The theory of Pass-on: proving the causation and quantifying the overcharge

In an indirect purchaser litigation, if only the claimant successfully satisfies the preconditions of the presumption laid down in Article 14(2) of the Directive, it is for the defendant to show that there is the possibility of some other circumstances that will influence the overcharge suffered by indirect purchasers.⁶⁰² The rebut allegation purported by defendant could be that there is no initial overcharge caused by the cartel (though it is unlikely) or there are other circumstances that may probably be responsible for the loss so that the presumption should not be applied. When the defendant succeeds to establish the possibility, the presumption will not be applied and the claimant still needs to produce evidence and facts relating to the proving the causation.

In the traditional tort law, the crucial factor of the causation is to determine that the rise of price for intermediate purchasers results from the cartel (or abuse of dominance) committed by the defendants, not from the other facts, namely the ‘but-for’ test. Therefore, the cost structure of intermediate purchasers is significant for determining the causation and damages. In antitrust actions, proving the causation is usually closely connected to the establishment of the occurrence of damages suffered by claimants and also with the quantification, especially from the perspective of the economic assessment. ⁶⁰³ As discussed above, the differences are, the court usually requests an extremely high legal standard on proving causation (99.9% probability)

600 See Robert G. Harris and Lawrence A. Sullivan, supra n 597, 299-331

601 See George J. Benston, ‘Indirect Purchasers’ Standing to Claim Damages in Price Fixing Antitrust Actions: A Benefit/Cost Analysis of Proposals to Change the Illinois Brick Rule’, Antitrust Law Journal (1986), 234-235

602 Joint Cases C-295/04 to C-298/04, Manfredi and Others [2006] EUR I-06619, paras 63-64

603 see Jochen Burrichter and Thomas B. Paul, supra n 545, 203

and a relatively low standard for the quantification. It is not clear whether the remote indirect purchasers are capable of satisfying the strict standard of causation under the present limited experience.

Roughly summing up the contribution from the literatures and settled cases, such as the Spanish sugar cartel, there are actually several basic questions that needed to be examined in the trial to assist the judge in his determination of causation and overcharge having been passed on to indirect purchasers. In the first place, the structure of distribution chain should be examined, including the definition of the layers of direct purchasers, other intermediate purchasers and final consumers. Both direct purchasers and other intermediate purchasers are able to pass on the overcharge downstream. Generally, it is not very troublesome to define direct purchasers, other intermediate purchasers and final consumers in a litigation. Moreover, a deeper examination of the components of the structure of distribution chain is essential because the structure of distribution chain may be different when the cartel product that was brought by intermediate purchasers was used to resell or reproduce. The general pricing strategy of retailers could be the wholesaler-price plus a fixed or proportional mark-up. But if the intermediate purchaser is a manufacturer who bought the cartel product to reproduce it, the passing-on overcharge that occurred may depend on various factors, such as fix or variable cost, demand or supply elasticity. Therefore, it is a necessary precondition for the litigation that the distribution chain and the transaction relation can be identified.

Secondly, the possibilities of the passing-on overcharge can be roughly estimated under certain circumstance. The estimation of the possibilities of the passing-on overcharge is meaningful at least for invoking or rebutting the passing on defence. The estimation could also incentivise the settlement between litigants before and during the litigation in the meantime. The tax incidence theory is one of the most important instruments, which has frequently been applied in US class action by the expert witness to identify the common proof of impact and method of proving harm during the certification stage.⁶⁰⁴ It studies the tax that splits between the producer and the consumer in a perfectly competitive market with the calculation of elasticity and addressed that the passing-on overcharge (that is analogous to the tax) does not occur under two extreme scenarios. Firstly, in a perfectly competitive market, when the demand elasticity is perfectly elastic, the intermediate purchaser cannot raise their price, otherwise their will lose all their sales. Harris and Sullivan mentioned that the cartel is unprofitable under such a scenario because the high elasticity of demand of an intermediate purchaser may result in a high elasticity of demand of the producer.⁶⁰⁵ The second extreme scenario is under perfectly inelastic supply where the intermediate purchaser cannot change the output so as to increase its price, which rarely happens in the real world.⁶⁰⁶ However, according to the settled cases of indirect purchasers class action in the US, both the ‘sanguine’ and the ‘sceptical’ views were adopted by courts on the reliability of the tax incidence. Some with ‘sanguine’ position found that it is sufficiently plausible for certification and show that passing-on is inevitable.⁶⁰⁷ The

