Differentiating between Horizontal and Vertical Restraints - ABA YLD 101 Practice Series

By Daniel J. Fletcher

Generally, restraints on trade are agreements between two or more companies that force the participants to behave in a certain way. Such agreements become a concern of antitrust law when they unreasonably harm competition between companies. However, instead of hindering competition, some restraints actually provide pro-competitive benefits to companies, such as increasing the participant's efficiency. Thus, antirust law seeks to condemn those restraints that hurt competition and allow those that help.
A helpful first step in analyzing restraints of trade is to classify the agreement as either a vertical or horizontal restraint.

Classifying Restraints

  • Classifying a restraint as horizontal or vertical depends on the relationship of the firms that entered into the agreement. If the companies are competitors that sell similar products (e.g. Coke and Pepsi), an agreement between them is known as a horizontal restraint. Alternatively, if the companies in question cooperate with each other in that one company uses the other's product (e.g. a sugar company and Pepsi); an agreement between them is known as a vertical restraint.
  • Examples of horizontal restraints include agreements between competitors to set prices (setting the price of soda at one dollar per can), set output (producing only one million cans of soda per year), or to allocate customers (Pepsi sells only to the West of the Mississippi River and Coke only to the East).
  • Examples of vertical restraints include exclusive dealing contracts (Pepsi will buy all of its sugar from one sugar company), and resale price maintenance (the sugar company then sets the price for a can of Pepsi).
  • In a vertical relationship, a company is either the upstream or downstream company. A company that sells its product to another company (e.g. a sugar company), is referred to as the upstream company. Therefore, a company that purchases the product from another company (e.g. Pepsi) is referred to as the downstream company.

The Applicable Law -- Sherman Act Section 1

  • The majority of restraints are challenged under Section 1 of the Sherman Act, which prohibits "contracts, combinations or conspiracies" in restraint of trade. See, 15 USC 1. ( Note: While restraints may also be challenged under Section 2 of the Sherman Act, which prohibits monopolization of a market, the majority of analysis falls under Section 1).
  • When challenging both horizontal and vertical restraints, there are three general steps to consider under Section 1.
    • First, one must prove that there was an agreement between the companies in question. ( Note: Proving that an agreement took place is a question of fact judged under the same standard for both vertical and horizontal restraints. See Parkway Gallery Furniture v. Kittinger/Pennsylvania House Group, 878 F.2d 801, 805 (4th Cir. 1989).)
    • Second, one must prove that the agreement unreasonably restrains trade.
    • Finally, one must prove that the agreement affects interstate commerce.
  • While all three steps are important, the majority of substantive antitrust analysis is done under the second step - which is to determine whether the restraint unreasonably restrains competition.

Restraints as "Unreasonable Restraints on Trade"

  • Determining whether a restraint is an "unreasonable restraint on trade" generally hinges on whether the restraint is a horizontal or vertical restraint.
  • Horizontal Restraints
    • Horizontal restraints that directly effect price or output are generally looked at skeptically under Section 1, and are considered per se illegal. See Northern Pac. Ry. v. United States, 356 U.S. 1, 5 (1958).
    • Per se illegal means that a court will presume that a restraint unreasonably restrains trade simply because of the nature of the restraint.
    • If a horizontal restraint occurs between two companies within the context of a cooperative, legal arrangement (such as a joint venture), the restraint will not be considered per se illegal, but will be judged under the rule of reason. See NCAA v. Board of Regents, 468 U.S. 85, 104 (1984).
    • Under the rule of reason, a court will conduct a detailed market analysis to determine whether the restraint will actually hurt competition; if it is determined that the restraint will hurt more than help, the restraint will be considered illegal. See id.
  • Vertical Restraints
    • Vertical agreements, especially those in non-price agreements, are generally looked at less skeptically and tend to be analyzed under the rule of reason. See Business Elecs. Corp. v. Sharp Elecs. Corp., 485 U.S. 717, 724 (1988).
    • It is important to note, however, that if a vertical agreement sets the price for the downstream company, the agreement will likely be held per se illegal under Section 1. See id.

Determining the legality of restraints can be a difficult task, but understanding the difference between horizontal and vertical restraints, a simple process, is the first step for successful analysis.

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About the Author

Daniel Fletcher received his J.D. from the University of Iowa in 2006 and is now an associate at Freshfields, Bruckhaus, Deringer in Washington, D.C.

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