The Capitol Forum February 21, 2014

Transcription

1 The Capitol Forum February 21, 2014 Gogo Litigation: Gogo Class Action Survives Motion to Dismiss; Litigation Will Center on Whether Gogo s Exclusive Contracts Foreclosed Competition Conclusion On January 29 th, the district court for the Northern District of California denied Gogo's motion to dismiss the antitrust class action brought against it, permitting the case to move to the discovery phase. Gogo faces significant antitrust risk if the evidence shows its long-term exclusive contracts with airlines effectively shut out competitors, or that its market share is not attributable to a superior product. Nonetheless, Gogo has strong arguments that long-term contracts are a business necessity given its large infrastructure investment in pioneering inflight Internet access. Moreover, Gogo s exclusive Air-to-Ground (ATG) technology, using spectrum the federal government licensed only to it, may be superior to competing technologies that were available during the time the lawsuit covers. Key Points From our review of the court filings and our conversation with an airline industry expert, key risks include: The recent court ruling that denied Gogo s motion to dismiss the case was not a judgment on the merits, but it gives the class action plaintiffs leverage for settlement. Whether Gogo settles at this stage or proceeds with litigation will depend on a cost-benefit analysis. Any evidence of intent to monopolize by utilizing exclusive long-term contracts with the majority of domestic airlines will increase Gogo s incentives to settle as well as the risks it faces in litigation. Damages could be the monopoly overcharge for every Gogo use between 2008 and 2012, tripled. Gogo s high market share has indeed left few opportunities for competitors to expand to the U.S. According to the expert, the only current opportunities for expansion are international. Gogo nonetheless may raise several potential arguments going to the superiority of its product and the reasonableness of its exclusive contracts, including: Gogo s high market share may be attributable primarily to its exclusive license to ATG spectrum. The government arguably granted its ATG spectrum monopoly power. Gogo will argue less expensive technology that is faster and easier to implement, rather than exclusive long-term agreements, were the source of any market power. Gogo will argue its product was superior to more expensive and less developed satellite technology. Exclusive long-term contracts may have been the only viable business model given Gogo s high infrastructure investment. Recouping its investment as a pioneer of a new technology that users were slow to adopt would take significant time. 1

2 Gogo will argue that its pricing is not supracompetitive. Quantifying a monopoly overcharge will likely be difficult because Gogo did not have the capacity for the higher demand that a lower price would elicit. Gogo may argue that high switching costs, rather than long term contracts, are likely to contribute to its high market share. Switching from Gogo to a competitor requires taking aircraft out of service and changing the antenna, an expensive proposition. New competitors have entered the market. Although these competitors did not operate in the U.S. during the time the lawsuit covers, and they still do not have access to airlines that have contracted with Gogo, their entry could weaken plaintiffs argument that the exclusive contracts foreclose competition. Overview of Lawsuit In Stewart v. Gogo, class action plaintiffs allege that Gogo s exclusive contracts with domestic airlines are agreements in restraint of trade in violation of Section 1 of the Sherman Act ( of the Second Amended Complaint ( SAC )). They also bring two claims under Section 2 of the Sherman Act for unlawful acquisition and maintenance of monopoly power ( 81-98). Plaintiffs also allege California State claims, the analysis of which largely will track the federal claims. Plaintiffs seek damages and a permanent injunction. Seizing on a market share figure that surfaced in Gogo s IPO papers, plaintiffs allege that Gogo possesses at least an 85% market share of all commercial aircraft servicing flights within the continental United States because Gogo has entered into long-term exclusive agreements with most domestic carriers pursuant to which Gogo is the exclusive provider permitted to provide internet service for these carrier s entire or near entire fleet. (SAC 22). Gogo s ten-year contracts allow airlines to terminate only if (i) another company provides an alternate connectivity service that is a material improvement over Gogo s, such that failing to adopt such service would likely cause competitive harm to the airline, or (ii) the percentage of passengers using Gogo Connectivity on such airline s flights falls below certain negotiated thresholds. Judge Chen of the Northern District of California previously granted Gogo s motion to dismiss the first amended complaint because plaintiffs had not demonstrated that aircraft not yet equipped with internet access should be excluded from the relevant market. Plaintiffs allege the relevant market is inflight internet service on domestic commercial flights within the US. With such unequipped aircraft included in the relevant market, plaintiffs could not plead Gogo had monopoly power or had foreclosed enough of the market to constitute a restraint of trade. The judge, however, allowed plaintiffs to re-plead their case. Plaintiffs subsequently filed a second amended complaint, pleading that Gogo s contracts were negotiated on a fleet-wide basis, meaning that Gogo allegedly also foreclosed competitors from unequipped planes. On that ground, Judge Chen denied Gogo s motion to dismiss the second amended complaint. And contrary to Gogo s arguments that Gogo s exclusive contracts do not foreclose competition because airlines can terminate the contracts, the court s order stated that such termination was, in fact, quite difficult. The Court noted that Gogo sued AirTran when it terminated its contract, although the suit was unsuccessful. The denial of the motion to dismiss is not a decision on the merits, but it gives plaintiffs leverage for settlement. For a complaint to survive a motion to dismiss in federal court, it must present enough facts to state 2

