Appeal from the United States District Court for the Central District of Illinois, Peoria Division. No. 84-1048 -- Michael M. Mihm, Judge.
En Banc. Bauer, Chief Judge, Cummings, Cudahy, Posner, Coffey, Flaum, Ripple, Manion, and Kanne, Circuit Judge, and Fairchild, Senior Circuit Judge.*fn*
Central Illinois Light Company (CILCO) is a publicly regulated retail distributor of natural gas. It bought natural gas from Panhandle Eastern Pipe Line Company at prices allegedly inflated because of violations of the antitrust laws by Panhandle, and resold the gas to residential and industrial consumers. In its resales to residential consumers, CILCO passed on the entire overcharge in the form of higher rates. In 1984 the State of Illinois brought this federal antitrust suit on behalf of CILCO's customers against Panhandle -- which moved to dismiss the suit as barred by the "indirect purchasers" rule of Hanover Shoe, Inc. v. United Shoe Machinery Corp., 392 U.S. 481, 20 L. Ed. 2d 1231, 88 S. Ct. 2224 (1968), and Illinois Brick Co. v. Illinois, 431 U.S. 720, 52 L. Ed. 2d 707, 97 S. Ct. 2061 (1977). The district court denied the motion, but certified its order of dismissal for an immediate appeal under 28 U.S.C. § 1292(b), and we agreed to hear the appeal. A panel of this court revert the district court and directed it to dismiss the complaint. 839 F.2d 1206 (7th Cir. 1988). The full court granted rehearing en banc to decide whether regulatory cost-plus pricing can ever be excepted from the rule that "indirect purchasers" (CILCO's customers are indirect purchasers from Panhandle, CILCO being the direct purchaser) are barred from obtaining antitrust damages from their indirect seller. While the appeal was pending in this court, the district judge conducted a 13-week trial on liability, but he has deferred making a decision until we decide the appeal.
In Hanover Shoe the Supreme Court held that it is not a defense to an antitrust damages action that a buyer forced to pay a higher price because of the seller's antitrust violation passed on the cost of the violation to the buyer's customers (the seller's indirect purchases) by raising his prices to them, unless the buyer had a cost-plus contract with these customers. Illinois Brick announced a corollary to Hanover Shoe: the indirect purchaser cannot sue to recover the part of the overcharge that the buyer passed on to him. The Court again recognized an exception for the cost-plus contract, noting that it insulates the direct purchaser from "any decrease in its sales as a result of attempting to pass on the overcharge, because its customer is committed to buying a fixed quantity regardless of price." Id. at 736. Fastening on the words "fixed quantity", the panel majority in this case held that the cost-plus exception is never available when the indirect purchasers are free to vary the quantity they buy from the direct purchaser. The question for decision today is whether the exception is as confined as the panel thought.
The panel's opinion was not the first to read the exception so narrowly. See Mid-West Paper Products Co. v. Continental Group, Inc., 596 F.2d 573, 577 n. 9, 580 (3d Cir. 1979); In re Midwest Milk Monopolization Litigation, 730 F.2d 528, 533 (8th Cir. 1984); Lefrak v. Arabian American Oil Co., 487 F. Supp. 808, 819 (E.D.N.Y. 1980); cf. Arizona v. Shamrock Foods Co., 729 F.2d 1208, 1212 n. 2 (9th Cir. 1984); but see In re Uranium Antitrust Litigation, 552 F. Supp. 518 (N.D. Ill. 1982). And its reading was followed in In re Wyoming Tight Sands Antitrust Cases, 695 F. Supp. 1109 (D. Kan. 1988). Yet it was not dictated by precedent. Not only had the prior cases all involved privately negotiated cost-plus contracts rather than cost-plus contractual provisions required by public utility regulation, but there was no reason to believe that the reference to "fixed quantity" in the Supreme Court's opinion in Illinois Brick was intended to govern cases so remote from the actual arrangements under scrutiny in that case. The case did not involve a fixed-quantity contract; indeed, it did not involve a cost-plus contract, but merely an argument (which the Court rejected, see 431 U.S. at 744) that a buyer's practice of rule-of-thumb cost-plus pricing should be enough to allow his customers to sue the seller. Certainly there is no indication that by using the words "fixed quantity" the Supreme Court meant to address the issue of the status of regulatory cost-plus pricing. We do a disservice to the Court by wrenching its words out of context and giving them a talismanic significance; we make language a trap rather than a mode of communication. The Supreme Court has never adverted to the issue involved in the present case, and we must consider that issue in relation to the rationale of Illinois Brick rather than to isolated phrases in the Court's opinion. If we are to play the language game to which Panhandle invites us, moreover, then we must consider isolated phrases in other Supreme Court opinions, notably the majority opinion in Blue Shield of Virginia v. McCready, 457 U.S. 465, 474-75, 73 L. Ed. 2d 149, 102 S. Ct. 2540 (1982), where the concern behind Hanover Shoe and Illinois Brick is described as "the risk of duplicative recovery engendered by allowing every person along a chain of distribution to claim damages arising from a single transaction that violated the antitrust laws." There is, as we shall see, no such risk in this case, at least so far as the residential purchasers from CILCO are concerned; and it is only they who have, in our view, a persuasive claim to be entitled to sue.
