United States: California Supreme Court Rules that Pass-On Defense Is Not Available in Price-Fixing Cases

Settling an open question under California law, the California Supreme Court held that a plaintiff in a price-fixing case may seek the full amount of an alleged overcharge even if that plaintiff passed on the overcharge to another purchaser, and a defendant may not raise the plaintiff's lack of actual damages as a defense.

On July 12, 2010, the Supreme Court of California issued an opinion in Clayworth v. Pfizer declaring that California state antitrust law does not permit a defendant accused of price fixing to raise as a defense that direct purchasers passed on any alleged overcharges to downstream indirect purchasers—what is known as a pass-on defense. By eliminating the availability of this pass-on defense, the Supreme Court of California brought California law in line with federal antitrust law on the question of how to allocate damages in a suit for price fixing, as federal law also does not recognize a pass-on defense. Yet California law differs from federal law on the question of who may bring such a suit. Under federal law, only direct purchasers may bring price-fixing actions, but California law permits indirect purchasers to bring such claims as well. The decision thus opens the door for both direct and indirect purchaser plaintiffs to recover damages in California price-fixing cases, even when direct purchasers passed on the alleged overcharges to the indirect purchasers.

Federal Antitrust Law and the Previous Application of California Antitrust Laws

In a typical price-fixing lawsuit, plaintiffs accuse several defendant manufacturing companies of conspiring to fix prices at above-market-competitive levels. When price fixing occurs, two types of plaintiffs may suffer injury as a result of these overcharges: direct purchasers that purchase the goods initially from the defendant manufacturers, and indirect purchasers that purchase the goods when they are resold by the direct purchasers.

Passing-on occurs when a manufacturing company fixes the initial price of a good at an impermissibly high level, and then the direct purchaser passes on this price increase to the indirect purchaser by similarly raising the price it charges. In such a situation, the defendant manufacturer could raise a pass-on defense, arguing that its liability to the direct purchaser should be reduced or eliminated, because the direct purchaser passed on the price overcharge to the indirect purchaser and suffered limited or no actual damages.

Under federal antitrust law, indirect purchasers cannot sue for price-fixing violations. To ensure that direct purchasers can recover where price fixing occurs, the Supreme Court of the United States held in Hanover Shoe v. United Shoe Machine Corp. that a defendant cannot assert a pass-on defense and escape liability by arguing that illegal overcharges were passed on by direct purchasers to indirect purchasers. Thus federal direct purchasers can recover regardless of any pass-on. By contrast, under California state antitrust law, both direct purchasers and indirect purchasers can sue a defendant for fixing prices. But until Clayworth v. Pfizer, whether defendants in California courts could assert the pass-on defense in situations where a direct purchaser passed on alleged overcharges to indirect purchasers was an open question.

The Supreme Court of California Rejects the "Pass-On" Defense

Clayworth v. Pfizer involves a group of retail pharmacies as direct purchaser plaintiffs alleging claims of price fixing against a group of defendant drug manufacturers. It was undisputed that the pharmacies set their prices in a way that would pass on any overcharge by the manufacturers. The drug manufacturers asserted the pass-on defense and sought summary judgment, arguing that since the direct purchaser pharmacies had passed the alleged price overcharges on to their customers, the pharmacies suffered no damages. The trial court recognized the availability of the pass-on defense and granted summary judgment for the defendants. The court of appeal affirmed this decision, rejecting an argument by the plaintiffs that the California legislature had approved application of the federal rule of Hanover Shoe. Like the trial court, the court of appeal concluded that the pass-on defense was available and that it was fatal to the plaintiffs' claims.

The Supreme Court of California reversed this decision and held that under California's Cartwright Act, as under the federal rule in Hanover Shoe, the pass-on defense is generally not permitted. Because the text of the Cartwright Act itself did not provide guidance regarding the availability of the defense, the court looked to the legislative history of the act. The court read the California legislature's amendments to the Cartwright Act, made in response to Illinois Brick v. Illinois, a Supreme Court of the United States case following Hanover Shoe, as demonstrating an intent by the California legislature to incorporate the federal rule against allowing the pass-on defense. Further, the overarching policy goals of strongly deterring antitrust violations, ensuring enforcement of the state's antitrust laws and providing for the full disgorgement of any improperly gained proceeds weighed heavily against a finding that the pass-on defense should be available to California antitrust defendants. The court also reasoned that in most cases, the risk of double recovery by multiple classes of plaintiffs was not great enough to warrant the application of the pass-on defense. Finally, according to the court, direct purchasers that passed on an overcharge may still have suffered an injury, for example by losing overall sales as a result of raising prices because of the overcharge, even if they paid none of the overcharge themselves. The defense should not be allowed to defeat direct plaintiffs' claims in such cases.

However, the court recognized two limited circumstances in which the defense may be available. First, the court noted that Hanover Shoe recognized an exception for "cost-plus" contracts, and given the California legislature's endorsement of the federal rule in Hanover Shoe, the court stated that the exception for cost-plus contracts would also apply under California law.

Second, the court noted that in cases where various levels of direct and indirect purchaser plaintiffs were entitled to damages, defendants would be permitted to raise the pass-on defense to prevent double recovery. Thus a pass-on defense appears to be available when assessing damages in a case where both direct and indirect purchasers have been successful in establishing price fixing by the defendant, but it is not available as a general defense to the action. Neither of these two exceptions applied in Clayworth, however, and the court did not address the scope of the pass-on defense in these situations.

Impact of the Decision

The Clayworth decision is a big win for class action lawyers, because it eliminates a very important defense for defendants. This decision likely will result in more cases brought in California state court, especially because the federal courts in the last few years have applied a much more rigorous standard when considering class certification motions, making federal courts a less friendly forum for plaintiffs.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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