The UK Court of Appeal Clarifies the Legal Test for Excessive Pricing

By Covington Competition on May 4, 2020

Posted in Abuse, Antitrust, Competition Law, Dominance, European Commission, Pharmaceutical Companies, United Kingdom

Under Article 102 of the Treaty on the Functioning of the European Union (“TFEU”), an undertaking may abuse its dominant position by “directly or indirectly imposing unfair purchase or selling prices”. The UK Court of Appeal recently provided guidance regarding the legal test to determine whether pricing is excessive and unfair. In March, it dismissed the UK Competition and Markets Authority’s (“CMA”) appeal in the Phenytoin case.

Background

Phenytoin sodium is a prescription anti-epilepsy drug available in a variety of forms, including capsules and tablets. Phenytoin sodium capsules were manufactured and sold by Pfizer Limited (“Pfizer”) under the brand name “Epanutin” in the UK. In 2012, Pfizer transferred the marketing authorisation (“MA”) for the capsule form of phenytoin sodium to Flynn Pharma Limited (“Flynn”), but continued manufacturing the capsules for Flynn, who then sold them to the NHS.

Prior to the transfer of the MA, the price for the capsules was regulated under the UK’s Pharmaceutical Price Regulation Scheme (“PPRS”). However, following the transfer of the MA, Flynn de-branded Epanutin and began to distribute a generic version of the drug. As only branded drugs are covered by the PPRS, the generic version of the drug was not price regulated. Following de-branding, Pfizer increased its manufacturing price for the capsules by between 783% and 1,615%, and Flynn raised the price at which it supplied the capsules to the NHS by between 2,387% and 2,656%. Pfizer’s price was calculated as a percentage of Flynn’s supply price to the NHS.

In December 2016, the CMA found that Pfizer and Flynn had abused their dominant positions in the markets for the manufacture and distribution of phenytoin sodium capsules, respectively, by charging excessive prices in the UK. The CMA imposed a record fine of £84.2 million on Pfizer and £5.2 million on Flynn, and ordered both companies to reduce their prices.

In June 2018, the UK Competition Appeal Tribunal (“CAT”) quashed the CMA’s decision after it found that the CMA had (i) misapplied the legal test for excessive pricing, (ii) not properly evaluated the evidence adduced by the companies by not taking sufficient account of the prices of comparable products (in particular phenytoin sodium tablets), and (iii) not properly considered the economic value of phenytoin sodium capsules.

The CMA, supported by the European Commission, appealed the CAT’s judgment to the Court of Appeal. On 10 March 2020, the Court of Appeal handed down its judgment which broadly upheld the CAT’s ruling.

The Legal Test for Excessive Pricing – Are The Tests in the Unfairness Limb Alternatives?

The first point in dispute before the Court of Appeal concerned the legal test for excessive pricing established by the European Court of Justice (“ECJ”) in its seminal United Brands judgment. The ECJ held in that judgment that a price can be considered excessive when it has “no reasonable relation to the economic value of the product supplied” (see para. 250 of the ECJ judgment). The ECJ stated that the excessive nature of a price could be determined “inter alia” based on the following two-limb test:

the price must be “excessive”, which is the case when the difference between the cost of production and the selling price of the product is excessive (“excessive limb”); and
the price must be “unfair” either (i) in itself or (ii) when compared to competing products (“unfair limb”) (see paras. 251 and 252 of the ECJ judgment).

To determine whether the prices for the generic drug were excessive and unfair, the CMA had compared Pfizer’s and Flynn’s respective costs and the prices they charged against a theoretical Cost Plus benchmark, calculated based on cost plus a reasonable return on sales (“ROS”) of 6% (which had been the ROS for the branded version of phenytoin sodium capsules). The CMA concluded that the prices were excessive because they exceeded the Cost Plus benchmark, as the ROS for both parties throughout the relevant period was significantly above 6%. Further, it found that the prices were also unfair “in themselves” because they had no reasonable relation to the economic value of the capsules which was not higher than their cost of production plus a 6% ROS (i.e., the Cost Plus benchmark).

