Designing the rules for private enforcement of EC competition law

Frank Verboven, Theon van Dijk, 24 July 2007

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The European Commission is currently determining its policy regarding private enforcement of EC competition law. In December 2005 it published a Green Paper (“Damages actions for breach of the EC antitrust rules”) setting out the main policy questions. Apart from legal issues such as access to evidence, fault requirement and jurisdiction and applicable law, there are a number of key economic choices facing the Commission. Should defendants (price cartel members) be allowed to use a passing-on defence against direct purchasers (distributors) in damages claims? Should indirect purchasers (final consumers) have standing to claim for damages?

Objectives of private enforcement

Before turn to these questions, we must address the issue of what the goals are of private enforcement in Europe. (As opposed to the US, private damages actions following competition law infringements are currently rare in Europe.) A first objective is to provide compensation for those who suffered damages as a result of a price cartel. There are various ways in which this compensation can be calculated, some of which are further discussed below.1 The second objective is deterrence of anticompetitive conduct. While public enforcement uses fines as a deterrence instrument, private enforcement can allow for “treble” or “double” damages to deter anticompetitive behaviour. Both objectives require the calculation of damages to the various parties affected by a cartel.

Economic damages to various affected groups

It is useful to distinguish between the effects of a cartel on direct purchasers and on indirect purchasers, and the total harm caused by the cartel (the sum of the two) – see Table 1 below.2

 

Table 1 – Damage caused by cartel on direct and indirect purchasers

Affected group Price overcharge Pass-on effect Output effect
(1) Direct purchasers + price overcharge - pass-on effect + output effect
(2) Indirect purchasers   + pass-on effect  
Total harm ((1) + (2)) + price overcharge + 0 + output effect

 

Following our recent research3, the effect on direct purchasers can be decomposed into three parts: (1) the price overcharge; (2) the pass-on effect; and (3) the output effect. The price overcharge is defined as the cartel price minus the price that direct purchasers would have paid “but for” the cartel (multiplied by the total inputs purchased from the cartel). The pass-on effect is the increase in revenue that follows if direct purchasers pass some of the cost increase on to their customers (indirect purchasers) in the form of higher prices. The output effect, finally, is an often neglected element that reflects lost business that direct purchasers experience if higher prices to indirect purchasers result in a decrease in demand. Note that this output effect is part of the deadweight loss due to the cartel.

The effect on indirect purchasers (eventually final consumers) is given by the pass-on effect. The pass-on effect is essentially a transfer of damages from direct purchasers to indirect purchasers.

Therefore, the cartel’s total harm to direct and indirect purchasers is given by the sum of the price overcharge and the output effect (the pass-on effect cancels out as a transfer).

Practical considerations

Although the economic effects of a cartel can be fully characterised in this way, there may be practical reasons not to base damages on these economic effects. Information costs and complexity of calculations, for example, were put forward as reasons not to allow cartel members a passing-on defence in damages actions in the landmark 1968 Hanover Shoe case4 in the US. Another example is the 1977 Illinois Bricks case5 in the US, which denied indirect purchasers standing to claim damages, on the basis that final consumers each individually have too weak incentives to sue, thus increasing the probability that cartel members are never faced with damages claims from this group.

Passing-on defence and indirect purchaser standing

The following table summarises two of the key policy options that the EC is currently facing, namely whether or not to give legal standing to indirect purchasers, and whether or not to allow for a passing-on defence. These two options are often viewed as one (in the sense that not allowing a passing-on defence implies no indirect purchaser standing), but they can be considered separately.

 

Table 2 – Policy options and economic effects

    Passing-on defence
    No Yes, unadjusted for output effect Yes, adjusted for output effect
Indirect purchaser standing No      

Unjust enrichment of direct purchasers

Unjust empoorment of indirect purchasers

Insufficient liability of defendant


Unjust empoorment of direct purchasers

Unjust empoorment of indirect purchasers

Insufficient liability of defendant

Correct compensation to direct purchasers

Unjust empoorment of indirect purchasers

Insufficient liability of defendant

  Yes

Unjust enrichment of direct purchasers

Correct compensation to indirect purchasers

Double liability of defendant for pass-on effect but no liability for output effect

 

Unjust empoorment of direct purchasers

Correct compensation to indirect purchasers

Insufficient liability of defendant

Correct compensation to direct purchasers

Correct compensation to indirect purchasers

Full liability of defendant

 

In the top left cell, damages are purely based on the price overcharge, neglecting the pass-on and output effects. The defendant pays the complete price overcharge to its direct purchasers whilst the indirect purchasers receive nothing. As a result direct purchasers receive more compensation than the actual damages they suffered (“unjust enrichment”), since they typically pass on part of the overcharge to the indirect purchasers. Although they suffered damages because part of the overcharge was passed on to them, indirect purchasers do not receive compensation (“unjust enpoorment”). Furthermore, the defendant is not made liable for the total harm he caused because the output effect is not taken into account in the damages claims (“insufficient liability”). This does not necessarily imply an unjust enrichment of the defendant, as cartels can typically not appropriate all the harm caused.

