On June 14, 2016, District Judge Jorge L. Alonso of the Northern District of Illinois denied the State of Illinois and the Federal Trade Commission's (FTC) motion for a preliminary injunction seeking to enjoin the proposed merger of Advocate Health Care and NorthShore University HealthSystem.
The FTC had sought to enjoin the two Chicago-area hospital systems from taking steps to consummate their transaction pending the completion of a full administrative trial on the merits. Judge Alonso's decision comes on the heels of Judge John E. Jones' May 9, 2016 denial of the FTC's request for a preliminary injunction barring the merger of Penn State Hershey Medical Center and PinnacleHealth System in the Middle District of Pennsylvania, meaning the FTC has now been dealt two district court losses in hospital merger cases in as many months. As with Judge Jones' decision, Judge Alonso's denial of the FTC's requested injunction was based on a finding that "plaintiffs ha[d] not shouldered their burden of proving a relevant geographic market," and as in the Penn State Hershey case, the FTC is seeking an appeal. Judge Alonso has since issued an injunction preventing the hospital systems from merging until the appeal is resolved.
In September 2014, Advocate and NorthShore signed an agreement to merge, and following an investigation that lasted more than a year, the FTC voted in December 2015 to initiate an administrative proceeding to challenge the transaction. The FTC also filed a complaint for preliminary injunctive relief in the Northern District of Illinois.
The FTC's complaint characterized Advocate and NorthShore as the "two leading providers" of general acute care inpatient hospital services in the "northern suburbs" of Chicago, Illinois, whose merger would "create by far the largest hospital system in northern Cook County and southern Lake County."
The FTC alleged that this section of northern Cook and southern Lake counties represented the relevant geographic market in which to analyze the transaction, which it called the "North Shore Area." The merging parties would own six of the eleven hospitals within the so-called North Shore Area and control, based on the FTC's calculations, a 55% share of commercial general acute care inpatient admissions in that geographic market post-transaction. If one accepted the proposed market and shares, the transaction would result in increases in market concentration in excess of Horizontal Merger Guidelines thresholds, creating a presumption that the merger was likely to create or enhance market power.
The FTC alleged that Advocate and NorthShore are "close – if not each other's closest – competitors in the North Shore Area" and are seen as "key alternative providers" for health care consumers in the North Shore Area, who "strongly prefer" that their health care network include at least one of the defendant health systems.
Accordingly, the FTC alleged that transaction would enhance the defendants' negotiating leverage with health insurance payors, enabling the merged entity to obtain higher reimbursement rates because it would be "very difficult" for payors to market a health plan network in the North Shore area without either of the defendant hospital systems.
The parties agreed the relevant product market was inpatient general acute care services sold to commercial health insurance payors and their insured members, so the dispute was over the relevant geographic market. The court noted that there is "no formula for determining the geographic market; rather, it should be identified in a pragmatic and factual way and should correspond to the commercial realities of the industry."
Judge Alonso's decision focused on the methodology employed by the FTC's expert, Steven Tenn, in determining the bounds of the purported North Shore Area geographic market. In particular, in constructing his geographic market, Tenn included local hospitals but excluded what he called "destination hospitals," such as Northwestern Memorial Hospital, Rush University Hospital, Loyola University Hospital, and University of Chicago Hospital, "that attract patients from throughout the Chicago metropolitan area, at long distances."
He excluded these hospitals because they "are not located in the northern Chicago suburbs" and would not, in his view, be considered to be substitutes by commercial insurance payors building provider networks in that geographic area. Tenn also included only hospitals that overlapped with both Advocate and NorthShore, rather than those that overlapped with only one of the hospital systems.
After constructing his proposed geographic market, Tenn calculated diversion ratios, determining that 48% of patients admitted to one of the eleven hospitals in the North Shore Area would substitute to one of the other hospitals in that area if their first choice hospital was not available. He concluded this was a "sufficiently high" percentage for the North Shore Area to pass the "hypothetical monopolist" test, meaning a monopolist of all the hospitals in that area would be able to impose a small but significant non-transitory price increase (SSNIP) in that area.
