On July 25, 2008, in a case that presented an issue of first impression in California antitrust law, California’s Court of Appeal of the First Appellate District ruled that the pass-on defense is available to defendants accused of price-fixing. See Clayworth v. Pfizer, No. A116798, __ Cal.App.4th __, 2008 Cal.App. LEXIS 1151 (7/25/08) (hereafter “Pfizer”). The case is significant in that, for now, despite the long-standing rule to the contrary in the seminal United States Supreme Court case of Hanover Shoe v. United Shoe Mach. Corp., 392 U.S. 481 (1968) (“Hanover Shoe”), antitrust defendants in California may assert as a defense that an antitrust plaintiff “passed on” any of its alleged damages to its customers. 

A. Background: Hanover Shoe, Illinois Brick, and California’s Illinois Brick Repealer Statute 

In Hanover Shoe, a shoe manufacturer (Hanover Shoe), sought damages under section 4 of the Clayton Act, 15 U.S.C. § 15, for purported overcharges in violation of the antitrust laws, amounting to the difference between what it had paid in shoe machine rentals and what it would have paid had the defendant been willing to sell those machines. The defendant countered that Hanover Shoe suffered no legally cognizable injury because any illegal overcharge was reflected in the price it charged its customers for its shoes. The United States Supreme Court held that the plaintiff proved antitrust injury and damages when it proved that it was overcharged, and the possibility that it might have recouped the overcharge by “passing it on” to its customers was not relevant. The decision was premised on “insurmountable evidentiary problems” because “[a] wide range of factors influence a company’s pricing policies” and the amount of the overcharge passed on to the consumer. The Supreme Court also expressed concern that if a direct purchaser were not allowed to sue for overcharges passed on to indirect purchasers, indirect purchasers would lack the incentive to bring an antitrust action. Hanover Shoe, 392 U.S. at 494. 

Nine years later, in Illinois Brick v. Illinois, 431 U.S. 720 (1977) (“Illinois Brick”), the Supreme Court addressed the flip-side of Hanover Shoe, addressing whether the pass-on theory could be used “offensively” such that an indirect purchaser plaintiff could pursue a claim against an alleged antitrust violator. The Supreme Court held that indirect purchasers were not parties “injured in [their] business or property” within the meaning of the antitrust laws and therefore lacked standing to sue in federal antitrust cases. Only the direct purchaser was the injured party. To avoid serious risks of multiple liability, the Court reasoned that the Hanover Shoe rule prohibiting use of the defensive pass-on theory “must apply equally to plaintiffs and defendants,” and was concerned that permitting the use of pass-on theories would “transform treble-damages actions into massive efforts to apportion the recovery among all potential plaintiffs.” Id. at 737.

Following the Supreme Court’s holding that indirect purchasers lack standing, numerous states enacted so-called Illinois Brick repealer statutes. In California, the amendment took the form of Assembly Bill 3222. Thus, while indirect purchasers lack standing to bring an action for treble damages under the federal antitrust law pursuant to Illinois Brick, such purchasers can pursue a claim in California.

As the Pfizer court noted, few California authorities have even mentioned the defensive use of the pass-on issue in the almost 40 years since Hanover Shoe’s publication, and have explicitly recognized that “this 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,113 Cal.App.4th 195, 213, fn. 10 (2003). It is against this backdrop that the Pfizer court was presented with an issue of first impression.

B. The Facts in Pfizer

In Pfizer, retail pharmacy plaintiffs alleged that pharmaceutical companies fixed pharmaceuticals prices, and asserted claims under California’s antitrust statute - the Cartwright Act (Bus. & Prof. Code § 16700 et seq.), and for restitution and injunctive relief under California's Unfair Competition Law ("UCL") (Bus. & Prof. Code § 17200 et seq.).

Defendants asserted as an affirmative defense that plaintiffs’ claims were barred because plaintiffs passed on any alleged overcharge to third parties and therefore did not suffer a compensable injury. Prior to deciding the viability of the pass-on defense in California, the trial court permitted defendants to conduct discovery relevant to the pass-on defense. That discovery demonstrated that each time defendants increased their prices for a product, plaintiffs increased the price they charged their customers by at least the same amount, i.e., plaintiffs passed on all of the alleged overcharges. Plaintiffs also admitted that the only damages that they sought were the claimed overcharges.

Plaintiffs argued that the pass-on defense could not be asserted against their Cartwright Act claims based on Hanover Shoe, the legislative history of the Cartwright Act, and public policy. Plaintiffs also argued that the pass-on defense was inapplicable to the calculation of restitution under their UCL claim. Defendants argued that California never adopted the Hanover Shoe holding and that the language of the Cartwright Act makes clear that plaintiffs in an antitrust action cannot recover for an overcharge passed on to a subsequent purchaser.

As a result, the court in Pfizer was forced to address head on whether the pass-on defense was available to antitrust defendants in California.

C. The Pfizer Decision

The court in Pfizer began its analysis by noting that interpretations of federal antitrust law were not dispositive of the issue of recovery under California’s antitrust statutes as embodied in the Cartwright Act because “judicial interpretation of the Sherman Act, while often helpful, is not directly probative of the Cartwright drafters’ intent,” State of California ex. rel. Van de Kamp v. Texaco, Inc., 46 Cal.3d 1147 (1988), and that such precedent should be used “with caution.” Freeman v. San Diego Ass’n of Realtors, 77 Cal.App.4th 171, 183, fn. 9. (1999).

