Opinion
00 Civ. 5008 (CM) (LMS)
March 15, 2002
MEMORANDUM DECISION AND ORDER GRANTING DEFENDANT'S MOTION TO DISMISS IN PART AND DENYING IN PART
On October 5, 2001, this Court dismissed Plaintiffs First Amended Complaint for failure to state a claim under Federal Rule of Civil Procedure 12(b)(6). Plaintiff filed the Second Amended Complaint on November 13, 2001.
Plaintiff and counterclaim-defendant Commercial Data Servers, Inc. ("CDS") now sues defendant and counter-claim-plaintiff International Business Machines Corporation ("IBM") for violations of Sections 1 and 2 of the Sherman Act, Section 3 of the Clayton Act, and Section 340 of New York's General Business Law (the "Donnelly Act") (collectively, "the antitrust claims"), and tortious interference with prospective business advantage.
IBM moves to dismiss the antitrust claims (Counts I through VI of Plaintiff's Second Amended Complaint). IBM has not made a motion to dismiss CDS's tortious interference claim asserted in Count VII.
FACTUAL BACKGROUND
Among the products manufactured by IBM is the "P/390" card, which may be added to certain computer systems, thereby enabling them to run the IBM S/390 operating system software. (Second Am. Compl. ¶ 26.) IBM has built and marketed its own computer systems containing the P/390 card. ( Id.) IBM also has sold these cards to other technology companies, called original equipment manufacturers ("OEMs"), which in turn integrate the P/390 cards into their own computer systems and market those systems under their own names. ( Id., ¶ 29)
In 1997, CDS entered into an Original Provider Agreement with IBM (the "OPA Agreement"), pursuant to which CDS invested in IBM's development of the P/390E processor card, an enhanced version of the P/390 card. ( Id.) CDS then developed computers incorporating the P/390 and P390E cards. ( Id. at ¶¶ 5, 27.) CDS marketed these computers under various names, including CDS-104, CDS 2000, and CDS 2000E. ( Id.)
Through an earlier contract with IBM, CDS was eligible for favorable entry system level ("ESL") pricing for OS/390 software. ( Id. at ¶ 4, 20.) ESL pricing was IBM's most favorable software pricing. ( Id. at ¶ 4, 20, 42.) CDS alleges that it relied on IBM's provision of favorable ESL pricing in marketing its computers. ( Id. ¶¶ 24, 26, 27, 29, 31.)
In May 1998, IBM announced its new product, the S/390 Integrated Server, scheduled for release in November 1998. ( Id. ¶¶ 6, 47, 69, Ex. 15.) This product was based on the P/390E, and competed with CDS's computers. ( Id. ¶¶ 6, 41, 48, 51.) IBM released this product in November, as scheduled. IBM stopped offering the S/390 Integrated Server in February 2000. ( Id. ¶ 71.)
CDS alleges that IBM's S/390 Integrated Server was introduced as part of a scheme to "eliminate CDS." ( Id. ¶ 6.) In furtherance of this scheme, IBM allegedly imposed certain restrictive conditions on CDS's favorable ESL pricing qualification by, for example, prohibiting it from describing its product in certain terms and comparing its product to certain IBM computers. ( Id. ¶¶ 45-47.) IBM also allegedly "threatened" and/or "coer[ced]" two value added resellers ("VARs"), Information Technology Co. ("ITC") and Intelliware, in an effort to "prevent CDS from distributing the CDS 2000" through certain distribution channels. ( Id. ¶ 56; see also id. ¶¶ 60, 64.)
Plaintiff argues that IBM (1) violated state and federal antitrust laws by engaging in anticompetitive conduct; and (2) tortiously interfered with prospective business advantage.
Defendant responds that the newly pleaded antitrust claims (Counts I through VI of the Second Amended Complaint) should be dismissed for the three reasons: (I) failure to provide specific factual allegations justifying CDS's market definition; (2) failure to allege anticompetitive conduct or a substantial foreclosure of competition; and (3) failure to state a claim for a per se violation of Section 1 of the Sherman Act.
