In re: Brand Name Prescription Drugs Antitrust Litigation Appeals of Lawrence Adams, et al.…

In the
United States Court of Appeals
For the Seventh Circuit
Nos. 00-4206, 00-4264 to 00-4266
In re Brand Name Prescription Drugs Antitrust
Litigation
Appeals of Lawrence Adams, et al.
Appeals from the United States District Court for the
Northern District of Illinois, Eastern Division.
No. 94 CV 897, MDL 997--Charles P. Kocoras, Judge.
Argued April 19, 2002--Decided May 6, 2002
Before Bauer, Posner, and Easterbrook,
Circuit Judges.
Posner, Circuit Judge. The plaintiffs in
this Sherman Act price-fixing case appeal
from the grant of summary judgment to the
defendants. The plaintiffs had opted out
from a large antitrust litigation, other
phases of which are discussed at 123 F.3d
599 (7th Cir. 1997), and 186 F.3d 781
(7th Cir. 1999); despite some overlap
with the issues in the other phases, it
will simplify analysis to treat this
offshoot of the litigation as if it were
completely free-standing, like an
adversary proceeding in a bankruptcy
case. The question for decision is
simple, at least to state: did the
plaintiffs present enough evidence to
create a triable issue? Equivalently,
could a reasonable jury, if all it had
before it was the evidence presented in
the pretrial proceedings, conclude that
the defendants had engaged in price
fixing?
The plaintiffs are retail sellers of
prescription drugs, and the defendants
that are the appellees are wholesale
sellers of such drugs, that is, the
plaintiffs’ suppliers. The plaintiffs
argue that the wholesalers conspired with
the manufacturers of the drugs to deny
the plaintiffs discounts they would have
received had it not been for the
conspiracy. The manufacturers are also
defendants but they are not before us.
They remain, their liability as yet
unresolved, in the district court. But as
authorized by Rule 54(b) of the Federal

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Rules of Civil Procedure, the district
judge entered final judgment for the
wholesaler defendants in order to enable
an immediate appeal.
The plaintiffs’ theory is that the
manufacturers agreed not to give
discounts to pharmacies and other retail
sellers and enlisted the wholesalers to
police the agreement by means of a
"chargeback" system that the wholesalers
had adopted early in the 1980s. Then as
later, manufacturers of brand-name
prescription drugs engaged in price
discrimination. That is, a manufacturer
would sell the same product, costing the
same to make and sell, at different
prices to different customers. The lowest
price, presumably, covered the
manufacturer’s cost (for there is no
allegation that the manufacturers were
engaged in predatory pricing or forced by
adverse business conditions to sell at
distress prices), implying that the
higher prices in the discriminatory price
schedule generated revenues in excess of
cost. That sounds like monopoly pricing,
but we must be careful here to
distinguish between fixed and variable
costs. Many of the costs of a new drug
are incurred before manufacturing for
sale begins--costs of research, of
development, of obtaining patents, of
obtaining FDA approval, and so forth. A
price equal to just the cost of
manufacturing and selling the drug, the
cost that varies with the amount of the
drug sold (the marginal cost, in other
words, as distinct from the average total
cost of the drug), would therefore not
cover the product’s total costs. The firm
could try to cover those costs by
charging a uniform markup over marginal
cost, but if customers vary in their
willingness to pay for a particular drug,
the firm may do better to charge
different prices to different customers
or groups of customers. A customer’s
willingness to pay will be a function of
the customer’s options. In the drug
industry, as it happens, hospitals and
HMOs, because they "control" to a
considerable extent the physicians whom
they employ or contract with, are in a
good position to effect the substitution
of generic equivalents for brand-name
prescription drugs. They therefore are
unwilling to pay as much for the brand-
name drugs as the typical drugstore,
which simply fills the physician’s

