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A. The Foundation of Antitrust’s Treatment of Vertical Price Restraints

A. The Foundation of Antitrust’s Treatment of Vertical Price Restraints

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476 Antitrust Law and Intellectual Property Rights

and wholesale dealers, but also the wholesale and retail prices. The bill alleged that

most of its sales were made through retail druggists, and that the demand for its

remedies largely depended upon their good will and commendation, and their

ability to realize a fair profit; that certain retail establishments, particularly those

known as department stores, had inaugurated a ‘cutrate’ or ‘cut-price’ system

which had caused ‘much confusion, trouble, and damage’ to the complainant’s

business, and ‘injuriously affected the reputation’ and ‘depleted the sales’ of its

remedies; that this injury resulted ‘from the fact that the majority of retail druggists

as a rule cannot, or believe that they cannot, realize sufficient profits’ by the sale of

the medicines ‘at the cut-prices announced by the cut-rate and department stores,’

and therefore are ‘unwilling to, and do not keep’ the medicines ‘in stock,’ or, ‘if

kept in stock, do not urge or favor sales thereof, but endeavor to foist off some

similar remedy or substitute, and from the fact that in the public mind an article

advertised or announced at ‘cut’ or ‘reduced’ price from the established price suffers

loss of reputation and becomes of inferior value and demand.’

***The defendant is a Kentucky corporation conducting a wholesale drug

business. The bill alleged that the defendant had formerly dealt with the complainant, and had full knowledge of all the facts relating to the trade in its medicines; that

it had been requested, and refused, to enter into the wholesale contract required by

the complainant; that in the city of Cincinnati, Ohio, where the defendant conducted

a wholesale drug store, there were a large number of wholesale and retail druggists

who had made contracts of the sort described, with the complainant, and kept its

medicines on sale pursuant to the agreed terms and conditions. It was charged that

the defendant, ‘in combination and conspiracy with a number of wholesale and

retail dealers in drugs and proprietary medicines, who have not entered into said

wholesale and retail contracts’ required by the complainant’s system, and solely for

the purpose of selling the remedies to dealers ‘to be advertised, sold, and marketed at

cut rates,’ and ‘to thus attract and secure custom and patronage for other merchandise, and not for the purpose of making or receiving a direct money profit’ from

the sales of the remedies, had unlawfully and fraudulently procured them from the

complainant’s ‘wholesale and retail agents’ by means ‘of false and fraudulent representations and statements, and by surreptitious and dishonest methods, and by

persuading and inducing, directly and indirectly,’ a violation of their contracts. ***

Mr. Justice Hughes, after making the above statement, delivered the opinion of

the court:

The complainant, a manufacturer of proprietary medicines which are prepared

in accordance with secret formulas, presents by its bill a system, carefully devised,

by which it seeks to maintain certain prices fixed by it for all the sales of its products, both at wholesale and retail. Its purpose is to establish minimum prices at

which sales shall be made by its vendees and by all subsequent purchasers who

traffic in its remedies. Its plan is thus to govern directly the entire trade in the

medicines it manufactures, embracing interstate commerce as well as commerce



Vertical Price Restraints and Intellectual Property 477



within the state respectively. To accomplish this result it has adopted two forms

of restrictive agreements limiting trade in the articles to those who become parties

to one or the other. The one sort of contract, known as ‘Consignment Contract—

Wholesale,’ has been made with over four hundred jobbers and wholesale dealers,

and the other described as ‘Retail Agency Contract,’ with twenty-five thousand

retail dealers in the United States.

The defendant is a wholesale drug concern which has refused to enter into the

required contract, and is charged with procuring medicines for sale at ‘cut prices’

by inducing those who have made the contracts to violate the restrictions. The

complainant invokes the established doctrine that an actionable wrong is committed by one who maliciously interferes with a contract between two parties, and

induces one of them to break that contract, to the injury of the other, and that, in

the absence of an adequate remedy at law, equitable relief will be granted. [citation

omitted]

The principal question is as to the validity of the restrictive agreements. ***

That these agreements restrain trade is obvious. That, having been made, as the

bill alleges, with ‘most of the jobbers and wholesale druggists and a majority of

the retail druggists of the country,’ and having for their purpose the control of

the entire trade, they relate directly to interstate as well as intrastate trade, and

operate to restrain trade or commerce among the several states, is also clear.

