Sixth Circuit Affirms FTC Order of Divestiture and Prohibits ProMedica Health System's Purchase of Competing Hospital

by Wilson Sonsini Goodrich & Rosati

In an opinion published on April 22, 2014, the United States Court of Appeals for the Sixth Circuit sided with a Federal Trade Commission (FTC) decision that ProMedica Health System, Inc.'s acquisition of rival St. Luke's Hospital was anticompetitive. The decision embraces relatively novel definitions of hospital services rarely seen in hospital merger law, requiring hospitals to carefully assess the antitrust risks when contemplating mergers going forward. The decision is also noteworthy because it continues the FTC's trend of challenging proposed mergers by multi-hospital systems of even single-location hospitals.

This appeal came before the court following the FTC's finding that the merger of the two Toledo, Ohio-area hospitals would adversely affect competition in violation of § 7 of the Clayton Act. The FTC decided, and the court of appeals agreed, that, as a result of the transaction, ProMedica's market share increased far above the threshold required to create a presumption that the merger would lessen competition, and that evidence showed that the merger would have substantial anticompetitive effects.1 In proving its case, the FTC relied heavily on both testimonial evidence and contemporaneous business documents from the merging parties. The Sixth Circuit affirmed the FTC's decision that the merger was likely to result in higher rates paid by insurers (known as Managed Care Organizations, or MCOs) and, by extension, consumers. Going forward, both the FTC and its sister agency, the Antitrust Division of the U.S. Department of Justice, are certain to rely upon this precedent. Coupling this FTC victory in Ohio with its recent win against (the unrelated) Saint Luke's Health System in Idaho (discussed here), parties contemplating transactions that will give rise to high market shares must be prepared to face a skeptical audience at the antitrust enforcement agencies and ensure that their arguments in support of the transaction, including the creation of merger-specific efficiencies, are robust and well-developed.

Background on the Transaction and Parties

ProMedica and St. Luke's signed a merger agreement in May 2010; the FTC opened an investigation into the competitive effects of the merger two months later. The FTC investigation examined four categories of hospital services: (1) primary care services, including basic hospital procedures like hernia surgeries, radiology, and obstetrical (OB) services; (2) secondary services that involve more specialized resources, such as hip replacements and bariatric surgery; (3) tertiary services requiring a still-higher level of specialization, including brain surgery and treatment of severe burns; and (4) quaternary services, which require the most specialized resources of all, for things like major organ transplants. ProMedica is Lucas County, Ohio's dominant hospital provider, which, post-merger, enjoys a market share of more than 50 percent for primary and secondary hospital services, and an over 80 percent market share for OB services. ProMedica operates three hospitals in the county, providing primary (including OB), secondary, and tertiary services. St. Luke's is an independent, not-for-profit hospital located in southwest Lucas County that offers both primary (including OB) and secondary services.

The Sixth Circuit's Opinion

The court began by accepting that ProMedica and St. Luke's were direct competitors in the mutually agreed upon relevant geographic market of southwest Lucas County before the merger. This was grounded upon the testimony of MCOs that explained that they were unlikely to exclude ProMedica, the county's most dominant hospital system, from their health plans in favor of St. Luke's, which serviced just one small region of the county. Indeed, the court points out that ProMedica's pre-merger rates were among the highest in the state, while St. Luke's' rates were so low that they barely covered the cost of patient care. Moreover, testimony from St. Luke's' CEO reveals that the merger was intended to improve St. Luke's' "negotiating clout."

The parties' most significant disagreement concerned the definition of the relevant product market(s). The court recognized the difficulty in analyzing hospital mergers under a straightforward substitutability standard, and proceeded with a "cluster market" approach. The FTC advocated for an "administrative convenience theory," dubbed the "similar conditions" theory by the court. ProMedica, on the other hand, argued that the "transactional compliments" or "package deal" theory would be more appropriate. The court adopted the FTC's approach, opining that where competitive conditions are similar for a range of services, the antitrust analysis should be similar for each of them, and those services can properly be "clustered" to form one relevant product market. The result is much a narrower definition of hospital services than previously embraced in hospital merger challenges.

