticompetitive in violation of both Section 1 of the Sherman Act1 and California’s antitrust statute (the Cartwright Act).2

In Orchard Supply Hardware LLC v. Home Depot USA, Inc,3 the plaintiff operated a chain of retail hardware stores in competition with Home Depot USA, Inc. (Home Depot).4 METCo and Makita were horizontal competitors at the same level of distribution (supplier-supplier), and they each were vertically aligned with various retailers (supplier-dealer), such as Home Depot and Orchard. On June 7, 2012, Home Depot publicly announced that it would enter into “exclusive supplier contracts with Key suppliers, so that it would become the principal or only supplier of the single most important kind of core hardware product – professional power tools and related accessories.”5 Within one week, the two principal suppliers of power tools – Makita and METCo – notified Orchard that they no longer would sell Orchard professional power tools.6

Orchard then sued the two suppliers (Makita and METCo) and Home Depot alleging, among other things, the existence of a horizontal group boycott in violation of both Section 1 of the Sherman Act and the Cartwright Act.7 The district court granted defendants’ motion to dismiss, with leave to amend, on the ground that Orchard had failed to establish that the suppliers had conspired with each other to boycott Orchard rather than each independently deciding that they no longer would deal with the Orchard chain of hardware stores.8 In its second amended complaint (SAC), Orchard asserted both a per se horizontal group boycott antitrust claim and, alternatively, a rule of reason vertical boycott claim.

Orchard’s Horizontal Group Boycott Claim.

Pursuant to its per se group boycott claim, Orchard alleged that METCo and Makita participated in a horizontal arrangement to jointly participate in an unlawful group boycott with Home Depot, which constituted a per se violation of Section 1 of the Sherman Act and the Cartwright Act. In order to plead a per se group boycott claim, however, Orchard was required to establish, inter alia, the existence of a horizontal arrangement between METCo and Makita to jointly participate in the boycott. This requirement is founded in the Supreme Court’s holding in NYNEX Corp. v. Discon, Inc.,9 that “antitrust law does not permit the application of the per se rule [to group boycott claims] ... in the absence of a horizontal agreement ...”10Thus, Orchard's per se claimwould rise or fall based on whether Orchard had alleged evidentiary facts establishing the existence of a horizontal agreement between METCo and Makita.

Orchard’s horizontal per se antitrust claim, in effect, alleged what is known as a “hub-and-spoke” conspiracy in a horizontal arrangement constituting an unlawful boycott – in this instance with Home Depot acting as the “hub” connecting two “spokes” – i.e., METCo and Makita. Thus, in order to state a per se group boycott claim based on its alleged hub-and-spoke conspiracy, Orchard needed to allege facts sufficient to infer that the spokes – i.e., METCo and Makita – acted pursuant to a horizontal agreement – a “rim” – as opposed to acting in parallel.11 Because Orchard did not – indeed, could not – allege facts from which one could plausibly infer that METCo’s and Makita’s decisions not to sell to Orchard were the result of a horizontal agreement, the Court granted the defendants’ motion to dismiss Orchard’s per se antitrust claim. That left Orchard with its rule of reason antitrust claim.

The Rule of Reason.

To state a rule of reason antitrust claim, the plaintiff must allege plausible evidentiary facts which show:

  • (1) a contract, combination or conspiracy among two or more persons ...
  • (2) by which the persons ... intended to [unreasonably] restrain trade or commerce ... [and]
  • (3) which actually injures competition.[12]

In order to satisfy the third prong (antitrust injury), the plaintiff must allege that the challenged agreements have resulted in harm to competition, not just harm to Orchard or other competitors.13 The rationale for this requirement is clear: the antitrust laws are intended to protect competition, not individual competitors.14 Accordingly, a plaintiff asserting claims under the Sherman Act – and the Cartwright Act – must plead and prove “an injury to competition, rather than just an injury to plaintiff's business.”15

Orchard’s Rule of Reason Vertical Boycott Claim.