‘sceptical’ opinion doubted the practical effect of tax incidence because it is based on a perfectly competitive market which seldom exists in reality and the operation of market is not always like the hypothetical model submitted by experts.⁶⁰⁸ For the market in the real world with practical commercial pricing, Harris and Sullivan indicated five classes of factors that are

604 See Chris S. Coutroulis, D. Matthew Allen, The Passing-on Problem in Indirect Purchaser Class Litigation, 44 Antitrust Bull., 1999, 180,184

605 See Robert G. Harris, Lawrence A. Sullivan, supra n 597, 289; the similar sentiment held by Schaefer, see Elmer J. Schaefer, ‘Passing-on Theory in Antitrust Treble Damage Actions: An Economic and Legal Analysis’, William and Mary Law Review Vol.16:883, 897-899

606 Harris and Sullivan addressed such scenario may occur on the transaction of antique and work of art, such as

‘Picasso paintings’, that the output is limited. See Robert G. Harris, Lawrence A. Sullivan, supra n 597, 289-290

607 See John E. Lopatka, William H. Page, ‘Indirect Purchaser Suits and the Consumer Interest’, 48 The Antitrust Bull., 2003, 544; see William H. Page, ‘Class Certification in the Microsoft Indirect Purchaser Litigation’, Journal of Competition Law and Economics 1(2), 303-338

608 See William H. Page, ‘The Limits of State Indirect Purchaser Suits: Class Certification in the Shadow of Illinois Brick’, Antitrust Law Journal Vol.67 No.1, 1999, pp.23-27; see John E. Lopatka, William H. Page, supra n 607, 545

essential for the estimation of pass-on rate, including temporal factors, pricing factors, directness of cost factors, supply factors and demand factors. ⁶⁰⁹ To be specific, the frequency of price changes and the duration of cartel determine the frequency of and likelihood of the passing-on overcharge respectively.When the intermediate purchaser employs a fixed markup, the pass-on rate could be 100%; conversely, when the intermediate purchaser relies more on the cost of cartel product in setting the price, the pass-on rate could be more likely to be less than 100% in the short term. The initial overcharge that is spent on direct cost (cost of production) or indirect cost (such as cost spent on freight) may influence the change and the size of pass-on rate. Ultimately, the elasticities of demand and supply which implies the substitution in the market undoubtedly play a vital role in producing the pass-on rate. For example, as discussed above, if the intermediate purchasers bought the cartel product under the cost-plus contract with fixed quantity and fixed mark-up, the overcharge is very likely passed on downstream.⁶¹⁰ Or if the demand of the (intermediate purchaser’s) product is inelastic and the cartel product only constitutes a small portion of the product of intermediate purchaser, the overcharge is more likely to be passed on to the final consumer. The market power of intermediate purchasers is also significant. Generally speaking, with a successful cartel, the intermediate purchasers and the final consumers would probably do not have great market power. But if the final consumers have a greater market power, the passing-on overcharge would very likely be absorbed by the intermediate purchasers. In addition, apart from five classes of factors, the pricing strategies of intermediate purchasers that are upstream undertakings of the claimant should also be examined. For instance, in the retail market, apart from the basic ‘wholesaler price plus a mark-up’ pricing, various pricing strategies including promotion actually exist, like ‘every-low-price’, ‘high-low-price’, ‘focal pricing’ and ‘loss leader’. ⁶¹¹ These promotions also influence the price setting, especially for the multi-product manufacturers who may allocate their cost to several products. The historic information related to the pricing strategies of intermediate purchaser plays a vital role in tracing the overcharge along the distribution chain.

