UPDATE Antitrust & Trade Regulation .................................................................................................................................................................................... MARCH 2000 FTC and Antitrust Division Release Draft Guidelines on Collaboration Among Competitors American businesses are increasingly finding that joint ventures and other collaborative efforts with their competitors are the most cost-effective way of delivering goods and services that their customers want. The Federal Trade Commission and the Antitrust Division of the United States Department of Justice have released for public comment a draft version of their Antitrust Guidelines For Collaborations Among Competitors. (the “Joint Venture Guidelines” or the “Guidelines”). Like the Horizontal Merger Guidelines, the Statements of Antitrust Enforcement Policy on Health Care (the “Health Care Guidelines”) and the Antitrust Guidelines for the Licensing of Intellectual Property (“IP Guidelines”) which preceded them, the Joint Venture Guidelines were jointly issued by the principal federal antitrust enforcement agencies (the “Agencies”) to provide the business community with insight into how the Agencies decide what activites to challenge. I. OVERVIEW Since the Joint Venture Guidelines primarily state broad legal principles reflected in existing judicial precedent, the Joint Venture Guidelines provide less specific guidance than the Agencies’ guidelines on other areas of antitrust law. In summary, the Guidelines emphasize an analytic method, rather than bright line rules. Nevertheless, the Guidelines reflect significant developments regarding collaboration among competitors: The Guidelines embody the first official recognition by the antitrust enforcers that collaboration among competitors can be procompetitive. This reflects a change from earlier attitudes in which joint efforts by competitors were considered inherently suspicious. For the first time, the Guidelines explicitly recognize that procompetitive collaboration may take forms other than the formation of a separate entity owning specific assets. Equal significance is accorded to contractual alliances or licensing arrangements. The Guidelines identify two antitrust safe harbors for collaboration among competitors, which are described in Section IV below. Although intended to provide guidance to the business community, the Joint Venture Guidelines do not alleviate the necessity for careful evaluation of the specific circumstances of contemplated collaboration with competitors. For instance, The Guidelines do not address the problem that a firm which shares ownership of a joint venture with a competitor can be guilty of a per se antitrust violation if it co-ordinates its competitive behavior (pricing, product offerings or markets served) with that of the joint venture or those of the other participants in the joint venture. This problem has often discouraged joint conduct even among firms with comparatively small market shares; The Guidelines recognize that, in structuring a joint venture, covenants among the participants to restrain competition with the joint venture can be essential to aligning the participants’ interests to permit effective collaboration. However, the Guidelines provide little practical guidance regarding when such restraints will be permissible; Although the United States Supreme Court in California Dental Association v. Federal Trade Commission last term held that collaborators’ agreements to inhibit competition among themselves must be analyzed substantively under the Rule of Reason rather than being condemned per se whenever the competitive restraint is “plausibly” related to the procompetitive effect of the ............................................................................................................................................................................... .................................................................................................................................................................................... collaboration, the Guidelines propose to apply the more restrictive standard of per se illegality unless the joint venturers can meet the arguably more demanding standard of demonstrating that the restraint is “reasonably necessary” to the procompetitive effect; The Joint Venture Guidelines make clear, by comparison with the Agencies’ earlier Guidelines, that the broader safe harbor outlined in the Health Care Guidelines for cooperative purchasing will, contrary to most practitioners’ expectations, be confined to the health care markets. In all other circumstances, analogous conduct will be subject to the more restrictive safe harbor described in the Joint Venture Guidelines; arrangement as to make separate evaluation meaningless. Accordingly, the Agencies may not only challenge the totality of a collaboration, but may instead challenge one provision (traditionally referred to as an “ancillary restraint”) which is part of a collaboration, the existence of which goes unchallenged. Moreover, the Agencies will evaluate the competitive effects of the collaboration not only as of the time the collaboration is formed, but also as of any later date at which the collaboration impairs competition. Thus, a joint venture which was not a problem when it was formed may be attacked later because of exogenous changes in the market in which it functions. On the other hand, the Guidelines extend assurances that, in The Guidelines focus solely upon the issue of when assessing a joint venture after the collaboration has limitations upon competition among the been in operation, the Agencies will be sensitive “to the participants in the collaborative activity may create reasonable expectations of participants whose a violation of the antitrust laws, foregoing any significant sunk cost investments in reliance on the comment upon the often equally important question relevant agreement were made before it became of whether exclusionary effects of the arrangement anticompetitive.” (i.e., excluding participation by other competitors) may render the collaboration unlawful; III. LEGAL ST ANDARDS STANDARDS The Guidelines provide that, in varying circumstances, Since the Guidelines only apply where competitors any of