3 a claim for relief that is plausible on its face. Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 127 S.Ct (2007). At the motion to dismiss stage, the judge does not assess the merits or the facts of the case but merely whether the complaint is sufficient to state a claim, assuming its allegations as true. Plaintiffs are not required to prove the 85% market share at this stage, or even to plead market power with specificity. Accordingly, that Judge Chen denied Gogo s motion to dismiss does not mean plaintiffs will ultimately succeed on the merits. Nonetheless, overcoming a motion to dismiss is an asset for plaintiffs. Here, it means plaintiffs can now obtain formal discovery from Gogo, a costly process that also risks uncovering any problematic internal company documents. Accordingly, there is a powerful incentive to settle at this stage. Whether Gogo settles will depend on its balancing of costs and benefits its confidence that it will ultimately succeed, the cost of litigation, and the amount of settlement monies required to make the case go away. Any problematic internal documents and the amount of potential liability are risks Gogo faces in proceeding with litigation. If Gogo has internal company documents that show intent to monopolize or to foreclose competition by utilizing exclusive long-term contracts with the majority of domestic airlines, such documents will increase its incentives to settle as well as the risks it faces in litigation. Moreover, the potential damages here could be quite high. Plaintiffs have alleged that Gogo charged supra competitive prices during the class period (from 2008 to 2012). Using what is known as the benchmark approach, plaintiffs will attempt to quantify the monopoly overcharge by comparing Gogo s rates (ranging from $14.95 to $19.95 per day) with the $5 rates charged by the only other domestic competitor during the period of alleged misconduct, Row 44. Alternatively, plaintiffs may construct an economic model to arrive at the competitive price. Such a monopoly overcharge could be quite a substantial sum, something Gogo will weigh in deciding whether to proceed with litigation or settle. However, Gogo will get a second chance to dismiss the lawsuit through a motion for summary judgment, but only after plaintiffs conduct costly and potentially incriminating discovery. Gogo indeed has a high market share in the U.S., and by locking up most of the major airlines in exclusive long-term contracts, there is little opportunity for potential competitors. Plaintiffs 85% market share figure came from Gogo s IPO documents, and Gogo does indeed dominate the U.S. inflight internet market. Gogo is the internet provider for American, Delta, Alaska, Frontier, US Airways, Virgin America, and some United planes. Explained the airline industry expert, There is not much room to expand in the US, although there are opportunities internationally, he noted, which require satellite-based service. Gogo s Potential Arguments While Gogo does face significant antitrust risk based on its exclusive long term contracts and high market share, it also has several arguments in its defense. Exclusive agreements are not per se unlawful under the antitrust laws, unlike, for example, price-fixing agreements, which are presumptively illegal. Accordingly, in analyzing plaintiffs claims under Section 1 of the Sherman Act, the Court will assess the reasonableness of the restraint under the rule of reason. In analyzing the Section 2 monopolization claims, the Court will determine whether monopoly power has resulted from something other than superior skill, foresight, and industry. Gogo may argue the federal government granted it monopoly power over ground-based spectrum. In August 2008, Gogo was the first to bring internet access to planes in the U.S., utilizing Air-to-Ground (ATG) 3

