Roots of Antitrust Policy in the United States' Sherman Act Summary

Roots of Antitrust Policy in the United States' Sherman Act

• Origins of modern competition policies can be traced to the end of the 19th century in the USA.
• This was a reaction to the growth and economic power of certain companies.
• The growth resulted from economic development and increased competition.
• Companies formed large groups, establishing coalition relationships and becoming subject to the same control.
• This control was exercised through fiduciary contracts, leading to the term "trust" to designate these corporate structures.
• Legislation to control these groups, resize companies, and prevent excesses was named "antitrust."

Factors Allowing Increase in Company Size (Late 19th Century)

• Implementation of the railway network.
• Expansion of the telegraph and telephone, creating a single market.
• Companies exploited economies of scale and scope.
• Technological development in chemistry, metallurgy, and energy.
• Emergence of more advanced capital markets and efficient management systems.
• Liberalization of corporate rules allowed company enlargement via mergers and professionalization of managers.
• The period was characterized by low and unstable prices, with economic crises between 1873-79 and 1883-86 sometimes referred to as the "Great Depression."
• Companies organized themselves into trusts and cartels to reduce price wars and market instability.
• These agreements allowed them to:
  • Maintain high prices and margins.
  • Invest in machinery for more efficient production.
  • Eliminate small entrepreneurs.
  • Reduce wages.
• Price stability was achieved at the expense of consumers, farmers, small industrialists, and traders.
• They were subjected to discriminatory, unfair practices, and restrictive agreements.
• Monopolies of large companies were strengthened, eliminating small business competitors.
• Unfavorable conditions were imposed on those negotiating with large companies.
• Farmers witnessed falling selling prices contrasted with rising input prices, especially in transport and energy.
• This led to public outcry, culminating in state antitrust laws and the Sherman Act.

Antitrust Policy in Common Law

• The aim is to demonstrate the origins of at US antitrust policy by examining the Sherman Act.
• Begin by tracing the evolution of antitrust policy in Common Law.
• US antitrust policy has been forged by economic ideology.
• "Contract in restraint of trade" in England restricted a person's right to trade.
• Originally seen as harmful to people and those bound to them.
• Later, partial and reasonable restrictions were excluded under economic doctrine, requiring consideration.
• The rule of reason was enunciated in the English case of Mitchel v. Reynolds (1711).
  • Time and space limitations were the main criteria for assessing reasonableness.
• Restrictions could be admitted if ancillary to the main purpose of the contract.
  • Necessary for the enjoyment of fruits or to prevent unfair enjoyment by another party.
• In 1890, Maxim Nordenfelt Guns and Ammunition Co. v. Nordenfelt improved on Mitchel's decision.
  • Recognized enforceability of a partial restriction.
  • A 25-year worldwide non-compete obligation was imposed on Thorsten Nordenfelt after selling his arms company.
  • Lord Mcnaghten constructed a criterion for legality of restrictions:
    • "Justified by special circumstances of a particular case."
    • "Reasonable in reference to the interests of the parties concerned and reasonable in reference to the interests of the public."

