Ruling on Economic Favoritism Puts ‘NC Dental’ Back in Spotlight

by BakerHostetler

In a recent opinion, a divided panel of the U.S. Court of Appeals for the Second Circuit ruled that an economic regulation passed by a state agency solely to protect one group from competition would not violate the constitutional guarantees of due process or equal protection. The court noted that such action might still violate antitrust laws, but went no further since no antitrust claim had been raised in the case. At least in the Second Circuit, this decision raises the stakes in future cases interpreting the scope of state-action immunity under the antitrust laws.

Pure Economic Favoritism Not Unconstitutional

In Sensational Smiles LLC v. Mullen, No. 14-1381-cv (2d Cir. July 17, 2015), the Second Circuit upheld a 2011 declaratory ruling of the Connecticut State Dental Commission stating that various teeth-whitening procedures could be legally performed only by licensed dentists. Plaintiff Sensational Smiles LLC, a non-dentist teeth-whitening business, then received a letter from the state threatening legal action if it continued to provide teeth-whitening services. Sensational Smiles challenged the commission’s declaratory ruling as unconstitutional under the due process and equal protection clauses.

During the district court proceedings, the parties’ dispute narrowed to just one of the commission’s rules on teeth-whitening—a rule that allowed only licensed dentists to point an “enhancing light” at a customer’s mouth as part of a teeth-whitening procedure. As practiced by the plaintiff, the procedure in question—intended to promote the whitening process—entailed aiming a low-powered LED light at a seated customer’s teeth for 20 minutes while the customer listened to music. The rule prohibited Sensational Smiles and other non-dentist businesses from assisting a customer to position the light, though the rule permitted a customer to use the lamp without assistance. It also permitted a non-dentist to provide a customer with an LED enhancing light and a facility in which to use it, so long as the non-dentist did not assist the customer in adjusting the light. Under the commission’s rule, assisting a customer in this manner was deemed the unlicensed practice of dentistry, a felony punishable by up to five years of imprisonment.

Because the commission’s rule does not implicate a fundamental right, such as voting, and does not employ a “suspect” classification, such as gender or race, it was subject only to “rational basis” review by a court. Under rational basis review, it is the challenger’s burden to refute “any conceivable basis which could be advanced” in support of the challenged rule, regardless of whether that basis is supported in the record and regardless of whether that basis actually motivated the rule’s enactment. The reviewing court does not evaluate the wisdom or logic of the challenged rule but considers only whether there was some basis on which the legislative body could have relied. Accordingly, the standard is extremely deferential to lawmakers. As the district court commented, it is sometimes stated that rational basis review is “not meant to be toothless,” but “the teeth are dull and the bite rare.” Applying this standard, the district court upheld the rule, and the plaintiff appealed to the Second Circuit.

The Second Circuit panel was unanimous in affirming the district court, citing in its published decision the government interest in protecting the public’s oral health and testimony presented to the commission regarding potential risks associated with bleaching lights (though not LED lights). Even though dentists were not trained in teeth whitening or the use of LED lights, the Second Circuit came up with several reasons why the commission could have believed that use of LED lights should be restricted to licensed dentists. For example, Judge Guido Calabresi, writing for the majority, said the commission could have believed that dentists would be better equipped to deal with any oral health issues that might arise during the procedure or that customers seeking teeth-whitening services should first receive a dental examination. While the rule was not particularly well tailored to address these concerns, it is sufficient under rational basis review that “at least some evidence exists that LED lights may cause some harm to consumers” and “there is some relationship (however imperfect) between the commission’s rule and the harm it seeks to prevent.”

Given the difficulty of prevailing under rational basis review, this result is not a surprise. However, a majority of the panel chose to go further to address another issue. Sensational Smiles, supported by amicus, asserted that the commission’s rule—regardless of the explanations offered—was in reality nothing but economic protectionism, intended only to give dentists a monopoly over teeth-whitening services at the expense of consumers and would-be competitors. Regulations like these, the argument goes, result from what economists call “rent-seeking”—the use of the political process by interest groups (like dentists) to advance their own financial self-interests. Sensational Smiles contended that there was no legitimate government interest in protecting dentists from competition.