three different standards will be utilized to judge form a collaboration, they do not discuss the circumstances in which a collaboration among the legality of a competitor collaboration: customers and suppliers will be deemed unlawful the standard of per se illegality, because it forecloses too much competition at either the Rule of Reason standard, and level of distribution. the merger standard. II. APPLICA TION OF THE GUIDELINES APPLICATION The Guidelines cover a much broader scope of collaborative activity than the traditional joint venture in which the participants set up a corporation, partnership, limited liability company or other entity as the vehicle for cooperation. The Guidelines stipulate that they will be used by the enforcement agencies to evaluate any “set of one or more agreements, other than merger agreements, between or among competitors to engage in economic activity, and the economic activity resulting therefrom.” The term “competitors” is used in the Guidelines to encompass both traditional competitors already operating in the same product and geographic markets and potential competitors. Since the Guidelines generally apply to agreements among competitors other than mergers, they will be used to evaluate, in addition to traditional joint ventures, a variety of joint research and development efforts, technology licensing arrangements, strategic alliances and other purely contractual undertakings. Per se illegality Some types of agreements are automatically considered illegal because they have no significant competitive benefits. Instead, such agreements always or almost always tend to raise prices or to reduce output. Such agreements are considered by the courts not worthy of the time required to complete a particularized analysis of their effects. Typically these are agreements not to compete on price or output, including agreements to fix prices, to rig bids, or to divide the market by allocating customers, territories or products. Agreements of a type that otherwise would be considered per se illegal, however, are nevertheless analyzed under the more lenient Rule of Reason if they are reasonably necessary to achieve the procompetitive benefits of an efficiency-enhancing integration of economic activity. In an efficiency-enhancing integration, participants collaborate to perform (or cause to be performed) one or more business functions, such as production, distribution or research and The Guidelines assess the competitive effects of the development. Typically they combine, “by contract or collaborative arrangement as a whole. However, they otherwise,” significant capital, technology or other also isolate for review each individual covenant, unless complementary assets to achieve procompetitive the covenant is so intertwined with the remainder of the benefits that neither participant could achieve .................................................................................................................................................................................... ............................................................................................................................................................................................... separately. The procompetitive benefits of such integration ordinarily are an expansion of output, a reduction of costs and prices, an enhancement of quality or an increase in innovation. However, the Guidelines point out, mere coordination of decisions on price, output, customers, products or territories is not integration and is not sufficient to escape per se condemnation. Nor are mere “cost savings without integration” a basis for avoiding per se illegality. Thus, actual integration of economic activity is critical to avoiding per se treatment. Even where there is integration, however, a restraint on competition will be lawful only where it is “reasonably necessary” to obtaining the benefits of integration. Under the Guidelines, a covenant restricting competition will not be considered “reasonably necessary” if the participants could achieve “an equivalent or comparable efficiency-enhancing integration through practical, significantly less restrictive means.” The Guidelines assert, however, that the Agencies will not invalidate a restrictive covenant on the basis of “a theoretically less restrictive alternative that was not practical given the business realities.” Rule of Reason Under the Rule of Reason, the central inquiry is whether the relevant agreement harms competition by increasing the participants’ incentive or ability to raise prices or to reduce output, quality, service or innovation below what would likely prevail in the absence of the agreement. The Rule of Reason analysis focuses on the state of competition with, as compared to without, the agreement under analysis. Factors considered under the Rule of Reason analysis include: the nature and purpose of the agreement, including the extent to which it limits independent decisionmaking or combines the participants’ financial interests; the extent to which the collaboration facilitates collusion through information-sharing; the market shares of the participants and the concentration of the market; Markets affected may include not only markets for goods and services, but also markets for technology (where intellectual property is sold separately) and even a market for innovation itself where the capacity to engage in research and development is associated with specialized assets. To evaluate the effect of a joint venture on market concentration, the Agencies do not assign to the venture a determinate market share, but rather a range of market shares. The low point of the range is the share of the joint venture alone; the high point is the combined share of the joint venture and each of the participants which is independently present in the market. the extent to which the participants in the collaboration have the ability and an incentive to compete among themselves; Since participants in a joint venture may either continue to compete independently of the joint venture or confine their activities to the joint venture, the extent to which competition among the participants endures can significantly affect the impact of the joint venture. Considerations which can influence the incentive to