For the reasons stated below, Defendant's motion to dismiss is granted in part and denied in part. Count I is dismissed. Counts II through VI remain.
DISCUSSION
Rule 12(b)(6) of the Federal Rules of Civil Procedure provides for dismissal for failure to state a claim upon which relief can be granted. The standard of review on a motion to dismiss is heavily weighted in favor of the plaintiff. The Court is required to read a complaint generously, drawing all reasonable inferences from the complaint's allegations. California Motor Transport Co. v. Trucking Unlimited, 404 U.S. 508, 515 (1972). "In ruling on a motion to dismiss for failure to state a claim upon which relief maybe granted, the court is required to accept the material facts alleged in the complaint as true." Frasier v. General Electric Co., 930 F.2d 1004, 1007 (2d Cir. 1991). The Court must deny the motion "unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Stewart v. Jackson Nash, 976 F.2d 86, 87 (2d Cir. 1992) (quoting Conley v. Gibson, 355 U.S. 41, 45-46 (1957)).
There are no heightened pleading requirements for antitrust cases. Todd v. Exxon Corp., 275 F.3d 191, 198 (2d Cir. 2001). Furthermore, "dismissals prior to giving the plaintiff ample opportunity for discovery should be granted very sparingly." id. (quoting Hospital Bldg. Co. v. Trustees of Rex Hosp., 425 U.S. 738, 746 (1976)). However, "[i]t is nonetheless improper `to assume that the [plaintiff] can prove facts that it has not alleged or that the defendants have violated the antitrust laws in ways that have not been alleged.'" Id. (citing Associated Gen. Contractors of California. Inc. v. California State Council of Carpenters. 459 U.S. 519, 526 (1983)).
I. Per Se Violation of Section 1 of the Sherman Act
____IBM argues that Count I of the Complaint should be dismissed because IBM has failed to state a claim for a per se violation of the Sherman Act.
Under Section I of the Sherman Act, "[e]very contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several States . . . is declared to be illegal." 15 U.S.C. § 1; Electronic Communications Corp., 129 F.3d at 243. To establish a per se violation of the Sherman Act, Plaintiff must allege anticompetitive conduct that falls into one of four categories: (1) price-fixing; (2) division of markets; (3) tying arrangements; or (4) group boycotts. See Bogan v. Hodgkins, 166 F.3d 509, 514 (2d Cir. 1999);In re European Rail Pass Antitrust Litig., 166 F. Supp. 836, 840 (S.D.N.Y. 2001).
Honizontal restraints, i.e. agreements between competitors at the same level of market structure, are per se violations of the Sherman Act.Oreck Corp. v. Whirlpool Corp., 579 F.2d 126, 131 (2d Cir. 1978). The per se rule is not applicable, however, where there are "vertical" restraints — agreements between firms "at different levels of distribution" that do not include price fixing. See Nynex Corp. v. Discon. Inc., 525 U.S. 128, 138 (1998) ("antitrust law does not permit the application of the per se rule in the boycott context in the absence of a horizontal agreement"); Business Elec. Corp. v. Sharp Elec. Corp., 485 U.S. 717, 735-36 (1988) ("a vertical restraint is not illegal per se unless it includes some agreement on price or price levels"); Oreck Corp. v. Whirlpool Corp., 579 F.2d 126, 131 (2d Cir. 1978) (vertical restraints are "to be examined under the rule of reason standard"). Plaintiff in this case does not allege price fixing. CDS asserts that IBM made threats to two of its distributors, ITC and Intelliware. This constitutes a vertical restraint.
The allegations in the Second Amended Complaint are similar to those asserted in Floors-N-Moore, Inc. v. Liquidators, 142 F. Supp.2d 496 (S.D.N.Y. 2001). In that case, a furniture retailer alleged that defendant, another furniture retailer, contacted some of its suppliers and threatened that they would not do business with the suppliers unless the suppliers refused to deal with the plaintiff. Id. at 499. Plaintiff's allegations in Floors-N-Moore, Inc. were insufficient as a matter of law.
