A common area for the Federal Trade Commission ("FTC") anti-trust law enforcement to arise is in merger and acquisition transactions. Although down slightly from the same period in 2013, hospital mergers and acquisitions ("M&A") are occurring frequently.
In the first six months of 2013, 46 transactions occurred, compared with the 43 transactions for the same period in 2014. Of the 2014 transactions, "40 involved acquisition of not-for-profit organizations—33 by other not-for-profit organizations and seven by for-profit organizations." The acquired organizations represented a total operating revenue of $10 billion transactions, which "occurred across a broad range of acute-care segments, including not-for-profit, for-profit, rural, urban, and academic health centers."
This means that certain nuances associated with combining a not-for-profit system and a for-profit system need to be considered closely.
This article analyzes some recent cases in hospital mergers where the FTC brought cause of action. Particular emphasis is given to the "failing firm defense" – an affirmative defense often employed by parties to the transaction in an effort to circumvent anti-trust law violations and allow the transaction to continue. In sum, some key legal issues are highlighted that should not be ignored by entities entering into an M&A transaction.
Hospital M&As and Anti-trust considerations
In FTC v. OSF Healthcare System, a U.S. District Court in Illinois granted the Federal Trade Commission's ("FTC's") motion for a preliminary injunction because the FTC established a prima facie case that the merger between OSF Healthcare System and Rockford Health System ("RHS"), two not-for-profit health systems, had anti-competitive implications and the defendants failed to overcome their burden of rebuttal. "Section 7 of the Clayton Act prohibits acquisitions, including mergers, "where in any line of commerce or in any activity affecting commerce ... the effect of such acquisition may be substantially to lessen competition, or to tend to create a monopoly." 15 U.S.C. § 18. Section 7 is "designed to arrest in its incipiency ... the substantial lessening of competition from the acquisition by one corporation" of the assets of a competing corporation. United States v. E.I. du Pont de Nemours & Co., 353 U.S. 586, 589, 77 S.Ct. 872, 1 L.Ed.2d 1057 (1957)." The Court indicated that the injunction would continue until the FTC's Administrative Hearing finished.
From a planning standpoint, this case provides insights into several related matters that arise during M&A transactions in relation to anti-trust law. For example, if the Federal Trade Commission Act ("FTCA") enables a court to grant a preliminary injunction to prevent a violation of the Clayton Act. In deciding whether to grant a preliminary injunction, a court uses a two-prong test: (1) the likelihood that the FTC will succeed on the merits; and (2) the balancing of equities. At this juncture of a proceeding, which may arise in the context of a Motion to Dismiss under Section 12(b)(6) of the Federal Rules of Civil Procedure, the court is not determining whether an anti-trust violation actually exists, rather:
It is important to bear in mind that, when ruling on a request for a preliminary injunction pursuant to § 13(b), "[t]he district court is not authorized to determine whether the antitrust laws have been or are about to be violated. That adjudicatory function is vested in FTC in the first instance." FTC v. Food Town Stores, Inc., 539 F.2d 1339, 1342 (4th Cir.1976); see also FTC v. Whole Foods Mkt., Inc., 548 F.3d 1028, 1035 (D.C.Cir.2008) (explaining that, in a § 13(b) preliminary injunction proceeding, "a district court must not require the FTC to prove the merits" of its underlying antitrust claim); Univ. Health, 938 F.2d at 1218 ("[O]ur present task is not to make a final determination on whether the proposed acquisition violates section 7 ...." (alterations and quotation marks omitted)). Rather, "[t]he only purpose of a proceeding under [§ 13(b) ] is to preserve the status quo until FTC can perform its function." Food Town, 539 F.2d at 1342.
What this means is that the court considers the evidence from both the FTC and the defendants. But, the FTC only needs to show "threshold evidence" or enough information to show "substantial doubts about the transaction." Once the FTC meets its requirement, then the burden shifts to the defendants to rebut, "the presumption of illegality that arises, "the
defendants must produce evidence that shows that the market share statistics give an inaccurate account of the merger's probable effects on competition in the relevant market."" From here, the defendants must present non-statistical evidence, as well as any unique evidence and affirmative defenses, such as the failing firm defense.
