Parallel Trade in Europe - the Tide is Turning

James Killick writes:[1]

Parallel trade has been around for almost as long as the European Community. But the nature and scale of parallel trade has changed: it is now big business rather than a small-scale affair. And as parallel trade has changed, the courts' approach to parallel traders has also changed. National courts and competition authorities have started to find against parallel traders of pharmaceuticals. This article explores the reasons behind this paradigm shift.

Parallel trade - for so long the cause célèbre of European law

From the earliest days of the Common Market parallel traders recognised that there were profits to be made from arbitrage. Their business model was simple: buy products in countries where the price is low, transport them to countries where prices are higher, and resell them. For many products, there was a chance of some consumer benefit as price discrepancies diminished through market forces.

Pharmaceutical parallel traders found they had a number of legal obstacles. But they waged a successful campaign of litigation in the European Court in the 1970s. Trademarks and patents were held not to be lawful obstacles.[2] The parallel traders won the right to repackage the products they had bought so as to conform to that of the country of resale.[3] They even won, later on, the right to change the trademark when repackaging,[4] a right which is now exercised routinely.

The tide was in favour of the parallel traders in those days. They won major court case after major court case for a 20-year period.

So much so that the parallel trader became a cause célèbre in European Union law. A generation of students of European law was taught to admire the efforts of the plucky parallel traders, who embodied the then unachieved goal of a single market in Europe. We were taught to support the heroic little guys in their fight against those nasty big pharmaceutical companies whose only interest was in maintaining separate national markets.

What was not appreciated until recently is that these theories of market integration through parallel trade do not work in the case of prescription medicines, as prices are effectively set by the Member States.

The economic reality was always different from this heroic vision

In a normal market, the phenomenon of arbitrage will have the effect of eliminating price disparities. Arbitrage creates an efficient market, thereby eliminating the opportunity for further arbitrage. This is why arbitrage is a fringe activity in most markets.

But arbitrage in the pharmaceutical sector is different. It is national governments that effectively set prices. Pharmaceutical companies are price takers rather than price setters. Prices vary due to government policy: the countries with lower GDP will set lower prices to match the national budget; the higher GDP countries with a pharmaceutical industry and bigger health budgets are ready to pay higher prices. These are decisions based on public policy, not on normal market forces.

So, unlike other products, parallel trade in prescription pharmaceuticals does not reduce the price levels for the patients. And if prices in the two countries do not change, then the amount of profit made by the parallel trader depends solely on the volume of parallel traded goods. Arbitrage can continue indefinitely. There is big money to be made. Hence the huge expansion of parallel trade throughout the 1990s.

The myth exposed

By the late 1990s, parallel trade in prescription medicines really had become big business. Backed by the case law from the 1970s, when parallel trade was a more marginal activity, the parallel traders started making profits that look impressive even judged by the standard of investment bankers. One company, which had 12 modestly paid employees, made £650,000 profit per employee, just under £8m in total. With that sort of money to be made, parallel traders appeared on the Sunday Times list of the richest 500 people in Britain, alongside footballers and tycoons.

Some dared to ask what parallel trade in prescription medicines contributes to the wider economy. Despite the prevailing doctrine in European circles that parallel trade is always beneficial, the answer seems to be very little. The profits made by arbitrage accrue almost entirely to the arbitrageurs and others in the medicine distribution chain. Patients pay the same price or almost the same price. Governments likewise get little from this lucrative trade.

And as parallel trade became increasingly big business, it had increasingly significant effects on the major research-based pharmaceutical companies, which produced the medicines that were being parallel traded. Their profits fell, with a corresponding impact on their budget for R&D to develop new medicines. Moreover, with up to 80% of national demand for particular medicines supplied by parallel imports, research-based pharmaceutical companies started to encounter real difficulties in guaranteeing a steady supply.

Patients in low price countries also started to suffer as stock shortages occurred - the medicines on which the highest profits could be made were being exported in parallel trade rather than dispensed to patients in these countries.

