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In re BRAND NAME PRESCRIPTION DRUGS ANTITRUST LITIGATION.

Appeals of Robert A. HUGGINS, et al.

Nos. 96-2814, 97-2456, 96-2458, 96-2485.

United States Court of Appeals, Seventh Circuit

Argued June 25, 1997. Decided Aug. 15, 1997.*

Rehearing and Suggestion for Rehearing En Bane Denied Oct. 8, 1997.

Guy L. Tipton, Birmingham, AL, for Alabama AFL-CIO, amicus curiae.

Thomas P. Sullivan, Richard T. Franch, Jenner & Block, Chicago, IL, Stephen S.

Madsen, Douglas D. Broadwater, Cravath, Swaine & Moore, New York City, for BristolMeyers Squibb Co., amicus curiae, and for Bristol-Meyers Squibb Co.'s Long-Term Disability Income Plan.

Robert H. Rawson, Jr., Thomas Demitrack, Jones, Day, Reavis & Pogue, Cleveland, OH, for Sandoz Pharmaceuticals Corp., amicus curiae.

David M. Schiffman, Howard J. Trienens, Sidley & Austin, Chicago, IL, for G.D. Searle & Co., amicus curiae.

Raymond J. Smith, Ronald L. Sandack, Thomas J. Cunningham, Smith, Lodge & Schneider, Chicago, IL, for Chicago Drug Co., Ltd. Pharmacy, Kadel Drugs, Berdel, and Fullerton Drug Co.

Marvin A. Miller, Miller, Faucher, Cherlow, Cafferty & Wexler, Chicago, IL, Michael D. Hausfeld, Cohen, Milstein, Hausfeld & Toll, Washington, DC, John W. Sharbrough, III, Ezell & Sharbrough, Mobile, AL, Steve W. Berman, Hagens & Berman, Seattle, WA, Daniel E. Gustafson, Heins, Mills & Olson, Minneapolis, MN, Steven A. Martino, Jackson, Taylor & Martino, P.C., Mobile, AL, Bernard Persky, Goodkind, Labaton, Rudoff & Suchrow, New York City, Wyman 0. Gilmore, Jr., Gilmore & Gilmore, Grove Hill, AL, for Robert A. Huggins.

Frank Cicero, Jr., Kirkland & Ellis, Chicago, IL, John S. Langan, Davis, Davis, Langan & Laker, Indianapolis, IN, Sharon E. Jones, for Abbott Laboratories.

Jerold S. Solovy, Jenner & Block, Chicago, IL, for Mead Johnson & Co.

Robert H. Rawson, Jr., Jones, Day, Reavis & Pogue, Cleveland, OH, argued for Sandoz Pharmaceuticals Corp.

George L. Saunders, Jr., Saunders & Moore, Chicago, IL, argued for LakesideSchwettmann Pharmacy, Brady's Pharmacy, Fullerton Drug Co., Rite Aid, and Fox Meyer Drug Co.

Before POSNER, Chief Judge, and BAUER and WOOD, Jr., Circuit Judges.

POSNER, Chief Judge.

We have consolidated for decision four appeals (in two of which we have jurisdiction under 28 U.S.C. § 1292(b) and in the other two under 28 U.S.C. § 1291 and Fed.R.Civ.P. 54(b)) from rulings in a huge price-fixing litigation that the Judicial Panel on Multidistrict Litigation has consolidated in the Northern District of Illinois for pretrial proceedings. The consolidation covers hundreds of separate cases (a number of them class actions) brought under section 1 of the Sherman Act, 15 U.S.C. § 1, by retail pharmacies against manufacturers and wholesalers of prescription drugs. The pharmacies complain that the defendants have conspired among themselves to deny all pharmacies,

including chains and buying groups, discounts off the list price of brand-name drugs that the manufacturers sell to the wholesalers and that the wholesalers in turn resell to the pharmacies. A brief sketch of the operation of the alleged conspiracy will provide the essential background to understanding the issues presented by these appeals.

