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A long-running antitrust battle between a small independent movie theater owner, Flagship Theaters, and the third largest U.S. movie theater chain, Cinemark Holdings (CNK) and its Century Theatres subsidiary, (the “defendants”) has taken a turn in favor of David instead of Goliath. A recent California Court of Appeals decision could have far-reaching ramifications for the distribution and exhibition of motion pictures.
The just published opinion of the Appellate Court in Flagship Theatres of Palm Desert, LLC v. Century Theatres, Inc. reversed a lower trial court’s decision that threw out this 2006 case. This decision reignited the case and included several rulings that pose increased risk to the way large movie theater chains, such as Regal Cinemas (RGC), AMC Entertainment, Cinemark and Carmike Cinemas (CKEC), compete with independent theater operators and smaller theater exhibition chains like Reading International (RDI) and Marcus (MCS) to license and show first run movie product from the movie studios.
Should rulings in this important decision stand, the thresholds to prove improper competitive behavior, at least to obtain discovery (evidence gathering via depositions, subpoenas, etc.) and get to a trial of the facts, will have been lowered. Cinemark says they will appeal to the California Supreme Court, if necessary.
As a result of this Appellate Court ruling, executives of some of the movie industry's top distribution companies such as Warner Brothers (TWX), Paramount (VIA), Disney (DIS), Twentieth Century Fox (NWS), Sony/Columbia (SNE), Universal (CMCSA) and Lionsgate (LGF) could be called to testify about the normally behind-the-scenes deal-making between studios and theater chains. What’s also intriguing is that the court additionally ordered the unsealing of substantial documents in this case previously kept under wraps.
Why Is This important?
Antitrust laws make it illegal for a large theater chain to manipulate the cut off of movie supply to independent theaters and smaller chains by threatening to use its larger size to retaliate against movie distributors who choose to supply these "pesky" competitors. Because the larger chains have theaters in areas without any competition (possibly having driven it out earlier) movie distributors wanting the largest audiences in the aggregate are under pressure to comply with the large chain’s wishes or risk getting shut out of desirable markets.
Several U.S. Supreme Court decisions on this topic govern the distribution and exhibition of movies, leading to a general prohibition of the movie production companies owning theater exhibition chains and also requiring films be licensed on a theater by theater, film by film basis. These cases have made film licensing negotiated on a chain by chain basis, also known as “circuit dealing," illegal. (See case like United States v. Paramount Pictures (1948) 334 U.S. 131 and United States v. Griffith (1948) 334 U.S. 100.)
Case Background And Highlights Of The Court Opinion
In the original 2006 lawsuit, Flagship Theatres (the plaintiff) contends that the defendants have used the power deriving from both the enormous size of its theater circuit and its many theaters in noncompetitive markets to undermine the competitive process through which theaters bid for and obtain licenses to exhibit first-run films. According to Flagship, superior bids by its only theater, the Cinemas Palme d’Or 10-plex in Palm Desert, California (the Palme), are often rejected in favor of inferior bids by the Century’s 15-plex in Rancho Mirage (the River) as a result of the defendants’ abuse of the power of their circuit.
The lower trial court ruled that Flagship could not show an “antitrust injury” and could not show that Century had market power in “the market in which the Palme and the River compete” (California’s Coachella Valley - the Palm Springs area) and entered judgment against Flagship, throwing out its case.
Flagship appealed, arguing that the trial court erred in requiring Flagship to show actual harm to competition and limited Flagship’s discovery to defendant’s market power over suppliers just in the local market of the Coachella Valley.
The recent ruling from the California Court of Appeals agreed with Flagship in holding that:
  • The plaintiff need not show the market has actually become less competitive, just that Flagship was being injured by a “competition-reducing aspect or effect of the defendant’s behavior.” And ...
  • The circuit dealing claimants are entitled to engage in discovery concerning theater circuit and film licensing practices outside the market in which the two theaters compete. “The essence of Flagships claim is that Century has used its power outside the Palme/River market to influence competition within the Palme/River market.”
As importantly, the Appellate Court also clarified one point of law with regard to proving prohibited circuit dealing. It specifically disagreed with defendant’s contention that, in order for improper circuit dealing to be found, an agreement covering all of a circuit’s theaters was necessary. Instead the court clearly thinks even licensing agreements covering some theaters may be all that is needed to prove the illegal behavior when it stated:

“When a dominant theater circuit uses its overall size or its monopoly power in certain locations (or both) to obtain more favorable film licensing treatment in competitive locations than it otherwise could have obtained, the circuit’s conduct may have the same effects regardless of whether the resulting licensing agreements cover all of the theaters in the circuit or only some of them.”

Stay Tuned
Future proceedings are sure to have major implications for the competitive balance between large theater exhibitors vs. independent cinemas and small chains, exhibitors in general vs. studios and distributors, and certainly the movie-going consumer.
Funds I manage are long RDI, RDIB. These funds or its affiliates may buy or sell securities of this issuer at any time.
Disclosure: I am long RDI, RDIB.
Source: Small Cinema's Antitrust Win: Big Implications For Large Exhibitor Chains