Most recently, on November 6, 2019, the Federal Trade Commission (“FTC”) issued an Opinion and Final Order in which the Commission upheld the Administrative Law Judge’s (“ALJ”) decision that Otto Bock HealthCare North America, Inc.’s (“Otto Bock”) acquisition of FIH Group Holdings, LLC (“Freedom”) was anticompetitive and that Otto Bock must divest Freedom’s entire business with the limited exceptions granted by the ALJ.  The Commission’s order was approved by all five commissioners and continues the trend of unwinding consummated acquisitions that are deemed to be anticompetitive.

Accordingly, buyers must be aware of the risks of closing a non-reportable transaction that eliminates competition.  Here are a couple of points to keep in mind:

First, Non-Reportable Transactions That Eliminate a Competitor May Raise Antitrust Scrutiny

Indeed, corporate executives that enter into non-reportable acquisitions of their competitors must be aware that in some cases these deals entail significant antitrust risk.  Just because the deal is not reportable under the HSR Act does not mean that the federal or state antitrust agencies won’t investigate, challenge, and unwind it.

Second, Size of Transaction Does Not Matter

The antitrust agencies can investigate and unwind a deal, no matter the size of the transaction.  The antitrust agencies have challenged consummated deals valued as low as $3 million (see George’s/Tysons,  Complaint, United States v. George’s Foods, LLC, No. 5:11-cv-00043 (W.D. Va. May 10, 2011).  Other small deals challenged by the agencies include Renown Health’s $3 and $4 million deals; a $5 million transaction (Complaint, United States v. Election Sys. & Software, Inc., No. 1:10-cv-00380 (D.D.C. Mar. 8, 2010); Magnesium Elektron/Revere Graphics, a $15 million deal; Charlotte Pipe/Star Pipe, a $19 million deal; Dun & Bradstreet’s $29 million deal;  BazaarVoice/Power Reviews; and the list goes on.

Third, Length of Transaction Has Been Closed Does Not Matter

The FTC has challenged a consummated transaction more than eight years after the transaction closed (see Complaint, Graco Inc., No. 101 0215 (F.T.C. Apr. 17, 2013).

Fourth, Disgorgement of Profits Is Possible

The agencies have sought disgorgement of profits earned from post-merger price increases to remedy the anti-competitive effects of a consummated merger.  For example, under the terms of the consent order in FTC v. Hearst Trust, Hearst agreed to disgorge $19 million in profits earned from price increases following its acquisition of MediSpan, Inc. (Final Order, FTC v. Hearst Trust, No. 1:01CV00734 (D.D.C. Nov. 20, 2001)).  In another example from the DOJ, U.S. v. Twin America, LLC, et. al, Twin America, Coach, and City Sights together were required to pay $7.5 million in disgorgement to remedy alleged violations of Section 7 of the Clayton Act, Section 1 of the Sherman Act, as well as New York State law, including the Donnelly Act (see Proposed Final Judgment, United States v. Twin America, LLC, Civil Action No. 12-cv-8989 (ALC) (GWG) (March 16, 2015)).  In one case, the DOJ and New York State sought disgorgement of defendants’ illegal profits earned from increased prices charged after the formation of an illegal joint venture that eliminated competition and created a monopoly in “hop-on, hop-off” bus tours in New York City.

How Does the Government Learn of Non-Reportable Anticompetitive Mergers?

In the absence of an HSR notification, the agencies become aware of possibly anticompetitive mergers through the companies own press releases, news reports, complaints from competitors or customers, information from other investigations, or, in some cases, self-reporting by the parties.

Background of Otto Bock/Freedom Deal

On September 22, 2017, Otto Bock and Freedom simultaneously executed a merger agreement and consummated their merger.  The transaction did not require a pre-merger notification filing in the United States so the FTC did not have a chance to evaluate whether the acquisition was anticompetitive prior to the closing.  But, shortly after the deal Otto Bock issued an ill advised press release that highlighted that the deal combined the #1 and #3 players in the field of prosthetics in the United States, led to market share gains and strengthened its leading position.  Believing that “antitrust issues had already been clarified”, they closed the deal and then Otto Bock took steps to integrate Freedom’s business, including personnel, intellectual property, know-how, and other critical assets.

Shortly after the closing, the FTC started an investigation and within three months took action by filing an administrative complaint seeking to unwind the merger.  At the same time, Otto Bock agreed with the FTC to hold the businesses separate during the litigation to preserve the acquired business from Freedom.  According to the FTC’s administrative complaint, the merging parties were head-to-head competitors in the manufacture of microprocessor prosthetic knees (“MPKs”) and the deal eliminated head-to-head price and innovation competition, removed a significant and disruptive competitor, and entrenched Otto Bock’s position as the dominant supplier of MPKs.

Otto Bock made a number of arguments in its defense.  First, it offered a divestiture of Freedom’s MPK assets to an identified buyer, which it argued eliminated the FTC’s allegations of purported harm.  The FTC, however, rejected the remedy as insufficient.  It also argued that the efficiencies would outweigh the procompetitive effects and that Freedom was a failing firm.

ALJ Decision in Otto Bock

On April 29, 2019, the ALJ upheld the FTC’s administrative complaint finding that the transaction substantially lessened competition in the relevant market for the sale of MPKs to prosthetic clinics in the United States.  The deal eliminated competition between Otto Bock and Freedom that spurred innovation and lower prices.  The ALJ found that Otto Bock’s divestiture remedy was insufficient and found that the appropriate remedy was the divestiture of all the assets acquired with the possible exception of certain foot products that are not necessary to competition in the relevant MPK market.  On May 8, 2019, Otto Bock filed a notice of appeal stating that it would appeal the entirety of the ALJ’s initial decision and order. 

Commission Opinion and Order

The Commission found that there was a presumption of harm based on high market shares and concentration levels.  In addition, the Commission found that the record evidence of competitive harm was compelling.  The evidence confirmed that Otto Bock possesses the leading share of U.S. MPK sales with the C-Leg 4 and showed that Otto Bock and Freedom vigorously competed against each other in terms of price and innovation competition.  Internal documents showed that they would respond against each other with price promotions and discounts.  If one came out with a new generation, the other would try to “leap frog” the other.  The evidence further demonstrated that Otto Bock viewed Freedom as a direct competitive threat and demonstrated that one of the reasons for the acquisition was to eliminate the development of Freedom’s new MPK, the Quattro, that had the nickname the “C-Leg Killer”.  Part of the reason for the acquisition was to make sure that no other competitor acquired Freedom’s Quattro.  In summary, the Commission upheld the ALJ’s decision that the acquisition substantially lessened competition and that to fully restore the competition lost from the acquisition, Otto Bock must divest Freedom’s entire business with the limited exceptions granted by the ALJ.

Lessons Learned

The FTC’s investigation, challenge, and successful litigation serve as a reminder to corporate executives and antitrust counsel that antitrust risks do not end once a deal closes, and that a transaction is not free of antitrust risks simply because the transaction is not reportable under the HSR Act.  The Commission’s Opinion and Order unwinding the merger further demonstrates the risks of closing a deal that presents significant antitrust concerns and makes clear that such challenges will continue to be pursued by the FTC.  The Commission’s Opinion and Final Order requiring a complete divestiture of the business that was acquired also makes clear that when the FTC is evaluating a proposed remedy that its goal is to fully restore competition.  When a buyer proposes to sell a carve out of assets instead of a whole business to a divestiture buyer, it must show how the partial divestiture of assets to the divestiture buyer restores competition.

Corporate and private counsel should be aware of the likely consequences and the risks of consummating transactions that raise significant competitive issues.  The risks may include: defending against costly and lengthy government investigations as well as government and private litigation; unwinding the merger through either complete or partial divestitures even after integration has taken place; and disgorging profits gained from the alleged anticompetitive merger.  Accordingly, before competitors execute a transaction agreement, counsel should conduct a preliminary assessment of whether the proposed transaction gives rise to substantive antitrust issues no matter the deal’s size.

Andre Barlow
(202) 589-1838
abarlow@dbmlawgroup.com

Coalition Opposing the Merger

The coalition includes Families USA, Public Citizen, U.S. PIRG Education Fund, Service Employees International Union, American Federation of State, County, and Municipal Employees, UNITE HERE, Consumer Action, American Federation of Teachers, Alliance for Retired Americans, American Family Voices, Doctors for America, End AIDS Now, Prescription Justice, Social Security Works, the Other 98, Treatment Action Group, and NextGen California.  It is asking the FTC to conduct a thorough investigation and to block the merger if the facts support it and a remedy cannot be devised to restore competition.  The coalition highlights the competitive problems arising from continued consolidation in the pharmaceutical industry and requests that the FTC include in its investigation ongoing anticompetitive conduct by the parties, such as the use of rebate walls, which will have an even more profound anticompetitive effect if this merger is consolidated, as well as past abuse of the patent system.

The letter makes three points.

First, the merger of AbbVie and Allergan will continue a tremendous trend of consolidation and the evidence shows that consumers are paying higher prices and losing out on access and choice because of less innovation by big pharma companies.  Mergers result in fewer choices for consumers, and drug companies are increasingly spending their money on acquisitions instead of research and development.

Second, the merger will reduce competition in a number of markets where the companies directly overlap with each other.  The coalition underlines an overlap between AbbVie’s blockbuster, Humira, which already treats 10 indications including Crohn’s disease and ulcerative colitis, and its new IL-23 blockbuster, Skyrizi, which is currently marketed to treat moderate to severe psoriasis but is being investigated to treat Chron’s disease and ulcerative colitis, with Allergan’s brazikumab, an IL-23 inhibitor that is currently being investigated to treat Crohn’s disease and ulcerative colitis.  The coalition further points out that the FTC’s policy is to accept divestitures of actually manufactured pharmaceutical products over pipeline products.

Third, the merger will exacerbate competitive problems that already exist in the pharmaceutical drug industry relating to rebate walls and patent abuses.  The coalition requests that the FTC not limit its investigation to direct product overlaps because the combination of AbbVie’s and Allergan’s blockbuster drugs will enable AbbVie to engage in a whole range of potentially anticompetitive conduct to hamper the ability of rivals to compete.  Indeed, both manufacturers have previously engaged in anticompetitive behavior to prolong their monopolies, suppress competition and raise prices.  The coalition points out, for example, that the merger would enable AbbVie to increase its bargaining leverage over payors to use exclusionary practices such as rebate walls to limit the ability of rivals to expand and enter.  It underscores that both AbbVie and Allergan have used rebate walls to stifle competition in the past.

