United States: Ninth Circuit Articulates New Standard For Bundling

On September 4, 2007, the Ninth Circuit vacated a $16.2 million antitrust judgment, holding that the lower court erred in instructing the jury that it could impose liability for bundled discounts even without finding that the defendant priced the bundled services below cost. Cascade Health Solutions v. PeaceHealth, --- F.3d ----, Case Nos. 05-35627, 05-35640, 05-36202, 2007 WL 2473229 (9th Cir. Sept. 4, 2007). This decision re -affirms the trend in the Courts to find that bundling products can in fact constitute exclusionary conduct under Section 2 of the Sherman Act. However, it adds to the confusion concerning the appropriate standard for anticompetitive bundling, as the decision adopts a standard that differs from those previously articulated by other courts and even that most recently suggested by the Antitrust Modernization Commission.

In PeaceHealth, the plaintiff and defendant were the only two hospital care providers in Lane County, Oregon. Plaintiff (known as McKenzie-Willamette during the time period leading up to the litigation) operated a 114-bed hospital in Springfield, Oregon that offered primary and secondary acute care (common medical services), but not tertiary care (complex services). Defendant PeaceHealth operated three hospitals in Oregon, with a 432-bed facility in Eugene, Oregon offering primary, secondary and tertiary care. PeaceHealth controlled 75% of the market for acute care hospital services in Lane County.

McKenzie alleged, inter alia, that PeaceHealth attempted to exclude and did exclude McKenzie from the market for acute care hospital services over a number of years, and thereby harmed competition for hospital services in Lane County, through among other things "bundled discount[s]," offering certain insurers significant discounts on tertiary services if the insurers made PeaceHealth their sole preferred provider for all services, including primary and secondary acute care. PeaceHealth, 2007 WL 2473229, at *2. In preferred provider plans, health care providers contract with insurers to provide health care services to the insurers’ customers, and those customers pay much higher prices if they obtain services from providers that are not in the preferred plan. Id. at *2 n.2. McKenzie argued that as a result of PeaceHealth’s pricing behavior, it was excluded from preferred provider plans; therefore insureds in Lane County had to pay substantially more out-of-pocket expenses for inpatient services obtained from McKenzie than from PeaceHealth. McKenzie also claimed that PeaceHealth had engaged in illegal tying.

Before trial, the district court had granted PeaceHealth summary judgment dismissing McKenzie’s tying claim. The jury, though, ultimately found that PeaceHealth had attempted to monopolize the local market for hospital services, had engaged in price discrimination under state law, and had unlawfully interfered with McKenzie's business relationships. PeaceHealth appealed the judgment, and McKenzie cross-appealed the award of summary judgment dismissing its tying claim. Both parties appealed the award of attorneys’ fees and costs.¹

On appeal, PeaceHealth argued that the verdict should be vacated because the district court permitted the jury to find that a defendant with monopoly power engaged in impermissible exclusionary conduct simply by offering a bundled discount that a competitor could not match, without requiring the jury to consider whether the defendant priced below cost. Id. at *7. The district court had based its instruction on the standard articulated by the Third Circuit in LePage’s, Inc. v. 3M, 324 F.3d 141 (3d Cir. 2003), in which the court found that a company with monopoly power violates Section 2 if it engages in exclusionary or predatory conduct without a valid business justification, even if it sells its products above cost. At the invitation of the Ninth Circuit, many companies submitted amicus briefs on the questions of whether bundled discounts must be below-cost to be anticompetitive and if so, what type of costs should be used for this determination.

The Ninth Circuit first observed that bundled discounts are a fundamental and pervasive option for buyers and sellers in the current economic system, and that they generally benefit buyers, who get more for less. mÉ~ÅÉeÉ~äíÜ, 2007 WL 2473229, at *4. The Court acknowledged that the mere fact that bundled discounts are common does not insulate them from antitrust review, but it does mean that courts should ensure that any rule adopted "does not expose inventive and legitimate forms of price competition to an overbroad liability standard." fÇK at *4 n.5. Although it conceded bundling may produce procompetitive effects of reduced prices and costs, the Court explained that bundling could also be used to exclude an equally or more efficient but less diversified competitor from the market and thereby reduce overall consumer welfare. Id. at *4-*5.

