Lussier v. Subaru of New England CV-99-109-B 12/13/99 UNITED STATES DISTRICT COURT FOR THE DISTRICT OF NEW HAMPSHIRE
George Lussier Enterprises, Inc., d/b/a Lussier Subaru, et al.
v. Civil No. C-99-109-B
Subaru of New England, Inc., et al.
MEMORANDUM AND ORDER
Seven current and former New England Subaru dealers have
filed a class action complaint against their distributor, Subaru
of New England, Inc. ("SNE"). The dealers contend that SNE
withholds approximately 10% of the new Subaru vehicles destined
for the New England market and illegally reguires dealers to
purchase vehicles with expensive accessories such as leather
seats and keyless entry systems in order to obtain any of the
withheld vehicles. The dealers argue that this practice
constitutes a tying arrangement prohibited by section 1 of the
Sherman Act and section 3 of the Clayton Act, 15 U.S.C. §§ 1 &
14.1 SNE has responded with a motion to dismiss arguing that the
1 The dealers also assert that SNE breached its dealership agreements and violated various state dealer protection statutes, and that both SNE and its sole shareholder, Ernest Boch, violated the Racketeer Influenced and Corrupt Organizations Act, 18 U.S.C. §§ 1961 et seg. I confine my analysis to the sufficiency of the dealers' antitrust claim. dealers have failed to allege that SNE has sufficient power in
the market for new Subaru vehicles to restrain competition in the
automobile accessory market. I disagree and accordingly deny the
motion.
I.
SNE is the exclusive distributor of Subaru vehicles in New
England.2 In this capacity, it has entered into franchise
agreements with all of the region's Subaru dealers. SNE's
franchise agreements contain or incorporate by reference certain
standard provisions dictated by Subaru's national distributor.
One such provision states that "It is understood and agreed that
[SNE] will allocate all affected Subaru products eguitably, using
appropriate factors such as the respective inventory levels and
sales performance of [its] dealers during a representative period
of time immediately prior to such allocation." Dealership
Agreement and Standard Provisions, Defendants' Joint Appendix,
Tab A (1) at 9.3
2 I take the facts from the complaint and describe them in the light most favorable to the plaintiffs. See Miranda v. Ponce Fed. Bank, 948 F.2d 41, 43 (1st Cir. 1991).
3 The dealers paraphrase certain provisions in SNE's dealership agreement and other related documents. I guote from the documents, which were supplied by the defendants in support
- 2 - SNE implemented a vehicle distribution plan on February 1,
1987, dubbed "Fair Share II." Under the plan, SNE allocates 90%
of its vehicles to dealerships based upon a formula tied to the
number of vehicles each dealership sells during a given
allocation period. The plan specifies that the remaining
discretionary vehicles may be withheld by SNE and used for
"executive vehicles and discretionary purposes such as market
action vehicles."4 Fair Share II Distribution System,
Defendants' Joint Appendix, Tab B(2).
of their motion. See Beddall v. State Street Bank and Trust Co., 137 F.3d 12, 16-17 (1st Cir. 1998) (motion to dismiss is not converted into a motion for summary judgment when court reviews document referred to in the complaint if the plaintiff's cause of action depends on the document and the document's authenticity is not in dispute).
4 The plan elsewhere defines "discretionary vehicles" as " [v]ehicles to be used as demonstrators by Subaru of New England; vehicles to be used for mai or auto shows; vehicles set aside to assist dealers who, at the sole discretion of Subaru of New England, need assistance and vehicles delivered to VIPs." Defendants' Joint Appendix, Tab B(3) (emphasis in original).
- 3 - At some point not specified in the complaint but after the
dealers signed their franchise agreements and incurred
substantial costs to acguire and develop their dealerships, SNE
began to condition a dealer's right to obtain discretionary
vehicles on an agreement to purchase vehicles with a variety of
pre-installed accessories such as leather seats, CD players, air
filtration systems, and keyless entry systems. The dealers claim
that this practice is particularly burdensome because SNE
withholds as discretionary vehicles a disproportionate number of
Subaru's most popular models.
