Illinois ex rel. Hartigan v. Panhandle Eastern Pipe Line Co.

FAIRCHILD, Senior Circuit Judge.

This appeal involves a treble damage action on behalf of Illinois consumers of natural gas. These consumers buy from distributors, who buy from defendant Panhandle, an interstate pipeline company. It is alleged that Panhandle violated the antitrust laws and overcharged the distributors. Under public utility regulation, one component of the price the distributors charge the consumers is the cost of gas to the distributors. It is claimed that Panhandle’s overcharge is thus passed on to the consumers; because they are only indirect purchasers from defendant, they can claim injury in a treble damage action only if their purchases are within an exception to the rule of Illinois Brick Co. v. Illinois, 431 U.S. 720, 97 S.Ct. 2061, 52 L.Ed.2d 707 (1977).

Plaintiff argues, in substance, that the public utility regulation creates a sufficiently close approximation of a pre-exist-ing cost-plus contract for a fixed quantity so as to fulfill that exception. 431 U.S. at 736, 97 S.Ct. at 2069. The district court agreed and denied Panhandle’s motion to dismiss. Permission for this appeal was obtained pursuant to 28 U.S.C. § 1292(b). We reverse.

Plaintiff is the state of Illinois. It is both a direct and indirect purchaser of natural gas from Panhandle, but the State’s claims as to direct purchases are not before us. The state also sues as parens patriae on behalf of natural persons residing in Illinois¹ who are indirect purchasers from Panhandle, and also brings a class action on behalf of all indirect purchasers from Panhandle.

The complaint did not spell out a claim that these indirect purchasers fall within an exception to Illinois Brick. Plaintiff alleged only that it had been injured in its business and property. Facts illuminating the claim of an exception to Illinois Brick have, however, been brought before the district court. There has been no argument that the pleading was deficient, that the claim of exception was waived, or that the issue cannot be decided on the present record.

Central Illinois Light Company (CILCO) is one of the distributors of Panhandle gas (along with smaller quantities of gas of other producers). There are distributors other than CILCO, and their customers are among the consumers represented by the State in this action. The parties have concentrated their discussion, however, on the CILCO facts, and appear to accept them as representative.

CILCO’s monthly bills to its customers contain three components: (1) an amount per customer not dependent on the amount of gas used; (2) an amount per therm of gas used, calculated to recover a share of fixed expenses and provide a profit margin; and (3) a gas charge factor. Through a process of estimate in advance and retrospective adjustment,² the gas charge factor approximates the actual cost of gas, but without perfect accuracy at any one time. As plaintiff looks at it, component (3) represents the “cost” and components (1) and (2) the “plus” in analogizing to the cost-plus exception in Illinois Brick. The arrangement has no element which corresponds to the agreed quantity element of that exception.

For the purpose of discussion, it is convenient to separate CILCO’s customers into two groups:

(a) Sixteen Large Industrial Customers

These customers are able to switch to alternate fuel. In 1983, CILCO was threatened with the loss of these customers because of the high cost of gas. A loss of up to 20% of its sales was expected. CILCO responded by obtaining permission from the regulators to reduce its profit margin and thus its price for gas for a four-month period. Although in form there was no reduction in component (3), and component (3) included the unlawful overcharge if there was any, the reduction in the profit portion of component (2), and consequently in the total price, made it unreal to say that the full amount of any overcharge was passed on. Thus there was necessarily an injury to CILCO if some part of the cost resulted from an unlawful overcharge. Hence, it is especially clear as to these customers that there is no Illinois Brick exception. The relationship between CILCO and these industrial customers did not approach a cost-plus contract for a fixed quantity. Moreover, if the industrial customer were permitted to press a claim on a pass-on theory, it could not claim that it suffered the entire injury. Apportionment between the direct and indirect purchaser would be required, precisely the process rejected by the Illinois Brick Court. 431 U.S. at 746, 97 S.Ct. at 2074.

(b) Residential and Other Smaller Quantity Consumers

These consumers, like the large industrial customers, have no obligation to purchase any particular quantity of gas. Their demand is elastic to some degree, and a high price (including an unlawful overcharge, if any) will reduce CILCO’s sales and profits. Consumers of this type can to some extent use alternative fuels, and they have resorted to conservation in response to an increased price.

CILCO sold 46,400,000 Mcf of gas in 1982, but its sales decreased by 14.7% in 1983 and 2.3% in 1984. It lost 1,061 customers in 1983 and 693 in 1984. Increased prices thus reduced CILCO’s sales and profits as well as being passed on to customers to the extent of sales made. Assuming that the prices charged CILCO by Panhandle included an unlawful overcharge, it had adverse consequences on both CILCO and its customers. Again, if the customers’ claims were to be recognized, there must be apportionment of recovery between the direct and indirect purchasers.

As the Illinois Brick Court observed, with respect to the pre-existing cost-plus contract,

[i]n such a situation, the purchaser is insulated 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. The effect of the overcharge is essentially determined in advance without reference to the interaction of supply and demand that complicates the determination in the general case.

431 U.S. at 736, 97 S.Ct. at 2069.

As is evident, plaintiff here cannot really claim that CILCO’s relationship with its customers falls literally within the confines of a pre-existing cost-plus contract for a fixed quantity. Plaintiff does, however, assert that the relationship is the “functional equivalent” of a cost-plus contract for a fixed quantity, and relies on In re Beef Industry Antitrust Litigation, 600 F.2d 1148 (5th Cir.1979).