In order to balance these competing considerations, the Court determined "the exclusionary conduct element of a claim arising under § 2 of the Sherman Act cannot be satisfied by reference to bundled discounts unless the discounts result in prices that are below an appropriate measure of the defendant's costs." Id. at *11. As for what that "appropriate measure" would be, the Court adopted a "discount attribution" standard for the appropriate measure of the defendant’s costs: the full amount of the discounts given by the defendant on the bundle are allocated to the competitive product, and if the resulting price of the competitive product is below the defendant’s incremental cost to produce it, then the bundled discount may be found anticompetitive. Id. at *14. This standard "makes the defendant’s bundled discounts legal unless the discounts have the potential to exclude a hypothetical equally efficient producer of the competitive product." Id. It is also the cost standard endorsed by the Antitrust Modernization Commission ("AMC"). Id. at *15 (citing AMC, Report and Recommendations 99 (2007) ("AMC Report")).

The Court acknowledged that liability under the discount attribution standard has the potential to sweep more broadly than under other suggested cost standards considered, as well as the limited judicial experience with bundled discounts and their competitive effects, but held that the discount attribution standard "will allow courts the experience they need to divine the prevalence and competitive effects of bundled discounts and will allow these difficult issues to further percolate in the lower courts." PeaceHealth, 2007 WL 2473229, at *16. A plaintiff "challeng[ing] a package discount as anticompetitive must prove that, when the full amount of the discounts given by the defendant is allocated to the competitive product or products, the resulting price of the competitive product or products is below the defendant’s incremental cost to produce them." Id. at *16. The relevant inquiry is going to be not whether the defendant’s pricing practices forced the plaintiff to price below its cost, but whether the defendant priced its own services below an appropriate measure of its cost. Id. at *18. The Ninth Circuit determined that the appropriate measure of costs for the cost-based standard is the average variable cost. Id. at *17.

In accepting one of the AMC’s recommendations, the Ninth Circuit rejected the other two proposed elements of the AMC test, namely, that: (a) "the defendant will recoup its investment in the bundled discounting program"; and (b) "the bundled discount or rebate program has had or is likely to have an adverse effect on competition." Id. at *17 n.21 (citing AMC Report, at 99). It rejected the recouping investment standard because a bundled discounter can exclude its rivals who sell fewer products even when products are priced above the discounter’s incremental cost to produce them. It rejected the requirement of having an adverse effect on competition because this seemed redundant to the requirement for antitrust injury. The Ninth Circuit explicitly rejected the Third Circuit’s standard from LePage’s because by not considering whether a plaintiff was as efficient as the defendant, the Third Circuit test could end up protecting less efficient competitors at the expense of consumers. PeaceHealth, 2007 WL 2473229, at *8.

The Ninth Circuit also rejected the standard used in Ortho Diagnostic Sys., Inc. v. Abbott Labs., Inc., 920 F. Supp. 455, 469 (S.D.N.Y. 1996), which deemed a bundling discount exclusionary if either the monopolist has priced below the plaintiff’s average variable cost or the plaintiff is at least as efficient a producer as the defendant but the defendant’s pricing makes it unprofitable for the actual plaintiff to continue to produce. Under this standard, the Ninth Circuit explained, above-cost prices are not per se legal, and below-cost prices are simply "one beacon for identifying discounts that create the risk of excluding firms that are as efficient as the defendant — the unique anticompetitive risk posed by bundled discounts." PeaceHealth, 2007 WL 2473229, at *13. Above-cost discounts can still be anticompetitive under this standard if the plaintiff proves it is as efficient as the defendant but still excluded because the defendant sells in more markets than the plaintiff and can spread the discount over all its product lines and force competitors to provide the entire dollar amount of the discount on a smaller collection of products. But the Ninth Circuit found that this standard fails to provide adequate guidance to sellers wishing to offer procompetitive bundling discounts because it requires them to know competitors’ costs, and also may require multiple suits for every subsequent rival plaintiff needing to prove that they are as efficient as the defendant. Id. at *14.

In PeaceHealth, the Ninth Circuit has re-affirmed the trend in the Courts to find that bundled discounts can under appropriate circumstances be deemed an independent form of exclusionary conduct under Section 2 of the Sherman Act. However, by adopting a test that is different from that used by the other Courts to have considered the issue, the Ninth Circuit has created increased confusion concerning when bundling may be deemed legal and when it may be problematic. It remains to be seen whether this state of disarray is sufficient to warrant a grant of certiorari by the Supreme Court

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