This roughly describes the current policy option taken in some US states. Its advantage is simplicity, since the price overcharge is viewed to be easier to measure than the other effects. However, it overcompensates direct purchasers at the expense of indirect purchasers, and the cartel is not held accountable for the negative output effect it has caused.
In the bottom left cell, damages to the direct purchasers are still purely based on the price overcharge, but now the indirect purchasers get legal standing. This describes the policy option taken in some other US states (which allow indirect purchaser standing). There is again a risk of unjust enrichment of direct purchasers if they had to some extent been able to pass on the price overcharge. However, this unjust enrichment is no longer at the expense of the indirect purchasers. Instead, it is at the expense of the defendant who faces a risk of “double liability” by paying twice for the pass-on effect.

The middle column cells show policy options where the pass-on effect is taken into account, but where the output effect is neglected (as proponents of a passing-on defence often tend to do). In this case there is a risk that direct purchasers get under-compensated (unjust enpoorment), because they face reduced damages payments to reflect the pass-on effect, but their lost business resulting from pass-on (the output effect) is neglected. In absence of indirect purchaser standing (top cell), there is again unjust enpoorment of indirect purchasers, so that the defendant gets away with some of the extra profit due to the cartel. This latter effect is neutralised if indirect purchasers are given standing (bottom cell), but it still results in insufficient liability of the defendant for the total cartel harm caused because there is unjust enpoorment of the direct purchasers.

The right column cells show the policy options where the passing-on defence is taken into account, but suitably adjusted for the output effect. In this case, the direct purchasers are correctly compensated, and the indirect purchasers as well if they have legal standing (bottom cell). From an economic perspective, the latter is the best policy option since all parties receive correct payments. Moreover, the defendant is held fully accountable for all the harm caused by the cartel. From a practical view, however, this approach requires more information since it is necessary to collect evidence on both the price overcharge, pass-on and output effect.

Conclusion: what policy option should be chosen?

The policy choices the EC faces require finding a balance on the trade-off between the economically correct compensation for various groups, holding cartel members fully accountable for the harm they cause, and practical (mainly informational) considerations.

The top middle and right cells of Table 2 can immediately be ruled out because they lead to a situation in which cartel members are substantially rewarded for forming the cartel: they are eligible to a passing-on defence against direct purchasers, and do not pay the indirect purchasers for the damages from pass-on. Furthermore, the bottom left cell should be rejected because of the risk of multiple liability for defendants; while this may serve as a deterrence instrument, from an economic perspective it is more desirable to obtain deterrence through explicit doubling or tripling of damages claims. The bottom right cell is preferable to the bottom middle cell, because the extra informational requirements to take account of the output effect are relatively small.

The policy options therefore boil down to a choice between the top left cell (no passing-on defence and no indirect purchaser standing, which imply relatively low informational requirements) and the bottom right cell (adjusted passing-on defence and indirect purchaser standing, which better account for the genuine economic effects of cartels).

In our view it is desirable to follow the option of allowing for an adjusted passing-on defence and giving indirect purchasers legal standing. First, the informational requirements are not insurmountable, in part because of improved data availability and empirical techniques in recent years. Second, the methodology is more in line with damage assessment in other cases (e.g. infringement of patents).


1 Economic damage calculation is generally based on the difference between a world in which the cartel infringement has actually occurred and a counterfactual world in absence of the infringement (also called the “but for” world). Within this general approach the EC Green Paper mentions two further definitions of damages: “compensatory damages” (the loss suffered by a claimant, also called damnum emergens) and “recovery of illegal gain” (damages based on the illegal gain of the infringer).
2 In this example we assume there is an upstream price cartel, one intermediary layer of distributors, and final consumers. There may be more intermediary layers and other affected parties, such as suppliers to the cartel who sell fewer products because the cartel members have agreed to reduce output.
3 Verboven, F. and T. van Dijk (2007), “Cartel Damages Claims and the Passing-On Defence”, CEPR Discussion Paper 6329, June 2007.
4 Hanover Shoe Inc. v. United Shoe Machinery Corp., 392 U.S. 481 (1968).
5 Illinois Brick Co. v. Illinois, 431 U.S. 720 (1977)

Topics: Competition policy
Tags: competition law, European Commission, private enforcement

Comments

incentives to seek damages

I notice you didn't address the issue of weakened incentives for a party to seek damages with the passing-on defense and indirect purchaser standing. It seems likely that adding treble damages to your policy recomendation would helpt to overcome the weakened incentives. I'm curious

Founder of Lexonomics

Professor of Economics at the Catholic University of Leuven and CEPR Research Fellow

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