In Secret Rebate Case, If It Walks Like A Duck, Allegations That It Will Also Quack Are Plausible

On May 24, 2011, United States District Court, Central District of California, denied a motion to dismiss allegations of a “price squeeze” implemented through the granting of secret rebates to the plaintiff’s customers, finding that the complaint stated a plausible claim under California Business and Professions Code section 17045. Drawing on “judicial experience and common sense”, District Judge Dean D. Pregerson held that the allegations of the first amended complaint are sufficiently “plausible” on their face to withstand challenges under Bell Atl. Corp. v. Twombly, 550 U.S. 544, (2007). Western Pacific Kraft, Inc. v. Duro Bag Manufacturing Company, Case No. CV 10-06017 DDP (SSx), 5/24/11.

Plaintiff Western Pacific Kraft, Inc. (“WPK”) is a wholesaler of paper bag products to smaller wholesale distributors. Defendant Duro Bag Manufacturing Company (“Duro”) is the largest manufacturer of paper bags in the country, and the largest seller of paper bags in California. Duro was WPK’s supplier, and also its principal competitor. For twenty years or more, Duro would reduce its prices to WPK, where WPK informed Duro that it had to meet competition from competing sources.

On October 9, 2010, however, Duro informed WPK that it would no longer do so. Instead, it raised the prices it charged WPK, while at the same time lowering the prices it charged WPK’s customers. WPK only became aware of the discriminatory pricing when asked by its existing customers to meet the competition from Duro’s lower prices.

WPK filed a complaint in federal court, alleging violations of California Business and Professions Code section 17045. Section 17045 has been a feature of California law since 1913, and was added to the California Unfair Practices Act in 1941. It prohibits the “secret payment” of rebates and unearned discounts, or secretly extending to certain purchasers special services or privileges not extended to all purchasers buying on like terms and conditions. However, additional elements of a violation are that there also be (a) injury to a competitor, and (c) a showing that such payment tends to destroy competition. It has been held to be applicable to competition at either the seller or the purchaser level, or both. ABC International Traders, Inc. v. Matsushita Elec. Corp., 14 Cal. 4th 1247 (1997). In Diesel Elec. Sales & Serv., Inc. v. Marco Marine San Diego, Inc., 16 Cal. App. 4th 202 (1993), the Court of Appeal, Fourth District, held that Section 17045 must be “liberally construed”.

The first amended complaint alleged that as a result of the price discriminations, which were unknown to WPK, Duro’s course of conduct “effectively put it out of business”. It alleged that Duro had injured WPK and destroyed competition by providing secret rebates, refunds, or discounts to its customers.

As is much in vogue, Duro moved to dismiss, citing Twombly, and Ashcroft v. Iqbal, 129 S.Ct. 1937 (2009). In discussing the applicable legal standards, the District Court recited the litany of quotes from Twombly that, while a complaint need not include “detailed factual allegations”, it must offer “more than an unadorned, the–defendant–unlawfully–harmed–me accusation.” Iqbal at 1949. While “conclusory allegations”, “labels and conclusions”, including “formulaic recitation of the elements,” or “naked assertions” are insufficient, the court will assume the veracity of “well-pleaded factual allegations”. Because this is somewhat of a subjective exercise, courts are to draw on their “judicial experience and common sense” in evaluating the two schools of thought. When is an allegation “well-pleaded” and “factual”, as opposed to being a “legal conclusion”? This may be difficult to parse prior to at least initial discovery.

Nevertheless, the court is to use its “common sense”. To paraphrase Lewis Carroll’s famous logical fallacy of officers marching, where at least one of the officers “waddles”, and has been heard to even utter the phrase, “quack”, a degree of common sense may tell us whether the allegation is, in context, “plausible on its face”. Is one of the officers really a duck?

The central attack by Duro was that the allegations of the first amended complaint do not plead sufficient factual allegations to show that Duro’s price discriminations were “secret”. Duro argues that this is so because it advised WPK that it would no longer grant “meeting competition” price reductions. However, as the court reasoned, WPK alleged a “price squeeze” in which Duro simultaneously raised its net prices to WPK, while at the same time lowering net prices charged to its former customers. The court held that on a motion to dismiss on Twombly grounds, the allegations were sufficient that the prices attributable to secret rebates were “secret”. This was on the basis of the allegations that the rebates were never disclosed to WPK. Here we have a “hint” of a possible concerted refusal to deal.

