Ixchel Pharma, LLC v. Biogen, Inc. 9 Cal. 5th 1130 (2020): California Supreme Court Applies Rule of Reason to Business to Business Non-Competes Under the Business and Profession Code Section 16600.

Robert E. Connolly      
Law Office of Robert E. Connolly

Summary

            This Supreme Court of California case addressed the legal standards that applied when Biogen, Inc. (Biogen) settled a patent dispute with Ixchel related to the use of a compound (DMF) dimethyl fumerate that required Ixchel to terminate an at-will contract it had with Forward Pharma (Forward) under which Ixchel Pharma (Ixchel) and Forward were working together to develop a drug using DMF.  Ixchel and Forward were developing a drug for the treatment of a disorder called Friederichs’s ataxia. The drug development was proceeding according to plan when Forward terminated the at-will contract with Ixchel as required by the settlement agreement it reached with Biogen. 

              Ixchel sued Biogen in federal court for numerous violations but the instant case involved two questions the Ninth Circuit asked the Supreme Court of California to decide:

              (1) where a plaintiff has an at-will contract, does a claim against another business for tortious interference with that contract require an independently wrongful act to establish tortious interference with the at-will contract.  Answer: Yes.

              2)  Ixchel also alleged that Biogen’s requirement that Forward terminate its relationship with Ixchel constituted a violation of California’s Business and Professions Code section 16600.  This claim raised the question of whether Section 16600 applied to restraints involving businesses (Answer: Yes) and if so what standard applied (Answer: Rule of Reason). 

              The California Supreme Court stated: “We hold that tortious interference with at will contracts requires independent wrongfulness and that a rule of reason applies to determine the validity of the settlement provision under Business and Professions Code section 16600.”  Ixchel Pharma, LLC v. Biogen, Inc. 9 Cal. 5^th 1130, 1131 (2020).

Discussion

              In 2016 Ixchel entered into Collaboration Agreement with Forward to develop a new drug for the treatment of neurological diseases containing DMF.   The Collaboration Agreement authorized Forward to terminate the agreement “at any time” so long as it provided Ixchel notice of 60 days.  At the same time that Forward and Ixchel were working together, Forward was negotiating with Biogen, another biotech company to settle a patent dispute relating to the use of DMF for the treatment of multiple sclerosis.  The Biogen/Forward patent settlement required Forward to terminate its at will agreement with Ixchel, which Forward did.

              A.          Independent Wrongful Act Required Where Contract is At-Will

              The court first addressed Ixchel’s claim that Biogen tortiously interfered with Ixchel’s at-will contract with Forward.  The question before the court was whether Ixchel must allege that Biogen committed an independently wrongful act in order to state a claim for tortious interference with an at-will contract. Id. at 1140.  The court traced the legal history of the tort of interference with contractual relations and interference with prospective economic advantage.  At one time the two torts were treated similarly, but in Della Penna v. Toyota Motor Sales, USA, 11 Cal.4^th 376 (1995) the Supreme Court held that “a plaintiff seeking to recover damages for interference with prospective economic advantage must plead as an element of the claim that the defendant’s conduct was ‘wrongful by some legal measure other than the fact of interference itself.’”  Ixchel at 1142 (citing Della Penna at 393).  Again citing Della Penna, the court recognized that an actual contract was entitled to greater legal protection than the prospect of future economic gain: “The purpose of the independent wrongfulness requirement in economic interference torts is to ‘balance between providing a remedy for predatory economic behaviors and keeping legitimate business competition outside litigative bounds.’”  Ixchel at 1142 (citing Della Penna at 378). On the other hand, where a binding contract exists, “the stability of the contractual relationship takes precedence over business competition [and therefore no independent wrongful act is necessary].” Id. The court found that, like a prospective economic relationship, “parties to at-will contracts have no legal assurances of future economic benefit.” Therefore, like tortious interference with prospective economic advantage, to claim tortious interference with an at-will contract “the plaintiff must allege that the defendants engaged in an independently wrongful act.”  Ixchel at 1149.

              B.           Rule of Reason Standard Applies to Restraints Between Businesses

              Ixchel contended that the wrongful act Biogen committed was to violate section 16600 of the Business and Professions Code by requiring in the patent settlement that Forward terminate its at-will contract with Ixchel and barred Forward from engaging with and other entity to develop neurological treatments containing DMF.  Id.  Ixchel claimed this contract clause violated section 16600 which provides : “Except as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade or business of any kind is to that extent void.” 

