Apple Prevails on “Epic” Antitrust Claim
Published: May 4, 2023
On April 24, 2023, the Ninth Circuit issued its opinion in Epic Games, Inc. v. Apple, Inc., and affirmed the trial court’s ruling in Apple’s favor as to Epic’s Sherman Act claim for restraint of trade relating to Apple’s distribution of apps in its App Store. (This article does not address the other antitrust and state law claims also at issue in the 91-page opinion.)The legal battle involved “a multi-trillion dollar technology company” (Apple) versus “a multi-billion dollar video game company” (Epic).
Shortly after the 2007 rollout of the iPhone, Apple moved away from “its native-apps-only approach” and opened its iOS to apps developed by third parties. In essence, as the Ninth Circuit observed, Apple was providing app developers with a ready-made customer base, and Apple could increase its customer appeal given the rapidly growing “pool of iOS apps.” Today, Apple has about a 15% market share of the global smartphone market, with more than 1 billion iPhone users. It is estimated there are approximately 30 million iOS app developers and that iOS gaming apps generate annual revenue of about $100 Billion.
Epic has three primary lines of business: it’s a video game developer, it’s the parent company of the gaming-software developer, and it’s a video game publisher/distributor. In 2010, Epic agreed with Apple to a Developer Program Licensing Agreement (DPLA) that was standard for developers to distribute apps to iOS users. After releasing a couple of games for iOS, Epic began objecting to Apple’s approach with regard to third-party apps. Nevertheless, it continued to comply with the DPLA and, in 2020, renewed the DPLA but sought a “side letter” trying to modify some of its terms. Apple rejected this attempt to modify the DPLA.
Epic was apparently expecting this and put into play what it called “Project Liberty.” First, it lowered the price of its popular Fortnite in-app purchases on all platforms except Apple’s (and the Google Play Store) and formed an advocacy group seeking to put PR pressure on Apple to change its ways. Epic also submitted a software update for its popular Fortnite game for review by Apple, but the update contained hidden code that, once activated, would allow users to make in-game purchases outside of Apple’s in-app payment process. Once Epic activated the undisclosed code, Apple became aware of what Epic was attempting to do and removed Fortnite from the App Store. Apple notified Epic that it had to cure the breaches of the DPLA, or Apple would terminate its developer account.
Within days, Epic filed the instant lawsuit against Apple, claiming, among other things, violations of antitrust law, as well as California’s unfair business practices act. Epic was initially successful in obtaining a partial restraining order preventing Apple from taking any adverse action regarding its developer account. When the restraining order expired, Apple immediately terminated Epic’s developer account, but the Court then issued a preliminary injunction preventing it from terminating the developer accounts of Epic’s subsidiaries. To expedite matters, the Court ordered a bench trial on an expedited basis to begin eight months after the filing of Epic’s complaint against Apple.
After a 16-day bench trial, the trial court issued its rulings and found against Epic on its Sherman Action, Section 1 restraint of trade claim. The district court held that the DPLA at issue was not a contract that fell within the scope of section 1 of the Sherman Act and that even if it did, the court found that Epic could not satisfy the Rule of Reason in that it had not identified less restrictive alternatives to Apple’s business approach. Epic appealed this ruling, among others, to the Ninth Circuit.
The Ninth Circuit began analyzing the Section 1 claim by focusing on the proper definition of the market. Epic argued that the relevant market should be aftermarkets of iOS app distribution and iOS in-app payment solutions rather than the mobile game transactions that the district court used. The Ninth Circuit concluded that while the district court may have erred in certain aspects in defining the appropriate market, the Ninth Circuit concluded that these errors were harmless and did not affect the result. The Ninth Circuit recognized that Section 1 of the Sherman Act targets concerted action “in restraint of trade.” The Ninth Circuit noted that “the relevant market for antitrust purposes is `the area of effective competition,’” and includes both a geographic component and a product or service component.
In turning to the trial court’s findings, the Ninth Circuit found that the district court had erred by ruling categorically “that an antitrust market can never relate to a product that is not licensed or sold here, smartphone operating systems.” In essence, the Ninth Circuit concluded that this was putting “form over substance to say that such products cannot form a market because they are not directly licensed or sold.”
