An interesting and growing debate in the antitrust arena is whether most favored nation (“MFN”) pricing provisions are pro-competitive or anticompetitive. For many years, MFN provisions have been considered a fairly noncontroversial contract term included by purchasers in an attempt to assure that other buyers do not receive a more favorable price. But not all agree that MFNs result in lower prices, including some economists and, more importantly, the Department of Justice Antitrust Division (“DOJ”). The DOJ not only has expressed potential concerns about MFN clauses but also has filed several antitrust actions alleging that particular MFN clauses violate Sherman Act § 1 and cause anticompetitive effects. The challenge for businesses that prefer to include MFN clauses in their purchase agreements is to recognize when those clauses potentially raise antitrust risk.

The procompetitive benefits of MFN clauses are fairly straightforward. First, the most typical reason for obtaining an MFN clause is to reduce the buyer’s price in the event that the seller agrees to sell to another customer at a price lower than that specified in the contract with the MFN clause. This is usually considered procompetitive because a reduction in the cost of inputs may enable the buyer to lower the price it charges when selling the product downstream. Indeed, if the downstream market is highly competitive, we would expect that competition in the downstream market would cause the MFN beneficiary to pass on most or all of that cost savings to the downstream customers.

A second procompetitive effect of an MFN clause is a reduction in the transactional costs associated with negotiating a sales contract. The purchasing agent for the buyer need not wring every nickel from the seller on price because the buyer has the protection of the MFN. In the technology licensing context, and particularly when there is no good understanding of the market for the technology, an MFN clause assures that the first licensee pays no more than a later licensee. This facilitates negotiation of the license and thereby helps push new technology to the market sooner than it would have if the licensee waited to see what its competitors would pay for the technology.

So with these benefits, what is the antitrust concern? Typically the antitrust issues arise when the buyer has a large market share and can exclude competitors or make it more difficult for them to compete. For example, one concern is that if MFN protection is given to a large customer, the clause will cause a seller not to give procompetitive discounts that it might otherwise provide. Consider the hypothetical in which a very large customer of a seller agrees to purchase 100,000 widgets at $10 apiece but also negotiates an MFN provision. If a new prospect is prepared to purchase 10,000 widgets from the supplier but will only pay $9 per widget, the supplier must consider not only whether that 10,000 widget order is profitable relative to manufacturing costs but also whether that second transaction is profitable after the seller also provides the discount to the larger customer under the MFN clause. In our example, the MFN clause would result in a $100,000 discount on the first order – more than the $90,000 total that the second customer would pay for all 10,000 widgets. Under that hypothetical, it makes no sense for the seller to agree to discount the second sale.

Another concern expressed by economists and the DOJ is that colluding firms could use MFN clauses as a means to effect or police a conspiracy among sellers to raise prices. For example, economic theory suggests that members of a price fixing conspiracy have an incentive to “cheat” on the conspiracy and increase revenues by selling to most customers at the inflated price but also secretly selling to a few customers at lower prices. That strategy only works if undetected by the other conspirators, so the widespread use of MFN clauses would increase the amount of product sold under the lower price and make the cheating easier to detect and police.

The DOJ has brought several cases based on MFN-type theories. In one case, the DOJ alleged that the MFN clause in a large insurance company’s contracts with hospitals acted as a barrier to entry because the clause caused hospitals to avoid entering contracts at lower rates with other health insurers that considered entering the market. In a more recent case filed by DOJ against American Express, the DOJ is challenging an Amex rule that allegedly prevents retailers from offering a lower price to consumers who pay for their purchases with cash or another brand of credit card. The DOJ contends that, without the rule, customers would benefit from the discount retailers would otherwise offer on purchases made with cash or non-AMEX cards.

In most situations, particularly when the parties have relatively small market shares, MFN clauses should have procompetitive benefits and are likely to result in lower prices to downstream customers. When the MFN clause applies to a large percentage of customers or increases the difficulty of entry by competing suppliers or when the MFN clauses are inserted at the insistence of the seller rather than the buyer, antitrust issues arise and should be considered before entering into the agreement.