The rule of reason states that only contracts, buyouts and mergers that unreasonably restrict trade are affected by anti-trust laws. It further declares that monopolies are not, in and of themselves, illegal. The rule was developed by the United States Supreme Court and made its first written appearance in the 1911 same-day rulings on Standard Oil Co. of New Jersey v. United States and on United States v. American Tobacco Co..
The Sherman Antitrust Act was passed in 1890 to protect businesses and consumers from greedy and often vicious cartels and corporations. The act declared as illegal any activity that limited the ability of consumers to choose their preferred vendor or prevented new companies from entering a market. Prior to the emergence of the rule of reason, the courts typically interpreted the law very strictly. Any company that made a contract that restricted trade in any way or that, in essence, had no competitors was found to be acting illegally.
In 1911, the United States brought action, as per the requirements of the Sherman Antitrust Act, against Standard Oil Company. Standard Oil had monopolized the oil business in the United States and was using its monopoly power to impose unreasonable prices on consumers and to keep potential competitors from entering the market. The Supreme Court found Standard Oil guilty, but ruled that the illegal act was not the possession of a monopoly, but rather the unfair and restrictive acts stemming from it.
The United States also brought action against American Tobacco Company for violation of anti-trust laws. In this case, the court ruled again that the mere possession of a monopoly was not illegal, but that the way in which the monopoly was obtained could be. Since both rulings were made on the same day, they are taken together to represent the rule of reason.
Further United States court cases have refined the rule of reason to address issues such as price-fixing and geographical market divisions. Other courts around the world, particularly those in European countries, have also adopted the rule. The European Court of Justice uses the rule when deciding cases that effect the European common market.
In its simplest form, the rule of reason recognizes that sometimes trade restrictions are unavoidable and may even be desirable. For example, mergers or co-branding contracts that create a monopoly may actually benefit consumers by marrying advanced technology with superior customer service. As long as no laws were violated in the attainment of the monopoly or contract, and as long as the monopoly or contract is not used to perform illegal acts, the simple possession of the monopoly or restrictive contract remains legal.