123 F.3d 599 (7th Cir. 1997), 96-2814, In re Brand Name Prescription Drugs Antitrust Litigation

Docket Nº:96-2814, 97-2456, 96-2458, 96-2485.
Citation:123 F.3d 599
Case Date:August 15, 1997
Court:United States Courts of Appeals, Court of Appeals for the Seventh Circuit

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123 F.3d 599 (7th Cir. 1997)


Appeals of Robert A. HUGGINS, et al.

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

United States Court of Appeals, Seventh Circuit

August 15, 1997

Argued June 25, 1997.


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

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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 Bristol-Meyers 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 O. 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 Lakeside-Schwettmann Pharmacy, Brady's Pharmacy, Fullerton Drug Co., Rite Aid, and Fox Meyer Drug Co.

Before POSNER, Chief Judge, and BAUER and Diane P. WOOD, 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,

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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

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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...

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