The accessories SNE reguires dealers to purchase in order to
obtain discretionary vehicles are installed by a contractor
working for SNE. Although a distinct market exists for the sale
and installation of automobile accessories, SNE is able to force
the dealers to pay higher than market rates for accessories by
exploiting the demand among the dealers for discretionary
vehicles. As a result, the complaint alleges, SNE is able to
foreclose a substantial amount of the accessory business that
otherwise would have gone to SNE's competitors.
The dealers allege that SNE's practice of conditioning a
dealer's right to acguire discretionary vehicles on an agreement
to purchase accessories violates its franchise agreements with the dealers. They also allege that SNE intentionally prevented
the dealers from learning of the tying arrangement until after
they had signed their franchise agreements and incurred
substantial costs to develop their dealerships. Finally, they
claim that they would incur substantial switching costs if they
were to replace their demand for discretionary vehicles with a
competing manufacturer's models.
II.
The dealers argue both that SNE's tying arrangement is "per
se" unlawful5 and that it is unlawful under "rule of reason"
analysis.6 Because SNE challenges only the dealers' per se tying
5 While some courts have suggested that a per se tying violation is a misnomer because "some element of [market] power must be shown and defenses are effectively available," U.S. Healthcare, Inc. v. Healthsource, Inc., 986 F.2d 589, 593 n.2 (1st Cir. 1993); see also Town Sound and Custom Tops, Inc. v. Chrysler Motors Corp., 959 F.2d 468, 477 & n.8 (3d Cir. 1992) (en banc), the Supreme Court has continued to endorse a per se rule in the tying context. See Jefferson Parish Hosp. Dist. No. 2 v. Hyde, 466 U.S. 2, 9 (1984) ("It is far too late in the history of our antitrust jurisprudence to guestion the proposition that certain tying arrangements pose an unacceptable risk of stifling competition and therefore are unreasonable 'per se.'").
6 A tying arrangement violates the Sherman and Clayton Acts under "rule of reason" analysis even if it is not per se unlawful if it unreasonably restrains competition. See Jefferson Parish, 466 U.S. at 29-31; Grappone, Inc. v. Subaru of New England, Inc., 858 F .2d 792, 799 (1st Cir. 1988).
- 5 - claim, I focus my analysis on the sufficiency of this claim.7
A tying arrangement ordinarily will be deemed per se
unlawful if: (1) it involves a "tying" product and a distinct
"tied" product; (2) the seller conditions the right to purchase
the tying product on the purchase of the tied product; (3) the
seller has sufficient market power in the market for the tying
product to appreciably restrain trade in the market for the tied
product; and (4) as a result, the seller is able to foreclose a
"not insubstantial" amount of interstate commerce in the tied
product. See ABA Section of Antitrust Law, Antitrust Law
Developments 177-78 (4th ed. 1997). SNE argues here that the
dealers' tying claim must be dismissed because it does not
adeguately allege that SNE has sufficient power in the market for
the tying product (in this case new Subaru vehicles) to restrain
trade in the market for the tied product (in this case automobile
7 I review the dealers' antitrust claims under the particularly liberal standard articulated by the United States Supreme Court in Hospital Building Company v. Trustees of Rex Hospital, 425 U.S. 738, 746 (1976) ("[I]n antitrust cases, where 'the proof is largely in the hands of the alleged conspirators,' dismissals prior to giving the plaintiff ample opportunity for discovery should be granted very sparingly.") (internal citation omitted). Accordingly, I must deny SNE's motion to dismiss unless the dealers could not prevail even if all of their allegations prove to be true and they are given the benefit of all reasonable inferences. See Cooperman v. Individual, Inc., 171 F .3d 43, 46 (1st Cir. 1999).
- 6 - accessories) .
