Judicial Recognition of Merger Efficiencies in the United States

By William J. Kolasky (U.S. Deputy Assistant Attorney General, Antitrust Division) and Andrew R. Dick (Acting Chief, Competition Policy Section, U.S. Antitrust Division):

As in other areas, the Merger Guidelines have been influential in shaping the judicial treatment of efficiencies. Just as the agencies have, the courts have increasingly begun to accept the idea that efficiencies may, in appropriate circumstances, be used to rebut a prima facie case of anticompetitive effect based on market concentration. In addition, the court have largely adopted the analytical framework for evaluating efficiency claims that is set out in the Guidelines.

The Supreme Court

The Supreme Court has not had an occasion to revisit the issue of whether efficiencies can be used as a defense in a merger case since its early decisions in Brown Shoe, Philadelphia National Bank, and Procter & Gamble. The only Supreme Court case since then that has explicitly considered the role of efficiencies in merger litigation is Cargill, Inc. v. Monfort of Colorado, Inc.(117) In Cargill, the Court implicitly overruled its earlier decision in Procter & Gamble to the extent that decision might have been understood to hold that a merger could be found to violate Section 7 because it would make an already leading firm more efficient, thereby making it harder for smaller rivals to compete against it. Cargill arose from a private action brought by a competitor seeking to enjoin the proposed merger of two leading meat packers. The plaintiff claimed it would be injured because the merger would produce “multiplant efficiencies” that would enable the merged firm to lower prices in order to compete for market share. The Supreme Court held that “it would be inimical to the purposes of the antitrust laws” to enjoin a merger because it would lead to increased efficiency and lower prices:

To hold that the antitrust laws protect competitors from the loss of profits due to such price competition would, in effect, render illegal any decision by a firm to cut prices in order to increase market share. The antitrust laws require no such perverse result, for “[i]t is in the interest of competition to permit dominant firms to engage in vigorous price competition, including price competition.”(118)

The Courts of Appeals

Since the publication of the 1982 Merger Guidelines four circuits (the 11th, 8th, 6th, and D.C. Circuits) have had occasion to consider the availability of an efficiency defense in merger cases. All four have shown a willingness to treat efficiencies as serving to rebut a prima facie showing of anticompetitive effect based on market share and concentration and have generally applied the same analytical framework as the Merger Guidelines in evaluating efficiency claims.

FTC v. University Health, Inc.(119) The 11th Circuit was the first to hold squarely that efficiencies may be used to rebut a prima facie showing of anticompetitive effect: “We conclude that in certain circumstances, a defendant may rebut the government’s prima facie case with evidence showing that the intended merger would create significant efficiencies in the relevant market.”(120) The court did not cite the guidelines in reaching this conclusion, but relied instead principally on the Areeda-Turner treatise and other scholarly articles advocating an efficiencies defense.

The approach the court adopted nevertheless closely mirrored the then-extant 1984 Guidelines. The court held that efficiencies should not be a defense to a merger that was found to be anticompetitive, but should instead be integrated into the competitive effects analysis, where it could be used to rebut a prima facie case based on market share presumptions. In addition, the court held that to be considered the efficiencies would have to be “significant” and “ultimately [to] benefit competition and, hence, consumers.”(121) Applying these standards, the court of appeals reversed the district court’s denial of a preliminary injunction. It held, inter alia, that the parties had “not presented sufficient evidence to support the claim that the intended merger would produce efficiencies benefiting consumers.”(122)

FTC v. Butterworth Health Corp.(123) In a 1997 per curiam decision affirming the denial of a preliminary injunction, the Sixth Circuit rejected an FTC argument that the district court had committed legal error in allowing the merging hospitals to rebut the FTC’s prima facie case with evidence of efficiencies. Citing University Health and Rockford Memorial Hospital,(124) where the Seventh Circuit had held that section only “forbids mergers that are likely to hurt consumers,”(125) the court held that the district court’s approach “was not legally erroneous,” without further explanation.