Duro also contended that the first amended complaint failed to establish that WPK could have been harmed by the secret rebates, assuming they were “secret” at all. The court disagreed, as a fair reading of the first amended complaint was that as a result of the price discriminations and rebates, “virtually all of the plaintiff WPK’s major customers began buying paper products directly from defendant Duro”. Thus, it alleged that as a result of the secret discriminatory pricing, it had been effectively run out of business. Perhaps not surprisingly, and as it would have been endorsed by Lewis Carroll, these allegations were sufficient to satisfy the three prongs of 17045. First, the price discriminations were “secret”. Second, by effectively putting WPK out of business, WPK was harmed as a competitor. Third, the elimination of WPK as a competitor would have reduced consumer search opportunities, and thus would have contracted the available consumer choices, and thereby allocatively inefficiently injuring the competitive process.

The motion to dismiss, interestingly, did not attack the first amended complaint on DuPont Cellophane grounds. It did not argue that paper bags, like cellophane, may have been substitutable with an array of packaging materials, and that “paper bags” or “paper bags in California”, were an insufficient allegation of a properly defined relevant market for an evaluation whether the allegations of antitrust injury were sufficiently “plausible”. See United States v. E.I. DuPont de Nemours & Co., 353 U.S. 586 (1957). Thus, the court has held that through an application of “common sense” as determined by the district court, there can be life after Twombly. While further developments could determine that we have but an impersonation of a duck, the allegations are sufficient to allow the connection between the waddles, the quacks, and a judicial determination that in fact, we are dealing with something like a duck.


Time To Review Your Company’s Consumer Disclosures?

A series of recent federal court decisions highlight the importance of making sure your company’s online consumer disclosures are robust and accurate. If done properly, they just might help you avoid a class-action lawsuit.

In Berry v., Inc., the court dismissed a putative nationwide consumer class action, concluding that the company’s business practices were not unfair or misleading as a matter of law because of the company’s disclosures. Slip Opinion, No. 10-1358 (S.D. Cal. Apr. 11. 2011).

The case involved “post-transaction marketing,” the practice of presenting a consumer with an offer from a third party after the primary transaction has been completed. This type of marketing generally involves a data-sharing arrangement, where the company completing the primary transaction passes data to a second company for marketing purposes. After the consumer takes some further action (e.g., entering an email address, checking a box and clicking “yes”), the second company charges the consumer for a new product or service using the payment information provided to the first company.

This practice has been criticized by certain legislators and officials at the Federal Trade Commission. Last December, Congress passed and the President signed the Restore Online Shoppers’ Confidence Act into law, targeting online post-transaction marketing; the law now requires additional disclosures to be made and prohibits third-party sellers from charging consumers for goods or services without the consumer’s express consent and from receiving certain financial information obtained during the initial transaction.

Notwithstanding any public debate over the propriety of these marketing practices, several federal courts have granted motions to dismiss in post-transaction marketing cases based on the companies’ disclosures. The most recent example is Berry, where the court took judicial notice of the company’s disclosures and ultimately dismissed the case, concluding that no reasonable consumer could have been misled, given the disclosures that were made.

After reviewing the online disclosures and terms of service, the court in Berry held that “the explicit and repeated disclosures that defendants made in their enrollment page suffices to defeat” all of the plaintiffs’ claims, including fraud, invasion of privacy and violations of the Electronic Communications Privacy Act, Electronic Funds Transfer Act and California’s Unfair Competition Law. Slip Op’n at 9. The court explained that by completing his transaction after receiving such disclosures, plaintiff had consented to the conduct about which he complained. Id. Although the plaintiff claimed he did not understand he would be charged for the third party’s product (here a membership club providing discounts on products and services), the court emphasized that the enrollment page disclosed more than five times that, by signing up, plaintiff would be charged $12 per month after an initial thirty-day trial period. Id. at 10.

Bsed on these disclosures, the court granted the defendants’ motion to dismiss, thus ending the case and potentially saving the companies millions in discovery costs and other expenditures.