Families USA, one of the groups that signed onto the letter, said, “The proposed acquisition of Allergen by AbbVie will combine two companies that independently engage in anticompetitive practices that make prescription drugs unaffordable for families into one mega corporation.  We urge the FTC to carefully consider the impact of this proposed drug company merger on competition and prices and protect access to critical medicines for consumers.”  And Peter Maybarduk, Access to Medicines Director for Public Citizen, said, “Two leading price gouging patent manipulators unite.  AbbVie is notorious for manipulating its patent power over the blockbuster medication Humira and AIDS drugs like ritonavir, keeping affordable generics off the market and even slowing innovation.  Allergan is notorious for hiding its patents behind the sovereign immunity of a Mohawk tribe.  Unless the FTC steps in, we can look forward to new efforts to destroy competitive markets by the pharma giant that emerges from this deal, in an industry increasingly focused on monopolizing yesterday’s inventions instead of creating new ones.”

Rebate Walls

Pharmaceutical manufacturers have implemented a new strategy to block and delay entry of biosimilars and other drugs from the market through a contracting practice that creates what is known as a “rebate wall” or “rebate trap”.   A rebate wall occurs when a manufacturer leverages its market-dominant position to secure preferred formulary access for its products by offering lucrative incentives to pharmacy benefit managers (“PBMs”) and health insurers in the form of volume-based rebates.  These rebates are often offered across multiple products, indications, and therapeutic specialties, the breadth of which cannot be matched by new and innovative therapies.  The Trump Administration earlier this year sought to eliminate rebates from the Medicare prescription drug program because pharmaceutical rebates raise more profound competitive problems than discounts in other industries.  In fact, the coalition notes that there is increasing evidence that rebates actually inflate prices (as opposed to decreasing them) and that these rebates, unlike typical discounts, do not ultimately benefit consumers.

FTC is Currently Investigating Rebate Walls

On July 29, 2019, Johnson & Johnson (“J&J”) disclosed that the FTC issued a civil investigative demand regarding its investigation of whether J&J’s contracting practices related to its rebates for Remicade (infliximab) amount to exclusionary conduct illegal under the antitrust laws.

In 2017, Pfizer Inc. (“Pfizer”) filed a lawsuit against J&J for its contracting practices that protect Remicade’s position in the market and deny patients access to Pfizer’s infliximab biosimilar, Inflectra.  The lawsuit is still in the discovery phase.

Biosimilar developers have been urging the FTC to weigh in on whether exclusionary contracts for brands based on aggressive rebating strategies are legal and the agency has chosen a high-profile example to investigate.

Pfizer applauded the FTC’s investigation in a statement: “We believe the [FTC’s] decision to open an investigation into the competitiveness of the biosimilar is an important step, which we hope will lead to a robust, competitive marketplace for patients and physicians to access biosimilar medicines.”

Rebate Wall Concerns Were Raised in the FTC’s Investigation of Bristol-Myers/Celgene

On January 11, 2019, Rep. Peter Welch (D-VT) and Rep. Francis Rooney (R-FL) wrote a letter to the FTC, urging the agency to investigate Bristol-Myers Squibb Company’s (“Bristol-Myers”) acquisition of Celgene Corporation (“Celgene”).  The letter asked the FTC to examine how the acquisition allows Bristol-Myers to increase its drug portfolio and leverage over PBMs when negotiating preferred drug placement on formularies.  The letter argued that the larger the firm, the more it can use rebate walls to block more affordable and, in some cases, more efficacious products’ access to formularies.

Thoughts

The AbbVie/Allergan merger gives the FTC an opportunity to investigate the questionable contracting practice in the pharmaceutical drug industry known as a “rebate wall”.  Payors such as PBMs and health insurers obtain rebates on prescription drugs from pharmaceutical manufacturers that have actually inflated the price of drugs and stifled the ability of rival drug manufacturers to effectively compete.  This practice is recognized by both the administration and industry players as anticompetitive.  Department of Health and Human Services Secretary Alex Azar has noted that rebate walls can prevent competition and new entrants into the system.  Moreover, major drug manufacturers such as Pfizer, Shire, and Sanofi have filed antitrust suits challenging rebate walls as antitrust violations.  In theory, rebates could have a positive impact on the prescription drug market if they led to lower prices and benefitted consumers.  But, in practice, this is simply not the case.  Rebate walls distort the workings of the free market, result in higher drug prices, and reduce patients’ access to affordable branded drugs.

While rebates and discounts can be procompetitive if they lead to lower prices for consumers, some drug manufacturers are structuring discounts to limit competition from rivals in an effort to protect their monopolies.  The FTC understands that when a rebate wall is successfully erected by a market-dominant manufacturer, a payor faces strong financial disincentives to grant access to new and innovative therapies, as doing so would result in the loss of hundreds of millions in guaranteed rebate dollars for the payor.  This condition creates a “trap” for payers who would otherwise be inclined to grant formulary access to therapies that are newer and more innovative, yet lack established volume and subsequent potential for rebate revenue.  In many cases, these actions prevent patients and physicians from seriously considering new medications at competitive prices.

Given the competitive risks that rebate walls pose, the coalition has asked the FTC to investigate how this transaction may make the situation related to this suspect contracting practice worse.  Competition works when new rival drugs (biosimilars, branded drugs or generics) are allowed open and fair access to the market and consumers have access to cost saving treatments.  And while the FTC has not publicly acknowledged examining mergers between drug manufacturers under this type of theory before, the issue is now in front of the staff.

Complaint

The DOJ alleges that the acquisition would substantially lessen competition in the North American market for rolled aluminum sheet for automotive applications, commonly referred to as aluminum auto body sheet.  The complaint explains that steel companies are developing lighter, high strength steel varieties for the auto industry. But as Novelis has observed, high strength steel “is largely replacing existing mild steel” and “cannibalizing the existing material” (i.e., traditional steel). The threat of substitution from aluminum to high strength steel is, as Aleris confirms, “limited.”  The price of aluminum auto body sheet is three or four times more expensive than traditional steel.  The complaint further alleges that the transaction would combine two of only four North American producers of aluminum auto body sheet.  The other two suppliers’ capacity is mostly committed to automakers.  Thus, other automakers rely on Novelis and Aleris to produce aluminum body sheet for automobiles to make cars lighter, more fuel-efficient, safer and more durable.

For years, Novelis was operating in a three firm market where it was the price leader.  It had the ability to increase prices without a loss of sales.  DOJ alleges that in 2016, Aleris entered the North American market as an aggressive competitor, which had an immediate impact on pricing and services.  Indeed, Novelis’ documents show that it decreased prices and increased the quality of its services in response to Aleris’ entry.

Novelis’s acquisition of Aleris would eliminate a rival it described as “poised for transformational growth.”  The complaint quotes other internal presentations to the Board of Directors and emails describing an anticompetitive rationale for the transaction:

• Novelis worried that Aleris could be sold to a “[n]ew market entrant in the US with lower pricing discipline” than Novelis, and that an “[a]lternative buyer [was] likely to bid aggressively and negatively impact pricing” in the market.
• “[A]n acquisition by us as the market leader will help preserve the industry structure versus a new player . . . coming into our growth markets and disturbing the industry structure to create space for himself, while hurting us the most.”
• Novelis should acquire Aleris because there is a “disincentive for market leader [i.e., Novelis] to add capacity and contribute to a price drop” and an acquisition of Aleris “prevents competitors from acquiring assets and driving less disciplined pricing.”

If this deal were allowed to proceed without a remedy, Novelis would lock up 60 percent of projected total domestic capacity and the vast majority of uncommitted capacity of aluminum body sheet, enabling the company to raise prices, reduce innovation and provide less favorable terms of service to the detriment of automakers and ultimately American consumers.

Novelis Contends That DOJ Suit Ignores The Full Scope Of Automotive Body Sheet Competition

It says that the DOJ lawsuit is based on the contention that the only relevant competition among automotive body sheet providers is that among aluminum manufacturers such as Novelis and Aleris. It ignores competition from steel automotive body sheet, even though steel automotive body sheet is currently used for nearly 90 percent of the market.

Novelis says that aluminum automotive body sheet attempts to take share from steel automotive body sheet.  And argues that for the DOJ to prevail in its lawsuit, it needs to prove that there is a distinct “relevant market” for aluminum automotive body sheet, which means that steel automotive body sheet does not significantly constrain the price and quality of aluminum automotive body sheet. Novelis further states that the DOJ does not deny that steel automotive body sheet usually competes with aluminum automotive body sheet, but instead contends that the constraint from steel is absent from some procurements (where an automotive manufacturer has supposedly already decided between steel and aluminum). Novelis believes that by focusing on just a small slice of steel-aluminum competition and ignoring the broader competitive process, the DOJ’s theory contravenes well-established principles of market definition.

Novelis further contends that the DOJ also disregards the extraordinary bargaining power of the automotive manufacturers and their ability to generate bid processes that will ensure competitive pricing for automotive body sheet.

Arbitration

The Antitrust Division has agreed with defendants to refer the matter to binding arbitration should certain conditions be triggered.  The arbitration would resolve the issue of product market definition.  The arbitration would take place pursuant to the Administrative Dispute Resolution Act of 1996 (5 U.S.C. § 571 et seq.) and the Antitrust Division’s implementing regulations (61 Fed. Reg. 36,896 (July 15, 1996)).  This would mark the first time the Antitrust Division is using this arbitration authority to resolve a matter.  The head of the Antitrust Division, Makan Delrahim, said that “[t]his arbitration would allow the Antitrust Division to resolve the dispositive issue of market definition in this case efficiently and effectively, saving taxpayer resources.  Alternative dispute resolution is an important tool that the Antitrust Division can and will use, in appropriate circumstances, to maximize its enforcement resources to protect American consumers.”

Lessons Learned:

Here, the transaction is presumptively anticompetitive because a large dominant player with 60% of a concentrated market is acquiring a new disruptive entrant.  What is noteworthy is the use of the arbitration procedure agreed to by Novelis and the DOJ.  The DOJ and Novelis clearly are debating the product market definition.  If the DOJ is right on the product market definition, the merger is anticompetitive in the North American market for aluminum auto body sheet and it would require a fix.  The merging parties can then negotiate a divestiture remedy that would resolve the competitive concerns.  As Assistant Attorney General Makan Delrahim of the Justice Department’s Antitrust Division put it, “[t]his arbitration would allow the Antitrust Division to resolve the dispositive issue of market definition in this case efficiently and effectively, saving taxpayer resources.” He added that “[a]lternative dispute resolution is an important tool that the Antitrust Division can and will use, in appropriate circumstances, to maximize its enforcement resources to protect American consumers.”  So, this may be the start of a trend to obtain settlements without the need for a full trial on the merits.

This complaint also demonstrates that the DOJ will use merging parties’ own words against them when challenging their deal.  Historically, “hot docs” provide an easy way to capture the interest of a judge by saying this case is simple and all you have to do is examine the merging parties’ own words.  The DOJ routinely cites “hot docs” in its complaints because they catch the interest of the media and, particularly, the judge.  The DOJ will focus on supposed “hot docs” to support its case because the buyer appears to be touting the intended anticompetitive consequences of the acquisition.  At the end of the day, however, a “smoking gun” document regarding anticompetitive intent will be rejected by a judge unless the DOJ provides the foundations of an antitrust case through market analysis and empirical evidence.  Nevertheless, this case demonstrates why corporate executives must be mindful about what they write as careless and inappropriate language in company documents can have an extremely negative effect on a merger review.