As part of the initial hurdle the FTC has to clear to have a preliminary injunction issued, the relevant product and geographic markets must be defined. This can be thought of like a non-compete clause in an employment contract. These two items are assessed in relation to the anti-competitive impact.
"It is ... essential that the FTC identify a credible relevant market before a preliminary injunction may properly issue" because a merger's effect on competition cannot be properly evaluated without a well defined relevant market. Tenet Health, 186 F.3d at 1051. In fact, "[a] monopolization claim often succeeds or fails strictly on the definition of the product or geographic market." Id. at 1052. In this case, however, defendants do not meaningfully dispute the relevant market definitions proposed by the FTC."
A relevant product market focuses on the monopolist and the ability to impact profitability and prices. By way of contrast, the geographic market is the defined area where consumers turn to for alternatives and where the defendants face competition. In relation to hospital mergers, the court would look at the systems or hospitals that were merging, the number of alternatives in the area for consumers and where defendants face competition. In healthcare, it is not only related to actual healthcare services but reimbursement from insurance companies, too. The court ultimately ruled in favor of the FTC because they met the threshold and the defendants failed to provide enough evidence to overcome their burden and refute the FTC.
Another example of the FTC meeting its threshold requirements occurred in Federal Trade Commission, et al. v. Promedica Health System, Inc., 2011 WL 1219281 (N.D. Ohio, Mar. 29, 2011). Here, the court evaluated the consolidation of operations between St. Luke's Hospital and ProMedica Health System, Inc. ("ProMedica"). The Joinder Agreement was contested by the FTC when the agency filed an administrative complaint alleging violations of Section 7 of the Clayton Act. In this instance, ProMedica not only operated an acute care hospital, but a childrens' hospital and an insurance company. One provision of the Agreement required "ProMedica to add St. Luke's to the provider network of its health-insurance subsidiary, Paramount, at rates comparable to other general acute-care hospitals in the ProMedica system." In applying the same factors as the court in OSF Healthcare, the district court found that the Agreement was anticompetitive from both a product market and geographic standpoint. Thus underscoring the importance of the anti-competitive implications before commencing the deal.
Failing firm defense
One item that defendants rely on when trying to overcome an anti-trust roadblock is "the failing firm defense." This is because this exception may enable a merger that is otherwise deemed to be anticompetitive (i.e., either impedes competition or is monopolistic) to go through. Under the Horizontal Merger Guidelines, which were jointly established by the FTC and the U.S. Department of Justice ("DOJ"), four elements must be met before this defense can be invoked. The four criteria include:
"the allegedly failing firm would be unable to meet its financial obligations in the near future;"
"it would not be able to reorganize successfully under Chapter 11 of the Bankruptcy Act;"
"it has made unsuccessful good-faith efforts to elicit reasonable alternative offers of acquisition of the assets of the failing firm that would both keep its tangible and intangible assets in the relevant market and pose a less severe danger to competition than does proposed merger; and"
"absent the acquisition, the assets of the failing firm would exit the relevant market."
If these four elements are not met, then the affirmative defense, which the defendant bears the burden of proving is ineffective. In ProMedica, the defendant could not "meet the requirements of the failing firm defense, under which ProMedica must prove that it was St. Luke's only available purchaser and that St. Luke's was in imminent danger of business failure." As the FTC has indicated, the financial position of an entity is the least substantive way to overcome anti-competitive implications.
Similarly, a merger is unlikely to cause competitive harm if the risks to competition arise from the acquisition of a failing division. The Agencies do not normally credit claims that the assets of a division would exit the relevant market in the near future unless both of the following conditions are met: (1) applying cost allocation rules that reflect true economic costs, the division has a persistently negative cash flow on an operating basis, and such negative cash flow is not economically justified for the firm by benefits such as added sales in complementary markets or enhanced customer goodwill;17 and (2) the owner of the failing division has made unsuccessful good-faith efforts to elicit reasonable alternative offers that would keep its tangible and intangible assets in the relevant market and pose a less severe danger to competition than does the proposed acquisition.