Thirdly, on the concrete calculation of the passing-on overcharge, the US Supreme Court opined it is an insurmountable task for the judicial system in the case Hanover Shoe. Bulst has once addressed that ‘there seems to be no reported court decision, neither in the United States, the United Kingdom, France nor Germany, in which a court calculated or estimated the amount of an overcharge passed on to an intermediate purchaser.’⁶¹² In past decades, literatures attempted to study the economic and econometric tools for the quantification. Hellwig distinguished three different effects of the change in the intermediate purchaser’s profit due to the rise of input price, including per unit revenue, business-loss effect and cost effect.⁶¹³

609 See Robert G. Harris, Lawrence A. Sullivan, supra n 597, 317-320; other studies include Robert Cooter who stated the significance of substitution in the factor market. The existing of the passing-on overcharge depends on whether the substitution is easy to find in the market, which further depends on the technical characteristics of the industry and time. Viton and Winston submitted a hypothetical welfare analysis (without the empirical evidence) and further concluded that the Illinois Brick rule would result in an increase of the social welfare. Werden and Schwarz attempted to discuss the deterrent effect generated from the different models of direct and indirect purchasers’

standing. They summarized that although the Illinois Brick rule is not perfect, it is appropriate under the condition that the treble-damages action is the major weapon for creating the deterrent effect. See Robert Cooter, ‘Passing on the Monopoly Overcharge: A Further Comment on Economic Theory’, University of Pennsylvania Law Review, Vol.

129, 1981, 1523-1532; See Philip A. Viton, Clifford M. Winston, ‘Passing on the Monopoly Overcharge: The Welfare Implications’, University of Pennsylvania Law Review, Vol. 129, No. 6 (Jun., 1981), 1516-1522; See Gregory J. Werden and Marius Schwartz, ‘Illinois Brick and the Deterrence of Antitrust Violations – An Economic Analysis’, 35 Hastings L.J. 629-668, 1983-1984

610 See Herbert Hovenkamp, ‘The Indirect-Purchaser Rule and Cost-Plus Sales’, Harvard Law Review Vol.103:1717, 1720

611 See Samid Hussain, Daniel M. Garrett, Vandy M. Howell, ‘Economics of Class Certification in Indirect purchaser Antitrust Cases’, The Journal of the Antitrust and Unfair Competition Law Section of the State Bar of California Vol.10 No.10 Summer/Fall 2001, 40-46

612 See Friedrich Wenzel Bulst, ‘Private Antitrust Enforcement at a Roundabout’, European Business Organization Law 7(2006), 738

613 See Martin Hellwig, Private Damage Claim and the Passing-on Defense in Horizontal Price-Fixing Cases:An Economist’s Perspective, working paper, Max Planck Institute, Bonn, Germany, 1-29

Verboven and van Dijk (2007) attempted to study the discount to the overcharge suffered by direct purchasers in the three-level distribution chain (i.e. producers as cartelists, direct purchasers and indirect purchasers).⁶¹⁴ They further relied on their theory to calculate the discount to the overcharge sustained by premixers in a European vitamin cartel case based on the assumptions regarding the competition and the market share of the premixers.⁶¹⁵ Boone and Müller presented a model to calculate the damages suffered by the final consumer in the three-level distribution chain under different market structures.⁶¹⁶ They suggested such a three-level model can also be applied in the distribution chain of four or more than four levels repeatedly.⁶¹⁷ In practice, the two basic approaches mentioned in the Practical guide on quantifying harm can be used as cross-checking in the action, namely comparing the actual price and but-for price, as well as estimating the pass-on rate.⁶¹⁸ Generally speaking, a certain industry may have a standard and specific pricing strategy. Therefore, a large amount of detailed information and data should be taken into account when assessing the overcharge. For example, as regards the cartelized product that is used to resell, assuming the three-level distribution chain consisting of manufacturer, retailer and consumer, the price of retailer may commonly be based on the wholesaler-price plus a fixed mark-up. The overcharge may be passed through within the wholesaler-price of the cartelized product wholly or proportionally allocated among multiple products of the cartelist. The wholesaler-price and the mark-up should be examined respectively before and/or after the cartel (or refer to the data of a similar market without cartel).

