WIth apologies to The Clash
With apologies to The Clash

The class-action variety of plaintiffs’ lawyer abhors the federal Arbitration Act.

You can see why. The Supreme Court has turned the FAA into a class action killer. See AT&T Mobility LLC v. Concepcion, 563 U.S. 321 (2011) (holding that FAA pre-empts state law against bans on class treatment of claims),  and Am. Express Co. Italian Colors Restaurant, 133 S. Ct. 2304 (2013) (holding that FAA requires enforcement of class action ban even if it thwarts claimants’ ability to vindicate their rights).

But a new FAA ruling by the Second Circuit may afford some comfort to other plaintiffs’ lawyers. Not a lot. Some. Continue Reading Stay or Go?

Screen Shot 2015-07-29 at 10.46.19 PMTexas Bar Top 10 Badge.pdfWho says law review notes don’t matter?

A new decision proves that what students write in law journals can matter a great deal.

In Mullins v. Digital Direct, LLC, No. 15-1776 (7th Cir. July 28, 2015), the Seventh Circuit all but adopted a Yale law student’s analysis of, and rationale for freeing class action law from, a godawful “ascertainability” test that threatens to kill class cases involving low-dollar claims. A pair of other circuits had either championed the standard since creating it in 2012 (the Third Circuit) or quietly embraced it (the Eleventh).

Both the Yalie and the panel deserve our thanks. Continue Reading Can We Kiss Ascertainability Goodbye?

Remain calm
Remain calm

Changing the status quo

Plaintiffs’ lawyers tend not to count patience as a virtue.

Thirty years ago, I showed a busy plaintiffs’ lawyer a new Fifth Circuit decision that took three paragraphs to explain why the district court should have let the plaintiffs amend their complaint.

Those judges need to make better use of their time, he said — and stop wasting mine!

As an aspiring disturber of the status quo — as someone whose job required him to disturb it — he wanted to get on with the disturbing, and to do so with the least amount of nonsense and a minimum waste of time and effort.

That kind of attitude can backfire. In the contest of a motion to dismiss, it might lead an impetuous plaintiffs’ lawyer to propose an amendment of the complaint even before the district court rules on the merits of the motion. But, as the old Fifth Circuit case illustrated three decades ago and a new one from the Second Circuit stresses anew, the let’s-get-on-with-it view of the world can rob you of an important advantage — clarity on what to fix.

The right to amend

The case that provoked the mini-tirade, Auster Oil & Gas, Inc. v. Stream, 764 F.2d 381 (5th Cir. 1985), alleged a Keystone Cops-like scheme to detect theft of oil from a field in Calcasieu Parish, Louisiana. The oddity of the facts prompted the author of the opinion, my judge, to use names of novels by William Faulkner as headings. I’ve always liked it.

The court in Auster Oil & Gas upheld a complaint that accused the Louisiana officials of conspiring with the owners of an oil field to conduct an unlawful search of gathering lines in order to determine whether the operator had diverted some of the oil via a secret outlet. In doing so, the panel stressed that Rule 15 mandates leave to amend a complaint any time “justice so requires”. An effort “to correct any flaws in its original statement of its claims”, the court noted, “cuts in favor of . . . allowing the amendment.”

Collateralized debt obligations

In Loreley Financing (Jersey) No. 3 Ltd. v. Wells Fargo Securities, LLC, No. 13-1476-cv (2d Cir. July 24, 2015), the court vacated the district court’s dismissal of a complaint alleging fraud against Wells Fargo, Wachovia, and others for their roles in the sale of complex financial instruments (collateralized debt obligations) for many millions of dollars.

The 3-0 opinion — a sparkler by the former dean of the Yale Law School, Guido Calabresi — elucidates nuances of New York law on scienter, loss causation, and other matters on the way to reversing dismissal of the CDO purchasers’ complaint.

But the last section, which ran four and a half pages, focused on the district court’s abuse of discretion in refusing to permit the plaintiffs to amend the complaint. Judge Calabresi wrote as follows:

[The district court erred when] it presented Plaintiffs with a Hobson’s choice: agree to cure [pleading] deficiencies not yet fully briefed and decided or forfeit the opportunity to replead. Without the benefit of a ruling, many a plaintiff will not see the necessity of amendment or be in a position to weigh the practicality and possible means of curing specific deficiencies.

Loreley Financing, slip op. at 53-54. Judge Calabresi continued:

The present case combines a complex commercial reality with a long, multiprong complaint. In such situations, pleading defects may not only be latent, and easily missed or misperceived without full briefing and judicial resolution; they may also be borderline, and hence subject to reasonable dispute. As discussed in Part I, supra, dismissal was partly based on the district court’s determination that Plaintiffs’ fraud allegations raised neither plausible inferences of material misrepresentations nor strong inferences of scienter. Id. at *10-15. These determinations entail judgment calls on which reasonable minds can differ in a not insignificant number of cases. Cf. [Ashcroft v.] Iqbal, 556 U.S. [662,] 679 [(2009)] (“Determining whether a complaint states a plausible claim for relief will . . . be a context-specific task that requires the reviewing court to draw on its judicial experience and common sense.”). The district court’s rejection of Plaintiffs’ position that the strength-of-inference requirements had been met by the facts set forth in the original complaint was, without more, insufficient reason to bar Plaintiffs from repleading. Indeed, that our opinion today partially vindicates Plaintiffs’ position is, we think, some measure of the potential for reasonable disagreement here.

Id. at 55-56.

The bright side

In 1985, a judicial trend — towards making cases procedurally more difficult for plaintiffs — had already begun. The lawyer who railed against a three-paragraph explanation of why plaintiffs should get a second chance to pleading a viable case sensed the shift and did not like it.

