Three Phoenix Co. v. Pace Industries, Inc.

Decision Date12 January 1983
Docket NumberNo. 15775-PR,15775-PR
Citation659 P.2d 1258,135 Ariz. 113
Parties, 1982-83 Trade Cases P 65,154 THREE PHOENIX COMPANY, Plaintiff-Appellant, v. PACE INDUSTRIES, INC., Defendant-Appellee.
CourtArizona Supreme Court

Kenneth A. Winsberg, Cruse, Meadow & Firetag by Stephen T. Meadow, Phoenix, and William W. Webb and Jonathan Rose, Tempe, for plaintiff-appellant.

Brian K. Stanley, Kenneth R. Reed, Phoenix, for defendant-appellee.

HOLOHAN, Chief Justice.

Respondent, Three Phoenix Company, initiated this litigation seeking injunctive and other relief based upon an alleged breach of covenants not to compete by the petitioner, Pace Industries, Inc. Pace moved to dismiss on the grounds that the respondent was not the proper party to enforce the covenants and that the covenants were unenforceable in any event. The trial court treated the motion as one for summary judgment, considered affidavits submitted by respondent, and granted judgment to petitioner Pace.

Three Phoenix appealed. The Court of Appeals reversed the trial court's judgment. Three Phoenix Co. v. Pace Industries, Inc., --- Ariz. ----, 659 P.2d 1271 (1 CA-CIV 4773, filed March 10, 1981). We granted the petition of Pace for review. The opinion of the Court of Appeals is vacated.

The essential facts are that Wabash Computer Corporation (Wabash) sought to divest itself of a portion of its computer business. Wabash accomplished the divestiture by selling its single-disc tester business to Three Phoenix and by selling the pack-scan tester business to Pace. Wabash and Three Phoenix entered a written agreement in June 1973. Pace and Wabash entered a written agreement in October, 1973, although it appears that there was an oral agreement prior to that time.

The written agreement between Pace and Wabash contained two covenants which in essence provided that Pace would not compete with Three Phoenix. These covenants stated:

9. Non-Competition. BUYER shall not during the term of this agreement within the world manufacture, use, lease, sell or otherwise dispose of any equipment or inventions which would directly or indirectly perform the same operations as said INVENTIONS or be in competition therewith nor shall BUYER for a period of two (2) years or for so long as they manufacture or sell said INVENTIONS, whichever period is longer, design, manufacture or sell any other equipment or products which were heretofore designed, manufactured or sold by the SELLER INCLUDING THE # SSA AND # SDT FOR THE WINCHESTER DISC which SELLER intended to design, manufacture or sell.

10. Non-Competition with Three Phoenix Company. SELLER has sold the following product lines to Three Phoenix Company, an Arizona corporation: the certification equipment, disc memo and TCT-300. BUYER shall not in any way compete with Three Phoenix in said product lines and shall not engage in any business activity with respect to them, including without limitation consulting services, maintenance or the supplying of spare parts.

The trial court found that the covenants at issue were unenforceable because they failed to include any time limit, and the trial court also ruled that the covenants violated the antitrust laws. We believe that it is only necessary for us to address the antitrust issue. Three Phoenix brought this action to enforce the covenants. We have no difficulty in holding that, if legally enforceable, Three Phoenix as a third party beneficiary could enforce the covenants.

The issues to be resolved are:

1. Did the restrictive covenants contained in the Pace-Wabash agreement constitute a horizontal market division scheme or were they ancillary to an otherwise legitimate transaction?

2. If the restraints were ancillary to a valid transaction, were they reasonable?

Three Phoenix sought to enforce the covenants, claiming they are ancillary to an otherwise valid transaction (namely, Wabash's sale of its disc-testing technology). If the covenants are in fact ancillary restraints, they will be scrutinized under the so-called rule of reason and enforced if "reasonable."

Conversely, Pace asserts, inter alia, that the restrictive covenants constitute a market division scheme between competing firms. As such, the covenants are naked restraints of trade which state and federal antitrust statutes prohibit. Under this view, the rule of per se illegality would apply to invalidate the covenants.

The language of the Sherman Act, 15 U.S.C.A. § 1 (and its Arizona counterpart, 14 A.R.S. § 44-1402) paints with a very broad brush, making illegal every contract, combination, or conspiracy in restraint of trade. Taken literally, this language would outlaw virtually every commercial contract, since each time a buyer elects to deal with a particular seller the contract limits the freedom of both to deal with others. Consequently, the courts found it necessary to interpret the statutory language in a somewhat looser fashion. L. Sullivan, Handbook of the Law of Antitrust, § 63 (1977). Thus, the U.S. Supreme Court adopted the more flexible "rule of reason" for determining whether most business relationships violate the prohibitions of the Sherman Act. United States v. Topco Associates, Inc., 405 U.S. 596, 92 S.Ct. 1126, 31 L.Ed.2d 515 (1972); Standard Oil Co. v. United States, 221 U.S. 1, 31 S.Ct. 502, 55 L.Ed. 619 (1911).

Rule of reason analysis considers "the facts peculiar to the business in which the restraint is applied, the nature of the restraint and the reasons for its adoption." (i.e., purpose, power and effect). Chicago Board of Trade v. United States, 246 U.S. 231, 38 S.Ct. 242, 62 L.Ed. 683 (1918).

