APPLYING ILLINOIS BRICK TO E-COMMERCE: WHO IS THE DIRECT PURCHASER FROM AN APP STORE?

By Ryan M. Sandrock¹

Fifty years after Hanover Shoe, the Supreme Court will decide a case that could confirm the existing Hanover Shoe/Illinois Brick framework or create some new structure for private antitrust enforcement. The core Supreme Court decisions on the "direct purchaser" rule considered facts regarding shoe manufacturing machinery and concrete blocks. The case on which the Supreme Court will next hear argument on the this rule—Apple v. Pepper — involves facts regarding the iPhone and Apple’s App Store. And whether the sale of apps is comparable (or not) to the sale of concrete blocks could have a substantial impact on not just the law of antitrust and internet commerce but also alleged anti-competitive activity in any industry. In the view of Assistant Attorney General Makan Delrahim and others, Hanover Shoe and Illinois Brick should be reconsidered. If the Supreme Court follows that path, there could be a new Apple rule regarding who can sue and a new framework for private antitrust enforcement that could make it easier for indirect purchasers (including end-user consumers) to bring claims. Alternatively, the Court could reaffirm its precedent, thereby allowing antitrust defendants to continue to use Illinois Brick to fend off liability under federal law to indirect purchasers.

I. THE LONG-STANDING ILLINOIS BRICK WALL TO INDIRECT PURCHASER CLAIMS

The Supreme Court’s 1977 decision in Illinois Brick² provides that only those plaintiffs who purchased directly from antitrust defendants are entitled to sue for damages under federal law—"indirect purchasers" cannot recover under federal antitrust laws. A variety of state laws, however, do allow for such damages claims.

In Illinois Brick, the State of Illinois sued a concrete block manufacturer for fixing the price of those blocks. The manufacturers had sold the blocks to contractors, who used the blocks to build structures for the State. The State alleged that the contractors had passed on the manufacturer’s overcharge to the State. The Supreme Court refused to permit the State to assert damages claims against the concrete block manufacturer under the Sherman Act claim. A primary focus of the Court’s analysis was the correlating rule established in Hanover Shoe that an antitrust defendant could not assert as a defense that a plaintiff passed on overcharges to its customers. Given the bar on "defensive pass through," the Court concluded that a bar on "offensive pass through" was required. The Court focused on practicality, explaining that it would be impossibly complex to trace anti-competitive effects down the distribution chain.³

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The Illinois Brick rule means that "only the first party in the chain of distribution to purchase a price-fixed product has standing to sue."⁴ A plaintiff does not have standing because it paid supra-competitive prices that an intermediary initially bore but then "passed-on" to the plaintiff.⁵

The Illinois Brick decision came nine years after the Supreme Court’s decision in Hanover Shoe.⁶ In that case, a shoe manufacturer alleged that a machinery corporation had used its monopoly over shoe-manufacturing machinery to charge the manufacturer supra-competitive prices. As a defense, the machinery corporation argued that the shoe manufacturer had not suffered any damages because it had "passed-on" any overcharge to consumers. The Court rejected that argument, holding that a direct purchaser is injured by the amount of its overpayment, regardless of who eventually bears the cost of that injury.⁷

II. NORTHERN DISTRICT OF CALIFORNIA GRANTS APPLE’S MOTION TO DISMISS

Plaintiffs—purchasers of iPhone apps—alleged violations of Section 2 of the Sherman Act regarding the market for iPhone apps. Plaintiffs alleged that:

1. Apple had monopolized and attempted to monopolize an alleged market for iPhone apps;
2. the apps at issue in the case were manufactured by app developers and were only sold through Apple’s App Store;
3. for every third-party app sold through the App Store, Apple received 30% of the revenue and the developer received the remaining 70%;
4. payment was made directly to the App Store;
5. Apple prohibited developers from selling iPhone apps through any means other than the App Store; and
6. if an iPhone user purchases and installs an app on an iPhone from a source other than the App Store, Apple will void the warranty for that iPhone.⁸

Apple moved to dismiss. Apple asserted that plaintiffs are indirect purchasers of apps from the app creators, and the App Store is simply the store in which the apps are purchased. The app creators set the prices to charge for their apps, and Apple is charging the app creators—not the plaintiffs—a 30% commission of the total price of the app. Apple also argued that plaintiffs’ claims necessarily give rise to the difficult issues of pass-through damages as they would require a court to determine what price the app creators would charge if they were to sell through a different venue than the App Store or if the App Store had different policies.