Other federal courts have reached similar conclusions. In Baxter v. Intelius, Inc., No. 09-1031, (C.D. Cal. Sept. 16 2010), the court granted a motion to dismiss, concluding that “[t]he disclosures combined with the affirmative steps for acceptance are sufficient that, as a matter of law, the webpage is not deceptive.” Similarly, in In re Vistaprint, Marketing and Sales Practices Litigation, No. 08-1994 (S.D. Tex. Aug. 31, 2009), aff’d, No. 09-20648 (5th Cir. Aug. 23, 2010), the court held that a “consumer cannot decline to read clear and easily understandable terms that are provided on the same webpage in close proximity to the location where the consumer indicates his agreement to those terms and then claim that the webpage, which the consumer has failed to read, is deceptive.”

A key factor in each of these cases was the courts’ willingness to examine the company’s online disclosures in connection with a motion to dismiss. In each case, the plaintiffs opposed any review of the disclosures, arguing that they were outside the four corners of the complaint and may not be authentic. In Baxter and Vistaprint, the court rejected the argument because plaintiffs came forward with nothing to challenge the authenticity of the disclosures. In Berry, the court took the extraordinary step of allowing discovery on the authenticity and accuracy of the disclosures before ruling on the motion to dismiss. When the plaintiffs were unable to offer any evidence that the disclosures were not authentic, the court considered them in connection with the motion to dismiss and granted the motion.

These cases highlight two strategies that could help your company reduce the risk of class-action lawsuits.

First, the cases demonstrate that, even for controversial business practices, robust consumer disclosures may provide an effective defense against a consumer class-action lawsuit.

Action Step: Consider conducting a comprehensive review of your company’s consumer disclosures to evaluate whether your company is adequately protected and in compliance with existing law.

Second, the cases demonstrate the importance of being able to provide a court with accurate copies of the disclosures individual consumers saw and in a form that is subject to judicial notice in connection with a motion to dismiss.

Litigating a class action can be incredibly expensive and risky. One effective way to mitigate the risk is to have a strategy for defeating them at the earliest stages of the case, preferably on a motion to dismiss. But if you cannot provide accurate copies of the actual disclosures made to the named plaintiff, the court may be unwilling to consider them on a motion to dismiss and you may have lost one of your company’s most effective weapons against class actions.

Action Step: Consider reviewing your company’s systems for documenting consumer transactions to ensure you can provide accurate copies of consumer disclosures for any given transaction.

Sixth Circuit Reverses Dismissal of a Shareholder Derivative Action Based Upon the Lack of Independence of the Special Litigation Committee

In Booth Family Trust v. Jefferies, No. 09-3443, 2011 WL 1237583 (6th Cir. Apr. 5, 2011), the United States Court of Appeals for the Sixth Circuitreversed the district court dismissal of a shareholder derivative action, holding that the special litigation committee (“SLC”) of the board of directors, which recommended the dismissal, was not sufficiently independent of management.  The Court reached its decision despite the fact that one of the two members of the SLC recused himself from considering claims against the defendant Robert S. Singer (“Singer”), CEO of Abercrombie & Fitch Co. (“Abercrombie”), with whom the SLC member had a personal relationship. In fact, the Court held that the SLC member’s recusal constituted an admission that he, and thus the SLC as a whole, lacked independence. This decision, which applies Delaware law, reinforces the high standard of independence imposed on members of SLCs.

Plaintiffs were shareholders of Abercrombie. They filed a shareholder derivative suit against certain of Abercrombie’s officers and directors based upon allegations that they caused Abercrombie to make misleading public statements regarding the company’s business model of selling products with low manufacturing costs at high retail prices, resulting in a high per-unit margin. Plaintiffs alleged that while defendants were making the misleading statements, Abercrombie was amassing a large surplus of inventory such that the company would have to dramatically mark down its merchandise to clear out its inventory. The complaint alleges that insiders, including Singer, were aware that share prices would soon fall and sold a large number of their personally held shares on insider information.

