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Seattle law firm Graham & Dunn reports on a ruling that will affect the hotel franchisor-franchisee relationship.
The hotel industry has its own way of doing business. Sometimes, outside of our day-to-day awareness, the industry’s practices are based on cases found in dusty law books a hundred years old. But long-standing lines of cases can be overturned. When that happens, the impact on the way we do business can be surprising and far-reaching.
A change of this kind has just occurred, when the Supreme Court decided the Leegin case at the end of last month. The Leegin case says that everything we knew about a brand’s ability to set rates in its franchise system is wrong.
Case History
Back in 1911, the Supreme Court in a case called Dr. Miles ruled that the federal antitrust laws strictly prohibit suppliers from setting minimum “resale” prices of their goods and services. Since 1911, courts had uniformly and consistently applied the Dr. Miles case to franchise relationships, making it illegal for a franchisor to set minimum resale prices (a practice generally referred to as vertical price fixing or resale price maintenance).
In the hotel world, the Dr. Miles ruling meant that any branded hotel company that franchises its system could not impose rate structures on its franchisees. A franchisee, for example, was free to set its own room rates even if they were inconsistent with the franchisor’s suggested pricing. The ruling prevented the branded hotel company from maintaining rate integrity within the hotel company’s franchise system. One consequence has been that franchisees have been free to sell blocks of discounted rooms to internet resellers, such as Travelocity, thereby allowing the resellers to undercut rates charged by the hotel company’s branded web sites.
At the end of July, however, the Supreme Court changed this long-standing rule, over-ruled Dr. Miles, and substantially opened the door for hotel franchisors to exercise much greater control over rates and other prices set by hotel franchisees. In Leegin Creative Leather Products, Inc. v. PSKS, Inc. dba Kay’s Kloset, the court held that “resale price maintenance” was legal, unless in a particular case the pricing activity “unreasonably restrained” competition.
Leegin was a clothing manufacturer that produced the “ Brighton” line of leather products. Kay’s Closet was a retail store in Texas that sold the Brighton line. Kay’s Closet started selling the Brighton line at discounted prices, Leegin terminated Kay’s Closet as one of its retailers for doing so, and Kay’s Closet sued for violation of the antitrust laws, citing the rule in Dr. Miles.
Based on Dr. Miles, Kay’s Closet won in each lower court, until the case reached the Supreme Court. The high court held that Leegin’s minimum resale price fixing was not categorically illegal, but was only illegal if it unreasonably restrained competition based on all of the facts and circumstances.
Price Setting and the Franchise Relationship
While it may sound technical, this change in analysis means a fundamental change in how price setting is handled in franchise relationships. It is very difficult (and expensive) to prove that a particular pricing practice unreasonably restrains competition, which means that in many (if not most) circumstances minimum resale price setting is now legal. A critical pricing practice that was once absolutely forbidden is now, in most circumstances, permitted.
Leegin provides branded hotel companies with new opportunities to manage their distribution networks. As always, a hotel franchisor is able to require its franchisees to provide specific levels of service. Now, for example, the hotel franchisor may be able to help guarantee the margins necessary to support those services by establishing minimum prices for all franchisees. Hotel franchisors may also be able to use pricing policies to protect price integrity at branded hotel web sites.
Don't forget to Consider These Key Points
Before a hotel company starts dictating minimum rates or prices to their franchisees under Leegin, however, there are several key points to keep in mind. First, the hotel franchisor may have existing franchise contracts that explicitly grant pricing freedom to the franchisees. The fact that the antitrust laws now permit a hotel franchisor to set franchisee rates and prices is not permission to violate existing valid contracts.
Second, the Supreme Court’s decision affects only federal law. States are generally permitted to have more restrictive state antitrust laws (many do), and particular states may have their own rules on minimum resale price maintenance. Even in states that do not presently have such laws, there may be efforts to reinstate the Dr. Miles rule as a matter of state law.
Third, the decision in Leegin is still only a few weeks old. It may be some time before all of its consequences fully shake out. There may even be efforts at the federal level to restore Dr. Miles as a matter of federal antitrust law. Before a hotel company changes a well-established pricing program based on Leegin, it will be wise for the company to consult with its trusted counselors.
Conclusion
Whether Leegin will be good or bad for the U.S. economy may be uncertain, but whether it will affect how business is done in the U.S. is not. Hoteliers should be familiar with the new rules and determine how they may impact their alternatives and opportunities.
For more information
Please contact Irv Sandman at Grarham & Dunn.
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