Jump to Navigation

California Supreme Court Rejects the Pass-On Defense: Clayworth v. Pfizer

M. Brian McMahon

Introduction.

Clayworth v. Pfizer, Inc, 49 Cal. 4th 758 (July 12, 2010) is one of the most important California antitrust decisions in many years. The California Supreme Court unanimously rejected the "pass-on" defense for antitrust violations under the Cartwright Act and the Unfair Competition Law ("UCL") except to prevent duplicate recovery. The Court held that generally an antitrust conspirator may not claim that a purchaser of the overpriced goods was not injured by an antitrust violation, because it passed on some or all of the higher prices it sustained. The decision has two very important consequences, one obvious and one not so obvious:

  • First, antitrust claims may not be dismissed on the ground that the plaintiff passed on to its customers the damages it sustained from the defendant's antitrust violation.

  • Second, an antitrust plaintiff is not required to submit to discovery that seeks evidence that the plaintiff recouped some or all of the increased costs it suffered as a result of an antitrust violation. As discussed below, the second consequence is extremely important to large public entities. Large cities, for example, have the ability to raise money in many ways to offset costs they incurred because of overpriced goods. They should not be required to submit to burdensome discovery designed to uncover the many ways that they offset their higher costs stemming from the antitrust violation.  

Background.

The pharmaceutical market consists of four vertical levels. Pharmaceutical companies manufacture and sell prescription drugs to wholesalers; wholesalers sell those drugs to pharmacies; and pharmacies sell drugs to consumers. The four levels are manufacturers, wholesalers, retailers and customers. In Clayworth, pharmacies sued pharmaceutical companies under the California Cartwright Act and the UCL alleging that they had engaged in price fixing in order to raise the prices of prescription drugs. The pharmaceutical companies moved for summary judgment claiming that the pharmacies had not been injured by the conspiracy. Plaintiffs who bring antitrust claims under the Cartwright Act and the UCL must prove as part of their case that they were injured by the antitrust violation. If they cannot prove that they were injured, their antitrust claims must be dismissed. The defendant pharmaceutical companies produced evidence showing that the plaintiff pharmacies had recouped their increased costs resulting from the conspiracy by passing on those higher prices to their customers. The trial court granted summary judgment to the defendants, because plaintiffs had not been injured by the alleged price fixing conspiracy. The appellate court affirmed the trial court's ruling. The California Supreme Court reversed holding that the pass-on defense is generally prohibited under the California Cartwright Act and UCL.  

Federal Antitrust Law under the Sherman Act.

Two United States Supreme Court decisions shape the price fixing analysis in Clayworth. In Hanover Shoe v. United Shoe Machines, 392 U.S. 481 (1968), the court held that a defendant in an antitrust suit may not assert as a defense that the plaintiff was not injured by the antitrust violation because it had passed on to its customers the overcharges it suffered. As the California Supreme Court in Clayworth described the holding of Hanover Shoe: "the initial amount of the overcharge is chosen as a default measure of all the injuries a price-fixing conspiracy may engender for a given purchaser." (Clayworth at 785-86).

In Illinois Brick v. Illinois, 431 U.S. 720 (1977), the court held that only direct purchasers of the defendants may bring an antitrust lawsuit; indirect purchasers may not. Thus, in federal court, wholesalers may sue pharmaceutical companies for price fixing, but pharmacies and their customers may not, even if the wholesalers passed on their costs to pharmacies and pharmacies passed on some or all of their higher costs to their customers. As a result of the Hanover Shoe and Illinois Brick decisions, in federal court only those who purchased directly from the defendants may sue for price fixing. Those who are direct purchasers may sue for the entire dollar amount of the overcharge even if they passed on their higher costs to their customers.  

As a result of the Hanover Shoe and Illinois Brick decisions, in federal court only those who purchased directly from the defendants may sue for price fixing. Those who are direct purchasers may sue for the entire dollar amount of the overcharge even if they passed on their higher costs to their customers.

California Antitrust Law under the Cartwright Act and the UCL.

In direct response to Illinois Brick, the California State Legislature amended the Cartwright Act, Bus. & Prof. C. §16750(a), in 1978 to permit indirect purchasers to sue for antitrust violations. Thus, pharmacies are legally permitted to sue drug manufacturers in state court for price fixing even though they were direct purchasers from wholesalers and only indirect purchasers from drug manufacturers.

The issue to be decided in Clayworth was whether the amendment to the Cartwright Act, which set aside the Illinois Brick rule, also set aside the Hanover Shoe rule. The appellate court in Clayworth held that that the amendment to the Cartwright Act not only set aside the rule of Illinois Brick that precluded indirect purchasers from suing for antitrust violations, but also the rule of Hanover Shoe that precluded the pass-on defense for antitrust violations. Affirmatively stated, the appellate court ruled that because the pharmacies had passed-on all of the price increases caused by the pharmaceuticals� price fixing conspiracy, they had not been injured, as required by their Cartwright Act and UCL claims. Accordingly, their suit was dismissed.