Andre Barlow
(202) 589-1838
abarlow@dbmlawgroup.com

Complaint

The DOJ alleges that Sabre and Farelogix compete head-to-head to provide booking services to airlines.  Booking services are IT solutions that allow airlines to sell tickets and ancillary products through traditional brick-and-mortar and online travel agencies to the traveling public.  The DOJ alleges that the acquisition would eliminate competition that has substantially benefited airlines and consumers in both the traditional and online markets.  The complaint further alleges that the transaction would allow Sabre, the largest booking services provider in the United States, to eliminate a disruptive competitor that has introduced new technology to the travel industry and is poised to grow significantly.

As alleged in the complaint, Sabre is the dominant provider of booking services in the United States with over 50% of airline bookings through travel agencies.  Sabre operates a global distribution system (“GDS”), which is a digital platform that provides booking services to airlines in addition to other functionality.  The DOJ characterizes Farelogix as an innovative technology company that has stepped in to address the needs of airlines and their customers.  The DOJ says that Farelogix has injected much-needed competition and innovation into stagnant booking services markets by developing new technology {new distribution capability} that empowers airlines to make a wider array of offers to travelers who book tickets through travel agencies.  This new technology enables airlines to make more varied and personalized offers to consumers who book through travel agents, including bundles of ancillary products such as wi-fi, lounge passes, entertainment options, and meals – choices not available to travelers through Sabre’s legacy technology.

The DOJ also points to some hot docs in its complaint.  The DOJ alleges that Sabre executives acknowledged that acquiring Farelogix would eliminate a competitive threat and further entrench Sabre in booking services.  For example, on the day Sabre announced its intention to buy Farelogix, Sabre’s chief sales officer texted a colleague that one major U.S. airline would “hate” it.  The colleague replied, “Why, because it entrenches us more?”  Similarly, a Farelogix executive observed that buying the company would allow Sabre to “tak[e] out a strong competitor vs. continued competition and price pressure.”  Sabre’s internal documents show that Sabre’s attempt to acquire Farelogix follows many other attempts by Sabre to neutralize its competitor, including a campaign to “shut down Farelogix.”  Indeed, Farelogix has long complained about Sabre’s tactics, alleging that Sabre has sought to stifle competition.  For example, in 2013, Farelogix’s Chief Executive Officer alleged that “Sabre has wielded its monopoly power in an attempt to destroy Farelogix and prevent competition….”  Moreover one Sabre sales executive noted after the announcement of the acquisition that the airline’s “FLX [Farelogix] bill is going up big time.”

The DOJ’s complaint alleges that Sabre has used a broad range of contractual and technical barriers to prevent entry or expansion by suppliers that could threaten its control over bookings through travel agencies. For instance, Sabre’s contracts include provisions that inhibit airlines’ use of an alternative supplier like Farelogix, even when doing so would be less expensive for airlines.  As recently as 2018, Farelogix denounced these restrictions, complaining that airlines’ GDS contracts “effectively prohibit working with third parties or make doing so cost prohibitive.”  In January 2019, a Sabre senior vice president acknowledged that airlines view Sabre’s restrictions as “abusive but there’s nothing they can do because they need the distribution and they are tied with a contract.”

The DOJ alleges that the two relevant markets are highly concentrated but acknowledges that Farelogix’ share is very small.  The DOJ alleges, however, that Farelogic’s market share understates its competitive significance in the current and in future markets.

In summary, the DOJ alleges that Sabre controls over 50 percent of bookings through traditional and online travel agencies in the United States, so airlines must sell tickets through Sabre to reach a broad set of U.S. travelers. Sabre has used this power to suppress Farelogic’s entry and expansion.  Nevertheless, Farelogix’s presence in these markets has led to lower prices and increased innovation that would be lost if the merger is not blocked.

Lessons Learned

The DOJ’s block of Sabre’s proposed purchase of Farelogix demonstrates that it is willing to challenge large dominant companies that seek to acquire small nascent rivals in technology markets that are highly concentrated.  Sabre’s proposed acquisition of Farelogix is a dominant firm’s attempt to take out a disruptive competitor that is an important source of competition and innovation.  The DOJ is taking the position that acquisitions of small disruptive rivals in highly concentrated markets can result in higher prices, reduced quality, and less innovation regardless of the target’s low market share.  The DOJ views the transaction as part of an emerging trend of large technology firms acquiring nascent competitors to keep them from emerging as full-fledged rivals.

This complaint also demonstrates that the DOJ will use merging parties’ own words against them when challenging their deal.  Here, the hot docs in Sabre’s text messages, documents, emails, and corporate filings support the DOJ’s decision to block the merger. Historically, “hot docs” provide an easy way to capture the interest of a judge by saying this case is simple and all you have to do is examine the merging parties’ own words.  The DOJ routinely cites “hot docs” in its complaints because they catch the interest of the media and, particularly, the judge.  The DOJ will focus on supposed “hot docs” to support its case because the buyer appears to be touting the intended anticompetitive consequences of the acquisition.  This case demonstrates why corporate executives must be mindful about what they write as careless and inappropriate language in company documents can have an extremely negative effect on a merger review.  A good rule of thumb is to write every document so that neither you nor the company would be embarrassed if it appeared on the front page of the Wall Street Journal.

Andre Barlow
(202) 589-1838
abarlow@dbmlawgroup.com

Complaint

The FTC is alleging the merger of the chemical companies would substantially reduce competition in the Pacific Northwest and the Southern and Central United States for the production and sale of hydrogen peroxide, a commodity chemical used for oxidation, disinfection, and bleaching.

Most hydrogen peroxide produced in North America is sold to pulp and paper customers for bleaching pulp and de-inking recycled paper, according to the complaint.  Hydrogen peroxide is also used to sterilize food and beverage packaging, and in chemical synthesis, fracking, water treatment, and electronics.  For most end uses, there are no effective substitutes, the complaint alleges.  Because of high transportation costs, customers prefer nearby suppliers.

The complaint alleges that the acquisition would harm competition in at least two ways.  First, it would increase the likelihood of coordination in a market  that already functions as an oligopoly and has a long history of price-fixing including guilty pleas and litigation settlements.   The markets are highly concentrated, with significant transparency among rival firms, and long-term, stable customer-supplier relationships, low elasticity of demand, and a history of strong interdependent behavior, the complaint states.  Evonik has high market shares of approximately 50% in both geographic markets.  Second, the acquisition would eliminate significant head-to-head competition between Evonik and PeroxyChem in the Pacific Northwest, where it would leave only one other hydrogen peroxide producer, and in the Southern and Central United States, where it would leave three other producers.  The complaint alleges that customers have benefitted from competition between Evonik and PeroxyChem in the form of lower prices.

New competitors or expansion by existing firms is unlikely to be timely or sufficient to offset anticompetitive harm, due to the massive investment necessary to build a new hydrogen peroxide plant.

The FTC vote to issue the administrative complaint and file the agreed-upon request for a temporary restraining order in the U.S. District Court for the District of Columbia was 4-0-1.  Chairman Joseph J. Simons was recused.  The administrative trial is scheduled to begin on January 22, 2020.

Lessons Learned

The FTC’s challenge of the merger is demonstrates that the FTC will take action to preserve competition and protect consumers when the facts support a lawsuit.  The FTC action shows that  firms that propose a merger or acquisition in a concentrated industry with a history of past collusion should expect increased scrutiny. As the FTC noted in its Complaint, evidence of past collusion is important to the FTC’s coordinated effects analysis. Merging parties should be prepared to show that market conditions have changed since the past collusion has occurred. Here, the parties were not able to do that and the FTC alleged that the market is vulnerable to coordination.  Besides relying on a coordinated effects theory, the FTC alleges that the merger eliminates head to head competition, which will likely lead to higher prices.

Andre Barlow
(202) 589-1838
abarlow@dbmlawgroup.com

Key Provisions of the Model Timing Agreement

Concluding Thoughts

Parties still encouraged to reach out to staff early on in a Second Request investigation to negotiate a timing agreement. The FTC expects that most parties will enter into timing agreements that will conform to the new Model Timing Agreement. But as always, different circumstances will result in deviations from the Model. The Bureau of Competition’s Front Office will review all timing agreements before execution and will consider the justification for any changes or deviations from the Model.  Part of the goal of an effective timing agreement is to facilitate constructive feedback between staff and the parties by creating more certainty about the timing of an investigation.  The new Model allows parties to better anticipate the Bureau of Competition’s expectations in negotiating timing agreements.

On May 16, 2018, the Department of Justice (“DOJ”) announced that a federal grand jury returned an indictment against Christopher Lischewski, the President and CEO of Bumble Bee Foods LLC (“Bumble Bee”), for participating in a conspiracy to fix prices for packaged seafood sold in the United States.

The indictment, filed in the U.S. District Court for the Northern District of California in San Francisco, charges Lischewski with participating in a conspiracy to fix prices of packaged seafood beginning in or about November 2010 until December 2013.  The one-count felony indictment charges that Lischewski carried out the conspiracy by agreeing to fix the prices of packaged seafood during meetings and other communications.  The co-conspirators issued price announcements and pricing guidance in accordance with these agreements.

Bumble Bee has already pleaded guilty and been sentenced to pay a criminal fine of at least $25 million as a result of the government’s ongoing investigation.

Bumble Bee CEO Indicted After Merger Review Debacle

The indictment of the Bumble CEO serves as a reminder to corporate executives and antitrust counsel that merger investigations can lead to serious trouble and even criminal prosecution.  In 2015, the DOJ informed Thai Union Group P.C.L., owner of Tri-Union Seafoods LLC, doing business as Chicken of the Sea International, and Bumble Bee that it had serious concerns about their deal.  The parties ended up abandoning the transaction but not until after providing the government with a lot of documents and information that the civil lawyers passed on to the criminal section.

Thai Union’s proposed acquisition of Bumble Bee would have combined the second and third largest sellers of shelf-stable tuna in the United States in a market long dominated by three major brands.  Reducing competition from three to two always draws scrutiny so it should have been no surprise that the parties received second requests for information.  When the DOJ completed the merger investigation, the DOJ said it was convinced that the parties knew or should have known from the get go that the market was not functioning competitively so further consolidation would only have made things worse.  Indeed, this deal should not have ever made it out of the boardroom.