4 technology. According to an airline industry expert, Gogo bought up the entire spectrum for ground-based technology. In terms of the ATG technology, said the expert, Gogo effectively got a monopoly granted by the U.S. government which licensed off the spectrum. The competitors that have subsequently emerged, including Row 44, LiveTV (owned by Jet Blue) and Panasonic, all rely on satellite technology, not ATG. However, according to the expert, satellite technology was not developed in the early days. Gogo likely will argue its high market share is a result of a superior product. In order to prevail on a monopolization claim, plaintiffs must show the monopoly power has resulted from something other than superior skill, foresight, and industry. Gogo likely will argue, however, that its superior product, not exclusive long-term agreements, were the source of any market power. According to the expert, ATG is cheaper and easier to install than satellite technology. ATG can be installed much more quickly than satellite service, and, said the expert, Faster is important when you re taking an airplane out of service. Moreover, ATG bandwidth is cheaper than satellite, because it s not going to space, but rather is using ground-based frequencies. Hence, when Row 44 appeared on the scene, it was going to be a lot more expensive, he explained. In fact, Row 44 did trials with Alaska airlines and then Alaska switched and went with Gogo instead. In addition to satellite technology being more expensive, the ATG technology was available before the satellite technology was ready for implementation, explained the industry expert. In the early years, satellite technology was unproven, he said. New technologies have emerged in the last couple of years, including Ku-band and Kaband satellite technology. The Ka-band satellite didn t even go up until the last year. These are better alternative products that couldn t exist at the time of Gogo s rollout, noted the expert. Gogo may argue its long-term contracts were needed to recoup its infrastructure investment. When Gogo first introduced inflight internet access, it was initially a tough sell because there wasn t a business case that the airlines needed it, said the expert. As a result, Gogo subsidized the installation for the early customers and made it super cheap to get them on board. He continued, The problem is that Gogo took on a lot of the early costs to install this, and the only way to recoup that is with a long term contract. The exclusive long-term contract, according to the expert, may have been the only viable business model given the high investment Gogo made to launch the technology. The expert further explained that in-flight internet usage has been really low ever since the technology was launched. Thus, the pay back period in the early days was long because of the slow rate of adoption of the technology. As a result, the time needed for Gogo to recoup its investment may have been a legitimate business reason for its long-term contracts. Gogo likely will argue that pricing was not supra competitive and cannot be compared to the pricing of a competitor with a different business model. One defense to the claim that Gogo s pricing is supra competitive is that Gogo must deliberately set its prices high because it does not have the capacity to handle too much demand, according to the expert. ATG spectrum is not very broad, he explained, and Gogo does not have the capacity to handle a high percentage of customer usage. Gogo has already had two different upgrades to try to increase capacity and speed to counter the low capacity of ATG. It first increased the height of its towers and then introduced a hybrid of satellite and ground-based service. This hybrid should still be less expensive than a pure satellite product, said the expert. Furthermore, comparing Gogo s prices with the pricing of Row 44 likely does not make sense given the companies different business models. Gogo sells its internet access as a Gogo-branded 4

5 product over which the airlines have little control. Gogo manages the service, sets the price, and collects the revenue. Row 44, in contrast, offers airlines control over the product, pricing, and the user experience. To the user, it appears as a Southwest service, not as Row 44. Southwest also has to pay a heftier price for installing Row 44 than it would for installing Gogo, but Southwest is the one that collects the revenue from the service. Given that Southwest sets the pricing after paying Row 44 upfront and also may care more about the customer experience than about internet service profits, the pricing of Row 44 is unlikely to provide an accurate benchmark for competitive pricing levels. Thus, proving that Gogo s pricing is supra-competitive is not likely to be an easy task. Comparing the pricing between the two is completely apples and oranges, said the expert. Gogo may argue that airlines are unlikely to switch to competitors even in the absence of long-term contracts. High barriers to entering the inflight internet market cuts both ways for Gogo. On the one hand, such high barriers can show the exclusive long term contracts were not the source of any monopoly power. On the other hand, high entry barriers weigh in favor of finding that Gogo has market power and the ability to foreclose competition. According to the airline industry expert, switching a plane that is equipped with Gogo technology to a competitor s technology is a huge undertaking. Because all potential competitors rely on satellite technology, airlines cannot switch to them without changing their equipment. The ATG antenna faces down whereas the satellite antenna faces up. Even if they had short term contracts, said the expert, what s the chance of them pulling [all of their planes] out of service? He continued, It s very unlikely they are going to make that move. Notably, switching between Row 44 and another satellite-based provider would be much easier because they could use the same antenna, said the expert. New competitive entry undermines Plaintiff s arguments that the exclusive contracts foreclose competition. Gogo argued in its motion to dismiss that new competitors have emerged, including Row 44, LiveTV, and Panasonic, all of which utilize satellite technology. Gogo noted that Row 44 has won contracts for all of Southwest s domestic fleet and is taking over service for AirTran from Gogo after Southwest acquired AirTran. Similarly LiveTV has won the contract with JetBlue, but has not yet launched its service after several years of trying to get it off the ground. The expert noted that bird strike issues recently have caused the FAA to demand testing and impose new standards, and have slowed the rollout of these new technologies. The expert added that United contracted with LiveTV for its domestic fleet, which will be rolled out to the pre-merger portion of its domestic fleet. Panasonic has contracts for the other half of the United Fleet as well as American s international business. Gogo s ATG product does not work offshore, but it has launched an offshore product using satellite technology, which requires a different antenna. In their opposition to the motion to dismiss, plaintiffs argue that the competitors that Gogo cites either have never provided any internet service on U.S. domestic flights or have not done so during the period of interest (i.e., from the time of the launch of inflight internet service until the time plaintiffs filed their antitrust complaint four years later), are of no competitive significance here. They further explain that, in the alleged relevant market, Gogo was the sole provider, with the exception of Southwest airplanes that were equipped by Row 44. Although these new competitors did not exist during the class period, the fact that they are entering the market weakens plaintiffs argument that the exclusive contracts foreclose competition. 5