The tide has gone out much further since then. Twombly and Iqbal have toughened the test for pleading in all kinds of cases. Little wonder then that courts have shown little hesitation when dismissing complaints also to deny leave to amend them.

Loreley Financing provides a welcome reminder that Rule 15 mandates an opportunity to repair a complaint in light of the district court’s actual ruling on the sufficiency of the original allegations. Plaintiffs counsel should therefore resist asking for leave to amend until after the court issues its ruling. You will then have the benefit of the court’s reasoning.

Acting sooner may make you feel smart and on top of things. But Auster and Loreley Financing counsel that you can, and should, wait.

Pick one.
Pick one.

Contingent fee ruling

A couple of months ago, the Fifth Circuit upheld a fee agreement that entitled the lawyers to full-price hourly fee plus a 15 percent contingent-fee on any recovery. An arbitration panel had ruled that the lawyers might never have received anything, including the hourly portion, in view of the fact that the contract said the clients could defer payment until “financially practicable”. The fact that the underlying case settled for $188 million meant that the lawyers would receive more than $28 million — now, with interest, north of $40 million — for less than $5 million worth of work.

I opined that the decision “enhances confidence in contingent-fee agreements and therefore lowers the collection risk that law firms face when entering into contingent-fee arrangements with clients.” That, I went on, “should save clients who live up to their contracts money” because the lawyers do not need to “build in an additional premium for the lawyer’s risk of enforcing the fee deal.”

But thinking about that case put me in mind of an article about a more basic notion — why clients choose the contingent-fee lawyers they do. With contingent-fee rates “uniform” or nearly so — running about a third of the recovery — how do clients get their money’s worth, the article asked.

Assortative matching of lawyer and client

The article answered like this:

The notion of assortative matching was introduced and analyzed from an economic perspective by Gary Becker (1973). Becker used it to model decisions regarding whether and whom to marry. Among other things, he showed that when the division of output from marriage is uniform and nonnegotiable, a positive assortative matching is expected. Applying this model to a legal-services market with nonnegotiable CF rates, plaintiffs with particularly strong cases, where the anticipated recovery is particularly large, are expected to match with lawyers of particularly high repute; plaintiffs with the second-most lucrative cases are expected to pair with second-best lawyers; and so forth. The high value of the case is likely to result in an especially large fee for the top lawyer, and the high quality of legal services is expected to result in a particularly large net recovery for the plaintiff with the lucrative case, without deviating from the standard CF rate. At the other end of the scale, low-quality cases are expected to match with low-quality lawyers, thus yielding small net recovery for the plaintiff and a minimal fee for the lawyer.

The hypothesis of positive assortative matching in the CF market is supported by a large-scale study of Texas plaintiff lawyers conducted by Stephen Daniels and Joanne Martin. Daniels and Martin (2002, pp. 1783-95) describe a hierarchical plaintiff bar. The “Bread and Butter” lawyers at the bottom of this hierarchy ordinarily deal with low-value cases, while the “Heavy Hitters” at the top handle very large ones. Sara Parikh (2001, pp. 59-61) provides a comparable description of the CF market in Chicago. The lawyers in these categories, as well as the intermediate ones, differ with regard to the mean value of the cases they handle, with the mean and median cases ranging from several thousand dollars to several million. These categories also differ with regard to the scope of the geographic market the lawyers serve (local, regional, or state/national) and the percentage of potential clients they turn away.

Eyal Zamir, Barak Medina, and Uzi Segal, The Puzzling Uniformity of Lawyers’ Contingent Fee Rates: An Assortative Matching Solution  at 6-7 (Jan. 16, 2012).

The authors propose that the best lawyers charge the same percentage but get a far better result for the client and therefore earn a larger fee than their less-capable colleagues would have.

Return on investment

You could also look at the phenomenon in terms of the return on the lawyers’ investment.

You can figure out the implicit value of what the lawyer invests if you have a proxy for the lawyers’ value. In the case of a lawyer who does work by the hour as well as on a contingent-fee basis, you can simply multiply his or her hourly rate by the number of hours he or she must spend to obtain the favorable outcome.

If the lawyer typically earns $1,000 per hour from clients who pay her by the hour and she works 1,000 hours on the case before it settles or she wins an award or judgment, her investment totals $1,000,000. A less able lawyer might charge $400 an hour but take more time to achieve the result, investing (say) 1,500 hours for an implicit investment of $600,000.

If the dispute settles for $10 million, the more expensive lawyer would receive $3.33 million — a 3.33 multiple on her time. But the less costly colleague would receive the same multiple in the event of a resolution totaling only $6 million. The client nets $6.67 million for a one-third fee to the pricier lawyer but only about $4 million for the one with the lower hourly rate.

You can use different numbers of course, but you will always find that the lawyer who has the higher rate — which presumably the competitive market has blessed — must get a better result for the client in order to obtain the same return on investment unless he can handle the case with far greater efficiency. And even if he does get to a resolution faster and with less brain damage, that also confers a net benefit on the client, other things remaining equal.

What do you think? Should clients prefer a contingent-fee lawyer who charges a top hourly rate?

 

Lessons LearnedA golden age of civil antitrust, from the 1960s into the 1980s, enriched the victims of cartels and monopolies but upset corporate America.  The high cost of paying treble damages claims eventually provoked a spare-no-expense approach to defense. That in turn influenced the way plaintiffs prosecuted their Sherman Act claims.

Much the same thing has now happened with patent infringement cases, which had their own golden age in the last decade. What, if anything, can patent litigants learn from the antitrust experience? I think they can divine quite a lot. In this post, I will tell you why.

Bigger cases on average

The “millions for defense, but not one cent for tribute” attitude that developed in the antitrust defense bar and their gigantic clients aims to deter the bringing of cases in the first place. It also taxes the resources of the plaintiff, who may thus find out too late that she cannot afford to take a case through trial. Scorching the earth additionally makes a loss on the merits all the more painful for the plaintiff (or her counsel), who will have now lost a great deal of money as well.

