Legal Issues for Buying Groups

In almost any given industry, the small to mid-size businesses tend to find themselves disadvantaged by the fact that the dominant players can purchase goods and services at dramatically cheaper prices. Without being able to buy competitively, there is no way small to medium-sized businesses can price their goods and services competitively with the giants in their industry. A well organized and well run buying group can serve as the equalizer in this situation. By pooling their purchasing power together, small and medium-sized businesses can create many of the same efficiencies in purchasing that the largest businesses offer. The result is that they can once again become competitive.

The health care industry has long been a leader in the use of buying groups. Through buying groups, tremendous savings are achieved on a wide array of products used by the hospitals -- everything from bed sheets to syringes to durable medical equipment (DME). Buying groups work well in any field where products are purchased and resold. This concept certainly works well for distributors of home health care products, also.

As beneficial as these buying groups are, they are viewed with some degree of suspicion by federal and state agencies charged with enforcing antitrust laws. This article will discuss a few of the antitrust issues that confront many of these groups and will provide recommendations that will help minimize the exposure of the group and its members.

Enforcement of the antitrust laws comes from three potential sources: namely, federal agencies (i.e., the Federal Trade Commission FTC and the Antitrust Division of the Department of Justice), state agencies (usually a section in the state attorney general's office) and individuals bringing lawsuits for private remedies. During the years of the Reagan administration, there was a definite throttling back of federal enforcement of antitrust laws. The size of the staff charged with the responsibility of enforcing these laws was reduced and the number of cases brought by the federal government dropped off sharply. This trend reversed itself somewhat during the Bush administration. With President Clinton in the White House, antitrust enforcement efforts have been increased significantly.

During the Reagan years, the state and federal antitrust enforcement agencies were at loggerheads with one another on many issues, the state agencies taking the more aggressive stance in enforcement of antitrust laws. The federal agencies have come around to the more aggressive position of the state agencies, so that they are now of one mind. This spells double trouble for those groups who are not strictly in accord with the antitrust laws.

Small and medium sized businesses can price their goods and services competively with the giants in their industry by pooling their purchasing power.

Federal antitrust laws may be enforced against a buying group (as well as its members, directors, officers and employees) both by governmental officials and by private parties through treble damage actions. In both cases, penalties are severe. An individual convicted of a criminal violation of the Sherman Act may be fined as much as $350,000 and imprisoned for up to three years. A corporation convicted of such a criminal offense may be fined as much as $10,000,000. Violation of the FTC Act can result in the issuance of a cease and desist order, which would place extensive governmental restraints on the activities of group and its members. Failure to obey such an order can result in penalties as much as $10,000 per violation.

The U.S. Department of Justice and the FTC jointly issued Statements of Antitrust Enforcement Policy in Health Care in 1996. Statement No. 7 deals with joint purchasing arrangements among health care providers. The second paragraph of this statement reads as follows:

Joint purchasing arrangements are unlikely to raise antitrust concerns unless: (1) the arrangement accounts for so large a portion of the purchases of a product or service that it can effectively exercise market power in the purchase of the product or service; or (2) the products or services being purchased jointly account for so large a proportion of the total cost of the services being sold by the participants that the joint purchasing arrangement may facilitate price fixing or otherwise reduce competition. If neither factor is present, the joint purchasing arrangement will not present competitive concerns.

In other words, there is little danger of purchasing arrangements restricting market conditions, at least in the eyes of the federal enforcement authorities, so long as the purchasing arrangement does not represent a large portion of the market share for that particular product or service and so long as the products or services being purchased through the group do not account for too large of a portion of the total cost of the services provided by the participants in the group.

Statement No. 7 goes on to provide a safety zone for purchasing groups whose combined purchases represent less than 35 percent of the market and who are able to show that the cost for the products and services purchased through the group account for less than 20 percent of the total revenues from all products and services sold by the members of the group.

Failure to meet these criteria does not mean that the law has been broken. It simply means that the conservative criteria set up for this safety zone have not been met. The government acknowledges that there may be other factors that mitigate competitive concerns for joint purchasing arrangements that fall outside of the antitrust safety zone. One of the most important safeguards mentioned is that the members should not be required to use the arrangement for all of their purchases of a particular product or service. They should be allowed to opt out of the arrangement. Another safeguard is to limit the amount of communications that the members have among themselves. They should communicate directly with the purchasing group and those communications should be kept confidential.

Just what are the antitrust concerns associated with group purchasing organizations(GPOs)? These concerns include illegal restraints on the market resulting from price discrimination practices, market allocation, price fixing and boycott activities. The first two of these problems could arise when a group has established territorial restraints among its members.

Territorial Restraints

Perhaps the problem area most frequently encountered by groups arises when applicants for membership are turned down on the basis of geographical location. Members of a group generally do not want the group to admit a new member that is in direct competition with one of them for several reasons. Some of those reasons may be legitimate and some of them not so legitimate. One of the important benefits a group has to offer is the opportunity for the membership to discuss common problems they are experiencing in the industry. The discussion is more likely to be frank and open if the participants are not in competition with each other. There is less likelihood of an antitrust violation arising within the membership of the group if they are not competitors.

On the other hand, the motivation for excluding competitors from a given territory can be less than honorable. The members of a group may simply want to keep competitors from being able to purchase from manufacturers at the same low price that they are enjoying through the group's purchasing volume. If an excluded competitor is, in fact, put at a price disadvantage by not being able to belong to the group, he may have a claim against both the manufacturer, the group and its members, under the Robinson-Patman Act which, among other things, protects against price discrimination. Although there are defenses available to Robinson Patman Act claims, they are sometimes difficult to prove. Some groups have resolved this problem by opening their membership to all qualified applicants, and by expressly stating that the geographical location of a prospective member shall not be a criteria for membership. However, at the same time, they do not actively seek new members from areas where members already exist.