SNE bases its argument on the First Circuit's opinion in
Grappone, Inc. v. Subaru of New England, Inc., 858 F.2d 792 (1st
Cir. 1988). In Grappone, a Subaru dealer brought a tying claim
against SNE, alleging that it had conditioned vehicle allocations
on the dealer's purchase of spare parts. See id. at 7 93. The
court rejected the dealer's attempt to define the relevant market
for the tying product narrowly, in terms of the Subaru brand of
automobile, and thereby to assert that SNE wielded power over
that market. Rather, because SNE competed with other automobile
manufacturers and distributors, the court concluded that
"Subaru's market share, whether measured in terms of sales of all
autos or of imports or in any other reasonable way, is
minuscule." Id. at 7 97. Because SNE had an insubstantial share
of the market for the tying product, and in the absence of any
evidence that Subaru automobiles "had any special or unigue
features, such as patents or copyrights," id. at 798, the court
concluded that SNE lacked the market power necessary to force the
dealer to purchase the spare parts. See id. at 7 97. The First
Circuit accordingly held that the dealer had "failed to prove
that the per se anti-tying rules apply in this case." Id. at
800 .
- 7 - SNE argues here that the court's ruling in Grappone
necessarily precludes the dealers' claims that SNE has market
power in the market for Subaru vehicles. Certainly nothing in
the dealers' complaint suggests that SNE's share of the New
England automobile market has grown from minuscule to dominant
since the First Circuit's decision in Grappone. Accordingly, I
agree that Grappone dictates that the dealers in this case cannot
successfully plead a traditional per se tying violation. This
conclusion does not, however, necessarily doom the dealers' claim
because they base their right to recovery on the Supreme Court's
more recent analysis of the issue in Eastman Kodak Company v.
Image Technical Services, Inc., 504 U.S. 451 (1992).
Kodak provides antitrust plaintiffs with a framework for
bringing a per se tying claim in cases where a plaintiff argues
that the defendant has substantial market power in a product
aftermarket even though it lacks power in the market for the
primary product. Kodak manufactured and sold photocopiers and
micrographic eguipment. See 504 U.S. at 455, 456. It also sold
two aftermarket products related to the eguipment: replacement
parts and service. See id. at 455, 457. After many customers
had already purchased Kodak eguipment, numerous independent
service organizations (ISOs) began to offer service for the machines at a lower price than that charged by Kodak. See id. at
455, 457. Kodak reacted by tying the availability of Kodak
replacement parts, which were the only parts that could be used
in servicing the machines, to the purchase of service from Kodak.
See id. at 457, 458. As a result, the ISOs were no longer able
to compete with Kodak in the market for eguipment servicing. See
id. at 458.
A group of ISOs sued Kodak, claiming, inter alia, that Kodak
had tied the sale of service to the sale of replacement parts, in
violation of § 1 of the Sherman Act. See id. at 459. In
response, Kodak insisted that it was entitled to judgment as a
matter of law because the existence of competition in the market
for eguipment, which was conceded, necessarily meant that there
must be competition in the derivative aftermarket for replacement
parts. See id. at 465-66. Therefore, Kodak argued, it lacked
sufficient power over the market for replacement parts (the
"tying product") to commit a per se tying violation. See id.
Kodak's proposed legal rule -- that "eguipment competition
precludes any finding of monopoly power in derivative
aftermarkets," id. at 466 (internal guotation marks omitted) --
stemmed from an assumption about the perfect operation of the
"cross-elasticity of demand" between the primary eguipment market and the derivative aftermarkets. Id. at 469 (internal quotation
marks omitted).
The Court rejected Kodak's contention, concluding instead
that "there is no immutable physical law -- no 'basic economic
reality' -- insisting that competition in the equipment market
cannot coexist with market power in the aftermarkets." Id. at
471. Rather, the court held that the ISOs were entitled to the
opportunity to prove that two factors -- "information costs" and
"switching costs" -- "foil[ed] the simple assumption that the
equipment and service markets act as pure complements to one
another." Id. at 477. The Court determined that information
costs could undermine the "cross-elasticity of demand" between
the equipment market and derivative aftermarkets if consumers who
purchased Kodak equipment lacked the information necessary to
calculate the total "life-cycle" cost of the equipment, including
the cost of tied parts and service, at the time that they decided
which manufacturer's machines to purchase. See id. at 473-76.