Making the prosecution of civil antitrust cases more costly had a predictable demonstration effect over time. It principally resulted in an increase, on average, in the stakes at issue. A higher damages figure made the average Sherman Act case attractive enough to lawyers willing to work on a contingent-fee basis. It also rendered the case a better candidate for a worthwhile settlement, one that more than covered fees and expenses.

A similar dynamic exists in patent litigation. For companies that face a lot of infringement actions, the standard defense budget tops $1 million. The plaintiff needs a case worth more than $10 million in such circumstances to obtain the services of a capable contingent-fee lawyer, who will insist on a chance to earn at least three times his investment.

Aggregation

One way to make antitrust cases large enough to justify their risk and cost involves aggregation. Rule 23 of the Federal Rules of Civil Procedure permits one kind of aggregation — the class action. Rule 23 and its state-law counterparts allow even a single class representative to bring claims on behalf of hundreds, thousands, or millions of claimants who have similar claims. Class treatment could convert a small, hopelessly uneconomic one-off lawsuit into a juggernaut involving many hundreds of millions of dollars and possibly even billions.

The stakes-raising feature of the class action device has turned the class certification process into an extremely expensive battlefield. In a case that I have handled for more than a decade, for example, the parties submitted more than 30 different expert reports and presented live testimony and dozens of exhibits at a five-day evidentiary hearing.

Class members with larger claims may also choose to opt out of a class action. They generally engage lawyers who specialize in handling those sorts of cases, typically on a contingent-fee basis. The lawyers in those instances may serve as aggregators, enhancing their clients’ collective bargaining leverage while reducing average costs by spreading them over more claimants and higher aggregate damages.

Patent cases do not qualify as readily for class treatment. Nor can different patent holders band together to bring infringement claims as a group. The venue and joinder rules under the America Invents Act of 2012 made multiple-party patent cases much harder to bring.

But patent holders aggregate anyway. They do it by acquiring a critical mass of patents in particular fields and even entire portfolios. In February 2015, for instance, RPX Corporation bought the large portfolio of Rockstar Consortium.

The aggregation of patents in a single holder makes for a more formidable adversary. That has led the targets of their infringement lawsuits to call them names. A favorite rhymes with goal.

Specialization

The higher cost and greater complexity that came to characterize antitrust cases as defendants counterattacked them led to another device for managing risk on the plaintiff side. Taking a Sherman Act case across the juridical goal line now demanded a high degree of skill, mastery of the subject matter, and staying power. Few plaintiff’s firms could meet those criteria.

In 1980, Steve Susman founded the first litigation boutique, Susman Godfrey (my firm), which served as lead counsel in the largest price-fixing class action then working its way through the courts, Corrugated Container. The case produced a jury verdict for the plaintiff class and more than $360 million in settlements. Other boutiques have followed suit.

Boutiques that specialize in patent cases have likewise sprung up as infringement actions have proliferated. A significant part of my firm’s cases involve infringement claims. These firms’ trial-savviness, knowledge of the peculiarities of patent law and litigation, and financial resources are all but essential for high-stakes infringement actions.

Counterclaim avoidance

A factor that deterred antitrust cases — the possibility of having to defend against a counterclaim — also may limit the appeal of patent infringement cases. Antitrust claimants often avoided the counterclaim problem by taking a low profile in class action cases but then demanding a settlement at an opportune moment, usually after the class reached a resolution of the class claims. Assignment of claims to a trustee may also work.

Patent holders generally have two choices for dealing with the possibility of a counterclaim. Either they can build or buy a patent portfolio that enables them to overawe the defendant in a dueling-patent contest (Apple and Samsung provide an example), or they can limit their business to ownership, licensing, and litigation of patent rights and thus avoid countercharges of infringing conduct.

The second model tends to make repeat infringement defendants say undiplomatic things about patent holders that do not “practice” the inventions by doing or making things or providing services with them. But the non-practicing entities are simply doing what any sensible plaintiff would do if she could — avoiding a costly and complicating counterclaim.

Past as prologue

That an older type of high-stakes commercial cases can provide lessons for a newer kind should not surprise us. The basics of the civil justice system have not changed that much.

What do you think about the way patent infringement cases have followed a pattern similar to what happened with antitrust cases? Do you think the responses of defendants have gone over the top? Have they struck an appropriate balance? Or should they go even further?

Let your fellow readers know what you think.

IMG_0195Antitrust v. patent

The extraordinary risk in antitrust cases has prompted courts to erect ever-higher hurdles to them. Extending a trend that began decades before, the Supreme Court used a sprawling antitrust case — Bell Atl. Corp. v. Twombly (2007) — to toughen the test for pleading a claim. It warned about the high costs of “false positives” and “interminable litigation” in a monopolization case, Verizon Communications, Inc. v. Trinko (2004). And it extended its dislike of big class actions to the antitrust arena in Comcast Corp. v. Behrend (2013).

Until about a decade ago, courts did not show similar skepticism about another kind of complex commercial dispute — patent infringement cases. Entire judicial districts, in fact, seemed to open their adjudicatory arms to them, acquiring expertise that permitted them to streamline and expedite resolutions on the merits.

But will patent cases become more like antitrust actions? Have they already?

A string of new decisions suggests a one-word answer.

Yes!

New rulings

Three of the four opinions originate from the Federal Circuit, which has exclusive jurisdiction to hear appeals from final orders that arise under patent law.

