Consummated LabCorp Deal Challenged By FTC

On December 1, 2010, in a 4-1 vote, the Federal Trade Commission (“FTC”) authorized the filing of an administrative complaint, alleging that Laboratory Corporation of America's (“LabCorp”) consummated acquisition of Westcliff Medical Laboratories (“Westcliff”) would harm competition in Southern California. In his dissenting statement, Commissioner J. Thomas Rosch criticized the definition of the relevant product market in the complaint but he noted that he agreed that Commission action was warranted.
In June 2010, LabCorp acquired Westcliff, the Santa Ana California-based lab, for $57.5 million. The acquisition came after Westcliff filed for Chapter 11 bankruptcy protection. The FTC did not review the deal before closing. It is rare for the FTC to challenge acquisitions involving companies in bankruptcy.

The complaint alleges the acquisition would leave only two significant laboratories – Quest Diagnostics (“Quest”) and LabCorp – in Southern California to be in control of approximately 89 percent of the market. The complaint states that in California, a majority of physician groups sign contracts on a per-member, per-month (“capitated”) basis with laboratories for tests performed on patients who belong to health maintenance organizations (“HMOs”). Capitated contracts are significantly less expensive than fee-for-service (“FFS”) contracts. In FFS contracts, physician groups pay laboratories for each test. The administrative complaint alleges that in several instances, LabCorp's attempts to increase the price of its capitated contracts were thwarted by Westcliff's offer of lower rates.

The complaint defines the product market as (i) the sale of capitated clinical laboratory testing services to physician groups operating under the delegated managed care model, and (ii) the sale of clinical laboratory testing services to physician groups operating under the delegated managed care model.

In his dissenting statement, Commissioner Rosch disagreed with this product market definition, because of its narrow scope that does not include FFS contracts. He identifies three problems with the current product market definition. First, he states that the proposed product market definition is inconsistent with the Commission's product market definition in Quest/Unilab matter, in which the market definition was not limited to capitated contracts. Second, Commissioner Rosch mentions that the inclusion of a capitated-only market cannot be reconciled with Footnote 4 of the Horizontal Merger Guidelines. Based on Commissioner Rosch's interpretation of Footnote 4, “if the sale of one product affects the prices of another product sold by the same company, the two products should be placed in the same candidate market.” He explains that labs enter into capitated contracts with lower prices, in return for physician groups' promise for FFS contracts. According to Commissioner Rosch, this link is an example of what Footnote 4 stands for, and as the result, FFS contracts should have been included in the product market definition. Third, to show proper application of Footnote 4 of the Merger Guidelines, Commissioner Rosch mentions several cases in which the courts have held that “when a company sells a product at a deflated price (as in the case of a capitated contract) with the expectation of subsequent high-margin sales of related products (FFS contracts), the products should be treated as being in the same market.” See, e.g., Kentmaster Mfg. Co. v. Jarvis Prods. Corp., 146 F.3d 691 (9th Cir. 1998); NewCal Indus. v. IKON Office Solution, 513 F.3d 1038 (9th Cir. 2007); Queen City Pizza v. Domino's Pizza, 124 F.3d 430 (3d Cir. 1997). Despite his criticism of the product market definition, Commissioner Rosch stated that “there is a reason to believe that this transaction will have anticompetitive effects” and warrants further scrutiny.

In addition to product market definition problems identified by Commissioner Rosch, the FTC may have to deal with the failing firm defense given that the acquisition was made in bankruptcy. The FTC, however, spent some time in its administrative complain explaining that the failing firm defense does not apply because there were a number of buyers willing to purchase Westcliff and Westcliff was pushed into bankruptcy by LabCorp as part of the procedure of carrying out the acquisition.

The administrative trial of the case is scheduled for May 2, 2011. The FTC also is filing an action in federal court to prevent LabCorp from integrating the Westcliff assets while the case is being tried in the administrative court. On June 25, 2010, LabCorp agreed to hold the Westcliff assets separate and apart while the agency investigated the transaction; the FTC is seeking a federal court order requiring LabCorp to continue that separation during the administrative proceeding.

Andre Barlow
(202) 589-1838
abarlow@dbmlawgroup.com

Robert W. Doyle, Jr.
(202) 589-1834
rdoyle@dbmlawgroup.com