Pursuant to its alternative rule of reason antitrust claim, Orchard alleged that the two vertical agreements to boycott Orchard – i.e., the Home Depot-METCo agreement and the separate Home Depot-Makita agreement – constituted rule of reason violations of both Section 1 of the Sherman Act and the Cartwright Act. This means that Orchard was alleging the existence of arimless hub-and-spoke conspiracy, which in reality, constituted multiple conspiracies. The question presented to the district court was whether the anticompetitive effect of each spoke must be considered separately when determining whether it violates the rule of reason. At the pleading stage, this means that the court had to decide whether Orchard was required to allege facts demonstrating the separate anticompetitive effects of each spoke in order to state a rule of reason claim.

Orchard alleged the following in support of its rule of reason antitrust claim against the defendants:

  • Orchard owns and operates 92 hardware stores in seven geographic markets in California and Oregon;
  • Home Depot is the largest, and dominant, seller of hardware products in the United States, and is a retail competitor of Orchard;
  • METCo and Makita supply and distribute professional power tools to consumers through retail hardware stores, including Home Depot and formerly Orchard;
  • METCo and Makita are highly regarded suppliers of various power tools among professional power tool consumers, and retail hardware stores cannot successfully operate without access to their power tools;
  • METCo and Makita (combined) control between 31 and 50 percent of the market share of various power tools, and account for two of the three professional power tool product lines in the United States;
  • The alleged relevant product submarket consists of seven specific professional-grade power tools purchased by professional customers, and there is little cross-elasticity of demand among products within the alleged relevant product market; and
  • Professional customers purchase these power tools only from a relatively small number of hardware outlets, very few of which compete with Home Depot on price, and that the combined competitive effect of the separate and distinct Home Depot-Makita and Home Depot-METCo vertical exclusive dealing agreements resulted in the complete foreclosure of those smaller hardware outlets’ ability to compete for professional customers in the relevant product market – obviously, including Orchard.

In its SAC, Orchard made no effort to plead the separate anticompetitive effects of the two exclusive supply agreements. Instead, Orchard's allegations regarding harm to competition focused entirely on the combined effect of the Home Depot-METCo and Home Depot-Makita agreements. All of Orchard’s market power-related allegations were focused on METCo’s and Makita’s combined market power within the alleged relevant market. Conversely, Orchard purposefully made no effort to establish or allege that METCo or Makita individually had market power in the alleged relevant market.

The Defendants’ Motion to Dismiss.

METCo, Makita and Home Depot each moved to dismiss Orchard’s SAC, arguing that the SAC failed to state valid causes of action against any of the defendants. METCo, Makita and Home Depot argued that, in the absence of a horizontal agreement, Orchard needed to allege facts demonstrating the separate effects on competition of each of the alleged Home Depot-Makita and Home Depot-METCo agreements in order to establish that one or both of the separate vertical agreements were unreasonable restraints of trade. Because Orchard failed to do so – indeed, it expressly predicted its antitrust injury claim solely upon the combined effects on competition within the alleged relevant market – the defendants argued that Orchard’s SAC therefore failed to state a rule of reason claim as to either the Home Depot-METCo or Home Depot-Makita agreement.

Given that Orchard’s SAC failed to allege factual allegations sufficient to establish a horizontal agreement between METCo and Makita, the question squarely presented to the United States District Court for the Northern District of California was this: where there exist two or more separate and distinct vertical agreements – i.e. there is no evidence of a horizontal conspiracy – between separate suppliers-competitors and their dominant common retail dealer-customer, can the court aggregate the competitive effects of the multiple vertical agreements for the purpose of establishing market power and antitrust injury when evaluating the legality of one or more of the individual vertical agreements under a rule of reason antitrust analysis. In the context of Orchard’s factual allegations, the issue was whether the alleged vertical exclusive distributorship agreements (Home Depot-METCo and Home Depot-Makita) must be analyzed separately to determine if they violate Section 1 under a rule of reason analysis. If so, then the defendants’ motion to dismiss Orchard’s SAC – of necessity – would be granted, because Orchard could not adequately allege antitrust injury resulting from either vertical agreement alone, and because Orchard implicitly conceded that there was no harm to competition ostensibly caused separately by each alleged agreement.