The first, Intellectual Ventures I LLC v. Capital One Bank (USA), N.A., No. 14-1506, slip op. at 7 (Fed. Cir. July 6, 2015), held under Alice Corp. v. CLS Bank Int’l, 134 S. Ct. 2347 (2014), that patents on “tracking financial transactions to determine whether they exceed a pre-set spending limit (i.e., budgeting)” and “customizing web page content as a function of navigation history and information known about the user” involved “abstract ideas” that did not qualify for patenting.

In In re Cuozzo Speed Technologies, LLC, No. 14-1301, slip op. at 5-10 (Fed. Cir. July 8, 2015), a different panel of the Federal Circuit concluded that it lacked jurisdiction to consider challenges to decisions by the U.S. Patent and Trademark Office (USPTO) to institute “inter partes review” of patents under the America Invents Act. The panel also approved the USPTO’s use of a test — the “broadest reasonable interpretation” (BRI) standard — that increases the likelihood of patent’s invalidation as obvious. Id. at 10-19. And the court affirmed an obviousness determination against the patent holder. (The full court denied en banc reconsideration by a 6-5 vote.)

The court in Versata Devel. Group, Inc. v. SAP Am., Inc., No. 14-1194, slip op. at 25-26 (Fed. Cir. July 8, 2015), ruled that it could second-guess decisions by the Patent Trial and Appeal Board (PTAB), a branch of the USPTO, to treat a patent as a “covered business method” patent and therefore eligible for possible invalidation. But it also held that the PTAB did not err in deeming the patent-in-suit a CBM, in giving it BRI treatment, and invalidating it as an “abstract idea” under Alice.

The last of the four decisions dealt with the “exclusive jurisdiction” matter I mentioned at the outset of this section. In Amity Rubberized Pen Co. v. Market Quest Group Inc., No. 13-55796 (9th Cir. July 13, 2015), the district court dismissed a patent infringement case not on any patent-law ground but because principles of res judicata precluded the patent holder from suing again. The Ninth Circuit held that it had no power to consider the appeal and that only the Federal Circuit could do that.

Patent as the new antitrust

What theme unites these four outcomes? Each made getting a patent infringement case to trial and a resolution on the merits harder and therefore riskier and more expensive. Intellectual Ventures, Cuozzo Speed, and Versata all resulted in invalidations of patents. Cuozzo Speed and Versata also adopted a construction test (BRI) that makes invalidation more likely. Cuozzo Speed also put IPR institution decisions beyond the reach of appellate review. And Amity Rubberized Pen points up the unique procedural complexity of patent infringement suits.

Looking ahead

The recent placement of obstacles in patent cases recalls similar developments in antitrust cases years before. What lessons can we learn about what happened in antitrust cases? Do they apply in the context of patent infringement actions?

I will present observations on those questions in the next post, on Monday, July 20.

Royalty dollars
Royalty dollars

A tough record for royalty owners

The highest civil court in the Lone Star State has tended over the years to issue rulings that have made Big Oil even bigger and richer — often at the expense of the Texans who owned the oil and gas deposits in the first place.

Disputes over how to compute the royalties owing under Texas leases raised questions worth billions of dollars. Sadly for the royalty owners, the ExxonMobils, ConocoPhillipses, and Chesapeakes won far more of those fights than they lost.

Just last year, for example, an ex-member of the Texas Supreme Court relied on a decision she had participated in 18 years earlier while a justice to rule against royalty owners. The leases in the 2014 rulings stated that the lessee, Chesapeake, would pay the royalty “free of all costs related to the exploration, production and marketing of oil and gas production from the lease”. But Chesapeake calculated the royalties on the dollars it received for the lessors’ gas less all of those “costs”. Potts v. Chesapeake Expl., L.L.C., 760 F.3d 470 (5th Cir. 2014) (applying Heritage Resources v. NationsBank, 939 S.W.2d 118 (Tex. 1996), to declare no-deduct clause surplusage); Warren v. Chesapeake Expl., L.L.C., 759 F.3d 413 (5th Cir. 2014) (same). The Fifth Circuit, applying Texas law, said fine.

Along comes a Hyder

The trend that the Fifth Circuit thus extended hit a bit of a wall last month.

The turnabout came in another Chesapeake case — Chesapeake Expl., L.L.C. v. Hyder, No. 14-0302 (Tex. June 12, 2015). That lawsuit involved Hyder family members who had reserved in their lease to Chesapeake’s predecessor “a perpetual, cost-free (except only its portion of production taxes) overriding royalty of five percent (5.0%) of gross production” from wells on their 948 mineral acres in the Barnett Shale. Chesapeake paid the Hyders five percent of what it sold the gas to third-parties for in distant market less its post-production costs.

The trial court, after a bench trial, ruled that “cost-free” meant “cost-free” and ordered Chesapeake to pay the Hyders more than $500,000 for the post-production costs that it had deducted before computing the overriding royalty. The San Antonio court of appeals affirmed. And so did the Supreme Court of Texas, by a 5-4 vote.

Basis for decision

Chief Justice Nathan Hecht explained the background thus:

In Heritage Resources, Inc. v. NationsBank, we noted that a royalty is free of production expenses but “usually subject to post-production costs, including taxes . . . and transportation costs.” But we added that “the parties may modify this general rule by agreement.” We long ago defined an overriding royalty as “a given percentage of the gross production carved from the working interest but, by agreement, not chargeable with any of the expenses of operation.” That agreement is now understood to be part of an overriding royalty, and an overriding royalty is like a landowner’s royalty in that it usually bears postproduction costs but not production costs, though the parties may agree to a different arrangement.

Two of the royalty provisions in the Hyder–Chesapeake lease are clear. The oil royalty bears postproduction costs because it is paid on the market value of the oil at the well. The market value at the well should equal the commercial market value less the processing and transporting expenses that must be paid before the gas reaches the commercial market.

