Defendants Search in Vain for the Vanishing Cost-Plus Exception

Ignoring decades old precedent, defendants nevertheless continue to seek burdensome and irrelevant discovery of plaintiffs in antitrust cases.

Nearly 50 years ago, in , the Supreme Court crafted a simple rule with a simple goal: in order to spare the courts the burden of tracing antirust injury though the distribution chain, Clayton Act standing to seek damages would be restricted to those that purchased directly from the anticompetitive actors.  Hanover Shoe, Inc. v. United Shoe Machinery Corp., 392 U.S. 481 (1968) (“when a buyer shows that the price paid by him for materials purchased for use in his business is illegally high and also shows the amount of the overcharge, he has made out a prima facie case of injury and damage.”).  In this manner, antitrust cases are made more efficient,  direct purchasers are incentivized to vigorously pursue antitrust violators, and the deterrence goals of antitrust are best served.

However, the Hanover Shoe court mused that the direct purchaser rule might be relaxed where a purchaser had a “pre-existing ‘cost-plus’ contract,” with its customers, requiring the purchase of a fixed amount of product, at a fixed price.  Under such conditions, in theory mimicking perfect (i.e., infinite) inelasticity of demand, a defendant “might” be permitted to show that 100% of the overcharges were passed along to downstream purchasers, and none were absorbed by the direct purchaser, “thus making it easy to prove that [the direct purchaser plaintiff] has not been damaged.” 392 U.S. at 494.

As envisioned in a follow-on case to Hanover Shoe, the cost-plus exception is an extraordinarily narrow one, applying only to contracts entered into before the wrongful conduct at issue and providing that a purchaser’s customer must buy a fixed quantity of the drug regardless of price. See Illinois Brick Co. v. Illinois, 431 U.S. 720, 736 (1977).  Contracts or other arrangements not meeting this strict definition do not suffice, because they do not mimic the theoretical requisites of infinite demand elasticity required to ensure that a direct purchaser has absorbed no portion of the overcharge.  In fact, courts have yet to find a case in which the exception should be applied to shift antitrust standing away from direct purchasers and to their customers.  The Third Circuit has questioned whether the exception still exists.  See McCarthy v. Recordex Serv., Inc., 80 F.3d 842, 855 (3d Cir. 1996) (“The vitality of the pre-existing cost-plus contract’ exception is doubtful, however, in light of [Kansas v. Utilicorp United, Inc., 497 U.S. 199 (1990)] . . . [which] expressly refused to recognize an exception to Illinois Brick even where one hundred percent of the cost increases had been passed through to indirect purchasers”) (citation omitted).  In the Utilicorp case, the Supreme Court recognized that even if the direct purchaser acts as a “mere” pass-through, the quantity demanded from it might be lower due to the overcharge, meaning that it absorbed a portion or was otherwise harmed, and remained the sole plaintiff able to seek damages under the Clayton Act.

In the most recent example, In re Namenda, the defendant tried to use this exception to justify discovery of a direct purchaser plaintiffs’ sales and pricing information. See Slip. Op., In re Namenda Direct Purchaser Antitrust Litig., 15 Civ. 7488 (CM) (JCF) (S.D.N.Y. June 6, 2017).  As the defendant learned, however, the exception, like the rule, remains simple -- where there is no fixed-quantity contract between the direct purchaser and the customer that pre-exists the conduct creating the alleged overcharge, there can be no exception.  In Namenda, direct purchaser plaintiffs had already represented that they “do not have contracts with customers obligating them to purchase specific quantities of products at a fixed markup.” Slip Op. at 20.  Nonetheless, the defendant moved to compel broad discovery of plaintiffs’ sales and pricing practices under the cost plus exception.  Defendant argued that, despite the absence of contracts, let alone ones mandating fixed quantities and prices, the exception should apply anytime a wholesaler prices on the basis of its acquisition cost plus a fixed margin.  Defendants reasoned that, where demand for a product was inelastic, as it is with prescription pharmaceuticals, a fixed-quantity term would be superfluous.

The Namenda court declined this invitation to expand the cost-plus exception: “In Illinois Brick, the Court noted that some lower courts had urged an exceptions [sic] to the Hanover Shoe rule for situations in which most of the overcharge is purportedly passed on, such as when the demand for the price-fixed good is highly inelastic.  The majority rejected these attempts to carve out exceptions to the Hanover Shoe rule for particular types of markets.”  Slip Op. at 21 (internal cites and quotes omitted).  In detecting the defendants’ inapt revisiting of settled law, the Namenda court not only hewed closely to the Supreme Court’s words, but also joined a long line of courts refusing to add “functional equivalents” to the ambit of the “cost-plus” exception.  Thus, the exception remains (vanishingly) small, if it even exists at all.

A copy of the decision can be found here.

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About Adam Steinfeld

Adam Steinfeld is a partner in Faruqi & Faruqi, LLP’s New York office.  He practices in the area of antitrust litigation with a focus on competition in the pharmaceutical industry.

Posted by Adam Steinfeld

Partner at Faruqi & Faruqi, LLP
New York Office
Tel: (212) 983-9330
Fax: (212) 983-9331
Email: asteinfeld@faruqilaw.com
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