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Clayworth v. Pfizer

July 12, 2010


Ct.App. 1/2 A116798 Alameda County Super. Ct. No. RG04172428 Judge: Ronald M. Sabraw and Harry R. Sheppard.

The opinion of the court was delivered by: Werdegar, J.

When a group of companies conspires to fix prices at higher than a competitive level, the resulting overcharge is paid in the first instance by the direct purchaser of the cartel's goods. In markets where the direct purchaser is not also the ultimate purchaser, but an intermediary between the cartel and the consumer (the indirect purchaser), several questions arise: First, who should be permitted to sue for price fixing, the direct purchaser, the indirect purchaser, or both? Second, how should damages be allocated? Should an antitrust conspirator be permitted to raise as a defense that the direct purchaser passed on some or all of the overcharge to indirect purchasers downstream in the chain of distribution?

Under federal antitrust law, the answer to these questions is settled. In Hanover Shoe v. United Shoe Mach. (1968) 392 U.S. 481 (Hanover Shoe), the United States Supreme Court held antitrust violators ordinarily could not assert as a defense that any illegal overcharges had been passed on by a plaintiff direct purchaser to indirect purchasers. Instead, the full measure of the overcharge is recoverable by the direct purchaser. In a related decision nine years later, the Supreme Court concluded only direct purchasers, not indirect purchasers, could sue for price fixing. (Illinois Brick Co. v. Illinois (1977) 431 U.S. 720 (Illinois Brick).)

Under state antitrust law, only the first question--who may sue--is settled. In 1978, in direct response to Illinois Brick, the Legislature amended the state's Cartwright Act (Bus. & Prof. Code, § 16700 et seq.)*fn1 to provide that unlike federal law, state law permits indirect purchasers as well as direct purchasers to sue (§ 16750, subd. (a)). This left open the further question how damages should be allocated. Does the Cartwright Act permit a pass-on defense, or in this respect are state and federal law the same?

We conclude that under the Cartwright Act, as under federal law, generally no pass-on defense is permitted. While the text of the Cartwright Act does not answer the question, the Legislature's actions in response to Illinois Brick and related federal statutory amendments reveal a clear legislative preference for the Hanover Shoe rule. As well, that rule is the one most closely in accord 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. Accordingly, we reverse the Court of Appeal, which held that a pass-on defense was available and that it entitled the alleged price-fixing defendants here to summary judgment.


On appeal from a grant of summary judgment, we review and recite the evidence in the light most favorable to the nonmoving party (here, plaintiffs). (Aguilar v. Atlantic Richfield Co. (2001) 25 Cal.4th 826, 843.)

Plaintiffs (hereafter Pharmacies) are retail pharmacies located in California.*fn2 Defendants (hereafter Manufacturers) are, with two exceptions, companies that manufacture, market, and/or distribute brand-name pharmaceutical products throughout the United States.*fn3 Manufacturers also manufacture, market, and/or distribute similar brand-name pharmaceutical products in Canada where, unlike in the United States, the products are subject to government pricing restrictions.

Pharmacies filed suit under section 1 of the Cartwright Act (Stats. 1907, ch. 530, § 1, pp. 984-985, as amended; §§ 16720, 16726) and the unfair competition law (UCL) (§ 17200 et seq.), alleging Manufacturers had unlawfully conspired to fix the prices of their brand-name pharmaceuticals in the United States market, including in California. The complaint alleged Manufacturers had agreed to set artificially high prices for their products, and had acted in concert to restrain reimportation of their lower-priced foreign drugs into the United States and to restrict price competition from generics. As a result, the complaint alleged, Manufacturers were able to maintain prices for their drugs in California, as elsewhere in the United States, at levels 50 to 400 percent higher than for the same drugs sold outside the United States. Pharmacies alleged they consequently had been forced to pay an overcharge, the differential between the conspiracy-inflated prices set by Manufacturers and the prices Pharmacies would have paid in a competitive market. They sought treble damages, restitution, and injunctive relief.