The gas royalty in the lease does not bear postproduction costs because it is based on the price Chesapeake actually receives for the gas through its affiliate, Marketing, after postproduction costs have been paid. Often referred to as a “proceeds lease”, the price-received basis for payment is sufficient in itself to excuse the lessors from bearing postproduction costs. And of course, like any other royalty, the gas royalty does not share in production costs. But the royalty provision expressly adds that the gas royalty is “free and clear of all production and post-production costs and expenses,” and then goes further by listing them. This addition has no effect on the meaning of the provision. It might be regarded as emphasizing the cost-free nature of the gas royalty, or as surplusage.

The overriding royalty in the Hyder–Chesapeake lease is not as clear as either of the other two royalty provisions. The Hyders argue that the requirement that the overriding royalty be “cost-free” can only refer to postproduction costs, since the royalty is by nature already free of production costs without saying so. But as with the gas royalty, “cost-free” may simply emphasize that the overriding royalty is free of production costs. Chesapeake argues that “cost-free overriding royalty” is merely a synonym for overriding royalty, and a number of lease provisions discussed in other cases support that view.

The exception for production taxes, which are postproduction expenses, cuts against Chesapeake’s argument. It would make no sense to state that the royalty is free of production costs, except for postproduction taxes (no dogs allowed, except for cats). The exception for taxes might be taken to indicate that “cost-free” refers only to postproduction costs. But a taxes exception to freedom from production costs is not uncommon in leases, suggesting only that lease drafters are not always driven by logic.

We thus disagree with the Hyders that “cost-free” in the Hyder–Chesapeake overriding royalty provision cannot refer to production costs. As noted above, drafters frequently specify that an overriding royalty does not bear production costs even though an overriding royalty is already free of production costs simply because it is a royalty interest. But Chesapeake must show that while 22 the general term “cost-free” does not distinguish between production and postproduction costs and thus literally refers to all costs, it nevertheless cannot refer to postproduction costs here.

Hyder, slip op. at 4-7 (footnotes omitted).

Upshot

Chesapeake could not, of course, persuade the majority that “cost-free” excluded the “postproduction costs” that Chesapeake had deducted before computing the Hyders’ five percent overriding royalty.

Hyder implies three guideposts for royalty computation disputes:

  • Basing a royalty “on the market value of the [hydrocarbons] at the well” allows the lessee to deduct postproduction costs from the price at which it sells the hydrocarbons at points distant from the well.  Id. at 5 (emphasis added; footnote omitted).
  • Basing a royalty “on the price actually received by the lessee, not the market value at the well” means that it “does not bear postproduction costs”. Id. at 8 (emphasis added).
  • The outcome of a dispute over computation of royalties under any lease will generally depend on “a fair reading of its text.”  Id. at 10.

ConspiracyReview

In the last post, I went over the basics of the Second Circuit’s 2-1 antitrust ruling against Apple in United States v. Apple, Inc., No. 13-3741-cv (2d Cir. June 30, 2015).

Apple, you will recall, served as the hub of a hub-and-spoke conspiracy that had five spokes — each of them a book publisher — to raise prices on e-books in late 2009 and early 2010.

To review:

  • The spokes settled before the trial, but the hub — Apple — insisted that it had done nothing wrong and that it had instead done competition a service by breaking the e-book monopoly of Amazon.com.
  • Despite urging that no wrong did it do, Apple agreed to pay state and private plaintiffs $450 million if it lost its appeal and $70 million if it won.
  • All three of the court of appeals panel members accepted that Apple “orchestrated” the conspiracy (majority) or “enable[d]” it (dissent).

Which brings us to the topic we promised to discuss this time.

The per se melee

That far more consequential part of the majority opinion — and the focus of the dissent — dealt with whether the per se rule of Sherman Act liability for price-fixers extends to entities that orchestrate (or enable) the price-fixing conspiracy but do not occupy the same level of distribution as the other participants in the conspiracy do. As we will see at the bottom of this post, the per se rule simplifies antitrust claims, makes them less costly to prosecute, and renders them more suitable for class treatment.

Majority

Circuit Judges Debra Ann Livingston and Raymond Lohier opined that Apple’s “vertical” relationship with the publishers did not absolve it of per se liability. As Judge Livingston wrote:

“The true test of legality” under § 1 of the Sherman Act “is whether the restraint imposed is such as merely regulates and perhaps thereby promotes competition or whether it is such as may suppress or even destroy competition.”   Bd. of Trade of City of Chi. v. United States, 246 U.S. 231, 238 (1918) (emphasis 5 added).   By agreeing to orchestrate a horizontal price‐fixing conspiracy, Apple committed itself to “achiev[ing] [that] unlawful objective,” Monsanto [Co. v. Spray‐Rite Serv. Corp., 465 U.S. [752,] 764 [(1984)] (internal quotation marks omitted): namely, collusion with and among the Publisher Defendants to set ebook prices.  This type of agreement, moreover, is a restraint “that would always or almost always tend to restrict competition and 10 decrease output.”  Leegin [Creative Leather Prods., 15 Inc. v. PSKS, Inc.], 551 U.S. [877,] 886 [(2007)] (internal quotation marks omitted).

The response, raised by Apple and our dissenting colleague, that Apple engaged in “vertical conduct” that is unfit for per se condemnation therefore misconstrues the Sherman Act analysis.  It is the type of restraint Apple agreed to impose that determines whether the per se rule or the rule of reason is appropriate. These rules are means of evaluating “whether [a] restraint is unreasonable,” not the reasonableness of a particular defendant’s role in the scheme.  Atl. Richfield [Co. v. USA Petroleum Co.], 495 U.S. [328,] 342 [(1990)] (emphasis added) (internal quotation marks 18 omitted); see also Nat’l Collegiate Athletic Ass’n v. Bd. of Regents of the Univ. of Okla., 468 U.S. 85, 103 (1984) (“Both per se rules and the Rule of Reason are employed to form a judgment about the competitive significance of the restraint.” (internal quotation marks omitted)).