FTC v. Tenet Health Care Corp.(126) In the most favorable court of appeals decision on efficiencies to date, the Eighth Circuit reversed a preliminary injunction blocking the merger of the only two general care hospitals in Poplar Bluff, Missouri. The court found two errors in the district court’s decision, both relevant to its view of the claimed efficiencies. First, the court held that the FTC had produced “insufficient evidence” to prove that Poplar Bluff was a separate geographic market and not part of a broader Southeastern Missouri market.(127) Second, the court held that the district court had committed legal error in refusing to consider “evidence of enhanced efficiency in the context of the competitive effects of the merger.”(128) The court described that evidence as showing that combining the two hospitals would create a larger and more efficient hospital capable of delivering better medical care and that this would “enhance competition” in the broader Southeastern Missouri area. The court noted that even if third party payors “reaped the benefit of a price war in a small corner of the health care market in southeastern Missouri,” the loss of that benefit needed to be balanced against the improved quality of health care received by their subscribers.(129)

FTC v. H. J. Heinz Co.(130) In the most recent court of appeals decision on this issue, the D.C. Circuit, while not squarely holding that efficiencies could be used to rebut a prima facie case, noted that “the trend among lower courts is to recognize the defense.”(131) The court held, however, that the parties had failed to produce sufficient evidence to rebut the inference of anticompetitive effect and that the district court’s finding to the contrary in denying a preliminary injunction was clearly erroneous.

The court held, first, that the very high concentration levels required, on rebuttal, “proof of extraordinary efficiencies.”(132) To support this proposition the court cited the 1997 Guidelines statement that “efficiencies would never justify a merger to monopoly or near-monopoly.”(133) The court found the claimed efficiencies not to be sufficiently large to meet this standard when measured across the combined entity’s total output and cost structure.(134)

The court held, second, that asserted efficiencies must be “merger specific” to be cognizable, again citing the 1997 Merger Guidelines.(135) The court held that the district court had committed error by failing to explain why the parties could not achieve comparable efficiencies without a merger.(136)

District Court Decisions

There are a growing number of district court decisions, in these circuits and others, that assume the availability of an efficiencies defense, often citing the guidelines to support that assumption, and then proceed to evaluate the parties’ efficiency claims. In three cases the courts accepted the defense and in four the courts rejected it. (This excludes the cases decided on appeal discussed in the last section.) In each case the court used the basic analytical framework set out in the Merger Guidelines to evaluate the claimed efficiencies. Rather than discuss all of these cases, we will focus on just five.

U.S. v. Long Island Jewish Medical Center.(137) In finding the merger of two hospitals on Long Island lawful over the Department’s objections, the court adopted the guidelines’ approach and held that to rebut a prima facie case of illegality the efficiencies claimed must be “significant” and must be shown “ultimately to benefit consumers.”(138) The court held that to show this the parties must prove that the merger is likely to “enhance rather than hinder competition because of increased efficiency.”(139) The court found that the efficiencies that were claimed, which were on the order of $25-30 million per year, met both standards, in part because the hospitals were nonprofit and would therefore be likely to pass any cost savings on to the community, which they had also committed to doing in an agreement with the New York state attorney general.

U.S. v. Country Lakes Foods, Inc.(140) This case, a Justice Department challenge to a merger of two dairies, is the only litigated non-hospital case in which an efficiencies defense has prevailed. In finding the merger lawful, the court found that the efficiencies that would result from an increased volume of production due to the merger would enable the merged firm “to compete directly with the market leader” and thereby “enhance competition.”(141) As in Tenet, this conclusion depended importantly on the court’s related conclusion that the government had failed to prove that the geographic market was as narrow as it had alleged.

Staples,(142) Cardinal Health(143), and Swedish Match.(144) This trilogy of FTC preliminary injunction cases in the District Court for the District of Columbia all closely followed the analytical framework of the Merger Guidelines in finding that the efficiencies claimed did not rebut the FTC’s prima facie case. In Staples, the court expressly rejected an effort by the FTC to impose on parties a higher standard of proof in litigation than the guidelines impose for agency review of mergers. The court refused to apply the “clear and convincing evidence” standard the FTC advocated, observing that imposing such a heightened standard “would saddle section 7 defendants with the nearly impossible task of rebutting a possibility with a certainty.”(145) In each case, the court nevertheless found that the claimed efficiencies were badly overstated, that they had not been shown to be merger specific, and that the parties had also exaggerated the extent to which they would be passed onto consumers.