Section 16750 of the Cartwright Act, at subdivision (a) provides, “Any person who is injured in his or her business or property by reason of anything forbidden or declared unlawful by this chapter, may sue therefor . . . and to recover three times the damages sustained by him or her . . . .” (emphasis added). Thus, the Pfizer court articulated the issue as follows —— “Recovery for the antitrust plaintiff is three times the ‘damages sustained.’ What does that phrase mean?”

Applying the rules governing statutory construction in California “to determine the lawmakers’ intent,” which requires first “look[ing] to the words of the statute themselves,” the court determined that the express “damages sustained” language of the Cartwright Act requires that a plaintiff suffer a compensable injury, and prohibits a plaintiff from recovery when it sustains no injury. Among other things, the court noted that while the term “damages sustained” is not defined in the Cartwright Act, it is defined “in other places and cases,” and those authorities hold that the phrase refers to actual financial loss suffered.

In sum, the Pfizer court determined that, based on the language of the Cartwright Act, plaintiffs have no “damages sustained.” Thus, the law in California based on Pfizer is that the pass-on defense is available to defendants and, as applied here, defeats plaintiffs who have passed on all the claimed overcharges.

The Pfizer court rejected plaintiffs’ arguments that Hanover Shoe required any different result. As an initial matter, the Pfizer court noted that nowhere in Hanover Shoe does the Supreme Court analyze the phrase “damages sustained,” and that opinion does not stand for the proposition that the federal antitrust laws were intended to include any amount plaintiff was overcharged even if the full amount was passed on to a subsequent purchaser. In addition, in Hanover Shoe, the Supreme Court did not create an absolute bar to the pass-on defense in all situations but, rather, “recognize[d] that there might be situations . . . where the considerations requiring that the passing-on defense not be permitted in this case would not be present.” Hanover Shoe, 392 U.S. at p. 494. And, while Hanover Shoe presented a particularly complicated problem with respect to the pass-on issue, those complications did not exist on the facts before the Pfizer court.

In fact, while the court concluded that Hanover Shoe is not the law in California, it also held that even if it were, plaintiffs’ claim would still be rejected under Hanover Shoe because Hanover Shoe did not establish an absolute bar to the assertion of the pass-on defense, and this is the type of case “where the considerations requiring that the passing-on defense not be permitted in this case [are] not present.” Hanover Shoe, 392 U.S. at p. 494. In fact, here, the facts demonstrated “a clearer scenario of a ‘perfect and provable’ pass-through,” as Justice White described it in Hanover Shoe.

The court also rejected plaintiffs’ extensive citation to legislative history and public policy arguments to support the argument that Hanover Shoe is the law in California. Plaintiffs’ primary argument was that the legislative history demonstrates a recognition by the Legislature of the risk of multiple liability which, according to plaintiffs, “necessarily presumes the recognition of Hanover Shoe.” The Pfizer court rejected that argument because the Legislature could have, but did not, include a safeguard against double recovery in section 16750. Since it did not, one can reasonably conclude that it did not consider multiple liability in private actions a problem because the pass-on defense is available to defendants.

The court further rejected plaintiffs’ argument that, in passing the Illinois Brick repealer amendment, the Legislature intended to adopt the Illinois Brick dissent in its entirety, which includes recognition of Hanover Shoe. The court observed that “one thing is clear: not once in the numerous pages of legislative history on which plaintiffs rely is Hanover Shoe even mentioned. Such fact militates strongly against plaintiffs.” Finally, the court rejected plaintiffs’ public policy argument that “California policy requires that ‘offensive’ and ‘defensive’ pass-on be treated differently,” because, as explained in Illinois Brick, “whatever rule is to be adopted regarding pass-on in antitrust damages actions, it must apply equally to plaintiffs and defendants.” Illinois Brick, 431 U.S. at 728. The court also noted that while deterrence and disgorgement are no doubt significant policy considerations, “compensation” is the primary rationale for private antitrust lawsuits and, here, plaintiffs could not require compensation because they did not sustain actual damages.

As to plaintiff’s argument that recognizing the pass-on defense will deprive plaintiffs of the incentive to sue for an antitrust violation, claiming that the “availability of the pass-on defense would virtually wipe-out all but end-consumer overcharge cases,” the court also noted that plaintiffs’ argument is belied empirically by recent consolidated class action cases by indirect purchasers.

In conclusion, the Pfizer court held that to allow plaintiffs to recover would violate a fundamental precept of California damage law—that plaintiffs not receive a windfall. In sum, “In the language of the issue as framed by the parties, the pass-on defense is available in California.”

nIn addition to their Cartwright Act claim, plaintiffs also alleged that defendants committed illegal business practices in violation of California's Unfair Competition Law. The court noted that the exclusive monetary remedy available to private plaintiffs under the UCL is restitution, and such “restitution” is limited to the return of property or funds in which the plaintiff has an ownership interest. Here, there was no such interest. Finally, while the court decided that plaintiffs could not be awarded restitution, and that it need not analyze the standing arguments in detail, the court noted that plaintiffs’ position that they can bring what amounts to a representative action and keep for themselves any potential recovery although they suffered no monetary loss flies in the face of Proposition 64, which limits UCL actions to “any person . . . ‘who has suffered injury in fact and has lost money or property as a result of such unfair competition.’”