The turning of the tide

The pharmaceutical companies were faced with a difficult situation. Their deliveries to low price countries were as much as seven times the needs of local patients. This raised significant logistical problems. How to serve patients in the UK needing particular medicines when 80% of the supplies of those medicines were being delivered via Greece? And, more difficult, how to ensure there was sufficient supply for Greek patients?

The industry's response was to re-establish the supply-demand balance. Supplies to each market would be based on the needs of local patients. Many companies also introduced systems to ensure emergency supplies to pharmacies so patients did not suffer if the wholesaler had exported all its stock.

At this point, the parallel traders went back to the courts, claiming that such arrangements were illegal. But they were in for a surprise. The tide had turned.

Competition agencies and courts around Europe were awake to the absurdity of the current situation. They acknowledged the difficulties in ensuring supplies of needed drugs to patients. A series of national courts issued judgments rejecting the parallel traders' complaints. The parallel traders lost over 20 cases in a short period of time.

The European Court

In Syfait v. GSK,[5] the question of parallel trade came before the European Court of Justice (ECJ), the court whose judgments in the 1970s made parallel trade in prescription medicines possible. But the parallel traders encountered a more sceptical audience this time.

At the relevant time,[6] Greek law provided that Greek pharmaceutical prices must be the lowest in Europe. So Greece was the obvious source for parallel traders. GSK experienced stock shortages in certain products, despite delivering several times Greek demand, because the products were being exported. GSK decided unilaterally to adjust its deliveries to match national prescription needs, plus a large safety margin.

The parallel traders duly complained and the Hellenic Competition Committee asked the ECJ whether a refusal by a dominant undertaking to satisfy unlimited orders by wholesalers in full was automatically an abuse of a dominant position, contrary to Article 82 of the EC Treaty, if its aim was to limit exports by wholesalers and thus parallel trade.

The ECJ gave no ruling on the substance, as it can only rule on questions from national courts and it found the Committee was not a court. However, in his Opinion, Advocate General Jacobs concluded that a refusal by a dominant pharmaceutical company to meet all its customers' orders was not automatically an abuse in particular because:

• A dominant undertaking is not obliged to meet orders that are out of the ordinary.

• A restriction of supply by a dominant pharmaceutical company in order to limit parallel trade may be justified as a reasonable and proportionate way of defending the company's commercial interests.

The Advocate General emphasised that these statements applied only to the pharmaceutical industry, which is not a normal competitive market, since prices are not fixed by the market players themselves.

In reaching his conclusion that GSK's conduct was not abusive, the Advocate General looked carefully into the social and economic effects of parallel trade.[7] He found that parallel trade does not discernibly benefit the patient or national governments, and that the benefits were in some states 'entirely absorbed as profit by those involved in the distribution chain.'[8] He also noted that parallel trade could have adverse impacts on patients, notably because innovative medicines might be launched later in low price countries - something that would actually lead to a greater fragmentation of the common market.[9]

The Advocate General's analysis in Syfait v. GSK is currently the definitive statement of EC law. It is also representative of judicial opinion all across Europe, where a series of different courts have reached similar conclusions. Almost all of these cases circled around the question of whether it would be illegal for a research-based pharmaceutical company to limit its supplies to what is actually required to satisfy national demand.

Greece

Since the Hellenic Competition Committee's much-discussed Interim Decision of 3 August 2001, which ordered GSK Greece to supply unlimited quantities to Greek wholesalers, Greek courts have rendered more than a dozen judgments. Almost all have been won by the research-based companies.

For example, on 31 January 2003, the Athens Multimember First Instance Civil Court issued a definitive ruling in two cases brought by K. P. Marinopoulos, one of the largest Greek wholesalers, against GSK Greece.[10] The court dismissed the actions as unfounded, holding that GSK's policy of harmonising supplies with national demand did not infringe Article 82. Irrespective of the existence of a dominant position, a company has the right to protect its commercial interests and choose the distribution policy which best serves those interests. Any other line of reasoning would mean that GSK could be obliged to supply unlimited quantities to parallel traders, who in turn could supply all Member States with medicines at Greek prices and thereby overturn national price regimes. Such a result was clearly unacceptable.

K.P. Marinopoulos lost another case before the Athens Court of Appeal against Servier on 6 May 2004, in which the court held that: 'the refusal to sell the medicine at issue was neither unreasonable nor abusive.'