Monopolies

• Historically, monopolies began as sums paid by the King to stop them from previously unrestricted commercial activity.
• This limited entry into the market.
• Monopolies were traditionally illegal because they limited individual freedoms.
• Contrary to the English Constitution and the interests of the people.
• Common law did not contain express prohibitions against monopolies set up by individuals, since these were an emanation of royal power; however, common law criticized the harmful results of monopolies.
• Individuals could engage in abusive behavior to obtain monopoly power, harming society.
• Common law criticized harmful results of monopolies like price rises, hoarding, distribution of territories, and limits on production.
• Unlawfulness was not centered on its creation by the individual, but on acts that could lead to its typical results, restricting the freedom to contract and causing harm to society.
• All contracts and acts with these effects were covered by the common law concept of restraint of trade.
• In Mogul Steamship Co. v. McGregor (1892), individuals were free to contract, not to contract, and to exercise any reasonable right unless it unfairly restricted trade.
• A cartel of shipowners used restrictive practices to prevent a rival, Mogul, from entering the market.
  • This agreement was considered a void restraint in trade because it was contrary to public policy.
• Restrictions contrary to public policy were not enforceable, even if not criminal offenses.
• In the United States, fear of monopoly justified acts being considered unconstitutional, including repression of contracts and acts by individuals that could lead to these effects.
• The US legal system adapted known restrictions to new behaviors that could produce monopoly results.
• Analysis of vertical restrictions balanced freedom of contract with freedom of trade.
• English legal system favored competition but recognized enforceable reasonable restrictions.
• The US legal system moved away from this position, influenced by neoclassical competition, denying enforceability of restrictions and criminalizing them.
• Faced with the inefficiency of state-level cartel and trust control, the Sherman Act was adopted in 1890 as a federal law.
  • Still a perfect example of antitrust legislation.

Sherman Act

• Sections 1 and 2 are the most relevant.
• Section 1 prohibits contracts, agreements, and conspiracies that restrict trade.
• Section 2 prohibits unilateral conduct by companies aimed at monopolizing or attempting to monopolize the market and conspiracies to monopolize any part of trade between different states or nations.
• Violations are treated as predicate offenses, punishable by high fines and prison sentences and can trigger civil proceedings.
• The generic nature of these provisions gives federal courts broad powers.
  • To draw the line between acceptable cooperation and illegal collusion.
  • To draw the line between aggressive competition and illegitimate monopolisation.
• Allows for unprecedented convergence between economics and the law.
• The Sherman Act allows for the progressive construction by case law of a competition policy that follows the evolution of economic doctrine.
• Section 1 prohibits any contract, association, or conspiracy that restricts trade.
  • Covers all practices that reduce output and increase price, including joint ventures, vertical agreements, and mergers.
  • Requires conduct resulting from the coordination of efforts of one or more economic agents.
• Section 2 prohibits companies from monopolizing or attempting to monopolize the market or conspiring to monopolize the market.
  • Covers all practices by which dominant companies maintain their monopolistic position and practices used by a company intending to monopolize the market.
• The use of the verb "monopolise" is interpreted as criminalising all anti- competitive conduct aimed at creating and maintaining monopolies, without, however, covering the mere possession of monopoly power.
• Proof of "the willful acquisition or maintenance of that power, as distinguished from growth or development as a consequence of a superior product, business accumen, or historic accident" is required.
• Courts are concerned that repressing monopolies obtained without violating competition will dissuade companies from competing on merits.
• Some defend criminalizing "no fault monopolisation," arguing that the mere existence of a monopoly increases price and reduces quantity.
• However, courts require that the acquisition and holding of a monopoly result from anti-competitive practices.
• Economists doubted the Sherman Act's effectiveness or feared it would prevent companies from joining to take advantage of economies of scale.

The Common Law School - Sherman Act: 1890-1914

• The early years of the Sherman Act were shaped by classical economics, associated with individual self-determination in resource allocation, limiting state intervention.

• Classical economics repudiated inequalities caused by special privileges from the state.

• Free enterprise was considered a fundamental value, compatible with how the market works.

• This notion of competition, justified censoring contracts in restraint of trade, as they restricted an individual or company in favor of the competitor.

• Anti-competitive behavior is identified with practices limiting freedom and coercion by one economic agent on another.

• Economic and contractual doctrine showed that some restrictions on contract freedom are important for industry and good faith.

• Case law developed the doctrine of consideration, making legality dependent on a quid pro quo for the non-competition obligation.

• Classic competition intertwined with the principle of freedom of contract.

• Restrictions on freedom could be legal if they resulted from a contract and provided consideration.

• Limitations in time and space evident in the rule of reason, paved the way for the admission of partial restrictions.

• Restrictions merely ancillary to the main purpose of the contract and necessary for the enjoyment of fruits or to prevent unfair enjoyment by another party began to be recognised as enforceable.