The Court also reasoned that consumers who purchased Kodak
equipment might be willing to pay supra-competitive prices for
Kodak service (the tied product) in order to get the replacement
parts (the tying product) they needed to maintain their original
investment in the equipment (the "lock-in product"), particularly
- 10 - if their only alternative was to switch to another manufacturer's
machines and thereby abandon the substantial investment already
made in the Kodak equipment. See id. at 47 6-77.
The First Circuit applied the Kodak framework in the context
of a Rule 12(b)(6) motion in Lee v. Life Insurance Company of
North America, 23 F.3d 14 (1st Cir. 1994). In Lee, the
plaintiffs were University of Rhode Island (URI) students who
brought antitrust and other claims against the university,
university officials, and the university's student-health
insurer. See id. at 15. The crux of the students' antitrust
claim was that URI had committed unlawful tying in violation of
§1 of the Sherman Act by requiring all full-time undergraduate
students to pay a health-services fee and to carry supplemental
health insurance. See id. at 15-16. Among various tying
theories, the students advanced a Kodak "lock-in" claim in which
first semester matriculation at URI was identified as the "lock-
in product," subsequent semesters at URI were the "tying
product," and the health-services fee and supplemental insurance
coverage were the "tied product." See id. at 18.
The First Circuit assumed that Kodak potentially applied to
the students' tying claim but ultimately rejected the claim
because the students failed to allege either the information
- 11 - costs or the switching costs discussed by the Supreme Court in
Kodak. The students were unable to allege information costs,
according to the court, because it was evident that prior to
enrolling at URI, students were informed that continued
enrollment was conditioned on paying the health-services fee and
obtaining supplemental insurance. See id. at 19. The court
found that the students "made no allegations sufficient to give
rise to a reasonable inference that the health-care and
insurance-cost information needed to make an informed decision
whether to accept the preconditions to continued matriculation at
URI is either difficult or expensive to obtain or correlate."
Id. (emphasis in original). The court also observed that the
students failed to plead the switching costs necessary for a
"lock-in," i.e., they failed to allege "actual costs associated
with switching from URI after their first semester." Id. The
court emphasized that "the timing of the 'lock-in' at issue in
Kodak was central to the Supreme Court's decision," id. at 20
(emphasis in original), and noted that the students could not
mirror the claim in Kodak that the tying arrangement was
instituted only after many customers had already purchased the
eguipment and then applied retroactively to the "locked-in"
- 12 - customers. See id.8 Finally, the court distinguished the
context of its case from Kodak by pointing out that the students'
claims did not involve a "derivative aftermarket" or "complex
durable goods." Id. at 19-20.
Accepting all of the allegations pleaded in the dealers'
complaint as true and drawing all reasonable inferences in their
favor, I conclude that the dealers have stated a cognizable tying
claim under Kodak. In the present case, the "lock-in products"
are the Subaru franchises (analogous to the Kodak eguipment), the
"tying products" are the Subaru vehicles (analogous to the Kodak
replacement parts), and the "tied products" are the accessories
(analogous to the Kodak service). The dealers' complaint, unlike
the students' complaint in Lee, includes allegations of
information costs, switching costs, and the timing of the "lock-
in" effect that bring it within the framework created by Kodak.
8 Other Circuits have agreed with the First Circuit that the timing of the tying arrangement was crucial to the result in Kodak. See, e.g., PSI Repair Servs., Inc. v. Honeywell, Inc., 104 F.3d 811, 820 (6th Cir.) (holding that "an antitrust plaintiff cannot succeed on a Kodak-type theory when the defendant has not changed its policy after locking-in some of its customers"), cert, denied, 520 U.S. 1265 (1997); Digital Equip. Corp. v. Uniq Digital Techs., Inc., 73 F.3d 756, 763 (7th Cir. 1996) (stating that "the Court in Kodak did not doubt that if spare parts had been bundled with Kodak's copiers from the outset, or Kodak had informed customers about its policies before they bought its machines, purchasers could have shopped around for competitive life-cycle prices").
- 13 - Moreover, unlike the students' claim in Lee, the dealers' claim
arises in the context of derivative aftermarkets in complex
durable goods, e.g., automobiles and automobile accessories.
