What is a Tying Agreement?
In simple words, a tying agreement is an arrangement wherein a customer may be able to buy a particular product only when he/she agrees to buy a second product from the company or at least agree not to buy the second product from the company’s competitors. Thus, a tying arrangement is when a company manufacturing products A and B requires a buyer who wants to purchase only product A to buy product B as well. An example of a tying arrangement is when a patented drug is tied to an unpatented medicine dispenser. This seeks to increase the monopolistic rights of patent holders over unpatented products.
In the case of Northern Pacific Railway Co.v, United States, the Northern Pacific Railway Company, received a large land grant from the federal government upon which it broke the land into many tracts and then sold the individual tracts to various buyers. In the sales agreement for each stretch of land, Northern Pacific includes a clause that forced all buyers to use Northern Pacific’s railway lines to ship all commodities produced or manufactured on the land.
The U.S. Supreme Court considered this scheme as tying arrangement. Where the tract of land was the “tying” product, the use of the railway was the “tied” product. It was observed that such arrangements deny competitors free access to the market for the tied product only because the company imposing such arrangements has power or leverage and not because the competitors’ products are not good enough.
It is often compared to the term ‘bundling’ wherein a seller may offer a lower combined price to buyers to buy two or more products together, but the customer always has the option of buying only one product with the cost of giving up the discount. In the case of tying agreements, the buyers cannot just purchase one item; if they want to buy the first item, they must purchase the second one as well. Thus, tying is sort of like bundling but has an element of coercion involved.
Who are the Parties to a Tying Agreement?
In the simplest form of a Tying Agreement, there are only two parties to the agreement.
- The seller: It can be a single person or a parent company that sells the product.
- The buyer: It is a single person or company that buys that particular product.
What is the purpose of a Tying Agreement?
The main purpose behind tying is to sell a less desirable product along with a product that is well associated with the company by making use of its market power. Thus, a product that does not have a competitive edge over other similar products in the market is sold with a product that does have a competitive advantage over the others. In this way, the seller prevents other companies from selling the second of the ‘tied’ item to the customer.
Elements of a Tying Agreement
A tying agreement typically consists of the following elements:
- Two separate products: A tying agreement must typically consist of two products that have different demands and that the seller can tie and sell together.
- Coercion: The second element is basically establishing a tie, i.e., a buyer would be able to buy the first product only if he also agrees to buy the second product.
- Market power: Usually, in such an agreement, the seller has significant market power with respect to one of the products he is selling, and using that market power or monopoly, he also tries to sell the second product. Therefore, the seller or product must have market power.
- Substantiality: This means that the second product that the seller is trying to sell must not have a substantial amount of commerce or demand in the market for it to be tied to a product that does. If this is not the case, then claiming of tying agreement would not be considered.
Contents of a Tying Agreement
A tying agreement typically consists of the following clauses:
- Parties to the agreement: The parties to a tying agreement need to be specifically spelled out. They generally consist of a service provider and the buyer.
- The purpose behind tying: It is always pertinent to include, why a tying arrangement is envisaged.
- Tying definition: A tying definition should be included. The same may be structured to show that the ask is reasonable so as to later help in enforcing the agreements.
- Products being tied: Which products are being tied or bundled together also needs to be specified in the tying agreement.
- Exit options: It is pertinent, especially for the buyer to have their exit options outlined in the agreement.
- Term: It is always preferable to have a fixed duration tying agreement in place.
- Boilerplate clauses such as dispute resolution, choice of law, severability, etc. need to be included.
Drafting Tying Agreements
The following guidelines should be followed while drafting tying agreements:
- Define tying: Tying definition, structured as a reasonable bundling of products together in order to further the commercial purpose of both the entities, should be included in the agreement.
- The purpose of the agreement should somewhat reflect that such tying and bundling arrangement would be for the larger good of consumers.
- Exit clauses should include both events for default and an option for termination simpliciter.
- It is always preferable to provide arbitration as a method of dispute resolution and put a jurisdiction where such agreements are enforceable as the venue for arbitration.
A tying agreement may become contentious on the following points:
- Products being tied up together: Try to include a popular and a less popular product together.
