An evidentiary nightmare

'Passing on' in antitrust cases was first debated in US courts as early as 1908. The debate was revived in 1968 and it was finally killed in 1977 in Illinois Brick Co. v State of Illinois 431 U.S. 720 (1977). It has now reared its head in Europe. If the European Commission has its way, the result will create an evidentiary nightmare for judges and litigants throughout Europe but will provide full employment for economists (see the proposed directive prepared by the commission staff which was 'leaked' to the public earlier this year).

'Passing on', a concept more frequently referred to as 'unjust enrichment' in EU and UK law, may be explained by the following example: John Smith, a widget reseller or middleman, bought widgets from one or more widget manufacturers who conspired to 'fix' (agree upon) the price. He then resold at a profit the price-fixed widgets in their original form to Jim Jones' end user oil company which used them to make its oil refinery more efficient. Question: who has the claim? Under US law, the first purchaser, Smith; under UK and EU law, Jones' end user oil company.

This is so because the European Court of Justice has ruled that any individual direct or indirect purchaser can sue for damages for a breach of Art.81(1) EC (for example, price fixing) before a national court (Case C-453/99 Courage Ltd v Crehan [2001] ECR 1-6294 para.24; Case C-295/04 Manfredi v Lloyd Adriatico [2006] ECR 1-6619).

The 'first purchaser' ruling in Illinois Brick is therefore inapplicable either in the UK or in any other EU jurisdiction. But in the EU, passing on remains an available defence to the price-fixer or to any claimant lower down the chain of distribution save the end user. The burden of proving it is, of course, on the party asserting it.

Proving passing on

Passing on is not difficult to prove where the product is sold in its original form on a percentage or uniform mark-up (see, for example, West Virginia v Pfizer 314 F. Supp. 710, 746 (S.D.N.Y. 1970) affd. 440 F. 2d 1079 (2 Cir. 1971)). In such a case the higher the illegal overcharge, the more profit for the reseller or middleman. Nor is it much more difficult to prove when a reseller sells the product in its original form at some other kind of mark-up. The question in that case, obviously, is evidence of unit profit.

A much more difficult situation (which may be impossible to prove in a courtroom) is where the product is not sold in its original form but is a relatively small part of a different product. In Hanover Shoe v United States Shoe Machinery Corp. 392 U.S. 481 (1968), the US Supreme Court held that a defendant could not invoke passing on because it was almost impossible to prove in the courtroom '“ except in 'cost plus' cases.

Hanover Shoe is therefore not only good common sense but, at the moment, good law in the UK and other EU jurisdictions. How long that is so is difficult to say. For if the commission's leaked directive becomes law it will have succeeded in throwing out Hanover Shoe.

The court held in Illinois Brick: 'The principal basis for the decision in Hanover Shoe was the court's perception of the uncertainties and difficulties in analysing price and out-put decisions in the real economic world rather than an economist's hypothetical model'¦ and of the costs to the judicial system and the efficient enforcement of the antitrust laws of attempting to reconstruct those decisions in the courtroom.'

US courts thereafter sought to expand the 'cost plus' exception to include its functional equivalent, i.e. uniform percentage mark-ups and middleman mark-ups of price-fixed products sold in their original form or as a small but vital input into a much larger product, making the price-fixed good 'highly inelastic' (In Re Master Key Antitrust Litigation, 1973 Trade Cas. para.74, 680 (D.Conn.); see also In Re Beef Industry Antitrust Litigation, 600 F.2d 1148, 1163-67 (5 Cir. 1979)).

Unmanageable cases

More than that is taking 'cost plus' too far. Suppose a group of plumbing fixture manufacturers agreed to 'fix' the price of their fixtures, and homeowners old and new sued for the overcharge; the cost of the fixtures representing less than one per cent of the cost of the home. The court would have to trace the overcharge from manufacturer to wholesaler to contractor to builder to the first and then to the ultimate homeowner.

Now suppose all these middlemen and homeowners sued in joint, parallel or consecutive actions. The trials would not only be unmanageable, but, as several courts have pointed out, impossible (see, for example, Philadelphia Housing Auth. v American Radiator & Standard Sanitary Corp. 50 F.R.D. 13, 19-20, 25-26. (E.D. Pa 1970) affd. sub nom., Mangano v American Radiator & Standard Sanitary Corp., 438 F.2d 1187 (3 Cir.1971)).

A different (but unlikely) result might obtain if the ultimate consumer was the builder not the original or ultimate homeowner. But even here the court would have to reconstruct the pricing decisions and competing claims of all the intermediate purchasers at each step in the chain beyond the wholesaler. Because in our example the plumbing fixtures represent less than one per cent of the cost of the finished home, the homeowner, old or new, is too remote a claimant and the overcharge too difficult, if not impossible, to prove (see Illinois Brick, 431 U.S. at 719-741).

Suppose, however, that the price-fixed good is 50 per cent of the end product; should evidence of passing on be permitted? How about 30 per cent or 20 per cent or some lesser percentage? Assuming it is impossible to trace the overcharge by other means, parties may seek to prove or disprove passing on by resorting to economic evidence, thereby creating the very problem Hanover Shoe sought to avoid: trials of competing economic theories in price-fixing cases (392 U.S.at 492-93). Despite that, courts in Europe will probably try to solve the pass on problem by turning to the economists.

