Turnbull & Turnbull v. Ara Transportation, Inc.

Opinion

Defendant ARA Transportation, Inc. (ARA), appeals from a judgment entered after a jury found ARA had sold its bus transportation services at below its cost of providing the services with the purpose of injuring competitors or destroying competition in violation of Business and Professions Code section 17043 (hereafter all undesignated section references are to this code). The jury awarded plaintiff Turnbull & Turnbull, doing business as Sullivan & Co. (Sullivan), $259,568 in compensatory damages and $1 million in punitive damages.

At trial, John Bahnsen, the deputy superintendent of schools of San Joaquin County, testified that ARA and Sullivan provided services of equivalent quality, but ARA was awarded the contracts in question because it was the lowest bidder.

George Grundig, an economist specializing in transportation economics and transportation analysis, testified that in his opinion ARA had submitted bids that were lower than its cost of providing the contract services. Grundig used four different methods in calculating whether ARA’s bid was below its costs. The first method involved comparing the revenue per mile received by ARA on the San Joaquin County contract with the revenue per mile it received on other bus transportation contracts in other counties, after having made adjustments for cost differentials between the counties. The second method compared the revenue per mile ARA received on the San Joaquin County contract with the revenue per mile it received on its Delta College contract in San Joaquin County. In the third method, Grundig calculated ARA’s costs based on two national cost surveys regarding operating costs of private passenger vans. Grundig’s fourth method entailed an analysis of ARA’s operating statements and an allocation of ARA’s operating expenses per mile traveled. ARA’s total operating costs for the year were divided by the total miles traveled to yield an average cost per mile. This figure was then multiplied by the contract mileage to determine the contract cost. In each year in question, ARA’s bid was below its costs of providing the contract services. Katherine Porter, who had a degree in mathematics and worked primarily as an investment adviser and financial planner, assisted Grundig in calculating both ARA’s costs and Sullivan’s damages.

Based on the limited information provided to Sullivan by ARA, Grundig was unable to calculate more accurately ARA’s costs of providing the contract services. In response to interrogatories from Sullivan requesting the amount of overhead and administrative expenses and the amount of net profit or loss on each contract, ARA stated it did not maintain records which allocated overhead expenses and profits on a per contract basis. Some ARA witnesses verified that ARA did not have any documents allocating its costs per contract. However, according to Robert Griffiths, who had

Augustine Zemba, who had been ARA’s executive vice-president of the transportation group until mid-1977, testified concerning ARA’s policy of bidding below cost. Zemba oversaw operations, assisted in the bidding process and worked at the policy-setting level with ARA. His office was located at the group headquarters in Encino. Apparently the transportation group was comprised of approximately five regions or areas and each area had several divisions. ARA’s Stockton operation was part of a division that belonged to the central area. All of the Stockton operation’s bids were approved by the Encino office prior to being submitted to the parties seeking transportation service bids.

According to Zemba, ARA’s overall policy was to penetrate the market and where there was existing competition, it would bid at any cost, even below cost, a process known as “low-balling.” Other ARA personnel involved in this policy were Mel Sherman, who was the president of the transportation group, Bill Seegel, who was president of ARA’s food services and executive vice-president of ARA Services, Inc., and Livingston Kosborg, who was senior vice-president of ARA Services, Inc. Zemba became aware of ARA’s below cost bidding policy approximately one year after he joined the corporation in 1972. At a transportation group meeting, attended by Sherman, Kosborg, and Zemba, Kosborg announced his objective was for ARA to become the largest transportation company and show tremendous growth in specific areas including Northern California. Kosborg stated ARA would bid below cost, secure contracts and eliminate the competition. After that meeting, below cost bids were submitted to various school districts by ARA.

Zemba explained the process that was used in bidding below cost. He stated that true cost figures, submitted by the bidding division to the group

Zemba testified he left ARA because he was concerned that Kosborg would conveniently forget he had endorsed the below cost bidding policy and Zemba would be held responsible. He was also embarrassed by being repeatedly put in the awkward position of approaching the school district and asking for more money, using the excuse that a mistake had been made in preparing the bid. He had been asked to do this several times and had been successful in obtaining the necessary increases.

Based upon information Zemba received after his departure from ARA and upon his 30 years of experience as an executive at the policy-making level of large private corporations and government organizations, he believed ARA’s “low-balling” was continuing as a matter of practice as corporate policy is slow to change. In May 1978, Zemba met with Marvin Heaps and Frank Pfizenmayer, the president and general counsel of ARA Services, Inc., and discussed, among other things, ARA’s low-ball bidding practices. Zemba stated one purpose of the meeting was to ask him to be quiet as there was other litigation going on throughout the country and publicity throughout the news media. According to Zemba, Heaps asked him to “lay off” and stated he knew there was low-ball bidding going on. Zemba remembered that after the meeting, Heaps sent him a letter thanking him and stating something to the effect that Heaps knew he had “a lot of mud to clean up.”