Defendants had argued that Tenn's geographic market was "arbitrarily" drawn by excluding destination hospitals and should instead include hospitals that, although based outside the North Shore Area, have outpatient facilities or doctors' offices located within the North Shore Area and thus "drive significant inpatient volume" to the outside hospitals.
In support, they noted that Tenn's own diversion ratios showed that one of the destination hospitals – Northwestern Memorial Hospital – was the second or third choice for patients who used five of the defendants' hospitals within the North Shore Area.
Judge Alonso agreed with the defendants that "the criteria Tenn used to identify the geographic market are flawed" because the expert offered "no economic basis" for excluding destination hospitals and thereby "assume[d] the answer to the very question the geographic market exercise is designed to elicit" (i.e.,whether those hospitals were substitutes for Advocate and NorthShore).
Judge Alonso concluded that the exclusion of destination hospitals "ignores the commercial realities of this industry." He seemed to accept defendants' argument that outpatient facilities of these hospitals compete within the relevant geographic market by citing to testimony on the growth of outpatient services and the competitive significance of outpatient facilities in attracting patients to hospitals. While Judge Alonso acknowledged testimony from commercial payors that they "could not successfully market a health plan that did not include Advocate or Northshore" in the northern Chicago suburbs, he noted that testimony "from parties opposed to the merger" was "undermined" by Tenn's diversion ratios, presumably those showing the significance of the destination hospitals as a second or third choice for patients within the North Shore Area. He also found Tenn's criterion of including only hospitals that overlap with both defendants rather than with just one of them equally problematic, because "instead of analyzing data to make this determination, Tenn simply assume[d] the answer" that "next best alternative" hospitals were "likely" to be in areas that overlap with both defendants' hospitals.
Accordingly, Judge Alonso found that the FTC had failed to carry its burden of proving a relevant geographic market and, absent that showing, could not demonstrate a likelihood of success on its Clayton Act claim.
He thus denied the request for a preliminary injunction.
After a long winning streak in hospital merger cases, the FTC now faces two recent losses in Advocate Health Care and Penn State Hershey. Though both decisions are under appeal, it is worth considering whether these two cases auger a fundamental shift in the standard for analyzing hospital transactions. While both cases involve disputes about geographic market definition, the two decisions are quite distinct analytically and, it seems, at least at first glance, the FTC has more at risk in the Penn State Hershey case than in the Advocate Health Care case.
As an initial matter, Judge Alonso adopted the FTC's preferred standard for review of preliminary injunction motions under Section 13(b) of the FTC Act,
while Judge Jones in the Penn State Hershey case seemed to hold the FTC to a more stringent standard. Second, while Judge Alonso's decision focused only on the geographic market issue, Judge Jones's opinion ranged further afield, offering support for the notion that the health care regulatory climate, including the Affordable Care Act, makes hospital mergers almost inevitable. The Advocate Health Care decision was silent on that issue. With respect to the dispositive issue in both cases – the proper contours of the geographic market – the Penn State Hershey case at least arguably takes a position contrary to recent case law and to the FTC's standard approach to geographic market determination in hospital merger transactions. Judge Alonso's decision, in contrast, focuses on the details of how the FTC drew the geographic market in this instance, but does not appear to quarrel with the FTC's general approach to defining a geographic market.
Thus, a loss in Advocate Health Care might more easily be viewed as a loss on the facts, with potentially fewer implications for the broader FTC hospital merger enforcement agenda.
Though we can expect the FTC to continue to be active in hospital merger enforcement regardless of the outcome of these cases, if the FTC loses Penn State Hershey it may force a more fundamental rethinking by the agency on its approach to such mergers, given the issues involved in that case. Hospital administrators and others considering potential deals of their own should be watching with interest the outcome of both of these appeals – in particular Penn State Hershey – to see whether the FTC will be able to maintain its current approach to hospital mergers.