On 12 July 2010, the California Supreme Court in Clayworth v. Pfizer, Inc., No. S166435, 2010 WL 2721021 (Cal. July 12, 2010), held that California law bars antitrust defendants from invoking a pass-on defense in most circumstances even though both direct and indirect purchasers may sue for treble damages. Defendants (or groups of defendants) in antitrust lawsuits are typically accused of illegally overcharging for their products. An overcharge would be initially borne by direct purchasers of the defendant's products such as dealers or distributors, and may be passed on, in whole or in part, to indirect purchasers such as consumers. If the direct purchasers do pass on the overcharge, a possibility of duplicative recoveries exists when multiple levels of purchasers are permitted to sue the defendant for damages. In such instances, the defendant will likely seek to argue that the plaintiff passed on the overcharge, which leaves the claimant with no measurable injury and therefore no cognizable claims for damages. This argument is referred to as a pass-on defense. The Clayworth decision raises significant questions about the scope of liability under California antitrust law and potentially opens the door for separate antitrust lawsuits to be filed by multiple levels of purchasers, and leaves defendants subject to duplicative recoveries.
Legal Background
The United States Supreme Court has provided conclusive answers to the questions of whether a pass-on defense is available under federal law and how to avoid duplicative recoveries in federal antitrust lawsuits. In Hanover Shoe, Inc. v. United Shoe Machinery Corp., 392 U.S. 481 (1968), the Supreme Court held that federal antitrust defendants generally may not assert a pass-on defense. The Court reasoned that even a direct purchaser who passes on an overcharge will likely be damaged in other ways by the antitrust violation and that permitting a pass-on defense would potentially compromise antitrust enforcement by barring the parties most likely to sue – the direct purchasers – from recovery. Several years later, as a corollary to the Hanover Shoe principle, the Supreme Court 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). Thus, under the federal antitrust enforcement scheme, only direct purchaser plaintiffs are permitted to seek damages, and defendants may not assert as a defense that the direct purchaser passed on the alleged overcharge to an indirect purchaser.1
After Illinois Brick, many states, including California, enacted laws specifically permitting indirect purchasers to sue for damages under state antitrust laws.2 Therefore, California law was clear that both direct and indirect purchasers could sue for damages (unlike federal law). However, it was not clear whether a defendant could invoke as a defense to a direct purchaser lawsuit that the direct purchaser passed on any alleged overcharge to the indirect purchasers.3 Many assumed that if indirect purchasers had standing, then defendants would be able to assert a pass-on defense in lawsuits by direct purchasers to avoid duplicative recoveries.
Facts of Clayworth
In Clayworth, a group of retail pharmacies sued a group of pharmaceutical manufacturers alleging that the manufacturers violated California's antitrust law, known as the Cartwright Act,4 and state unfair competition laws by conspiring to fix the prices of brand-name pharmaceuticals. The defendant manufacturers argued that the pharmacy plaintiffs had passed on the alleged overcharge to consumers who purchased the drugs. After reviewing the parties' evidentiary submissions, the trial court agreed with the manufacturers, finding that the pharmacies had passed on all of the overcharges to consumers. The trial court granted summary judgment for the manufacturers because the pharmacies had sustained no apparent damages. The California Court of Appeal affirmed.
California Supreme Court's Analysis
The California Supreme Court reversed the judgment for the manufacturers. The court analyzed the legislative history of the Cartwright Act and its amendments over time, particularly its amendment in response to the Illinois Brick decision, and concluded that, "under the Cartwright Act, as under federal law . . . a pass-on defense generally may not be asserted" even through the Cartwright Act differs from federal law in permitting indirect purchasers to sue.5
The manufacturers had argued that permitting multiple levels of purchasers to recover while barring the pass-on defense could permit direct purchasers who passed on overcharges to receive a windfall recovery. The court acknowledged that this risk existed but appeared to find it acceptable. The court stated that the primary purpose of the Cartwright Act is to punish violators and promote free competition. If forced to choose between direct purchasers who had passed on overcharges but may still have suffered collateral effects of the antitrust violation receiving a windfall or antitrust violations going unpunished, the court indicated a preference for the first option, which would provide a greater deterrent effect.