- Exit options: As a buyer, negotiate hard to outline as many exit options as you can.
- Term: Always negotiate for a shorter duration.
Benefits and Drawbacks of a Tying Agreement
The advantages are:
- Cost savings: In a tying agreement, a customer ends up buying two or more products for a lesser price than he would have spent if he had bought the products individually. The transaction costs are thus decreased because he has to negotiate with only one firm to buy the products instead of two or three.
- Prevention of free-riding: Freeriding is a situation wherein a company benefits from another company’s efforts to promote and sell its own products without contributing to the costs. A tying agreement thus prevents free-riding and restricts competition at the same time.
- Consumer demand: A tying agreement may be beneficial from a customer’s point of view because they end up paying a lesser aggregate price than they would have to pay if they had bought the products individually. It also helps them save time because they would negotiate only with one company to buy the products instead of two or three.
The disadvantages are:
- Restricts competition: The primary concern related to such agreements is the fact that it restricts competition. While it looks like a benefit to the company in the short run, it only prevents the company from improving its own products in the long run because it does not feel the need to do so. Also, this is a clear anticompetitive practice that is against the law and thus illegal and promotes a monopolistic competitive or business environment in the market.
- Coercion: In a typical tying agreement, a customer is often forced or ‘coerced’ to buy a second product that he does not want to buy but must do so if he wants to buy the first product. In the long run, it restricts consumer choice, which is against consumer protection norms.
What Happens in Case of Violation?
The antitrust laws in the U.S. can be seen from a federal as well as state-level(1). Both money damages and injunctive remedies are available to those suffering from the breach. The federal laws are as follows:
Section 1 of the Sherman Act(2) bans any agreement which unreasonably restrains trade and is thereby anticompetitive. For this arrangement to be per se illegal under Section 1 of the Sherman Act, the following parameters must be met:
- There are two separate products or services into consideration.
- The purchase of one of the products is conditioned on the purchase of the other product.
- The seller has an economic power in the market for the tying product to enable it to restrict trade in the market for the tied product.
- A substantial amount of commerce in the market for the tied product is foreclosed.
Section 2 of the Sherman Act talks about monopolization, which happens if the firm imposing the tie has considerable market power in the tying product, and the tie has deemed a means for maintaining the firm’s power in the tying market.
Section 3 of the Clayton Act prohibits certain types of agreements, which considerably lessen competition or tend to form a monopoly in any line of commerce.
The Federal Trade Commission Act has issued a prohibition against unfair competitive methods. However, no criminal penalties have been imposed on the same.
Most states, such as Washington state, have enacted their own antitrust laws to prohibit such arrangements within their states and to supplement enforcement of federal antitrust laws. The state and federal antitrust laws are often conceptually the same, but the codification of state differs from state to state. In many cases, state antitrust laws are more expensive than the federal antitrust laws in terms of the amount and quality of prohibited conduct. The interpretation of state antitrust laws may, but will not always, substantially mirror the federal antitrust laws.
Both the government and private plaintiffs are entitled to obtain an injunction against a tie that has been found unlawful. In some cases, damages for successful plaintiffs are the loss of profits or loss of business value of the particular company. When the plaintiffs are consumers, the damages can simply be obtained by filing a case against the defendant company, and the proportion of damages would be decided by the court depending upon how much the consumer was benefited by the tying arrangement.
We can conclude from the above provisions that a tying agreement is clearly violative of antitrust laws, is anticompetitive and monopolistic in nature and thereby illegal and unenforceable in the U.S. courts and federal antitrust institutions often look at the economic perspective of these tying agreements while looking into their legality. Thus, the courts do not prohibit such arrangements per se. They tend to look into all aspects before doing so, and in case they find a substantial reason for rendering them illegal, they definitely will.
Tying agreements are a very common aspect seen in the commercial market and lead to a significant amount of harm to consumers and is against consumer protection norms. From a legal point of view, they are obviously illegal as they are against the antitrust laws and are anticompetitive and monopolistic in nature. It is thus important for courts to look into the long-term effects of such anticompetitive behavior on the foreclosure of competition and consumer interests and not just the business justifications for the same.