The Recorder: “Should ‘Hanover Shoe’ and ‘Illinois Brick’ Be Discarded?”

(The Recorder)  Partner Steven Williams and Senior Associate Jiamie Chen of the Joseph Saveri Law Firm today authored the following article for The Recorder entitled, “Should ‘Hanover Shoe’ and ‘Illinois Brick’ Be Discarded?”

Private civil antitrust enforcement in the United States may be on the verge of its biggest change since 1968.  That year in Hanover Shoe v. United Shoe Machinery, 392 U.S. 481 (1968), the U.S. Supreme Court ruled that an antitrust defendant could not assert as a defense that the plaintiff passed on overcharges to its customers.  In 1977 in Illinois Brick v. Illinois, 431 U.S. 720 (1977), the Supreme Court ruled that because Hanover Shoe prevented a defendant from asserting a “pass on” defense, a plaintiff who did not purchase directly from a defendant but who alleged that an illegal overcharge was passed on could not sue that defendant.  After Illinois Brick, states began providing damage remedies to indirect purchasers either through legislative action or through judicial interpretation.  In California v. ARC America, 490 U.S. 93 (1989), the Supreme Court ruled that these state laws were not pre-empted even if they imposed penalties on antitrust violators that were cumulative of remedies provided to direct purchasers under federal law.  Since the Class Action Fairness Act (CAFA) was enacted in 2006, antitrust actions on behalf of all plaintiffs, federal and state, are typically presided over by a single federal judge appointed by the Judicial Panel on Multidistrict Litigation.

“Hanover Shoe” and “Illinois Brick”

In Hanover Shoe, the U.S. Supreme Court held that the defense of “pass-on”—that is, that a plaintiff had recouped some or all of the overcharges resulting from an antitrust violation by passing them on to its own purchasers—was not available in a claim for damages brought under the Sherman and Clayton Acts.  The plaintiff alleged that defendant had monopolized the shoe machinery industry, and that one part of its monopoly was its practice of leasing shoe machinery equipment instead of selling it.  The plaintiff alleged that it was damaged by the difference between what it paid to rent shoe machinery equipment and what it would have paid had the defendant been willing to sell the equipment.  The defendant argued that it should be permitted to prove that the plaintiff had not suffered injury if it had charged higher prices to its customers as a result of defendant’s violation.  The Supreme Court, after noting that established law long has held that the simple fact of overcharge was sufficient to demonstrate antitrust injury, rejected defendants’ argument.  The court noted that a variety of factors would influence the pricing behavior of an antitrust plaintiff and that, because “establishing the applicability of the passing-on defense would require a convincing showing of each of these virtually unascertainable figures, the task would prove virtually insurmountable.”  Thus, permitting the defense would not only lead to long and complicated proceedings involving massive evidence and complicated theories, but also give rise to claims by ultimate purchasers who had little economic incentive to bring claims against the defendants.  As a result, “those who violate the antitrust laws by price-fixing or monopolizing would retain the fruits of their illegality because no one was available who would bring suit against them.  Treble-damage actions, the importance of which the court has many times emphasized, would be substantially reduced in effectiveness.”

In Illinois Brick, the state of Illinois sued Illinois Brick and other concrete block manufacturers for conspiring to raise the cost of concrete blocks in violation of the Sherman Act.  The Supreme Court held that because Illinois Brick would not have been permitted to assert a pass-on defense if it had been sued by direct purchasers, it should not be subject to suit by indirect purchasers because it might be exposed to duplicative liability.  In other words, the court held that, because Hanover Shoe prohibits the defensive use of pass-on overcharge, the plaintiffs in Illinois Brick are not entitled to the offensive use of pass-on overcharge.  Thus, Hanover Shoe and Illinois Brick go hand-in-hand as a matter of civil antitrust enforcement.

Since Illinois Brick, approximately 30 jurisdictions have either amended their statutes or had their courts rule that their law permits antitrust damage claims by indirect purchasers.  These states are typically referred to as “repealer” states.  In some cases, the antitrust law of these jurisdictions predated the Sherman Act, and, in most cases after Illinois Brick, these states’ laws developed in manners distinct from federal law.  This includes issues of standing, defenses, and proof of claims.  Almost all of these jurisdictions permit class claims.  In fact, the majority of states that now provide for antitrust recovery by indirect purchasers, including ultimate purchasers, arguably calls into question the Supreme Court’s reasoning in Illinois Brick that the lack of economic incentive for private enforcement by ultimate purchasers may allow antitrust violators to retain their ill-gotten gains.

Since the passage of the Class Action Fairness Act in 2006, most indirect purchaser cases are filed in federal court and are often centralized before a single federal district court judge by the Judicial Panel on Multidistrict Litigation.  Ordinarily, indirect purchaser cases are coordinated with direct purchaser class actions, direct action plaintiffs (i.e., parties who are otherwise members of putative classes but choose to bring their own actions), and actions brought by state attorneys general that have been centralized in a single court.  This coordination extends to all pre-trial proceedings, including discovery, and sometimes trial, and may call into question the Supreme Court’s concern in Hanover Shoe and Illinois Brick, over 40 years ago, that indirect purchaser antitrust actions necessitate evidence and analyses that present insurmountable challenges.