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prescription--and physicians are often
indifferent to the price of the drug they
are prescribing.
If brand-name drugs were interchangeable
not only with generics but with each
other, then unless the manufacturers
colluded they would be unable to
discriminate in price between hospitals
and HMOs on the one hand and drugstores
on the other hand. The high markup in the
price to the disfavored customers would
be competed away. Suppose marginal cost
is $5 and price $10; at any price above
$5, the seller obtains some contribution
to his fixed costs, and so a seller who
starts out with a price of $10 will be
tempted to shade it to attract sales from
his rivals and this competitive process
will continue until price is bid down to
$5. If, however, the drugs are not
interchangeable, whether because of
chemical differences protected by patents
against being duplicated or because of
perceived differences having to do with a
manufacturer’s reputation or his
advertising or other promotional activity
on behalf of particular brands, then each
manufacturer might be able to engage in
price discrimination. Price
discrimination is in fact quite common in
competitive industries; think only of the
difference in price between hardback and
paperback books, a difference that almost
always exceeds the difference in the
marginal cost of the two types; or the
difference in ticket prices between the
same first-run and subsequent-run movie;
or discounts for senior citizens. As long
as competitive products are not perfect
substitutes to all consumers, the fact of
their being competitive does not preclude
discriminatory pricing. The publishing
industry is extremely competitive but, as
just noted, price discrimination is the
norm in it. Just as copyrights give the
publisher a temporary monopoly of each
book he publishes, so patents give
manufacturers of drugs a temporary
monopoly of each drug he manufactures.
These monopolies create preconditions for
discriminatory pricing.
Yet even in the case of the
differentiated product protected from
immediate competitive duplication by a
patent, copyright, or trade secret, price
discrimination would be feasible only if
the manufacturer could prevent (or at
least limit) arbitrage--the erasure of a

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price difference not attributable to a
cost difference (that is, a
discriminatory price difference) by a
middleman’s buying from the favored
customers and reselling to the
disfavored. (Or the favored customer
might overbuy and resell the surplus
directly to the disfavored one.) And that
brings us to the chargeback system.
Suppose that a manufacturer wanted
hospitals to be able to buy its drugs for
10 percent less than pharmacies, and so
it granted its wholesalers a 10 percent
discount on all sales intended for resale
to hospitals. The wholesaler would have
an incentive to overstate the number of
those sales and divert the excess above
those necessary to meet the hospitals’
demand to the pharmacies. Suppose the
retail price suggested by the
manufacturer for some drug was $10 to
pharmacies and $9 to hospitals, and the
price charged by the manufacturer to
wholesalers for sales destined for
pharmacies was $5 and the price for sales
destined for hospitals was $4.50. Any
quantities of the drug that the
wholesaler obtained for $4.50 and resold
to a pharmacy would yield the wholesaler
$5.50 per sale ($10-$4.50) rather than
$5, and so the wholesalers might end up
buying their entire supply for $4.50 per
unit on the representation that they were
selling only to hospitals. The result
would be a reduction in the
manufacturer’s revenue from sales
destined for pharmacies from $5 to $4.50,
its anticipated revenue from sales
destined for hospitals.
Enter the chargeback system, whereby the
manufacturer contracts directly with the
retail level of distribution, the
hospitals and the pharmacies in our
example. Continuing with the example, the
manufacturer promises a hospital a 10
percent discount, the hospital so informs
its wholesaler, the wholesaler reduces
its price to the hospital accordingly,
and then the wholesaler, which had bought
the drug for $5, bills the manufacturer
50%, thus preserving its own margin. To
get the 50% it must present proof that it
sold the drug to a customer authorized to
buy at a discount. There is no way the
wholesaler can pay only $4.50 for a drug
that he resells to a pharmacy for $10.
Arbitrage by wholesalers is thus
prevented.