Id. at 72-73.

Dissent

The dissenter, Circuit Judge Dennis Jacobs, wrote that “[t]his appeal turns on whether purely vertical participation in and facilitation of a horizontal price-fixing conspiracy gives rise to per se liability.” United States v. Apple, Inc., No. 13-3741-cv, slip op. at 14 (2d Cir. June 30, 2015) (Jacobs, J., dissenting). Judge Jacobs regarded the majority’s view of the question old-timey and maybe quaint:

A vertical relationship that facilitates a horizontal price conspiracy does not amount to a per se violation. In another age, the Supreme Court treated such a hub-and-spokes conspiracy as a per se violation. See Interstate Circuit, Inc. v. Paramount Pictures Distrib. Co., 306 U.S. 208, 226-27 (1939). But the per se rule has been in steady retreat.

Id. at 16.

The Supreme Court’s decision in Leegin Creative Leather, Judge Jacobs felt, signaled the doom of hub-and-spoke conspiracies as foundations for per se liability of the hub. He wrote:

The most recent and explicit signal is given in Leegin, which explains that “the Sherman Act’s prohibition on ‘restraints of trade’ evolves to meet the dynamics of present economic conditions,” such that “the boundaries of the doctrine of per se illegality should not be immovable.” 551 U.S. at 899-900 (alterations omitted). Leegin held that a manufacturer did not commit a per se violation of § 1 when it agreed with several retailers on a minimum price that the retailers could charge–a holding that overruled a century-old principle articulated in Dr. Miles Medical Co. v. John D. Park & Sons Co., 220 U.S. 373 (1911). See Leegin, 551 U.S. at 881. Leegin reasoned that Dr. Miles had “treated vertical agreements a manufacturer makes with its distributors as analogous to a horizontal combination among competing distributors,” but that, “[i]n later cases, . . . the Court rejected the approach of reliance on rules governing horizontal restraints when defining rules applicable to vertical ones.” Leegin, 551 U.S. at 888. Dr. Miles was held to be inconsistent with “[o]ur recent cases[,] [which] formulate antitrust principles in accordance with the appreciated differences in economic effect between vertical and horizontal agreements, differences the Dr. Miles Court failed to consider.” Id.

Although the express holding of Leegin does not extend beyond the overruling of Dr. Miles, the Court’s analysis reinforces the doctrinal shift that subjects an ever-broader category of vertical agreements to review under the rule of reason. The Court first stated the subsisting scope of per se liability: A horizontal cartel among competing manufacturers or competing retailers that decreases output or reduces competition in order to increase price is, and ought to be, per se unlawful. Leegin, 551 U.S. at 893. The Court then rejected per se liability for hub-and-spokes agreements, in wording that prescribes rule-of-reason review of vertical dealings that facilitate per se unlawful horizontal agreements (the type of agreement that the district court found Apple had undertaken): To the extent a vertical agreement setting minimum resale prices is entered upon to facilitate either type of cartel [among 17 manufacturers or among retailers], it, too, would need to be held unlawful under the rule of reason. Id. (emphasis added). After Leegin, we cannot apply the per se rule to a vertical facilitator of a horizontal price-fixing conspiracy; such an actor must be held liable, if at all, “under the rule of reason.” Id.

Significance

The ultimate outcome of United States v. Apple on the per se v. rule of reason issue — whether in the Second Circuit or the Supreme Court — will affect antitrust law in three principal ways.

First, a per se case is simpler, costs millions of dollars less to try, and has greater odds of success with a judge or jury. Why? Because, unlike the rule of reason, per se:

  • does not require an economist to opine about the relevant product and geographic markets;
  • obviates the need to prove that the defendants had market (or monopoly) power or that their conduct was anticompetitive;
  • simplifies proof of damages; and
  • precludes defendants from claiming, and presenting evidence, that their agreement enhanced competition.

Second, a per se case stands a much better chance of meeting the requirements of Rule 23(b)(3), which allows certification of claims to recover damages on a class-wide basis. The irrebuttable presumption of unlawfulness prevents defendants from injecting “pro-competitive” justifications and other complicating issues that may affect different class members differently and may therefore lead to the conclusion that issues common to class members do not, as Rule 23(b)(3) requires, “predominate” over individual questions.

Finally, a win for Apple on the per se issue would lend credence to the dissenting judge’s claim that “the per se rule has been in steady retreat” since the 1970s, notably (according to the dissent) in Leegin. The idea of a trend against per se treatment might encourage courts to question all of the traditional per se categories (including price-fixing, customer and market allocation, and agreements to limit supply).

As we know from Chief Justice John Marshall, “the power to tax involves the power to destroy”, McCulloch v. Maryland, 17 U.S. (4 Wheat) 416, 431 (1819), and converting antitrust cases from per se to rule of reason would impose a tax that would make them much harder to afford, more difficult to win, less likely to qualify for class treatment, and generally scarcer.

What do you think about that possibility? Does the prospect of weakening enforcement of antitrust law sound like a good thing to you or a bad thing? Or do you believe that the dissent has the better argument about the proper scope of the per se shortcut?

 

 

ConspiracyApple’s loss

Two years ago, on July 10, 2013, the United States and 33 states and territories won a bench trial against Apple for its role in a conspiracy to fix prices on electronic book (e-books). On June 30, 2015, two members of a three-judge Second Circuit panel upheld the judgment against Apple under section one of the Sherman Act. United States v. Apple, Inc., No. 13-3741-cv (2d Cir. June 30, 2015).

If the ruling stands, Apple must pay the states and private plaintiffs $450 million under a deal that it cut while its appeal pended, on July 10, 2014.

