Last week, Judge Andrew Guilford of the United States District Court for the Central District of California rejected a motion by the Federal Trade Commission (FTC) to issue a preliminary injunction preventing Laboratory Corporation of America (LabCorp) from purchasing Westcliff Medical Laboratories. Federal Trade Commission v. Laboratory Corporation of America, Case No. SACV 10-1873 AG, slip op, (C.D.C.A. February 22, 2011). The LabCorp investigation and decision reveal several important trends in U.S. merger control, including a broadening gap between regulatory and judicial views on horizontal merger analysis.
Background
LabCorp and Westcliff are each independent clinical laboratories that provide clinical laboratory testing services in California. In late May 2010, Westcliff filed for bankruptcy and, shortly thereafter, publicly announced an agreement to be acquired by LabCorp for $57.5 million. The bankruptcy court approved the sale, which, because the purchase price fell below the applicable notification thresholds, was not reportable under the Hart-Scott- Rodino Antitrust Improvements Act (HSR Act).
The FTC became aware of the transaction on June 2, 2010, and opened an investigation. LabCorp voluntarily agreed to suspend the closing of the transaction and executed a hold separate agreement that restrained the parties from closing the deal until 30 days after LabCorp had substantially complied with the FTC's subpoena duces tecum and Civil Investigative Demand (CID). Those requests were issued on July 2, 2010. After a lengthy investigation, FTC staff remained opposed to the transaction and LabCorp certified substantial compliance with the subpoena and CID on November 4, 2010. On November 30, 2010, the FTC authorized staff to seek a temporary restraining order and preliminary injunction preventing the closing of the transaction. The FTC also issued an administrative complaint alleging that the transaction violated Section 7 of the Clayton Act and Section 5 of the FTC Act. A trial in the FTC's administrative courts is scheduled for May 2, 2011.
The FTC's Allegations
In its administrative complaint, the FTC alleged that LabCorp and Westcliff each competed in the market for the sale of capitated clinical laboratory testing services to physician groups in Southern California. The complaint primarily set forth a coordinated effects case, alleging that the transaction would eliminate a price-cutting maverick (Westcliff) that was aggressively seeking to expand its share of the market. The FTC concluded that the transaction would "enhance the likelihood of collusion or coordinated interaction between Quest and LabCorp," the two remaining significant competitors. The FTC also alleged a unilateral effects case, arguing that the lost competition from Westcliff would permit LabCorp to unilaterally and profitably raise prices. To support this theory of harm, the FTC alleged that LabCorp's recent efforts to raise prices to its customer physician groups had been thwarted by Westcliff.
The FTC further analyzed and rejected the merging parties' failing firm defense, arguing that the fact that Westcliff was in Chapter 11 bankruptcy was irrelevant to the failing firm analysis; the FTC alleged that the bankruptcy filing was a specific condition that had been imposed on Westcliff as part of the LabCorp acquisition agreement and not indicative of the profitability of the company. The FTC similarly dismissed the fact that no alternative bids were received for the company at the auction held after LabCorp had been installed as the "stalking horse bidder." The FTC argued that because there "a number of firms willing to purchase Westcliff for a consideration above liquidation value," immunity from antitrust scrutiny under the failing firm defense was not appropriate.
The Court's Decision
The District Court did not rule on the ultimate merits of the FTC's complaint. That determination is reserved for the administrative process currently underway at the FTC itself. The Court's decision concerned only the propriety of issuing a preliminary injunction preventing the parties from closing the transaction at this stage.
The Court's decision to decline to issue a preliminary injunction rested on several grounds. First, the Court found that the FTC's product market definition was too narrow. Specifically, the Court found that the FTC erred in failing to include so-called "fee for service" clinical labs in its market definition. Moreover, the Court found that at least 16 other companies provided clinical laboratory services in Southern California on a capitated basis in addition to the parties. The Court therefore concluded that the parties' share of a properly defined relevant product market would be significantly smaller than alleged. Second, the Court disputed whether the relevant geographic market could be larger than Southern California. Specifically, the Court found that both LabCorp and Westcliff provide clinical lab services to customers located hundreds of miles from their laboratories. The Court stated that if the relevant geographic market were defined to include Northern California, the parties' share of that relevant market would be significantly reduced due to the presence of other prominent competitors. Taken together, the Court found that there was sufficient competition in the market for clinical laboratory services in California to discipline any post-acquisition price increase, whether by way of entry or expansion of existing laboratories' services. Third, the Court in any event did not find that Westcliff had constrained LabCorp's competitive behavior, noting that Westcliff's recent expansion had not caused LabCorp to reduce its pricing or alter its bidding behavior. The Court also found that LabCorp customers had not switched to Westcliff. Finally, given the length of time needed to conclude the administrative challenge, the Court found the balance of the equities favored the private parties, not the FTC.