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Price discrimination by a firm that is
not a monopolist and is not colluding
with its competitors is generally not an
antitrust violation at all; as we said,
it is common in competitive industries.
It is particularly difficult to object to
it when, as in the case of drugs or
books, a producer has heavy fixed costs,
so that a price equal to marginal cost
would not be compensatory. The
alternative in such a case to price
discrimination is as we said a high
uniform markup over marginal cost, and
there is no reason to think it a superior
alternative to a differential pricing
scheme. Indeed often, as quite probably
in the book case and possibly in the drug
case as well, the differential scheme
enables the industry to achieve a larger
output than with a uniform price. If the
average hardback book is priced at $25
and the average paperback at $9, and if
publishers were constrained to price them
on the basis of the cost difference and
as a result set a price of (say) $18 for
hardbacks and $16 for paperbacks, they
would probably lose more sales at the low
end than they gained at the high end, and
if so their total output would be less.
Since price discrimination is not (in
general) unlawful, neither are efforts to
prevent arbitrage. An agreement by
distributors to adopt a system for
preventing arbitrage, the better to serve
their suppliers, would surely not be a
per se violation of the antitrust laws,
as the principal effect of invalidating
it might simply be to induce the
manufacturers to take over the wholesale
function themselves. In any event, the
charge here is not that a "horizontal"
agreement to ban arbitrage is unlawful
(there is a hint of such a charge in the
plaintiffs’ brief, but it is
insufficiently developed to preserve the
issue for our review), but that the
defendant wholesalers joined a conspiracy
by manufacturers of brand-name
prescription drugs to fix prices, the
wholesalers’ role in the conspiracy being
to prevent arbitrage that would undermine
the manufacturers’ price-fixing scheme.
To make the charge stick, the plaintiffs
would have had to prove two things. The
first was that the manufacturers
conspired to fix prices. The second was
that the wholesalers joined the
conspiracy by adopting the chargeback

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system. We said that manufacturers of
differentiated products can engage in
price discrimination unilaterally,
because each manufacturer has a little
monopoly power. But in addition
manufacturers who have no individual
monopoly power may find it feasible and
attractive to engage in price
discrimination collusively, that is, to
agree on a discriminatory schedule of
prices. Suppose the defendant drug
manufacturers cannot charge a very high
price to hospitals because if they do the
hospitals will simply substitute
generics, but that drugstores have no
such option. Then it would make sense for
the manufacturers, even if their brand-
name drugs were fungible, to agree (if
they thought they could get away with it
and that the agreement would be
effective) to charge a higher price for
drugs destined for drugstores and a lower
price for drugs destined for hospitals.
But if they reach their customers through
wholesalers, they need a way of
preventing the wholesalers from engaging
in arbitrage; and the chargeback system
is that way. That is, the chargeback
system is equally efficacious whether
used to prevent arbitrage against
individual price discrimination or
arbitrage against collusive price
discrimination. In the second case the
chargeback system would have the
additional benefit to the conspiring
manufacturers of preventing any of them
from cheating on their coconspirators
(the bane of conspiracy) by trying to
lure the high-margin customers (the
drugstores in our example) with prices
slightly below the agreed-upon price to
disfavored customers.
It is not easy to distinguish factually
between the two forms of discrimination--
one legal, the other illegal--in the
setting of this case, since, as we said,
the defendant manufacturers do sell
differentiated products. The plaintiffs
(who remember are the disfavored
purchasers, the drugstores and other
retail sellers) did present considerable
evidence that some of them, at least,
have competitive options just as good as
those of some of the favored purchasers.
For example, in a number of states
pharmacists have the legal right, unless
the prescribing physician expressly
forbids, to substitute a chemically
identical drug for the one prescribed.