[citation omitted]

But it is insisted that the restrictions are not invalid either at common law or

under the act of Congress of July 2, 1890, [the Sherman Act], upon the following grounds, which may be taken to embrace the fundamental contentions for the

complainant: (1) That the restrictions are valid because they relate to proprietary

medicines manufactured under a secret process; and (2) that, apart from this, a

manufacturer is entitled to control the prices on all sales of his own products.

First. The first inquiry is whether there is any distinction, with respect to such

restrictions as are here presented, between the case of an article manufactured by

the owner of a secret process and that of one produced under ordinary conditions.

The complainant urges an analogy to right secured by letters patent. E. Bement &

Sons v. National Harrow Co. 186 U. S. 70. In the case cited, there were licenses for

the manufacture and sale of articles covered by letters patent, with stipulations as

to the prices at which the licensee should sell. The court said, referring to the act

of July 2, 1890: ‘But that statute clearly does not refer to that kind of a restraint

of interstate commerce which may arise from reasonable and legal conditions

imposed upon the assignee or licensee of a patent by the owner thereof, restricting the terms upon which the article may be used and the price to be demanded

therefor. Such a construction of the act we have no doubt was never contemplated

by its framers.’

But whatever rights the patentee may enjoy are derived from statutory grant

under the authority conferred by the Constitution. This grant is based upon

public considerations. The purpose of the patent law is to stimulate invention by



478 Antitrust Law and Intellectual Property Rights

protecting inventors for a fixed time in the advantages that may be derived from

exclusive manufacture, use, and sale. ***

The complainant has no statutory grant. So far as appears, there are no letters

patent relating to the remedies in question. The complainant has not seen fit to

make the disclosure required by the statute, and thus to secure the privileges it

confers. Its case lies outside the policies of the patent law, and the extent of the right

which that law secures is not here involved or determined. ***

Second. We come, then, to the second question,—whether the complainant,

irrespective of the secrecy of its process, is entitled to maintain the restrictions by

virtue of the fact that they relate to products of its own manufacture.

The basis of the argument appears to be that, as the manufacturer may make

and sell, or not, as he chooses, he may affix conditions as to the use of the article or

as to the prices at which purchasers may dispose of it. The propriety of the restraint

is sought to be derived from the liberty of the producer.

But because a manufacturer is not bound to make or sell, it does not follow in

case of sales actually made he may impose upon purchasers every sort of restriction. Thus, a general restraint upon alienation is ordinarily invalid. ***

With respect to contracts in restraint of trade, the earlier doctrine of the common law has been substantially modified in adaptation to modern conditions. But

the public interest is still the first consideration. To sustain the restraint, it must be

found to be reasonable both with respect to the public and to the parties, and that it

is limited to what is fairly necessary, in the circumstances of the particular case, for

the protection of the covenantee. Otherwise restraints of trade are void as against

public policy. *** The question is whether, under the particular circumstances of the

case and the nature of the particular contract involved in it, the contract is, or is not,

unreasonable. *** But agreements or combinations between dealers, having for their

sole purpose the destruction of competition and the fixing of prices, are injurious to

the public interest and void. They are not saved by the advantages which the participants expect to derive from the enhanced price to the consumer. [citation omitted]

The complainant’s plan falls within the principle which condemns contracts

of this class. It, in effect, creates a combination for the prohibited purposes. No

distinction can properly be made by reason of the particular character of the commodity in question. It is not entitled to special privilege or immunity. It is an article

of commerce, and the rules concerning the freedom of trade must be held to apply

to it. Nor does the fact that the margin of freedom is reduced by the control of

production make the protection of what remains, in such a case, a negligible

matter. And where commodities have passed into the channels of trade and are

owned by dealers, the validity of agreements to prevent competition and to maintain prices is not to be determined by the circumstance whether they were produced by several manufacturers or by one, or whether they were previously owned

by one or by many. The complainant having sold its product at prices satisfactory

to itself, the public is entitled to whatever advantage may be derived from competition in the subsequent traffic. ***

[Dissent by Mr. Justice Holmes omitted]



Vertical Price Restraints and Intellectual Property 479



Comments and Questions

1. What rationale did Dr. Miles provide for why it needed to impose resale

price maintenance? Is it persuasive?