• Cartels and mergers didn't receive much attention because they weren't the result of a limitation on freedom, and the attack on monopolies was justified because they resulted from the granting of special privileges.

• The courts adopted a more demanding stance whenever restrictions concerned essential goods, which included price-fixing agreements and mergers, considering that these, given the effects produced, including price increases, constituted means of coercion and therefore an intolerable limitation on the freedom of consumers, who had no other alternatives.

• The rule of reason applied to this type of restriction with the following guiding criteria:

  • Limitation in time and space.
  • The use of coercive means against third parties.
  • The nature of the products.

• The Supreme Court also adopted the rule of reason for certain restrictions, considering that the restriction on the non-compete obligation was illegal if it was unreasonable.

• The courts found it difficult to apply to Section 1 against restraints in trade and Section 2 against cartels and mergers with the intention of acquiring or maintaining a monopoly, because the common law, influenced by classical competition and the emphasis on the freedom of individuals, looked down on voluntary agreements that restricted competition.

• The Sherman Act was initially limited to artificially imposed restrictions on individual freedom, without curing voluntary agreements that had the effect of increasing prices, unless they involved basic necessities.

• The Sherman Act, at this stage, was considered a mechanism through which the legislator had federalised the common law.

• US courts prohibited and considered unlawful contracts or acts with the intention of harming the public and unfairly restricting competitive conditions, limiting the rights of individuals, restricting free trade, increasing prices or reducing production.

• This interpretation of the Sherman Act under common law will favor the conclusion of horizontal agreements and the consequent increase in the size of business organizations.

• Neoclassical competition began to influence US economics and jurisprudence, characterized by hostility towards cartels and focus on consumer surplus and monopoly.

• This will essentially be characterized by hostility towards cartels, with the repression of price-fixing agreements, accompanied by a reduction in the repression of trade restrictions.

• Initially, cartels initially condemned involved basic necessities, but progressively this distinction lost importance and hostility towards cartels became widespread.

• In response to those who considered that these price-fixing agreements were the product of voluntary agreement between the parties, protected by freedom of contract, and therefore did not constitute unreasonable restraints of trade, the Supreme Court, replied that although freedom of contract has constitutional protection, the power of Congress to regulate interstate commerce is also protected by the Constitution.

• The courts began to shape the generic terms of the regulation, starting by distinguishing between forms of collaboration that suppress competition and those that promote growth.

• In 1897, the Supreme Court ruled that it was illegal, even after it had been voluntarily dissolved, for the fifteen railways that were part of the Trans-Missouri Freight Association, to set prices for the transport of goods by agreement.

• That the wording of the Sherman Act was intended to cover all contracts and acts that restricted trade without leaving any room for the rule of reason, with the result that the prohibitions contained therein had to be applied to all cases covered by the literal element.

• All the prohibitions contained in the Sherman Act applied to all contracts containing restrictions on interstate or international commerce without exceptions or limitations, and were therefore not limited to unfair restrictions.

• The reasoning put forward is a response to those who, like Judge White, argued that the Sherman Act only covered unreasonable restrictions and that, in this case, the reasonableness of the price fixing would depend on the Interstate Commerce Commission's (ICC) judgement of reasonableness on the price fixed.

• Peckham rejected the reasonableness criterion, which he considered to be subject to great uncertainty and very difficult to formulate.

• As far as competition is concerned, this United States v. Freight Association decision inaugurated the prohibition of price agreements between competitors, which is still a very strong principle in US law today, with few exceptions.

• the 6th Circuit's decision in Addyston Pipe and Steel Co. v. United States, considered that the rules contained in the Sherman Antitrust Act were subject to the rule of reason, invoking the common law principle according to which restrictions on trade can only be admitted if they are merely ancillary to the main purpose of the contract and if they are necessary for the enjoyment of fruits or to prevent them from being enjoyed by third parties

• Taft distinguishes between naked trade restraints, in which the rivals agreed to restrict output and increase prices, which were therefore unreasonable and unnecessary given the objectives of the agreement, and reasonable ancillary restraints, in which the restriction was to the extent necessary to increase output or create a new product that only one of the parties alone could not produce.