The court relied on the parties' respective market shares across both primary and secondary services, as well as barriers to entry across the two categories, in concluding that competitive conditions were indeed sufficiently similar to justify clustering those markets when analyzing the competitive effect of the merger. OB services, the court wrote, cannot be clustered with primary and secondary services in this way, because competitive conditions differ significantly for those services. The court also excluded tertiary and quaternary services from its analysis of the merger's competitive effects because those services too are provided under different competitive conditions from primary and secondary services. The court was unconvinced by ProMedica's "package deal" theory and stressed that the critical question under this analysis would be whether MCOs are willing to pay a premium to have a package of services that includes tertiary and OB services delivered by a single provider. The record made plain, the court concluded, that MCOs do not demand a single provider to present such a "package deal," and that therefore no market forces exist that bind all four categories of service together in one single cluster. The court's unequivocal acceptance of the FTC's analytical approach on this point is notable, and will surely be welcomed and relied upon by the antitrust authorities going forward. As such, this method of market definition should be borne in mind by hospitals, healthcare providers, and other parties contemplating similar transactions.

The practical effect of defining the product markets in this way meant that post-merger, ProMedica would be Lucas County's dominant hospital provider, enjoying a market share over 50 percent for primary and secondary hospital services, and a market share over 80 percent for OB services. Within southwest Lucas County specifically, St. Luke's and ProMedica were the two dominant providers before the merger, and St. Luke's, the court explained, was one of the few independent, not-for-profit hospitals in that region offering both primary (including OB) and secondary services.

The court rejected ProMedica's argument that the FTC's reliance on market-concentration data was misplaced. Although the court was more receptive to ProMedica's arguments here than elsewhere in the opinion, its reasoning rested on two points—first, the strong correlation revealed by the record between ProMedica's bargaining power (and consequently, its prices) and its market share; and second, the sheer increase in concentration in an already concentrated market. According to the court's decision, the Herfindahl-Hirschman Index (HHI) numbers at issue here, which are designed to measure market concentration before and after transactions, "blew through [the barriers for presumption of illegality] in spectacular fashion," such that the data by itself was entitled to significant deference. Buoyed by this decision, the antitrust authorities will likely continue to rely heavily on market-share data and evidence of high market concentration in challenging transactions of this kind.

The court took care to address the efficiency claims that ProMedica put forward, but ultimately disposed of them quickly. Specifically, the court admonished the appellant for failing to put forward arguments as to how the merger would result in any benefit to consumers. The decision instead quoted St. Luke's' CEO's admission that the merger might "[h]arm the community by forcing higher rates on them." The court also paid homage to evidence presented by MCO witnesses who testified that removing a combined ProMedica and St. Luke's from their network, in the event of monopoly prices, would not be commercially viable because it would leave a "hole" in the suburbs of southwest Lucas County. The court pointed out that although ProMedica characterized this testimony as "self-serving," no evidence to the contrary was presented.

Finally, the court dispensed with ProMedica's "flailing firm" argument concerning St. Luke's, pointing out that such a defense is accepted only in "rare cases," and relying on the record's demonstration that St. Luke's' market share was actually on the rise prior to the merger, and that St. Luke's' finances had improved by that point such that it was again able to meet its expenses as they fell due. Clear from the court's treatment of ProMedica's efficiencies claims is the ongoing need for parties to prepare and present strong evidence of consumer benefit in order to overcome a presumption of illegality arising from high market concentration figures.

In similarly curt fashion, the court agreed with the FTC's order of divestiture, finding that "an undoing of the acquisition is a natural remedy," and finding no abuse of the FTC's discretion with regard to this decision.

FTC Chairman Edith Ramirez welcomed the ruling, commenting that the decision demonstrated that the "FTC's vigilant enforcement of the antitrust laws in health care provider markets helps deliver lower cost, higher quality health care to consumers." A written statement by ProMedica spokeswoman Tedra White announced that the hospital "intend[s] to appeal" the decision. Ms. White said that the hospital is "committed to exhausting" all of its legal options and emphasized that St. Luke's remained part of the ProMedica system in the meantime. An appeal would first be made for en banc review by the Sixth Circuit, with a final appeal possible to the United States Supreme Court.

1 In a January 2012 Initial Decision, an FTC Administrative Law Judge (ALJ) ruled largely in favor of the FTC staff who litigated the matter. ProMedica then appealed the ALJ decision to the sitting commissioners, who issued a de novo ruling on the ALJ's opinion in March 2012 that found in favor of the FTC staff.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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