The FTC has filed notice that it intends to appeal the District Court's ruling to the Ninth Circuit.
Conclusion
Written decisions in U.S. merger control cases are infrequent when compared with other jurisdictions around the world. Each decision, therefore, forms an important part of the precedential patchwork of cases that guides the interpretation of Section 7 of the Clayton Act. LabCorp is no exception and both the conduct of the FTC's investigation and the District Court's opinion provide important guidance for companies and practitioners alike.
First, it remains clear that the FTC continues to aggressively regulate competition in the healthcare sector, despite recent setbacks. Six months ago, a federal district court in Minnesota rejected the FTC's efforts to unwind Ovation's 2006 acquisition of NeoProphen from Abbott Laboratories, largely along the same market definitiontype lines that proved the FTC's undoing here. It remains to be seen if these litigation losses will temper the FTC's future enforcement efforts in this sector.
Second, the U.S. antitrust agencies are increasingly investigating and challenging transactions that were not reported under the HSR Act; indeed, neither Ovation nor LabCorp were subject to premerger notification requirements in the U.S. Over the last two years or so, the U.S. agencies have investigated and challenged at least a dozen transactions that, for one reason or another, were not reported under the HSR Act. This is a marked and significant change from prior enforcement of non-reportable transactions and parties to non-reportable horizontal transactions should not assume that their deals will be "exempt" from antitrust scrutiny in the U.S.
Third, as LabCorp demonstrates, transactions approved by bankruptcy courts are not immune to antitrust scrutiny, even where the transaction falls outside of the HSR premerger notification process. To the contrary, LabCorp underscores the tension between the priorities of bankruptcy courts and antitrust regulators. The primary goal of the bankruptcy process is to recoup as much money as possible for the creditors of the bankrupt entity. In auction situations, this often results in the approval of higher bids from close horizontal competitors, as they can typically reap the greatest efficiencies from the acquisition. It is exactly these sorts of horizontal acquisitions, however, that are most likely to attract a heightened level of antitrust scrutiny. The FTC, as it made clear in LabCorp, would have preferred that the bankruptcy court approve a transaction at a lower price, resulting in reduced recovery by Westcliff's creditors, than the allegedly anticompetitive deal that was ultimately approved.
Fourth, the Court tacitly rejected the new, more flexible merger analysis set forth in the restated Horizontal Merger Guidelines, which were released by the FTC and DOJ last August. Although the Court agreed that merger analysis "need not start with market definition," citing the new Guidelines, the Court ruled that the FTC's prima facie case must consist of "[e]vidence establishing undue concentration in the relevant market." The Court, therefore, strictly followed the traditional method of merger analysis as set forth in the 1992 version of the Guidelines: defining relevant markets, determining the degree of horizontal concentration in those markets, and determining the likelihood that entry would be sufficient to offset any perceived anticompetitive effects. Indeed, the Court suggested that the FTC's failure to properly define a relevant market in this case could result in the dismissal of its administrative complaint. This is a significant departure from the agencies' position in the new Guidelines that market concentration is only "one useful indicator" of likely competitive effects and may not be relevant to the agencies' analysis in all cases. Moreover, while the enforcement agencies elected to delete the 35% safe harbor from the Guidelines, the Court found that a presumption of anticompetitive effects is unwarranted where the parties' combined share does not exceed 35% in a differentiated products market, where proof of a monopoly or dominant position is typically required to prove a unilateral effects claim.
Although the ultimate resolution of this case rests for now with the Ninth Circuit, the agencies' losses in District Courts over the last ten years continue to mount: save for one case (CCC Holdings/Mitchell), the agencies have not prevailed on a preliminary injunction motion since 2003. In CCC Holdings, the D.C. District Court had held that the FTC could rely on nothing more than presumptions about the post-merger market structure to raise "serious questions" about the merits of a transaction to win a preliminary injunction. It now appears that that holding, derived from the DC Circuit's deeply divided opinion in the Whole Foods case, may now be more the exception than the rule.
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