The Ninth Circuit held that the trial court did not error, however, in requiring “Epic to produce evidence regarding a lack of consumer knowledge of Apple’s app distribution and IAP restrictions.” The Court concluded that the trial court properly found “there [was] no evidence in the record demonstrating that consumers [were] unaware that the App Store is the sole means of digital distribution on the iOS platform.” The Ninth Circuit concluded that the district court’s “middle ground market of mobile games transaction” was an appropriate definition, and therefore the next issue to analyze was whether Apple’s conduct was an unreasonable restraining.
As mentioned above, the Ninth Circuit found that the trial court made an error in holding that “a non-negotiated contract of adhesion like the DPLA falls outside the scope of Section 1.” The Ninth Circuit noted that there had been a number of cases involving agreements where one party sets the terms “and the other party reluctantly acquiesced.” However, because the trial court had properly applied the Rule of Reason analysis, its conclusion on the DPLA contract issue was harmless.
Under the first step of the Rule of Reason, Epic had to show “that the challenged restraint has a substantial anti-competitive effect that harms consumers in the relevant market.” The Ninth Circuit concluded that the district court properly found that “Epic produced both sufficient direct and indirect evidence to show that Apple’s distribution and IAP restrictions impose substantial anti-competitive effects.” One form of direct evidence was “that Apple has for years extracted a supracompetitive commission that was set almost by accident” and “without regard” to its own costs, resulting in “extraordinarily high” operating margins that “have exceeded 75% for years.”
The second step of that Rule of Reason analysis is that Apple had the burden to offer “non-pretextual legally cognizable pro-competitive rationales for its app distribution and IAP restrictions.” The district court found that Apple had implemented the restrictions concerning its App Store “to improve device security and user privacy – thereby enhancing consumer appeal and differentiating iOS devices and the App Store from those products’ respective competitors.” The Ninth Circuit found that this was appropriate because “with Apple’s restrictions in place, users are free to decide which kind of app transaction platform to use” and that “users who value security and privacy can select … Apple’s closed platform and pay a marginally higher price for apps.”
Finally, step three of the Rule of Reason analysis shifts the burden back to Epic “to prove the existence of substantially less restrictive alternatives to achieve Apple’s pro-competitive rationales.” The Ninth Circuit agreed with the district court that Epic had failed to meet its burden on this issue.
Epic argued that Apple could use the “notarization model” for iOS apps that it used on its macOS for apps. However, the notarization model was not the same as a full app review that Apple conducts on its iOS apps, and apps distributed under the notarization model carried a warning “that Apple has not scanned it for Malware.” Further, the notarization model did not include a level of human review like what Apple had instituted for apps in its App Store. Thus, the Ninth Circuit concluded that the trial court properly found that “Epic failed to establish that [the notarization model] would be `virtually as effective’ in accomplishing Apple’s pro-competitive rationales of enhancing consumer appeal and distinguishing the App Store from competitor app transaction platforms by improving user security and privacy.”
Epic argued (with several amici) that there should be a fourth step to the analysis, a balancing of the totality of the circumstances step. The Ninth Circuit concluded that neither its precedence nor the U.S. Supreme Court required or prohibited such an approach. Nevertheless, the Ninth Circuit concluded that such a balancing analysis did not add much to what was already being considered by the Court. The Ninth Circuit concluded that even had the district court done such a balancing, it would have reached a similar result. Therefore, the Ninth Circuit affirmed the trial court’s ruling in Apple’s favor as to the section 1 claim asserted by Epic under the Sherman Act.
Justice Sidney R. Thomas was the sole dissenter on the panel. While he largely agreed with much of the Court’s analysis, he would have remanded to the district court to re-define the appropriate market at issue. He felt that the Ninth Circuit was engaging in “appellate court fact-finding” and that this issue should have been left to the district court, especially since “[t]he parties formulated arguments around their own markets – not the district court’s market.” Thus, he concluded that the errors below were not harmless.
The Epic v. Apple decision is an important lesson for antitrust plaintiffs as to the importance of defining the appropriate market for purposes of asserting an ant-trust claim, as well as preparing evidence to rebut any pro-competitive rationales that a defendant may offer in response to such claims.