Plaintiff argues in its opposition papers that there was a conspiracy between IBM and its distributors, resulting in a "secondary boycott" against CDS's products. CDS asserts that there was a horizontal agreement between the distributors not to deal with CDS. Plaintiff argues that while there are vertical elements here (because IBM made the initial threat to the conspirators) what really occurred is a horizontal agreement. They cite Business Electronics Corp. v. Sharp Electronics Corp., 485 U.S. 717, 720 n. 4 (1988), which states that "a facially vertical restraint imposed by a manufacturer only because it has been coerced by a `horizontal cartel' agreement among its distributors is in reality a horizontal restraint."
The problem with CDS's argument is that nowhere in the complaint is anagreement alleged on a horizontal level. The Supreme Court held inBusiness Electronics Corp. v. Sharp, that a restraint is not horizontal because it has horizontal effects but because it is the product of a horizontal agreement. Id. CDS only alleges that IBM threatened its downstream distributors, not that the downstream distributors agreed amongst themselves. This is insufficient to support a claim of horizontal conspiracy. While Plaintiff alleges a "conspiracy" in its motion papers, even this assertion, with nothing more, would not be sufficient to survive a motion to dismiss. See Granite Partners, 58 F. Supp.2d 228, 238 (S.D.N.Y. 1999); see also Heart Disease Research Found. v. General Motors Corp., 463 F.2d 98, 100 (2d Cir. 1972) ("[A] bare bones statement of conspiracy or of injury under the antitrust laws without any supporting facts permits dismissal."); Telectronics Proprietary, Ltd. v. Medtronic. Inc., 687 F. Supp. 832, 837 (S.D.N.Y. 1988) (dismissing complaint which alleged that defendants "conspired and contracted with [each other] . . . to restrain trade"). Plaintiffs do not provide a single fact in support of an allegation of a horizontal agreement.
Therefore, because Count I alleges a vertical restraint not involving price fixing, it fails to state a claim for a per se violation of Section I of the Sherman Act and is dismissed.
II. The Relevant Product Market
Plaintiffs remaining claims, Counts II through VI, allege violations of Sections 1 of the Sherman Act (under the rule of reason), Section 2 of the Sherman Act, Section 3 of the Clayton Act, and Section 340 of the New York General Business Law, also known as the Donnelly Act.
In order to make out an antitrust claim, "plaintiff must allege a relevant product market in which the anti-competitive effects of the challenged activity can be assessed." Carrell v. The Shubert Org., Inc., 104 F. Supp.2d 236, 264 (S.D.N.Y. 2000); Re-Alco Indus., Inc. v. Nat'l Ctr. For Health Inc., 812 F. Supp. 387, 391 (S.D.N.Y. 1993) (citingJefferson Parish Hosp. Dist. No. 2 v. Hyde, 466 U.S. 2, 29 (1984). The defined market must be supported in the complaint by a "theoretically rational explanation" for why the boundaries of the market are defined as they are. Int'l Audiotext Network, Inc. v. American Tel. Tel. Co., 893 F. Supp. 1207, 1213 (S.D.N.Y. 1994), aff'd, 62 F.3d 69 (2d Cir. 1995).
Because a relevant market includes all products which are reasonably interchangeable, Re-Alco Indus., Inc. v. National Ctr. for Health Educ., Inc., 812 F. Supp. 387, 391 (S.D.N Y 1993) (citing United States v. E.I. DuPont de Nemours Co., 351 U.S. 377, 76 S.Ct. 994, 100 L.Ed. 1264 (1956)), a plaintiffs "failure to define its market by reference to the rule of reasonable interchangeability is, standing alone, valid grounds for dismissal." B.V. Optische Industrie De Oude Delft v. Hologic. Inc., 909 F. Supp. 162 (S.D.N.Y. 1995); Int'l Audiotext Network. Inc. v. ATT, 893 F. Supp. 1207, 1213 (S.D.N.Y. 1994) ("[A]n antitrust plaintiff must set out a theoretically rational explanation to support its proposed relevant product market"). In addition, to state an antitrust claim, the alleged product market must be plausible. See B.V., 909 F. Supp. at 171. (S.D.N.Y. 1995); Deep South Pepsi-Cola Bottling Co. v. Pepsico. Inc., No. Civ. A. 88-6243. 1989 WL 48400, at *7 (S.D.N.Y. May 2, 1989) ("The federal courts, in the context of Rule 12 motions to dismiss, have not hesitated to reject market allegations that make no economic sense under any set of facts").
