A decision re-made: the CAT's decision on phenytoin sodium 

On 20 November 2024, the Competition Appeal Tribunal (CAT) rejected the Competition and Markets Authority's (CMA) revised decision to fine Pfizer and Flynn Pharma (the Appellants) £63.3 million and £6.7 million respectively for engaging in excessive and unfair pricing with regards to various dosages of phenytoin sodium capsules, constituting an abuse of a dominant position in a market, infringing Chapter II of the Competition Act 1998 (CA98). The CAT also took the unusual step to remake the decision, issuing comparable fines for the same infringements of £62.3 million and £6.7 million respectively.

What you need to know

• The CAT criticised the economic methodology the CMA used in applying the United Brands legal test for ascertaining excessive and unfair pricing, finding that the original decision cannot be sustained.
• The CAT then exercised its seldom-used power to remake a decision it finds to be untenable, signalling the latest step in a trend of heightened scrutiny of CMA decisions.
• Despite the outcome being similar in practical terms, the judgment highlights the importance for regulators to propose a robust economic methodology when alleging behavioural abuses.

Background

In December 2016, the CMA fined Pfizer and Flynn Pharma £84 million and £5.2 million respectively in respect of excessive and unfair pricing practices regarding branded and generic versions of phenytoin sodium capsules (a drug used to treat epilepsy). The parties successfully appealed the CMA's decision in the CAT. On appeal, the Court of Appeal held that the matter should be remitted to the CMA for further consideration. 

The CMA commenced its remittal investigation in June 2020 and issued its final decision in July 2022, making the same findings and issuing revised fines of £63.3 million for Pfizer and £6.7 million for Flynn. Pfizer and Flynn appealed the decision to the CAT which handed down its judgment on 20 November 2024.

Legal context: the United Brands test

The seminal authority on excessive pricing is a 1978 judgment from the European Court of Justice (Case 27/76 United Brands) concerning the supply of bananas. The United Brands test stipulates that in order for pricing practices to constitute an abuse of a dominant position: 

• the price charged for the relevant product must be excessive; and
• the imposition of such an excessive price is also "unfair", either intrinsically or by reference to competing products.

Excessive pricing

The CMA's approach

In conducting a "cost-plus" methodology (i.e. assessing the cost of producing phenytoin capsules plus a reasonable rate of return), the CMA departed from the more traditional approach of applying the Return on Sales (ROS) methodology, in favour of the Return on Capital Employed (ROCE) methodology.

The CMA argued that any producer surplus above a reasonable rate of return was indicative of excessive pricing. The CMA's position was that producer surpluses should not exist in a competitive market and that prices should trend towards cost plus a reasonable return.

The CAT's criticism

The CAT had three main criticisms of the CMA's approach to the excessive pricing limb:

• First, the shift from the traditional ROS assessment to the ROCE methodology was not adequately objectively justified.
• Second, the CMA did not exercise careful judgment when calculating the reasonable rate of return by reference to the weighted average cost of capital.
• Third, the CMA did not consider comparables that are active in "real world competition" despite the fact that comparables have traditionally only been considered in the context of assessing unfair pricing.

The judgment places emphasis throughout on the CMA's approach regarding producer surplus. The CAT indicated that it is important to consider producer surplus and that its existence cannot be presumed because the excessive limb is satisfied. However, the judgment also notes that "the existence of Producer Surplus over the course of a reasonably lengthy “relevant period” is a good indicator of excess". Having addressed both sides of the debate regarding producer surplus, the CAT appears to have left the excessive limb test of United Brands largely unchanged (i.e. prices above cost-plus are excessive unless justified). 

In addition to comparing the Appellants' capsules to comparable products in the context of "real world competition", the CAT proposed two tests that were useful in generally ascertaining excessive pricing:

• "excess ought to be demonstrable", i.e., one should not observe a price in isolation and judge "that looks excessive to me"; and
• the temporal persistence of a high profit margin.

Unfair pricing

The CMA's approach

The CMA used two alternative tests to assess whether prices charged by the Appellants were unfair.

• The unfair in itself test, which examined whether the prices charged bore a reasonable relation to the economic value of the capsules. Pursuing the cost-plus approach, the CMA concluded that the prices were unfair in themselves because they were very high relative to costs reasonably incurred, suggesting that the prices charged did not reflect any demand-side factors or the economic value attributable to the capsules.
• The unfair when compared to competing products test, which evaluated whether the prices were unfair in relation to the prices of other products that could be considered as meaningful comparators: for example, the same drug sold in other European countries. The CMA rejected the comparators proposed by the Appellants (such as tablets and other drugs used for the same condition) on the grounds that they were not sufficiently similar to phenytoin capsules in terms of therapeutic benefit, substitutability, market conditions and regulatory framework.

