CAT overturns CMA’s excessive pricing decision against Pfizer and Flynn

• United Kingdom

• Competition, EU and Trade
• Health and life sciences

18-06-2018

On 7 December 2016, the Competition and Markets Authority (CMA) issued a decision entitled “Unfair pricing in respect of the supply of phenytoin sodium capsules in the UK” (the Decision) addressed to Pfizer Limited and Pfizer Inc. (together, Pfizer), and Flynn Pharma Limited and Flynn Pharma (Holdings) Limited (together, Flynn). The CMA found that each company had abused their respective dominant positions. In relation to the prescription medicine phenytoin sodium (the Pfizer Flynn Capsules) both Pfizer’s supply prices to Flynn and Flynn’s selling prices to consumers were unfairly high, and therefore in breach of the Chapter II prohibition of the Competition Act 1998 and Article 102 of the Treaty on the Functioning of the European Union. As a result the CMA imposed fines of £84.2 million on Pfizer and £5.3 million on Flynn.

Pfizer and Flynn appealed the Decision to the Competition Appeals Tribunal (CAT), who overturned the Decision on 7 June 2018¹. Whilst the CAT ruled that the CMA was correct to find that both parties held a dominant position, it found that the CMA’s conclusions on abuse of dominance were in error. The CMA had misapplied the legal test for finding that the prices were unfair. In particular the CMA did not appropriately consider what was the right economic value for the relevant product and it did not take sufficient account of the situation of other comparable products, in particular the phenytoin sodium tablet. The CAT was invited to come to a new decision on abuse but declined to do so on the basis that the correct application of the unfair pricing test in this instance would involve detailed consideration of further information from the parties and the careful assessment of what normal competitive conditions might have been, which the CAT was not best placed to do.

The legal test for unfair (excessive) pricing², which we refer to further below, is that in order for a price to be considered excessive:

(i) the price of the product must be excessive (in United Brands, it was said that this could be calculated as the difference between the cost of production of the product and the selling price (the Excessive Limb); and

(ii) the price must be unfair either in itself (Alternative 1) or when compared to competing products (Alternative 2) (the Unfair Limb).

We summarise the CMA original decision (briefly) and the key findings of the CAT below as well as setting out our comment on the Judgement.

The CMA’s decision

1. Dominance

• The relevant markets were for Pfizer - Pfizer manufactured Pfizer Flynn Capsules - and for Flynn - the distribution of Pfizer Flynn Capsules.
• No switching was available for patients.
• There were weak competitive constraints from parallel imports and phenytoin sodium capsules marketed by NRIM Limited (NRIM) (the NRIM Capsules).
• There were significant barriers to entry.
• NHS and the Department of Health exercised no countervailing buyer power (or regulatory constraint).
• The parties were therefore dominant in their respective relevant markets.

2. Abuse – Excessive Pricing

• Excessive and unfair prices were changed by Pfizer and Flynn.
• The CMA determined the excessiveness of the price by reference to a cost plus approach.
• Under the cost plus approach, a return on sales (ROS) of no more than 6% was reasonable (Cost Plus) and the ROS for both parties throughout the relevant period was significantly above 6%, so the CMA determined the prices were excessive (the Excessive Limb was met).
• The economic value of the capsules was Cost Plus because there were no demand-side or non-cost factors to be taken into account. Therefore Pfizer and Flynn’s prices were unfair because the prices bore no reasonable relation to economic value of capsules.
• Because the prices were unfair in themselves (under Alternative 1), it was not necessary for the CMA to reach a conclusion on whether those prices were also unfair when compared to competing products (Alternative 2) (so the Unfair Limb was met).