Heaps and Pfizenmayer admitted that the meeting took place, but denied that Heaps made any statements concerning ARA’s bidding practices. A portion of the letter Heaps sent to Zemba was introduced and it stated: “I appreciate your sharing your views on so many subjects. Please be assured I take this matter seriously and continue to be desirous that ARA and all of its components operates [sic] in a completely ethical way.” There was nothing specifically about cleaning up mud.

Charles Gross, ARA’s chief financial officer between 1975 and 1979, testified that ARA was concerned with making a profit on each contract

The Legislature has declared the purpose of the Unfair Practices Act “is to safeguard the public against the creation or perpetuation of monopolies and to foster and encourage competition, by prohibiting unfair, dishonest, deceptive, destructive, fraudulent and discriminatory practices by which fair and honest competition is destroyed or prevented.” (§ 17001.) Although the California Supreme Court has determined the purpose and policy of the Legislature in enacting the Unfair Practices Act and the means employed to subserve the legislative purpose by prohibiting sales below costs made with intent to injure competitors or competition is a valid exercise of the police power (Wholesale T. Dealers v. National etc. Co. (1938) 11 Cal.2d 634 [ 82 P.2d 3 , 118 A.L.R. 486 ]), it has not directly addressed the issue of whether the act’s method of cost allocation is constitutional. (Id ., at p. 662; People v. Pay Less Drug Store (1944) 25 Cal.2d 108 , 118 [ 153 P.2d 9 ].) The court did note, however, that any difficulty in computing costs is a factual one, and statutes are not to be declared invalid because in their application factual difficulties may arise. (Pay Less Drug Store, supra, at p. 118.)

ARA points out that some authorities question the use of the fully allocated cost method or average total cost method in determining the costs below which a business may not sell its goods or services for federal antitrust law purposes and instead propose the use of the average variable cost or long-run incremental cost method. (MCI Communications v. American

The Seventh Circuit has stated that the fully distributed cost (FDC) method, which is one method of calculating average total cost, “is a quite arbitrary allocation of costs among different classes of service. There are countless FDC methods, each allocating costs by a different mathematical formula)[] Despite trenchant criticism on economic grounds) 1 FDC continues to be widely used for regulatory purposes, inter alia, because of its ease of application in dividing an authorized total revenue requirement among individual products or services—much as a pie is divided into slices. But FDC cannot purport to identify those costs which are caused by a product or service, and this is fundamental to economic cost determination.” (MCI Communications v. American Tel. & Tel. Co., supra, 708 F.2d at p. 1116, fns. omitted, italics original.) The court also noted various FDC methods would normally produce quite different calculations of the cost of a product or service and set forth a simple example to highlight what it termed the arbitrariness of FDC methodology. It stated: “Imagine a railroad line that simultaneously transports three different products: gold, lead and feathers. If the railroad attempted to calculate, on a fully distributed cost basis, the cost of shipping each of these products, it would reach radically different results depending on whether it allocated joint and common costs on the basis of the value, weight, or bulk of the respective commodities shipped.” (Id., at p. 1116, fn. 48.)

The Sixth and Ninth Circuits have not adopted any particular cost method, but have instead held that whatever method is used only affects the burden of proof. If the plaintiff establishes the defendant sold its product below its average total cost but above its average variable cost, then the plaintiff has the burden of proving defendant did so with a predatory intent. If the plaintiff establishes the defendant sold its product below its average variable cost, then the defendant has the burden of negating that it had a predatory intent. (William Inglis, etc. v. ITT Continental Baking Co., supra, 668 F.2d at pp. 1035-1036; accord Arthur S. Langenderfer, Inc. v. S.E. Johnson Co. (6th Cir. 1984) 729 F.2d 1050 , 1056.) The Ninth Circuit has stated the opinion that prices exceeding average total cost may be considered predatory where the plaintiff provides clear and convincing evidence of the defendant’s predatory intent. (Transamerica Computer Co., Inc. v. IBM

We find the use of the fully allocated cost method, when viewed in conjunction with the injurious intent requirement of section 17043, is rationally related to the valid legislative purpose enunciated in section 17001 as it assists in preventing the creation or perpetuation of monopolies. For example, assume that a large multiproduct company that uses the average variable cost method is in competition with a small single-product company which manufactures widgets (a product familiar to all lawyers and law students). The multiproduct company could allocate major indirect or fixed costs disproportionately to its nonwidget products and allocate little or nothing except variable costs to its widgets. In contrast, the single-product competitor’s total fixed and variable costs must of necessity be allocated among its widgets. Accordingly, the multiproduct competitor could claim its cost of manufacturing widgets was far below that of the single-product competitor and set its prices at a level that would technically be above its costs and profitable, yet be damaging to competition. Because the single-product competitor could not meet the multiproduct competitor’s artificially low prices, it might be driven from the marketplace, leaving the multiproduct competitor with a monopoly on the sale of widgets. The multiproduct competitor could then dramatically increase widget prices, disproportionately allocate its fixed costs to widgets, and by using the same variable cost method attack some other competitor’s product line or market with unrealistically low prices. The fully allocated cost method, although not perfect, prevents this method of monopolization by requiring that a pro rata portion of the multi product competitor’s overhead and fixed costs be included in its widget cost figures.

