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THE RULE OF REASON

 

Kok Chee Kheong explains the Standard Oil Case

The last few decades of the nineteenth century witnessed the consolidation of various industries, such as the steel industry, the tobacco industry, the sugar refining industry and the refining and transportation of oil, in the United States.

Advocates of 'progressivism', a nascent reform movement whose principal aims included consumer protection and social justice, were concerned that the large industrial enterprises that emerged from the consolidation would evolve into monopolies to the detriment of the working class as well as the owners of small businesses who would be squeezed out of the market.

The growing concern of the threat posed by these industrial behemoths gained momentum and led to the passing of the Anti-Trust Act 1890, commonly described as the Sherman Act, after John Sherman, the Republican Senator from Ohio who had initiated the bill.

THE SHERMAN ACT

The main prohibitions in the Sherman Act are found in sections 1 and 2.

Section 1 declares every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce, among several States, or with foreign nations, to be illegal.

Section 2 renders it an offence for any person to monopolise, or attempt to monopolise, or combine or conspire with any other person or persons, to monopolise any part of the trade or commerce, among several States, or with foreign nations.

Apart from the imposition of fines, the courts were given powers under section 4 to prevent and restrain violations of the legislation.

THE STANDARD OIL LEVIATHAN

Standard Oil came into existence in 1870 when John D Rockefeller, a bookkeeper turned oil refiner, combined two firms, Standard Works and Excelsior Works, to form the Standard Oil Company of Ohio.

The company grew rapidly through vertical and horizontal integration to become the largest refiner and transporter of oil in the United States. In January 1882, Rockefeller and his cohorts established the Standard Oil Trust and vested stocks of the various companies and other assets in trustees for the benefit of its members.

With the coming into force of the Sherman Act, the Standard Oil Trust was dissolved in 1892. However, in 1899, the companies were consolidated under the Standard Oil Company of New Jersey ("SONJ"), a corporation formed in the State of New Jersey which had recently revised its laws to permit the establishment of holding companies.

According to a Government report produced in 1907, SONJ and its subsidiaries controlled about 90% of the business of refining, transporting and selling petroleum products at home and abroad. The group was more than 20 times larger than its closest competitor and controlled more than 4,000 miles of pipelines and more than 5,000 railroad tank cars for transporting oil.

THE FEDERAL CIRCUIT COURT CASE

On 15 November 1906, the Roosevelt Administration charged SONJ and 70 companies and partnerships under its control, as well as seven individuals, including Rockefeller, in the Federal Circuit Court in Missouri with monopolistic conduct in violation of the Sherman Act.

The Government framed its allegations of misconduct into three periods: the first, from 1870 to 1882; the second, from 1882 to 1899; and the third, from 1899 to the filing of the action.

The Government alleged that the Standard Oil companies had monopolised the oil industry and conspired to restrain trade through various malpractices, including predatory pricing, obtaining illegal railroad rebates and drawbacks and abuse of the pipelines which they controlled.

The defendants denied the charges and contended that their success was the result of lawful competitive methods and modern management and production methods which reduced production and distribution costs. Any wrongdoing, the defendants argued, was the exception rather than the rule, and in most cases, the result of excessive individual zeal.

At the end of a trial which lasted for more than two years and involved the testimony of 444 witnesses and production of 1,371 exhibits, the four judges of the Federal Circuit Court held that the seven individual defendants, SONJ and 37 other defendant companies had violated sections 1 and 2 of the Sherman Act as the combining of stocks of various companies under SONJ in 1899 constituted a combination in restraint of trade and was an attempt to monopolise and a monopolisation under section 2 of the statute. Amongst other orders, the court ordered SONJ to divest its ownership of the said 37 defendant companies. The case against the other defendant companies was dismissed.

The defendants who were found to have violated the Sherman Act appealed.

THE SUPREME COURT DECISION

On 15 May 1911, Chief Justice Edward White delivered the opinion of the Supreme Court (221 U.S.1).

Before addressing the four main issues, the Chief Justice overruled the appellant's contention that the Federal Circuit Court, in considering the alleged conduct which occurred before the passage of the Sherman Act, had committed a prejudicial error which warranted a reversal of the trial court's judgment. The judge said that the Federal Circuit Court, as well as the Supreme Court, did not give any weight to the conduct which occurred during the first and second periods except insofar as such conduct threw light upon acts done after the Sherman Act was passed.

The Chief Justice then proceeded to deliver the court's opinion on the four issues.

The meaning of the text of the Sherman Act

The learned judge observed that the law in the United States in relation to restraint of trade was very similar to the common law of England. He then briefly traced the development of the law in both jurisdictions and concluded that prior to the passage of the Sherman Act, the doctrine of restraint of trade had evolved from prohibiting, without exception, all contracts which restrain trade to one which, in the interest of preserving the freedom to contract, prohibits only those contracts which operated as an undue restraint of trade.