The CAT’s key findings

1. Dominance

The CAT upheld the CMA’s assessment of a narrow relevant product market – the CAT determined that the CMA was right to exclude other anti-epilepsy drugs including NRIM Capsules and phenytoin sodium tablets manufactured by Teva UK Limited (the Teva Tablets) from the relevant market. This was because MHRA guidance issued in November 2013 advised that epilepsy patients be maintained on a specific manufacturer’s product. This had the effect of stopping NRIM growing its share of sales further even though the NRIM Capsules were cheaper than the Pfizer Flynn Capsules. This, combined with NRIM’s limited commercial strategy for the product (not to threaten Flynn’s position), meant that these products did not provide a competitive constraint on Pfizer and Flynn³. The CAT also rejected the appellants’ arguments that the relevant period should be divided up into shorter periods because the characteristics of the market were broadly similar over the whole period and the degree of competitive pressure exerted by NRIM was not sufficiently strong to constrain Flynn’s behaviour at any time⁴.

The CAT upheld the CMA’s finding of dominance – on the facts the CAT assessed that by early 2013 the Department of Health did not and was not able to exercise countervailing buyer power (or more accurately regulatory restraint) to effectively constrain Pfizer and Flynn’s conduct either as a buyer or a regulator⁵. This was in spite of the fact that the Department of Health (DH) had intervened five years before in relation to the pricing of the Teva Tablets. The CAT also agreed with the CMA’s assessment that the fact that Pfizer and Flynn were able to increase the price so significantly without materially losing market share was evidence of there being limited competitive constraints on Pfizer and Flynn⁶. The CAT therefore upheld the CMA’s finding that Pfizer and Flynn were dominant⁷.

2. Abuse - Excessive Pricing

The CAT ruled that the CMA was wrong in law in its assessment of the Excessive Limb – in the Decision, the CMA limited its assessment of this limb of the excessive pricing test by assessing what a reasonable rate of return would be for Pfizer and Flynn (a 6% return on sales) on top of the costs incurred in marketing the product (Cost Plus) and comparing that to the prices charged by the parties⁸. The CAT ruled that the CMA was

(a) wrong in law to restrict its Excessive Limb assessment to a Cost Plus approach, and to exclude other methodologies rather than seeking to establish a benchmark price (or range) that would have pertained in circumstances of normal and sufficiently effective competition using the evidence more widely available;

(b) wrong in law to adopt a Cost Plus methodology that produced a result that would have pertained in circumstances of perfect or, more accurately, idealised competition, rather than the ‘real world’; and

(c) made an error of assessment by relying only on the Cost Plus approach that it selected⁹.

The CAT explained that the United Brands test referred to the comparison of production costs and prices as an example of a method of calculating the excess and not the only or required method. It also ruled that competition authorities cannot simply choose the methodology that was most favourable to finding an infringement. The CAT also took issue with the selection of 6% as a reasonable rate return. The figure was taken from the Pharmaceutical Price Regulation Scheme (PPRS). Under the PPRS this figure is applied across the participating firms’ portfolio of products and there is scope within the PPRS for firms to exceed this. Meanwhile the parties suggested other possible benchmarks which were rejected by the CMA¹⁰.

The CAT ruled that the CMA did not apply the Unfair Limb correctly – the CAT ruled that the CMA wrongly relied on Alternative 1 (unfair in itself) without properly considering Alternative 2. The CAT ruled that whilst a competition authority could find there to be an infringement where a price is unfair under one Alternative but not the other, the authority must consider whether a prima facie case of fairness under one Alternative undermines the basis for the finding of unfairness under the other Alternative and produce a reasoned basis for determining that the Unfair Limb is satisfied¹¹. Whilst there are difficulties in identifying comparators, including the fact that cost information about the comparator product in question would be required, the CAT stated that the CMA was best placed to gather this information¹². The CAT determined that there was enough evidence to suggest that the Teva Tablets were a meaningful comparator which the CMA should have used to consider whether there was a prima facie case of fairness under Alternative 2¹³. The CAT rejected the use of the price of the product before the increase as a comparator¹⁴ (which may have been underpriced). The CMA also used the price in five other EU Member States as a comparator. However the CAT found that the CMA had failed to demonstrate in the Decision why prices across different EU Member States should be used a comparator¹⁵. Following C-177/16 Autortiesību un komunicēšanās konsultāciju aģentūra / Latvijas Autoru apvienība EU:C:2017:286 (Latvian Copyright), the authority must select the reference states in accordance with objective, appropriate and verifiable criteria¹⁶. As the CMA had not explained how and why the five reference states it used had been selected, the CAT was not in a position to determine if they were suitable comparators. The CAT referred to Pfizer’s submission that prices in other EU Member States may not be suitable comparators because sales were very small, the prices may have been artificially suppressed by regulatory intervention and, in any event, Latvian Copyright would require that parity of purchasing power be taken into account¹⁷.

