News
May 15, 2019

Supreme Court Clarifies Indirect Purchaser Rule; Permits Class Action Against Apple to Go Forward

Advisory

On May 13, 2019, the Supreme Court, in a 5-4 decision, affirmed a Ninth Circuit ruling that permitted a massive consumer class action against Apple concerning the Apple App Store to proceed, even though the prices at issue were set by independent app developers, not Apple. The decision clarifies a fundamental ambiguity in the Supreme Court's 40-year old Illinois Brick precedent, which held that only direct purchasers have standing to seek damages for antitrust violations. Apple Inc. v. Pepper, __ U.S. __ (May 13, 2019).

Background

Apple permits iPhone owners to purchase apps only through the Apple App Store. Apple generally permits any app developer to list its apps for sale in the App Store (though there have been some well-publicized exceptions). The app developer specifies the price for its app (although any non-zero price must end in .99). Apple collects a 30% commission on every sale through the App Store and remits the balance of payments to the developer.

In 2011, four iPhone owners filed suit in the Northern District of California, alleging that Apple had unlawfully monopolized the aftermarket for iPhone apps. Plaintiffs alleged that if there were other outlets through which consumers could buy apps, Apple would not be able to maintain a 30% commission rate and prices for apps would be lower.

Apple moved to dismiss on the basis of the Supreme Court's 1977 decision in Illinois Brick Co. v. Illinois¸431 U.S. 720 (1977). Illinois Brick held that federal antitrust damages actions could be brought only by a direct purchaser who purchased the overpriced good from the alleged antitrust violator. The Supreme Court was concerned that allowing indirect purchasers to sue would introduce enormous difficulties of proof, as indirect purchasers would have to establish how much of the overcharge had been passed on to them as opposed to having been absorbed by the direct purchaser. In addition, because the Supreme Court had previously held that defendants could not interpose a "pass-on" defense—that the direct purchaser plaintiff had passed on the overcharge to its customers—a contrary rule would have created the specter of duplicate recoveries by different plaintiffs for the same overcharge. Hanover Shoe, Inc. v. United States Shoe Machinery Corp., 392 U.S. 481 (1968).

The District Court granted Apple's motion to dismiss. However, the Ninth Circuit reversed, finding that the alleged monopoly was in distribution and the Plaintiffs had dealt directly with the alleged monopolist. In 2018, the Supreme Court granted certiorari.

Arguments

The briefing and oral argument before the Supreme Court made clear that the parties had very different concepts of Illinois Brick. In Illinois Brick, the plaintiff was removed from the defendant in two senses: it was not in privity of contract with the defendant, and it did not pay a price set by the defendant. This arrangement is typical of traditional distribution involving a physical good: as the good moves through the chain of commerce, each successive buyer deals with a seller who specifies the price. But the Apple case involved a more complex model. Apple sells distribution services to developers (for which it charges an allegedly monopolistic 30% commission) and facilitates the delivery of apps to consumers by acting as an agent for the developers. On the consumer side, it is in contractual privity with the consumers, to whom it delivers the apps and from whom it collects payment. But it is the app developers who bear the brunt of the 30% commission in the first instance, and it is the app developers who specify their prices for the apps—which might be increased 30% as a result of the commission (if the app developer can "pass on" the entire commission), might not be increased at all (if the app developer absorbs the entire commission), or might be somewhere in the middle.

At oral argument, Justice Kagan seized on the question of "what was Illinois Brick about? Was it about a vertical supply chain or, instead, was it about a pass-through theory?" She noted that in Illinois Brick and in all the court's prior cases, "you had both" but in the Apple case "this is not a vertical supply chain [problem] but there is still a pass-through [issue]."

Apple, of course, emphasized the pass-through issue and that the proposed class action had all of the difficulties of proof that arose in Illinois Brick. In addition, because app developers might also sue—complaining that they were forced to bear a 30% commission—Apple might be subject to multiple recoveries on the same overcharge. The United States, as amicus curiae, supported Apple.

Plaintiffs, for their part, emphasized the supply chain issue and argued that Illinois Brick should be understood as a bright-line rule permitting lawsuits by persons who dealt directly with the alleged antitrust violator and prohibiting lawsuits by persons who did not. Thirty States and the District of Columbia filed an amicus brief in support of Plaintiffs and went further: they argued that the Court should overrule the Illinois Brick precedent in its entirety and permit indirect purchaser lawsuits in federal court.

Decision

In a majority opinion authored by Justice Kavanaugh, the Court adopted the Plaintiffs' view and affirmed the Ninth Circuit. The decision is Justice Kavanaugh's first antitrust decision on the court, and only his fourth majority opinion overall. The court's four most liberal members joined Justice Kavanaugh. Justice Gorsuch, joined by Justices Roberts, Thomas and Alito, dissented.

The Court's majority took a straightforward approach: Illinois Brick permits suits by direct purchasers and Plaintiffs were direct purchasers from Apple. The Court found support for this conclusion in the language of the Clayton Act (which permits suit by "any person who shall be injured in his business or property by reason of anything forbidden in the antitrust laws") and in precedent that the Court said provided a "bright-line rule" that direct purchasers had standing to sue. The Court rejected "Apple's effort to transform Illinois Brick from a direct-purchaser rule to a 'who sets the price' rule." In the Court's view, this would result in arbitrary distinctions and the evasion of antitrust liability by monopolistic retailers who exercise their power through commissions on prices set by manufacturers as opposed to through retail mark-ups. The Court was also not persuaded that Apple faced a risk of "multiple parties at different levels of a distribution chain . . . trying to recover the same passed-through overcharge initially levied by the manufacturer at the top of the chain." Rather, while Apple could face suit by both consumers and app developers, such "[m]ultiple suits are not atypical when an intermediary in a distribution chain is a bottleneck monopolist or monopsonist (or both) between the manufacturer on the one end and the consumer on the other end." Moreover, the Court insisted, the damages that each seeks are different. The consumers seek some portion of the allegedly monopolistic 30% commission (a damages calculation that requires first showing how much the 30% commission exceeds a competitive rate, and then showing how much of that overcharge was passed on to consumers and not absorbed by the app developers). In the Court's view, the app developers "would seek lost profits that they could have earned in a competitive retail market."