While the Supreme Court applies this approach to most restraints, over time it has delineated certain categories of business activity which are per se violative of antitrust law. With respect to these activities, the conclusion of illegality is reached without conducting the extensive inquiry into "purpose, power and effect" required under rule of reason analysis. United States v. Topco Associates, Inc., supra; Wedgewood Investment Corp. v. International Harvester Company, 126 Ariz. 157, 613 P.2d 620 (App.1980).

One such category of per se violations is the horizontal market division, i.e., a market division scheme between two or more firms which otherwise would be competitors. Prior to the U.S. Supreme Court's decision in the Topco case, there was some dispute as to whether horizontal market division agreements were per se illegal, in the absence of other Sherman Act violations such as price fixing. See United States v. Topco Associates, Inc., supra, 405 U.S. 596 at 613-19, 92 S.Ct. 1126 at 1136-39, 31 L.Ed.2d 515 at 529-533, (Burger, C.J. dissenting), discussing Serta Associates, Inc. v. United States, 393 U.S. 534, 89 S.Ct. 870, 21 L.Ed.2d 753 (1969), aff'g 296 F.Supp. 1121 (N.D.Ill.1968); United States v. Arnold, Schwinn & Co., 388 U.S. 365, 87 S.Ct. 1856, 18 L.Ed.2d 1249 (1967); United States v. Sealy, Inc., 388 U.S. 350, 87 S.Ct. 1847, 18 L.Ed.2d 1238 (1967); Northern Pacific Ry. Co. v. United States, 356 U.S. 1, 78 S.Ct. 514, 2 L.Ed.2d 545 (1958); Timken Roller Bearing Co. v. United States, 341 U.S. 593, 71 S.Ct. 971, 95 L.Ed. 1199 (1951); United States v. National Lead Co., 332 U.S. 319, 67 S.Ct. 1634, 91 L.Ed. 2077 (1947); United States v. Addyston Pipe & Steel Co., 85 F. 271 (6th Cir.1898), aff'd 175 U.S. 211, 20 S.Ct. 96, 44 L.Ed. 136 (1899). Topco removed any doubts in this regard, however. In an expansively worded majority opinion, Justice Marshall stated:

One of the classic examples of a per se violation of § 1 is an agreement between competitors at the same level of the market structure to allocate territories in order to minimize competition. Such concerted action is usually termed a "horizontal" restraint, in contradistinction to combinations of persons at different levels of the market structure, e.g., manufacturers and distributors, which are termed "vertical" restraints. This court has reiterated time and time again that "[h]orizontal territorial limitations ... are naked restraints of trade with no purpose except stifling of competition." ... Such limitations are per se violations of the Sherman Act. (citations omitted).

United States v. Topco Associates, Inc., supra, 405 U.S. at 608, 92 S.Ct. at 1133-34, 31 L.Ed.2d at 525.

Although Topco dealt with a horizontal market division along territorial lines, and the market division in this case is along product lines, the courts and commentators have not been willing to make any distinctions between the two types of market division. * Both are illegal.

Their reasoning is sound in that the adverse effect on competition is the same whether the division is along territorial or along product lines.

[F]orms of market division can vary to an almost capricious degree. Collision with competitors can be avoided by agreements which parcel out exclusive territories, exclusive customers, or exclusive products, but all of this has long been assimilated and the law has displayed no tendency to draw overly fine distinctions between such alternative ways of dividing markets.... Whether we call such devices imaginative or crude, once they have been found out they do nothing to drape over the fact that firms which might have given each other the competitive nudge have instead agreed to permit each other an abundant elbow room. L. SULLIVAN, supra, § 79, at 213.

A covenant not to compete ancillary to an agreement for the sale of a business or a transfer of business property will be enforced, if the restraint imposed is no greater than necessary to afford fair protection to the parties, and if the restraint is partial in nature and reasonably limited in scope.

The classic covenant not to compete incident to the sale of a business in one restricting the seller's right to compete in order to effectuate a transfer of the good will associated with the tangible assets sold. The rationale for upholding such...

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    ...and agreements that fall under the rule of reason when applying § 44–1402 of the AAA. See, e.g.,Three Phoenix Co. v. Pace Indus., Inc., 135 Ariz. 113, 115, 659 P.2d 1258, 1260 (1983). Given the harmony between the AAA and the Sherman Act, for the same reasons discussed in the DPP Order and ......
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    ...of Appeals which reversed in 1981. Three Phoenix Co. v. Pace Industries, 135 Ariz. 126, 659 P.2d 1271 (1981), vacated, 135 Ariz. 113, 659 P.2d 1258 (1983) (en banc). The Arizona Court of Appeals in turn was reversed in 1983 by the Arizona Supreme Court which ruled that the restrictive coven......
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1 books & journal articles
  • Arizona. Practice Text
    • United States
    • ABA Antitrust Library State Antitrust Practice and Statutes (FIFTH). Volume I
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    ...at 1096. 9. Ariz. Rev. Stat. Ann. § 44-1407. 10. Id. § 44-1408(A). 11. Id. § 44-1408(B). 12. Id. 13. Three Phoenix Co. v. Pace Indus., 659 P.2d 1258, 1259-60 (Ariz. 1983) (consulting federal precedent regarding per se and rule of reason analysis); Dattilo v. Tucson Gen. Hosp., 533 P.2d 700,......

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