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Queen City Pizza, Inc. v. Domino's Pizza

August 27, 1997

QUEEN CITY PIZZA, INC.; THOMAS C. BOLGER; SCALE PIZZA, INC.; BAUGHANS, INC.; CHARLES F. BUCK; F.M. PIZZA, INC.; ROBERT S. BIGELOW; BLUE EARTH ENTERPRISES, INC.; KEVIN BORES; DAVIS PIZZA ENTERPRISES, INC.; DIANE A. DAVIS; FISHER PIZZA, INC.; JAMES B. FISHER, JR.; SEPCO, INC.; S&S PIZZA CORP.; G&L PIZZA CO.; STEPHEN D. GALLUP; LUGENT PIZZA, INC.; JOSEPH J. LUGENT; BILLIO'S PIZZA, INC.; WILLIAM J. MURTHA; SPRING GARDEN PIZZA, INC; BRAD L. WALKER; JRW PIZZA, INC.; JAMES R. WOOD, INDIVIDUALLY AND AS CLASS REPRESENTATIVES OF A CLASS CONSISTING OF ALL PRESENT AND CERTAIN FORMER DOMINO'S FRANCHISEES IN THE UNITED STATES; INTERNATIONAL FRANCHISE ADVISORY COUNCIL, INC., APPELLANTS,

v.

DOMINO'S PIZZA, INC.



On Appeal from the United States District Court for the Eastern District of Pennsylvania

(D.C. Civil Action No. 95-cv-03777)

Before: SCIRICA, ALITO and LAY, *fn* Circuit Judges

SCIRICA, Circuit Judge.

Filed August 27, 1997

Argued February 28, 1997

OPINION OF THE COURT

In this appeal, we must decide whether certain franchise tying restrictions support a claim for violation of federal antitrust laws. Eleven franchisees of Domino's Pizza stores and the International Franchise Advisory Council, Inc. filed suit against Domino's Pizza, Inc., alleging violations of federal antitrust laws, breach of contract, and tortious interference with contract. The district court dismissed the antitrust claims under Fed. R. Civ. P. 12(b)(6) for failure to state a claim for which relief can be granted, because the plaintiffs failed to allege a valid relevant market. The district court declined to exercise supplemental jurisdiction over the plaintiffs' remaining common law claims. Queen City Pizza, Inc. v. Domino's Pizza, Inc., 922 F. Supp. 1055 (E.D. Pa. 1996). We will affirm.

I. Facts and Procedural History

A.

Domino's Pizza, Inc. is a fast-food service company that sells pizza through a national network of over 4200 stores. Domino's Pizza owns and operates approximately 700 of these stores. Independent franchisees own and operate the remaining 3500. Domino's Pizza, Inc. is the second largest pizza company in the United States, with revenues in excess of $1.8 billion per year.

A franchisee joins the Domino's system by executing a standard franchise agreement with Domino's Pizza, Inc. Under the franchise agreement, the franchisee receives the right to sell pizza under the "Domino's" name and format. In return, Domino's Pizza receives franchise fees and royalties.

The essence of a successful nationwide fast-food chain is product uniformity and consistency. Uniformity benefits franchisees because customers can purchase pizza from any Domino's store and be certain the pizza will taste exactly like the Domino's pizza with which they are familiar. This means that individual franchisees need not build up their own good will. Uniformity also benefits the franchisor. It ensures the brand name will continue to attract and hold customers, increasing franchise fees and royalties. *fn1

For these reasons, section 12.2 of the Domino's Pizza standard franchise agreement requires that all pizza ingredients, beverages, and packaging materials used by a Domino's franchisee conform to the standards set by Domino's Pizza, Inc. Section 12.2 also provides that Domino's Pizza, Inc. "may in our sole discretion require that ingredients, supplies and materials used in the preparation, packaging, and delivery of pizza be purchased exclusively from us or from approved suppliers or distributors." Domino's Pizza reserves the right "to impose reasonable limitations on the number of approved suppliers or distributors of any product." To enforce these rights, Domino's Pizza, Inc. retains the power to inspect franchisee stores and to test materials and ingredients. Section 12.2 is subject to a reasonableness clause providing that Domino's Pizza, Inc. must "exercise reasonable judgment with respect to all determinations to be made by us under the terms of this Agreement."

Under the standard franchise agreement, Domino's Pizza, Inc. sells approximately 90% of the $500 million in ingredients and supplies used by Domino's franchisees. *fn2 These sales, worth some $450 million per year, form a significant part of Domino's Pizza, Inc.'s profits. Franchisees purchase only 10% of their ingredients and supplies from outside sources. With the exception of fresh dough, Domino's Pizza, Inc. does not manufacture the products it sells to franchisees. Instead, it purchases these products from approved suppliers and then resells them to the franchisees at a markup.