Each Manufacturer answered, denying Pharmacies' allegations and asserting as an affirmative defense that Pharmacies' claims were barred on the ground Pharmacies passed on any alleged overcharge to third parties and therefore did not suffer a compensable injury.

Pharmacies filed a motion for summary adjudication of Manufacturers' pass-on defense, arguing that the defense was unavailable under the Cartwright Act in light of Hanover Shoe, supra, 392 U.S. 481, the subsequent legislative history of the Cartwright Act, and public policy. Manufacturers responded with a cross-motion for summary judgment, arguing that under the plain language of the Cartwright Act, a pass-on defense was available and defeated both the Cartwright Act and UCL claims.*fn4

Evidence presented in connection with the cross-motions established the following essentially undisputed facts. Manufacturers sell their drugs to wholesalers at a price referred to as the wholesale acquisition cost. In turn, various independent entities use the wholesale acquisition cost to calculate and publish benchmark drug prices, termed the average wholesale price, for use in the industry. Wholesalers resell the drugs to Pharmacies at prices based on a percentage of the average wholesale price. Because the published average wholesale price is a fixed percentage above the price charged by Manufacturers to wholesalers, any price increases by Manufacturers will increase the average wholesale price proportionally. As a result, when Manufacturers increase their prices, the costs of drugs to Pharmacies increase by the same percentage amount.

In turn, Pharmacies sell the drugs to two groups of consumers: (1) those with third party insurance or a drug benefit plan offered by either a private entity or the government, which in turn pays customers' claims on their behalf, and (2) uninsured (or cash-paying) consumers. For the first group, those covered by third party payers, Pharmacies are reimbursed at a contractually or statutorily fixed amount, predetermined as a percentage of the average wholesale price, plus a dispensing fee; this reimbursement is greater than Pharmacies' acquisition costs. For the second group, the cash-paying consumers, Pharmacies establish the retail prices unilaterally. Though not required to be, these prices traditionally have been based on a set percentage of the average wholesale price as well, plus in some instances an additional dispensing fee.

Currently, consumers covered by third party payers comprise the bulk of Pharmacies' customers. It appears the percentage of cash-paying consumers has declined over time, with the consequence that the degree of price-setting discretion Pharmacies have has fallen as well.

In light of this evidence, the trial court granted Manufacturers' summary judgment cross-motion and denied as moot Pharmacies' summary adjudication motion. It held a pass-on defense was available under the Cartwright Act: A defendant could reduce or eliminate its liability upon proof that the plaintiff had passed on the alleged price overcharge and thereby limited its damages or suffered no injury. The trial court interpreted the evidence before it as showing that Pharmacies had passed on all of Manufacturers' overcharges to consumers and had thus sustained no damages under the Cartwright Act. The pass-on defense similarly defeated Pharmacies' UCL claim; the trial court concluded Pharmacies lacked standing to pursue the claim because, having recouped the overcharge, they had not "lost money or property," as required under section 17204.

The Court of Appeal affirmed. It rejected the argument that the Legislature had approved application to the Cartwright Act of Hanover Shoe, supra, 392 U.S. 481, and its bar against pass-on defenses. Relying instead on its reading of the plain meaning of the Cartwright Act's damages provision (§ 16750, subd. (a)), the Court of Appeal concluded a pass-on defense was available and was fatal to Pharmacies' claims because they could show no "damages sustained" (ibid.). It likewise rejected Pharmacies' UCL claims on the grounds that Pharmacies were not entitled to restitution and lacked standing to challenge Manufacturers' alleged unfair business practices.

We granted review to address a significant issue of first impression: whether under the Cartwright Act an antitrust defendant can defeat liability by asserting a pass-on defense. (See Global Minerals & Metals Corp. v. Superior Court (2003) 113 Cal.App.4th 836, 852, fn. 10 ["[T]his issue of the availability of a 'pass-on defense' in antitrust law still remains an open question in California...."]; J. P. Morgan & Co., Inc. v. Superior Court (2003) 113 Cal.App.4th 195, 213, fn. 10 [same]; B.W.I. Custom Kitchen v. Owens-Illinois, Inc. (1987) 191 Cal.App.3d 1341, 1353 [same].)