Observations

Corporate executives and antitrust counsel must be mindful of the risks of turning over ordinary business documents and information to civil antitrust lawyers in a merger investigation.  Part of the company’s review is to determine whether the documents tell a competitive story so turning over documents demonstrate the merging parties and the industry is acting anticompetitively is certainly counterproductive.  While the government’s antitrust lawyers might be tasked with a merger review, merging parties should understand that they do not operate in a silo.  Civil antitrust lawyers at the DOJ and the Federal Trade Commission closely review the documents and if they spot anticompetitive activity within an industry, merging parties can expect an industry wide criminal or civil investigation into the conduct uncovered.  This is not the first time a merger review has resulted in an industry wide investigation, and it likely won’t be the last.  One thing is for sure, it is hard to imagine a worse-case scenario resulting from a failed merger.

Andre Barlow
(202) 589-1838
abarlow@dbmlawgroup.com

Background

CDK and Auto/Mate supply dealer management systems (“DMS”) software to franchise new car dealerships. Car dealerships use DMS software, a mission-critical business software to manage nearly every aspect of their business including payroll, accounting, financing and inventory.  They track their services, prices, and other crucial functionalities.  The top two DMS software providers, CDK, which had 41% and Reynolds & Reynolds (“Reynolds”), which had 29%, combined for about a 70% share of the DMS software market. The big two are the highest priced, and have similar business models, which include long-term contracts and significant initial and monthly fees for third-party applications (app) vendors to integrate with their respective DMS. Dealertrack, Autosoft and Auto/Mate also had competitive DMS offerings as well as others. Auto/Mate was a very small competitor with only 6% of the market.  After the deal, CDK’s market share would have been 47%.

Despite this market structure with numerous competitors and the target firm having a very small share, the FTC believed that Auto/Mate was on the cusp of becoming a “much more important and vibrant competitor” so the market share understated its current competitive and future competitive significance.  Indeed, the FTC alleged that Auto/Mate is an innovative, disruptive challenger to the two market leaders. It offers franchise dealerships low pricing, an agnostic platform for third-party applications, extensive OEM certifications, short contracts, free software upgrades and training, and a reputation for high-quality customer service. In recent years, Auto/Mate became a competitive threat in the franchise DMS market, including by specifically targeting CDK customers. Auto/Mate expanded its customer base and revenues through both aggressive pricing putting pressure on CDK’s pricing and margins. Auto/Mate was disproportionately taking customers and market share away from CDK.

Indeed, CDK’s internal documents identified Auto/Mate as a current and emerging threat. “We are so serious about acquiring new customers that we bought the DMS [Auto/Mate] that has been kicking our butts.” According to the complaint, CDK significantly increased its bid for Auto/Mate when it realized “that other well-financed, credible bidders recognized Auto/Mate’s competitive strengths and were seriously interested in buying the company,” perceiving that “if Auto/Mate fell into the hands of a well-financed buyer willing to invest additional resources, Auto/Mate would become an even more aggressive and effective competitor.” The parties abandoned the merger two days after the FTC’s complaint.

Lessons Learned

 The FTC’s block of CDK’s proposed purchase of Auto/Mate demonstrates that it is willing to challenge companies that seek to acquire small nascent rivals in technology markets.  The FTC viewed the transaction as part of an emerging trend of large technology firms acquiring nascent competitors to keep them from emerging as full-fledged rivals. Large technology firms have been buying start-ups or small competitors, which in some circumstances could be foreclosing the development of emerging rivals.   While we believe that the FTC may take these cases seriously going forward, we also tend to believe that the evidence in this particular case led the FTC to this decision.  The inquiry into whether a small nascent firm has the ability to become a stronger competitor in the future will need to be demonstrated through internal company documents and economic analysis.  There needs to be some basis to determine that the acquired firm will in a short time frame be a significant competitor.  Otherwise, the agencies would simply be making arbitrary decisions to block deals that shouldn’t be blocked.  Indeed, there are dangers to blocking an acquisition of a start-up with a good idea.  For instance, the larger company may have the wherewithal to actually help that start-up’s innovative product actually reach consumers.  So, we do not anticipate that the FTC will bring many of these types of cases without the strong evidence that existed in this challenge.

Andre Barlow
(202) 589-1838
abarlow@dbmlawgroup.com

According to Sparton, during the review of the proposed merger by the United States Department of Justice (“DOJ”), the United States Navy (“Navy”) expressed the view that instead of the parties proceeding with the merger, each of Sparton and Ultra should enhance its ability to independently develop, produce and sell sonobuoys and over time work toward the elimination of their use of the companies’ ERAPSCO joint venture for such activities. DOJ staff then informed Sparton and Ultra that it intended to recommend that the DOJ block the merger. The parties expected the DOJ would follow this recommendation and seek an injunction in court to block the merger. As a result of the view of the Navy and the DOJ’s position, Ultra and Sparton determined it was in the best interests of the parties to proceed to terminate the merger agreement.

Also according to Sparton, the parties understand that the DOJ intends to open an investigation to evaluate their ERAPSCO joint venture. Sparton said that based on historical practice, the company anticipates the Navy will assist in funding Sparton’s transition to independently develop, produce and sell sonobuoys.

Regulatory Backdrop

On September 22, 2017, the DOJ issued a Second Request for additional information in connection with the transaction. One month later Ultra and Sparton entered into a timing agreement with the DOJ, pursuant to which they agreed not to consummate the merger until 90 days following the date on which both companies shall have certified compliance with the Second Requests.  On January 31, 2018, Sparton said it expected that the merging companies will have certified compliance with the Second Requests on or before February 8, 2018.  The Committee on Foreign Investment in the United States (CFIUS) cleared the deal back on November 20, 2017.

ERAPSCO Joint Venture

ERAPSCO is a 50/50 joint venture between Sparton and UnderSea Sensor Systems, Inc. (“USSI”). USSI’s parent company is Ultra, based in the United Kingdom. Sparton and USSI are the two only major producers of U.S. derivative sonobuoys – signaling systems that are launched from aircraft and ships during anti-submarine warfare (“ASW”). They are used in support of multiple underwater missions for detection, classification, and localization of adversary submarines during peacetime and combat operations. This JV supplies the Navy, as well as foreign governments that meet Department of State licensing requirements, with sonobuoys.

ERAPSCO has been in existence since 1987 and, historically, the agreed upon products included under the venture were generally developmental sonobuoys. In 2007, the JV expanded to include all future sonobuoy development and substantially all U.S. derivative sonobuoy products for customers outside of the United States. The JV was further expanded three years later to include all sonobuoy products for the Navy beginning with the Navy’s 2010 fiscal year contracts.

According to publicly available information, the joint venture serves as a pass-through entity maintaining no funds or assets.  The Board of Directors of ERAPSCO has the responsibility for the overall management and operation of the JV. The six-member board consists of equal representation (full-time employees) from both JV partners for three-year terms.  In some instances, either Sparton or USSI handles the complete production and delivery of sonobuoys to ERAPSCO’s customer. In other instances, either Sparton or USSI starts the production and ship completed subassemblies to the other party for additional processing before being delivered to the customers.

Competition Concern

Ultra Chief Executive Officer Douglas Carter says that the Navy wants to increase competition in the production of sonobuoys as demand rises along with heightened geopolitical tensions, in particular a bigger threat to the U.S. East Coast.

Significantly, Sparton is the only U.S. producer of sonobuoys, and the worldwide market is a duopoly between Sparton and Ultra. International regulations create a strong barrier to entry; in fact, when the Navy contract was last up for renewal in 2014, the ERAPSCO JV was the only bidder.

According to Sparton’s Form 10-K, “while the ERAPSCO agreement provides certain benefits to Sparton, the company does not believe that it is substantially dependent upon this agreement to conduct its business.” If in the future, Sparton determines that this commercial arrangement is no longer beneficial, the company has the ability to terminate the joint venture in relation to future business awards and return to independent bidding for Navy and foreign government sonobuoy contracts. Similarly, if USSI were to terminate this JV, Sparton would be required to return to independent bidding and production for both the Navy and other foreign governments that meet the State Department licensing requirements. If this were to happen, Sparton says its future results could be negatively impacted.

Takeaways

The market for sonobuoys has limited opportunities for competition as well as significant barriers to entry. In this context, blocking the merger of the only two producers of U.S. derivative sonobuoys can hardly come as a surprise.

What is surprising in this case, however, is that the combining firms were already 50/50 joint venture partners with respect to the relevant product market, specifically.

Though the Navy at present purchases sonobuoys from the Ultra/Sparton JV, the DOJ and the Navy are opposed to the full-fledged integration of these two suppliers that could potentially compete with each other in the future. According to the DOJ, “The transaction threatened to permanently combine the only two qualified suppliers of sonobuoys to the U.S. Navy.” (Emphasis added.)

In other words, the DOJ is drawing a line in the sand between temporary, if prolonged, partnership on the one hand, and all-out combination on the other.  Clearly, the fact that two firms already cooperate via a 50/50 JV does not guarantee that a merger of those same two firms will be approved. Moreover, the fact that CFIUS approves a deal does not suggest that the DOJ and the U.S. military will approve the deal.

Here, the DOJ plans to conduct a further review of ERAPSCO and will likely require Ultra and Sparton to operate independently going forward. Beyond merely eliminating a future potential anticompetitive effect of a proposed transaction preemptively, the DOJ seems to be looking to undo an existing “partnership” between two rivals – that together happens to be the sole supplier of critical equipment to the Navy.

Indeed, the fact that the customer most likely to lose out in a potential merger of Ultra and Sparton – and clearly most likely to benefit by the unraveling of the joint venture – is the Navy is hard to ignore.

A joint venture between competitors can have procompetitive effects when it can create efficiencies and economies of scale, leading to lower costs, higher quality products, and increased innovation. On the other hand, a JV can be anticompetitive if it presents as a JV in name only.  Here, Sparton openly admits that it could compete, bid, and produce independently so there does not appear to be any specific need for the JV to continue.

The DOJ’s recommendation to sue to block the deal and open a separate investigation into the ERAPSCO JV demonstrates how aggressive the DOJ is willing to be when it uncovers information suggesting that the merging parties were not acting appropriately prior to the merger review.  Within the past couple of years, the DOJ has opened criminal investigations into the packaged tuna industry and hop-on/hop-off bus tour markets, as well as a civil investigation into DirecTV’s conduct related to the LA Dodgers after uncovering evidence of bad behavior during merger reviews.

Andre Barlow
(202) 589-1838
abarlow@dbmlawgroup.com

Smucker currently owns the Crisco brand, and by acquiring the Wesson brand, it would control at least 70% of the market for branded canola and vegetable oils sold to grocery stores and other retailers.  Smucker and Conagra both manufacture and sell a wide range of food products, including canola and vegetable oil, other types of oils, and shortening.  The FTC also claims that other branded canola and vegetable oils available in the United States, such as Mazola and LouAna, each control only a small share of the market, and do not hold the same brand equity.  Furthermore, building sufficient brand equity to expand would require substantial investment and take at least several years.

