Alert: California Supreme Court Denies Pass-On Defense in Price-Fixing Cases

July.13.2010

On July 12, 2010, the California Supreme Court issued its much-anticipated opinion in Clayworth v. Pfizer, Inc., in which the Court held that the so-called "pass-on" defense is generally not available to alleged price fixers under California law. A full copy of the decision can be found here.

Background

In civil actions in federal court alleging price fixing, only those who purchased directly from the defendants have the right to sue for damages. Under the holding of Illinois Brick Co. v. Illinois, 431 U.S. 720 (1977), indirect purchasers – parties who bought at one or more levels downstream from the direct purchasers – cannot sue for damages. A corollary to this restrictive standing regime is that (except in very narrow circumstances) the direct purchaser may sue under federal law for the full amount of the alleged overcharge, even if that purchaser "passed on" that overcharge to its customers. See Hanover Shoe, Inc. v. United Machinery Corp., 392 U.S. 481 (1968) (holding there is no federal pass-on defense). Many states (including California) passed legislation in the wake of the Illinois Brick decision to allow indirect purchasers to sue alleged price fixers. 

A persistent question is whether defendants in state price-fixing cases, in states where indirect purchasers may sue, can argue that a plaintiff passed on all or part of an alleged overcharge to downstream customers and so to that extent has not suffered damages. In some states the question is resolved legislatively, but in others, where statutes give standing to indirect purchasers, the question has been infrequently addressed, and not resolved consistently.

Indirect purchaser antitrust suits are authorized under California's Cartwright Act by California Bus. and Prof. Code 16750(a). The issue of first impression before the Clayworth Court was whether California law, like federal law, denies accused price fixers a pass-on defense. 

Factual Summary

Plaintiffs in the case are thirteen California retail pharmacies. The Defendants are, for the most part, pharmaceutical companies that manufacture and distribute brand name pharmaceuticals. The Plaintiffs bought pharmaceuticals manufactured by the Defendants from various drug wholesalers. The Plaintiffs sell the pharmaceuticals they purchase to cash-paying customers as well as to insured customers. In both cases, the evidence showed that the pharmacies passed on to their customers any overcharge that would have been passed on to them by drug wholesalers.

The Plaintiffs brought price-fixing claims under the Cartwright Act and California's Unfair Competition Law, alleging overcharges of 50% to 400%. The Plaintiffs conceded they passed on the full amount of the overcharges to pharmacies, and stipulated that they were suing for damages equal to the amount of the overcharge. The Defendants asserted the pass-on defense and argued that the Plaintiffs' claims were barred. On cross-motions for summary judgment, the trial court held that the pass-on defense was available under the Cartwright Act, and that the pharmacies therefore had sustained no damages and lacked standing under either the Cartwright Act or the UCL. The Court of Appeal affirmed in a 3-0 ruling.

The Supreme Court's Holdings

With respect to the Cartwright Act claim, the Supreme Court first looked to the plain language of the statute itself, and found that the words "damages sustained" did not clearly establish an intent to compensate only for damages that were not passed on. The Court then examined two amendments to the Cartwright Act – one following the enactment of the federal Hart-Scott-Rodino Act which, among other things, permitted state attorney general parens patriae suits on behalf of indirect purchaser plaintiffs, and one expressly permitting indirect purchaser suits following the U.S. Supreme Court's decision in Illinois Brick – and found that these amendments were consistent with application of the federal Hanover Shoe rule barring a pass-on defense.

The Court turned to antitrust policy, and the Court held that the Cartwright Act's purpose of deterring antitrust violations outweighs concerns that a given private party might receive a windfall – an award of treble damages in a situation in which it had suffered no out-of-pocket loss. It also echoed Hanover Shoe's concerns with "minitrials" to trace "every penny" of an overcharge and to seek to measure the further ramifications that an overcharge might have in the form of lost sales and other tertiary consequences. The Court also rejected the Defendants' argument that the Plaintiffs were not damaged at all and therefore would receive a windfall if the pass-on defense were not allowed, citing evidence of possible lost profits and lost sales, and arguments about potential reduced going concern value of the Plaintiffs' businesses. "At its core," the Court concluded, the Defendants' argument is that the Cartwright Act "should be read to go beyond the primary consequence of the price conspiracy (the overcharge) to consider the secondary consequence of the conspiracy (the pass-on), but that it should blind itself to the tertiary consequences (lost sales, lost profits, and so on)." But Hanover Shoe "is not a case about what constitutes injury, but about how to measure damages. That a purchaser passes on an overcharge does not mean it lacks for injury or damages." 