In response to the allegations, Abercrombie’s board of directors created a SLC eventually composed of two board members, Allen Tuttle and Lauren Brisky. The SLC retained the law firm of Cahill Gordon & Reindel LLP, which took the lead in what would be a sixteen month investigation. Cahill did the bulk of the work in interviewing witnesses and reviewing documents and records, advised the two SLC members on the progress and results of the investigation, and made recommendations on how to proceed. When it came time to consider potential claims against Singer, Tuttle recused himself due to his prior personal and business relationship with Singer. Ultimately, the SLC produced a 144-page report which detailed its investigation and recommended to Abercrombie to seek a dismissal of the case on the ground that pursuing the claims would not be in the best interests of Abercrombie’s shareholders. The United States District Court for the Southern District of Ohio granted Abercrombie’s motion to dismiss, finding that the SLC was independent, proceeded in good faith and had a reasonable basis for its conclusions. Plaintiffs appealed.

Under the standard set out in Zapata Corp. v. Maldonado, 430 A.2d 779 (Del. 1981), a court must determine whether the SLC is independent, and whether it acted in good faith and had a reasonable basis for seeking the dismissal.  If the court makes these findings, it then has the option to apply its own business judgment to determine whether to dismiss the derivative action.

In Booth, the Sixth Circuit began by noting that other courts have not clearly articulated the standard of review to be applied to a lower court’s decision granting a motion to dismiss a derivative action based on the recommendations of an SLC. The Court found that the de novo review standard applies with respect to the first prong of the Zapata inquiry as to whether the SLC was independent, carried out the investigation in good faith, and had a reasonable basis supporting its conclusions. It also, however, left open the possibility that a more deferential review standard may apply to a lower court’s application of its own business judgment under the optional second prong in the Zapata test.

The Court then turned to the merits. It reversed the district court’s decision to grant the motion to dismiss. It based its reversal upon a finding that SLC member Tuttle was not independent. Because Tuttle lacked independence, the SLC also was not independent. The Court pointed to the fact that Tuttle had recused himself from considering allegations against Singer, a named defendant and central player in the shareholders’ allegations. “[B]ecause Tuttle … recused himself from considering claims against Singer,” the Court held “he effectively admitted he was not independent.” The Court also considered evidence that Tuttle and Singer had previously worked together, that Singer had spearheaded the effort to add Tuttle as a board member, and that Tuttle was planning on vacationing with Singer and his wife. Additionally, the Court noted that the claims against defendants were “not individual in nature.” In other words, Tuttle could not conclude that any claims against any other defendants had merit without implicitly concluding that those against Singer had merit. Abercrombie also did not establish that Tuttle’s recusal was effective. Moreover by recusing himself, Tuttle had impermissibly altered the Board’s resolution creating a two-member committee by creating a de facto one person committee led by Brisky. The Court did not rule on Brisky’s independence.

Under Delaware law, SLC’s are not presumed to be independent, and the SLC must prove its independence “beyond reproach.” The Court concluded by finding that, “Tuttle’s decision to recuse himself from considering claims against Singer, and Singer’s central role in the alleged wrongdoing, cast serious doubt on Tuttle’s objectivity as to the claims as a whole … where Abercrombie had the opportunity to work with competent counsel and cherry pick who would serve on its special litigation committee, it cannot now rely on the recommendation of a special litigation committee with such dubious independence.”

This decision confirms that Delaware corporations seeking to employ an SLC to investigate the allegations underlying a derivative lawsuit must take great care to ensure that the individuals it nominates to form the committee have no potentially material independence issues, including close personal relationships, with the defendants. At least according to the Sixth Circuit, recusal by a committee member will not automatically cure a potential independence issue. Because the precise contours of independence are highly fact specific and have not been delineated, a board seeking to establish an SLC should take great care to ensure independence of committee members at the outset of the committee’s work.

Are You A Foreign Company With A Relationship To A New York Company? It May Be Your Agent And Provide A Basis For Jurisdiction

In Arbeeny v. Kennedy Executive Search,Index No. 105733/2007 (Sup. Ct., NY County, Jan. 14, 2011) (“Arbeeny“), Defendants Jason Kennedy (“Kennedy”) and Kennedy Associates (“Kennedy Associates “) (collectively the “Moving Defendants”) moved to dismiss on the basis of Plaintiff Daniel Arbeeny’s failure to serve the complaint in a timely manner pursuant toCPLR § 306-b. Justice Eileen Bransten, of the New York Commercial Division, granted the Moving Defendants’ motion to dismiss as to Kennedy but denied it as to Kennedy Associates. In so doing, she addressed issues that may be important to United States-based companies that have a relationship with foreign corporations.