In particular, the explanatory allegations must take into account both the "product market, those commodities or services that are reasonably interchangeable by consumers for the same purposes, and a geographic market, the area in which sellers of the relevant product effectively compete." Smith Johnson v. Hedaya Home Fashions, Inc., No. Civ. A. 96-5821, 1996 WL 737194 at *5 (S.D.N.Y. Dec. 26, 1996) (quoting Sunshine Cellular v. Vanguard Cellular Sys., Inc., 810 F. Supp. 486, 493 (S.D.N.Y. 1992)). Further, the supporting allegations must specifically address reasonable interchangeability by "reference to cross-elasticity of demand and the similarity of purpose and clientele of each product."Smith Johnson, 1996 WL 737194, at *5 Dismissal is appropriate "[i]f a complaint fails to allege facts regarding substitute products, to distinguish among apparently comparable products, or to allege other pertinent facts relating to cross-elasticity of demand." Re-Alco Indus. Inc., 812 F. Supp. at 391 see also E G Gabriel v. Gabriel Bros., Inc., Civ. No. 93-0894. 1994 WL 369147, at *3 (S.D.N.Y. July 13. 1994) (failure to define market "by reference to the rule of reasonable interchangeability is, standing alone, valid grounds for dismissal").
In the case at bar, CDS defines the relevant market as follows: existing IBM customers owning "low-end IBM mainframe S/390 computers with processing power of 10 MIPS, or less." (Second Am. Compl. ¶¶ 20, 74.) IBM has market share in excess of 70% of this market. (Id. ¶ 74.)
IBM argues that CDS's complaint fails: (1) to allege properly that existing S/390 customers are "locked in;" and (2) to provide any theoretically rational explanation for limiting the market to S/390-compatible computers with processing power of"10 MIPS, or less."
A. The lock-in effect
CDS defines the relevant product market as limited to existing IBM customers because high switching costs lock-in these customers to the IBM platform. (Compl. ¶¶ 74, 75.) CDS argues that the lock-in effect is caused by years of investment in IBM's proprietary hardware and software. Customers desiring to run production applications on their IBM mainframes must purchase the OS/390 operating system and write applications customized to the platform. Software applications written for the S/390 system are not transferrable to other non-IBM computing platforms. (Compl. ¶¶ 74.)
IBM argues that the lock-in paradigm addressed in Eastman Kodak Co. v. Image Technical Services. Inc., 504 U.S. 451 (1992) is not applicable to the case at hand. They assert that Kodak creates a narrow exception to the general prohibition against single-brand markets. In Kodak, independent service organizations sued Kodak after it instituted a new policy that it would only sell Kodak replacement parts to customers who used Kodak maintenance services to maintain their machines (or maintained their own). at 458. The ISOs alleged that Kodak had violated the antitrust laws by unlawfully tying the sale of copier maintenance services to the sale of Kodak replacement parts. Id. at 459. IBM argues that Kodak's holding relies on the fact that there was an abrupt change in policy that prevented customers from assessing the applicable costs and risks at the time they initially invested in the relevant product or services.
CDS does not allege tying. It uses the lock-in theory to justify a product market consisting of only one brand of computers.
IBM is correct that this fact was important to the Supreme Court's findings in Kodak. In Hack v. President and Fellows of Yale College, 237 F.3d 81 (2d Cir. 2000), the Second Circuit recently held insufficient as a matter of law plaintiffs' claim that they were "locked in" to a Yale education. The students in that case had alleged antitrust violations with respect to the New Haven housing market. Id. at 87. The court noted that "Yale's housing policies were fully disclosed long before plaintiffs applied for admission. They had no `lock-in' costs." Id. The court also distinguished the Yale students' situation from those in Hamilton Chapter of Alpha Delta Phi, Inc. v. Image Technical Services. Inc., 128 F.3d 59, 64-65 (2d Cir. 1997). The court noted that in Hamilton, plaintiffs were "locked in" by their investment in housing which they could no longer use because of an abrupt change in policy. The court explained that the situation in Hamilton might have raised Kodak concerns, but the Yale student's situation did not. Hack, 237 F.3d at 86.