According to the learned Chief Justice, the Sherman Act was enacted in the light of the law against restraint of trade as it existed at that time and it was not the intention of Congress to restrain the right to make and enforce contracts which did not restrain interstate or foreign commerce, but to protect such commerce from contracts or combinations by methods which constitute an undue restraint upon it.

Chief Justice White then declared that the Sherman Act contemplated and required a standard of interpretation, and it was intended that the standard of reason which had been applied at common law should be applied in determining whether particular acts fell within the prohibition in the statute. In other words, a restraint would be in violation of the statute only if it was unreasonable and worked against public interest.

In the judge's opinion, section 2 of the Sherman Act supplemented section 1 to ensure that the public policy embodied in section 1 was not frustrated or evaded. In essence, section 1 forbids all means of monopolising trade, that is unduly restraining it (trade), and section 2 makes such prohibition more complete and perfect by embracing all attempts to reach the end prohibited by section 1. According to the learned judge, when section 2 is so harmonised with section 1, it became evident that the criteria to be adopted to ascertain whether the section has been violated, is the rule of reason.

The Government's contention

The court then considered the Government's argument that the statute prohibited every contract or combination that restrains trade and its text leaves no room for the exercise of judgment. The Chief Justice opined that the cases relied upon by the Government did not sustain its contention as the cases, with the exception of United States v Trans-Missouri Freight Association 166 U.S. 290 and, arguably, United States v Joint Traffic Association 171 U.S. 505, rested upon the premise that reason was the guide by which the provisions of the statute were interpreted. Thus, the Chief Justice concluded that the rule of reason had to be applied in every case where it was claimed that an act violated the statute.

In the Trans-Missouri Case, the Supreme Court had held that every contract in restraint of trade is invalid. The apex court in the Joint Traffic Case followed the decision in the Trans-Missouri Case due to the similarity in the facts of those cases, but acknowledged that certain contracts did not amount to restraint of trade and that the statute applied only to contracts whose direct and immediate effect is a restraint on interstate commerce.

The Chief Justice concluded that the decisions in Trans-Missouri Case and the Joint Traffic Case must henceforth be qualified to the extent that the language in those cases conflict with the construction given to the Sherman Act in the instant case.

The application of the statute to the facts

According to the court, the unification of power and control over a commodity, such as petroleum and its products, by combining the stocks of many corporations in one corporation, namely SONJ, gave rise, of itself, to the prima facie presumption of an intention to dominate and control the movement of those products in the channels of interstate commerce in violation of the Sherman Act.

This presumption, in the opinion of the learned judge, was made conclusive by the proof of specific acts of the defendants. According to Chief Justice White, "We think no disinterested mind can survey the period in question [since 1870] without being irresistibly drawn to the conclusion that the very genius for commercial development and organisation which it would seem was manifested from the beginning soon begot an intent and purpose to exclude others ... from their right to trade and thus accomplish the mastery which was the end in view."

With the above remark, the Supreme Court appears to have given little weight to the appellants' contention that their success had been achieved through modern management and production methods.

The remedy to be administered

According to Chief Justice White, as a general rule, where it was found that the acts had been done in violation of the statute, it would be adequate to restrain the doing of such acts in the future.

However, where the condition which has brought about the violation of the statute, in and of itself, is not only a continued attempt to monopolise, but also a monopolisation, the duty to enforce the statute required the application of broader and more controlling remedies. The court was of the view that to meet a situation as that of the instant case, it was necessary to apply remedies which were two-fold in character: first, to forbid the continuance of the prohibited act; and second, to dissolve the combination whose existence violates the statute so as to neutralise the force of that unlawful power.

As the ownership by SONJ of the stocks of the other Standard Oil entities was a combination that violated section 1, and was an attempt to monopolise or a monopolisation contrary to section 2 of the Sherman Act, the Supreme Court upheld the decree of the Federal Circuit Court which ordered that the combination be dissolved.

Seven of the other judges of the Supreme Court concurred with the opinion of the Chief Justice, and the ninth judge, with the decision but not the reasoning.

THE DISSOLUTION

In furtherance of the Supreme Court's decision, the Standard Oil combination was dissolved through a distribution by SONJ of its stock holdings in the other appellant companies to its (SONJ's) shareholders on a proportionate basis. Several of the largest oil and gas companies in the world today, namely ExxonMobil, Chevron, Phillips 66 and the American arm of British Petroleum, bear the enduring legacy of having once been Standard Oil companies.

CONCLUSION

The Standard Oil Case did not give rise to the rule of reason. According to Chief Justice White, the rule had long existed in the United States as the basis for determining whether a contract that restrains trade is valid and had been applied in almost every case where it was claimed that an act violated the Sherman Act.

Nevertheless, the Standard Oil Case is noteworthy as it firmly established the rule of reason as the standard to be applied in determining whether the prohibitions in the Sherman Act have been violated.

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