Relying heavily on the legislative policy behind the amendment to the Cartwright Act that rejected the indirect purchaser rule, the California Supreme Court reversed holding that the 1978 amendment to �16,750(a) did not reject the Hanover Shoe rule that prohibited the pass-on defense.

The Clayworth court did, however, agree that the pass-on defense would still be available where the application of the Hanover Shoe rule raises the prospect of duplicative recovery. If pharmacies and consumers sue drug manufacturers for injuries resulting from price fixing, then "defendants may assert a pass-on defense as needed to avoid duplication in the recovery of damages."(Clayworth at 787). The court reasoned that if the pass-on defense is not available, the pharmaceutical companies could be liable for the full amount of the overcharge to the pharmacies and an additional amount to consumers reflecting the amount of the overcharge passed-on to consumers. The court allowed the pass-on defense but only to the extent necessary to avoid duplicative recovery. The key here is that the limited exception to the Hanover Shoe rule arises only when antitrust defendants are faced with claims that might subject the defendants to duplicative recovery.

Does the exception to the Hanover Shoe rule that Clayworth approved effective undermine the Hanover Shoe rule? The answer is no for several reasons. First, the exception applies only when participants in different vertical levels of the market -- for example, pharmacies and consumers -- are suing the same defendants. But if the only plaintiffs suing the price fixing defendants are from the same level of the market, for example, only pharmacies and not consumers, then the Clayworth exception to Hanover Shoe does not apply. Second, the defendants are still liable for the whole amount of the higher prices they caused by their conspiracy, whether plaintiffs from only one vertical level or from several vertical levels in the market. The pass-on defense permitted by the Clayworth decision does not permit the antitrust defendants to reduce their liability below the total amount of increased costs that their conspiracy caused. Third, certain methods by which plaintiffs might recoup the damages they suffered as a result of the antitrust violation are not subject to the pass-on defense, even if the exception applies. If, for example, pharmacies were to raise the price of non-drug merchandise to offset the higher prices they paid for drugs, the revenues from the sale of non-drug merchandise could not be used by defendants to offset the higher prices their antitrust violation caused. Otherwise, the pass-on defense in such a circumstance would reduce the total amount of damages owed by the defendants. The Clayworth court was concerned about potential duplicative recovery subjecting the defendants to pay more in damages than they caused. The Clayworth court was not, however, concerned that individual plaintiffs might offset more than the damages they suffered through various means. To repeat, the Clayworth exception to the Hanover Shoe no pass-on defense is intended to prevent defendants from paying duplicative recovery. It is not intended to and cannot be invoked by defendants to reduce their liability below the amount of damages they caused.

Third, certain methods by which plaintiffs might recoup the damages they suffered as a result of the antitrust violation are not subject to the pass-on defense, even if the exception applies. If, for example, pharmacies were to raise the price of non-drug merchandise to offset the higher prices they paid for drugs, the revenues from the sale of non-drug merchandise could not be used by defendants to offset the higher prices their antitrust violation caused. Otherwise, the pass-on defense in such a circumstance would reduce the total amount of damages owed by the defendants. The Clayworth court was concerned about potential duplicative recovery subjecting the defendants to pay more in damages than they caused. The Clayworth court was not, however, concerned that individual plaintiffs might offset more than the damages they suffered through various means. To repeat, the Clayworth exception to the Hanover Shoe no pass-on defense is intended to prevent defendants from paying duplicative recovery. It is not intended to and cannot be invoked by defendants to reduce their liability below the amount of damages they caused.

The Effect of Clayworth on Permissible Discovery.

If participants in only one level of a market sue the members of a cartel, then no discovery directed to showing the amount passed-on to lower levels of the market is justified. Even where participants in different levels of the market sue and the pass-on defense is permitted to avoid duplicative recovery, discovery should not be permitted as to all of the means and devices by which the injured party attempted to cover its losses. Discovery should be limited to transactions directly related to the goods whose prices were increased by the conspiracy. Large entities, such as cities, should not be concerned in filing antitrust suits that they are opening themselves up to large scale, oppressive discovery aimed at showing the myriad ways they attempted to cope with higher prices.

This Bulletin is intended to convey general information and does not constitute legal advice. The attorney listed above would be pleased to discuss in detail the information in this Bulletin and its application to your situation. We welcome your comments and suggestions.

333 S. Hope Street, Suite 4000 | Los Angeles, California 90071
Phone: 213-628-9800 | E-mail Us | Map & Directions