Under the proposed acquisition, Smucker would obtain all intellectual property rights to the Wesson brand, as well as inventory and manufacturing equipment.

The complaint alleges that the acquisition is likely to increase Smucker’s negotiating leverage against retailers, especially traditional grocers, by eliminating the vigorous head-to-head competition that exists between the Crisco and Wesson brands today.

According to the complaint, internal documents from both parties, as well as other evidence, indicate that Crisco and Wesson compete intensely for sales to retailers.

• In , Smucker’s Region Sales Manager for described a
  Wesson advertisement for gallons of canola, vegetable, and corn oil as “downright irresponsible trade spending by our friends at Con Agra.” Smucker’s Director of , responded, “that’s clearly irresponsible trade spending,” and stated, “if you feel some of the recent Wesson tactics are going to materially impact your fiscal year projections, we’ll want to talk about it
  sooner than later.  Again, we’re hopeful that our tactical spending and innovation will help offset any of Wesson’s targeted tactics.”
• In August 2016, Conagra’s recaps from a meeting about the Wesson brand included: “Crisco is running deeper price points at major retailers (i.e. ); Crisco’s pricing strategy is irrational; Crisco did not follow [Wesson’s list] price increase; [and] Tom is asking to grow share having lost volume [by] pulling out trade [funding].”

Smucker’s own internal documents acknowledge that eliminating price competition between Crisco and Wesson is a central part of its rationale for the acquisition.

• In a document submitted with Smucker’s Hart-Scott-Rodino
  filing, Smucker stated that a “strategic rationale” for the Acquisition is that it “[t]akes [a]competitor [Wesson] out of the marketplace and allows us to more effectively manage
  pricing/trade.”
• In Smucker’s view, this price competition is
  a “race to the bottom” that “unnecessarily tak[es] dollars out of the category.”
• Smucker admits that it will increase prices: “Once we close the deal, our plan would be to execute a price increase on Wesson consistent with our latest Crisco pricing action.”

The FTC alleges that the transaction would give Smucker the ability to raise prices to retailers, ultimately leading to higher prices for U.S. consumers for branded canola and vegetable cooking oil.

The FTC also authorized its staff to seek a temporary restraining order and a preliminary injunction in federal court to prevent the parties from consummating the merger, and to maintain the status quo pending the administrative proceeding.  The FTC vote to issue the administrative complaint was 2-0.  The administrative trial is scheduled to begin on August 7, 2018.

Lessons Learned:

This complaint demonstrates that the FTC will use merging parties’ own words against them when challenging their deal.  Historically, “hot docs” provide an easy way to capture the interest of a judge by saying this case is simple and all you have to do is examine the merging parties’ own words.  The FTC routinely cites “hot docs” in its complaints because they catch the interest of the media and, particularly, the judge.  The FTC will focus on supposed “hot docs” to support its case because the buyer appears to be touting the intended anticompetitive consequences of the acquisition.  At the end of the day, however, a “smoking gun” document regarding anticompetitive intent  will be rejected by a judge unless the FTC provides the foundations of an antitrust case through market analysis and empirical evidence.

Nevertheless, this case demonstrates why corporate executives must be mindful about what they write as careless and inappropriate language in company documents can have an extremely negative effect on a merger review.  Ambiguity or exaggeration in memoranda, marketing presentations, or board presentations may convey the erroneous impression that the company is more dominant or powerful than it is or that the acquisition will injure competition.  All such documents should be written clearly and carefully in order to avoid misinterpretation.  Documents that contain careless and inappropriate language may make a perfectly legal merger appear anticompetitive.  Facetious or ironic comments may seem funny and be understood by other insiders at the time of the comments, but invariably can be misinterpreted after the fact by a government agency or a court.  A good rule of thumb is to write every document so that neither you nor the company would be embarrassed if it appeared on the front page of the Wall Street Journal.

Andre Barlow
(202) 589-1838
abarlow@dbmlawgroup.com

Critics raised concerns about the merged company’s shutting out competitors, which would leave consumers with fewer options and less freedom of choice.  For example, if the merged firm bundles together frames and lenses for sale in its Lenscrafters stores, other lens manufacturers will lose sales.  Independent stores might also be left out or excluded from the markets.  The concern was not just in these critics’ imagination as Luxottica has a history of shutting out its rivals.  Year ago, Luxottica and Oakley had a disagreement about pricing, and Luxottica stopped Oakley’s products in their stores. Oakley’s stock price collapsed, and it was later bought by Luxottica. Critics also claimed the merger eliminated competition between the two companies and ends the possibility of future competition. Essilor had started promoting its own sunglasses and online sales, and Luxottica was beginning its own lens manufacturing.  The two firms were expanding into each other’s markets and competing against each others, which would have driven down prices, improved quality, and helped consumers.  Given the decisions by the FTC and EC, that competition will never occur.

According to the FTC in its statement to close its investigation of the merger, the evidence did not support a conclusion that Essilor’s proposed acquisition of Luxottica violates federal antitrust laws: “FTC staff extensively investigated every plausible theory and used aggressive assumptions to assess the likelihood of competitive harm.  The investigation exhaustively examined information provided by a wide and deep swath of market participants, as well as the parties’ own documents and data.  Assessing the likely competitive effects of a proposed transaction is a fact-specific exercise that takes into account the current market dynamics, which may be different in the future.  Here, however, the evidence did not support a conclusion that Essilor’s proposed acquisition of Luxottica may be substantially to lessen competition in violation of Section 7 of the Clayton Act.”  The FTC vote to close the investigation and issue the closing statement was 2-0.

Meanwhile, European Union Competition Commissioner Margrethe Vestager said: “Our job is to ensure that a merger won’t lead to higher prices or reduced choices.  In this case for opticians and consumers in the EU.  We’ve received feedback from nearly 4,000 opticians in a market test in Europe that Essilor and Luxottica would not gain market power to harm competition.  As the result of the market test did not support our initial concerns we can let this merger go ahead unconditionally.”  To date, the deal has been unconditionally approved in 13 other countries: Australia, Canada, Chile, Colombia, India, Japan, Mexico, Morocco, New Zealand, Russia, South Africa, South Korea and Taiwan.  Essilor and Luxottica expect to finalize their proposed combination in the first part of 2018 after obtaining all necessary authorizations.

Clearly, close coordination between the FTC and EC on the closing of these investigations into this merger.

Andre Barlow
(202) 589-1838
abarlow@dbmlawgroup.com

Background

On November 21, 2017, the U.S. Department of Justice’s (“DOJ”) Antitrust Division filed a complaint in federal court block AT&T’s acquisition of Time Warner Inc. (“Time Warner”).

On February 16, 2018, the DOJ and AT&T faced off at a hearing in front of Judge Leon regarding AT&T’s discovery requests related to internal communications between the White House and the DOJ and its identification of Makan Delrahim, the Assistant Attorney General (“AAG”) of the DOJ’s Antitrust Division, on its witness list for trial. AT&T’s discovery requests were in line with one of the company’s affirmative defenses in its Answer to the Complaint, namely that: “Plaintiff’s claim reflects improper selective enforcement of the antitrust laws.”

In front of Judge Leon, AT&T simply asked for a privilege log of communications between the DOJ and the White House, if any exist. The DOJ could have ended the discovery dispute by simply answering that no communications exist. But, the DOJ claimed that the discovery requests were actually broader and made a legal argument that the discovery is barred.

AT&T’s selective enforcement defense asserts that the DOJ singled out its deal.  First, the DOJ hasn’t litigated a vertical merger in 40 years. Second, in 2011, the DOJ approved Comcast’s JV with NBCUniversal, a vertical deal that raised largely the same concerns at issue in AT&T/Time Warner. Of course, that deal was resolved through behavioral remedies, which happens to be a pet peeve of Delrahim. The DOJ is not interested in resolving the current deal without a structural remedy.

The DOJ raised the issue of filing a motion to strike the selective enforcement defense, objecting to the discovery demands and objecting to Delrahim being put on the witness list. The DOJ argued that under the law, it is a high hurdle to obtain such discovery. First, AT&T has not been singled out. Despite not litigating a vertical merger case in 40 years, the antitrust agencies have challenged numerous vertical mergers over the years and have forcing parties to abandon their deals or enter into settlement agreements resolving the antitrust concerns.  Moreover, AT&T compares its case to Comcast/NBCU, which the DOJ actually challenged.

Judge Leon’s Ruling:

Judge Leon did not rule on the DOJ’s motion to strike the selective enforcement defense.  However, he might as well have.  He denied AT&T’s motion to compel the DOJ to provide privilege logs of communications between the White House and the DOJ and quashed AT&T’s discovery requests for those same communications.

Judge Leon focused on the Supreme Court’s decision in United States v. Armstrong to determine if the defendants should be able to obtain discovery related to the selective enforcement defense. Judge Leon said the D.C. Circuit has recognized that “prosecutors have broad discretion to enforce the law, and their decisions are presumed proper absent clear evidence to the contrary.” United States v. Slatten, 865 F.3d 767, 799 (D.C. Cir. 2017)(citing Armstrong). Order at 3. Judge Leon noted that it is a rigorous standard that defendants must meet to obtain discovery.  Under the standard, defendants must put forward evidence of discriminatory effect and intent. Order at 4.

Judge Leon stated that defendants “fall far short” of the necessary demonstration of selective enforcement. He went further to say that “it is difficult even to conceptualize how a selective enforcement claim applies in the antitrust context,” because of the uniqueness of each merger enforcement action. Order at 5. He noted that comparing Comcast/NBCU to A&T/Time Warner was unavailing given that the DOJ actually filed an enforcement action against Comcast and while there was a remedy for that deal, the FCC was involved to monitor it. Order at 5. He then hammered the defendants for trying to claim that the DOJ’s action against a vertical merger was somehow discriminatory when it is clear that this is not the first time the government has brought a vertical case. “While it may, indeed be a rare breed of horse, “it is not exactly a unicorn.” Order p. 6.

Observations:

According to Judge Leon, the selective enforcement defense may not be applicable in antitrust enforcement cases.  Undoubtedly, all antitrust defendants feel like they are being singled out as they point to past deals within the same industry that were approved by the antitrust agencies. But, the antitrust agencies have made it clear that each merger raises its own unique set of facts.

In raising the selective enforcement defense, AT&T was questioning the DOJ’s prosecutorial discretion. It had little, if anything, to do with the substantive claims that are being brought against the company. Antitrust is about law enforcement. The case is brought in front of a federal judge, and the court will decide whether the deal is anticompetitive.

The DOJ does not typically need to explain why it brings an enforcement action other than the deal raises competitive concerns that may substantially lessen competition. It can choose to challenge one merger but not another even when they raise similar issues. Further, it is entirely permissible for a new administration to change its merger enforcement priorities as well as how it remedies problematic mergers. The decision to sue-to-block rather than adopt conduct remedies is up to the DOJ’s own discretion even though that decision may have the appearance of being essentially ideological or political.

