Apple Ruling Heaps Doubt on 'MFN' Clauses

• 

• LAW JOURNAL
• July 14, 2013, 7:40 p.m. ET

Decision Has Implications for Industries Ranging From Entertainment to Health Care

By 
• JOE PALAZZOLO
 
• CONNECT

Guaranteeing the lowest price doesn't necessarily lead to lower prices—at least as far as a handful of federal courts are concerned.

In the latest example, a federal judge ruled last week that the price-matching provision in Apple Inc.'s contracts with five major book publishers was part of a conspiracy to fix e-book prices. The contracts required the publishers to give the technology giant's iTunes store the best deal in the marketplace on e-books.

Other courts have taken a similarly dim view of these so-called most-favored-nation clauses, which take their name from a longstanding principle of international trade and are common in industries ranging from health care to television to financial services. One skeptical ruling came in a recent Justice Department complaint against insurer Blue Cross Blue Shield of Michigan.

What is MFN?

• A most-favored-nation clause, in a business contract, requires the seller to provide the buyer the lowest price offered to any rival purchaser.
• Such arrangements can help protect long-term investments, eliminate bargaining delays and avoid price discrimination.
• The risk is that they create a financial incentive for the seller not to offer low prices, resulting in higher overall prices in the market. They can also be used by a company that dominates its market to keep out competitors.

But the finding by U.S. District Judge Denise Cote in the Apple case was especially significant because it was made following a trial, rather than in pretrial proceedings.

"Defendants in antitrust cases have liked to have the sound bite that no court has found an MFN to be anticompetitive," said Mark Botti, a former Justice Department antitrust lawyer now in private practice. "They can no longer say that."

Apple, meanwhile, has strongly denied that it conspired to fix prices, and has said it will appeal the decision.

Xinhua/Zuma Press

Chinese consumers play with Apple iPads, a popular device for e-books.

Judge Cote avoided a broad denunciation of MFN clauses, but her decision could haunt contract negotiations in industries as diverse as entertainment and health care, legal experts said. In recent years, the Justice Department has sued a few companies over the use of MFN clauses and is investigating others.

"While most favored-nation clauses can be competitively benign, when they are used as a tool to engage in anticompetitive conduct that harms consumers, the Antitrust Division will take enforcement action," said Assistant Attorney General Bill Baer, who oversees the division at the Justice Department.

MFN clauses guarantee the recipient the lowest prices or rates charged to any buyer. While in theory that could encourage competition and lower prices for consumers, in practice such agreements sometimes end up establishing a minimum price, according to antitrust lawyers and government officials.

Apple entered the e-books market in 2010, at time when Amazon.com Inc. accounted for between 80% and 90% of all e-book sales and was discounting titles below cost to lure customers to the new format and promote its Kindle e-book reader.

Apple's gambit was to let publishers set the prices themselves, under an "agency model," unless one of Apple's rivals was selling an e-book for less. In that case, the publishers would have to offer the same lower price in Apple's store, taking a hit on their margin.

Unwilling to do so, the publishers approached Amazon after reaching their agreements with Apple and demanded that it switch to the agency model, threatening to withhold e-books if it didn't, an Amazon executive testified at the Apple trial. Amazon relented, and in short order e-book prices for many new titles and best sellers jumped to $12.99 or more from $9.99.

Apple said the provisions guaranteed its customers would get the lowest price for new and popular e-books. But Judge Cote offered a less-flattering interpretation.

"[The MFN] eliminated any risk that Apple would ever have to compete on price when selling e-books, while as a practical matter forcing the publishers to adopt the agency model across the board," she wrote in her 160-page ruling.

The debate isn't unique to publishing. The Wall Street Journal reported in June 2012 that the Justice Department was investigating whether cable companies were acting improperly to quash competition from online video.

MFN clauses are among the issues getting scrutiny, according to people familiar with the matter.

The Justice Department declined to comment.

Some groups, including a Minnesota trade association that represents automotive-service providers, have asked the Justice Department and the Federal Trade Commission to investigate MFN clauses in their industries.

Judell Anderson, executive director of the Alliance of Automotive Service Providers of Minnesota, said such provisions in contracts between collision-repair shops and insurers has artificially depressed what the shops can charge for their labor.

Insurers that command the most market share will accept only the lowest rates for repairs, and their smaller competitors, knowing this, refuse to accept higher rates, fearing they'll lose business, she said in a letter to the two federal agencies last year.

In a 2010 antitrust lawsuit against Blue Cross Blue Shield, the dominant health insurer in Michigan, the Justice Department and state authorities took aim at contract provisions that required hospitals to offer the company the lowest non-government rate for hospital services.

The lawsuit said the provisions effectively forced hospitals to raise prices for Blue Cross's competitors, making it hard for them to compete.

A federal judge refused to dismiss the case in 2011, finding that it was "plausible" that Blue Cross's contracts hurt competition. However, the Justice Department voluntarily withdrew the complaint this year after Michigan passed a law barring insurers from using MFN clauses. Roughly 20 states have similar bans, according to James Burns, an antitrust lawyer at Dickinson Wright PLLC in Washington.

A spokeswoman for Blue Cross declined to comment.

Gregory Vistnes, an economist at consulting firm Charles River Associates, said the Apple case represented a counterpoint to the Blue Cross lawsuit. While the latter centered on the idea that a dominant player can use MFN clauses to block smaller rivals from entering the market, the Apple case presented a scenario in which no single market participant with MFN benefits had the power to raise prices, but could do so by acting in concert with others.

In coming weeks, the Justice Department is expected to ask Judge Cote to impose a variety of conditions on Apple's business, including barring the company from using MFN clauses.

Write to Joe Palazzolo at joe.palazzolo@wsj.com

A version of this article appeared July 15, 2013, on page B1 in the U.S. edition of The Wall Street Journal, with the headline: Apple E-Book Ruling Heaps New Doubt on 'MFN' Clauses.