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The Honorable Yvonne Gonzalez Rogers granted the motion to dismiss with leave to amend, finding that plaintiffs had not provided sufficient allegations that they were the direct purchasers of any unlawfully-priced app.⁹

Plaintiffs amended their complaint in an attempt to address the Court’s Illinois Brick concerns. Plaintiffs’ amended complaint alleged that plaintiffs were, in the Court’s words, "straightforward direct purchasers" because Apple collects fees from consumers and takes 30% of that fee for itself.¹⁰ Apple conceded that "(i) there is a 30% fee, (ii) the fee is Apple’s, (iii) Apple collects said fee, and (iv) consumers pay the fee for every App they purchase."¹¹ Apple argued that the consumers were merely asserting a prohibited "pass-on" theory—that they were injured by developers passing-on the 30% fee to consumers in the form of higher prices.¹²

The Court agreed with Apple, finding that the complaint "is fairly read to complain about a fee created by agreement and borne by the developers to pay Apple 30% from their own proceeds—an amount which is passed-on to the consumers as part of the purchase price."¹³ The Court relied heavily on In re ATM Fee Antitrust Litigation, in which the Ninth Circuit had found that inflated ATM fees paid by banks and then passed-on to consumers could not be the basis for direct purchaser claims by bank customers.¹⁴

III. NINTH CIRCUIT REVERSES

The Ninth Circuit rejected the District Court’s reasoning and reversed.¹⁵

The Court framed its analysis by reviewing the holdings in Hanover Shoe and Illinois Brick, emphasizing that the transactions in both cases had the "same structure" in which "a monopolizing or price-fixing manufacturer sold or leased a product to an intermediate manufacturer at a supracompetitive price" and the intermediate manufacturer then "used that product to create another product, which was ultimately sold to the consumer."¹⁶

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The Court then explained factors that it did not consider in its analysis, including: (1) whether app developers are direct purchasers of distribution services from Apple, (2) that Plaintiffs pay Apple, (3) that Apple does not take ownership of the apps, and (4) who sets the ultimate price.¹⁷ Instead, the Court rested its decision "on the fundamental distinction between a manufacturer or producer, on the one hand, and a distributor, on the other."¹⁸ The Court concluded that "Apple is a distributor of the iPhone apps, selling them directly to purchasers through its App Store" and therefore "Plaintiffs have standing under Illinois Brick to sue Apple for allegedly monopolizing and attempting to monopolize the sale of iPhone apps."¹⁹ The bright-line rule for the Ninth Circuit appeared to be that a distributor can be sued by purchasers.

The Court conceded that its decision was at odds with the Eighth Circuit’s decision in Campos v. Ticketmaster Corp.²⁰ That case concerned an allegation that Ticketmaster had a monopoly over ticket distribution services that resulted in inflated ticket prices to consumers. The Eighth Circuit concluded that concert venues were the direct purchasers from Ticketmaster, and any injuries to consumers were derivative of those injuries.²¹

IV. APPLE SEEKS CERTIORARI ON AN ISSUE OF "EXCEPTIONAL NATIONAL IMPORTANCE"

Apple petitioned for a writ of certiorari, presenting the question of "whether consumers may sue for antitrust damages anyone who delivers goods to them, even where they seek damages based on prices set by third parties who would be the immediate victims of the alleged offense." Apple described itself as a "marketplace sponsor" who "interacts with and delivers goods ‘directly’ to consumers" but only as an "agent" on behalf of third-party sellers.²²

Apple emphasized the importance of the decision "in the era of electronic commerce," pointing to the age of the leading decisions.²³ Apple argued:

The Ninth Circuit’s decision implicates issues of exceptional national importance. This is not a one-off case that can be dismissed as an outlier. Along with Campos, it is the most important case to have come along testing the application of Illinois Brick to electronic marketplaces. Those marketplaces serve hundreds of billions of dollars in commerce annually, and they are growing fast. The Ninth Circuit’s new test essentially treats operators of electronic marketplaces as if they were the owners and direct sellers of every item that passes through their marketplaces, and as if a commission that sellers have agreed to pay is actually charged to and paid by buyers.²⁴

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Plaintiffs’ brief argued that the Ninth Circuit did not in fact create a test based on "distributor function" and that there was no conflict with Ticketmaster.²⁵ The Supreme Court asked for the opinion of the Solicitor General. The Solicitor General filed a brief largely in line with Apple’s brief, contending that the Ninth Circuit erred and the Supreme Court should hear the case.