But much more than $450 million turns on the durability of a key holding by the Second Circuit majority — that per se liability attaches not only to “horizontal” competitors who conspire to fix prices to their customers but also to “vertical” orchestrators of the horizontal conspiracy.

In this post, I will lay out the background and talk about why the Second Circuit upheld the finding that Apple participated in the conspiracy. In a later post, I will flesh out the momentous battle between the majority judges and their dissenting colleague over per se liability. I will also explain why I believe the fight has such vast implications for antitrust law.

Beginnings

The case concerned events that culminated  during April 2010 with a sharp bump in e-book prices. The government plaintiffs alleged that Apple and five book publishers unlawfully agreed to raise e-book prices by ganging up on Amazon and forcing it to stop charging a below-cost price of $9.99 for e-book versions of the the publishers’ best-selling titles.

All of the publishers settled before trial.

The evidence at the trial showed that on the eve of its launch of the iPad, in late 2009 and early 2010, Apple used the terms of its contracts with HarperCollins, Simon & Schuster, Penguin Group, Hachette, and Macmillan for Apple’s new iBookstore service and a swarm of high-level phone calls and e-mails to link the publishers in a hub-and-spoke conspiracy. Apple occupied the center (the hub), the publishers sat at the ends of the spokes, and a rim connected the publishers to each other.

After 17 days of evidence and arguments, United States District Judge Denise Cote issued a 160-page opinion. She summed up the outcome as follows:

[T]he Plaintiffs have shown that Apple conspired to raise the retail price of e-books and that they are entitled to injunctive relief. A trial on damages will follow.

United States v. Apple Inc., 952 F. Supp. 2d 638, 645 (S.D.N.Y. 2013).

Settlement

In the meantime, some of the states and a class of people who bought e-books had brought actions against Apple for treble damages under federal and state antitrust laws. All of the cases ended up in front of Judge Cote.

In March 2014, her honor granted a motion to certify the claims of the private plaintiffs for treatment on a class-action basis. Within four months, both the state plaintiffs and the private plaintiffs entered into a settlement agreement with Apple.

The pact provides for payment of $450 million “[i]n the event the Final Liability Decision affirms the Liability Finding” and $70 million “[i]n the event the Final Liability Decision vacates and remands, or reverses and remands with instructions, for reconsideration, or for retrial of the Liability Finding”.

“Final Liability Decision” means “a final decision by the Second Circuit [or the Supreme Court] on the merits of the Liability Finding”. “Liability Finding” refers to “the holding of the Opinion and Order issued by the District Court on July 10, 2013 that Apple violated Section 1 of the Sherman Act”.

Affirmance on participation in conspiracy

The Second Circuit panel split 2-1 on the Liability Finding, with the majority affirming Judge Cote’s conclusion that Apple had indeed committed a section one violation.

Writing a 117-page opinion for herself and her colleague Raymond J. Lohier, Circuit Judge Debra Ann Livingston lays out how Apple’s Eddy Cue, Kevin Saul, and Keith Moerer worked with the book publishers to set up and implement a conspiracy to implement a regime in which the publishers could set the prices at which not only Apple but also Amazon sold the publishers’ titles as e-books.

Apple claimed innocence:

Because (in Apple’s view) the Contracts were vertical, lawful, and in Apple’s independent economic interest, the mere fact that Apple agreed to the same terms with multiple publishers cannot establish that Apple consciously organized a conspiracy among the Publisher Defendants to raise consumer‐facing ebook prices — even if the effect of its Contracts was to raise those prices.

United States v. Apple, slip op. at 53.

Judge Livingston found the argument unpersuasive in light of the evidence:

Apple understood that its proposed Contracts were attractive to the Publisher Defendants only if they collectively shifted their relationships with Amazon to an agency model [that gave the publishers the power to set retail prices for e-books of their titles ] — which Apple knew would result in higher consumer‐facing ebook prices. In addition to these Contracts, moreover, ample additional evidence identified by the district court established both that the Publisher Defendants’ shifting to an agency model with Amazon was the result of express collusion among them and that Apple consciously played a key role in organizing that collusion. The district court did not err in concluding that Apple was more than an innocent bystander.

Id. at 58. One of the two principal questions on appeal — whether Apple in fact orchestrated a hub-and-spoke conspiracy — thus went against the Cupertino crowd.

Looking ahead

That of course leaves the other major question.

The dissenting judge, Circuit Judge Dennis Jacobs, more or less accepted the majority’s conclusion regarding the “enabler” role that Apple played as a factual matter. But he objected to his colleague’s ruling on whether what Apple did violated section 1 of the Sherman Act.

And to that battle over per se liability I will turn in the next post.

Risk KnobPrologue

A story from a long-ago summer day highlights the big rewards that you can earn from taking purposeful risks.

In a little over a month, on August 5, 2015, 151 years will have passed since a commander took a gamble during the Battle of Mobile Bay.

The commander knew that the defenders had rigged 67 subsurface mines across most of the Bay’s mouth. Heavy guns guarded the remaining patch of open water.

As his attack began that morning, one of his vessels struck a mine — a torpedo — and sank within minutes. He expected that other mines likely lay in his flagship’s path. But he bet that they would either miss his hull or prove duds.

He shouted to Captain Percival Drayton: “Damn the torpedoes, full speed ahead!”

And David Farragut‘s side won the battle, captured Mobile Bay, and secured the resulting benefits for the Union.

Fortune favors the bold

The idea of taking risks to win rewards works for lawyers, too — and nowhere does it work as purely and as well as in the context of contingent fees.

In two earlier posts, I wrote, respectively, about the plusses and minuses of the hourly fee — which concentrates almost all risk on the client —  and the goods and bads of flat fees — which shift some of the “procedural” risk to the lawyers but none of the risk of losing on the merits.

