In Clayworth v. Pfizer, Inc., ___ Cal.4th ___ (July 12, 2010), the California Supreme Court limited the circumstances in which an antitrust defendant can avoid liability under California law where the plaintiff has passed on any alleged overcharges to its customers. While the Court held that the so-called “pass-on” defense is generally precluded, it went on to recognize two exceptions, one of which may very well swallow the rule: Where multiple levels of purchasers have sued or may sue, the defense remains available to prevent duplicative recovery. The decision might also have the unintended consequence of creating an additional impediment to direct purchaser class certification.
In Clayworth, California retail pharmacies alleged pharmaceutical manufacturers had conspired to fix prices for their drugs, in violation of California’s Cartwright Act and Unfair Competition Law (“UCL”). The pharmacies neither directly purchased from the manufacturers nor were end consumers. Rather, the manufacturers sold to wholesalers, who resold to the pharmacies, who in turn resold to end users. The pharmacies alleged that, as a result of the conspiracy, they were forced to pay the wholesalers an overcharge, but conceded that they passed it on, in full, to their customers. In response, the manufacturers asserted a pass-on defense, which they argued defeated the pharmacies’ claims.
On summary judgment, the trial court held that because the pharmacies passed on any alleged overcharge to their customers, they (1) had sustained no damages under the Cartwright Act and (2) had not “lost money or property” and thus had no standing under the UCL. The Court of Appeal affirmed.
The California Supreme Court’s Decision
In a unanimous decision, the Supreme Court reversed. The Court held that, as a general rule, the pass-on defense is not available under the Cartwright Act — with two notable exceptions that call into question the significance of the decision.
The issue was one of first impression in California, but has long been settled under federal law. In Hanover Shoe v. United Shoe Mach., 392 U.S. 481 (1968), the United States Supreme Court held that, under federal antitrust laws, the pass-on defense is generally not available in suits brought by direct purchasers, and in Illinois Brick v. Illinois, 431 U.S. 720 (1977), the Court concluded that only direct purchasers, not indirect purchasers, can sue for price-fixing. In California, however, both direct and indirect purchasers can sue. The question left open was whether, under California antitrust law, an alleged price-fixer could avail itself of a pass-on defense or whether, instead, direct purchasers could recover the full amounts they claim to have been overcharged, even if they passed on some or all of the overcharge to their customers.
Clayworth found that while the language of the Act and its legislative history provided no clear answer, the legislature’s amendments to the Act revealed “a clear legislative preference for the Hanover Shoe rule” barring the defense. The Court also reasoned that outcome was consistent with the legislature’s “overarching goals of maximizing effective deterrence of antitrust violations, enforcing the state’s antitrust laws against those violations that do occur, and ensuring disgorgement of any ill-gotten proceeds” — even at the risk of overcompensating plaintiffs.
While the Court generally precluded the use of a pass-on defense, it qualified its holding by recognizing “a few instances” in which it remains available: (1) “cost plus” contracts and (2) cases raising the prospect of duplicative recovery by direct and indirect purchasers. With respect to the second exception, the Court held that “where multiple levels of purchasers have sued, or where a risk remains that they may sue,” and “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.”
Because neither exception applied in Clayworth, the Court did not address their scope in detail, but it referred to the ability of trial courts and parties to employ procedural devices such as joinder, interpleader and consolidation to bring all claimants before the court.
Turning to the UCL claim, the Court rejected the manufacturers’ argument that the pharmacies’ pass-on of the alleged overcharges meant that they had not “lost money or property” and thus had no standing under the UCL. The Court held that the pharmacies “lost money: the overcharges they paid.” The fact that they ultimately may have recouped some or all of this lost money from someone else did not demonstrate a lack of standing, but instead went only to the remedy to which the plaintiffs were entitled.
The Decision’s Impact
For most cases, Clayworth’s ruling on the pass-on defense itself will have little, if any, effect, in light of the “duplicative recovery” exception. Cases, like Clayworth itself, that do not involve an alleged claim on behalf of end users — or at least a “risk” of one — are fairly rare. Defendants should be sure to take full advantage of the procedural devices Clayworth recognized, including removal, joinder and consolidation, to maximize the availability and utility of a pass-on defense. At the same time, opposing class certification for indirect purchasers often relies on the argument that pass-on is non-existent, or at least non-uniform. The tension in these arguments needs to be recognized and managed.
On the other hand, the decision suggests a new avenue to challenge direct purchaser classes. Since the decision expressly recognizes the pass-on defense where indirect purchasers have also sued, the question of whether and to what extent direct purchasers passed on the alleged overcharge raises (in most cases) a host of individualized questions. This is, in fact, the flip side of the argument usually made against indirect purchasers — whether and to what extent overcharges were passed on to them requires individualized proof. An important question will be whether this argument is one of impact or damages, since the former is often considered more problematic for the class where common issues do not predominate.
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This article was originally published by Bingham McCutchen LLP.