Competing economic theories

In its leaked directive, the European Commission purports to give a cause of action to those who 'purchased goods or services that are derived from or contain [price-fixed] goods or services' (emphasis added), thereby opening up antitrust litigation in Europe to competing economic theories sworn to by competing economists all spouting a point of view paid for by the competing parties (see leaked directive, Art.10 para.2(c)).

But economic theory cannot provide 'a precise formula for calculating how the overcharge is distributed between the overcharged party and its customers'. That theory requires an 'array of simplifying assumptions' which, 'even if accepted, [cannot overcome] the problem of measuring the relevant elasticities '“ the percentage change in the quantities of the [overcharged party's] product demanded and supplied in response to a one per cent change in price. In view of the difficulties that have been encountered'¦ with the statistical techniques used to estimate these concepts'¦ it is unrealistic to think that elasticity studies introduced by expert witnesses will resolve the pass on issue' (Illinois Brick, 431 U.S. at 742-43; Hanover Shoe, 392 U.S. at 492-93).

Recognising the difficulty the end user has in sustaining its burden of proof in such cases, the commission tries to solve the problem by creating a rebuttable presumption that the overcharge was in fact borne by the ultimate consumer (leaked directive para.18).

What the commission fails to understand is that the presumption cannot alleviate the burden. Why? Because the burden of proof never shifts. All the presumption does is shift the order of evidence (who goes first) from the ultimate consumer to the next party up the distribution chain (Denning, Presumptions and Burdens, 61 Law Quarterly Review, 879 (Oct. 1945); Phipson on Evidence, para. 6 '’ 17(c) (16th Ed. 2005)). Once the next party up the distribution chain introduces any credible evidence to rebut the presumption, the ultimate consumer's claim fails '’ he has failed to sustain his burden. How the commission missed this fundamental rule of evidence is, in my view, inexplicable.

'Cost plus' limited

While resort to the experts might be permissible at each end of the elasticity spectrum (for example, where demand is inelastic an increase in costs due to an overcharge will be passed on in full but where demand is elastic product choice will be driven solely by price), there might be some justification for rejecting such evidence on the ground that litigation over where the line should be drawn would inject the same 'massive evidence and complicated theories' that were at the heart of the Hanover Shoe ruling (Illinois Brick, at 745).

That, in my view, is tying Hanover Shoe too tight. There is, however, no justification whatsoever, no matter what Mr Justice White says, for excluding evidence of passing on where the product is sold in its original form on a percentage or some other mark-up (at 743-744). That is 'cost plus'.

Two years after Mr Justice White's 1968 decision in Hanover Shoe, which carved out an exception for 'pre-existing cost plus contracts', along came West Virginia v Pfizer, a classic 'cost plus' case in which local drugstores applied a uniform 66…” per cent mark-up to a price-fixed antibiotic called tetracycline. Judge Wyatt said:

'The illegal overcharge in Hanover was merely one of the many items of cost. As the court said, it 'was reflected in the price charged for shoes sold by Hanover to its customers'. Here the antibiotics in dosage forms (capsules, tablets, or other forms) were resold just as obtained from the defendants. Nothing was added or changed.

The mark-up was applied to the cost and the resultant price was collected from the consumer. The higher the cost, the higher the mark-up, and the higher the profit to the [local drugstores]. The situation here seems much like the 'cost plus contract' referred to in the Hanover opinion.' (314 F. Supp. 710, 746 (S.D.N.Y. 1970) affd 440 F.2d 1079 (2 Cir. 1971)).

Seven years later, in 1977, Mr Justice White struck again. This time he said Judge Wyatt was wrong, that only the first purchaser (local drugstores) could sue and there was, in fact, no Pfizer type 'cost plus' exception (Illinois Brick at 743-44).

What happened?

Some say that the 50 State Attorneys General who had been given the right to sue on behalf of all their injured consumers in West Virginia v Pfizer got 'greedy'. They went to the Congress, then controlled by the Democrats, and persuaded it to pass a law authorising them not only to sue under federal law on behalf of their consumers but to use any unclaimed consumer damages to enlarge the state's treasury. This was the Hart-Scott-Rodino Act of 1976. Under Hart-Scott-Rodino, states could now realistically threaten big corporate price-fixers with bankruptcy, the effect of which was to shift large chunks of federal antitrust enforcement from the Antitrust Division of the US Department of Justice to the Attorneys General of the 50 states.

When Illinois Brick, a rather murky 'tracing' case, reached the Supreme Court a year later, Mr Justice White redressed the balance. Consumers for all practical purposes were out under federal law. First purchasers '“ even those who profited from the overcharge '“ were in. Federal consumer antitrust litigation was thereby dealt a blow from which '“ some 32 years later '“ it has yet to recover. Several states have since enacted Illinois Brick 'repealers' thereby permitting their respective Attorneys General to sue on behalf of consumers under state antitrust law.

The truth will out?

One may search the majority and minority opinions in Illinois Brick and find nothing that supports this explanation. And, to the undersigned's knowledge, there is nothing save for some well sourced hearsay. Actual proof will only surface if court historians find it in the private papers of the then sitting Justices.

But, hearsay or not, if anyone can come up with a better explanation for the Supreme Court's about-face, one has yet to hear it.

Evidence of passing on in antitrust cases in Europe should be permitted in all cost plus cases or their functional equivalents. Beyond that, European courts need to tread carefully; they need to dissect the competing evidentiary issues, the competing economic theories and the competing economists who spout them '“ preferably with a scalpel.