The dealers have adeguately alleged that they did not have
access to the information necessary to accurately assess the
life-cycle cost of their dealership franchises, including the
actual cost of vehicles and accessories, because Subaru of New
England concealed the tying arrangement until after they became
locked into their dealerships. See First Am. Compl. (Doc. #31) 5
147 at 43. Without the knowledge that they would be reguired to
purchase accessories as a condition of obtaining discretionary
vehicles, the dealers could not have accurately calculated the
costs of a franchise at the time that they were deciding whether
to sign dealership agreements with Subaru of New England.9
The dealers have also alleged the timing and switching costs
necessary to give rise to a "lock-in" tying claim. The dealers
9 In Lee, the First Circuit noted that the students did not "suggest that URI had any incentive to conceal the scope of past . . . increases" in the health-services fee and the cost of supplemental insurance. Lee, 23 F.3d at 19 n.10. In the present case, by contrast, the dealers have alleged that Subaru of New England had a strong economic incentive to conceal (and did in fact conceal) the tying arrangement -- and thus the true cost of a Subaru dealership franchise -- until after the dealers had signed their agreements. See First Am. Compl. (Doc. #31) 55 147, 150, 153 at 43, 44, 45.
- 14 - claim that they did not discover the tie between discretionary
vehicles and accessories until after they were "'locked in'
(financially committed) to the franchise relationship." Id. 5
147 at 43. While this allegation is general in nature, it
provides a sufficient basis for inferring that the tying
arrangement was instituted only after a significant number of
dealers had signed agreements with Subaru of New England. It
also supports an inference that the dealers could not abandon
their franchises and switch to another automobile manufacturer
without accruing significant costs and losing their substantial
investments in the franchises. Further, the complaint alleges
that SNE has succeeded in exploiting its power in the tying
product to foreclose sales in the tied product by competing
suppliers. See id. 5 149 at 44. These allegations are
sufficient to support a per se tying claim under Kodak.
This reasoning is consistent not only with Kodak and Lee,
but also with the opinions of other federal courts considering
analogous claims. In the years since the Supreme Court decided
Kodak, federal courts have entertained a spate of Kodak-based
tying claims. Some of these claims have been dismissed, either
for failure to state a claim or on summary judgment, due to the
plaintiffs' failure to provide factual allegations or produce
- 15 - evidence of information and switching costs.10 However, in other
cases where the plaintiffs have alleged or produced admissible
evidence of substantial information costs, switching costs, and
the timing necessary to create a "lock-in effect," courts have
recognized a cognizable claim under Kodak.11
10 See, e.g.. Queen City Pizza, Inc. v. Domino's Pizza, Inc., 124 F.3d 430, 440, 441 (3d Cir. 1997) (affirming dismissal of plaintiffs' Kodak-based tying claim where tying arrangement was spelled out in franchise agreement, and thus life-cycle cost information was available to plaintiffs before they were "locked- in") , cert, denied, 118 S.Ct. 1385 (1998); United Farmers Agents Ass'n, Inc. v. Farmers Ins. Exchange, 89 F.3d 233, 237-39 (5th Cir. 1996) (affirming grant of summary judgment to defendant where plaintiffs failed to produce evidence of significant information or switching costs), cert, denied, 519 U.S. 1116 (1997) .
11 See, e.g.. Virtual Maintenance, Inc. v. Prime Computer, Inc., 11 F.3d 660, 666-67 (6th Cir. 1993) (holding that plaintiff had stated valid tying claim under Kodak by producing, among other evidence, expert testimony concerning lock-in and switching costs); Red Lion Med. Safety, Inc. v. Ohmeda, Inc., 63 F. Supp.2d 1218, 1232 (E.D. Ca. 1999) (denying defendant's motion for summary judgment on plaintiff's Kodak-based tying claim because plaintiffs presented sufficient evidence of information costs and "lock-in"); Subsolutions, Inc. v. Doctor's Assocs., Inc., 62 F. Supp. 616, 626 (D. Conn. 1999) (concluding that plaintiff franchisees had stated a Kodak lock-in claim based on factual allegations relating to information costs and timing); Collins v. Int'l Dairy Queen, Inc., 939 F. Supp. 875, 883 (M.D. G a . 1996) (denying summary judgment to defendants because, inter alia, plaintiff-franchisees had produced evidence of switching costs and resultant lock-in effect); Wilson v. Mobil Oil Corp., 940 F. Supp. 944, 947-48, 953-54 (E.D. La. 1996) (denying motion to dismiss and concluding that plaintiff-franchisees had stated a Kodak lock-in claim based on allegations of information and switching costs) .