On this point, a majority of the Second Circuit panel held that the rule would still pass rational basis review even if the commission’s only purpose was to protect dentists from competition, believing that this result was compelled by Supreme Court decisions upholding legislation with no purpose other than economic favoritism. The panel majority also pointed out that states regularly take actions that favor one group over another on economic grounds. In Calabresi’s plain words: “We call this politics.” Finally, the court noted the practical difficulty in attempting to disentangle a legislature’s protectionist purposes from “legitimate” ones and in finding an “acceptable” level of protectionism. In concurrence, Judge Christopher Droney stated that he would not have reached this issue, but that he believed “at least some perceived public benefit” was required, even under rational basis review.

Antitrust Laws and State-Action Immunity

While upholding the rule as constitutional, both the majority and the district court noted that they expressed no views on whether the rule might violate the antitrust laws, since no antitrust claims had been raised by the parties. Whether the antitrust laws are applicable depends upon whether the commission can successfully claim state-action immunity, which excludes actions taken by the states in their sovereign capacity from the scope of the antitrust laws.

Earlier this year, in North Carolina State Board of Dental Examiners (N.C. Dental) v. Federal Trade Commission, No. 13-534, the U.S. Supreme Court considered very similar actions taken by North Carolina’s state dental board, which had sent letters to non-dentists performing teeth-whitening services demanding that they cease the “unlicensed practice of dentistry.” The court held that, when a state agency is “controlled by market participants,” that agency can claim state-action immunity only if the challenged restraint is clearly articulated and affirmatively expressed as state policy and is “actively supervised by the state.” “Active supervision” for purposes of state-action immunity requires substantive review of the agency’s decisions, including veto power, by another who is not an “active market participant.” While the plaintiff in Sensational Smiles did not bring any antitrust claims, the district court’s opinion notes that six out of nine members of the Connecticut State Dental Commission are dental practitioners. This raises the possibility that the N.C. Dental exception to state-action immunity might have come into play had a Sherman Act claim been asserted.

Parties Challenging State Agency Actions

The Second Circuit’s approval of bare economic favoritism as a basis for competition-limiting legislation is unlikely to have much practical significance even within that circuit, since it is so difficult for a challenger to prevail under rational basis review. That said, it is unclear what remains of rational basis review over economic regulations under the majority’s approach. Under any standard of review, one might have expected that a law enacted only for the purpose of treating groups differently would not survive an equal protection challenge.

However, even if economic favoritism were not a “rational” basis for legislation, it is unlikely that many laws would be successfully invalidated on these grounds. A legislature is not required to articulate any reason for regulations affecting only economic activity, and under rational basis review, it does not matter what actually motivated the legislature’s actions. As the Sensational Smiles majority noted, the dental commission could have wanted to increase the cost of teeth-whitening services by limiting competition in order to subsidize the costs of more essential dental services. While no one believes such considerations were actually in play, that theoretical justification is likely sufficient under a rational basis review. As this case illustrates, it is not difficult for courts and lawyers to propose any number of reasons that could have justified a protectionist rule—which is all that rational basis review requires. Indeed, it is hard to imagine any monopoly-protecting law or regulation to which the majority’s “subsidization” rationale could not be applied.

With Sensational Smiles, the Second Circuit joined the Tenth Circuit in holding that the Constitution permits “protectionist” legislation even if passed solely to benefit one interest group over another, at the expense of the consumer public. This decision, however, appears to conflict with decisions of the Fifth, Sixth and Ninth circuits. Given the apparent circuit split, this issue could reach the Supreme Court. Regardless of how the constitutional questions are resolved, the antitrust laws likely remain the best option for challengers excluded from a market by a state agency’s action. N.C. Dental makes clear that certain regulations will be susceptible to antitrust challenge, depending on agency membership and degree of state supervision. But if the agency in question complies with the N.C. Dental requirements for claiming state-action immunity, there may be no recourse for an affected party, other than through the political process. As Justice Samuel Alito Jr. pointed out in his dissent in N.C. Dental, the majority opinion leaves many questions unanswered. It will be very interesting indeed to see where lower courts draw the lines in years ahead regarding whether an agency is “controlled” by market participants and whether a state exercises “active supervision” over the agency’s actions. Stay tuned.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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