This review of the case law shows that the Merger Guidelines have been influential in shaping the courts’ approach to efficiencies, just as they have been in other areas. The courts have followed the agencies’ lead in accepting that efficiencies may be used, in appropriate circumstances, to rebut a prima facie case of illegality based on presumptions drawn from market shares and concentration ratios. The courts have also adopted the same basic analytical framework as the guidelines, often citing the guidelines but also often relying on the Areeda-Turner treatise, on which the guidelines approach is largely modeled.

Resources

Notes and References

117. 479 U.S. 104 (1986).

118. Id. at 492, quoting Arthur S. Langenderfer, Inc. v. S. E. Johnson Co., 729 F.2d 1050, 1057 (6th Cir. 1984).

119. 938 F.2d 1206 (11th Cir. 1991).

120. Id. at 1222.

121. Id. at 1223.

122. Id.

123. 121 F.3d 708 (6th Cir. 1997).

124. U.S. v. Rockford Mem. Hosp., 898 F.2d 1278 (7th Cir. 1990).

125. Id. at 1282.

126. 186 F.3d 1045 (8th Cir. 1999).

127. Id. at 1053.

128. Id. at 1054.

129. Id.

130. 246 F.3d 708 (D.C. Cir. 2001).

131. Id. at 720.

132. Id. at 720. In Heinz, the merging parties were two of only three producers of baby food in a market in which entry was found to be unlikely and were the only two rivals for placement as the second baby food brand on supermarket shelves.

133. 1997 Revision, at § 4.

134. The Court’s conclusion in this regard would not necessarily hold in the case of a merger to monopoly or near-monopoly in a small market that would allow the firm to serve a broader market more efficiently, as the court found to be the case in Tenet. See p. 47 supra. In the absence of price discrimination even de minimis efficiencies can outweigh large potential adverse competitive effects in these circumstances. For example, suppose Appalachian coal is sold only in limited amounts in Appalachia, but much more could be profitably sold in a broader geographic market in competition with coal from many other sources if distribution costs from Appalachia could be cut even slightly. Now suppose that all the coal mines in Appalachia agreed to sell only “through the larger and more economic facilities of” a common sales agency (this example is very loosely based on the 1933 Appalachian Coals decision (Appalacian Coals v. U.S., 288 U.S. 344 (1933)). In theory, that agency might be set up to eliminate competition and substantially raise prices on local sales, but it might also be aimed at lowering costs in order to lower prices to allow profitable sales in a broad geographic market. Assuming no price discrimination, the agency may be able to increase its profits over what they were premerger by raising its prices in its local market while offering the coal at a lower price than it could have premerger in the broader geographic market. If coal consumption is significantly greater in the broader market than in the smaller local market, there may be a net gain to consumer welfare even if the efficiencies are small and the potential adverse competitive effects in the smaller local market are large.

135. 246 F.3d at 721.

136. One of the authors of this article has criticized the court of appeals decision for giving too little deference to the district court’s findings of fact and for applying too high a standard both with respect to the magnitude of the efficiencies and to the likelihood that they could be realized by alternative, less anticompetitive means. See William J. Kolasky, Lessons from Baby Food: The Role of Efficiencies in Merger Review, Antitrust, Fall 2001, at 82. For a different perspective on the case, see Thomas B. Leary, An Inside Look at the Heinz Case, Antitrust, Spring 2002, at 32; David Balto, The Efficiency Defense in Merger Review: Progress or Stagnation, Antitrust, Fall 2001, at 74.

137. 983 F. Supp. 121 (E.D.N.Y. 1997).

138. Id. at 137.

139. Id.

140. 754 F. Supp. 669 (D. Minn. 1990).

141. Id. at 680.

142. FTC v. Staples, Inc., 970 F. Supp. 1066 (D.D.C. 1997).

143. FTC v. Cardinal Health, Inc., 12 F. Supp. 2d 34 (D.D.C. 1998).

144. FTC v. Swedish Match, 131 F. Supp. 2d 151 (D.D.C. 2000).

145. 970 F. Supp. at 1089.