              The court “agree[d] with the parties that section 16600 applies to business contracts.” Id.  The parties disagreed as to whether the standard to apply to the contract was a per se rule or rule of reason.  Ixchel argued that California courts have consistently struck down restrictive covenants with employees, including noncompete and non-solicit provisions, and argued that should be the case with this at-will contract.  The court, realizing the consequences of a strict application to business contracts, did not bite.  Instead, the court discussed the statutory history, and precedent involving section 16600.  Id. at 1151-1160.  While the text of the statute seems to imply a per se standard, the court noted that in “reading statutes, we consider the text in the context of ‘the statutory framework as a whole in order to determine its scope and purpose.’” Id. at 1150.  In context, section 16600 “is best read not to render void per se all contractual restrains business delaings, but rather to subject such restrains to a rule of reason.” Id. The court also sought to harmonize section 16600 with the Cartwright Act. Not surprisingly, “mindful of the consequences of strictly interpreting the language of section 16600 to invalidate all contracts that limit the freedom to engage in commercial dealing [such as exclusive dealing contracts],” id. at 1160, the court held that “validity under section 16600 must therefore be evaluated on a rule of reason basis.” Id. 1162.

Postscript

              The California Supreme Court ruled that the Biogen/Forward agreement prohibiting Forward from working with Ixchel was subject to section 16600 of the California Business and Profession Code and that the restraint should be judged under the rule of reason.  The California Supreme Court, however, did not decide whether the restraint, judged under that standard, was unreasonable.  On September 17, 2020, in a not for publication opinion, the Ninth Circuit Court of Appeals found, based on the California Supreme Court interpretation of California law, that the District Court had correctly held that for Ixchel to state a claim against Biogen for tortious interference with an at-will contract, it was required to allege that Biogen engaged in an independently wrongful act.  Furthermore, the district court correctly analyzed the restraint in the Biogen/Forward settlement agreement under the rule of reason to determine its validity, and concluded that the restrain was not unreasonable and therefore did not violate section 16600.  The Ninth Circuit opinion is Ixchel Pharma, LLC v. Biogen, Case No. 18-15258 (Sept. 17, 2020).

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Insufficient Evidence Showing Anticompetitive Effects of Cinemark’s Circuit Dealing: The Latest Chapter in the Flagship Saga.

By Anthony Leon

Ready, Set, Action.

The latest episode of the Flagship antitrust saga has been released this month! A three-judge panel of the California Court of Appeal, Second District in Los Angeles, reversed the $3.5 million judgment awarded to Flagship Theatres of Palm Desert, LLC (Flagship) against Cinemark USA, Inc. and its subsidiary Century Theatres, Inc. (collectively, Century). (Flagship Theatres of Palm Desert LLC v. Century Theatres Inc. et al. (2020), case B292609 and B299014 (Flagship))

The appeal arose from a 2018 jury verdict finding that Century violated the Cartwright Act by engaging in ‘circuit-dealing’ to pressure film distributors into refusing to license films to the movie theatre then owned by Flagship. 

Extensively relying on Federal law relating to vertical restraints, the California Court ruled that circuit-dealing based on multi-theater licensing agreements is not per se illegal under the Cartwright Act, and should therefore be analyzed under the rule of reason.

BACKGROUND

Our story takes place in the Coachella Valley. If you are driving North on Route 111 and you are about to leave Palm Desert, you should see on your right a Westfield indoor mall. This is where Flagship owned and operated their sole movie theater Palme D’Or between 2003 and 2016. Keep driving an additional two miles and you will find as you enter Rancho Mirage—still on your right—an outdoor mall where Century owns The River, one of their 300 movie theaters.

Palme d’Or and The River are known in the film industry as “exhibitors:” they play to the general public copyrighted films licensed by “distributors,” more commonly known as film studios.

Films are distinguished for this dispute between “commercial” films, appealing to a larger audience and providing bigger revenues, and “independent’” or “more artistic class movies,” generally attracting a smaller audience. The movie is called a “first-run” when it first hits theaters at the release date, and becomes a less lucrative “moveover” after days on screen.

In an area where two or more theaters are located, distributors may decide on a film-by-film basis to grant a theater an exclusive license to show a first-run for a limited period. This “clearance” situation prohibits the distributor from granting a license to show the film to other theaters nearby during that period.