Plaintiff responds, however, that in the present case, the antitrust plaintiffs were not able to assess the potential costs and risks at the time that they made their initial investment in the IBM platform. As opposed to the students in Hack, who knew about Yale's housing policy when they enrolled in college, plaintiff alleges that IBM engaged in conduct that prevented efficient marketing of new technologies to customers in the relevant market after the customers invested in the IBM platform. CDS argues that it would be reasonable for customers considering purchasing an IBM platform to anticipate that they would benefit from competition in the market through cost-effective enhancements to the IBM platform. In the past, for example, customers in the high-end market were able to purchase lower-priced hardware and peripherals from Amdahl Corp. and Hitachi. (Compl. ¶ 23.)
At the motion to dismiss phase, plaintiffs must plead a market that is "plausible" and "rational." Todd, 275 F.3d 191 at 203. Plaintiffs have properly alleged the switching costs associated with changing platforms — once an initial investment is made in an IBM platform, it is an expensive proposition to switch to another one. Therefore, IBM platform owners might tolerate even uncompetitive prices as long as the increases did not exceed the cost of abandoning their original investment in the platform. (Compl. ¶ 75.) Whether plaintiff will succeed in proving the alleged market is a question for a later date. See Todd, 275 F.3d at 204.
B. S/390-compatible computers with processing power of 10 MIPS. or less
Plaintiff asserts that the limitation to computers with processing power of 10 MIPS, or less is appropriate since IBM itself has defined this as a category of customers. (See Pl. Opp. at 10; Compl. Ex. 30.) Emails between IBM executives create a reasonable inference that the "lowend" is a distinct market — indeed, the low-end market is one that IBM itself was concerned that CDS was threatening. (See Compl. ¶¶ 36, 37, 39, 40.) Exhibit 30 to the Complaint, an internal IBM document sets forth a "Less than 10 MIPS strategy for "Existing Customers." Given the fact that IBM itself draws the line at 10 MIPS, there is a theoretically rational explanation for the relevant market as alleged in the Complaint.
IBM responds that this reference to IBM's classification is insufficient to define the relevant market. Defendant cites State of New York v. Kraft Gen. Foods. Inc., 926 F. Supp. 321, 332 (S.D.N.Y. 1995), in support of this argument. Kraft does indeed state that "[i]t is not appropriate to use . . the marketing segments from time to time by any particular RTE cereal producer to define a relevant economic market." However, this statement appears in the Kraft court's findings of fact issued after a bench trial. I find that at the motion to dismiss stage, the allegations in the complaint sufficiently describe a plausible market.
"Because market definition is a deeply fact-intensive inquiry, courts hesitate to grant motions to dismiss for failure to plead a relevant product market." Todd v. Exxon Corp., 275 F.3d 191, 199 (2d Cir. 2001). While there is no absolute rule against the dismissal of antitrust claims for failure to allege a relevant product market, see Queen City, 124 F.3d at 436, "it frequently has been observed that `a pronouncement as to market definition is not one of law, but fact.'" Hayden Publ'g Co. v. Cox Broad. Corp., 730 F.2d 64, 70 n. 8 (2d Cir. 1984) (citations and alterations omitted). I find that the allegation of a market limited to existing IBM customers owning "low-end IBM mainframe S/390 computers with processing power of 10 MIPS, or less" is plausible on its face. Todd v. Exxon Corp., 275 F.3d at 205.
II. Anti-Competitive Conduct and Substantial Foreclosure of Competition
1. Group Boycott/Refusal to Deal/Exclusive Dealing Claims (Counts II-IV VI)
IBM made this argument with respect to Claim I, as well. Since that Claim has been dismissed, these arguments no longer apply to Claim I.