I. Hanover Shoe and Its Antecedents

In Hanover Shoe, supra, 392 U.S. 481, the United States Supreme Court considered whether the pass-on defense should be available to defendants found to have charged excess prices under federal antitrust law. The United States had obtained a judgment against United Shoe Machinery Corporation (United Shoe) under section 4 of the Sherman Act (15 U.S.C. § 4) for monopolizing the market for shoe manufacturing machinery. Relying on this judgment, shoe manufacturer Hanover Shoe, Inc. (Hanover Shoe) sought to recover the "damages by him sustained" under section 4 of the Clayton Act (15 U.S.C. § 15); United Shoe argued in response that Hanover Shoe had likely incorporated any overcharge it paid United Shoe into the prices it charged its customers for shoes, and accordingly had sustained no damage.

In a seven-to-one decision authored by Justice White, the United States Supreme Court rejected United Shoe's assertion of a pass-on defense.*fn5 It held that "when a buyer shows that the price paid by him for materials purchased for use in his business is illegally high and also shows the amount of the overcharge, he has made out a prima facie case of injury and damage within the meaning of § 4" of the Clayton Act (15 U.S.C. § 15). (Hanover Shoe, supra, 392 U.S. at p. 489.)

Explaining this conclusion, the Supreme Court pointed out that however a buyer responds to illegal overcharges, he inevitably will be damaged. First, if the buyer does nothing and absorbs the loss, he suffers lost profits because, while revenue is static, his costs have been increased by the amount of the overcharge. (Hanover Shoe, supra, 392 U.S. at p. 489.) Second, "if the buyer, responding to the illegal price, maintains his own price but takes steps to increase his volume or to decrease other costs, his right to damages is not destroyed. Though he may manage to maintain his profit level, he would have made more if his purchases from the defendant had cost him less." (Ibid.) Third, "the buyer is equally entitled to damages if he raises the price for his own product." (Ibid.) In this last scenario, to the extent the higher price costs the buyer sales, he is injured by his loss of sales; to the extent it does not cost him sales, because demand for his product is inelastic, his marginal profit would have been higher had his costs, illegally enhanced, been lower. In sum: "As long as the seller continues to charge the illegal price, he takes from the buyer more than the law allows. At whatever price the buyer sells, the price he pays the seller remains illegally high, and his profits would be greater were his costs lower." (Ibid.)

The Supreme Court offered two additional reasons why acceptance of the pass-on defense would be problematic. First, it would require a fact finder to decide a host of imponderables: whether in the absence of the illegal overcharge the plaintiff would have priced his product differently, what impact such a different price would have had on total sales "in the real economic world rather than an economist's hypothetical model" (Hanover Shoe, supra, 392 U.S. at p. 493), and whether the price change might have been pursued anyway even in the absence of the initial overcharge. "Since establishing the applicability of the passing-on defense would require a convincing showing of each of these virtually unascertainable figures, the task would normally prove insurmountable." (Ibid.) Proof of such factors would depend on massive and complex showings and rebuttals, potentially sidetracking every antitrust trial in a host of issues collateral to the central claim--whether the defendant had engaged in illegal anticompetitive conduct. (Ibid.)

Second, broad acceptance of the defense would create a risk that no one would be left with a sufficiently significant injury to be motivated to seek relief; individual end consumers, each harmed to the tune of a few pennies or dollars only, might have insufficient motivation even to pursue a class action. Consequently, "those who violate the antitrust laws by price fixing or monopolizing would retain the fruits of their illegality because no one was available who would bring suit against them" (Hanover Shoe, supra, 392 U.S. at p. 494), and enforcement of the antitrust laws would be compromised.