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The refusal of the defendant
manufacturers to grant discounts to
pharmacies in such states must mean, the
plaintiffs argue, that the manufacturers
have agreed to hold the line on
discounts. This is not an impressive
argument, because if pharmacies have the
same competitive options as hospitals,
why would the manufacturers’ cartel
charge different prices to pharmacies and
to hospitals? Stated differently, if the
manufacturers can by agreement avoid
giving discounts to pharmacies, why do
they give discounts to hospitals that are
identically situated so far as
competitive options, such as generics,
are concerned?
We need not pursue this issue, because
the district court has not yet determined
whether the manufacturers conspired among
themselves. Assuming they did, the
plaintiffs would still have to prove that
the wholesalers joined the conspiracy.
They would have to show not only that the
wholesalers knew that the manufacturers’
price discrimination which the chargeback
system assists was collusive rather than
individual, but also that the wholesalers
agreed with the manufacturers to support
that price discrimination by means of the
chargeback system.
There is authority for prohibiting as a
violation of the Sherman Act or of
section 5 of the Federal Trade Commission
Act an agreement that facilitates
collusive activity, see 6 Phillip E.
Areeda, Antitrust Law para.para. 1407a-b,
1435d-g (1986 & 2000 supp.); Herbert
Hovenkamp, Federal Antitrust Policy: The
Law of Competition and Its Practice sec.
4.6b-d, pp. 178-86 (2d ed. 1999)--for
example, a basing-point pricing system,
FTC v. Cement Institute, 333 U.S. 683,
696-700, 711-12 (1948); Clamp-All Corp.
v. Cast Iron Soil Pipe Institute, 851
F.2d 478, 484-85 (1st Cir. 1988); Boise
Cascade Corp. v. FTC, 637 F.2d 573, 576-
77 (9th Cir. 1980), or a system of
exchanging price information, United
States v. Container Corp. of America, 393
U.S. 333, 337 (1969); Todd v. Exxon
Corp., 275 F.3d 191, 198-99 (2d Cir.
2001); In re Baby Food Antitrust
Litigation, 166 F.3d 112, 118, 137 (3d
Cir. 1999); Wallace v. Bank of Bartlett,
55 F.3d 1166, 1169 and n. 5 (6th Cir.
1995), or industry-wide adoption in
contracts with customers of most-favored-

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nation clauses (which make discounting
more costly by requiring that a discount
to one buyer be granted to all buyers
protected by such clauses). George A.
Hay, "Faciliting Practices: The Ethyl
Case," in The Antitrust Revolution:
Economics, Competition, and Policy 182
(John E. Kwoka Jr. & Lawrence J. White
eds., 3d ed. 1999); 6 Areeda, supra,
para. 1435e; but see E.I. DuPont de
Nemours & Co. v. FTC, 729 F.2d 128, 133-
34 (2d Cir. 1984). But that is not the
theory of this case. The theory is that
the wholesalers joined the manufacturers’
conspiracy. And of that there is too
little evidence to permit a reasonable
jury to infer the wholesalers’ guilt.
There is first of all no evidence that
the wholesalers knew that the
manufacturers’ price discrimination was
collusive rather than individual. To
argue that because the uniform refusal to
grant discounts even to pharmacies that
seemed to have competitive options as
good as hospitals and HMOs smacks of
collusion the wholesalers knew that the
manufacturers were colluding is too much
of a stretch; it would amount to basing
an inference of conspiracy on negligence,
a careless failure to tumble to the
nature of one’s suppliers’ business
methods. It would mean that any time a
seller asked a distributor not to engage
in arbitrage the distributor would be in
peril of being found to have conspired
with the seller to fix prices should it
turn out that the price discrimination
engaged in by the distributor was
collusive rather than individual.
An inference of knowledge would be
particularly shaky here because, so far
as appears, the chargeback system was
adopted before the alleged collusion of
the manufacturers began and because the
system is supported by commercial reasons
independent of any desire to prevent
arbitrage, let alone to facilitate
collusive pricing. Without the chargeback
system or some simulacrum, a hospital or
other purchaser of brand-name
prescription drugs that was entitled to a
discount would have to pay the full price
to the wholesaler and then ask the
manufacturer for a rebate. The delay
entailed in that system would give these
purchasers something the wholesalers
dreaded, namely an incentive to buy
directly from the manufacturers. The
chargeback system enabled the purchasers

