Discon, Inc. v. NYNEX Corp.

• Decision Date: 26 August 1996
• Docket Number: D,No. 1126,1126
• Citation: 93 F.3d 1055
• Parties: 1996-2 Trade Cases P 71,535, RICO Bus.Disp.Guide 9107 DISCON, INCORPORATED, Plaintiff-Appellant, v. NYNEX CORPORATION, Nynex Material Enterprises, New York Telephone Company, Robert J. Eckenrode, and Bernard O'Reilly, Defendants-Appellees. ocket 95-7673.
• Court: U.S. Court of Appeals — Second Circuit

Page 1055

93 F.3d 1055

1996-2 Trade Cases P 71,535, RICO Bus.Disp.Guide 9107

DISCON, INCORPORATED, Plaintiff-Appellant, v. NYNEX CORPORATION, Nynex Material Enterprises, New York Telephone Company, Robert J. Eckenrode, and Bernard O'Reilly, Defendants-Appellees.

No. 1126, Docket 95-7673.

United States Court of Appeals Second Circuit.

Argued March 27, 1996.

Decided Aug. 26, 1996.

Samuel A. Cherniak, New York City (Phyllis Gelman, Gelman & Feinberg, New York City; Goldstein, Navagh, Bulan & Chiari, Buffalo, NY, on the brief), for plaintiff-appellant.

Guy M. Struve, New York City (James D. Liss, Vincent T. Chang, Seth R. Lesser, Davis Polk & Wardwell; Edward S. Bloomberg, Kevin J. English, Phillips, Lytle, Hitchcock, Blaine & Huber, Buffalo, NY, on the brief), for defendants-appellees.

Before: NEWMAN, Chief Judge, OAKES and PARKER, Circuit Judges.

JON O. NEWMAN, Chief Judge:

This appeal involves an antitrust suit brought by a former supplier alleging that its purchaser and a competitor acted in violation of the Sherman Act and the Racketeer Influenced and Corrupt Organizations Act ("RICO"). Plaintiff-appellant Discon, Inc. ("Discon") appeals from the June 14, 1995, judgment of the United States District Court for the Western District of New York (Richard J. Arcara, Judge). The District Court dismissed Discon's amended complaint pursuant to Fed.R.Civ.P. 12(b)(6) for failure to state a claim upon which relief can be granted. Discon argues that the District Court erred in holding that its complaint fails to allege a violation of either Section One or Section Two of the Sherman Act, 15 U.S.C. §§ 1, 2 (1994), or RICO, 18 U.S.C. § 1962 (1994). Because we believe that the District Court prematurely dismissed two of Discon's claims, we affirm in part, reverse in part, and remand.

Background

Discon is a New York corporation whose primary business is the provision of "removal services" to telephone companies. These removal services include salvaging and disposing of obsolete telephone central office equipment. Discon was first formed in June 1984 to meet a demand created by the court-ordered break-up of the American Telephone and Telegraph Company ("AT&T"), see generally United States v. American Telephone and Telegraph Co., 552 F.Supp. 131 (D.D.C.1982), aff'd sub nom. Maryland v. United States, 460 U.S. 1001, 103 S.Ct. 1240, 75 L.Ed.2d 472 (1983). Prior to 1984, AT&T was able to monopolize the market for telecommunications equipment, including the market for removal services, through its ownership of the regional Bell Operating Companies ("BOCs"). AT&T would compel the BOCs to purchase supplies only from AT&T and its manufacturing affiliates, the Western Electric Co. and Bell Telephone Laboratories. In this manner, AT&T was able to extend the regulated monopoly power of its BOCs into other non-regulated markets. 552 F.Supp. at 222-23. Pursuant to the Consent Decree of 1984, AT&T divested itself of control over the BOCs. Thereafter, each BOC was instructed to purchase its products and services from a competitive field of suppliers. Id. at 227. Discon became one of those suppliers of removal services in the New York State area.

NYNEX Corp. ("NYNEX") is a successor entity that emerged out of the 1984 divestiture and replaced the BOCs that operated in New York and New England. NYNEX itself is a holding company that controls several wholly-owned subsidiaries, including NYNEX Material Enterprises ("MECo") and two local telephone service providers, New York Telephone Co. ("NYTel") and New England Telephone and Telegraph Co. ("NET"). ¹ Within the NYNEX structure, MECo is a Delaware corporation whose primary business is the procurement of goods and services for NYNEX and its affiliated corporations, including NYTel. In effect, MECo serves as a purchasing agent for NYNEX and its other subsidiaries. NYTel is a New York corporation that provides local telephone service to most of New York State and some portions of Connecticut. NYTel is the dominant purchaser of removal services in the New York State area. As a regulated monopoly under the New York Public Service Laws, NYTel is subject to the state rate-making process. NYNEX and MECo, however, are not subject to state regulation.

AT&T Technologies is a wholly-owned subsidiary of AT&T, and is the successor entity to the Western Electric Co. ² AT&T Technologies provides numerous network services, including removal services, to telephone companies throughout the United States. Within the New York State area, AT&T Technologies competes directly with Discon in the market for removal services.