While refusing to give pharmacies any discounts, the defendants give steep discounts to favored classes of customers, including hospitals, health maintenance organizations, nursing homes, and mail-order companies. The defendants maintain this differential pricing through a "chargeback" system. Under that system, the manufacturer makes a contract with the favored customer establishing a discounted price at which the customer is entitled to buy from wholesalers; the wholesaler sells to the favored customer at that price; and the manufacturer then reimburses the wholesaler for the difference between the regular wholesale price and the discounted price. So if the manufacturer's regular price to the wholesaler for some drug is $100 and the contractually agreed upon discounted price for a favored customer is $75, the wholesaler will pay the manufacturer $100 for the drug but resell it to the favored customer at $75 and the bill the manufacturer $25. The plaintiffs claim that the purpose of the chargeback system is to make it difficult for the favored customers to engage in arbitrage, that is, to buy more than they need and resell the surplus to pharmacies at a price between the discounted price that the favored customers pay and the higher, undiscounted wholesale price that nonfavored customers pay. The chargeback system permits the wholesalers to buy cheap only when they are reselling to someone whom the manufacturer wants to be given a discount.

The defendants' differential pricing of their drugs is discriminatory in the technical economic sense'it involves charging different prices for the same goods, the differences being unrelated to savings in the costs of serving the favored customers. When the lower of two discriminatory prices covers the seller's cost, the higher price must exceed that cost. This creates an incentive for the favored purchasers to order more of the good than they need for their own use and to sell the surplus to disfavored customers at a price somewhere in between the seller's different prices. For example, an $80 resale by a hospital or other favored customer that had bought at $75 to a pharmacy that had bought at $100 would make both parties to the resale better off; the hospital would have a profit of $5 and the pharmacy would obtain a cost savings of $20. This is arbitrage and would erode the two-price system. The chargeback system prevents arbitrage; the wholesaler who resold to a pharmacy at a significant discount would incur a loss, since he would not be able to charge back any part of the discount to the manufacturer. Although a federal statute forbids hospitals and other providers of health care to resell to other sellers the pharmaceutical drugs that they buy, the statute does not cover all the favored customers for such drugs. 21 U.S.C. § 353(c)(3). Anyway statutes are not always fully obeyed. The chargeback system fills the gap in the statute's coverage and does not require heavy enforcement costs.

The presence of price discrimination in the economic sense is evidence of the presence of monopoly power'the power to raise price above cost without losing so many sales as to make the price rise unsustainable. If the lower price covers the seller's cost, the higher price must exceed it; so competition must be weak or absent, because it has failed to force price down to cost (including in "cost" a reasonable return on investment). Since monopoly power can be created by collusion among competing sellers, the existence of industry-wide price discrimination is some evidence of collusion. But it is not conclusive evidence, especially in an industry such as Pharmaceuticals many of the products of which are patented. The sellers may be selling goods that although close substitutes are not perfect substitutes, with the result that each seller has some monopoly power and therefore can price discriminate unilaterally. It might want to do so to take advantage of the fact that some consumers are less able to resist high prices than others. A fully developed record might show, in accordance with contested evidence in the record compiled to date, that a pharmacy has little choice but to buy a wide range of

competing drugs because it cannot know in advance which drug its customers' doctors will prescribe. An HMO, however, can (within limits) tell the doctors it employs what drugs to prescribe, and it can use that power to extract price concessions from the individual manufacturers, who naturally however do not wish to extend the concessions to captive consumers such as the pharmacies.

In the extensive pretrial proceedings that have been conducted to date in this litigation, the plaintiffs have presented evidence that the defendant manufacturers agreed among themselves, and also with the defendant wholesalers, to refuse discounts to pharmacies and to make this refusal stick by adopting the chargeback system in order to prevent arbitrage. In other words, the claim is that pervasive price discrimination in the pharmaceutical market is the result not of individual decisions by manufacturers who possess some monopoly power but of an agreement to practice price discrimination. The plaintiffs' objection is not to the discrimination as such; although there is a Robinson-Patman claim in the complaint, it is not part of the appeal. The plaintiffs' objection is to having to pay high prices that, but for the defendants' alleged conspiracy, would be brought down by competition.

One might have supposed that if the defendants were going to collude on price, they would go the whole hog and agree not to provide discounts to the hospitals and other customers favored by the discriminatory system. But the defendants' cartel'if that is what it is'may not be tight enough to prevent hospitals and other bulk purchasers with power to shift demand among different manufacturers' drugs from whipsawing the members of the cartel for discounts; or maybe these purchasers could shift demand to manufacturers that are not members of the cartel. If, for whatever reason, the elasticity of demand for a cartel's product differs among groups of purchasers, a single cartel price will not be profit-maximizing unless a discriminatory price scheme cannot be enforced at reasonable cost.

The manufacturers moved for summary judgment, arguing that there wasn't enough evidence of collusion to warrant a trial. The district judge denied the motion. The correctness of his ruling is not before us. And whether it was correct or not, the reader should bear in mind that the manufacturers have not been found to have violated the Sherman Act; the only determination is that there is enough evidence of a violation to require that the case be allowed to proceed to trial.