The Court of Appeal considered whether the CMA had correctly applied the “unfair limb” of the United Brands test. The CMA had argued that if it establishes that the prices are unfair under the “in itself” test, then “it is not necessary […] to reach a conclusion as to whether those prices are also unfair when compared to competing products” (see paras. 5.476 to 5.478 of the CMA’s decision). In other words, the CMA’s view was that the two tests in the “unfair limb” of the excessive pricing test are mutually exclusive in that, if the CMA relies upon one test (e.g., the “in itself” test) to establish the infringement, it does not have the legal duty to evaluate evidence based on the other test (e.g., the “competing products” test), regardless of whether such evidence is adduced by an undertaking in its defence (as Pfizer and Flynn had done).

The CAT had critised the CMA’s approach. It found that the two tests under the “unfair limb” are not strict alternatives and that, although the CMA was free to use either of the tests to establish the infringement, it should not have ignored a prima facie valid argument raised by the defendants that the prices were fair under the “competing products” test because it had satisfied itself that the prices were unfair solely based on the “in itself” test (see paras. 366 and 443(5) of the CAT judgment).

The Court of Appeal agreed with the CAT. It held that “the reading of the [“unfair limb” of the] test in United Brands by the CMA is unduly rigid and literal and invests far too much significance in the disjunctive “or”” (see para. 57 of the Court of Appeal judgment). However, this does not mean that competition authorities are required to apply both the “in itself” and “competing products” tests in all cases. The Court of Appeal held that the two-limb test established in United Brands is only one method by which abuse might be established, and that competition authorities have “a margin of manoeuvre or appreciation in deciding which methodology to use and which evidence to rely upon”. However, the Court of Appeal stated that, if an undertaking relies in its defence on a different test or alternative evidence to that relied upon by the competition authority, “then the authority must fairly evaluate it” (see para. 97 of the Court of Appeal judgment).

The “Benchmark Issue” – Is a Hypothetical Benchmark Always Required?

In applying the “excessive limb” of the United Brands test, the CMA based its analysis solely on the Cost Plus benchmark. The CAT held that the CMA’s almost total reliance on the “reasonable ROS” approach was “unconvincing” in this case. The CAT found that a competition authority “should”, as part of its analysis, construct a “hypothetical” benchmark price or range of prices against which to measure the actual prices charged (see, e.g., paras. 312 to 319 and 339 of the CAT’s judgment). The CMA argued before the Court of Appeal that there is no basis in law for a hypothetical benchmark price requirement, and that such a requirement would make it very difficult to establish abuse, since it would preclude use of other non-price benchmarks such as those based on cost, or it would at least compel the use of a price benchmark in addition to any other benchmark relied upon by a competition authority.

The Court of Appeal agreed in part with the CMA. It noted that “there needs to be “a” benchmark”, but that the benchmark is for the competition authority to select. It concluded that a competition authority has “a margin of manoeuvre or discretion as to how it goes about proving its case”, and that “the CAT fell into legal error when it held […] that [a competition authority] had to establish a benchmark price or a range of prices, beyond a cost plus calculation, in order to determine whether the prices charged by Pfizer and Flynn were excessive” (see paras. 120 and 254 of the Court of Appeal judgment).

Final Remarks

The case has been sent back to the CMA. While the Court of Appeal broadly upheld the CAT’s ruling, the CMA’s press release refers to the judgment as “a good result”, which represents “an important step forward in clarifying the legal test for excessive and unfair pricing”.

The Court of Appeal’s judgment makes clear that competition authorities face legal challenges when pursuing excessive pricing cases. The judgment’s key takeaways are as follows:

The “in itself” and “competing products” tests of the “unfair limb” of the United Brands test are not strict alternatives – authorities have a “margin of manoeuvre” in deciding which test they will use. However, they must fairly evaluate all evidence adduced (including evidence relating to the test being applied and defences fairly raised by the parties).
Competition authorities need establish a benchmark but they are not required to implement a specific hypothetical benchmark price (or range of prices) in determining whether pricing is excessive.