The Ninth Circuit Has Not Yet Decided This Issue.

In Twin City Sportservice, Inc. v. Charles O. Finley & Co.,16 (Finley), the plaintiff (a ballpark concessionaire) sued the defendant (a major league baseball owner) for breach of a concession contract, and the defendant filed a counterclaim alleging that the contract violated Sherman Act sections 1 and 2.17 The district court defined the relevant market to include concessions franchises at "stadiums with major league baseball and/or football, arenas with major league basketball and/or hockey, arenas without major league sports, auto racing tracks, and certain amusement parks."18 The district court concluded that the plaintiff, through its concession contracts, controlled twenty-four percent of the relevant market and had engaged in a continuing pattern of conduct (i.e., using unreasonably long concession franchise agreements, follow-the-franchise clauses, and predatory cash loans and advances) to produce that market share.19

On appeal, the plaintiff argued that in determining its market share the court should only have looked to its single contract with the defendant, which when considered in isolation constituted less than one percent of the relevant market.20 The Ninth Circuit disagreed, reasoning that determining the plaintiffs market share in the market required an examination of all of the plaintiff's conduct in that market, not just the one contract specifically at issue.21 Thus, Finley concluded that aggregation of a single defendant's contracts may be appropriate when determining the anticompetitive impact of that single defendant's conduct – although the Ninth Circuit took pains to qualify that conclusion by stating aggregation was appropriate "in the factual context of the instant litigation."22 Finley, however, did not address the question whether the effects of two competitors' independent agreements, as spokes in a rimless hub-and-spoke conspiracy, may be aggregated in determining the anticompetitive effect of each agreement. In other words, Finley did not involve a hub-and-spoke conspiracy; instead, the Ninth Circuit found only that the court could aggregate the conduct of a single defendant’s conduct in determining its effect on competition in a relevant market.

Cornwell Quality Tools Co. v. C.T.S. Co.,23 (Cornwell)another Ninth Circuit decision, also did not concern a hub-and-spoke conspiracy. Like Finley, Cornwell involved a breach of contract claim by the plaintiff (a hand tool manufacturer) and antitrust counterclaims by the defendant (a distributor), including a claim that the single plaintiff's aggregated exclusive dealing contractsviolated section 3 of the Clayton Act. The Ninth Circuit held that proof that 10-15 percentof hand tool dealers in California and Nevada had entered into exclusive dealing contractswith the plaintiff was sufficient to withstand summary judgment on defendant's section 3 claim.24 Like Finley, Cornwell could be read to allow aggregation of one defendant's conduct for purposes of proving that defendant's conduct was anticompetitive, but never addressed the issue presented in Orchardi.e., whether two competitors' conduct may be aggregated when there is no plausible allegation that they conspired with each other.

The Fourth Circuit Ostensibly Requires Evaluation of Separate Effects on Competition.