The CAT ruled that the CMA failed to consider the economic value of the product – in applying both limbs of the excessive pricing test, the CMA must have regard to the economic value of the product in question to the customer or end user. “Economic value” is a legal rather than an economic concept. The CAT considered whether or not the fact that the end user was dependent on the product negated this value. Although putting a monetary value on patient benefit is not an easy task the CMA should have tried this rather than assessing it as nil¹⁸. Furthermore factors on both the demand side AND the supply side should be considered. The CAT noted that the outright rejection of “any value at all to patients” was “surprising”¹⁹ The CAT discussed how patient dependency should be looked at. Whilst it is hard to apply the concept of economic value for the product to patients where there is medical dependency, it does not mean that the economic value is zero. The CMA should have tried to work this out.

The CAT ruled that the difference in the price before and after the increase could not in itself be the basis for determining if a price was excessive or unfair – at the hearing, the CMA said that the CAT could consider the difference between the higher price and the price of the product before the price increase (the Price Comparison over Time) either as part of applying the two-limb United Brands excessive pricing test or on a separate basis for finding that the prices were unfair²⁰. The CMA made much in this case about the ‘percentage price increase’²¹. The CAT agreed that a large differential in the Price Comparison over Time could be indicative of unfair pricing abuse, but said that it should not be confused with the legal test itself²². In this case, Pfizer’s price of the old phenytoin sodium product had been eroded by the PPRS to the extent that it was (according to Pfizer) loss-making.

The CAT rejected Pfizer’s ground of appeal that, because of the vertical nature of the relationship with Flynn, it could not be in breach of Article 102 – the CAT noted that an outcome in which a dominant company could interpose a third party and thereby prevent the effective application of Article 102²³ would be ‘surprising’ and inconsistent with Article 102. Moreover it was evident that there was a joint strategy between Pfizer and Flynn to remove the product from the PPRS for the purpose of increasing their profit. The CAT therefore rejected this ground of appeal²⁴.

Comment

There are a number of points of interest about this landmark judgement. Firstly, it is clear from the CAT’s judgement that it does not consider that competition authorities are best placed to intervene in unfair (excessive) pricing cases. As the CAT notes:

“Cases of pure unfair pricing are rare in competition law. Authorities find them difficult to bring and are, rightly, wary of casting themselves in the role of price regulators. Generally, price control is better left to sectoral regulators, where they exist, and operated prospectively; ex post price regulation through the medium of competition law presents many problems.”²⁵

Whilst the CAT explained that there could indeed be cases where the competition authority takes an excessive pricing decision, the tone of the judgement suggests that the CAT leans towards the view of Advocate General Wahl in his opinion (A-G Wahl’s Opinion) in Latvian Copyright that one would normally expect the circumstances for an excessive pricing abuse only to occur in markets where regulation or other barriers to entry protect a market from competition or where there has been a regulatory failure.