Judge Leon understands that every merger is unique to its own facts, not all mergers within the same industry should be treated similarly, and remedies used in one merger may not be appropriate in the next merger. Moreover, he was not about to compare AT&T to Comcast when he has not had the opportunity to study the facts related to the merger at hand. Based on the law, he made the right decision to keep everyone focused on the substantive antitrust issues.  Judge Leon is going to decide this case based on the economic realities of the video distribution and content markets and not on President Trump’s public battle with CNN.  While Trump’s political campaign promises may cast a shadow over the DOJ’s motivation for bringing the case, it should not influence the court’s decision on whether the acquisition is illegal or not.  Judge Leon will make the ultimate decision on whether the deal is anticompetitive and is unlikely to be distracted by the political noise.

Andre Barlow
(202) 589-1838
abarlow@dbmlawgroup.com

He noted that the Division’s recent consent decrees reflect several provisions designed to ensure the Division can meaningfully enforce them.  Delrahim stated that the DOJ’s approach will be to enter into consent decrees only when the DOJ can effectively enforce them, and when the DOJ enters into consent decrees, to enforce them effectively.

Consent decrees should be used consistent with a view of the Antitrust Division as a law enforcement agency, not a regulatory one. Faced with a violation, the Antitrust Division has an obligation to the public to ensure any settlement contains meaningful relief and that the settling parties obey its terms.  He said that “filing a consent decree that would be difficult to enforce certainly minimizes litigation risk and provides for a quick win in the press, but it goes without saying that the unenforceable decree provisions would not vindicate the Division’s duty to protect competition.”

Delrahim spoke about the difficulties of enforcing behavioral conditions as it puts enforcers and corporate counsel in an untenable position—“how can a small team of lawyers keep capable executives from doing what executives are trained to do, day after day for years?”  The free markets depend on businesses taking advantage of their assets to maximize their returns.  The risks and penalties of a civil consent decree violation would need to be high enough to deter such conduct.  Meanwhile behavioral conditions are fundamentally regulatory, imposing government supervision on what should be free markets.  Antitrust enforcers have long preferred structural remedies, in large part for these reasons.

Delrahim announced that all new consent decrees will contain a set of procedural provisions designed to improve their function and enforceability that will be used in future decrees.  First, a key provision relates to the burden of proof should the defendant violate the decree and the DOJ move for contempt.  The standard for proving a civil antitrust violation is a preponderance of the evidence, however, the default rule for seeking contempt on a settlement is clear and convincing evidence.   The new terms contract for the same preponderance standard for decree violations as for the underlying offense and for decree interpretations.  (Before these changes, it was difficult for the DOJ to investigate and prove violations of the decree.)  This provision will make enforcement of decrees substantially easier.  The second decree provision relates to the common practice of parties to a contract agreeing to more efficient fee shifting rules.  Before the change,  the Division had to bear the costs of decree enforcement investigations and proceedings.  The Division’s new fee-shifting provision requires defendants to agree to reimburse the DOJ for attorneys’ fees, expert fees, and costs incurred in connection with any successful consent decree enforcement effort.  (This provision should encourage speedy resolution of any potential violations as there will be no advantage for the defendants to delay).  Third, a new provision will allow the Division to apply for a one-time extension of the term of the decree, if a firm is found to have violated the decree.  (This provision discourages violations.) Fourth, a new term will be included that permits the DOJ to terminate the decree early upon notice to the Court and the defendant(s), if necessary.

Observations:

The DOJ has adopted new terms in recent consent decrees that enhance DOJ’s ability to enforce its settlements by lowering the evidentiary standard for proving a defendant has violated the terms of a settlement agreement.  In the past, the burden of proof in civil contempt cases sometimes forced DOJ to conduct burdensome investigations to prepare its contempt case and encouraged defendants to delay and “exacerbate the situation. In addition to lowering the evidentiary standard, the new consent decree terms require defendants to pay the costs of DOJ enforcement efforts and allow DOJ to extend the term of the decree or terminate it upon notice to the court and defendants.  These new terms increase DOJ’s leverage over settling in the event there is a dispute about compliance with the consent decree. Indeed, the fee-shifting provision should encourage speedy resolution of consent decree violation investigations and compensate taxpayers for the cost of enforcement.  Permitting the DOJ to extend the decree if a court determines defendants violated the decree is another hammer.  It appears that the DOJ will insist on these new terms to be included in all civil merger and non-merger consent decrees so there really will be no negotiation.  These new provisions are good for the DOJ but not so good for settling parties because there will be less flexibility in negotiating compliance details and greater potential risks associated with any future violations.

Andre Barlow
(202) 589-1838
abarlow@dbmlawgroup.com

Background

In June of 2017, the FTC and the North Dakota Attorney General sued to block the merger of the two largest physician groups in Bismarck and Mandan, North Dakota.  The FTC alleged that the two groups had based on physician headcount at 75 percent of the physicians for adult primary care physician services, pediatric services, and obstetrics and gynecology services, and 100 percent of the general surgery physician services in the Bismarck-Mandan area.  The merger would eliminate competition between them and substantially lessen competition in the four markets.

Sanford Health operates more than 40 hospitals and 250 clinics, and employs more than 1,300 physicians in nine states. In the Bismarck area, it operates a 217-bed hospital and employs 160 physicians and 100 other health care providers. Mid Dakota is a multispecialty physician group that operates six clinics in Bismarck and employs 61 physicians and 19 advanced practice practitioners. Catholic Health Initiative (“CHI”), with whom Mid Dakota had a close referral relationship, operates the only other acute care hospital in the Bismarck-Mandan area.

FTC’s Case

The Court agreed with the FTC regarding the four product markets and the geographic: adult primary care physician services, pediatric services, obstetrics and gynecology services, and general surgery physician services in Bismarck-Mandan area of North Dakota. The FTC successfully put on evidence showing that patients viewed Sanford and Mid Dakota’s physician groups as substitutable with each other.

In general, competition in the health care provider market can be divided into two “stages.” In the first stage, providers compete with one another for access to insurance plans offered regionally by commercial health insurers.  In the second stage, providers compete to attract patients to their facilities. Competition in the first stage is mostly related to price or reimbursement rates that providers receive from insurers for health care services provided to patients.  Competition in the second stage is mostly related to service such as quality provided, availability of procedures, hours of operation, convenience of facilities, and innovative technology.

The FTC focused on whether the combined physician groups would have increased bargaining leverage over commercial health insurers.  In this case, the merging parties and the FTC’s economic experts both agreed that the merger would provide the combined firm with increased bargaining leverage.  The FTC was able to establish that commercial health insurers needed to have all four services in its health insurance plan and that the commercial health insurers would pay higher fees rather than market a plan without one of those services.

The Court agreed with the FTC’s evidence that showed that the merged entity would provide 85.7% of adult PCP services, 98.6% of the pediatrician services, 84.6% of the OB/GYN services, and 100% of the general surgeon services in the Bismarck-Mandan area.  With such high shares, the Court agreed that the transaction was presumptively unlawful in each of the four physician service lines.

The Court found anticompetitive effects flowing from the merger in both stages of health care competition.  The acquisition would eliminate competition between the two physician groups vying to be included in a health insurer’s network.  Obviously, the combination would eliminate the competition among physicians to obtain patients in the second stage of competition.

Buyer Power Defense

Once the FTC met its prima facie case, the defendants principal defense was that the presence of a powerful buyer, Blue Cross Blue Shield of North Dakota (“Blue Cross”) would offset any power obtained by the physician groups through the combination and would preclude any anticompetitive effects that might otherwise result.  The argument was that the realities of the market place was that Blue Cross had all of the bargaining power and the merged firm would not be able to negotiate higher reimbursement rates against Blue Cross.  The FTC countered that the powerful buyer defense is limited to situations where either a buyer is able to use its leverage to sponsor entry or vertically integrate, or where there are alternative suppliers post merger where the buyer is able to obtain lower prices.  The district court found that those situations were not present.  Instead, it noted that the evidence showed that Blue Cross could not market health plan in the Bismarck-Mandan area without the merged firm.  Accordingly, if Sanford Health were to request a rate increase post merger, Blue Cross “would have to choose between agreeing to the increase or no longer offering health plans in the Bismarck-Mandan area.”

Lessons Learned

The FTC continues to win preliminary injunctions in provider markets.  The FTC is likely to continue to challenge small local provider (hospitals and physician groups) transactions that eliminate competition and substantially lessen competition in narrow product and geographic markets.  While health insurers may wield a great deal of bargaining power, the buyer power defense is unlikely to convince the FTC or a district court judge that a deal that concentrates 75-100 of the physicians in a local area to one provider.  The buyer power defense is available when large sophisticated buyers or health insurers can exert countervailing power against the merged firm because they have the ability and wherewithal to shift a large proportion of their business to other health care providers or the health insurer has the ability to credibly threaten that it can vertically integrate or sponsor new entry.  Here, the evidence showed that the health insurer could not market a plan without the merged firm’s physicians.  Hence, the power buyer defense is unlikely to work in physician group mergers that concentrate most if not all the doctors in one firm going forward.

Andre Barlow
(202) 589-1838
abarlow@dbmlawgroup.com

She said that antitrust enforcers adopted the Chicago School principles, which narrowed the scope of the antitrust laws and allowed mega-mergers to proceed resulting in many concentrated industries.  She believes that antitrust enforcers already have the tools to reduce concentrated markets and that they simply must start enforcing the law again.

Senator Warren’s recommendations included stronger merger enforcement, cracking down on anticompetitive conduct and increasing agency involvement in defending competition.

Senator Warren called for the blocking of mergers instead of negotiating weak settlements that allow deals to go through:

• The DOJ and the FTC need to block any mergers that “choke off competition” and take to court any large company that is impeding competition and innovation.
• “If we’re going to begin a new era of antitrust enforcement, we need to demand a new breed of antitrust enforcers. We need enforcers with steel spines who will stand up to companies with the best-dressed lobbyists, the craftiest lawyers, and the highest-paid economists.  Enforcers who will turn down papier-mache settlement agreements and actually take cases to court.”
• “To revive competition in our economy, vertical mergers, particularly mergers in already concentrated industries, should be viewed with the same critical eye that’s needed for mergers between direct competitors.”

Senator Warren called for a crack down on anticompetitive conduct:

• The DOJ and FTC should bring lawsuits against companies using anti-poaching and non-competition agreements among companies and franchises that prevent employees from obtaining jobs that could increase their pay.
• The DOJ and FTC need to “[g]row a spine and enforce the law.  No-poach agreements are a reminder that corporate concentration not only affects consumers by limiting choices and driving up prices. It also affects workers who can’t get the salary they would be able to get in a competitive economy.  It’s time to hold those corporations accountable for these competition-killing practices. And let’s be clear: holding everyone accountable means everyone….There is no exception in antitrust laws for big tech.”