Although several district courts have rejected an exception for cost-plus rate regulation, see (besides Tight Sands) Go-Tane Service Stations, Inc. v. Ashland Oil, Inc., 508 F. Supp. 200, 204 (N.D. Ill. 1981); City of Cleveland v. Cleveland Electric, Illuminating Co., 538 F. Supp. 1320, 1323-27 (N.D. Ohio 1980); U.S. Oil Co. v. Koch Refining Co., 518 F. Supp. 957, 962-63 (E.D. Wis. 1981), the cases are distinguishable; and in the case with facts most like those of the present case the court held that indirect purchasers could sue because public utility regulation had created "a straight cost passthrough." In re New Mexico Natural Gas Antitrust Litigation, 1982-1 Trade Cases para. 64,685, at p. 73,722 (D.N. Mex. 1982). Cf. County of Oakland v. City of Detroit, 628 F. Supp. 610, 613 (E.D. Mich. 1986); Illinois v. Borg, Inc., 548 F. Supp. 972, 975-76 (N.D. Ill. 1982). An additional wrinkle in the New Mexico Natural Gas case, however, was that the direct purchasers were in cahoots with the defendants; this was an independent ground for allowing the indirect purchasers to sue.
It is possible to allow indirect purchasers to sue in a case such as the present one without embracing the ill-defined "functional equivalent" approach of In re Beef Industry Antitrust Litigation, 600 F.2d 1148 (5th Cir. 1979); see also, e.g., Gulf Oil Corp. v. Dyke, 734 F.2d 797, 809 (T.E.C.A. 1984). That approach -- effectively criticized in In re Midwest Milk Monopolization Litigation, 529 F. Supp. 1326, 1337-38 (W.D. Mo. 1982), aff'd, 730 F.2d 528 (8th Cir. 1984); Comment, A Legal and Economic Analysis of the Cost-Plus Contract Exception in Hanover Shoe and Illinois Brick, 47 U. Chi. L. Rev. 743, 756-70 (1980), cf. Abbotts Dairies Division v. Butz, 584 F.2d 12, 16-17 (3d Cir. 1978), and found to be inapplicable to conditions in the beef industry itself in In re Beef Industry Antitrust Litigation, 710 F.2d 216, 219-20 (5th Cir. 1983) -- requires elaborate analysis of the incidence of a cost increase, which is precisely the analysis that the Court disparaged in Illinois Brick. Our approach does not require this. We have formal cost-plus pricing in this case rather than its "functional equivalent." We have formal cost-plus pricing, and more: a contract that required 100 percent passing on, and an acknowledgment of 100 percent passing on in every kilowatt hour resold to CILCO's residential consumers.
To determine whether (or to what extent) this case is within the rule of Illinois Brick, we must consider the reasons for confining the right to sue to the direct purchaser; for it is the reasons behind a rule that determine its scope. First, because the direct purchaser is closer to the violation and hence more likely to discover it, we want to make sure that he has a strong incentive to bring the violator to book, and we do this by holding out to him the prospect of recovering the entire damages caused by the violation if he wins the suit. Second, it is difficult to apportion damages between direct and indirect purchasers by the methods of litigation. A direct purchaser who finds himself paying a higher price for inputs would love to pass on all of the additional cost to his customers in the form of a higher price, but he cannot do so, because a price that much higher will so reduce the demand for his product that his profits will fall unacceptably. (If the higher price were optimal, the firm would have raised its price without waiting for its costs to increase.) The optimal adjustment by an unregulated firm to the increased cost of the input will always be a price increase smaller than the increase in input cost, and this means that the increased cost will be divided between the two tiers, the direct and indirect purchasers -- but in what proportions will often be hard to determine, even by sophisticated techniques of economic analysis. This is a central insight of the Illinois Brick decision. An additional complication that further demonstrates the wisdom of the decision is that the higher input price may induce the direct purchaser to use more of an alternative input, and this substitution will affect the proportion of the initial overcharge that the direct purchaser can recoup.