In ARC America, the Supreme Court ruled that states had the power to provide remedies to indirect purchasers under their laws regardless of whether antitrust offenders might be subject to duplicative damages.

The “Pepper” Case

On June 18, 2018, the Supreme Court granted Apple’s petition for certiorari in Pepper v. Apple, 846 F.3d 313 (9th Cir. 2017).  In Pepper, the U.S. Court of Appeals for the Ninth Circuit held that the indirect-purchaser rule of Illinois Brick did not bar antitrust claims against Apple by plaintiffs who purchased apps made by app developers from Apple’s App Store.  The Pepper plaintiffs brought suit against Apple for damages under federal antitrust law, alleging that: (1) Apple had monopolized and attempted to monopolize the market for iPhone apps; (2) the apps were manufactured by app developers and were only sold through Apple’s App Store; (3) for every third-party app sold through the App Store, Apple received 30 percent of the revenue and the developer received the remaining 70 percent; (4) payment was made directly to the App Store; (5) Apple prohibited developers from selling iPhone apps through any means other than the App Store; and (6) if an iPhone user purchases and installs an app on an iPhone from a source other than the App Store, Apple will void the warranty for that iPhone.  In their fourth amended complaint, plaintiffs alleged the following to address the indirect purchaser bar of Illinois Brick:

“When an iPhone purchaser buys an app from Apple, it pays the full purchase price, including Apple’s 30 percent commission, directly to Apple . . . . Apple sells the apps (or more recently, licenses for the apps) directly to the customer, collects the entire purchase price, and pays the developers after the sale.  The developers at no time directly sell the apps or licenses to iPhone customers or collect payments from the customers.”

Apple provides a starkly different description of the manner in which the App Store works and the issues raised by the plaintiffs’ claims. Apple asserts that plaintiffs are indirect purchasers of apps from the app creators, and the App Store is simply the store in which the apps are purchased.  The app creators set the prices to charge for their apps, and Apple is charging the app creators—not the plaintiffs—a 30 percent commission of the total price of the app.  Plaintiffs’ claims necessarily give rise to the difficult issues of pass-through damages as they would require a court to determine what price the app creators would charge if they were to sell through a different venue than the App Store or if the App Store had different policies.  Further, if anyone has an antitrust claim against Apple it is the app developers, and not the ultimate purchasers of apps.

The district court held that plaintiffs’ damage claims were barred by Illinois Brick and dismissed plaintiffs’ complaint with prejudice because they were not direct purchasers.  The Ninth Circuit reversed, holding that because Apple was the distributor who sold the iPhone apps directly to plaintiffs, Illinois Brick did not bar the plaintiffs’ damage claims.  On June 18, 2018, the Supreme Court granted Apple’s petition for certiorari.  On Aug. 10, 2018, Apple filed its opening brief, arguing that the case falls squarely within the Illinois Brick precedent, and a straightforward application of the doctrine bars antitrust recovery by the plaintiffs under the Sherman Act and the Clayton Act.  The Pepper plaintiffs will file their response brief by September 24, 2018.

Assistant Attorney General for the Antitrust Division Makan Delrahim has suggested that the Pepper case should be used to overrule the Supreme Court’s decision in Illinois Brick.  Delrahim’s perspective appears to be informed in part by his role as a member of the Antitrust Modernization Committee (AMC).  The AMC was created pursuant to the Antitrust Modernization Commission Act of 2002, and held its first meeting in 2004.  The AMC was composed of three members selected by President George W. Bush, three members selected by the Senate, and three members selected by the House of Representatives.  None of the members represented private civil plaintiffs in antitrust litigation, and only one—present Deputy Attorney General Delrahim—represented state attorneys general.  The AMC was tasked with conducting a review of, and suggesting changes to, proposed changes to the then-existing civil enforcement scheme for antitrust.  On May 8, 2018, the U.S. Department of Justice filed an amicus brief supported the certiorari petition in Pepper arguing as follows:

“That regime of parallel federal and state antitrust litigation has proved to be complex and inefficient.  See AMC Report 269-272.  Inter alia, suits by direct and indirect purchasers seeking to recover the same overcharge create a risk of inconsistent results or duplicative awards.  Id. at 271-272.  In addition, some commentators have concluded, based on the courts’ experience with state-law indirect purchaser claims, that the evidentiary complexities associated with pass-on analysis are not as great as this court believed them to be when it decided Hanover Shoe and Illinois Brick.  See, e.g., id. at 277; 2A Phillip E. Areeda et al., Antitrust Law: An Analysis of Antitrust Principles and Their Application ¶ 346k, at 219-227 (4th ed. 2014).  The parties have litigated this case within the framework established by Hanover Shoe and Illinois Brick, however, and have not asked this court to revisit those decisions.” —Brief of the United States as amicus curiae, Apple v. Pepper, No. 17-204, pp. 12-13.

While Apple has not directly asked the court to overrule or even revisit the Illinois Brick framework, the Supreme Court may nonetheless take the opportunity to do so, especially if the Department of Justice submits an amicus brief setting forth the same position expressed in its amicus brief in support of Apple’s certiorari petition, quoted above.  Overruling Illinois Brick would be a profound change in antitrust law, and the consequences could fundamentally change civil enforcement of antitrust claims.