B.

The plaintiffs in this case are eleven Domino's franchisees and the International Franchise Advisory Council, Inc. ("IFAC"), a Michigan corporation consisting of approximately 40% of the Domino's franchisees in the United States, formed to promote their common interests. *fn3 The plaintiffs contend that Domino's Pizza, Inc. has a monopoly in "the $500 million aftermarket for sales of supplies to Domino's franchisees" and has used its monopoly power to unreasonably restrain trade, limit competition, and extract supra-competitive profits. Plaintiffs point to several actions by Domino's Pizza, Inc. to support their claims.

First, plaintiffs allege that Domino's Pizza, Inc. has restricted their ability to purchase competitively priced dough. Most franchisees purchase all of their fresh dough from Domino's Pizza, Inc. Plaintiffs here attempted to lower costs by making fresh pizza dough on site. They contend that in response, Domino's Pizza, Inc. increased processing fees and altered quality standards and inspection practices for store-produced dough, which eliminated all potential savings and financial incentives to make their own dough. Plaintiffs also allege Domino's Pizza, Inc. prohibited stores that produce dough from selling their dough to other franchisees, even though the dough-producing stores were willing to sell dough at a price 25% to 40% below Domino's Pizza, Inc.'s price.

Next, plaintiffs object to efforts by Domino's Pizza, Inc. to block IFAC's attempt to buy less expensive ingredients and supplies from other sources. In June 1994, IFAC entered into a purchasing agreement with FoodService Purchasing Cooperative, Inc. (FPC). Under the agreement, FPC was appointed the purchasing agent for IFAC-member Domino's franchisees. FPC was charged with developing a cooperative purchasing plan under which participating franchisees could obtain supplies and ingredients at reduced cost from suppliers other than Domino's Pizza, Inc. Plaintiffs contend that when Domino's Pizza, Inc. became aware of these efforts, it intentionally issued ingredient and supply specifications so vague that potential suppliers could not provide FPC with meaningful price quotations.

Plaintiffs also allege Domino's Pizza entered into exclusive dealing arrangements with several franchisees in order to deny FPC access to a pool of potential buyers sufficiently large to make the alternative purchasing scheme economically feasible. In addition, plaintiffs contend Domino's Pizza, Inc. commenced anti-competitive predatory pricing to shut FPC out of the market. For example, they maintain that Domino's Pizza, Inc. lowered prices on many ingredients and supplies to a level competitive with FPC's prices and then recouped lost profits by raising the price on fresh dough, which FPC could not supply. Further, plaintiffs contend Domino's Pizza, Inc. entered into exclusive dealing arrangements with the only approved suppliers of ready-made deep dish crusts and sauce. Under these agreements, the suppliers were obligated to deliver their entire output to Domino's Pizza, Inc. Plaintiffs allege the purpose of these agreements was to prevent FPC from purchasing these critical pizza components for resale to franchisees.

Finally, plaintiffs allege Domino's Pizza, Inc. refused to sell fresh dough to franchisees unless the franchisees purchased other ingredients and supplies from Domino's Pizza, Inc. As a result of these and other alleged practices, plaintiffs maintain that each franchisee store now pays between $3000 and $10,000 more per year for ingredients and supplies than it would in a competitive market. Plaintiffs allege these costs are passed on to consumers.

C.

As noted, eleven Domino's franchisees and IFAC filed an amended complaint in United States District Court for the Eastern District of Pennsylvania against Domino's Pizza, Inc. seeking declaratory, injunctive, and compensatory relief under Section(s) 1 and 2 of the Sherman Act, 15 U.S.C. Section(s) 1 and 2. The plaintiffs also sought damages for breach of contract, breach of implied covenants of good faith and fair dealing, and tortious interference with contractual relations. *fn4

Domino's Pizza, Inc. moved to dismiss the antitrust claims for failure to state a claim, contending the plaintiffs failed to allege a "relevant market," a basic pleading requirement for claims under both Section(s) 1 and Section(s) 2 of the Sherman antitrust act. They maintained that the relevant market defined in the complaint -- the "market" in Domino's-approved ingredients and supplies used by Domino's Pizza franchisees -- was invalid as a matter of law because the boundaries of the proposed relevant market were defined by contractual terms contained in the franchise agreement, and not measured by cross-elasticity of demand or product interchangeability.

