Clayworth v. Pfizer: California Supreme Court Rejects "Pass-On" Defense

California Litigation Update

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On July 12, 2010, the California Supreme Court issued a unanimous opinion in Clayworth v. Pfizer, Inc., No. S166435, __ Cal. 4th __, 2010 WL 2721021 (Cal. July 12, 2010) deciding an issue of first impression: whether a “pass-on” defense is available with respect to claims under the Cartwright Act (Cal. Bus. & Prof. Code § 16700 et seq.), California’s state antitrust law. Unlike federal law, which limits antitrust damage claims to “direct purchasers,” the Cartwright Act allows indirect purchasers as well to sue on antitrust claims. The issue presented in Clayworth was whether defendants could defeat a Cartwright Act claim by showing that the plaintiff passed on any overcharge. Reversing the lower courts’ grant of summary judgment in favor of the pharmaceutical manufacturer defendants, the Court held – consistent with the rule established in Hanover Shoe v. United Shoe Mach., 392 U.S. 481 (1968) – “that under the Cartwright Act, as under federal law, generally no pass-on defense is permitted.”

BACKGROUND

California vs. Federal Law

As the Court explained in the introduction, “[i]n markets where the direct purchaser is not also the ultimate purchaser,” several questions arise, including: (1) “who should be permitted to sue for price fixing, the direct purchaser, the indirect purchaser, or both;” and (2) “[s]hould 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?”

Both questions, the Court explained, are settled under federal law. In Hanover Shoe, the U.S. Supreme Court held that a pass-on defense generally was unavailable, and in Illinois Brick Co. v. Illinois, 431 U.S. 720 (1977), “the Supreme Court concluded only direct purchasers, not indirect purchasers, could sue for price fixing.”

But only one issue was previously settled under California law. “In 1978, in direct response to Illinois Brick, the [California] Legislature amended the state’s Cartwright Act … to provide that unlike federal law, state law permits indirect purchasers as well as direct purchasers to sue. This left open the further question of 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?”

Allegations and Lower Court Opinions

The action was brought by retail pharmacies (referred to in the opinion as the “Pharmacies”) against a number of defendants generally involved in the manufacturing, marketing, and/or distribution of brand-name pharmaceutical products throughout the United States (the “Manufacturers”). Asserting claims for price-fixing under the Cartwright Act and for violations of California’s Unfair Competition Law (“UCL”) (Cal. Bus. & Prof. Code § 17200 et seq.), the Pharmacies alleged that the Manufacturers “had agreed to set artificially high prices for their products” – i.e., the wholesale acquisition cost – “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.”

The parties cross-moved for summary judgment/adjudication on the Manufacturers’ defense that the Pharmacies’ claims failed because the Pharmacies passed any overcharges on to consumers and thus were not themselves injured by the challenged conduct. The trial court granted summary judgment in favor of the defendants and the Court of Appeal affirmed. See Clayworth v. Pfizer, Inc., 83 Cal. Rptr. 3d 45 (2008). The Court of Appeal reasoned that a pass-on defense is available under the language, history, and purpose of the Cartwright Act, including the statutory language requiring that plaintiffs show “damages sustained” (Cal. Bus. & Prof. Code § 16750) and the fact that, unlike under federal law, California law allows claims by indirect purchasers. The Court of Appeal further held that the UCL claim failed because the Pharmacies had not “lost money or property” so as to have standing under Cal. Bus. & Prof. Code § 17204, and could not be entitled to restitutionary relief.

THE SUPREME COURT’S OPINION

The Cartwright Act

The California Supreme Court “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.” The Court first analyzed certain policies underlying Hanover Shoe and rejected the notion that the “damage sustained” language of the Cartwright Act compelled a contrary result. The Court concluded that legislative intent supported adopting the “Hanover Shoe rule,” and that allowing a “universal pass-on defense” would be contrary to the legislative history of the Act and policies favoring the protection of competition and prevention of antitrust violations.

The Court, however, qualified its holding by stating: “While a pass-on defense is generally precluded, a few instances remain in which it will still be available.” It then identified potential exceptions for: (1) “cost-plus” contracts, an exception recognized in Hanover Shoe;1 and (2) situations raising the prospect of duplicative recovery, given that the Cartwright Act also allows suit by indirect purchasers. With respect to the “duplicative recovery” exception, the Court stated:

“[I]n light of the

The court commented, however, that it “need not address in detail the scope of these two exceptions, for neither applies here.”

The UCL Claim

The Court similarly held that the Plaintiffs’ “passing on” of the overcharge did not defeat their UCL claim. The UCL, as amended in 2004, includes a standing requirement that the plaintiff have “lost money or property” as a result of the violation, and the Court held that Pharmacies could satisfy this requirement because they “lost money: the overcharges they paid.” Specifically addressing and rejecting the defendants’ argument, the Court stated:

While Manufacturers argue that ultimately Pharmacies suffered no compensable loss because they were able to mitigate fully any injury by passing on the overcharges, this argument conflates the issue of standing with the issue of the remedies to which a party may be entitled. That a party may ultimately be unable to prove a right to damages (or, here, restitution) does not demonstrate that it lacks standing to argue for its entitlement to them. The doctrine of mitigation, where it applies, is a limitation on liability for damages, not a basis for extinguishing standing.

The Court also rejected the contention that because the Pharmacies have no ability to recover restitution, they were not entitled to any remedy. The Court stated that it found “no obstacle that would preclude Pharmacies from obtaining injunctive relief” and held that, once standing is established, “[n]othing in the statute’s language conditions a court’s authority to order injunctive relief on the need in a given case to also order restitution. Accordingly, the right to seek injunctive relief under section 17203 is not dependent on the right to seek restitution; the two are wholly independent remedies.”

IMPLICATIONS

With respect to the price-fixing claims under the Cartwright Act, it remains to be seen whether the California Supreme Court’s decision marks the end of the pass-on defense, or will give it new life because the exceptions identified likely will be raised in many cases. In particular, the second exception recognized by the Court – for cases involving even the “risk” of “duplicative recovery” – will likely be present in a wide variety of cases, and courts will have to resolve numerous questions about its application, including: (1) what circumstances create a sufficient “risk” to trigger the exception; (2) what procedures does the availability of the exception require; and (3) can the defense result in the outright dismissal of a plaintiff’s claim, or would it only diminish the potential recovery.

1See Hanover Shoe, 392 U.S. at 494. A “cost-plus” contract, as explained by the Court, is one in which the seller and purchaser enter into a preexisting contract for a fixed markup and fixed quantity to be delivered.

2 The Court’s discussion of the second exception and reference to employing joinder, interpleader, consolidation and similar procedural devices appears consistent with Union Carbide Corp. v. Superior Court, 36 Cal. 3d 15, 24 (1984) (cited elsewhere in the decision). Union Carbide involved an action brought by indirect purchasers, and while it held that defendants there were not entitled to compulsory joinder at the pleadings stage, it noted the availability of mechanisms such as consolidation, coordination, and joinder to avoid duplicative liability upon a proper showing.

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