2. The Court never uses the phrase “per se,” but subsequent courts, including

the Supreme Court itself, interpreted Dr. Miles as holding that resale price maintenance is illegal per se. Why? What language in the case suggests a per se rule against

vertical price fixing?

3. Although Dr. Miles created the per se rule against resale price maintenance,

the case is actually not an antitrust case. Rather, Dr. Miles was suing John D. Park &

Sons for tortious interference with contract because Park was inducing Dr. Miles’

customers into breaching their contracts by selling products to Park, who then

resold them outside of the control of Dr. Miles’ resale price maintenance scheme.

Park defended itself by arguing that it could not be liable for tortious interference

because the contracts interfered with were illegal due to their resale price maintenance provisions.

4. The Court states “a general restraint upon alienation is ordinarily invalid.”

What is a restraint upon alienation?

The concern about restraints on alienation exists independent of antitrust law. In

general, restraints on alienation do not necessarily affect the competitiveness of markets. For example, in a market with twenty sellers of equal market share, if one seller

attempted to restrict its customers from reselling, competition would not be injured

despite the restraint on alienation. Of course, a horizontal agreement to impose

restraints on alienation would probably violate Section One of the Sherman Act.

5. Dr. Miles claimed that its medicines were protected by trade secret. Under

trade secret law, an innovator’s secrets are protected against misappropriation (so

long as the innovator implements reasonable safeguards). What does resale price

maintenance have to do with trade secrets? Does fixing the resale price of a product

made pursuant to a secret process help protect that secrecy?

6. Dr. Miles’ products were not protected by patents, but the Court notes

that they were protected by trademarks. Do you think that the Dr. Miles’ per se

rule against resale price maintenance should apply to trademarked goods? Why or

why not?

The issue of fixing the resale price of trademarked goods is discussed later in

this chapter.

7. Dr. Miles seems to suggest that resell price maintenance is not okay with

copyrighted works that may be okay with patented products. Even if there is a

statutory basis for the distinction, is there any policy reason to treat resale price

maintenance differently between copyrighted works and patented products?

8. Chapter 3 noted that in the early Supreme Court case of E. Bement & Sons v.

National Harrow, 186 U.S. 70 (1902), the Court interpreted antitrust law in a manner that was highly deferential to patent owners. This was certainly true with respect

to a patentee’s effort to fix the resale price charged by its licensees. Writing for a



480 Antitrust Law and Intellectual Property Rights

unanimous Court in Bement, Justice Peckham opined: “The owner of a patented

article can, of course, charge such price as he may choose, and the owner of a patent

may assign it, or sell the right to manufacture and sell the article patented, upon the

condition that the assignee shall charge a certain amount for such article.”

Can you reconcile Bement and Dr. Miles?

Both the Bement and Dr. Miles opinions have been controversial in their own

ways. Respected scholars have challenged the Court’s reasoning in Bement. For

example, Professor Herbert Hovenkamp observed: “The Court’s logic was bizarre.

If Ford owns three automobile production plants, it has the legal right both to produce cars in the plants and to set their price. But it does not follow that Ford could

sell one of the plants to Chrysler while “retaining” the right to set the price on the

cars that Chrysler made in that plant. Once the plant had passed into Chrysler’s

hands, any attempt by Ford to set the price of Chrysler cars would be naked pricefixing.” Herbert Hovenkamp, 256 Antitrust Enterprise (2005).

Criticism of the Dr. Miles opinion is presented in the Leegin case, excerpted

later in this chapter, in which the Supreme Court reversed Dr. Miles.