In Dickson v. Microsoft Corp.,25 the Fourth Circuit ostensibly did – but in actuality did not – examine the specific question issue presented in Orchardi.e., how to plead a section 1 claim under the rule of reason where the plaintiff alleges a hub-and-spoke conspiracy, but fails to allege the existence of a “rim” between the spokes. Dicksonalleged a rimless hub-and-spoke conspiracy involving parallel agreements between Microsoft-Compaq and Microsoft-Dell. The Fourth Circuit held that, because the plaintiff failed to allege a "rim" between Compaq and Dell, allegations regarding the anticompetitive effect of each agreement needed to be considered separately in evaluating whether a claim had been stated under the rule of reason: "to state a viable § 1 claim, [plaintiff] was required to allege facts which, if proven true, would demonstrate that Compaq's or Dell's individual agreements with Microsoft were likely to result in an anticompetitive effect.”26 Thus, in reliance upon the Fourth Circuit’s decision in Dickson, the defendants in Orchard argued that, absent a “rim” between METCo and Makita, Orchard could not base a rule of reason claim on the aggregate effect of the Home Depot-METCo and Home Depot-Makita agreements. Instead, according to the Orchard defendants, Orchard must allege facts establishing each agreement, on its own, unreasonably restrained trade.

The Decision of the United States District Court for the Northern District of California.

In response to the defendants’ motion to dismiss, the district court initially found that Orchard had adequately alleged relevant geographic and product markets. The district court, acknowledging that there exists no Ninth Circuit “precedent that clearly prohibits a plaintiff from aggregating the anticompetitive effects of multiple agreements to make an allegation of an unreasonable restraint of trade,”27 found that it was proper and appropriate to aggregate the effect of both the Home Depot-METCo agreement and the Home Depot-Makita agreement for the purpose of showing that Home Depot’s conduct was anticompetitive.28 To do so was consistent with the Ninth Circuit’s decision in Twin City, which stands for the proposition that the aggregation of a single defendant’s contracts “may be appropriate when determining the anticompetitive impact of that single defendant’s conduct.”29 And, as the Court noted with patent plausibility:

  • Under Defendants’ interpretation, a company could reach separate agreements with eleven different suppliers, each of whom has a nine percent market share, locking up 99% of the market, and yet still be outside the reach of Section 1’s prohibition of unreasonable restraints of trade.30

Finding that the defendants’ interpretation was counterintuitive, the district court denied Home Depot’s motion to dismiss Orchard’s rule of reason vertical boycott claim.

With respect to METCo and Makita, however, the district court found otherwise. Because METCo and Makita each separately made an agreement with Home Depot – and Orchard made no allegation that either of those two agreements separately had an anticompetitive effect within a relevant market – it was entirely inappropriate to aggregate the two vertical agreements for the purpose of evaluating whether METCo’s or Makita’s conduct was anticompetitive.31 This too is patently plausible for, as the district court said:

  • If an individual supplier could be held liable for the cumulative impact of all suppliers’ conduct, a company would have to investigate what other businesses were doing before it acted in order to make sure its own conduct wasn’t anticompetitive, a burden the antitrust law does not impose.32

Thus, the district court granted the motions of METCo and Makita to dismiss Orchard’s SAC.

As for the Fourth Circuit’s decision in Dickson, the district court found that the opinion was inapposite: Dickson did no more than allege “discrete conspiracies between Microsoft and Compaq and Microsoft and Dell;” thus, the Fourth Circuit was never asked to address the issue whether it “could consider the cumulative harm of Microsoft’s agreements with all OEMs but instead was required to consider – individually – Microsoft’s agreements with Compaq and Dell.”33