compete include: (i) whether there is an explicit commitment to exclusivity; (ii) whether the participants have actually competed following the establishment of the joint venture; (iii) whether the agreement requires the participants to contribute significant assets that would be difficult to replace; (iv) the relative magnitude of the participants’ financial interests in the joint venture and in their independent activities; and (v) the extent to which the joint activity’s governance structure enables the collaboration to make independent decisions. the duration of the collaboration; the likelihood that others will enter the market, as well as the time required for such entry and scale on which entry is likely to occur; any procompetitive benefits of the collaboration which can be verified by the Agencies, provided that the agreement is reasonably necessary to achieve those benefits. Cost savings that arise from output or service reductions, however, will not be recognized by the Agencies. Consistent with judicial precedent, the Agencies undertake no more extensive factual analysis than the specific circumstances require. In some cases, the nature of the agreement and the absence of market power together may demonstrate the absence of competitive harm. In such cases, the Agencies will cut short their analysis and will not challenge the agreement. Alternatively, where the likelihood of harm to competition is obvious from the nature of the agreement or competitive harm has already occurred, and where there are no overriding benefits that could offset the competitive harm, the Agencies will challenge such an agreement without doing a detailed market analysis. ............................................................................................................................................................................................... ......................................................................................................................................................... Merger Standard Competitor collaborations are generally viewed by the Agencies as distinct from mergers for at least two reasons. First, mergers completely end competition between the merging parties. Second, mergers are designed to be permanent, whereas competitor collaborations are more typically of limited duration. Accordingly, the Agencies will ordinarily evaluate a collaboration under a different analytical framework than a merger. However, the Agencies will treat a competitor collaboration as a merger and analyze the collaboration pursuant to the Horizontal Merger Guidelines if: percent of each relevant market in which competition may be affected. For purchasing cooperatives, this safe harbor is considerably narrower than that for health care purchasing cooperatives outlined in the Health Care Guidelines. Under the Health Care Guidelines, the Agencies ordinarily will not attack a purchasing joint venture as long as the joint purchases account for less than 35 percent of the total sales of the purchased product or service and the costs of the products or services purchased jointly account for less than 20 percent of the total revenues from all products or services sold by the participants in the joint purchasing arrangement. the participants are competitors in a relevant market; The Guidelines establish a special safe harbor for research and development collaborations because the formation of the collaboration involves an market shares in such activities are often difficult to efficiency-enhancing integration of economic determine. Research and development collaborations activity in the relevant market; will rarely be challenged based on competitive effects in an innovation market where three or more the integration eliminates all competition among independently controlled research efforts (in addition the participants in the relevant market; and to those of the collaboration) possess both the required the collaboration does not, by its own express terms, specialized assets and the incentive to engage in terminate within a sufficiently limited period research and development that is a “close substitute” (generally ten years). for the research and development activity of the collaboration. IV V.. SAFE HARBORS The Guidelines describe certain “safety zones” in Neither of these safety zones apply to agreements that which anticompetitive effects are presumed to be so are per se illegal, or that would be challenged without a unlikely that the Agencies will treat the arrangements detailed market analysis, or to those agreements that as lawful without further inquiry. In general, the are analyzed as mergers. Agencies will not challenge a competitor collaboration when the market shares of the collaboration and its CONCLUSION participants collectively account for no more than 20 The Joint Venture Guidelines give explicit recognition to the concept that collaboration among competitors can have important pro-competitive effects, and The Antitrust and Trade Regulation Practice Group provide a useful analytic framework for lawyers and of Kirkpatrick & Lockhart LLP provides antitrust judges to follow in analyzing such collaborations. counseling to clients on achieving business Nevertheless, they provide little concrete guidance objectives while minimizing the risks of violating regarding what the results of that analysis will be. federal and state antitrust laws. For more Decisions regarding whether to undertake any specific information on our antitrust services, contact collaboration with competitors must continue to be Thomas A. Donovan (412.355.6466 or based on a careful parsing by counsel and tdonovan@kl.com) or James E. Scheuermann knowledgeable business personnel of the specific facts (412.355.6215 or jscheuermann@kl.com) in the regarding the marketplace and the proposed Pittsburgh office of K&L. collaborative activity. Thomas A. Donovan Kirkpatrick & Lockhart LLP Challenge us. BOSTON HARRISBURG LOS ANGELES MIAMI NEW YORK PITTSBURGH WASHINGTON ......................................................................................................................................................... This publication is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting with a lawyer. © 2000 KIRKPATRICK & L OCKHART LLP. ALL RIGHTS RESERVED.