Antitrust Lawyer Blog Commentary on Current Developments

California Supreme Court Limits Pass-on Defense

On July 12, 2010, the California Supreme Court addressed the issue of “whether under the Cartwright Act an antitrust defendant can defeat liability by asserting a pass-on defense.” Clayworth v. Pfizer, Inc., No. S166435, 2010 WL 2721021 (Cal. July 12, 2010). The Cartwright Act is California’s state antitrust law. Unlike federal law, which limits antitrust damage claims to “direct purchasers,” the Cartwright Act allows indirect purchasers as well to sue on antitrust claims. In a unanimous decision, the California Supreme Court held consistent with federal law that California law bars a pass-on defense in most circumstances, even though both direct and indirect purchasers may sue for treble damages.

Defendants in antitrust lawsuits are typically accused of illegally conspiring to fix prices and overcharging for their products. Direct purchasers of the defendants’ products, such as dealers or distributors, may pass on such overcharges to indirect purchasers, such as consumers. The defendants usually argue that as the result of passing on the overcharges, the claimant has not suffered any injury, hence, not sustained any damages. This defense seeks to prevent duplicative recoveries, against claimants who have passed on the alleged overcharges.

Under the federal antitrust enforcement scheme, pass-on defense is barred and only direct purchaser plaintiffs are permitted to seek damages. In Hanover Shoe, Inc. v. United Shoe Machinery Corp., 392 U.S. 481 (1968), the United States Supreme Court held that federal antitrust defendants generally may not assert a pass-on defense, because even a direct purchaser who passes on an overcharge, will likely be damaged in other ways by defendants’ violation of antitrust law. The Court stated that permitting a pass-on defense would potentially bar the direct purchasers from recovery and would consequently affect their decision to bring suits. Such a dynamic may compromise enforcement of the antitrust laws. The Supreme Court has also held that indirect purchasers could not bring private treble damages actions under the federal antitrust laws. Illinois Brick Co. v. Illinois, 431 U.S. 720 (1977).

Since 1907, California has had its own antitrust law, the Cartwright Act (Bus. & Prof. Code § 16700). After Illinois Brick, California amended the Cartwright Act, specifically permitting indirect purchasers to sue for damages. Therefore, unlike federal law, California law allows both direct and indirect purchasers to sue for damages.

In Clayworth, plaintiffs, retail pharmacies, bought prescription drugs from pharmaceutical manufacturer defendants. Plaintiffs alleged that defendants violated the Cartwright Act by conspiring to keep the prices of brand-name drugs artificially high. Additionally, the plaintiffs sued for injunctive relief and restitution under the Unfair Competition Law (“UCL”). Under Proposition 64, the voters’ 2004 initiative, a UCL plaintiff lacks standing unless he can show that he “suffered injury in fact and has lost money or property” as a result of unfair competition. (Bus. & Prof. Code § 17204.)

Defendants asserted the pass-on defense on the basis that the plaintiffs had sustained no damages by passing on the alleged increased costs to their own customers. The trial court granted summary judgment for the defendants because the pharmacies had sustained no apparent damages. The California Court of Appeal affirmed. But, the California Supreme Court reversed.

The Court held that the fact that plaintiffs mitigated the damages by passing them on to their customers does not prevent them from having standing in this case and does not defeat their UCL claim:

“While Manufacturers argue that ultimately Pharmacies suffered no compensable loss because they were able to mitigate fully any injury by passing on the overcharges, this argument conflates the issue of standing with the issue of the remedies to which a party may be entitled. 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 doctrine of mitigation, where it applies, is a limitation on liability for damages, not a basis for extinguishing standing.”

Furthermore, the Court held that in most instances, there is no pass-on defense. Also, it allowed the indirect purchasers to sue for damages. The ruling somehow allows duplicative recovery: first by allowing direct purchasers to sue, with no pass-on defense; and then by allowing indirect purchasers to sue. The Court acknowledged existence of this risk, but stated that barring the pass-on defense would provide “maximum deterrence” from future antitrust violations; and this objective is in harmony with the legislature’s intention.

However, the Court identified potential exceptions where the pass-on defense might be allowed: (1) “cost-plus” contracts, an exception recognized in Hanover Shoe; and (2) situations raising the prospect of duplicative recovery. With respect to the “duplicative recovery” exception, the Court stated:

“[I]n light of the Illinois Brick repealer statute …, cases may arise where application of the Hanover Shoe rule raises 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; defendants may assert a pass-on defense as needed to avoid duplication in the recovery of damages.”

The Court commented, however, that it “need not address in detail the scope of these two exceptions, for neither applies here.”

It remains to be seen whether the California Supreme Court’s decision will reduce the use of the pass-on defense. The decision does not bar the defense rather it identifies exceptions that are likely to be raised by defendants in the future. In particular, the second exception recognized by the Court – for cases involving even the “risk” of “duplicative recovery” will be present in a wide variety of cases, and courts will have to resolve numerous questions about its application, including: (1) what circumstances create a sufficient “risk” to trigger the exception; (2) can the defense result in the dismissal of a plaintiff’s claim, or (3) would the defense only diminish the potential recovery. Accordingly, the California Supreme Court’s decision does not necessarily signal an end to the pass-on defense but rather it raises more questions on how and when it will actually apply.

Parva Fattahi
(202) 589-1834
pfattahi@dbmlawgroup.com