Antitrust - Ninth Circuit Vacates Jury Verdict in PeaceHealth Case and Adopts New Legal Standard for Illegal “Bundled Discounts” Under the Sherman Act, Section 2
In Cascade Health Solutions f/k/a McKenzie-Willamette Hospital v. PeaceHealth, an Oregon jury had found that the defendant, PeaceHealth, violated federal antitrust law and certain state laws by offering “bundled”
or “package” discounts to health insurers who made PeaceHealth their sole preferred provider for all hospital services, including primary, secondary and tertiary acute care hospital services. As a result of the bundled
pricing, insurers who wanted to purchase some services from the plaintiff, McKenzie, had to pay more than those who contracted exclusively with PeaceHealth for all hospital services. The Ninth Circuit held that the district erroneously
instructed the jury on the legal standard for predatory bundling under the Sherman Act, Section 2; however, the Ninth Circuit also found that the district court should not have granted summary judgment, before trial, to PeaceHealth
on McKenzie’s tying claim. Accordingly, the Ninth Circuit sent the case back to the district court for a new trial.
Background
McKenzie’s complaint against PeaceHealth alleged monopolization, conspiracy to monopolize and exclusive dealing in violation of the federal antitrust laws and price discrimination and intentional interference with prospective
economic advantage in violation of Oregon state law. The district court granted summary judgment to PeaceHealth on the tying claim, but the parties tried remaining claims to a jury.
On the monopolization and attempted monopolization claims, the jury found the relevant market to be the market for primary and secondary acute hospital services in Lane County, Oregon, where McKenzie and PeaceHealth competed. In
Lane County, PeaceHealth operates three hospitals, including its 432-bed flagship hospital, Sacred Heart, which offers primary, secondary and tertiary care. “Tertiary” refers to complex services like invasive cardiovascular
surgery and intensive neonatal care, whereas “primary” and “secondary” acute hospital services are more common medical services like bone-setting and tonsillectomies. McKenzie, for its part, operates just
one hospital in Lane County, a 114-bed facility offering primary and secondary acute care—but no tertiary services.
McKenzie asserted that PeaceHealth offered health insurers discounts of 35-40% on tertiary services if the insurers chose PeaceHealth as their sole preferred provider for all services, primary, secondary and tertiary. As a result,
insurers who contracted exclusively with PeaceHealth as the preferred provider for all services paid lower rates than insurers who purchased tertiary services from PeaceHealth, but some primary and secondary services from McKenzie.
PeaceHealth enjoyed a roughly 75% market share in Lane County for primary and secondary care services, 90% market share for tertiary neonatal services and 93% market share for tertiary cardiovascular services.
The jury found for PeaceHealth on the monopolization, conspiracy to monopolize and exclusive dealing claims, but for McKenzie on attempted monopolization, price discrimination and tortious interference. As damages, the jury awarded
$5.4 million, which the district court trebled to $16.2 million; and the district court also awarded approximately $1.6 million in attorneys’ fees, costs and expenses. PeaceHealth appealed, and McKenzie cross-appealed.
The Legality of “Bundled Discounts”
On PeaceHealth’s appeal, the Ninth Circuit first addressed the attempted monopolization verdict for PeaceHealth’s “bundling.” The Ninth Circuit began with a general discussion of bundling, which the court
defined as “the practice of offering, for a single price, two or more goods or services that could be sold separately.” A “bundled discount” then occurs “when a firm sells a bundle of goods or services
for a lower price than the seller charges for the goods or services purchased individually.” The court noted that bundled discounts are “pervasive” and frequently result in savings for both buyers and sellers.