The judge granted summary judgment to one of the manufacturers, however, DuPont Merck Pharmaceutical Company. The plaintiffs' appeal from that ruling is one of the four appeals before us. The judge also granted summary judgment to the wholesaler defendants because he thought there was insufficient evidence of their participation in the manufacturers' conspiracy to warrant a trial. That is another ruling appealed from. Another is the judge's refusal to dismiss indirect-purchaser claims by pharmacies that paid overcharges as a consequence of the alleged manufacturers' conspiracy. The manufacturers argued unsuccessfully that only the first tier of purchasers ("direct purchasers"), composed of the wholesalers and others who purchased drugs directly from the manufacturers, and not the second tier, composed of pharmacies that purchased the manufacturers' drugs from the wholesalers ("indirect purchasers"), are permitted to bring a suit for overcharges under the Sherman Act. In the last ruling that has been appealed to us, the judge refused to remand a class action that alleges violations not of the Sherman Act but of Alabama's antitrust statute, which expressly authorizes suits by indirect purchasers.

The indirect-purchaser issue (with which we begin) is separate from the issue of the wholesalers' participation in the manufacturers' alleged conspiracy. It is true that if we reversed the judge's ruling on the latter issue and so reinstated the wholesalers as defendants, and if the plaintiffs went on to obtain a judgment against the wholesalers and manufacturers, any indirect-purchaser defense would go by the board, since the pharmacies would then be direct purchasers from the conspirators. Fontana Aviation, Inc. v. Cessna Aircraft Co.,  617 F.2d 478, 481 (7th Cir.1980); Arizona v. Shamrock Foods

Co.,  729 F.2d 1208, 1212-13 (9th Cir.1984); see also In re Beef Industry Antitrust Litigation,  600 F.2d 1148, 1163 (5th Cir.1979) (requiring that the direct sellers, here the wholesalers, be joined as defendants'but that requirement is satisfied). But even if we do reinstate the wholesalers as defendants, an issue discussed later in this opinion, the plaintiffs may fail at trial to establish their liability, in which event the indirectpurchaser issue will be decisive. So, the issue being fully briefed and argued in this court, we should decide it; and the fact that it may in the end not prove decisive does not show that the district judge and we were wrong to certify his ruling on the issue under 28 U.S.C § 1292(b) (interlocutory appeal of a ruling on a controlling question) for an immediate appeal. Sokaogon Gaming Enterprise Corp. v. Tushie-Montgomery Associates, Inc.,  86 F.3d 656, 658-59 (7th Cir. 1996); Johnson v. Burken,  930 F.2d 1202, 1205 (7th Cir.1991); Katz v. Carte Blanche Corp.,  496 F.2d 747, 755 (3d Cir.1974); 16 Charles Alan Wright, Arthur R. Miller & Edward H. Cooper, Federal Practice and Procedure § 3930, pp. 426-27 (2d ed. 1996). A brief review of the evolution of the indirect-purchaser doctrine in the Supreme Court will point us toward a resolution of the issue. In Hanover Shoe, Inc. v. United Shoe Machinery Corp.,  392 U.S. 481, 88 S.Ct. 2224, 20 L.Ed.2d 1231 (1968), the defendant in a Sherman Act suit, a manufacturer of machinery for making shoes, defended on the ground that the plaintiff, a shoe manufacturer that had bought the defendant's machinery, had passed on any monopoly overcharge to its own customers, the wholesale purchasers of its shoes, and hence had not been injured. A firm hit with an increase in the cost of one of its inputs will try so far as competition allows to pass that cost on to its customers in the form of a higher price for its product. The Supreme Court held, however, that an antitrust defendant would not be permitted to defend against a damages suit, on the ground that the plaintiff had shifted the cost of the defendant's wrongdoing to the plaintiffs customers. Such a defense would complicate antitrust enforcement by requiring an apportionment of damages between different tiers of purchasers of the defendant's product. Tracing a price hike through successive resales is an example of what is called "incidence analysis," and is famously difficult.

The Court took the next step in Illinois Brick Co. v. Illinois,  431 U.S. 720, 97 S.Ct. 2061, 52 L.Ed.2d 707 (1977), and held that the second or subsequent tiers, the indirect purchasers from the antitrust violators, couldn't sue; only the first tier could. This was a logical corollary of the rejection of the passing-on defense in Hanover Shoe, since to determine the damages suffered by subsequent tiers of purchasers would require the very apportionment of damages that the Court had rejected in the earlier case.