The transfer of risk in the flat-fee context matters, I maintain, because it gives lawyers more control over things they can influence, aligns lawyer and client interests in avoiding unproductive work, and offers the lawyers a chance to earn a worthwhile reward for successfully managing procedural risks.

The third major way to structure a business client’s engagement of a law firm moves even more risk from the client to the firm in return for a share of the upside. In many cases, the contingent fee enables clients to bring claims they couldn’t afford to prosecute otherwise. In lots of other cases, it eases a client’s worries about unpredictable demands on cash flow. And in all instances it makes the interests and incentives of client and lawyer as indistinguishable as possible, short of marriage in a community property state.

What does contingent mean?

Let’s define what a typical contingent fee involves.

Any sort of contingent fee depends — is contingent — on a dispute’s outcome. The fee could come in the form of a lump-sum bonus, a multiple of hourly fees, or some other kind of compensation. But a usual contingent fee (I will address reverse and other unusual contingent fees in future posts) calls for the lawyers to receive a percentage of the “gross sum recovered” with respect to a claim or set of claims by settlement or judgment.

Variable percentages

The percentage will vary from case to case. It often starts at one-third. But it may range lower for engagements that present unusually large potential recoveries. The percentage also often ratchets up within a certain number of days before the final pretrial conference and again when trial begins and the lawyers’ work intensifies.

Another factor that can affect the level of the contingent percentage: who pays expert fees, travel expenses, and other costs. At my firm, where we invest about half of our hours on contingent-fee matters, we show our bias when we pay expenses both by calling for a several-points-higher percentage and by requiring a super-majority vote in favor of taking the case.

Plusses and minuses — client perspective

A client always retains the right to make some major decisions — including whether to settle and for how much — but by engaging a lawyer on a contingent fee the client as a practical matter chooses to exercise less control over the lawyer than under other fee arrangements. Because the client and the lawyer share a common interest in maximizing the recovery, the client expects the lawyer will exercise sound judgment in strategy and tactics and tends not to second-guess the lawyer’s approach. While contingent-fee lawyers do typically keep track of their time, they do not report those details to their clients, removing a key instrument that hourly clients use to manage hourly lawyers.

Nor do contingent-fee clients usually worry about whether the lawyers put enough resources into their cases. The incentive to maximize the gross sum recovered drives both client and lawyer.

Clients generally cannot avoid a promise to pay a contingent fee by discharging the lawyers without their consent. That, too, tends to lessen client control.

But the client can impose discipline by refusing to accept unreasonable settlement offers even if the lawyers recommend taking them.

The risk-sharing aspect of a contingent-fee arrangement compensates the client for the reduction in control. Unlike hourly lawyers but like flat-fee ones, contingent-fee lawyers assume what I have called procedural risk — the chance that the handling of a dispute will eat up far more resources than the lawyers planned for. Contingent-fee lawyers also assume the risk that they will receive nothing for their efforts. If they also fund expenses, out of pocket losses in business disputes can run into the millions and possibly tens of millions. 

With the shifting of great risk comes a transfer of great upside potential. The client promises to pay a portion of any recovery. The fact that the payment usually comes from money that the defendant remits allows the client to keep the promise without coming out of pocket.

Plusses and minuses — lawyer’s view

The control that contingent-fee lawyers exercise springs largely from the strong alignment of their interests with the clients’. Lawyers who work on a contingent-fee basis relish their relative freedom and the more trusting relationship that often prevails with their clients.

Liberty comes at a price. The risk of loss rests heavily on the lawyers under a contingent-fee deal. Inefficiency, bad strategy, poor execution, lack of diligence, burdensome discovery requests, fruitless motion practice, and other dumbness now come at the lawyers’ expenses as much as the clients’.

The corresponding upside gives the lawyers large incentives to handle a case quickly, cost-effectively, and successfully. Having skin in the game makes it more interesting, too.

Not for everyone

Not every case deserves contingent-fee treatment. Many do not.

All of the lawyers at my firm spend hundreds of hours almost every week evaluating and voting on contingent-fee proposals. Many more potential cases never make it even to the proposal stage. The reasons for saying no vary, but they include unpersuasive liability stories, iffy damages, client credibility issues, unrealistic client expectations, low likelihood of collection, unusually high litigation costs, and inability to resolve key issues early in a case.

Clients who can afford to pay hourly or on a flat-fee basis may also shy from contingent-fee engagements. Their reasons typically  involve a desire to maximize control over the handling of a case or concern over information and experience advantages that counsel may have in negotiating contingent fee terms.

The case for going contingent

But cases that do qualify for contingent handling provide big benefits to both client and lawyer.

The sharing of risk all but eliminates the potential conflicts between client and hourly or flat-fee lawyer.

The client largely sheds the risk of an adversary that scorches the earth with aggressive delaying and diversionary tactics and no longer shoulders alone the downside of losing.

The client’s cash flow avoids a constant drain.

And the happy day when the defendant pays the settlement or discharges the judgment makes the lawyer every bit as joyful as the client.

Next time

I’ll return to current events in the next post, on July 6.

It will concern the Second Circuit’s 2-1 decision upholding a judgment against Apple for orchestrating a per se illegal price-fixing conspiracy among book publishers. See United States v. Apple Inc., No. 13-3741 (2d Cir. June 30, 2015).

The dissenting judge on the panel urges that Apple’s role as a mere “enabler” of the horizontal cartel insulates it from liability for a per se antitrust violation.

I’ll offer thoughts on the huge stakes that the disagreement presents next Monday.

Feedback, please

 

In the meantime, take a minute to add a comment, post a question, or send me an email (bbarnett@thecontingency.com). I love hearing from you, and so do the other readers of The Contingency. Don’t hide your light under a basket.

Have a safe and fun Independence Day weekend.