As such, for the Ninth Circuit, the pervasiveness of bundled discounts and the potential pro-competitive benefits cautioned against an overly broad liability standard. At the same time, the court recognized, bundled discounts could
be used to exclude a less diversified—but more efficient—competitor who cannot match or beat the bundled discount, thereby reducing consumer welfare in the long run. For example, McKenzie alleged that it could provide
primary and secondary services at a lower cost than PeaceHealth; thus, PeaceHealth (theoretically) could “freeze” McKenzie out of the market for those services, even if it is more efficient, because McKenzie does not
provide as many services and therefore could not match the discount PeaceHealth offers to insurers.
With that background, the Ninth Circuit set out to find “where antitrust law draws the line between bundled discounts that are procompetitive and part of the normal rough-and-tumble of our competitive economy and bundled discounts,
offered by firms holding or on the verge of gaining monopoly power in the relevant market, that harm competition and thus are proscribed by § 2 of the Sherman Act[.]” The district court’s instruction was drawn
from the Third Circuit’s en banc decision in LePage’s Inc. v. 3M, 324 F.3d 141 (3d Cir. 2003), which upheld a jury’s finding that the manufacturer of Scotch brand tape wrongfully employed a bundled rebate
structure to exclude a less-diversified (and less efficient) rival from the private label tape market. The Ninth Circuit agreed with PeaceHealth, and with the Antitrust Modernization Commission, that the LePage’s standard “does not consider whether the bundled discounts constitute competition on the merits, but simply concludes that all bundled discounts offered by a monopolist are anticompetitive with respect to its competitors who
do not manufacture an equally diverse product line” and thus “could protect a less efficient competitor at the expense of consumer welfare.” Citing the Supreme Court’s recent decision in Weyerhaeuser Co. v. Ross-Simmons Hardwood Lumber Co.,
127 S. Ct. 1069 (2007), along with Brooke Group Ltd. v. Brown & Williamson Tobacco Corp., 509 U.S. 209 (1993), the Ninth Circuit concluded that, ordinarily, above-cost pricing will not violate the antitrust laws and
courts should exercise “strong caution” against condemning bundled discounts that result in above-cost prices. Thus, the court held that “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” (emphasis added).
As the appropriate cost-based rule, the Ninth Circuit looked to antitrust scholars, two district courts and the Antitrust Modernization Commission report and adopted the “discount attribution” standard. Under this standard,
a defendant’s bundled discount is legal unless it has the potential to exclude a “hypothetical” equally efficient producer of the competitive product. To determine this, the fact-finder must allocate the full amount of the package discount to the competitive product or products; and, if the resulting price of the competitive product or products is below the defendant’s incremental cost to produce them, then the fact-finder may
find that the bundled discount violates Section 2. The Ninth Circuit then applied its own precedent, consistent with that of other circuits and certain scholarly literature, to define “incremental cost” as the average
variable cost.
Because the district court instructed the jury based on the LePage’s standard—which the Ninth Circuit rejected—the instruction contained an error of law, and the verdict was vacated for further determination
as to whether “PeaceHealth priced its own services below an appropriate measure of its cost, as we have defined that concept using the discount attribution rule.”
McKenzie’s State Law Claims
The Ninth Circuit also vacated the jury’s verdict for McKenzie on its claim of “primary line” discrimination under Oregon state law (primary line meaning conduct, like predatory pricing, that injures the defendant’s
direct competitors). McKenzie alleged that PeaceHealth’s pricing favored the insurer choosing PeaceHealth as the exclusive preferred provider over the insurer without an exclusive arrangement. As with the attempted monopolization
claim, the district court’s jury instruction for primary line price discrimination did not require the jury to find that PeaceHealth priced its services below cost.
The Ninth Circuit found the district court’s jury instruction to be erroneous—even though it comported with a 1978 decision from the Oregon Supreme Court. Because the Oregon law mirrors the federal Robinson-Patman Act,
and the Oregon Supreme Court has held that federal price discrimination cases are important persuasive authority in interpreting the state price discrimination law, the Ninth Circuit concluded that “the Oregon Supreme Court,
if presented with the opportunity, would follow Brooke Group and require a plaintiff alleging primary-line price discrimination to prove that its rival priced below cost.” Moreover, because the Ninth Circuit vacated
the jury’s verdict in McKenzie’s favor on its antitrust claims, the court also vacated the favorable verdict on the complementary state-law tortuous interference claim.