Hanover Shoe's view of how properly to measure damages was not novel; as Justice White pointed out, a long line of Holmes and Brandeis opinions had adopted the same understanding. (See Hanover Shoe, supra, 392 U.S. at pp. 489-490.) Writing for the court in Chattanooga Foundry v. Atlanta (1906) 203 U.S. 390, Justice Holmes explained why a pass-on defense was inconsistent with the law's general take on damages: "A man is injured in his property when his property is diminished.... [W]hen a man is made poorer by an extravagant bill we do not regard his wealth as a unity, or the tort, if there is one, as directed against that unity as an object. We do not go behind the person of the sufferer. We say that he has been defrauded or subjected to duress, or whatever it may be, and stop there." (Id. at p. 399.) Several years later, he explained again why a pass-on defense should not stand as a bar to allegations of excessive rate charges under federal transportation law: "The only question before us is... whether the fact that the plaintiffs were able to pass on the damage... prevents their recovering the overpayment.... The answer is not difficult. The general tendency of the law, in regard to damages at least, is not to go beyond the first step.... The plaintiffs suffered losses... when they paid. Their claim accrued at once in the theory of the law and it does not inquire into later events." (Southern Pac. Co. v. Darnell-Taenzer Co. (1918) 245 U.S. 531, 533-534.) To similar effect in rejecting a pass-on defense in the context of an illegal overcharge by railroad yards, Justice Brandeis wrote for the court: "Neither the fact of subsequent reimbursement..., nor the disposition which may hereafter be made of the damages recovered, is of any concern to the wrongdoers." (Adams v. Mills (1932) 286 U.S. 397, 407.) To allow a pass-on defense would undermine the enforcement of the statutory scheme (there, the Interstate Commerce Act (49 U.S.C. former § 8)): "[T]he purpose of that section would be defeated if the tortfeasors were permitted to escape reparation by a plea that the ultimate incidence of the injury was not upon those who were compelled in the first instance to pay the unlawful charge." (Adams v. Mills, at p. 408.)

This rejection of using overcharge pass-ons as a defense occurs not because the law is blind to their existence, but rather because its eyes are open to their ubiquity. Justice Holmes, again: The disregard of pass-ons is in part a recognition of "the endlessness and futility of the effort to follow every transaction to its ultimate result. [Citation.] Probably in the end the public pays the damages in most cases of compensated torts." (Southern Pac. Co. v. Darnell-Taenzer Co., supra, 245 U.S. at p. 534.) The Hanover Shoe court certainly acknowledged that a buyer faced with an overcharge might seek to pass on that overcharge. (Hanover Shoe, supra, 392 U.S. at pp. 489, 493.) What the court also recognized, however, was how much deeper down the rabbit hole one could go. Price fixing has primary consequences: the overcharge to direct purchasers. It may have secondary consequences: the pass-on to indirect purchasers. It may have tertiary consequences: the price increase may result in lost sales or profits, or lost market share for a buyer forced to compete with sellers not subject to the overcharge. (Id. at pp. 489-493.)*fn6 To trace every consequence of a monopoly or a price-fixing conspiracy is to encounter Holmes's "futility of the effort to follow every transaction to its ultimate result." (Southern Pac. Co., at p. 534.) Hanover Shoe recognized fully the difficulties inherent in tracing an antitrust violation to its ultimate consequences. (See Hanover Shoe, at p. 493.) The rule it adopted, which accounts only for the primary consequence (the overcharge), recognizes that to stop after consideration of primary and secondary consequences (the overcharge and any pass-on) would fail to properly account for a host of tertiary consequences and thus underestimate the impact of the overcharge, but that attempting to actually account for those tertiary consequences would often be both impractical, given the difficulties of proving "in the real economic world" (ibid.) the ultimate impacts of a price change, and a severe impairment to deterrence (id. at p. 494).

With this background, we turn to the issue in this case. Does the rule of Hanover Shoe, that a defensive pass-on theory may not be used to defeat an antitrust ...

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