To state antitrust claims based on an alleged group boycott, refusal to deal or exclusive dealing arrangement between IBM and its VARs, which CDS does in Counts II through IV and VI, CDS "must allege as a threshold matter . . . a substantial foreclosure of competition" in the relevant market. Ford Piano Supply Co. v. Steinway Sons, Civ. No. 85-1284, 1998 WL 3488, at *1 (S.D.N.Y. Jan. 13, 1988); see also Tampa Elec. Co. v. Nashville Coal Co., 365 U.S. 320, 328 (1961) (competition foreclosed must "constitute a substantial share of the relevant market").
IBM argues that the allegation that IBM threatened two VARs in an effort to prevent them from selling CDS products is insufficient to allege a substantial foreclosure of competition. In response, CDS notes that IBM quashed the interest of two influential VARs, thereby making CDS's attemnpts to penetrate a broader universe of VARs futile. In its reply papers, IBM characterizes this reference to "influential" VARS as an improper attempt to amend its pleading through its opposition brief I disagree. CDS does not endeavor to amend their pleadings, rather they are arguing that two VARs may indeed be sufficient to substantially foreclose competition, depending on the particular facts relating to those VARs. I agree with CDS that they have met their burden of alleging a substantial foreclosure of competition in the relevant market. See Subsolutions. Inc. v. Doctor's Associates, Inc., 62 F. Supp.2d 616, 627 (D. Conn. 1999) (finding that allegation that antitrust defendant's anticompetitive conduct foreclosed competition in the relevant market, without more, "satisfied the liberal pleading requirements of the Federal Rules of Civil Procedure.")
2. The Attempted Monopolization Claim (Count V)
Section 2 of the Sherman Act provides that "every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other person or persons, to monopolize, any part of the trade or commerce among the several States . . . shall be deemed guilty of a felony." 15 U.S.C. § 2.
To state a claim under Section 2, a plaintiff must allege: (1) anticompetitive conduct; (2) specific intent to monopolize; and (3) dangerous probability of success. See National Ass'n of Pharm. Mfrs., Inc. v. Ayerst Lab., 850 F.2d 904, 915 (2d Cir. 1988); Tops Mkts., Inc. v. Quality Mkts., Inc., 142 F.3d 90, 99-100 (2d Cir. 1988).
IBM breaks down CDS's allegations in support of its monopolization claim into three categories of anticompetitive conduct: (1) IBM's coercion of and/or conspiracy with certain VARs to shut CDS out of the market; (2) IBM's "pre-announcement" of the S/390 Integrated Server; and (3) IBM's failure to give CDS an unqualified right to favorable ESL pricing. IBM then refutes each of these allegations individually, and therefore argues that CDS's attempted monopolization allegations do not support claims for antitrust liability.
CDS responds that the Court should view the allegations in their entirety. IBM has market share in excess of 70% of the relevant market, indicating monopoly power. IBM used this power to suppress competition by CDS. The Complaint asserts that IBM executives were fearful of losing their market share in the low-end of the S/390 market, and engaged in a series of restrictive actions. CDS alleges that IBM's conduct in its totality had the effect of increasing CDS's costs to compete with IBM, and decreasing customer interest in CDS's products. IBM's conduct therefore increased prices and decreased customer choice in the relevant market.
For the reasons set forth in Part One of this Section (Group Boycott/Refusal to Deal/Exclusive Dealing Claims (Counts II-IV VI), I disagree with IBM that the allegations regarding time coercion of two VARs are insufficient to support the assertion that the alleged conduct by IBM would have an anticompetitive impact. I also have already decided that CDS has adequately alleged a relevant market. Given that IBM has market share in excess of 70% in that relevant market, and that CDS adequately alleges a substantial foreclosure of competition (by arguing that IBM coerced of two VARs), CDS's allegation of attempted monopolization also survives this motion to dismiss.
CONCLUSION
For the foregoing reasons Defendant's motion to dismiss Count I is granted, with prejudice. Defendant's motion to dismiss Counts II through VII are denied.
This constitutes the decision and order of the Court.