Damages caused by cartels

In accordance with the principle of full compensation, damages awarded in a private antitrust lawsuit shall correspond to the harm suffered by the victims. Thus, in its Manfredi judgement of 13 July 2006, the Court of Justice of the European Union has defined a minimum standard of recoverable antitrust damages. Notwithstanding the fact that it is for the domestic legal system of each Member State to lay down the detailed rules governing the exercise of rights which individuals acquire directly under EU law, the ECJ points out that the Member States are under the Union law obligation to respect both the principle of equivalence and the principle of effectiveness [Cases C-295/04 to C-298/04, para 98]. Therefore, as far as damages are to be awarded on the basis of an infringement of Article 101 of the Treaty on the Functioning of the European Union (TFEU), it follows from the principle of effectiveness and the right of any individual to seek compensation for loss caused by a contract or by conduct which in effect restricts or distorts competition that injured persons must be able to seek compensation ‘not only for actual loss (damnum emergens) but also for loss of profit (lucrum cessans) plus interest’ [ibid., para 95].

-    The origins of cartel damages
-    How do cartels affect customers?
-    What are cartel damages?
-    Claims enforcement costs
-    Passing-on defence

The origins of cartel damages

Economic analysis has produced both a wealth of theoretical models and empirical cartel studies, aiming to offer insights into the inner workings and effects of cartels. The likelihood of cartel formation is dependent on the firms’ conscious decision to conspire to raise prices at the cost of their customers and to the potential detriment of consumers. From a theoretical economic perspective, in order for cartels to operate successfully, two constraints should be satisfied. First, the so-called ‘participation constraint’ must be satisfied for firms to join cartels, and second, the ‘incentive compatibility constraint’ must be satisfied so that the cartel can remain intact. In order to prevent cartel members from cheating on each other by attempting to sell extra quantities at the elevated price in order to increase one’s profits, cartelists have established different ways of monitoring and punishing such behaviour. The credible threat of such punishment is often an effective way to stabilise collusive arrangements.

The economics of cartels reveal that the easier it is to satisfy the participation and incentive compatibility constraints, the easier to sustain cartels. There are a number of factors which may be conducive to cartel stability. Below, a non-exhaustive list of examples of such market characteristics is presented:
 

• Cartels are relatively more prevalent in concentrated markets, in which a few large sellers account for the vast majority of sales. There are two reasons why concentrated markets facilitate cartels. First and foremost, a smaller number of players in the market makes it a priori easier to agree on any desired outcome (for example, price or quantity to be set) as well as to renegotiate those over time. Secondly, cartels tend to be more resilient when fewer players have to be monitored. In addition, the fewer players there are, the lower will be the incentives to deviate from the agreement (less profit to be earned in return) and the higher will be the punishment.
• In homogenous goods markets (such as cement) cartels are more likely than in the markets for heterogeneous products (such as cars). Homogeneity of products facilitates, amongst others, price comparisons and more transparency of expected market behaviour (for example, after symmetrical demand shocks). This can make monitoring and punishing deviators easier and less costly.
• A higher degree of transparency of information regarding prices, quantities, costs and technology allows the cartel members to identify deviations more easily and target their punishment. In many cartel cases, industry and trade associations have been forums for information exchange beyond what was non-sensitive common knowledge in the market. In a similar way, some forms of vertical agreements, such as meeting-competition clauses (whereby if a buyer receives a better offer from another supplier, the supplier will match a more competitive price quote) or resale price maintenance obligations, make the market more transparent and can increase the chance of deviations being detected.
• Symmetry of market players with regards to market shares, production technologies, costs, capacities etc. is conducive to cartels in so far as it makes it easier for firms to come to a common agreement.
• In markets characterised by high barriers to entry, such as absolute cost advantages of incumbent suppliers, economies of scale in production, sunk costs, consumer switching costs, brand loyalty and reputation, it can be easier for cartelists to sustain agreements when potential entrants face high costs and/or expect aggressive pricing upon entry. 
• Regularity and frequency of orders. The more frequent and/or smaller the orders in the market are, the less is the likelihood that cartelists deviate from a cartel agreement, as profits to be obtained by such deviation will be comparatively low. 
• Cross-ownership and other links among competitors increase the likelihood of cartels in the market because the incentives to compete are reduced since a company’s profit is linked to the performance of its competitors and vice-versa. 
• Weak buyer power enhances cartels as buyers fail to stimulate competition among sellers through, for example, threats of changing suppliers, a potential captive use through backward integration or inducing sellers to deviate from the agreement by aggregating their orders (see regularity and frequency of orders above) – all of which can be done more easily by buyers with a strong market power. 
• Demand stability increases the degree of market transparency as the likelihood of future demand shocks is smaller. This makes deviation easier to detect as well as punishment easier to implement (see transparency of information above).