Discon's complaint alleges that NYNEX, MECo, and NYTel (collectively, the "NYNEX Defendants") conspired with AT&T Technologies to eliminate Discon from the market for removal services. The crux of this conspiracy was a scheme to defraud the rate-paying public. During the mid-1980s, MECo, as a non-regulated affiliate of NYNEX, would purchase removal services at inflated prices from AT&T Technologies. These removal services, along with their inflated prices, were then passed on to NYTel, a regulated affiliate of NYNEX. In turn, NYTel was able to overcharge its captive rate-paying customers pursuant to the rate-making process. MECo would then recoup its inflated costs by receiving a secret year-end "rebate" from AT&T Technologies. Thus, without being subject to any oversight from the state regulatory commission, MECo and its parent company, NYNEX, were able to generate increased revenues that were essentially derived from NYTel's telephone monopoly. This scheme was replicated in numerous contexts by the NYNEX Defendants for other capital goods and services purchased by NYTel. See In re New York Telephone Co., 5 F.C.C.R. 866 (1990) ("FCC Order ").

In an independent regulatory proceeding, the Federal Communications Commission ("FCC") found that this method of generating revenues--using MECo as an "outside" profit center--violated the Communications Act of 1934, 47 U.S.C. § 201(b) (1988). The FCC ordered NYTel to issue a rebate to its rate-paying customers for overcharges that occurred between 1984 and 1988. FCC Order, 5 F.C.C.R. 866. The FCC and NYTel subsequently entered into a consent decree. See In re New York Telephone Co., 5 F.C.C.R. 5892 (1990) ("FCC Consent Decree "). Without admitting any wrongdoing or violations, NYTel agreed to refund over $35 million for "unreasonable rates reflecting improper capital costs and expense charges." Id.

Discon alleges that, as part of this conspiracy to defraud the rate-paying public, NYNEX and MECo, in purchasing removal services for NYTel, discriminated against Discon in favor of AT&T Technologies because Discon refused to inflate its prices. Also, Discon would sometimes contract directly with NYTel, thus bypassing MECo altogether and undermining the basic premise of the outside profit-center scheme. Discon claims that, in retaliation for its non-cooperation, MECo and AT&T Technologies conspired to disseminate false information about Discon, to burden Discon with undue obligations under threat of economic duress, and to give preferential treatment to AT&T Technologies.

Discon filed its original complaint in the Western District of New York in May 1990, alleging that the NYNEX Defendants had violated Section One and Section Two of the Sherman Act and RICO. In June 1992, the District Court granted an initial motion to dismiss with leave to replead. Shortly thereafter, Discon filed an amended complaint, and the NYNEX Defendants moved to dismiss pursuant to Fed.R.Civ.P. 12(b)(6). On June 14, 1995, the District Court dismissed with prejudice.

Discussion

I. Section One of the Sherman Act

This appeal typifies one of the primary difficulties in the judicial application of antitrust law. Under Section One of the Sherman Act, courts are asked to categorize various complex commercial arrangements into a rigid legal taxonomy, e.g., horizontal restraint, vertical restraint, price-fixing, market division, concerted refusal to deal, and so on. This initial categorization is often outcome-determinative. Under one category, the arrangement may be per se illegal, while under another, it may be found permissible under the rule of reason. Due to the complexity of modern business transactions, however, courts often find that commercial arrangements can be classified theoretically under a number of different categories. See Broadcast Music, Inc. v. Columbia Broadcasting System, Inc., 441 U.S. 1, 8, 99 S.Ct. 1551, 1556, 60 L.Ed.2d 1 (1979) ("[E]asy labels do not always supply ready answers.") In this case, we believe that the District Court may have been misled by a poorly drafted complaint into categorizing the arrangement as one that is presumptively legal. Since the complaint may properly be understood to allege arrangements that might be shown to be unlawful, we are obliged to reverse in part and remand. We believe that the complaint states a cause of action under Section One of the Sherman Act, though under a different legal theory than the one articulated by Discon.

To state a claim under Section One of the Sherman Act, Discon must allege (1) that the NYNEX Defendants entered into a contract, combination, or conspiracy, and (2) that their agreement was in restraint of trade. See 15 U.S.C. § 1. ³ Traditionally, restraints of trade are classified as either horizontal restraints or vertical restraints. See Business Electronics Corp. v. Sharp Electronics Corp., 485 U.S. 717, 730, 108 S.Ct. 1515, 1522-23, 99 L.Ed.2d 808 (1988) ("Sharp "). Horizontal restraints are generally considered illegal per se if they fall within certain broad categories. See United States v. Topco Associates, Inc., 405 U.S. 596, 608, 92 S.Ct. 1126, 1133-34, 31 L.Ed.2d 515 (1972) (market division); Klor's, Inc. v. Broadway-Hale Stores, Inc., 359 U.S. 207, 211-12, 79 S.Ct. 705, 708-09, 3 L.Ed.2d 741 (1959) (concerted refusal to deal); United States v. Socony-Vacuum Oil Co., 310 U.S. 150,...