For decades, courts, policymakers and academics have grappled with the intertwined issues of the pass-on defense and indirect purchaser rule. Now, these doctrines, which have been essentially unchanged in the context of federal litigation for a generation, could be on the brink of substantial change. Indeed, signifi cant changes to the passon defense and indirect purchaser rule are either under way or have already been realized in a number of states, and it may now be only a matter of time before similar changes make their way to the federal level.

The Current Federal Landscape

Defensive pass-on and the indirect purchaser rule are essentially mirror antitrust doctrines that are implicated when an action involves a chain of distribution. The classic example of such a scenario is a distribution chain that involves a manufacturer, a distributor and a consumer. The pass-on defense, put simply, is a theory under which a defendant (such as the manufacturer) is not liable for overcharges to the extent that a direct purchaser (a distributor) passed on those overcharges to subsequent purchasers or end-users further down the distribution chain (consumers). Under the indirect purchaser rule, an indirect purchaser of an overcharged product (the consumer) is not permitted to sue for damages based on that overcharge because a party further up the distribution chain (the distributor) purchased the overcharged product directly from the wrongdoer (the manufacturer) and thus the distributor is the party that sustained the damage.

The current strict limitations on the use of defensive passon in federal antitrust actions have their origins in the 1968 decision of the United States Supreme Court in Hanover Shoe v. United Shoe. Concerned that allowing evidence of defensive pass-on would complicate antitrust litigation and reduce the motivation for private plaintiffs to sue, the Hanover Shoe Court held that, in most circumstances, defendants in federal antitrust actions could not rely on pass-on evidence. For all practical purposes, broad-based use of defensive pass-on evidence ended after Hanover Shoe.

The Hanover Shoe Court was silent on the related issue of whether the mirror doctrine of offensive pass-on, i.e., an action brought by an indirect purchaser, remained viable. The Supreme Court addressed this question in 1977, however, with its ruling in Illinois Brick v. Illinois. In Illinois Brick, the Court tackled the offensive pass-on/indirect purchaser issue, holding as a matter of law that no offensive pass-on was allowed and that only direct purchasers could sue for alleged overcharges.

Taken together, Hanover Shoe and Illinois Brick created a landscape in federal antitrust litigation – which still exists today – that, with few exceptions, precludes the use of defensive pass-on and similarly bars indirect purchasers from bringing suit for alleged overcharges.

Defensive Pass-On and the Indirect Purchaser Rule in State Courts – The California Example

Through legislation or court decisions, a number of states reacted to the Illinois Brick decision by expressly allowing indirect purchasers to recover damages under their own state antitrust laws. The United States Supreme Court explained in California v. ARC America Corp. that such state action, which essentially runs afoul of Illinois Brick, is nevertheless permissible so long as it applies only to claims under state antitrust statutes. What is less than clear, however, is the extent to which the defensive pass-on doctrine remains viable in states that reject Illinois Brick and permit indirect purchaser actions.

California was among the earliest states to allow for offensive pass-on/indirect purchaser actions, amending its antitrust law, the Cartwright Act, in 1978. The 1978 amendment did not address the question of whether defensive pass-on was relevant in actions brought under the Cartwright Act.

Additionally, the California Court of Appeal has thus far declined to resolve the issue.

Recently, a California trial court in a high-profi le antitrust case fi nally tackled the issue of the applicability of defensive pass-on in actions brought under the Cartwright Act. In Clayworth v. Pfi zer, Inc., plaintiffs, several independent pharmacies, sued the nation’s largest pharmaceutical manufacturers and a pharmaceutical industry trade organization, claiming that the manufacturers conspired to fi x the prices of prescription drugs in the United States, resulting in an illegal overcharge. The defendants, one of which was represented by Drinker Biddle, sought summary judgment using undisputed defensive pass-on evidence demonstrating that even if the plaintiff pharmacies had incurred overcharges for drugs, those overcharges were passed on to the pharmacies’ customers. In granting the defendants’ summary judgment motion on the passon issue, the court held unequivocally that a defendant in a Cartwright Act action “can present evidence that it has no liability or that its damages are lessened because plaintiff(s) has passed on the alleged price overcharge and has either suffered no injury or has limited damages.” Although the court engaged in a lengthy discussion of policy considerations (deterrence, multiple liability concerns, legal counseling and case management), it ultimately based its decision on the language of the Cartwright Act, which limits recovery to “three times the damages sustained.” The court reasoned that a plaintiff has “sustained” no damages via an overcharge if it passed the entirety of that overcharge down the distribution chain.

The decision in Clayworth came from a trial court; the matter is now on appeal and likely will result in an appellate decision on the viability of defensive pass-on in California. Such a decision could infl uence the law in other states with similar statutes. If Clayworth does signal a trend toward acceptance of defensive pass-on in states that recognize offensive pass-on/indirect purchaser suits, its impact on how and where antitrust cases will be litigated could be signifi cant. What is perhaps more intriguing is whether a defi nitive decision by the California appellate courts on the issue will be overshadowed by potential changes to federal antitrust laws.

Changes at the Federal Level?

On April 2, 2007, the Antitrust Modernization Commission (“AMC”) – twelve commissioners appointed by the President and Congress who are charged with evaluating the current state of the federal antitrust laws and recommending changes to those laws – presented its Report and Recommendations concerning, among other things, indirect purchaser litigation. These recommendations, if made into law, would address many of the same issues now in play in California.

The AMC recommends that Congress enact a comprehensive statute that:

  • Affi rmatively overrules Illinois Brick and Hanover Shoe to the extent necessary to allow both direct and indirect purchasers to sue to recover actual damages under federal antitrust law. Damages in such actions could not exceed the overcharges (trebled) incurred by direct purchasers and would be apportioned among all purchaser plaintiffs (both direct and indirect) in full satisfaction of their claims in accordance with the evidence as to the extent of the actual damages that they suffered.
  • Allows for the removal of indirect purchaser actions brought under state law to federal court to the full extent permitted under Article III of the Constitution.
  • Allows consolidation of all purchaser actions in a single federal forum for both pretrial and trial proceedings (and thereby overrules the Supreme Court’s 1998 decision in Lexecon Inc. v. Milberg Weiss Bershad Hynes & Lerach, for purposes of such actions).
  • In putative class actions, allows for certifi cation of classes of direct purchasers, such that pass-on will only be a damages issue for trial, rather than an obstacle to class certification.

Should the AMC’s recommendations be accepted and become law, the impact on the federal antitrust litigation landscape would be substantial. By permitting federal antitrust suits by indirect purchasers (and allowing for the removal of state indirect purchaser actions), such changes to the law could lead to a proliferation of indirect purchaser actions in the federal courts. Additionally, for potential defendants entering this new world of federal indirect purchaser litigation without the rule of Hanover Shoe, defensive pass-on would constitute a means to limit and apportion liability among plaintiffs in actions involving different classes of purchasers. Thus, in such actions, direct purchaser plaintiffs would be limited to recovery of their actual damages (trebled), rather than the full amount of the overcharge.

Although the future of indirect purchaser suits and the defensive pass-on doctrine in state and federal courts is far from certain, the Clayworth litigation in California and the AMC’s Report and Recommendations suggest that signifi cant developments are in the offing. These developments may greatly infl uence how and where these types of antitrust cases are litigated in the years to come.