Plaintiff was formerly employed by Kennedy Executive Search (“KES”). KES was a New York-based executive search firm and was affiliated with Kennedy Associates, a British executive search firm. The underlying suit arose when KES allegedly lowered Plaintiff’s salary and terminated him for refusing to accept the reduction, allegedly a violation of Plaintiff’s employment agreement. Plaintiff commenced the action seeking to recover outstanding salary and commission pay.

KES and Jack Kandy, the former president of KES, were the only defendants that Plaintiff served. These defendants moved to dismiss. The court granted their motion to dismiss in April of 2008, but the First Department reversed in part in January of 2010. After the case was remanded, Kennedy Associates and Kennedy, moved to dismiss on the ground that they had not been served.

Mere Department and Agency Theories

In opposing Kennedy Associates’ motion to dismiss, Plaintiff argued that service upon KES constituted service upon Kennedy Associates because KES was a “mere department” of Kennedy Associates. Plaintiff also argued that KES was Kennedy Associates’ agent.

New York courts have repeatedly held that where a subsidiary is shown to be a “mere department” of a parent corporation, service on the subsidiary will constitute service on the parent. Though she acknowledged this history, Justice Bransten ultimately held that Plaintiff failed to show that KES was a mere department of Kennedy Associates. In so doing, she relied on a number of factors identified by the Second Circuit inVolkswagenwerk Aktiengesellschaft v. Beech Aircraft Corp., 751 F.2d 117, 120-22 (2d Cir. 1984). These factors include (i) the financial dependency of the subsidiary on the parent, (ii) the degree to which the parent corporation interferes in the selection and assignment of the subsidiary’s executive personnel and fails to observe corporate formalities, and (iii) the degree of control over the marketing and operational policies of the subsidiary. See id.  While Plaintiff alleged that these factors were present, Justice Bransten found that Plaintiff failed to submit evidence to support the allegations and, therefore, the Court held that KES was not a “mere department” of Kennedy Associates.

However, Justice Bransten found Plaintiff’s agency theory to be meritorious. Because KES and Kennedy Associates were commonly owned and KES was established to do all the business that the United Kingdom-based Kennedy Associates could do if it were present in New York, Justice Bransten held that KES was, for jurisdictional purposes, an agent of Kennedy Associates. Thus, service upon KES was sufficient for service upon Kennedy Associates.

The Moving Defendants asserted that the “mere department” and agency theories were inapplicable in actions where New York’s long-arm statute,CPLR § 302, is the alleged basis for personal jurisdiction. The Moving Defendants argued that because Plaintiff’s cause of action had a basis in New York, Plaintiff could not invoke the “presence doctrine” where another basis for jurisdiction existed.  The presence doctrine provides that if an entity is doing business in New York, it is “present” in New York for jurisdictional purposes. Justice Bransten rejected Moving Defendants’ argument. The Court held that while there is no requirement that a court undertake the presence doctrine analysis when the long-arm statute provides a basis for personal jurisdiction over the parent corporation, this does not mean that the presence doctrine cannot be used when there is an alternative basis for personal jurisdiction. See Arbeeny, at pg. 6.

Expanded Standing, or “Back to Basics”? Flash Memory Direct Purchasers Found to Have Standing to Assert Walker Process Claims

In Ritz Camera & Image, LLC v. SanDisk Corporation, et al., United States District Court, ND Cal., Case No. 5:10-CV02787-JF/HRL, the court denied a motion to dismiss in a Walker Process “fraud on patent office” case, and allowed standing to a direct purchaser. Is this an extension, or is it “business as usual”? A step by step analysis is in order.

Ritz Camera & Image, LLC (“Ritz”) filed an action under Section 4 of the Clayton Act alleging that SanDisk Corp., (“SanDisk”) and its founder, Harari, violated Section 2 of the Sherman Act. Ritz alleged that SanDisk and Harari conspired to monopolize, and actually monopolized the market for NAND/memory products, through the assertion of and prosecution of patents which were a fraud on the United States Patent and Trademark Office (“USPTO”). NAND/memory is a form of digital storage technology used in consumer electronics devices.