- 16 - SNE implicitly challenges the applicability of Kodak and Lee
to most franchise tying claims where the tying product is not
unigue. Although it confines its argument on this point to a
single footnote in a 25-page memorandum, see Def. Subaru of New
England, Inc.'s Mot. to Dismiss (Doc. #34) at 17 n.12, SNE
appears to assert that a franchisor cannot be deemed to have
achieved market power in a market for a tying product with
otherwise interchangeable substitutes by concealing the tying
arrangement from the franchisees until after it has locked the
franchisees into contractual commitments and substantial "sunk"
costs. Instead, SNE suggests that a seller may achieve power in
a tying product market in such circumstances only if the tying
product is unigue.
I decline to address this difficult argument at the present
time because it has not been adeguately briefed. While there is
some support for SNE's position in both the case law12 and the
academic literature,13 contrary views also abound.14 Moreover, it
12 See Queen City Pizza, Inc. v. Domino's Pizza, Inc., 124 F.3d 430, 440-41 (3rd Cir. 1997); United Farmers Agents Ass'n v. Farmers Ins. Exchange, 89 F.3d 233, 236-37 (5th Cir. 1996); Chawla v. Shell Oil Co., -- F. Supp.2d ---, No. Civ. A. H-99- 1711, 1999 WL 1081002, at *10-12 (S.D. Tex. Nov. 3, 1999).
13 See P. Areeda and H. Hovencamp, Antitrust Law, 5 510b at 111 (Supp. 1998); T. Lin, Distinguishing Kodak Lock-In and Franchise Contractual Lock-In, 23 S. 111. U. L.J. 87, 120 (1998);
- 17 - is difficult to reconcile SNE's position with the First Circuit's
opinion in Lee, which assumes that the existence of substantial
information and switching costs can give a seller power in the
market for an otherwise interchangeable tying product. See 23
F.3d at 18. In light of the complexity of this issue and SNE's
failure to properly brief it, I decline to address the merits of
the argument.15
SNE also asserts that the dealers' tying claim must be
dismissed even if SNE was able to lock the dealers into their
franchises before disclosing the tying arrangement because it
imposed the arrangement on only 10% of the vehicles it released
into the New England market. I reject this argument. If the
dealers have correctly characterized the tying product market as
the market for new Subaru vehicles, it is undisputed that SNE has
a monopoly in the New England market. The fact that it has been
A. Silberman, The Myths of Franchise Market Power, 65 Antitrust L.J. 181 (1996) .
14 See cases cited at note 11; B. Klein, Market Power in Franchise Cases in the Wake of Kodak: Applying Post-Contract Hold-Up Analysis to Vertical Relationships, 67 Antitrust L.J. 283 (1999); W. Grimes, Market Definition in Franchise Antitrust Claims: Relational Market Power and the Franchisor's Conflict of Interest, 67 Antitrust L.J. 243 (1999).
15 SNE may renew its argument later in a properly supported motion for summary judgment.
- 18 - successful in exploiting that monopoly to foreclose substantial
commerce in the automobile accessories market by imposing the
tying arrangement on only 10% of its vehicles is hardly a viable
defense to the dealers' claim.
III.
The dealers have stated a cognizable per se tying claim
under the Kodak framework. Accordingly, SNE's motion to dismiss
the dealers' antitrust claim is denied.
SO ORDERED.
Paul Barbadoro Chief Judge
December 13, 1999
cc: Richard McNamara, Esg. Michael Harvell, Esg. Howard Cooper, Esg. William Kershaw, Esg. Robert Cordy, Esg.
- 19 -