Vertical Maximum Price Fixing: State Oil v. Khan

Vertical Maximum Price Fixing: State Oil v. Khan

98-218 A
March 5, 1998
CRS Report for Congress
Received through the CRS Web
Vertical Maximum Price Fixing: State Oil v. Khan
Michael V. Seitzinger
Legislative Attorney
American Law Division
.Summary
Respondent Khan and his corporation entered into an agreement with petitioner
State Oil to lease and operate a gas station owned by State Oil. Respondents agreed to
obtain the station’s gasoline supply from State Oil at a price equal to a suggested retail
price set by State Oil. The Supreme Court granted certiorari to consider whether State
Oil’s conduct constituted a per se violation of the Sherman Act.
The Court held that State Oil’s conduct did not constitute a per se violation of the
Sherman Act, thereby overruling an earlier Supreme Court case, Albrecht v. Herald Co.
The Court stated that, in overruling Albrecht, it was not holding that all vertical
maximum price fixing is per se lawful. Instead, vertical maximum price fixing should
be evaluated under the rule of reason.
Discussion
Respondent Khan and his corporation entered into an agreement with petitioner State
Oil to lease and operate a gas station owned by State Oil. Respondents agreed to obtain
the station’s gasoline supply from State Oil at a price equal to a suggested retail price set
by State Oil, less a margin of 3.25 cents per gallon. Respondents could charge any
amount for the gasoline sold to its customers, but, if it charged a price higher than State
Oil’s suggested retail price, the amount over 3.25 cents per gallon had to be rebated to
State Oil. If respondents sold gasoline for less than the suggested retail price, the decrease
would reduce its profit margin.
Respondents later fell behind in lease payments, and State Oil gave notice of its
intent to terminate the agreement. The state court appointed a receiver to operate the gas
station, and the receiver was not subject to the price restraints. The receiver had an
overall profit margin more than 3.25 cents per gallon by lowering the price of regular-
grade gasoline and raising the price of premium gasoline.
Respondents sued State Oil in the United States District Court for the Northern
District of Illinois and alleged that State Oil had engaged in price fixing in violation of
Congressional Research Service ˜ The Library of Congress

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Section 1 of the Sherman Act1 by preventing the raising or lowering of retail gas prices.
Respondents claimed that, by charging different prices on grades of gasoline as the
receiver did, it could have increased sales and profits.
The District Court found that the allegations did not state a per se violation of the
Sherman Act because they did not have the manifestly anticompetitive implications or
pernicious effect on competition that is required to justify finding a per se violation. The
District Court also concluded that respondents did not demonstrate antitrust injury or
harm to competition. The District Court entered summary judgment for State Oil.
The Court of Appeals for the Seventh Circuit reversed.2 The Seventh Circuit, after
reviewing the legal and economic aspects of price fixing, concluded that State Oil’s
pricing scheme was a per se antitrust violation under an earlier Supreme Court decision,
Albrecht v. Herald Co.,3 in which the Supreme Court held that the action of a newspaper
publisher in fixing a ceiling at which its distributors could resell the newspaper to the
public was illegal per se. Yet, the Seventh Circuit expressed dissatisfaction with the
Albrecht ruling.
We have considerable sympathy with the argument that Albrecht is
inconsistent with the cases that establish the requirement of proving antitrust
injury. In fact, we think the argument is right and that it may well portend the
doom of Albrecht. In Jack Walters & Sons Corp. v. Morton Building, Inc., 737
F.2d 698, 706-07 (7th Cir. 1984), we said we regarded the continued validity of
Albrecht as an open question, albeit for a different reason; that after Albrecht
the Supreme Court had (reversing its previous position) recognized that
exclusive dealer territories may be procompetitive. Continental T.V., Inc. v.
GTE Sylvania Inc., 433 U.S. 36, 97 S.Ct. 2549, 53 L.Ed.2d 568 (1977). As we
pointed out earlier in this opinion, and as one of the dissenting opinions in
Albrecht had pointed out as well, 390 U.S. at 169, 88 S.Ct. at 881-82, a price
ceiling is a natural and procompetitive incident to a scheme of territorial
exclusivity. The majority opinion in Albrecht had rejected this argument on the
ground that price fixing cannot be “justified because it blunts the pernicious
consequences of another distribution practice,” 390 U.S.at 154, 88 S.Ct. at 874,
namely exclusive territories. We now know that the consequences of that other
practice are not (not generally, at any rate) pernicious. So another prop beneath
Albrecht has been knocked away, although State Oil does not make the
argument from Sylvania, maybe because it does not grant its dealers exclusive
territories (the record is silent on the matter).4
The Supreme Court granted certiorari to consider whether State Oil’s conduct
constituted a per se violation of the Sherman Act and whether respondents are entitled to
damages based on State Oil’s conduct.
1 15 U.S.C. § 1.
2 93 F.3d 1358 (1996).
3 390 U.S. 145 (1968).
4 93 F.3d at 1363.

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The Court held that State Oil’s conduct did not constitute a per se violation of the
Sherman Act, thereby overruling Albrecht, and remanded to the Court of Appeals the
question of whether respondents are entitled to recover damages in light of the overruling
of Albrecht.5
Not only are the potential injuries cited in Albrecht less serious than the
Court imagined, the per se rule established therein could in fact exacerbate
problems related to the unrestrained exercise of market power by monopolist-
dealers. Indeed, both courts and antitrust scholars have noted that Albrecht’s
rule may actually harm consumers and manufacturers. See, e.g., Caribe BMW,
Inc. v. Bayerische Motoren Werke Aktiengesellschaft, 19 F.3d 745, 753 (C.A.
1 1994) (Breyer, C.J.); Areeda, supra, par. 1636a, at 395; G. Mathewson & R.
Winter, Competition Policy and Vertical Exchange 13-14 (1985). Other
commentators have also explained that Albrecht’s per se rule has even more
potential for deleterious effect on competition after our decision in GTE
Sylvania, because, now that vertical nonprice restrictions are not unlawful per
se, the likelihood of dealer monopoly power is increased....
After reconsidering Albrecht’s rationale and the substantial criticism the
decision has received, however, we conclude that there is insufficient economic
justification for per se invalidation of vertical maximum price fixing. That is
so not only because it is difficult to accept the assumptions underlying
Albrecht, but also because Albrecht has little or no relevance to ongoing
enforcement of the Sherman Act.6
The Court went on to state that, in overruling Albrecht, it was not holding that all
vertical maximum price fixing is per se lawful. Instead, the Court stated, like most
commercial arrangements subject to the antitrust laws, vertical maximum price fixing
should be evaluated under the rule of reason.
As for whether respondents are entitled to damages based on State Oil’s conduct, the
Court held that, with its overruling of Albrecht, this issue should be reviewed by the Court
of Appeals in the first instance.
5 State Oil Co. v. Khan, 118 S.Ct. 275 (1997).
6 118 S.Ct. at 283.