Davis Polk & Wardwell Newsflash

Important Antitrust Decision:
California Court of Appeal Affirms Availability of Antitrust Pass-On Defense in Clayworth - Argument for Pharmaceutical Industry Defendants Handled by Davis Polk

August 1, 2008

On July 25, 2008, the California Court of Appeal issued its decision in Clayworth v. Pfizer, No. A116798, answering a previously open question of California antitrust law:  “whether the pass-on defense is available to defendants accused of price-fixing.”  A unanimous panel of the First Appellate District, Division Two, in San Francisco held that it is, and affirmed summary judgment for 17 major pharmaceutical companies and PhRMA, the pharmaceutical industry trade association.  Davis Polk & Wardwell represented defendant AstraZeneca LP, with principal responsibility for defense briefing on the pass-on legal issues in the trial court and on appeal.  Davis Polk partner Billy Fenrich argued the case on behalf of all defendants in both the trial court and the court of appeal. Plaintiffs were represented by the Alioto Law Firm.

In Clayworth, 17 independent pharmacies sued under California antitrust and unfair competition laws, alleging that the world’s largest drug companies had conspired to fix the prices they charged for their drugs in California above the prices that they or their affiliates charged for the same or similar drugs in Canada.  Throughout the litigation, the defendants have denied that they engaged in any conspiracy and argued that the drug price differential with Canada results from price restrictions imposed by the Canadian government. Ultimately, the Superior Court for Alameda County granted summary judgment for the defendants on a different ground:  that even if an overcharge had been imposed, the plaintiffs could not prevail because they had not suffered any damages.

The issue before the court of appeal was whether the retail pharmacy plaintiffs could recover the amounts that they claimed to have been overcharged as a result of the defendants’ alleged conspiracy to fix prices for their drugs, despite the fact that the plaintiffs admitted that they passed on the entire amount of any overcharge to their customers and waived any claims for non-overcharge damages such as lost sales or lost profits.  This issue has long been settled under federal law through a pair of U.S. Supreme Court decisions:  Hanover Shoe v. United Shoe Machinery Corp., 392 U.S. 481 (1968), which held that a defendant may not generally assert a “pass-on defense” as to claims by direct purchasers under the federal Sherman and Clayton Acts; and Illinois Brick Co. v. Illinois, 431 U.S. 720 (1977), which held that indirect purchasers (like the pharmacy plaintiffs in Clayworth) cannot bring antitrust claims under federal law.  In the wake of Illinois Brick, the California Legislature amended the Cartwright Act (California's antitrust statute) in 1978 to clarify that indirect purchasers have standing to sue under California law.  However, no California court had previously answered the question of whether Hanover Shoe's prohibition of the pass-on defense was incorporated into California law.  The court of appeal reached that issue in Clayworth, holding that the language of the Cartwright Act, which permits an antitrust plaintiff to recover three times the “damages sustained” by him or her, does not allow for recovery where the plaintiff has previously recouped the claimed losses in transactions with third parties, because in such cases there is no loss for which to compensate the plaintiff.  In reaching this conclusion, the court of appeal noted that California has consistently interpreted the term “damages sustained” in a variety of contexts, both within and beyond antitrust, to mean the actual monetary loss suffered as a result of the prohibited conduct, and it found nothing to suggest that the Legislature had intended to depart from the ordinary meaning of the term when drafting the Cartwright Act.

The court of appeal was not persuaded by the plaintiffs’ argument that the “damages sustained” language in the Cartwright Act is ambiguous because the Supreme Court construed nearly identical language in Hanover Shoe to reject a similar pass-on defense. The court of appeal noted that the Supreme Court had based its holding not on statutory language but on public policy considerations relevant to federal antitrust law at that time, such as the “nearly insuperable” problems of proof it saw in the presentation of pass-on evidence and concerns that applying the pass-on defense to preclude direct purchasers from recovering would leave only end-users with a small stake in the proceedings and little incentive to sue.

Having determined that the language of the Cartwright Act itself permits a pass-on defense, the court of appeal went on to note that nothing in the legislative history of the Cartwright Act suggests a different outcome.  The court of appeal dismissed the plaintiffs’ argument that Hanover Shoe’s prohibition of defensive pass-on “tacitly” became the law in California when the state passed the 1978 amendment to the Cartwright Act in response to Illinois Brick.  The court of appeal noted that the legislative history of the 1978 amendment, which nowhere mentions Hanover Shoe, demonstrates that the sole purpose of the amendment was to ensure that California courts did not apply the holding of Illinois Brick—that indirect purchasers lack standing to sue under the federal antitrust laws—to the Cartwright Act.

The court of appeal also held that allowing plaintiffs to recover where they have already recouped any claimed losses would violate a “fundamental precept of California damage law—that plaintiffs not receive a windfall.”  While the court of appeal recognized that deterrence and disgorgement are significant considerations under the Cartwright Act, it reaffirmed that “compensation is the primary rationale for the allowance of private antitrust lawsuits” (quoting Bruno v. Superior Court (1981) 127 Cal.App.3d 120, 132).

The court of appeal reached a similar conclusion with respect to the plaintiffs’ unfair competition law (“UCL”) claims, holding that because the plaintiffs had entirely recouped their alleged losses from third-party transactions, they neither had standing to sue under the UCL nor were entitled to restitution, the only remedy that the UCL provides.

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While the court of appeal did note that the Clayworth case presented an example of “perfect and provable pass-through” in that the plaintiffs conceded that they passed on the alleged overcharges to their customers and sought no other damages, it notably did not limit its ruling to cases where the plaintiffs have admittedly absorbed no overcharges.  Thus, in the future, defendants who are accused of price-fixing in California by anyone other than the ultimate consumers (who do not pass on) should be able to rely on Clayworth's holding to reduce the amount of damages for which they can be held liable.  Further, to the extent that the admissibility of defensive pass-on evidence is an open question in other states, litigants and courts may look to the Clayworth court’s extensive analysis for guidance in answering that question under the specific law of those jurisdictions.

If you have any questions regarding this newsflash, please call your Davis Polk contact.

Davis Polk & Wardwell