Illinois Brick left unclear whether there might be exceptions for cases in which the amount of the overcharge that was passed on to a lower tier of purchasers could be determined simply and with mechanical precision. A plausible example, we thought, would be a case in which the first tier of purchasers consisted of public utilities that as a consequence of government regulation passed on any cost increase dollar for dollar to their customers. Illinois v. Panhandle Eastern Pipe Line Co.,  852 F.2d 891 (7th Cir.1988) (en bane). Shortly afterward, in a similar case, the Supreme Court held that such cases are not within any exception to the Illinois Brick doctrine, Kansas v. Utilicorp United, Inc.,  497 U.S. 199, 110 S.Ct. 2807, 111 L.Ed.2d 169 (1990), and we duly overruled our Panhandle opinion. Illinois v. Panhandle Eastern Pipe Line Co.,  935 F.2d 1469 (7th Cir.1991). Utilicorp implies that the only exceptions to the Illinois Brick doetrine are those stated in Illinois Brick itself'"where the direct purchaser is owned or controlled by its customer," 431 U.S. at 736 n. 16, 97 S.Ct. at 2070 or, we suppose, vice versa. The first exception (ownership) is conceded to be inapplicable here; the wholesalers are not corporate affiliates of the manufacturers. The second (control) is inapplicable as well. The manufacturers do not control the wholesalers through interlocking directorates, minority stock ownership, loan agreements that subject the wholesalers to the manufacturers' operating control, trust agreements, or other modes of control sepa-

rate from ownership of a majority of the wholesalers' common stock. Jewish Hospital Ass'n v. Stewart Mechanical Enterprises, Inc.,  628 F.2d 971, 975 (6th Cir.1980); cf. Gould v. Ruefenacht,  471 U.S. 701, 705, 105 S.Ct. 2308, 2310, 85 L.Ed.2d 708 (1985).

The district judge held, however, primarily on the basis of the chargeback system, that the wholesalers are really nothing more than "glorified warehouses" of the manufacturers. In so ruling, the judge gave undue weight to the chargeback system. The favored customers, the ones who had contracts with the manufacturers though they took delivery from the wholesalers, are not parties to this litigation. They certainly are not complaining about the system of discriminatory pricing. They were not overcharged, and their right if any to recover overcharges in a suit against the manufacturers is not in issue. The plaintiffs are the disfavored customers. They did not have contracts with the manufacturers, they did not receive discounts, and the wholesalers did not receive chargebacks on sales to them. The plaintiffs' complaint is that they were overcharged because the wholesalers passed on to them the overcharge that the wholesalers had to pay the manufacturers by virtue of the price-fixing conspiracy. This is just the kind of complaint that Illinois Brick bars. The only entities permitted to complain about the manufacturers' overcharging the wholesalers are the wholesalers themselves, the direct purchasers, even if every cent, of the overcharge was promptly and fully passed on to the pharmacies in the form of a higher wholesale price.

Some wholesalers were plaintiffs in this litigation; they settled. Had they not done so, and had the case proceeded to trial and the pharmacies been permitted to seek damages for the amount of the overcharge passed on to them, the court would have had to apportion the overcharge between the wholesalers and the pharmacies. That's just what the Supreme Court in Hanover Shoe, Illinois Brick, and Utilicorp told the federal courts not to do.

We can imagine the present case reconfigured in a way that might take it out of the orbit of these decisions; it would not be a matter of carving a further exception. A number of pharmacies have tried to improve their bargaining position vis-a-vis the drug manufacturers by forming buying groups. The bigger a buyer is, the more likely it is to be able to obtain a discount from a member of a cartel, since the volume of its purchases may compensate the member for endangering the cartel by granting a discount. George J. Stigler, "A Theory of Oligopoly," in Stigler, The Organization of Industry 39, 4344 (1968). That is one motive for forming a buying group. The manufacturers have been steadfast in refusing to grant discounts to such groups. If this refusal, taking as it does the form of a refusal to enter into direct contractual relations with certain retailers, such as the manufacturers have with, their favored customers, were successfully challenged as a boycott, see FTC v. Superior Court Trial Lawyers Ass'n,  493 U.S. 411, 428, 110 S.Ct 768, 777, 107 L.Ed.2d 851 (1990); FTC v. Indiana Federation of Dentists,  476 U.S. 447, 458-59, 106 S.Ct. 2009, 2017-18, 90 L.Ed.2d 445 (1986); Collins v. Associated Pathologists, Ltd.,