Where the direct purchaser has a cost-plus contract with his customers that requires them to buy a fixed quantity, the reasons for confining the right to seek damages to the direct purchaser cease to be fully persuasive. There is no longer a problem of apportionment, because the whole of any price increase will have been passed on to the customers by virtue of the contract. Yet the second reason for confining the right to seek damages to the direct purchaser survives: he has better information about the violation. And despite the cost-plus nature of the contract, he has everything to gain from suing. He will not have to share any of the damages that he recovers with his customers unless the contract contains a clause (or a court is persuaded to adopt an imaginative conception of unjust enrichment) that entitles them to any rebate he might receive, probably years later, on an input used in performing his side of the bargain. Nevertheless the Supreme Court has said that the indirect purchaser may sue if he has a cost-plus contract with the direct purchaser.
In the present case, where cost-plus pricing is imposed by public utility regulation rather than by a purely private, purely voluntary contract, the reasons balance out slightly differently, but the case for applying the cost-plus exception of Illinois Brick is no weaker once the balance is restruck. The public utility has less to gain from suit than the direct purchaser in the case of the purely private contract. The public utility commission may force the utility to pass on to the consumers any and all damages that the utility recovers, and if it does utilities will have no incentive to sue because they will have nothing to gain from suit. In the present case CILCO finally did sue -- but not until 1987, by which time the present suit was far advanced and the statute of limitations with regard to the damages incurred by residential customers in the present suit either had run or was about to run; and the CILCO case has remained dormant pending our decision of the appeal. CILCO seems a most reluctant suitor, and why shouldn't it be? It has little or nothing to gain by such a suit. Indeed, one might argue that public utility regulation (to the extent effective -- admittedly a potentially big if) so far identifies a public utility with its customers as to bring the case within the separate exception recognized in Illinois Brick for situations in which the direct and indirect purchaser are under common control. See 431 U.S. at 736 n. 16.
Although the amount of gas purchased by a utility's customers is not fixed in their contract with the utility (it would be absurd for consumers to commit to a fixed quantity; their need for gas varies with the weather!), the special character of a public utility eliminates the problem of apportionment, here with respect to the only class of customers that we believe should be allowed to sue, the residential customers. The retail distribution of natural gas through a grid of pipes to the customers' homes or places of business is a natural monopoly, Omega Satellite Products Co. v. City of Indianapolis, 694 F.2d 119, 123, 126 (7th Cir. 1982); so, in the absence of regulation, a gas utility would charge a monopoly price. Although the efficacy of public utility rate regulation has been questioned (see, e.g., Stigler & Friedland, What Can Regulaters Regulate? The Case of Electricity, 5 J. Law & Econ. 1 (1962); Moore, The Effectiveness of Regulation of Electric Utility Rates, 36 So. Econ. J. 365 (1970)), the facts of this case suggest, and the parties seem to agree, that residential natural-gas rates in Illinois are lower because of regulation than they would be in an regulated market, implying that CILCO has unused monopoly power in that market, which it exploited by passing on the full overcharge by Panhandle. The situation in the industrial market is different. Some industrial consumers of natural gas have good alternatives, and as to them CILCO apparently had no unused monopoly power that would have enabled it to shift the whole of the cost increase to them. Instead CILCO sought and obtained regulatory permission to reduce its profit margin on sales to these customers, thereby offsetting in part the higher rates enabled by the automatic pass-through provision.
CILCO's dealings with its industrial customers show why the absence of a quantity provision in a contract can make a difference. Since the industrial customers were not obligated to take a fixed (or their required) quantity of natural gas, and since they had competitive alternatives, CILCO's profit-maximizing course of action was to swallow part of the overcharge rather than try to pass it on dollar for dollar in the form of higher rates. But its residential consumers unlike its industrial customers had no good alternatives to natural gas (of which CILCO was the sole purveyor), at least in the short term, and CILCO's profit-maximizing course of action was therefore to allow its rates to them to rise by the exact amount that its gas costs rose as a result of Panhandle's alleged overcharge. It was not only the absence of competition but the presence of regulation that made this the profit-maximizing course of action; regulation is a stand-in for the quantity requirement in an ordinary contract. Apparently rate regulation had succeeded in keeping CILCO's rates to a level where an increase in those rates was bound to increase the firm's revenues because the price increase (1) would not be offset by an equal or greater proportional decline in its sales and (2) would lead to a reduction in the firm's total costs (consumers would buy less, even if only a little less, at the higher price). CILCO therefore had every incentive to raise its price by the full amount allowed by the regulatory commission -- which was the full amount of the gas overcharge. And it did it.
The significance of the regulatory setting is that if regulation keeps a utility's rates below what it would like to charge, the utility will raise those rates by the full amount allowed by the regulatory commission unless such an increase would carry the utility above its optimum rate. An unregulated firm would not do that, since as we have noted an unconstrained profit maximizer will always find it in its best interest to swallow a part of any cost increase that it experiences unless its customers are committed to a fixed quantity. It is unclear from the record in this court how generous the commission's allowance was; the commission may have allowed CILCO to double its rates -- yet even so, if regulation forced CILCO to charge half or less of its ...