ARA claims the fully allocated cost method is arbitrary because there are many ways of allocating costs (for example, in the present case per mile, per bus or per student) each of which may result in significantly different cost profiles. While we agree there are many ways of fully allocating costs, the possibilities are not without limitation. To be legally acceptable, the allocation of indirect or fixed overhead costs to a particular product or service must be reasonably related to the burden such product or service imposes on the overall cost of doing business. (William Inglis & Sons Bak. Co. v. ITT Con. Bak. Co., Inc. (N.D.Cal. 1975) 389 F.Supp. 1334 , 1344, reversed on other grounds in Wm. Inglis & Sons Baking v. ITT Cont. Baking Co. (9th Cir. 1975) 526 F.2d 86 , 88.) Moreover, a defendant is free to demon

“ ‘The history of the Sherman Antitrust Act makes it clear that the Congress did not intend that the federal legislation preempt parallel state efforts to control unfair competitive practices.’ . . . [Citations.]” (Amarel v. Connell (1988) 202 Cal.App.3d 137 , 147 [ 248 Cal.Rptr. 276 ].) Therefore we need only decide whether the Unfair Practices Act actually conflicts with federal law.

ARA argues the Unfair Practices Act conflicts with the Sherman Act because it could be interpreted as anticompetitive, as the fully allocated cost method protects smaller or less efficient competitors from competition. Furthermore, it conflicts with federal law because it makes rational, profitable and nonpredatory pricing above long-run incremental cost presumptively unlawful.

A similar argument was raised by the defendant in William Inglis, etc. v. ITT Continental Baking Co., supra, 668 F.2d 1014 . Continental contended that California’s fully allocated cost standard conflicted with the Ninth Circuit’s interpretation of federal antitrust laws, which permitted pricing, under appropriate circumstances, at or above marginal or average variable cost. It argued that the California law proscribed conduct which federal law permitted and thereby frustrated the fundamental policies of the Sherman Act. (Id., at pp. 1048-1049.)

The Ninth Circuit held that the possibility of proscription by California of conduct that federal law might permit was not sufficient to warrant preemption. (668 F.2d at p. 1049.) The fact that federal law had established an evidentiary standard, which did not make all pricing below average total cost indicative of anticompetitive intent, did not create a federal right to set such prices. (Id., at p. 1049.) The court noted the cost method used by California’s statute essentially proscribed pricing below average total cost. (Id., at p. 1048.) The statute did not make all sales below average total cost illegal per se, but only such sales that had been made for the purpose of injuring competitors or destroying competition. The court found the only real difference between the California statute and federal law was in the

ARA disagrees with the statement in William Inglis that the Unfair Practices Act essentially proscribes pricing below average total cost and relies on the Seventh Circuit decision in MCI Communications, supra, 708 F.2d 1081 to support its position. The MCI Communications court noted that average total cost should not be equated with fully distributed cost and that it is best measured by average long-run incremental cost. (MCI Communications, supra, at p. 1122 .) It also noted that some federal circuits had rejected the use of the fully allocated cost method and endorsed a marginal cost method. (Id., at pp. 1120-1122.) We need not resolve or harmonize this apparent conflict among the federal circuits, however, as we are not bound by their decisions. (Rohr Aircraft Corp. v. County of San Diego (1959) 51 Cal.2d 759 , 764-765 [ 336 P.2d 521 ], revd. without comment on this point, 362 U.S. 628 [ 4 L.Ed.2d 1002 , 80 S.Ct. 1050 ]; accord Graham v. Scissor-Tail, Inc. (1981) 28 Cal.3d 807 , 830 [ 171 Cal.Rptr. 604 , 623 P.2d 165 ].) Absent a determination by the United States Supreme Court regarding what formula or cost method should be used in determining whether pricing is predatory, there is no clear federal standard with which the Unfair Practices Act may be said to conflict.

In any event, even if, as ARA contends, the Unfair Practices Act may hypothetically have an anticompetitive effect, this does not warrant an inference of preemption. “For if an adverse effect on competition were, in and of itself, enough to render a state statute invalid, the States’ power to engage in economic regulation would be effectively destroyed. H” (Exxon Corp. v. Governor of Maryland, supra, 437 U.S. at p. 133 [57 L.Ed.2d at p. 105].) The mere fact that the Unfair Practices Act proscribes conduct that might, according to some federal courts, be permitted under federal law is insufficient to demonstrate that the Unfair Practices Act is preempted by the Sherman Act. (Id., at p. 130-131 [57 L.Ed.2d at p. 103].)