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to obtain their discount at the moment of
purchase, just as they would have done
had they bought directly from the
manufacturers. It was a wholesaler
survival tactic.
At argument, pressed for examples of
evidence of the wholesalers’ culpability,
their lawyer referred us to a number of
places in the voluminous appendix. We
have looked at them and we cannot find
anything to create more than the barest
suspicion that the wholesalers knew the
manufacturers were colluding (at present
only a hypothesis, we remind) and knowing
this decided to help them by means of the
chargeback system. Most of it is evidence
that the manufacturers were engaged in
collusive pricing. This evidence was
deemed sufficient by the district court
to defeat the manufacturers’ motion for
summary judgment, but it was hardly
strong enough to compel or even permit an
inference that the wholesalers knew the
manufacturers were colluding. (In a trial
of the same claim by the plaintiffs who
did not opt out of the class action, the
manufacturers were exonerated of the only
price-fixing charge in which the
wholesalers may have been implicated. 186
F.3d at 784-88.) There is evidence that
the chargeback system was intended to
discourage arbitrage; undoubtedly it was,
but that is consistent with the
wholesalers’ believing, whether correctly
or not, that the manufacturers’ price
discrimination was individual rather than
collusive.
The plaintiffs’ best evidence is
testimony concerning meetings of the
wholesalers’ trade association at which
manufacturers were present (not that
there is anything suspicious in general
about suppliers talking to distributors).
All the testimony concerns retail buying
groups. At one meeting the wholesalers
asked the manufacturers whether the
latter would be selling directly to
groups of buyers, bypassing the
wholesalers, and were relieved to be
assured that they would not be. This
could be a form of compensation for the
wholesalers’ preventing arbitrage that
would thwart collusive price
discrimination by the manufacturers, but
that is sheer conjecture. A similar
statement--"that neither wholesalers nor
manufacturers should deal with retail
buying groups"--was made at another

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meeting and embellished with the more
intriguing suggestion that the retail
buying groups should be denied "access
through the chargeback system to the same
discounts on BNPDs [brand-name
prescription drugs] given to favored
purchasers." But actually that is just
another way of saying don’t deal with
retail buying groups, which if they don’t
receive a discount are not going to take
over the wholesale function from the
wholesalers--indeed, they are not going
to have any reason for being. At worst,
the statements we have quoted might be
evidence of a boycott by the
manufacturers of retail buying groups,
cheered on by the wholesalers; but the
plaintiffs have not argued boycott.
The plaintiffs’ evidence is consistent
with the existence of an overarching
conspiracy of which the wholesalers were
members. But it is equally consistent
with there being either no conspiracy at
all or one of which the wholesalers were
unaware, let alone of which they were
members. And we haven’t even reached the
question whether, if the wholesalers did
know there was a manufacturers’
conspiracy, they joined it. To infer
membership from knowledge would erase the
distinction between conspiring on the one
hand, which means joining an agreement,
and aiding and abetting on the other,
which means materially assisting a known-
to-be-illegal activity in the hope that
it will flourish to the benefit,
pecuniary or otherwise, of the aider.
E.g., United States v. Pino-Perez, 870
F.2d 1230, 1235 (7th Cir. 1989) (en
banc); United States v. Peoni, 100 F.2d
401, 402 (2d Cir. 1938) (L. Hand, J.). We
can assume without having to decide that
if the wholesalers knew there was a
manufacturers’ conspiracy and wanted it
to succeed, presumably in order to kill
the buying groups (mere knowledge that
some of the customers for one’s goods or
services plan to use them for an illegal
purpose is not enough to make one an
aider and abettor, United States v. Pino-
Perez, supra, 870 F.2d at 1235), then,
because preventing arbitrage was
important to the conspiracy and the
chargeback system was an effective way of
thwarting it, the wholesalers were guilty
of aiding and abetting (which can be a
civil as well as a criminal violation of
antitrust law, e.g., Allen Bradley Co. v.
Local Union No. 3, 325 U.S. 797, 801,

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808-10 (1945); see generally Electronic
Laboratory Supply Co. v. Cullen, 977 F.2d
798, 805 (3d Cir. 1992)) even though as
we have said a chargeback system has
innocent commercial virtues as well. But
that is not argued, and anyway essential
premises are missing.
On this record, no reasonable jury could
find for the plaintiffs, and so the
judgment of the district court must be
Affirmed.

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