In Beef Industry, defendants were retail chains which allegedly conspired to fix at low levels the prices to be paid packers for beef. The packers allegedly computed the price they paid cattlemen by a formula based on the price the packers were to receive. The plaintiffs were cattlemen, claiming that the unlawful undercharge was passed on to them. The Fifth Circuit held that plaintiffs had alleged the functional equivalent of cost-plus contracts, and thus an exception to the Illinois Brick rule which would otherwise have prevented recovery by an indirect seller.³

In Beef Industry, the court noted that economic forces made the supply of fat cattle “inelastic in the short term.” 600 F.2d at 1154. It is not clear, however, that the court relied on this inelasticity as the functional equivalent of the predetermination of volume inherent in a cost-plus contract for a fixed quantity. “Functional equivalence is not lost simply because the proponent of passing-on theory cannot demonstrate that the middleman suffered no loss in volume as the result of raising the price to his customers.” 600 F.2d at 1164.

In our view, however, the Illinois Brick Court regarded the predetermination of quantity as an essential element of the exception. Thus there could be a “functional equivalent” of a cost-plus contract for a fixed quantity only where factors such as obligations imposed by law or economic forces or a combination of them made inevitable an exact passing on of price variation applied to a predetermined quantity to the same extent as a contract so providing.⁴

In Hanover Shoe v. United Shoe Machinery Corp., 392 U.S. 481, 494, 88 S.Ct. 2224, 2232, 20 L.Ed.2d 1231 (1968), in suggesting that “a pre-existing ‘cost-plus’ contract” would be an exception to the Hanover rule against a pass-on defense, there was no express reference to the fixed quantity element of the cost-plus contract. In Illinois Brick, in describing the same exception, there was such a reference, and an explanation of its importance:

In such a situation, the [direct] purchaser is insulated 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....

As we have noted, supra [431 U.S.] at 735-736 [97 S.Ct. at 2069-2070], Hanover Shoe itself implicitly discouraged the creation of exceptions to its rule barring pass-on defenses, and we adhere to the narrow scope of exemption indicated by our decision there.

431 U.S. at 736, 745, 97 S.Ct. at 2069, 2074.

It appears in the case before us that Panhandle’s alleged antitrust violations would produce actual injury to both the direct and indirect purchasers. The indirect purchasers pay a higher price per therm of gas because Panhandle’s price is reflected in the price they pay. CILCO, the direct purchaser, is injured by loss of sales and profit. Where this is so, we conclude that Illinois Brick does not permit the indirect purchasers to sue for their part of the injury. It may be that because of the utility regulation requiring that CILCO’s cost per therm be passed through to its customers, the avoidance of multiple recovery against Panhandle will be less complex than in a case where the direct purchaser’s price to the indirect purchaser will be the result of less channeled market forces. It may be easier to separate accurately the injury to the indirect purchasers from the injury to CILCO. Illinois Brick did not, however, leave it to the discretion of the lower courts to expand the exceptions to include situations within some range of approximation of the exceptions defined in Illinois Brick. We read Illinois Brick as requiring that in this, as well as more complex cases, it is only the direct purchaser who may bring a treble damage action.

The order appealed from is Reversed, with directions to dismiss the complaint as to all claims by or on behalf of indirect purchasers.

1 . 15 U.S.C. § 15c.

2 . Under the Purchase Gas Adjustment (PGA) process, CILCO estimates the purchases, costs and sales in a future period, computes the cost for that period and adjusts its rates prospectively to reflect the estimate. At the end of each year, the estimated and actual costs are reconciled. In 1983, CILCO overcollected more than $3 million, and in 1984 more than $1 million. Overcollections are refunded through adjustments in the following year. A customer who terminates service before the refund does not receive it. A customer who used less gas in the refund period than he used in the overcollection period does not receive a full refund.

3 . On remand, it developed that plaintiff could not, in fact, demonstrate the habitual use by the packers of a predetermined formula, as alleged, preventing the packers from absorption of some of the undercharge. Judgment was granted to defendants. 542 F.Supp. 1122 (N.D.Tex.1982), affirmed 710 F.2d 216 (5th Cir.1983).

4 . Plaintiff has cited a case involving the regulated distribution of natural gas and a PGA mechanism similar to the one before us. New Mexico Natural Gas, CCH 1982-1 Trade Cases ¶ 64,685, p. 73,714 (D.N.M.1982) [Available on WEST-LAW, 1982 WL 1827]. Treble damage actions were brought by and on behalf of consumers who purchased from a defendant distributor, who purchased from defendant producers. Producer defendants sought summary judgment based on Illinois Brick. The New Mexico court denied the motion, finding an exception because two policy considerations underlying Illinois Brick were not significant in the case before it. One of the policy considerations was the difficulty in tracing the pass-on of an overcharge. The New Mexico court decided that the PGA clauses obviated this concern. The second policy consideration was the risk of multiple liability if indirect as well as direct purchasers could sue. The New Mexico court found this concern was not significant in the case before it. The cotut relied on the fact, which it acknowledged was unusual, that the distributor was a defendant and alleged to be a partner with defendant producers in the price-fixing conspiracy, and would be precluded from suing its co-conspirators. The New Mexico court did not address the question whether the demand for gas is elastic and the distributor (direct purchaser) may have been injured by loss of sales volume. The New Mexico Gas case is distinguishable.