Palme d’Or and The River differed in the experience provided to their patrons. As opposed to The River’s more familial theater and typical concession area business model, the Palme d’Or offered an upscale experience with more independent and artistic movies—without totally excluding high-end adult commercial pictures—and catered sophisticated food and drinks.

It is in this context that Palme d’Or has been in a clearance situation with The River for a very long period, so much that there were years where it did not receive a single license from certain distributors. Believing that Century was using its circuit of movie theaters’ purchasing power to undermine the competitive process of bidding for film licenses theatre by theatre, a practice known as “circuit-dealing,” Flagship sued Century in 2007.

According to the appellate court, two distinct forms of circuit dealing have been recognized by the United States Supreme Court, here summarized as “monopoly circuit-dealing claims” and “non-monopoly circuit-dealing claims.” (United States v. Paramount Pictures (1948) 334 U.S. 131, 154 (Paramount). As applied to movie theater circuit, “monopoly circuit-dealing” relates to a situation where an owner has monopoly power in a market and uses its power to gain an advantage to a related market. Differently, “non-monopoly circuit-dealing” relates to a situation where an owner of a theater circuit does not have or use its monopoly power: instead that owner will enter into agreements with distributors covering multiple theaters of the circuit. In doing so, the owner effectively eliminates a possible bidding for films theatre by theatre to the detriment of smaller competitors. Flagship, at *10.

In its complaint, Flagship alleged Century engaged in both types of circuit dealing. It alleges that the manner in which Century licensed films caused distributors to deny the Palme d’Or licenses to the most lucrative first-run commercial films, and that these film license agreements violated the Cartwright Act. While emphasizing that it does not believe the clearances themselves violated the Cartwright Act, Flagship claim that the clearances are the fruit of the circuit-dealing agreements. Id. at *11.

Facing difficulties to get revenues and having a limited ability to obtain licenses, Flagship closed the Palme in 2016. It was immediately replaced by another theater, the Tristone, that follows the same business model.

After an initial summary judgment ruling reversed in 2011, a dismissal in 2014 on the eve of trial and a reversal of that ruling in 2016, the case finally went to jury trial in 2018.

The trial court held that although monopoly circuit dealing are per se illegal under the Cartwright Act, non-monopoly circuit-dealing should be tested under the rule of reason. Flagship was therefore required to establish that the multi-theater licensing agreements caused an “anticompetitive effect” that “outweighed any beneficial effect on competition.” Id. at *12.

The jury found that Century had not engaged in a monopoly circuit-dealing, but did engage in non-monopoly circuit dealing. The jury awarded Flagship $1.25 million in damages, which was automatically trebled to $3.75 million, pursuant to provisions of the Cartwright Act applicable to all successful private antitrust suits. Id. at *12.

After the trial, the Court rejected Century’s motion for judgment notwithstanding the verdict or, in the alternative, for a new trial. Among other arguments, Century challenged statements as hearsay and that the jury has reached an improper “compromise verdict.”

Century timely appealed the judgment and the motions, arguing lack of substantial evidence to support the relevant geographic market definition Flagship identified at trial and the jury’s finding that century’s multi theater licensing agreements harmed competition in that or any other market.

DISCUSSION

The Court of Appeal reversed the judgment. The Court agreed with Century’s contention that substantial evidence does not support the jury’s finding that Century’s multi-theater licensing agreements harmed competition in the relevant market, whether defined as the Rancho Mirage clearance zone or the whole Coachella Valley. Id. at *17.

To reach that conclusion, the Court initially confirmed that the trial court did not err in applying the rule of reason to a non-monopoly circuit-dealing claim under the Cartwright Act. In doing so, it relied extensively on Federal law.

The Court noted that the United States Supreme Court’s last word on circuit-dealing goes back to the 1948 Paramount decision, where it was held that all film licensing agreements are per se illegal under the federal antitrust laws. However, the Court believed that this precedent cannot be fully applied to this case as the law and the film industry have considerably changed since that decision. Specifically, it explained that the Paramount decision involved a unique set up of vertically integrated film distributors who employed a broad range of anticompetitive practices, including horizontal coordination, to maintain their monopoly power over an entire industry. Here, absent any horizontal coordination and market power, the Court held Paramount did not stand for a proposition that all multi-theater license agreements, under all circumstances, are per se illegal. Flagship at *21.