How do cartels affect customers?

Whereas vertical agreements (that is, distribution and supply agreements) or mergers can have pro-competitive or welfare-enhancing effects, the (horizontal) exchange of sensible information among competitors (concerning production figures, sales volumes, prices, capacities or other price relevant data) or agreements to raise or fix prices, to carve up markets or allocate market shares, undermine the competitive process. Such behaviour increases the profits of the cartel members to the detriment of the customers. Cartels are viewed as the most severe violation of competition law. They are often referred to as ‘hardcore’ violations because they typically lack efficiency-enhancing or otherwise countervailing pro-competitive effects. Cartels seek to internalize the negative effects that any firm’s decisions have on the profitability of its competitors. By subverting the competitive process, cartels distort the market in which they operate and will impose extra costs on customers, non-participating competitors and suppliers. Customers of the cartel face substantial increases in input and/or production cost when cartel members conspire to fix prices at elevated target levels or to prevent price erosion. They tend to do this in a number of ways. The following are the most well known practices:

• Price fixing is probably the most common form of cartel behaviour. It involves the agreement among competitors to increase and maintain the price of the product at a higher than the competitive level without mutual undercutting. Such practice often results in prices approaching the monopoly level. Likewise, cartel members earn substantial profits above a normal (imperfectly) competitive return.
• Market allocation is the result of agreements under which cartelists sell exclusively into a certain geographic market or serve certain types of customers exclusively. Such agreements are intended to create local monopolies, creating local market power and effectively setting higher prices that are protected by agreement to respect each others’ home turf.
• Bid rigging is a form of price fixing or market allocation whereby the cartel members predetermine the lowest price to be offered and/or the winner of the commercial contract in question. The other companies do not bid at all or bid exclusively higher priced offers to ensure the successful implementation of the agreement.
• Restricting the industry output (for instance as a result of ‘mothballing’ capacity) can lead to higher prices than under a functioning, unaffected supply and demand mechanism, namely, as a consequence of the relative product scarcity on the market.
  

What are cartel damages?

Cartels impose massive losses on customers, non-participating competitors, suppliers and final consumers. Partly, the effects are direct in the sense that the injury is incurred instantaneously, upon purchase, so to say, while other cartel effects tend to be more indirect or long-term. Direct cartel effects are the actual losses, lost profits and interest. Indirect effects are market inefficiencies and other structural effects.

Direct cartel effects

•    Actual loss (overcharge)
The overcharge is often used as the basis for estimating the losses attributable to the violation of competition law. Given that there are several dimensions in which the cartel may affect its customers, the overcharge is, however, only part of the total effect of cartel agreements and must be seen as a lower bound for losses. Conceptually, the overcharge is the difference between the actual market price observed during the cartel and the hypothetical price that would in all likelihood have prevailed but for the cartel arrangements. Actual loss for a single entity is, therefore, considered to be the price overcharge multiplied by the quantity of the product purchased during the period in which the cartel resulted in price effects. According to established case law there is a factual assumption that hardcore cartels will regularly lead to an overcharge at the expense of other market participants (see Damage Quantification).

•    Loss of profit
Purchasers usually incur additional damages by a cartel as a result of restricted output quantities. Specifically, if supply decreases, purchasers are faced with smaller quantities of a good than they would face under the competitive circumstances. In this case, the actual damage calculation depends on each individual situation, that is, the profit a purchaser would have had if he or she had purchased additional quantities at the non-cartelized price. According to the Manfredi judgment of the ECJ, ‘[t]otal exclusion of loss of profit as a head of damage for which compensation may be awarded cannot be accepted’ in the case of a breach of EU law since, especially in the context of economic or commercial litigation, ‘such a total exclusion of loss of profit would be such as to make reparation of damage practically impossible’ [Cases C-295/04 to C-298/04, para 96].

•    Interest (opportunity cost)
To account for the full damage incurred by the establishment of a cartel on the market, one must consider the interest accumulated upon the value of the loss itself. In other words, the interest amount can be regarded as the opportunity cost or the forgone chance to invest. In the Manfredi judgment [ibid., para 97] the ECJ stated that ‘full compensation for the loss and damage sustained […] cannot leave out of account factors, such as the effluxion of time, which may in fact reduce its value. The award of interest, in accordance with the applicable national rules, must therefore be regarded as an essential component of compensation’. The ECJ’s objective is thus to ensure that the victim is given the real value of the loss suffered. This suggests that under EU law interest must be paid from the time the damage occurred until the capital sum awarded is actually paid. With regard to the amount of the interest rate concerned, it follows from the Marshall case that the award of interest must be ‘adequate’, which means that it must enable the loss and damage actually sustained as a result of the breach of EU law ‘to be made good in full’ in accordance with the applicable national rule [Case C 271/91, para 26]. Similarly, the German Act against Restraints of Competition, for example, stipulates that, as from the day the damage occurred, the infringer shall pay interest of at least five percent over the base rate per year on its obligations to pay damages.