The Solicitor General’s brief did break from Apple’s brief in one paragraph suggesting that the Court could reconsider Illinois Brick. The leading advocate for the position that Illinois Brick should be overruled has been Assistant Attorney General Makan Delrahim. Mr. Delrahim and other current members of the Antitrust Division have made statements that Illinois Brick and Hanover Shoe should be overruled, and that Pepper provides an opportunity to do so.

Mr. Delrahim’s views on these issues appear to be informed in large part by his role on the Antitrust Modernization Committee ("AMC"). In 2007, the AMC recommended that Hanover Shoe and Illinois Brick, be overruled.²⁶ The AMC concluded that "[d] uplicative federal direct purchaser and state indirect purchaser litigation imposes undue burdens on the judicial system and the parties, wastes resources, increases the risk of duplicative recoveries, skews the parties’ incentives to settle, and hinders efficient global settlements."²⁷ The solution to this problem, the AMC continued, is to "[o]verrule Illinois Brick and Hanover Shoe to the extent necessary to allow both direct and indirect purchasers to sue to recover for actual damages from violations of the federal antitrust laws."²⁸ As a member of the AMC, Delrahim supported this recommendation (with one exception that is not relevant to the current discussion).

The AMC-line is reflected in a paragraph of the Solicitor General’s brief that many attribute to Mr. Delrahim:

That regime of parallel federal and state antitrust litigation has proved to be complex and inefficient. Inter alia, suits by direct and indirect purchasers seeking to recover the same overcharge create a risk of inconsistent results or duplicative awards. In addition, some commentators have concluded, based the courts’ experience with state-law indirect purchaser claims, that the evidentiary complexities associated with pass-on analysis are not as great as this Court believed them to be when it decided Hanover Shoe and Illinois Brick. The parties have litigated this case within the framework established by Hanover Shoe and Illinois Brick, however, and have not asked this Court to revisit those decisions.²⁹

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This paragraph suggests that a better enforcement regime would allow one court to consider the claims of direct and indirect purchasers and apportion liability that would not exceed the overcharges (trebled).³⁰

V. SUPREME COURT BRIEFING

Apple submitted its brief on August 10, 2018. Apple framed the question of the case as "whether end-user consumers have standing to seek antitrust damages based on allegedly monopolistic commissions on app distribution—a service that iOS developers, not end-users, buy from Apple."³¹ Apple said that the answer to the question was found in Hanover Shoe and Illinois Brick, confirming the Solicitor General’s statement that the parties are litigating the case within the framework of the two cases (notwithstanding the Assistant Attorney General’s apparent interest in moving outside that framework).

Apple argued that the core problem with the Ninth Circuit’s decision is that it ignores the problems about pass-through and duplicative recovery that the Supreme Court identified in Hanover Shoe and Illinois Brick. Apple noted that the Ninth Circuit’s decision followed Justice Brennan’s dissent in Illinois Brick in that the goal of both opinions seemed to be to make sure that end-users had some damages remedy. Apple cited Judge Fletcher’s comment at oral argument that he thought "Justice Brennan got it right in Illinois Brick."³²

A slew of amici followed with briefs supporting Apple’s position: the R Street Institute, Washington Legal Foundation, Computer & Communications Industry Association, and Chamber of Commerce of the United States. Most importantly, the United States filed an amicus brief in support of Apple’s position, with the Solicitor General and Makan Delrahim listed as counsel.

The Government’s brief provides straightforward support for Apple’s position: Illinois Brick/Hanover Shoe bar all forms of pass-on; Pepper’s complaint is premised on pass-on allegations; the proper plaintiff for an action against Apple would be the app developers—the first purchasers from Apple; allowing consumers to recover from Apple would risk duplicative recovery; any pass-on analysis seeking to determine what overcharge if any was passed on from the app developer to consumer would be highly complex.

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But the brief does contain a paragraph that sticks out from this analysis and advances the AMC’s position and Mr. Delrahim’s views:

The regime of parallel federal and state antitrust litigation has proved to be complex and inefficient, and some commentators have concluded that the evidentiary complexities associated with pass-on analysis are not as great as this Court believed them to be. The parties have not asked the Court to revisit Illinois Brick or Hanover Shoe, however, and the only question presented is how to apply those precedents here.³³

Like the government’s prior brief, this brief suggests a need for reform to eliminate confusion and possible duplicative recovery but not does not explain in detail how this could be accomplished.