Rather, the Court sought guidance for an appropriate antitrust analytical framework applicable to non-monopoly circuit dealing claims by doing a review of modern developments in antitrust law applicable to vertical restraints and circuit-dealing.

As such, it is first reminded that since the Paramount decision, the United States Supreme Court has repetitively applied the rule of reason to vertical restraints. (Leegin Creative Leather Products, Inc. v. PSKS, Inc. (2007) 551 U.S. 877, 886–887 (Leegin)). In particular, the Court compares non-monopoly circuit-dealing to vertical boycott and exclusive dealing, two practices that are analyzed under the rule of reason.

Second, the Court noted that while federal cases do not provide a lot of guidance for circuit-dealing, the Redwood decision applied the rule of reason to a circuit dealing claim where there was “no evidence of predatory intent.” (Redwood Theatres, Inc. v. Festival Enterprises, Inc. (1988) 200 Cal.App.3d 687, 694) However, the Court here disagreed with Redwood because it left open a possibility of some non-monopoly circuit-dealing cases being considered per se illegal. Flagship at *39.

The Court ruled that a Cartwright Act plaintiff asserting a non-monopoly circuit-dealing claim must prove not only that a theater-circuit owner entered into film licensing agreements covering more than one of its theaters, but that such agreements caused net harm to competition, as determined by the balancing of anti and procompetitive effects under the rule of reason. Flagship at *40.

The analytical framework then established, the Court proceeded to evaluate the sufficiency of evidence presented to support the jury’s finding of competitive harm in the relevant market.

The Court noted that the jury was not instructed to make a finding on the relevant market. Rather, it was only instructed to consider whether Century’s conduct “caused harm to competition in the relevant geographic and product markets in the form of increased prices or decreased output of film the jury.” In this context, the Court evaluated whether substantial evidence supported that competition was harmed in a relevant market as defined by Flagship but also as defined by Century. Id. at *42.

Flagship’s definition of the geographic market was limited to the Rancho Mirage clearance zone, which only included the Palme d’Or and The River. Flagship argued that licenses for movies in other cities would not be viable substitutes. The Court gave some credence to the argument, but ultimately concluded that it conflicted with other antitrust movie theater industry cases. Generally, in those cases, it explained that the market is based on an area in which consumers are willing to travel to see movies. Id. at *45.

Century defined the geographic market more broadly. Aligned with the movie film industry cases, Century focused on the consumers’ ability to travel to different theaters. Century defined the market as the Coachella valley. Id. at *54.

Using Flagship’s geographic market, the Court found that there was not enough evidence to support that Century’s practice caused a reduction in the output of film licenses in the Rancho Mirage clearance zone. Indeed, in a clearance zone like Rancho Mirage, because there are only two theaters, there will always be at least one theater that will get a license for the first-run movie. Id. at *50. The Court also found that there was not enough evidence to support a reduction in consumer choice of theaters in the Rancho Mirage clearance zone. While Flagship did not provide evidence that consumers would not be willing to go out of the Rancho Mirage zone to see movies, the Court reminded that antitrust law does not view the elimination of a particular competitor—without more— as harm to competition. Id. at *52. Finally, the Court did not find substantial evidence to support the fact that Century’s practice created barriers to entry in the Rancho Mirage zone. In fact, the Court pointed out that the theater that replaced the Palme went into business immediately after the Palme d’Or closed in 2016. Id. at *54.

Using Century’s geographic market, the Court found again that there was not enough evidence to support Flagship’s allegation that the practice caused a reduction in output of unique films in the Coachella Valley. Flagship, on one hand, did not show that Century’s practice proximately caused the Palme to go out of business, and, on the other hand, did not show that the number of independent films exhibited in the Valley dropped after the Palme’s closure. In fact, the theater that replaced the Palme d’Or still shows independent films to the public. Id. at *56. The Court also did not find sufficient evidence to support the claim that Century’s practice caused a loss of unique art house theater in the Coachella Valley. Flagship did not show that it was the only theater offering those amenities, and the theater that replaced the Palme d’Or appeared to follow the old business model of the location. Id. at *58.

CONCLUSION

In the absence of sufficient evidence to support the jury’s finding of anticompetitive effects in the relevant market, whether defined as the Rancho Mirage clearance zone or the whole Coachella Valley, the Court is mandated to reverse the judgment. Id. at *60. In doing so, it relied extensively on Federal law relating to vertical restraints.