B. General Electric and the Ability of Patent Owners to

Set Resale Prices

United States v. Line Materials Co.

333 U.S. 287 (1948)



Mr. Justice REED delivered the opinion of the Court.

The United States sought an injunction under §§ 1 and 4 of the Sherman Act

in the District Court against continuance of violations of that Act by an allegedly

unlawful combination or conspiracy between appellees, through contracts, to

restrain interstate trade in certain patented electrical devices. The restraint alleged

arose from a cross-license arrangement between the patent owners, Line Material Company and Southern States Equipment Corporation, to fix the sale price of

the devices to which arrangement the other appellees, licensees to make and vend,

adhered by supplemental contracts. ***

I. The Facts.

The challenged arrangements center around three product patents, which are

useful in protecting an electric circuit from the dangers incident to a short circuit

or other overload. Two of them are dropout fuse cutouts and the third is a housing

suitable for use with any cutout. Dropout fuse cutouts may be used without any

housing. The District Court found that 40.77% of all cutouts manufactured and

sold by these defendants were produced under these patents. This was substantially all the dropout fuse cutouts made in the United States. There are competitive

devices that perform the same functions manufactured by appellees and others

under different patents than those here involved.



Vertical Price Restraints and Intellectual Property 481



The dominant patent *** in the field of dropout fuse cutouts with double jointed

hinge construction was issued March 7, 1939, to the Southern States Equipment

Corporation, assignee, on an application of George N. Lemmon. This patent reads

upon a patent *** issued October 17, 1939 to Line Material Company, assignee, on

an application by Schultz and Steinmayer. The housing *** was issued November

18, 1930 to Line, assignee, on an application by W. D. Kyle. The Kyle patent covers

a wet-process porcelain box with great dielectric strength, which may be economically constructed and has been commercially successful. We give no weight to the

presence of the Kyle patent in the licenses.

The applications for the Lemmon and Schultz patents were pending simultaneously. They were declared in interference and a contest resulted. The decision of

the Patent Office, awarding dominant claims to Southern and subservient claims

to Line on the Lemmon and the Schultz applications made it impossible for any

manufacturer to use both patents when later issued without some cross-licensing

arrangement. [citation omitted] Only when both patents could be lawfully used

by a single maker could the public or the patentees obtain the full benefit of the

efficiency and economy of the inventions. Negotiations were started by Line which

eventuated in the challenged arrangements.

The first definitive document was a bilateral, royalty-free, cross-license agreement of May 23, 1938, between Southern and Line after the patent office award but

before the patents issued. *** Sublicense royalties and expenses were to be divided

between Line and Southern. Although a memorandum of agreement of January 12,

1938, between the parties had no such requirement, Line agreed to sell equipment

covered by the Southern patent at prices not less than those fixed by Southern.

Southern made the same agreement for equipment covered solely by the Line

patent. No requirement for price limitation upon sales by other manufacturers

under license was included.

Six of the other manufacturers here involved were advised by Line by letter,

dated June 13, 1938, that Southern had authority to grant licenses under the

Schultz prospective patent. On October 3, 1938, Kearney took from Southern a

license to practice the Lemmon and Schultz patents. The license had a price, term

and condition of sale clause, governed by Southern’s prices, which bound Kearney

to maintain the prices on its sales of devices covered by the patents. On October 7,

1938, the five other manufacturers *** were offered by Southern the same contract

as the standard licensor’s agreement. ***

The price maintenance feature was reflected in all the licenses to make and vend

granted by Line, under the Line-Southern contract, to the other appellees. There

were variations in the price provisions that are not significant for the issues of this

case. *** There can be no doubt, however, that each licensee knew of the proposed

price provisions in the licenses of other licensees from the circulation of proposed

from of license on October 6, 1939, subsequent consultations among the licensees

and an escrow agreement, fulfilled July 11, 1940. That agreement was entered into

after General Electric took its license and required for fulfillment the acceptance

of identical licenses by Matthews, Kearney and Railway. The licenses that were the



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A. The Foundation of Antitrust’s Treatment of Vertical Price Restraints

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