McKenzie’s Cross-Appeal of Summary Judgment on the Tying Claim
Last, the Ninth Circuit considered McKenzie’s cross-appeal and decided that the district court should have allowed McKenzie’s tying claim to go to the jury. McKenzie alleged that PeaceHealth illegally tied its provision
of primary and secondary services to its provision of tertiary services in violation of the Sherman Act, Section 1. The district court had granted summary judgment to PeaceHealth on the tying claim, finding that McKenzie did not
show “coercion” as a matter of law. The Ninth Circuit disagreed, observing that “when all justifiable influences are draw in McKenzie’s favor, there is no doubt that PeaceHealth’s practice of giving
a larger discount to preferred provider may have coerced some insurers to purchase primary and second services from PeaceHealth rather than McKenzie.” For example, the court noted that just four out of twenty-eight insurers
operating in Lane County (14%) purchased PeaceHealth’s services separately; and McKenzie provided some evidence that it offered lower prices than PeaceHealth for primary and secondary services. Further, “[t]he substantial
market power PeaceHealth possessed as a result of being the exclusive provider of tertiary services in Lane County creates a possibility that PeaceHealth was able to force unwanted purchases of primary and secondary services.”
Consequently, the Ninth Circuit vacated the district court’s order granting summary judgment to PeaceHealth and remanded for further proceedings.
Conclusion
The PeaceHealth decision followed a somewhat unusual move two weeks after the oral argument in March, when the Ninth Circuit granted leave for “any person or entity wishing to file a brief as an amicus curiae in response to this order” to file a brief addressing the proper legal standard to evaluate PeaceHealth’s bundled discounts under the Sherman Act, Section 2. Numerous companies and groups thereafter filed amicus briefs, including the American Antitrust Institute (joined by the Consumer Federation of America and Consumers Union), Verizon, Microsoft, Visa U.S.A., Coca-Cola and Genentech. The court also was aided significantly by the Antitrust
Modernization Commission’s Report and Recommendations, which were submitted to Congress and the President on April 2, 2007, as well as the substantial body of academic literature on predatory pricing.
Although the Ninth Circuit ultimately reversed the jury’s verdict and adopted in substantial part the cost-based legal standard urged in the Commission’s report, the Ninth Circuit did not go as far as PeaceHealth as
some amici would have liked. In adopting the “discount attribution” standard as the appropriate measure of cost, the Ninth Circuit rejected the narrower “aggregate discount” rule, which would
condemn bundled discounts as anticompetitive only if the discounted price for the entire bundle does not exceed the bundling firm’s incremental cost to produce the entire bundle. Although the “aggregate discount”
rule would be consistent with the single product discount rule established in Brooke Group and Weyerhauser, the Ninth Circuit did not believe the same “safe harbor” necessarily was warranted for bundled
discounts. Indeed, according to the Ninth Circuit, Brooke Group “marked the culmination of nearly twenty years of scholarly and judicial analysis of the feasibility and competitive effects of single product predatory
pricing schemes,” and reflected a cost-benefit analysis of the risks of false positives and overdeterrence. By contrast, the Ninth Circuit cited the limited judicial and academic inquiry into the prevalence of anticompetitive
bundled discounts and concluded that the discount attribution standard would best guide parties and the courts as they grapple with the antitrust issues in the future. In this way, the Ninth Circuit implicitly acknowledged the fluid
nature of the antitrust laws and the interplay between experience and economic theory. It will be interesting to see in the coming months how these parties deal with the Ninth Circuit’s decision—whether they seek en
banc review and/or certiorari—as well as the reception PeaceHealth will receive from the antitrust community and other federal courts.