Although a pass-on defense generally may not be asserted under the Cartwright Act, the Court found a few instances where it will still be available. These include "cost-plus" contracts, and indirect purchaser cases raising the prospect of duplicative recovery. "In instances where multiple levels of purchasers have sued, or where a risk remains they may sue, trial courts and parties have at their disposal and may employ joinder, interpleader, consolidation, and like procedural devices to bring all claimants before the court. In such cases, if damages must be allocated among the various levels of injured purchasers, the bar on consideration of pass-on evidence must necessarily be lifted . . . ."  Neither of these exceptions was present in the Clayworth case.

As to the UCL claim, the Court held that the Plaintiffs had standing. The Plaintiffs had indirect business dealings with the Defendants. "They lost money: the overcharges they allegedly paid." And "that loss was the result of an unfair business practice: Pharmacies allegedly paid more than they otherwise would have because of a price-fixing conspiracy in violation of state law." The Court concluded that the voters' intent in passing Proposition 64 (a 2004 voter initiative that amended the statute) – that UCL suits be limited to those who suffer "injury in fact" – was satisfied. As to the pharmacies' pass-on of alleged overcharges, the Court concluded that the Defendants had conflated the issue of standing with the issue of remedy. "That a party may ultimately be unable to prove a right to damages (or, here, restitution) does not demonstrate that it lacks standing to argue for its entitlement to them." The Court also held that "nothing in the statute's language conditions a court's authority to order injunctive relief on the need in a given case to also order restitution. Accordingly, the right to seek injunctive relief under Bus. and Prof. Code section 17203 is not dependent on the right to seek restitution; the two are wholly independent remedies." Because the Plaintiffs had standing to seek injunctive relief, the Court declined to reach the question of whether the Plaintiffs ultimately may be entitled to restitution.

Discussion

The Court's decision generally may be seen as a victory for plaintiffs and a defeat for defendants, who now may be saddled with paying multiple windfall recoveries and defending against expensive lawsuits brought by plaintiffs who suffered no losses. The first of these concerns, at least, exists because the decision leaves unanswered some potentially troubling questions.

First, exceptions to the general rule that a pass-on defense is not allowed are not well defined. The Court has allowed, in theory, consideration of pass-on evidence in "instances where multiple levels of purchasers have sued, or where a risk remains they may sue . . . ."  However, the Court has not articulated how substantial the risk of suit must be, nor has it specified how various "procedural devices" can actually be used to avoid windfall recoveries and an unfair result. For example, suppose defendants are sued by a direct purchaser class, but no indirect purchaser case has yet been filed. If the statute of limitations has not yet run, is there a sufficient risk of a suit to justify allowing a pass-on defense – and at what point in time does that risk materialize? If not, and the case proceeds to trial and judgment within the statute of limitations period, and then an indirect purchaser case is filed, how precisely will pass-on be considered at that point? Or, if defendants wish to settle the case, how are they to weigh the effect of the potential exception identified by the Court? Alternatively, suppose that an indirect purchaser case is filed first. A defendant may have little incentive to argue that any overcharges were passed on to the indirect purchasers. If it does not do so, and a judgment against the defendant is entered, how will pass-on be addressed in a subsequent direct purchaser suit?   

Or, suppose that defendants are sued by a nationwide class of direct purchasers in federal court in California under the Cartwright Act, but are also sued by a purported statewide class of indirect purchasers in state court (either in California, or in another state – under some circumstances, the Cartwright Act may apply extraterritorially, e.g., to California companies). If the amount in controversy is not very large, the state action may not be removable under the Class Action Fairness Act ("CAFA"), and there may be no practical way to have it consolidated with the federal action. Or, indirect purchasers might disclaim a recovery that would trigger CAFA. Potentially dozens of state actions could be similarly situated, collectively raising a substantial risk of duplicative recovery, because there may be no procedural device by which to address the claims globally, even if pass-on considerations are entertained. A similar result may obtain when claims – even significant claims – are brought not by an indirect class but by fewer than 100 indirect purchaser plaintiffs, e.g., by a group of large governmental entities. Such suits also may not be removable.

In such cases, it is little comfort to defendants that at the end of the day various offsets for "duplicative" recoveries may be theoretically available. Unless all the arguments can be advanced in a coordinated way in a single forum, the risk of double (or even greater) recovery is great. And of course the potential defense costs, and the economic pressure to settle cases brought by plaintiffs freed from the obligation to show out-of-pocket losses, can be enormous.

These problems suggest that defendants may want to shore up their other defenses (such as standing) to indirect purchaser claims to avoid being whipsawed by direct and indirect claims. Standing arguments such as those advanced in the DRAM Antitrust Litigation (decision here) may become even more important in the wake of Clayworth. The decision also will place greater emphasis on class certification proceedings, where some courts may be sympathetic to arguments regarding the difficulty in determining how to apportion liability and damages among direct purchasers (e.g., wholesalers) and the chain of indirect purchasers (e.g., distributors, retailers and consumers).