Another problem, somewhat related, but having much more serious implications, arises when groups allocate sales territories among their membership. The U.S. Supreme Court has ruled this type of market allocation to be per se illegal as a horizontal restraint of trade.

Price Fixing

Perhaps one of the most dangerous areas of antitrust law which confronts buying groups is the prohibition against price fixing. What makes this area of antitrust law so dangerous is that these types of violations can easily occur, sometimes almost unknowingly. Whether done intentionally or unintentionally, price fixing violations are top priority for the governmental enforcement agencies. In fact, the enforcement agencies are more likely to seek incarceration for price-fixing offenders than they are for any other type of violation of the antitrust laws.

Price fixing concerns arise when a group enters a contract to service a national account. For instance, small distributors might join in an effort to serve a large retail account. Frequently in such arrangements, the members of the group agree to service the national account within each of their individual locations for a uniform price. While this is literally a form of price fixing, the Justice Department has given favorable business review letters in certain situations. Some of the factors the Justice Department has noted in granting such favorable opinions included the fact that the group had a small percentage of market share, that this arrangement created a new efficiency or a "new product" which would not be otherwise available to the purchaser, and that mechanisms were built into the arrangement to prevent spillover collusion. Chief among these is a mechanism whereby a single representative who is not one of the competing sellers collects pricing information from participants and submits bids to, or negotiates with, potential purchasers. Another mechanism would be to bar participants from discussing price or other terms with other participants, except where vital to the purpose of the venture. Yet another mechanism would be to insist that communications be generally channeled to and from the single representative. These mechanisms are sometimes referred to in legal circles as a "messenger model," because the mechanism depends on one person to serve as a messenger for price discussions, as opposed to allowing the participants to come together in a group discussion. Before any group undertakes to service a national account under an arrangement which includes uniform pricing or a feature which restricts which participants can sell to the national account, advice of legal counsel should be sought and followed.

Price fixing violations are top priority for the government enforcement agencies.

Another problem area exists for groups which hold meetings for their membership. Adam Smith once said, "People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public on some contrivance to raise prices."

While discussion of prices in and of itself is not against the law, such discussions quite often do lead to either an implicit or sometimes an explicit understanding among the participants of that conversation as to how they will set their prices. Suppose Competitors A and B have an open and frank discussion regarding their pricing policies. Suppose following their conversation, each independently raised its prices to the same price. Even if they had not discussed this action during their conversation, it would be difficult for them to convince a court of their innocence. One federal court of appeals stated that it was not "so naive as to believe that a formal signed-and-sealed contract or written resolution would conceivably be adopted at a meeting of price fixing competitors in this day and age. In fact, the typical price-fixing agreement is usually accomplished in a contrary manner."

Boycott Activities

Another significant danger which is attendant to GPOs is that they can violate Section 1 of the Sherman Act by forming a group boycott. An ill-advised GPO may decide to flex its muscles with its suppliers by agreeing among themselves not to purchase from a certain vendor who does not accede to their demands. Such an agreement would be an illegal boycott. In a less obvious form of a boycott, the group may agree to purchase exclusively from one particular vendor. When group members agree to purchase only from one vendor, by implication they are boycotting all of that vendor's competitors. Therefore, a group should always allow its members the option of purchasing from other vendors in order to avoid falling into the boycott trap.

What other measures can a group take to protect itself and its members from charges of antitrust violations? The answer lies in the establishment of an effective antitrust law compliance program. Such a program would include written guidelines, which would include basic ground rules as to what can and cannot be discussed at meetings. The group should have legal counsel present at its membership meetings. Many groups balk at incurring this type of expense. Nevertheless, it is money well spent, because not only does it reduce the likelihood of the group becoming enmeshed in an antitrust violation, but it also has a favorable impact upon those governmental officials charged with enforcing the antitrust laws. Legal counsel can also assist the group in any other legal issues which arise during the course of the meeting. Many times, advice given by legal counsel on the spot of a meeting will affect the group's selection of a particular course of action. The minutes of the organization should be carefully monitor ed by legal counsel. The minute book is one of the first documents requested by an antitrust enforcement agency during the course of an investigation.

Another important aspect of an antitrust compliance program is for legal counsel to provide the group with periodic updates on antitrust law in order to increase their awareness of the need for antitrust compliance. These are only a few of the measures that should be incorporated into an effective antitrust compliance program.

Despite the potential legal pitfalls that confront buying groups, there is no denying that these groups can serve a useful and legitimate purpose in our society. A group that is aware of what these pitfalls are and how to avoid them has already won half the battle. The rest of the battle will be won by those groups who establish well-designed antitrust compliance programs and carefully adhere to their guidelines. Legal counsel plays an important role in this process. In almost all cases, when businessmen have a legitimate objective in mind, there is a way to accomplish it, even if a slightly different path is required to be followed. So it is when a group travels through the obstacle course of antitrust law. Hopefully, this article will help groups identify and negotiate the obstacles.

Ray, Of Counsel with Grant, Konvalinka & Harrison, P.C., serves as legal counsel for several national buying and marketing groups. Contact: Ninth Floor, Republic Centre, 633 Chestnut Street, Chattanooga, Tennessee 37450;

This article originally appeared in the October 2000 issue of HME Business.

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