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Does Apple Monopolize the Retail Market for Apps: APPLE v. PEPPER, ___ U.S. ___, No. 17-204 (13 May 2019)

by | Jul 9, 2019 | Business Litigation

Antitrust; direct purchaser rule

  1. Facts

In 2007, Apple introduced the iPhone.  The next year, Apple created an electronic App Store where consumers could buy apps for their iPhones.  The apps sold to consumers are developed by third-party app developers, not by Apple.  Through contract and technical constraints, Apple prohibits the app developers from selling their apps directly to consumers. Even though Apple sells the apps through its App Store, the app developers set the sales prices for the apps.  An iPhone owner pays Apple the sales price of the app, and Apple deducts a 30% “commission” on each sale.  (For reasons that are unclear, Apple requires that all sale prices end in $0.99.)

Several consumers sued Apple in U.S. district court alleging that Apple charges too much for apps.  They contend that Apple monopolizes the retail market for apps and unlawfully uses its monopoly power to charge consumers higher-than-competitive prices.

  1. Relevant statutes

A claim that a monopolistic retailer uses its monopoly power to overcharge consumers is a classic antitrust claim subject to the Sherman Act and the Clayton Act.

Section 2 of the Sherman Act, 15 U.S.C. §2, provides in pertinent part:

Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other person or persons, to monopolize any part of the trade or commerce among the several States, or with foreign nations, shall be deemed guilty of a felony . . . .

Section 4 of the Clayton Act, 15 U.S.C. §15(a), provides in pertinent part:

[A]ny person who shall be injured in his business or property by reason of anything forbidden in the antitrust laws may

sue . . . and shall recover threefold the damages by him sustained, and the cost of suit, including a reasonable attorney’s fee.

  1. Prior Supreme Court decisions

Before discussing Apple v. Pepper, it is worth briefly reviewing two prior Supreme Court decisions: Hanover Shoe, Inc. v. United Shoe Machinery Corp., 392 U.S. 481 (1986) and Illinois Brick Co. v. Illinois, 431 U.S. 720 (1977).

  1. Hanover Shoe

In Hanover Shoe, the defendant United Shoe Machinery Corp. (“United”) manufactured shoe-making equipment.  Hanover Shoe, Inc. (“Hanover”) bought shoe-making equipment from United and used the equipment to make shoes.  Hanover sold the shoes to its customers who, presumably, were shoe wholesalers.  Hanover alleged that United had a monopoly and charged supra-competitive monopoly prices.  Hanover’s specific allegation was that United used its monopoly power to force shoe manufacturers to lease the shoe-making machinery from United rather than buy it.

It is important to note that there was a linear, vertical relationship between United (the alleged monopolist) and Hanover and that Hanover was the functional equivalent of a direct purchaser from United.

In defense, United argued that Hanover passed on the overcharges to its customers.  This was referred to as the “passing on defense.”  If Hanover passed on the overcharge, then Hanover itself was not injured.  In the words of §4 of the Clayton Act, Hanover was not “injured in [its] business or property by reason of anything forbidden in the antitrust laws.”

The Supreme Court rejected United’s passing on defense. The Court said that under long-standing rules of proximate causation the “general tendency of the law, in regard to damages at least, is not to go beyond the first step.” Id. at 490, n. 8.  The Court took a straightforward view of §4 of the Clayton Act, stating “[w]e think it sound to hold that when a buyer shows that the price paid by him for materials purchased for use in his business is illegally high and also shows the amount of the overcharge, he has made out a prima facie case of injury and damage within the meaning of §4. . . . As long as the seller continues to charge the illegal price, he takes from the buyer more than the law allows.  At whatever price the buyer sells, the price he pays the seller remains illegally high, and his profits would be greater were his costs lower.”  The bottom line is that an illegally high price always injures the direct buyer and creates an irrebuttable presumption of injury.

The Court also said that if a pass-through defense is allowed, then the result would be impossibly difficult, long, and complicated litigation, attempting to prove facts and motives that are not ascertainable.  In Hanover Shoe, the first step was United’s overcharging of Hanover.  To proceed beyond that point and inquire whether Hanover had passed on the overcharge would risk the sort of problems traditional principles of causation were designed to avoid.  A multitude of questions could follow from whether Hanover had the capacity and incentive to pass on to its customers United’s alleged monopoly prices. The Court declined to step into that quagmire.

  1. Illinois Brick

Illinois Brick concerned a variation of the issue in Hanover; but instead of the passing on defense, the issue was the “pass-through” attack.

The alleged monopolist, Illinois Brick, made bricks and sold them to masonry contractors.  The masonry contractors sold the bricks (and their brick-laying services) to general contractors who contracted with the public for the construction of buildings requiring bricks.  The State of Illinois was one of the ultimate customers.  It is important to note that, although there was a linear, vertical relationship between Illinois Brick and the State of Illinois similar to the linear, vertical relationship in Hanover Shoe, the State was not a direct purchaser from Illinois Brick; the State was a third-level purchaser.