Indirect cartel effects

•    X-inefficiency
The so-called ‘X-Inefficiency’ represents the ‘gap’ between the actual and minimum attainable average production costs. A lack of competitive pressure induces cartel members to maintain excessive production cost structures. As a result, ineffecient players often remain in the market. Likewise, cartels diminish incentives to innovate and/or invest in R&D. As a consequence, possible product or production technology improvements are not implemented and overall welfare is reduced both by lost product quality and/or diversity, as well as high prices. Altogether, cartel formation and the consequent lack of competitive forces fail to stimulate the potential for dynamic efficiency in the market.

•    Long-term structural effects on the market
Cartels normally have a lasting and detrimental effect on market structures by, for example, forcing competitors to exit the market. This is often done by using common battle funds, entry deterrence through predatory pricing, raising rival’s cost, and coordinated import purchases and quantity reallocations among the cartel members. Barriers such as common standards or allocation of resources prevent future competitors from entering the market. By these means, notably widespread and long term cartels influence markets and competition still after being terminated. In other words, increased prices and profits of former cartel members have significant lingering effects. The resulting damage is therefore often perpetuated long after the cartel has officially been investigated or fined for its activities.

Claims enforcement costs

Preparing and enforcing antitrust damage claims involves considerable efforts in terms of time, money and personnel. This might lead to significant financial losses as well. Such costs cannot fully be reclaimed from the defending party under the ‘loser pays’ rule contained in most of the European civil procedural systems, even if the claimant prevails in court.

The courts in Europe have not yet decided whether such further losses incurred by the cartel have to be compensated by cartel members. In the US, antitrust law provides the legal basis for mandatory treble damages. It is a common misunderstanding in Europe that such damages only serve as deterrence and punishment mechanisms. In fact, they also have a compensatory function, as they serve to assure that plaintiffs fully recover any losses caused by antitrust law violations. In the US, trebling is considered appropriate in cartel cases because the sole compensation of price overcharges would fail to measure the total harm suffered by the victims. It is therefore no surprise that in the European debate on private enforcement, independent entities (such as the German Monopolies Commission) advocate at least double damages. In the Italian Manfredi proceedings, the Justice of the Peace of Bitonto did award the claimant double damages in 2007; an appeal is currently pending before the Italian Court of Cassation. At the very least, national courts might consider further losses caused by cartels as a ‘plus-factor’ in the context of their damage estimation, in order to achieve the objective of full compensation as confirmed by the ECJ in its Manfredi decision.

Passing-on defence

In the context of antitrust damages, cartel members often refer to the ‘passing-on defence’. The argument purports that a direct customer of the cartel members fully or partially passed on the illegal price overcharges to his own customers, that is, indirect purchasers. It is said that the direct purchaser therefore has sustained only a reduced damage.

However, the passing-on defence is not a question of the occurrence of loss, but of its compensation. Direct purchasers are immediately damaged by the conclusion of purchase agreements that establish an obligation to pay a price above the hypothetical market price. This corresponds to the fact that a plaintiff does not need to demonstrate in court that he has not passed on the overcharge to its own customers. With a view of clarifying the subject, the German 2005 Act against Restraints of Competition explicitly states that the ‘damage is not precluded because of the resale of goods or services’ by the direct purchaser.

The passing-on defence can, if acknowledged at all, be justified only in few situations, as passing-on is an exception from the rule. The passing-on argument presupposes an inherent causal link between the price overcharge paid by the direct purchaser and the payments he received from his own customers. Such a link might be seen in ‘cost plus’ agreements between direct and indirect purchaser. However, the direct purchaser’s success in reselling his products or services at higher prices to the next market level generally results from his own commercial efforts, not from the fact that he had to pay overcharges. Cartel members should generally not benefit from the performance of their direct customers. On these and other grounds several national courts in Europe such as the Higher Regional Court of Berlin [Berlin Ready-mixed Concrete (2009)] have denied the passing-on defence in total. The US Supreme Court has also practically excluded the passing-on defence [Hanover Shoe, Inc (1968)].

At the very least, as the European Commission clarifies in its 2008 White Paper, the cartel members shall have the burden of substantiating and proving the passing-on of overcharges in each case. Undoubtedly, allowing the passing-on defence will significantly prevent direct purchasers from enforcing antitrust damage claims, thus weakening the private enforcement of antitrust law, and resulting in an unjust enrichment of the infringers and a perpetuation of the cartel effects.

Read about the quantification of cartel damages

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