These items should also be considered by merging firms before facilitating the transaction. Negative cash flow and sales, along with considering other viable alternative offers are key elements in discerning what side of the line a company falls on - "flailing" or "failing." The difference being that one poses an acceptable affirmative defense and the other does not. Therefore, given the significant amount of activity, defendants should be sure that the four elements of the failing firm rule are met before launching the affirmative defense.
Conclusion
It is often said that, "an ounce of prevention is worth a pound of cure." This is apropos in the context of healthcare sector M&A activity and anti-trust law. By evaluating the transaction in light of the different factors courts consider, including the burden that defendants must meet to thwart a preliminary injunction by the FTC, both time and money can be saved. When considering whether or not to invoke the failing firm defense, it is crucial to evaluate the company's financial position from a multitude of angles. The FTC's enforcement is active in this area. Depending on the scenario at hand, different considerations need to be given but two things are crucial for overcoming the burden of proof required by the FTC – understand the market and the geographic parameters. These items should be part of the ordinary course of due diligence.
Rajiv Leventhal, Hospital M&A Activity Down Slightly in 2014 (Aug. 13, 2014), available at, http://www.healthcare-informatics.com/news-item/hospital-ma-activity-down-slightly-2014.
Ibid.
Juniper Advisory, Current Trends in Hospital Mergers and Acquisitions, available at, http://www.juniperadvisory.com/current-trends-in-hospital-mergers-and-acquisitions-log-in-required/. "Consideration in these transactions typically comes from the sum of purchase price, assumption of liabilities (e.g., long-term debt, pension liabilities, interest rate swaps), and a legally binding commitment to make capital expenditures. Historically, not-for-profit boards negotiated for one, two, or all three essential elements of consideration. The new set of consolidators (the newly acquisitive, large, regionally prestigious not-for-profits) and the new sellers (strategy-minded, small not-for-profit hospitals) have struggled with transactions where the buyer accrues most of the benefit, with only incidental benefits to the community. In the absence of corporate (SEC) standards and consequences of the TransUnion case, distressingly little attention is given to the notion of "fair market value" in the not-for-profit hospital M&A market.
The heart of the issue is the fiduciary duty of the board to the hospital and the community to further the hospital's charitable purposes. The key issue is whether the hospital receives fair market value for ceding ownership and control of the organization. Boards should understand the strategic alternatives and assess them simultaneously, not sequentially. Tactically, this approach can be difficult, but it best fulfills the board's fiduciary obligations."
1 FTC v. OSF Healthcare System, 852 F.Supp.2d 1069 (N.D. Ill. Western Division, Apr. 5, 2012).
2 Id. at 1073.
3 OSF Healthcare, 852 F.Supp.2d at 1073.
4 Id. at 1074
5 Id.
6 Id.
7 Id. at 1075, citing FTC v. Tenet Health Care Corp., 186 F.3d 1045, 1051 (8th Cir.1999).
8 Federal Trade Commission, et al. v. Promedica Health System, Inc., 2011 WL 1219281, *1 (N.D. Ohio, Mar. 29, 2011).
9 Id. at *4.
10 Promedica at *58, see Citizen Publ'g Co. v. United States, 394 U.S. 131, 136–37, 89 S.Ct. 927, 22 L.Ed.2d148 (1969) (citing Int'l Shoe Co. v. FTC, 280 U.S. 291, 302, 50 S.Ct. 89, 74 L.Ed. 431 (1930) ); see also U.S. Steel Corp. v. FTC, 426 F.2d 592, 608 (6th Cir.1970) ; Merger Guidelines § 11.
11 FTC v. Arch Coal, Inc., 329 F.Supp2d 109, 154 (D.D.C. 2004).
12 U.S. Department of Justice and U.S. Federal Trade Commission, Horizontal Merger Guidelines, Section 11 (2010), available at, http://www.justice.gov/atr/public/guidelines/hmg-2010.html#1.