The dissenting justices accused the majority of engaging in empty formalism—focusing on who is or is not in contractual privity with the defendant—and ignoring the economic substance of Illinois Brick, which focuses on "the traditional proximate cause question where the alleged overcharge is first (and thus surely) felt." In the dissenters' view, the existence of an intermediary that set prices and might have absorbed some or all of the overcharge meant that Apple could not be the proximate cause of Plaintiffs' damages. The dissenters suggested that the majority rule could easily be evaded by Apple's restructuring its arrangements so that consumers pay developers in the first instance and developers in turn pay a commission to Apple. The dissenters were also much less sanguine that Apple faced no risk of duplicative damages. And, indeed, if developers are seen as purchasers of app distribution services from Apple, rather than sellers of apps to Apple, it seems likely that both app developers and consumers could seek to recover the same allegedly monopolistic 30% commission.

On one point, the majority and dissent agreed: the case did not present an opportunity for reconsidering Illinois Brick. The majority noted that in light of its ruling in favor of Plaintiffs there was no occasion to consider the question. The dissent also commented on the argument and that "[m]aybe there is something to these arguments; maybe not." But in the absence of "adversarial process in a complex area" the dissenters would also not reach the issue.

Observations

The case is not over. Despite news accounts predicting that Apple will be forced to trial immediately in a case with multi-billion dollar liability, the case (despite being eight years old) is only at the very first stage of litigation with the Plaintiffs having survived a motion to dismiss. Apple has a number of defenses that have not yet been litigated. For instance, there are other elements to standing that may be problematic for Plaintiffs. See Associated Gen. Contractors of Cal., Inc. v. Cal. State Council of Carpenters, 459 U.S. 519 (1983) (multi-factor test for finding standing in antitrust case). In addition, Plaintiff's theory is that Apple monopolizes an aftermarket consisting of apps for the iPhone. Plaintiffs make no argument that Apple monopolizes the market for phones or the market for all apps. Aftermarket cases are difficult to make out because in many instances competition in the foremarket (here, phones) will prevent the misuse of market power in the aftermarket. Plaintiffs also may face difficulty in obtaining class certification because many members of the class may have suffered no injury.

What to make of Justice Kavanaugh? On the same day the New York Times ran a front page article about the differences between Justices Kavanaugh and Gorsuch (A. Liptak, "2 New Justices Tilt Rightward, But Not as One," New York Times, May 13, 2019, page A1), the case illustrated the difference starkly. Justice Kavanaugh not only joined the four liberals, but wrote in surprisingly warm terms about private antitrust damages suits: he noted "The plaintiffs seek to hold retailers to account if the retailers engage in unlawful anticompetitive conduct that harms consumers who purchase from those retailers. That is why we have antitrust law." He concluded with a paean to the Sherman Act, which "Congress overwhelmingly passed and President Benjamin Harrison signed." For his part, Justice Gorsuch again joined the Court's most conservative justices.

Whose rule is easier to evade? Both majority and dissent accused the other of formulating easily evaded rules. The majority noted that a monopolist retailer could avoid the dissent's rule by simply moving to a commission structure rather than a mark-up structure on goods purchased from a manufacturer. The dissent argued the opposite: the majority's rule could be avoided by restructuring the flow of funds such that consumers paid the manufacturer in the first instance and the manufacturer then paid the retailer. In practice, the dissent's suggestion seems more difficult to operationalize in most contexts. It would be difficult for a traditional brick and mortar retailer to act as a payment agent for its many suppliers. But in e-commerce, the dissent's idea may be feasible and may be a way for businesses to limit their federal antitrust exposure. This is an important issue for all companies in an intermediate role—who are both buyers and sellers of a good or service—to consider.

The reality is that both direct purchasers and indirect purchasers can and do sue for the same damages. Neither majority nor dissent considers the effect of state laws that reject Illinois Brick. In many states, legislatures have adopted or courts have construed state laws to permit indirect purchasers to sue for antitrust violations. Moreover, because of the 2005 Class Action Fairness Act, large indirect purchaser class actions arising under state law typically wind up in federal court alongside direct purchaser actions. The result is that in most cases indirect and direct purchasers seek to recover damages for the same overcharge, and the complications and inefficiencies that motivated Illinois Brick are not avoided. Whether a particular indirect purchaser may recover is a function of the happenstance of where the purchaser lives or engaged in a transaction with the defendant. And Defendants remain forbidden by the Hanover Shoe decision from asserting a pass-on defense against the direct purchasers. Although neither the majority nor the dissent reached the issue, this is not the first time the suggestion has been made that a more sensible approach to antitrust law might result if both Illinois Brick and Hanover Shoe were overturned and, as the dissent suggests, "all potential claimants to the single monopoly rent be gathered in a single lawsuit as necessary parties."

© Arnold & Porter Kaye Scholer LLP 2019 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.

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