Spain

On 13 February 2003,[11] the Spanish Competition Defence Service dismissed a complaint brought by Spain Pharma, accepting that there was only a limited amount of products available to supply Spanish wholesalers. It also accepted that an undertaking was free to plan production centrally and supply products among subsidiaries according to the patterns of national consumption.

Italy

On 20 April 2005, the Milan Court of Appeals rendered a judgment accepting the legality of Pharmacia's decision to stop supplying a particular medicine to an Italian parallel trader, Petrone.

France

The French grossiste-exportateur Pharma-Lab, which engaged exclusively in exports, complained that decisions taken by Pfizer and GSK to stop supplying certain of their products infringed Articles 81 and 82 EC. It applied for an order forcing the two companies to supply the products.

In its Decision of 15 May 2002,[12] the French Competition Council rejected the case. The Paris Court of Appeal subsequently rejected Pharma-Lab's appeal.[13] The court noted that the extent to which parallel trade in prescription medicines was useful was subject to discussion. It found there was serious debate as to whether the margins deriving from parallel trade did in fact translate into a substantial reduction of costs for patients or health care systems, or whether, for the most part, they accrued to the parallel traders.

Austria

The Vienna Commercial Court issued a judgment on 31 March 2003[14] accepting that possible shortages of medicines resulted not from GSK's supply system, but from substantial parallel exports by Herba. The court explicitly stated that GSK supplied more pharmaceuticals than needed for the Austrian market.

European Commission

Despite these impressive decisions at national level, the Commission is still fighting against the tide. During the oral hearing in Syfait v. GSK, the Commission contended that GSK was obliged to supply unlimited quantities of medicines to wholesalers and parallel traders in order not to restrict their commercial freedom. The Commission also claimed that consumers benefit from parallel trade and that high price countries encourage parallel trade to exert pressure on the prices of pharmaceuticals. Of course, Advocate General Jacobs did not agree.

Conclusion

The judgments set out above show an impressive degree of consistency and coherence, despite the absence of any guidance from the Commission, which persists in following the 1970s orthodoxy that parallel trade in prescription pharmaceuticals creates a single market and must be encouraged.

The Commission should now acknowledge the new orthodoxy, which is for the first time based on a thorough economic analysis of how the market operates. Otherwise it will find itself portrayed as a modern day equivalent of King Canute, the King of England who famously ordered the incoming tide to stop and only succeeded in getting his feet wet.

Hopefully, future generations of students will be taught a more balanced picture about parallel trade. Arbitrage can be important in equalising prices in many markets, but not in the pharmaceutical sector, where prices are effectively set by the state. And when the advantages of market integration disappear, the parallel importer is just another profit-hungry trader, deserving no particular deference or legal privilege.

Footnotes:
[1] Co-author: Axel Schultz, White & Case, Brussels. The views expressed herein are entirely personal.
[2] See Case 15/74, Centrafarm v. Sterling Drug, [1974] ECR 1147 and Case 16/74, Centrafarm v. Winthrop, [1974] ECR 1183.
[3] See Case 102/77, Hoffmann-La Roche v. Centrafarm, [1978] ECR 1139.
[4] See Case 3/78, Centrafarm v. American Home Products, [1978] ECR 1823.
[5] Case C-53/03, Syfait and others v. GlaxoSmithKline AEVE and GlaxoSmithKline plc, not yet reported.
[6] Greek law is in the process of being changed, with a new reimbursement mechanism expected to be introduced in early 2006.
[7] Opinion, ¶¶ 84-99
[8] Opinion, ¶¶ 96-98.
[9] Opinion, ¶ 95.
[10] Decisions 519 and 609/2003 of 31 January 2003 of the Athens Court of First Instance.
[11] Case 2238/01.
[12] Decision No. 02-MC-07.
[13] Decision 2002/08966 of 26 June 2002.
[14] Decision of the Vienna Commercial Court of 31 March 2003 in GSK Pharma GmbH v. Herba Chemosan Apotheken-AG, Case no. 19 Cg 56/02k.

Author: James Killick ©

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