The Federal Trade Commission has filed an administrative lawsuit seeking to undo Laboratory Corporation of America’s ("LabCorp") acquisition of Westcliff Medical Laboratories, Inc. ("Westcliff"). According to the agency’s December 1 complaint, the merger will substantially lessen competition among providers of capitated clinical laboratory testing services to physician groups in southern California. The case represents the latest in a series of challenges to consummated transactions filed by the FTC during the past two years, keeping fresh the reminder that even closed deals are subject to agency review. It is also noteworthy because Westcliff had filed for bankruptcy protection and the sale to LabCorp had been approved by the bankruptcy court.
LabCorp and Westcliff are clinical laboratory testing companies that serve physician groups in southern California. In May 2010, Westcliff agreed to sell substantially all of its business assets to LabCorp for $57.5 million. As part of the sale, Westcliff agreed to file a voluntary petition for relief under Chapter 11 of the U.S. Bankruptcy Code. Thus the transaction was subject to the approval of the U.S. Bankruptcy Court for the Central District of California. In June, after a hearing at which no other bidder emerged to top the LabCorp offer, the court approved the sale, and the parties closed the deal.
According to the FTC complaint, LabCorp and Westcliff are the second and third largest providers of clinical laboratory testing services in southern California, and two of only three significant competitors serving the region. (Quest Diagnostics is the largest.) All three firms offer comprehensive laboratory testing products and services to physician groups through two basic contracting methods, either (1) capitated (per-member, per-month) contracts paid on a flat-rate, or (2) fee-for-service contracts. Capitated contract rates typically are lower, and the vast majority of physician groups employ the capitated model for patients enrolled in health maintenance organizations. The agency asserts that the merger will have anticompetitive effects in the market for all "clinical laboratory testing services" and separately in the market for "capitated clinical laboratory testing services." However, the FTC complaint downplays the distinction between these two putative markets: while the "absence of economic substitutes for capitated contracts" renders the provision of services pursuant to such contracts a distinct market, the inclusion of fee-for-service contracts in the relevant market "would not affect the assessment of the Acquisition’s impact on competition."
The complaint alleges further that Westcliff was "an upstart competitor seeking to expand its share of physician group business," and a "price-cutting maverick" that directly constrained LabCorp’s ability to raise prices. According to the FTC, the merger would allow LabCorp unilaterally to increase prices and also "enhance the likelihood of collusion or coordinated interaction between Quest and LabCorp."
The case will now proceed before an FTC administrative law judge.
This lawsuit marks another in a series of recent challenges by the FTC to consummated transactions. Although the federal antitrust agencies long have been willing to go after closed deals when conditions warrant, such challenges have been few, due in large measure to the existence of the comprehensive premerger reporting scheme under the federal Hart-Scott-Rodino Act. In recent years, the FTC has significantly increased its scrutiny of consummated mergers, with at least 10 challenges to closed transactions occurring just since November 2008.
It is also noteworthy that the transaction had been approved by the U.S. Bankruptcy Court, which allowed the sale after a hearing at which no competing bids were submitted. While bankruptcy court approval does not necessarily trump subsequent antitrust review, challenges to bankruptcy-approved sales are relatively rare. In this instance, the FTC disputed the claim that Westcliff was a "failing firm" whose assets would have exited the market in the absence of the merger. (Under the so-called "failing firm" defense, antitrust enforcers may not challenge an otherwise-anticompetitive combination if the only alternative is that assets of the failing firm will leave the market altogether.) Rather, the agency alleged that Westcliff was generating operating profits at the time of its sale and that there were other potential buyers available to purchase the company. According to the complaint, because the bankruptcy auction "was conducted after LabCorp was installed as the ‘stalking horse bidder,’" the absence of other offers at the hearing only showed there were "no bidders willing to pay the stalking horse price of $60 million or more for Westcliff. Even at that late date, there were a number of firms willing to purchase Westcliff for a consideration above liquidation value."
As a remedy in this action, the FTC is seeking "divestiture or reconstitution of all associated and necessary assets, in a manner that restores competition between distinct, separate, viable, and independent businesses in the relevant market, with the ability to offer such products and services as LabCorp and Westcliff were offering and planning to offer prior to the acquisition."
Commission votes and dissents always are interesting to the Kremlinologists. Commissioner J. Thomas Rosch voted against the complaint and issued a dissenting statement in which he criticized the "capitated contracts"-based market definition as "misleadingly narrow." According to Commissioner Rosch, capitated contracts and fee-for-service business are inextricably linked, as clinical testing laboratories offer the former at reduced rates in order to gain "lucrative pull-through fee-for-service business" from the same physician groups. Thus, stated Rosch, under the agency’s Horizontal Merger Guidelines and existing case law the two products should be included within the same relevant market. Commissioner Rosch stated further: "Although I think that there is reason to believe that this transaction will have anticompetitive effects, I cannot support a complaint that alleges an erroneous definition of the relevant product market."
This case should serve as a distinct reminder that the federal antitrust agencies, and the FTC in particular, will investigate and enforce against consummated transactions. Moreover, the mere fact that the seller is in bankruptcy is not by itself sufficient to prevent antitrust scrutiny of the sale.
The FTC filings can be found here.