Senator Warren called for all government agencies to participate in the protection of competition:

• “Sure, DoJ is law-enforcer-in-chief, but all government agencies should defend competition” and reduce monopoly power where they have the power to do so.  The FCC should enforce strong net neutrality rules.  The FDA can reign in pharmaceutical monopolies as it controls which drugs come to market and when.  The Federal Reserve and FDIC could make sure that banks are not to big to fail. The DOD could inject more competition in its defense contracting process by not limiting the number of bidders.

Background

On February 21, 2017, Tronox inked a deal to buy Cristal for $1.67 billion and a 24% stake in the new entity. The transaction would have created the largest TiO2 company in the world, based on titanium chemical sales and nameplate capacity.

Tronox Limited operates three titanium dioxide TiO2 pigment plants in the United States, Netherlands and Australia. Tronox has a TiO2 plant in Hamilton, Mississippi. Cristal operates eight TiO2 manufacturing plants in the USA, Brazil, United Kingdom, France, Saudi Arabia, China and Australia. Cristal has two TiO2 plants in Ohio.

FTC Has Taken Issue With Consolidation in the TiO2 Market Before

In 1999, the FTC blocked E.I. du Pont de Nemours & Co.’s (“DuPont”) acquisition of Imperial Chemical Industries (“ICI”). At the time, DuPont (25%) and ICI (10%) combined produced 35% of the global supply. DuPont was the leading supplier, both in the United States and the world, of TiO2 pigments and ICI was the second-largest supplier in the world, with plants located in the United States and abroad. The deal was structured so that DuPont would acquire ICI’s TiO2 facilities outside North America, and NL Industries (“NL”), another competitor, would acquire ICI’s TiO2 assets in the United States. The DuPont/ICI transaction, therefore, avoided a production overlap in North America. Nevertheless, the FTC’s concern was that the elimination of an important import competitor like ICI could facilitate or increase the likelihood of coordination. The parties abandoned the deal in January of 1999 when faced with a lawsuit.

Relevant Product and Geographic Market

Titanium dioxide is manufactured using either a chloride process or a sulfate process. The vast majority of titanium dioxide sold in the United States and Canada is made using the chloride process, which produces brighter, more durable coatings than the sulfate process. The FTC alleges that in the North American market, sulfate titanium dioxide is not a viable substitute for chloride process titanium dioxide. The FTC also alleges that major customers for titanium dioxide in the North American market, principally coatings manufacturers, could not easily or cost-effectively shift away from chloride process titanium dioxide in favor of sulfate process titanium dioxide.

FTC Alleges Coordinated Interaction Theory

The FTC’s administrative complaint alleges that the combination would reduce competition in the North American market for chloride process titanium dioxide. The FTC alleged that if the deal is consummated, it would increase the risk of coordinated action among the four remaining competitors, and increase the risk of future anticompetitive output reductions by Tronox. The FTC alleges that without a remedy Chemours and the merged firm would have 80% of the chloride process titanium dioxide market with Venator and Kronos making up the rest of the share.

Under this theory, the FTC needs to prove that the elimination of a competitor may create or enhance the ability of the remaining firms to more easily (either explicitly or through more subtle means) coordinate on price, output, and/or capacity.  The FTC alleges that the NA chloride TiO2 industry has a number of characteristics that make it vulnerable to coordination such as commodity like product; concentrated industry with small number of competitors; transparency into the strategic decisions of competitors; customers with long term contracts makes it easy for competitors to detect deviations from past practices; low elasticity of demand; and history of interdependent behavior and allegations of collusion.

Recent Collusion Case

The FTC cites a history of restricting production to support higher prices and past collusive conduct to support its coordinated interaction theory. In its Complaint, it made reference to the September 14, 2017 Third Circuit Court of Appeals decision in Valspar Corp. v. E.I. DuPont de Nemours and Co., 873 F.3d 185 (3rd Cir. 2017), where the court observed that the U.S. titanium dioxide industry has high entry barriers and is dominated by a few firms that closely track one another’s activities and the class action case brought against the entire industry several years ago in a federal court located in Maryland.

Valspar, a large-scale titanium dioxide purchaser, broke away from the class and brought its own claims against the industry for price fixing and settled with everyone except DuPont. Valspar filed its case in Delaware and alleged that the suppliers conspired to increase prices, beginning when DuPont—the largest American supplier—joined the Titanium Dioxide Manufacturers Association (TDMA) in 2002.  During a 10 year period, DuPont announced price increases 31 times, which were matched by the other suppliers. The Third Circuit affirmed the summary judgment in favor of DuPont because it found that Valspar’s characterization of the suppliers’ price announcements “neglects the theory of conscious parallelism” and is contrary to the doctrine that in an oligopoly “any rational decision must take into account the anticipated reaction of the other . . . firms.”  The Third Circuit noted that price movement in an oligopoly is interdependent and frequently will lead to successive price increases, because oligopolists may “conclude that the industry as a whole would be better off by raising prices.”  Valspar did not show that the suppliers’ parallel pricing went “beyond mere interdependence [and was] so unusual that in the absence of advance agreement, no reasonable firm would have engaged in it.” While this all sounds good for DuPont, which is Chemours today, it does not sound so good for Tronox at the FTC. Long story short, the FTC alleges that the proposed merger would make that situation even worse.

Procedure

Both FTC commissioners voted 2-0 to issue the administrative complaint and to authorize staff to seek a temporary restraining order and preliminary injunction in federal court. The administrative trial is scheduled to begin on May 8, 2018.

Another interesting point is that the FTC and the parties both issued press releases regarding the expiration of the waiting period.  The FTC claims it expired in October and Tronox agreed to a timing agreement, whereby Tronox would provide the FTC of 10 business days notice before consummating the transaction.  Tronox, however, claims that the waiting period expired on December 1 and that “expiration means that we can proceed toward completion of the transaction” following “antitrust clearance by the European Commission and the Kingdom of Saudi Arabia.”  Tronox also noted that while the FTC could “conceivably seek to enjoin the transaction at a later time, but we believe such action would be unprecedented and contrary to the rationale of the pre-merger notification system that is the framework of the U.S. regulatory process.”  Clearly, Tronox’s press release was misguided given that it knew that the FTC was about to file a lawsuit and there was no rush to do so given that Tronox is not in a position to actually close the transaction.

Possible Settlement?

A divestiture of Tronox’s Hamilton, MS plant or a divestiture of one if not both of Cristal’s Ohio plants might do the trick.  Tronox needs to determine what it is willing to sell and if it is something less than both plants in Ohio, and if the FTC is asking for more, Tronox may just come up with its own solution and take it to the Judge.

Lessons Learned

The FTC’s challenge of the Tronox/Cristal merger is another demonstration that President Trump’s FTC will take action to preserve competition and protect consumers when the facts support a lawsuit. The FTC action shows that the Trump administration is not simply waving through deals. Though the FTC lacks a full commission, the FTC is still doing its job to protect consumers. This action also demonstrates that firms that propose a merger or acquisition in an industry with a history of past collusion should expect increased scrutiny. As the FTC noted in its Complaint, evidence of past collusion is important to the FTC’s coordinated effects analysis. Merging parties should be prepared to show that market conditions have changed since the past collusion has occurred. Here, the parties were not able to do that and have not to date offered a remedy that the FTC is willing to accept.  The FTC’s action also demonstrates that the FTC does not operate in a vacuum as it takes into account not just the timing agreement with the merging parties but outside factors that make clear that the parties are unable to consummate the transaction, which may in some cases allow for the FTC to take advantage of additional time to file a lawsuit.

Andre Barlow
(202) 589-1838
abarlow@dbmlawgroup.com

According to the DOJ, the proposed acquisition will result in higher prices for programming, thus harming consumers. The DOJ’s complaint alleges that the merged firm will have the increased ability and incentive to credibly threaten to withhold or raise the price of crucial programming content – such as Time Warner’s HBO, TNT, TBS, and CNN – from AT&T’s multi-channel video programmer distributor (“MVPD”) rivals. At present, Time Warner negotiates with an MVPD to reach a price that depends on each party’s willingness to walk away. But the transaction would change the bargaining leverage such that AT&T/Time Warner would have less to lose from walking away. Or so the DOJ alleges. According to this reasoning, post-merger, if the merged firm and an MVPD are unable to reach an agreement, some customers would switch from their current MVPD to AT&T/DirecTV in order to obtain the sought-after Time Warner content. In addition, the DOJ alleges that AT&T/DirecTV has approximately 25 million subscribers and that there are 18 Designated Marketing Areas (“DMAs”) – out of 210, nationwide – where AT&T/DirecTV has approximately 40% share of the local MVPD market.

However, AT&T’s response indicates that the DOJ’s complaint is a misguided effort to block a pro-competitive deal that poses no real threat to consumers. The DOJ’s theory betrays a lack of understanding of the current and rapidly evolving market for content and distribution. The merged firm will still have a strong financial incentive to license Time Warner’s programming to as many outlets as possible. Because local cable monopolies dominate local markets through the bundling of broadband and MVPD services, AT&T does not have a clear economic incentive to cut off rival video distributors. After all, such a strategy is risky because AT&T might lose more than it gains with only the possibility that a small number of subscribers would switch to AT&T/DirecTV. In fact, consumers are increasingly willing to cut the cord entirely as they look to virtual MVPDs like Sling TV as well as subscription video on demand services (“SVODs”) such as Amazon Prime (80 million U.S. subscribers) and Netflix (109 million subscribers worldwide), demonstrating that the video distribution and content markets have become ever more dynamic – and competitive. And the lines between MVPDs, virtual MVPDs and SVODs are blurring as Amazon Prime recently carried the Titans/Steelers game live. AT&T called out the DOJ for not providing any market analysis or empirical evidence to support its theory that consumers would be harmed.

Beyond that AT&T claims that the DOJ’s case is arbitrary and accuses them of selective antitrust enforcement. Neither argument holds water nor matters very much because at the end of the day, Judge Leon is going to make a decision based on the economic realities of the video distribution and content markets. Nevertheless, AT&T also responded that Comcast/NBCU raised the same vertical issues and in that case, the DOJ resolved the concerns with behavioral remedies.

While AT&T does not concede that the transaction results in competitive harm, it offers the same behavioral fix used and approved by Judge Leon in Comcast/NBCU. Contingent on deal completion, Time Warner formally and irrevocably offered its distributors licensing terms for 7 years after the merger that entitle them arbitration if there are any disputes over arbitration and forbids Time Warner from “going dark” on any current distributor. The merging parties have done this on their own and the beauty of it is that it does not require any oversight by the Court or the DOJ.