VI. POTENTIAL IMPACT

The Supreme Court’s decision will be significant because it will apply long-standing rules regarding who may recover for anti-competitive behavior to the internet economy. As the Solicitor General argued, the decision will have impact on "existing and emerging e-commerce platforms," an issue of particular importance in the Ninth Circuit, the "home to a disproportionate share of the Nation’s e-commerce companies."³⁴ In addition, there is the possibility that the Court could take up Mr. Delrahim’s suggestion to reconsider the entire direct purchaser framework and set forth new rules. Should the Court in fact go on to overrule Hanover Shoe and Illinois Brick, it could create a blank slate regarding the process of civil antitrust enforcement, leaving it unclear as to which plaintiffs can pursue civil Sherman Act claims and the potential scope of total liability for defendants in such cases.³⁵ Or the Court could simply apply the existing rules, leaving the present regime unchanged.

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Notes:

^1. Ryan Sandrock is a partner in the San Francisco office of Sidley Austin LLP. The views expressed in this article are those of the author and do not necessarily represent the views of Sidley Austin LLP.

^2. Illinois Brick Co. v. Illinois, 431 U.S. 720 (1977).

^3. Id. at 745-46.

^4. In re Cathode Ray Tube Antitrust Litig., 911 F. Supp. 2d 857, 864 (N.D. Cal. 2012).

^5. Id.; In re ATM Fee Antitrust Litig., 686 F.3d 741, 748 (9th Cir. 2012).

^6. Hanover Shoe v. United Shoe Mach. Corp., 392 U.S. 481 (1968).

^7. Id. at 494.

^8. In re Apple iPhone Antitrust Litig., No. 11-cv-06714-YGR, 2013 WL 4425720, at *2-12 (N.D. Cal. Aug. 15, 2013).

^9. Id. at *12.

^10. In re Apple iPhone Antitrust Litig., No. 11-cv-06714-YGR, 2013 WL 6253147, at *4 (N.D. Cal. Dec. 2. 2013).

^11. Id.

^12. Id. at *4-5.

^13. Id. at *6.

^14. Id. at *5; ATM, 686 F.3d at 745-750.

^15. In re Apple iPhone Antitrust Litig., 846 F.3d 313 (9th Cir. 2017). Apple’s first two motions to dismiss were brought under FRCP 12(b)(7) and argued that Plaintiffs needed to add AT&T Mobility as a necessary party. Apple’s third and fourth motions raised the Illinois Brick argument under FRCP 12(b) (6). Plaintiffs argued that those motions were late-filed because FRCP 12(g)(2) provides that "a party that makes a motion under this rule must not make another motion under this rule raising a defense or objection that was available to the party but omitted from its earlier motion." The Court found that Apple’s motion was timely but that, even if it was not, it was harmless error for the Court to consider the argument. If the Court had not allowed it, Apple simply could have made the same argument in a FRCP 12(c) motion or later. Id. at 320.

^16. Id. at 322.

^17. Id. at 324.

^18. Id. at 324.

^19. Id.

^20. 140 F.3d 1166 (8th Cir. 1998).

^21. Id. at 1174.

^22. Apple’s Petition for Writ of Certiorari, Apple, Inc. v. Pepper, No. 17-204, p. i.

^23. Id. at 2.

^24. Id. at 13-14.

^25. Respondents’ Opposition to Petition for Writ of Certiorari, Apple, Inc. v. Pepper, No. 17-204, p. 7, 15.

^26. Antitrust Modernization Commission, Report and Recommendations, April 2007 at p. 271.

^27. Id.

^28. Id. at 275.

^29. Brief of the United States as Amicus Curiae, Apple, Inc. v. Pepper, No. 17-204, pp. 12-13 (citations omitted).

^30. See AMC Report at p. 275 ("To the maximum extent possible, a single federal court should hear all proceedings relevant to actions by direct and indirect purchasers alleging the same antitrust violation. To accomplish this, federal law should permit direct and indirect purchasers to recover the actual damages they suffer as the result of antitrust violations. The first step toward these goals is to overrule Illinois Brick and Hanover Shoe legislatively to the extent necessary to allow both direct and indirect purchasers to sue under federal law to recover for actual damage they suffer from antitrust violations resulting in an overcharge.").

^31. Petitioner’s Brief, Apple, Inc. v. Pepper, No. 17-204, at p. 3.

^32. Id. at p. 5.

^33. Brief for the United States as Amicus Curiae Supporting Petitioner, Apple v. Pepper, No. 17-204, p. 19 (citations omitted).

^34. Brief of the United States as Amicus Curiae, Apple, Inc. v. Pepper, No. 17-204, p. 21.

^35. Steve Williams and Jiamie Chen, "Should ‘Hanover Shoe’ and ‘Illinois Brick’ Be Discarded’?" The Recorder, August 15, 2018.