Secondly, there appears to be some tacit criticism of the DH²⁶. As the CAT notes, the DH’s engagement with the parties and the extent of its powers were key issues in the case. The Judgement notes this and regrets the DH’s lack of involvement in the case, stating that its task would have been easier with direct evidence from the DH. Whilst the CAT did not accept the appellants’ arguments that there was scope under the law at the time for the DH to intervene to force them to lower their prices, there is undoubtedly a question mark over its conduct. In the judgement the CAT treats the points about the DH’s involvement at a high level, which may suggest that they were not in a position to make a detailed assessment of this.

Thirdly, the judgement provides helpful guidance on the interpretation of the excessive pricing case law (e.g. on the discrepancies between A-G Wahl’s Opinion and the final Latvian Copyright judgement). The CAT agreed with Flynn’s counsel that much of A-G Wahl’s Opinion drew on established principles and that both the Advocate General and the court in Latvian Copyright had given useful guidance as to how a court or competition authority should approach an unfair pricing analysis. The CAT also found A-G Wahl’s Opinion to be very persuasive and his overall analysis to be ‘eminently sensible’²⁷. Although the CAT would not step into the CMA’s shoes and determine how the excessive pricing test should have been applied in this case, it does helpfully set out all the steps an authority should take in applying the test²⁸.

Fourthly, the judgement puts the CMA in a difficult position. The CAT had real issues with the CMA’s approach of assessing the whole excessive pricing test by reference to the degree to which a company’s profit exceeded (what the CMA considered to be) a reasonable rate of return, and not taking into account the value of the products in question and the nature of certain markets in practice. If the CMA accepts the CAT’s decision, it will need to investigate these issues much more comprehensively. This will make conducting an excessive pricing abuse of dominance investigation, which is currently difficult, even less appealing. Moreover, the CMA indicated in its recent press release²⁹ that it has “several active investigations” which may now be “severely delayed”.

Finally, we note that the CMA is actively considering whether to appeal this judgement. It seems likely that the CMA will appeal this decision, particularly given the fact that the CMA has a number of other investigations which may hinge on this Judgement (see above). Given the high barriers the CAT has imposed on the CMA for bringing excessive pricing cases in the Judgement, it is not inconceivable that the Court of Appeal might overturn the Judgment, at least in part.

0. Flynn Pharma Ltd and Flynn Pharma (Holdings) Ltd v Competition and Markets Authority & Pfizer Inc. and Pfizer Limited v Competition and Markets Authority, [2018] CAT 11 (the Judgement). A copy of the Judgement can be found here.
0. First described in C-27/76 United Brands v Commission EU:C:1978:22 (United Brands) (paragraphs 251 to 252).
0. Paragraph 196 of the Judgement.
0. Paragraph 195 of the Judgement.
0. Paragraph 234 of the Judgement.
0. Paragraph 244 of the Judgement.
0. Paragraph 253 of the Judgement.
0. Paragraph 266 of the Judgement.
0. Paragraph 310 of the Judgement.
0. Paragraph 340 of the Judgement.
0. Paragraph 367 of the Judgement.
0. Paragraph 380 of the Judgement.
0. Paragraph 392 of the Judgement.
0. Paragraph 400 of the Judgement.
0. Paragraph 402 of the Judgement.
0. Paragraph 402 of the Judgement.
0. Paragraph 401 of the Judgement.
0. Paragraph 419 of the Judgement.
0. Paragraph 412 of the Judgement.
0. In paragraph 253 of United Brands judgment, the court stated that there were “other ways” (aside from the two limb test) by which a price could be considered excessive.
0. See for example the CMA’s press release ‘CMA fines Pfizer and Flynn £90 million for drug price hike to NHS, 7 December 2016’ which refers to “prices increasing by up to 2,600% overnight”.
0. Paragraph 439 of the Judgement.
0. Paragraph 455 of the Judgement.
0. Paragraphs 457 and 458 of the Judgement.
0. Paragraph 3 of the Judgement.
0. Paragraph 82 of the Judgement.
0. Paragraph 307 of the Judgement.
0. Paragraph 443 of the Judgement.
0. CMA considers appeal in phenytoin case, 7 June 2018.