The State sued Illinois Brick, alleging that Illinois Brick had a monopoly and charged monopoly prices for bricks.  Essential to the State’s cause of action was the contention that the monopoly price was passed down the chain eventually to the State, and the State as the ultimate purchaser was “injured in [its] business or property by reason of” Illinois Brick’s monopoly pricing.  The State did not dispute the holding of Hanover Shoe prohibiting the “passing on” defense.  Instead, the State argued that it should be allowed to use a “passing on” theory to attack the alleged monopolist three steps up the distribution chain.  Illinois Brick was the real monopolist that created the monopoly price, and the intermediaries merely passed on that monopoly price.

The Supreme Court rejected the State’s argument.  The Court said that “whatever rule is adopted regarding pass-on in antitrust damages actions, it must apply equally to plaintiffs and defendants.”  “Indeed, the evidentiary complexities and uncertainties involved in the defensive use of pass-on against a direct purchaser are multiplied in the offensive use of pass-on by a plaintiff several steps removed from the defendant in the chain of distribution.” Illinois Brick, 431 U.S. at 732-733.  “Permitting the use of pass-on theories under §4 [of the Clayton Act] essentially would transform treble-damages actions into massive efforts to apportion the recovery among all potential plaintiffs that could have absorbed part of the overcharge from direct purchasers to middlemen to ultimate consumers . . . . [i]t would add whole new dimensions of complexity to treble damages suits and seriously undermine their effectiveness.” Id. at 737.

“[W]e understand Hanover Shoe as resting on the judgment that the antitrust laws will be more effectively enforced by concentrating the full recovery for the overcharge in the direct purchasers rather than by allowing every plaintiff potentially affected by the overcharge to sue only for the amount it could show was absorbed by it.” Id. at 734-735.

  1. Returning to Apple v. Pepper

Apple had to contend with the Illinois Brick decision holding that direct purchasers could sue. To outflank that decision and avoid a frontal attack, Apple asserted that the consumer-plaintiffs could not sue Apple because they were supposedly not “direct purchasers” from Apple.  Apple contended that Illinois Brick allows consumers to sue only the party who sets the retail price, whether or not that party delivers the goods or services directly to the complaining customer.  In other words, under Apple’s theory, for antitrust purposes the party that sets the retail price is the direct seller, even if someone else (in this case, Apple) actually deals directly with the consumer.  Here, according to Apple’s argument, Apple merely passed on the allegedly monopolistic price.  Apple contended that its theory accords with the economics of the transaction.  As mentioned, the app developers set the retail price charged to consumers, which under Apple’s theory means that consumers are not purchasing directly from Apple and may not sue Apple.

The Court rejected Apple’s argument.  The Court said: “Our decision in Illinois Brick established a bright-line rule that authorizes suits by direct purchasers but bars suits by indirect purchasers.” (Slip op., at 5.)  Thus, a direct purchaser can always sue and an indirect purchaser can never sue.  The question was whether the plaintiffs/consumers were direct purchasers from Apple.

The Court asserted that the plaintiffs were direct purchasers from Apple: “The plaintiffs purchased apps directly from Apple and therefore are direct purchasers under Illinois Brick. . . . Through the App Store, Apple sells the apps directly to iPhone owners.” (Slip op., at 2)  The Court said that “[t]here is no intermediary in the distribution chain between Apple and the consumer. The iPhone owners purchase apps directly from the retailer Apple, who is the alleged antitrust violator. The iPhone owners pay the alleged overcharge directly to Apple. The absence of an intermediary is dispositive.” (Bold added) (Slip op., at 6)

The Court rejected the argument that the party setting the retail price is the only proper defendant, stating that Illinois Brick is not based on an economic theory of who sets the price,

  1. The dissent

Justice Gorsuch dissented in an opinion joined by the Chief Justice and Justices Thomas and Alito.

The dissent said that “in Illinois Brick . . . this Court held that an antitrust plaintiff can’t sue a defendant for overcharging someone else who might (or might not) have passed on all (or some) of the overcharge to him.” (Italics in original) (Justice Gorsuch’s dissent, at 1).  According to the dissent, Illinois Brick held that convoluted pass-on theories of damages violate traditional principles of proximate causation and that the right plaintiff to bring suit is the one on whom the overcharge immediately fell.  What makes the dissent confusing is that the majority does not disagree with those statements.

Although the dissent is somewhat difficult to follow, it seems that in the dissent’s view, the party that set the retail price is the direct seller and, therefore, the consumer is a direct purchaser from the party that set the retail price.  By setting the retail price paid by the consumer for an app, the app developer directly charges the consumer for the amount of the allegedly monopolistic retail price, even if Apple initially collects the purchase price and deducts a 30% commission from the amount paid.  Apple is not the seller; it is only a delivery service that delivers the app and collects a delivery fee.

The dissent accused the majority of replacing the traditional rules of proximate cause and economic reality with an easily manipulated and formalistic rule of contractual privity.  The dissent predicts that the majority’s decision will cause exactly the horrific problem of apportioning damages amongst multiple claimants that Hanover Shoe and Illinois Brick aimed at preventing.

John Polk is a Special Counsel at Berenzweig Leonard, LLP. John can be reached at [email protected].