If the data are available, econometric techniques should be applied to calculate the elasticity and the pass-on rate of the wholesaler layer.⁶¹⁹ A more accurate amount of damages can be obtained by means of cross-checking the results from the before-and/or-after (or yardstick) method and from the pass-on rate. Moreover, if the cartelized product is used to re-manufacture, apart from the pass-on rate, it is more important to review the extent to which the price of cartel accounted for the final product and whether there is other price fluctuation within the input of final product, which were essential for the causation of the passing-on. For example, in Spanish sugar cartel, the cost-based approach was applied to quantify the damages of the cartel, by which the price of beet which accounts for 58% of the input of sugar has been examined throughout the cartel period to figure out whether the price of sugar was influenced by the input or the cartel.⁶²⁰

Of course, both of the two approaches have their limitations and deficiencies. The econometric assessment of elasticity needs vast amounts of data that can hardly be obtained in some cases.

On the other hand, it is occasionally difficult to find a market to use as a reference, or to define

614 See Frank Verboven, Theon van Dijk, Cartel Damages Claims and the Passing-on Defense, The Journal of Industrial Economics, Vol.57, No.3 (Sep., 2009), 457-491

615 See Frank Verboven and Theon van Dijk, supra n 614, 481-483

616 See Jan Boone and Wieland Müller, The Distribution of Harm in Price-Fixing Cases, International Journal of Industrial Organization 30 (2012), 265-276

617 See Jan Boone and Wieland Müller, supra n 616, 275-276

618 Oxera Consulting used a classification of methods and models including three levels, i.e. identifying the approach, identifying the counterfactual basis and the detailed estimation techniques. The three methods and models are comparator-based (including cross-sectional comparison, time series comparison and difference-in-difference), financial-analysis-based (using the financial information on comparator firms and industries, cost of capital and cost plus) and market-structure-based (using theoretical models like Gournot or Bertrand).

619 Landes and Posner indicated the formula of share of recovery received by indirect purchasers 1 − λ =_%&^%_'%^&₍, in which e^s and e^d represent the elasticity of supply and demand. As a comparison, the formula of the pass-on rate was simply stated by Verboven and van Dijk as τ =_*'+,^* , in which 𝜔 denotes the responsiveness of marginal cost to an output increase and 𝜀 represents the absolute value of the price elasticity of demand in perfectly competitive market. In the imperfectly competitive market, the pass-on rate is τ =*'+,'(ŋ1*)/(+4)^* , in which ŋ represents the curvature of demand and N is the number of firms in the industry. See William M. Landes, Richard A. Posner, supra n 597, 618; See Theon van Dijk, Frank Verboven, ‘Quantification of Damages’, in 3 Issue in Competition Law and Policy 2331 (ABA Section of Antitrust Law 2008), 2342-2343

620 see Francisco Marco, ‘Damages Claims in the Spanish Sugar Cartel’, Journal of Antitrust Enforcement 2015 3 (1), 205-225

the accurate duration of the cartel in the approach of comparing the actual price and the but-for price, no matter whether under the before-and-after or yardstick method. Sometimes, the duration of the cartel is hard to specify. For example, in German cement cartel, one of the major disagreements between the expert appointed by the court and defendant was the reference period. The defendant questioned the existence of the phasing-out period of the price war after the cartel, which impacted the setting of reference period, and suggested to extend the phasing-out period. ⁶²¹ Regrettably, the German court did not adopt another method as the cross-checking.⁶²²