Given that the DOJ has been unwilling to negotiate a comprehensive set of behavioral conditions that would insure that AT&T’s video rivals are able to obtain the Time Warner programming that they desire, AT&T is taking matters into its own hands. In other words, AT&T is cutting out the regulatory middle-man.

Such a strategy allows AT&T to greatly increase its chances that the DOJ will simply drop its case. It is a win-win for everyone involved, the merging parties, the DOJ, and AT&T’s video rivals. The DOJ can save face as it will have done its job of preserving competitive pricing and availability of content while avoiding the risks of trial and without becoming a day-to-day regulator of the merged firm’s conduct. That said, the DOJ rarely accepts a fix without a signed consent decree and presumably this offer was not good enough to avoid the complaint.

Alternatively, if the case goes on to trial, the irrevocable offer to video distributors for Time Warner programming provides Judge Leon, as the fact finder, with some evidence to counter the DOJ’s allegations that AT&T would withhold or raise the price of content to its video distributor rivals. Given the ever evolving video and programming markets, a band-aid may be all that is necessary.

Andre Barlow
(202) 589-1838
abarlow@dbmlawgroup.com

According to the DOJ’s complaint, SDK and SGL manufacture and sell large ultra-high power (UHP) graphite electrodes that are used to generate sufficient heat to melt scrap metal in electric arc furnaces.  The complaint alleges that SDK and SGL are two of the three leading suppliers of large UHP graphite electrodes to U.S. electric arc furnace steel mills, and that the two firms together have a combined market share of about 56%.  The third domestic player has a 22% market share.  While the rest of the market share (22%) is held by a number of importers, the DOJ alleged that none of the importers could individually or collectively are in a position to constrain a unilateral exercise of market power.

Under the terms of the proposed settlement, SDK must divest SGL’s entire U.S. graphite electrodes business, including its manufacturing facilities in Ozark, Arkansas and Hickman, Kentucky, to Tokai Carbon Co., Ltd., or an alternate acquirer approved by the United States within 45 days of the stipulated hold separate order.  The DOJ said that the divestiture will remedy the acquisition’s anticompetitive effects by providing the acquirer with the domestic manufacturing presence and robust local service capabilities that U.S. electric arc furnace steel mills prefer.  Moreover, the settlement will ensure that U.S. electric arc furnace mill operators continue to benefit from robust competition for this critical input in the steelmaking process.

Observations 

The DOJ’s enforcement action demonstrates that it is willing to force a divestiture in a situation where competition is being reduced from three to two domestic suppliers in a bid market.  It is also interesting to note that although imports make up 22% of the share, the DOJ discounted the importance of importers because neither individually nor collectively could an importer or importers constrain a unilateral exercise of market power.  Here, the DOJ entered into a stipulated hold separate order so that the merged firm will keep the divestiture assets economically viable as it searches for a buyer.  This demonstrates that the new administration may be amenable to approving settlement agreements without having a finalized contract with the upfront buyer.

Andre Barlow
(202) 589-1838
abarlow@dbmlawgroup.com

The Department of Justice’s Antitrust Division (“DOJ”) and Federal Trade Commission (“FTC”) have for years emphasized that they will investigate and challenge consummated transactions that were not initially reviewed or slipped through the cracks if those transactions substantially lessen competition.  It does not matter that for one reason or another that merging parties were able to successfully avoid a long drawn out investigation.  The DOJ’s lawsuit to block Parker’Hannifin’s acquisition of CLARCOR, Inc. illustrates that the DOJ may open an investigation and challenge a transaction even after it allowed the Hart-Scott Rodino (“HSR”) waiting period to expire.  The enforcement action also serves as a reminder that if merging parties do not cooperate with a merger investigation, they risk being sued.

DOJ Sues Parker-Hannifin Seven Months After Allowing it to Close its Acquisition of CLARCOR

On September 26, 2017, the DOJ continued its policy of blocking consummated transactions that harm competition, with its legal challenge to Parker-Hannifin’s $4.3 billion acquisition of CLARCOR.  Parker-Hannifin and CLARCOR entered into a deal on December 1, 2016 and closed the transaction on February 28, 2017 so the DOJ allowed the HSR waiting period to expire without taking any enforcement action or issuing a Second Request.  Approximately, seven months after closing the transaction, Parker-Hannifin is now put in the position of defending itself in court for a deal that it likely thought was approved.

Apparently, the DOJ opened an investigation into the combination after the deal closed.  There are not many details on what happened, but the DOJ’s Press Release announcing the lawsuit says that “during the pendency of the department’s investigation, Parker-Hannifin failed to provide significant document or data productions in response to the department’s requests.  In addition, the company has not agreed to enter into a satisfactory agreement to hold separate the fuel filtration businesses at issue and to maintain their independent viability pending the outcome of the investigation and, now, this litigation.”  What is also clear from the DOJ’s complaint is that several weeks prior to the deal announcement, Parker-Hannifin and CLARCOR had an email communication about the competitive overlap in the aviation filtration business, whether they should be forthcoming about the anticompetitive concern, and Parker-Hannifin informed CLARCOR that it was preparing to divest CLARCOR’s aviation fuel filtration business to obtain antitrust approval.

From the Press Release, however, the DOJ appears to be suggesting that Parker-Hannifin was not fully cooperating with the merger investigation or at least to the DOJ’s liking nor has Parker-Hannifin offered a sufficient remedy to resolve the DOJ’s competition concerns.

DOJ Alleges that the Deal is a Merger to Monopoly in a Relevant Market that Requires a Divestiture to Resolve the Concerns 

The DOJ alleges that the deal substantially lessens competition in the development, manufacture, and sale of aviation fuel filtration products in the United States.  Aviation fuel must be filtered properly to remove particulate contaminants and water droplets before such fuel is delivered into commercial or military aircraft.  The failure to do so can result in engine failure.  For this reason, aviation fuel filtration systems and filtration elements must be subjected to rigorous testing and qualification requirements.  U.S. commercial and military planes can only use aviation fuel filtration products qualified by the Energy Institute (“EI”).  The DOJ further alleges that the deal creates a monopoly in the United States as Parker-Hannifin and CLARCOR were the only two manufacturers of El-qualified aviation fuel filtration systems and filters.  So, the acquisition eliminated direct competition and the DOJ alleges that entry is not likely.

With this set of facts, the DOJ would typically requires a divestiture of the aviation fuel filtration business or assets to an appropriate buyer in order to restore competition that existed prior to the acquisition.  Allegedly, to date, Parker Hannifin has not fully cooperated with the investigation nor has it offered a remedy to the DOJ’s liking.  Thus, the DOJ filed a lawsuit seeking an order that Parker-Hannifin divest tangible and intangible assets sufficient to create a separate, distinct, and viable competing business that can replace CLARCOR’s competitive significance in the marketplace.

The ball is in Parker-Hannifin’s court now.  It must decide whether to defend the lawsuit or enter into settlement negotiations regarding a divestiture.

Observations

The DOJ’s willingness to file a complaint challenging this deal demonstrates that the DOJ is serious about enforcing the antitrust laws against consummated mergers that substantially lessen competition and that the DOJ will not back down to companies that fail to fully cooperate with its merger investigations.  The challenge also demonstrates that completed deals that slip beneath the agency’s radar screen initially are fair game if the DOJ learns about the anticompetitive effect later.  Corporate executives that enter into deals that raise competitive concerns must be aware that antitrust investigations that appear to be done may not be.  While corporate and private antitrust counsel would like assurances that the expiration of the HSR waiting period provides closure to the antitrust review, they must be mindful that the expiration of the HSR waiting period does mean that the merged firm is in the clear because sometimes competitive concerns are not readily apparent or customers may fail to raise concerns within the relevant HSR waiting period.  Accordingly, parties to a consummated deal that raise significant antitrust issues and avoided HSR scrutiny, for whatever reason, should proceed with reasonable caution and closely monitor post-acquisition conduct.  Moreover, corporate and private counsel should be aware of the likely consequences and the risks of not cooperating with the government’s merger investigation and consummating transactions that raise significant competitive issues.  The risks may include: defending against costly and lengthy government investigations; reorganizing to the government’s demands of possible divestitures even after integration has taken place; and disgorgement of profits gained from the alleged anticompetitive merger.

Andre Barlow
(202) 589-1838
abarlow@dbmlawgroup.com

Background of Case 

Valero is a refiner and retailer of gas in California and through the acquisition, it was seeking to add Plain’s storage and distribution terminals in Richmond and Martinez, California.  California alleged that the transaction would allow Valero to control the last independently operated gathering line in the state with available capacity.  Part of the state’s argument was that the acquisition would eliminate Plains as a maverick competitor.  California alleged that Valero’s acquisition would permit the vertically integrated refiner to reduce competitor access to the distribution terminals, which would result in increased fuel prices at retail gas stations.  California alleged that Valero would be able to recoup lost terminal profits (after withholding access from competitors) through a downstream increase in gas prices.  California also alleged that once all the fuel terminals were vertically integrated, there would be a higher risk of coordination among Valero and other vertically integrated providers to similarly reduce supply into the terminal and increase prices at gas stations.

While the district court denied California’s motion for a temporary restraining order and preliminary injunction motion, the judge did not appear to be ruling entirely against the state.  Indeed, the district court stated that the order was unnecessary as it would not be difficult to restore the status quo for two reasons.  First, Plains’ long-term contracts prevented Valero from restricting terminal services from any existing customers during the course of the planned litigation.  Second, Valero and Plains provided a declaration detailing firewalls and other commitments to maintain separate businesses while the litigation progressed.

In the order, however, the district court expressed that California raised “serious questions” about the anticompetitive effect of the transaction as the judge was skeptical that Valero’s purchase of the storage terminals in Martinez and Richmond, California wouldn’t harm competition so the judge made it clear to Valero that defendants were proceeding at their own risk if they closed the transaction before the court ruled on the matter.  In other words, while Valero won at the TRO and preliminary injunction stages, there was a real risk that it could lose if it went forward with its acquisition plans.  Accordingly, the Valero and Plains decided to terminate the transaction rather than go through a lengthy trial that would have resulted in continued uncertainty.

Lessons Learned

This case demonstrates that state attorneys general can and will take action against transactions that raise local competitive concerns even if the federal antitrust agencies clear the transaction.  Valero’s early merger litigation victories demonstrate that while it is difficult for a plaintiff to win a TRO or preliminary injunction motion, those victories are not indicative of how the judge might ultimately rule on a permanent injunction.  Given the risks, costs and time associated with litigating a merger, parties must determine whether proceeding to litigation is a realistic approach.  Here, apparently, there was not a meeting of the minds between the transaction parties so the transaction was abandoned.  As a result, parties to transactions need to be proactive and consider state and local competition concerns when evaluating the risks of a transaction and address those competition concerns during the investigation.

Andre Barlow
(202) 589-1838
abarlow@dbmlawgroup.com