The manufacturers also argued that permitting multiple levels of purchasers to recover while barring the pass-on defense could lead to duplicative recoveries. Again, the court acknowledged this risk but noted that trial courts and parties may employ procedural devices such as joinder, interpleader, and consolidation to bring all claimants before the trial court to prevent multiple lawsuits. The court further stated that in instances in which it became necessary to allocate damages among various levels of injured purchasers (for example, in a lawsuit involving both direct and indirect purchasers), it would then be permissible for a defendant to assert a pass-on defense to avoid duplicative recoveries. As a general rule, however, the court held that the pass-on defense could not be invoked where there was not at least some apparent risk of duplicative discovery in the case at bar.
Implications of Clayworth
The Clayworth decision raises significant questions about the scope of liability under the California antitrust laws. Permitting both direct and indirect purchasers to sue the same defendant for the same damages while barring the defendant from asserting a pass-on defense presents a risk of duplicative recovery. The California Supreme Court noted several methods by which trial courts could mitigate this risk, but it also acknowledged that the risk of duplicative recovery is a real one. Although the court suggested that an apparent risk of duplicative recovery in a single case would permit assertion of a pass-on defense, that situation was not present in Clayworth, and therefore the court declined to address it further. As a result, the decision may have far-reaching implications if multiple levels of purchasers, both direct and indirect, bring separate damages lawsuits relying on Clayworth to argue that the defendants are barred from invoking a pass-on defense in each suit. At a minimum, defendants may face the prospect of defending several such suits while attempting to consolidate them to enable assertion of a pass-on defense in a single proceeding.
The California Supreme Court's reliance on consolidation and coordination as the principal tool for eliminating the risk of duplicative liability is troubling for several reasons. First, the court assumed that separate suits by direct and indirect purchasers would be filed at times that permit use of such procedural devices. There is no guarantee that will occur, however, and the court offered no guidance on how duplicative liability will be avoided when the underlying assumption does not apply. Second, reliance on such procedural devices fails to account for those situations in which different levels of purchasers are litigating claims arising from the same facts in state and federal courts. Coordination of such proceedings may be difficult and will depend entirely on informal cooperation by the state and federal judges handling the litigation. Moreover, coordination may be constrained by differences in state and federal procedural rules. Third, the California court's analysis ignores other, related legal rules, such as the Full Faith and Credit Act6 and the Rooker-Feldman doctrine7, that might have substantive effect on Cartwright Act litigation in federal court. Such issues are bound to arise in subsequent cases and the California courts will eventually have to address them.
Footnotes
1 The Court has suggested potential exceptions to the bar on the use of pass-on theories in federal antitrust cases when direct purchasers (i) are owned or controlled by subsequent purchasers or (ii) resell goods under pre-existing, fixed-quantity, cost-plus contracts, but it has never formally recognized either.
2 In several other states, courts have interpreted existing antitrust laws to permit indirect purchaser lawsuits.
3 The handful of California appellate cases discussing the pass-on theory prior to Clayworth acknowledged that the availability of a pass-on defense under state antitrust laws was an "open question." J.P. Morgan & Co., Inc. v. Superior Court, 113 Cal. App. 4th 195, 213 n.10 (2003); Global Minerals & Metals Corp. v. Superior Court, 113 Cal. App. 4th 836, 852 n.10 (2003).
4 Cal. Bus. & Prof. Code, § 16700 et seq.
5 Clayworth, 2010 WL 2721021, at *17.
6 28 U.S.C. § 1738.
7 See District of Columbia Court of Appeals v. Feldman, 460 U.S. 462 (1983); Rooker v. Fidelity Trust Co., 263 U.S. 413 (1923). The Rooker-Feldman doctrine bars lower federal courts from exercising what is effectively appellate jurisdiction over state court judgments.
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