The CAT's criticism

The CAT affirmed the United Brands test as to unfairness: i.e., a price charged must be unfair "in itself" and/or "when compared to competing products". However, the CAT considered the tests to be interlinked meaning that the if a price is not unfair in comparison to competing products then the argument that the price is unfair in itself is likely to be weak. 

The CAT emphasised that in relation to the unfairness test the question is whether the existence and extent of the producer surplus is justifiable:

"The Unfair Limb is predominantly concerned with the Producer Surplus and its justifiability. If the Producer Surplus, including in particular its extent, can be justified, then the Product Unit Price can properly be found to be fair, and the Unfair Limb accordingly left unsatisfied. Put another way, whereas the Excessive Limb is concerned with the existence of Producer Surplus, the Unfair Limb is concerned with its justifiability. From this it follows that a cost plus approach to the Unfair Limb is the wrong approach."

The CAT considered the unfair limb is not concerned with ascertaining the "true" or "fair" price but with whether prices are too high over the alleged infringement period. This assessment will involve the weighing of multiple factors, including the classification of the producer surplus. 

The economic value of the product was considered to be closely related to the points surrounding producer surplus. In "real world competition", the economic value of a product can be equated to the price paid, due to the role of choice in the creation of the consumer surplus. In "impaired competition", this distinction cannot be made "because the existence of abuse cannot be tested for".

The CAT found that the CMA's unfair in itself test was incorrect on the basis that it was determined primarily by reference to factors relevant to the Excessive Limb and not to the Unfair Limb. The CAT also found that the CMA's unfair when compared to competing products test was based on an unreasonable and inconsistent rejection of the comparators proposed by the Appellants which could have provided some indication of the normal competitive price or the economic value of the capsules.

The decision re-made

Having found that the CMA's decisions could not stand, the CAT exercised its powers under section 46(1) CA98 to remake the decision. The CAT noted the need for separate excessiveness and unfairness analyses given that Flynn was a downstream purchaser from Pfizer.

Flynn

Excessive pricing analysis: the CAT applied a cost-plus methodology, considering the average profit margin over the relevant period. A different benchmark for a reasonable rate of return was employed, the per unit cost of capital to produce a single unit of the product. The reasonable rate of return was compared to the ROS, and the CAT considered that "a percentage reasonable rate of return could not possibly exceed 30%, and even that is high" (Flynn's ROS was consistently >35%) and on this basis "Flynn's profit margin is demonstrably immoderate". 

Unfair pricing analysis: the CAT used the "real world competition" comparator. The CAT considered that "it is difficult to see what value Flynn is providing so as to justify any producer surplus. Flynn is simply distributing products".

Pfizer

Excessive pricing analysis: the CAT found that Pfizer's prices were excessive, in light of a reasonable rate of return of 15%, calculated by reference to the time value of money and the impetus to reward entrepreneurs' risk-taking. With profit margins ranging from 38%-700%, Pfizer's prices were also assessed to be demonstrably excessive. 

Unfair pricing analysis: the CAT considered the objective health benefits to be a key factor to the product's economic utility. The CAT noted (i) the relative need for producer surplus with successful products given the need to recoup failed R&D investment, especially in the pharmaceutical sector, and (ii) the "real good" caused by the drugs which together justified the existence of some producer surplus. Despite these mitigating factors, the CAT noted that a producer surplus of 96% was clearly unfair and abused the Medicines and Healthcare products Regulatory Agency's advice not to switch brand to reap supernormal profits.

Fines

The CAT re-made the decision to find that the Appellants had engaged in excessive and unfair pricing during the relevant period for nearly all denominations of capsules investigated by the CMA and imposed comparable fines to those imposed by the CMA.

Comment

By exercising its rarely used power to remake the decision, the CAT emphasised the necessity of producing a robust economic methodology when alleging abuses of dominance contrary to Chapter II CA98. Accordingly, the CAT reminded practitioners that it is not enough to review a set of prices "and to say: "that looks excessive to me"."

Of particular interest will be how this judgment interplays with the newly handed down Le Patourel collective proceedings ruling which also concerns excessive and unfair pricing. In Le Patourel, the CAT concluded that the prices were excessive but not unfair (see our December 2024 update).