Antitrust Alert: California Supreme Court Passes on the "Pass-On" Defense for California Antitrust Claims
In its July 12, 2010, decision in Clayworth v. Pfizer, Inc., the California Supreme Court rejected the "pass-on" defense for claims brought under California's antitrust law, the Cartwright Act. Defendants have used the pass-on defense to argue that direct purchasers of goods sold by allegedly price fixing manufacturers were not injured because the purchasers "passed on" the overcharge to their own customers. Rejecting this defense, the California Supreme Court now has authorized purchasers at multiple levels of the distribution chain to recover for price fixing, even where the alleged overcharge was passed on from purchaser to purchaser.
The Clayworth case
Clayworth and other retail pharmacies brought an antitrust action under the Cartwright Act, alleging that pharmaceutical manufacturers had fixed the prices of their brand-name drugs and colluded to restrain competition from generics, thereby increasing the prices paid by pharmacies for drugs. The defendant-manufacturers claimed that the plaintiff-pharmacies could not recover damages because the pharmacies had passed on any overcharge to the pharmacies' customers and therefore did not themselves suffer compensable injury.
Given evidence that the pharmacies in fact did pass on price increases to downstream purchasers, the trial court granted summary judgment for the manufacturers because the pharmacies could show "no damages sustained." The California Court of Appeal affirmed, ruling that defendants could use the pass-on defense in Cartwright Act claims (despite the fact that the defense has not been available in federal antitrust claims since the U.S. Supreme Court's 1968 decision in Hanover Shoe v. United Shoe Machinery).
The pharmacies appealed, and the California Supreme Court reversed. As the text of the Cartwright Act does not say whether a pass-on defense is available, the Court looked to amendments and the purpose of the statute for the answer. The California Legislature had in the past amended the Act to allow indirect purchaser lawsuits and to prohibit awards of "duplicative" damages to indirect purchasers where direct purchasers already had recovered damages. From this, the Court inferred that the Legislature disapproved of the pass-on defense. The Court also found that permitting a pass-on defense would work against the Cartwright Act's overarching goals of "maximizing effective deterrence of antitrust violations, enforcing the state's antitrust laws…, and ensuring disgorgement of any ill-gotten gains." Perhaps more important to the ultimate ruling, the Court endorsed the view expressed in Hanover Shoe that even a direct purchaser that passes on an overcharge may have suffered some injury. Given these findings, the California Supreme Court unanimously ruled that, "under the Cartwright Act, as under federal law,  a pass-on defense generally may not be asserted."
The Supreme Court did limit its general rule. First, as recognized in Hanover Shoe, there may be situations where the drawbacks to the pass-on defense are not present, for instance where an overcharged buyer has "cost-plus" contracts with its customers, making it easy to show the buyer has not been harmed. Second, "if damages must be allocated among the various levels of injured purchasers [direct and indirect 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." But the Court said this should be rare, because where both direct and indirect purchasers have sued, "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."
Although the Clayworth Court suggested it was bringing California law in line with federal law, there remains a key distinction. Federal courts, although they reject the pass-on defense, allow direct purchaser lawsuits only. Whereas California, now with its ban on the pass-on defense, still permits direct and indirect purchaser actions.
Nevertheless, the California Supreme Court's pro-plaintiff ruling is not particularly surprising. What is surprising is the Court's belief that, in the absence of a pass-on defense, the risk of duplicative recoveries among direct and indirect purchasers can be managed through procedural devices, such as joinder and consolidation. Direct and indirect purchaser actions are being filed with increasing frequency, and are often filed in different jurisdictions at different times. In practice, joining or consolidating such actions will be more difficult than the Court suggests. It therefore will be important for defendants to present pass-on evidence where possible – although not a complete defense to a Cartwright Act claim – to minimize exposure to plaintiffs at different levels of the distribution chain.