In a second amended complaint, (“SAC”), Ritz alleged that Harari tortiously converted flash memory technology owned by Harari’s former employer, and then prosecuted fraudulent “crown jewel” patents. Allegedly, Harari intentionally failed to disclose invalidating prior art, and made affirmative misrepresentations to the USPTO. Further, defendants allegedly threatened competitors through harassing litigation and sales tactics, and caused the elimination of a major NAND competitor, in an anti-competitive settlement of bad faith litigation. Ritz alleged that it was injured in its “business or property” as a result. The defendants’ overt acts allegedly reduced market competition, thus allowing for an increase in prices. Ritz was a direct purchaser of NAND/memory from defendants.

Defendants moved to dismiss the complaint on two grounds. First, defendants alleged that plaintiffs lacked standing to pursue a Walker Process FOPO (Fraud On Patent Office) claim. Second, defendants claimed that plaintiffs had failed to properly allege a viable relevant market. The court denied the motion to dismiss on standing grounds, but granted it on the ground that SanDisk and Harari were a single entity for antitrust purposes, and thus could not have “conspired to monopolize”.

The gist of the defendants’ arguments as to standing is that all or almost all Walker Process claims are brought by defendants in patent infringement actions as antitrust counterclaims. The FOPO allegations are designed to strip the patent holder of antitrust exemption under the patent laws. Walker Process permits plaintiffs to seek damages under Section 2 of the Sherman Act for monopoly power maintenance, where the overt acts involved fraudulent patent claims. The central issue in the motion before the court was whether to have standing, a plaintiff must be a participant in, or poised to enter, the relevant market as a competitor.

While this may be the normal fact pattern in which most Walker Process claims are cast, the court’s analysis made it clear that the “back to basics” approach of a stepped analysis under Section 4 of the Clayton Act is all that is necessary. Here, as a direct purchaser, plaintiff would have paid in excess of a market price for the direct purchases made from the defendants. As such, it has been the victim of a consumer welfare rent transfer from consumers to producers. With the elimination of viable competitor, substitutable alternatives were reduced. Ergo, there is a cognizable injury under the antitrust laws.

This analysis finds support in any number of Supreme Court antitrust decisions through several generations. For example, in Reiter v. Sonotone Corp., 442 U.S. 330 (1979), the Supreme Court held that consumers who pay more for goods are injured in their business or property under Section 4. In Blue Shield of Virginia v. McCready, 457 U.S. 465 (1982), the Supreme Court held that Section 4 gave standing for a policyholder to sue her insurance company for allegedly conspiring with physicians to refuse to deal with a psychologist, thus causing injury to plaintiff, who was unable to obtain insurance reimbursement for psychologist services. TheMcCready Court observed, however, “that congress did not intend to allow every person tangentially affected by an antitrust violation” to maintain a treble damage action. To determine standing it is necessary to examine “the physical and economic nexus between the alleged violation and the harm to the plaintiff”.

The next year, in Associated General Contractors, Inc. v. California State Council of Carpenters, 459 U.S. 519, 529-535 (1983), the Supreme Court outlined a step series of factors to be evaluated in determining whether a given plaintiff should be afforded standing. The first is the nature of the plaintiff’s alleged injury, and whether it is of the type that the antitrust laws were intended to forestall. Here, basic principles of market foreclosure and the resultant allocative inefficiency warrant the conclusion that the plaintiff has been injured in its business or property within the meaning of Section 4 of the Clayton Act. A second factor is the directness of the injury. Here, plaintiff was a direct purchaser who paid a non competitive price for a product that it demanded. Accordingly, it arguably has been injured in the truest sense of classic industrial organization economics.

Thus, while the factual pattern may be a deviation from the usual Walker Process norm, one might say that it is nonetheless within the wellhead of traditional antitrust jurisprudence.

As to the defendants’ claim of a defective relevant market allegation, stay tuned. The court held that a plausible inference is that defendants’ course of conduct was Walker Process monopoly power maintenance. That may be good enough for a motion to dismiss, Twombly notwithstanding.