[1] 15 U.S.C. §1.
[2] Cal. Bus. & Prof. Code §§16700-16770 (the Cartwright Act is California’s principal antitrust statute).
[3] 2013 U.S. Dist. LEXIS 53214 (N.D. Cal. 2013).
[4] Id. at *2.
[5] Id. at *3.
[6] Id.
[7] Id. at *6.
[8] Id. at *6-10.
[9] 525 U.S. 128 (1998).
[10] Discon, 525 U.S. at 138.
[11] See Anderson News LLC v. Am Media, Inc., 680 F.3d 162, 187-89 (2d Cir. 2012); Toys “R” Us, Inc. v. F.T.C., 221 F.3d 928, 932-35 (7th Cir. 2000). See also Rheumatology Diagnostics Lab., Inc. v. Aetna, Inc., 2013 U.S. Dist. LEXIS 89208, *20 (C.D. Cal. June 25, 2013) ("[t]o be actionable, a hub-and-spoke conspiracy must have a 'rim,' which requires some kind of agreement or understanding between and among the spokes that the other spokes would cooperate in the conspiracy"); Howard Hess Dental Labs. Inc. v. Dentsply Int’l, Inc.; 602 F.3d 237, 255 (3d Cir 2010) (hub-and-spoke theory of conspiracy was not satisfied where “[t]he amended complaint states only in a conclusory manner that all of the defendants . . . conspired and knew about the alleged plan to maintain Dentsply’s market position” and thus “the rim” connecting the various ‘spokes’ is missing”); Dickson v. Microsoft Corp., 309 F.3d 193, 203-04 (4th Cir. 2002) (allegations that Microsoft had similar agreements with each of its customers failed to state a claim under the antitrust laws because the plaintiff did not allege a “rim” to the wheel, i.e., a conspiracy among the customers; the Supreme Court was "clear" in Kotteakos v. United States, 328 U.S. 750 (1946), that "a wheel without a rim is not a single conspiracy"); PSKS, Inc. v. Leegin Creative Leather Prods., Inc., 615 F.3d 412, 420 (5th Cir. 2010) (affirming dismissal where no allegation of "an agreement among retailers" to implement manufacturer's policy; "there is no wheel and therefore no hub-and-spoke conspiracy . . . .").
[12] Brantly v. NBC Universal, Inc., 675 F.3d 1192, 1197 (9th Cir. 2012); Kendall v. Visa U.S.A., Inc., 518 F.3d 1042, 1047 (9th Cir. 2008).
[13] Discon, 525 U.S. at 139 (a “simple allegation of harm to [plaintiff] does not automatically show injury to competition”).
[14] Brunswick Corp. v. Pueblo Bowl-O-Mat, Inc., 429 U.S. 477, 488 (1977).
[15] Sicor, Ltd. v. Cetus Corp., 51 F.3d 848, 854 (9th Cir. 1995) (emphasis in original) (citations omitted). In general, a “plaintiff [also] must allege both that a ‘relevant market’ exists and that the defendant has power within that market.” Newcal Indus., Inc. v. Ikon Office Solution, 513 F.3d 1038, 1044 (9th Cir. 2008); see also In re Wellpoint, Inc. Out-of-Network “UCR” Rates Litig., 865 F. Supp. 2d 1002, 1029 (C.D. Cal. 2011).
[16] 676 F.2d 1291 (9th Cir. 1982).
[17] Id. at 1296.
[18] Id. at 1297.
[19] Id. at 1301-02.
[20] Id. at 1302.
[21] Id.
[22] Id.
[23] 446 F.2d 825 (9th. Cir. 1971).
[24] Id. at 831.
[25] 309 F.3d 193 (4th. Cir. 2002).
[26] 309 F.3d at 211.
[27] 2013 U.S. Dist. LEXIS 134319, *28 (N.D. Cal. 2013).
[28] Id. at *34.
[29] Id. at *32-33 (internal quotation marks omitted).
[30] Id. at *33-34.
[31] Id. at *34.
[32] Id. at 35.
[33]Id. at *28 (citations omitted) (internal quotation marks omitted). See also Dickson, 309 F.3d at 200 (“[i]n the SAC, Gravity alleged two separate vertical conspiracies between Dell and Microsoft and Compaq and Microsoft.”); id. at 204 (“[i]n an effort to cure its failure to allege a legally viable conspiracy, Gravity alleged in the SAC separate vertical conspiracies between Microsoft and Compaq and between Microsoft and Dell.”) id. at 205 (“[w]e next address whether Gravity alleged facts which, if proven true, would establish that the two conspiracies separately imposed unreasonable restraints of trade in interstate commerce.”).




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    Jim Mulcahy - Vertical Resale Price Maintenance

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