Third Circuit Grants FTC Injunction in Penn State Hershey-Pinnacle Merger, Overruling Lower Court

by Patterson Belknap Webb & Tyler LLP
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On September 27, the U.S. Court of Appeals for the Third Circuit handed the Federal Trade Commission a big win, overturning the Middle District of Pennsylvania’s denial of an injunction to block the proposed merger of Penn State Hershey Medical Center and PinnacleHealth System, two major healthcare providers in central Pennsylvania.

As we previously covered on this blog, in May 2016, the Middle District of Pennsylvania denied the FTC’s request for a preliminary injunction to prevent the merger of Penn State Hershey and PinnacleHealth.  The Middle District’s ruling focused heavily on the geographic market definition, which the district court purported to analyze according to the hypothetical monopolist test.  The district court held the FTC’s proposed market (four counties in the Harrisburg area) was too restrictive.  In reaching that conclusion the district court emphasized that over 40% of the hospitals’ patients reside outside the four-county area and that there are numerous other hospitals in and around Harrisburg that could offer healthcare services to consumers if the Penn State Hershey-PinnacleHealth merger did not yield pro-competitive benefits.  The district court also found it “extremely compelling” that the hospitals had entered into private agreements with the two largest insurers in Central Pennsylvania, ensuring that post-merger rates would not increase for five years with one insurer, and ten years with the other.

On appeal, the Third Circuit concluded that the district court “erred in both its formulation and its application of the proper legal test.”  Although the district court correctly identified the hypothetical monopolist test as the appropriate legal framework, the Court of Appeals ruled that the district court committed numerous errors in its application of that test.

The district court erred in relying heavily on patient flow data, i.e. the number of patients that enter the proposed market.  In this respect, the Court of Appeals observed that the district court’s analysis closely resembled the Elzinga-Hogarty test, which was once the preferred method to analyze the relevant geographic market, but now has been discredited as a method for defining geographic markets in the hospital sector.

The Court of Appeals also held that the district court erred in focusing on the likely response of patients to a price increase, while ignoring the likely response of insurers.  This incorrect focus reflected a fundamental misunderstanding of the commercial realities of the healthcare market, because it is insurers, and not patients, that feel the brunt of price increases for hospital services.

The Third Circuit concluded that the district court also erred in grounding its reasoning, in part, on the private agreements between the Hospitals and two insurers.  Under Third Circuit precedent, such private contracts are not relevant to the hypothetical monopolist test.  In fact, the Court noted, any attention to such contracts would render the hypothetical monopolist test hollow: if such agreements were considered, the hospitals would not be able to profitably impose a small but significant non-transitory increase in price (SSNIP) because the agreements forbid them from doing so.  Moreover, if private contracts were permitted to impact the analysis, then a merging entity could enter into agreements (that may or may not be enforceable) to impermissibly broaden the scope of the relevant geographic market in analyzing anticompetitive effects.  But, the Third Circuit stressed, it is the court’s task—and not the province of the merging entities—to determine the relevant geographic market, and permitting such a loophole could allow antitrust defendants to escape effective enforcement of the antitrust laws.

After concluding the district court had erred in its analysis of the geographic market analysis, the Third Circuit then considered whether the FTC had met its burden in properly defining the relevant geographic market and concluded that it had.  Weighing the FTC’s evidence relating to post-merger market concentration, the Court concluded that the government had met its prima facie burden of demonstrating that the merger would be anticompetitive.

The Third Circuit’s decision is a big victory for the FTC, which has suffered a string of losses in the healthcare merger area as of late.  We previously predicted that the FTC’s aggressive enforcement stance in the healthcare arena would continue in spite of the agency’s losses.  With this victory, the tide may be turning in the FTC’s favor, and our prediction looks even more likely to be correct.

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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