The district court granted defendant's motion to dismiss with prejudice plaintiffs' federal antitrust claims. The district court observed that "in order to state a Sherman Act claim under either Section(s) 1 or Section(s) 2, a plaintiff must identify the relevant product and geographic markets and allege that the defendant exercises market power within those markets." Queen City Pizza, Inc. v. Domino's Pizza, Inc., 922 F. Supp. 1055, 1060 (E.D. Pa. 1996). Noting that plaintiffs did "not explicitly identify the relevant product and geographic markets in their amended complaint," the court said that "it is clear from the context, and confirmed in their memorandum in opposition to the instant motion, that Plaintiffs consider the relevant product market to be the market for ingredients and supplies among Domino's franchisees." Id. at 1061. Rejecting this concept of the relevant market, the court held that "antitrust claims predicated upon a `relevant market' defined by the bounds of a franchise agreement are not cognizable." Id. at 1063. The court noted that Domino's Pizza, Inc.'s power to force plaintiffs to purchase ingredients and supplies from them stemmed "not from the unique nature of the product or from its market share in the fast food franchise business, but from the franchise agreement." Id. at 1062. For that reason, plaintiffs' claims "implicate principles of contract, and are not the concern of the antitrust laws." Id. The district court also held plaintiffs had failed adequately to allege harm to competition, "a bedrock premise of antitrust law." Id. at 1063. Because plaintiffs failed to assert a cognizable antitrust claim and there was neither diversity among the parties nor special circumstances justifying exercise of supplemental jurisdiction, the court dismissed without prejudice plaintiffs' common law claims for lack of subject matter jurisdiction. Id. at 1063-64.

The district court granted plaintiffs leave to file an amended complaint to cure the jurisdictional pleading deficiencies in their state law claims. Plaintiffs decided not to replead their state law claims. Instead, they sought to amend their complaint for a second time in an attempt to state a valid federal antitrust claim. The district court denied their motion, noting that though the plaintiffs' proposed second amended complaint would cure the failure to plead harm to competition, it would not cure the failure to allege a valid relevant market. The court stated: "Plaintiffs do not and cannot purchase ingredients and supplies from alternative suppliers not because Domino's dominates the ingredient and supply market or because Defendant is the market's only supplier, but because the franchisee-plaintiffs are contractually bound to purchase only from suppliers approved by Defendant. It is economic power resulting from the franchise agreement, therefore, and not market power, that defines the `relevant market' Plaintiffs allege in support of their antitrust claims." The district court rejected plaintiffs' argument that a different result was required under the Supreme Court's decision in Eastman Kodak Co. v. Image Technical Services, Inc., 504 U.S. 451 (1992). This appeal followed.

II. Jurisdiction and Standard of Review

The district court had jurisdiction over the antitrust counts under 15 U.S.C. Section(s) 15 and 26 and 28 U.S.C. Section(s) 1331 and 1337. It declined to exercise supplemental jurisdiction over the common law counts. We have jurisdiction under 28 U.S.C. Section(s) 1291. Our review of the district court's dismissal under Fed. R. Civ. P. 12(b)(1) and 12(b)(6) is plenary. Stehney v. Perry, 101 F.3d 925 (3d Cir. 1996).

III. Discussion

Plaintiffs assert six distinct antitrust claims on appeal. First, plaintiffs allege Domino's Pizza, Inc. has monopolized the market in pizza supplies and ingredients for use in Domino's stores, in violation of Section(s) 2 of the Sherman Act, 15 U.S.C. Section(s) 2. In support of this contention, plaintiffs allege Domino's Pizza, Inc. has sufficient market power to control prices and exclude competition in this market. Second, plaintiffs contend Domino's Pizza, Inc. has attempted to monopolize the market for Domino's pizza supplies and ingredients, in violation of Section(s) 2 of the Sherman Act. Third, plaintiffs allege Domino's Pizza, Inc.'s exclusive dealing arrangements have unreasonably restrained trade in violation of Section(s) 1 of the Sherman Act, 15 U.S.C.Section(s) 1. Fourth, plaintiffs allege Domino's Pizza, Inc. imposed an unlawful tying arrangement *fn5 by requiring franchisees to buy ingredients and supplies from them as a condition of obtaining fresh dough, in violation of the Sherman Act Section(s) 1, 15 U.S.C. Section(s) 1. Fifth, plaintiffs allege Domino's Pizza, Inc. imposed an unlawful tying arrangement by requiring franchisees to buy ingredients and supplies "as a condition of their continued enjoyment of rights and services under their Standard Franchise Agreement," in violation of Section(s) 1 of the ...


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