• Underlying the determination of the need for the restriction, is the assessment of the existence of an alternative, less restrictive means.

• The existence of a less restrictive means that produces the same effects would make the restriction unreasonable, because it is no longer necessary, regardless of the pro-competitive effects it produces

• In Hopkins v. United States, the Sherman Act depends on the production of a direct effect on competition, implicitly rejects the automatic and generic application of the Sherman Act, forcing the application of the rule of reason.

• That qualification depends on the production of a direct effect on competition, implicitly rejects the automatic and generic application of the Sherman Act, forcing the application of the rule of reason

• in Standard Oil Co. v. United States, Justice White developed a defense of the application of the rule of reason that would have a decisive influence on US jurisprudence.

• Supreme Court has ruled that the rule of reason should be the main method of analysing possible anti-competitive behaviour, reserving the application of the criterion of illegality per se for particularly serious behaviour

• The Supreme Court takes as its starting point the general construction of the wording of the Sherman Act, considering that it allows for the inclusion in its provisions of contracts and associations that have arisen in the meantime, the purpose of which is to unfairly restrict trade, in particular those that reduce competition and thus increase prices.

• From this perspective, the Sherman Act was intended to absorb economic criteria, preventing the "evils" that the common law attributed to monopolies, i.e. the elimination of the power to fix prices, the power to restrict output and the dangers of deteriorating product quality.

• The fact that the rule refers to classes of acts and contracts which, in turn, cover all acts and agreements likely to restrict trade means that, when judging the lawfulness of a given act or contract, the judge must have a standard of reason, or later rule of reason, which allows him to assess the legality of the conduct in the light of the Sherman Act.

• traditionally in common law and US law, when these matters are at issue, the rule of reason is used as a paradigm, thus making it possible to verify whether or not the act under analysis produces any of the results that the Sherman Act was intended to repress.

• freedom of contract as the most efficient means of preventing the formation of monopolies, subjecting it to restrictions when used improperly and unfairly.

Conclusion

• Competition policy in US has been shaped by economy.
• The per se prohibition and the rule of reason are used by the Supreme Court to assess vertical agreements.
• identifying those that qualified under the Sherman Act
• If a commercial practice is considered illegal per se, it is not necessary to demonstrate that the conduct produces anticompetitive effects, since the conduct itself already amounts to a violation of the law.
• As such conduct does not produce any pro- competitive effects, but only seriously harms competition, it does not justify an investigation of the actual effects associated with it.
• However, through a case-by-case assessment and weighing of the pro- competitive and anti-competitive effects of the conduct, permitted by the rule of reason, it is possible for the alleged offender to convince the court that the commercial practice adopted, in those specific circumstances, does not jeopardize competition.
• One of the immediate consequences of this new formulation is to consider that the agreement is only reasonable if it regulates and thus promotes competition, contrary to the rule of reason enunciated in Standard Oil, which recognized as legal a conduct that, despite restricting competition, generated benefits that outweighed the losses caused by restrictions on competition.
• The court, instead of focusing on the necessity of the restriction, shifts attention to competition by proposing a cost-benefit analysis of the competitive and pro-competitive effects of the restriction.
• The use of the rule of reason made it possible to define, on a case-by-case basis, the limits imposed by the Sherman Act, reasonableness, the principles of law and the duty to pursue the public policy set out in the rule, revealing that the Sherman Act was therefore not intended to cover all contracts and acts blindly and unfairly.
• analysis of case law on Sherman Act until 1914 shaped by economy.
• Sherman Act enabled, through jurisprudence, the progressive growth of a competition policy, in which the application of the respective rules follows the evolution of economic literature.