Chapter 7. Possible Defenses

• Pages: 203-238

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CHAPTER 7

POSSIBLE DEFENSES

There are several possible defenses to transactions that may

otherwise violate Section 7. Some defenses are matters of federal

statutes, while others have been created by the courts. The statutory

defenses, such as those for railroads, are absolute and based on the

extensive regulatory scheme for the industry. In contrast, judicially

created exemptions, such as the failing company doctrine or the state

action doctrine, require detailed analyses of the facts and potential effects

of the transaction.

A. The Failing Company Doctrine

The “failing company doctrine” is a judicially created defense,

sanctioned by Congress,1 to actions challenging otherwise unlawful

mergers or acquisitions.2 The U.S. Supreme Court first articulated the

1.The Senate Report on the 1950 amendments to Section 7 stated:

The argument has been made that the proposed bill, if passed,

would have the effect of preventing a company which is in a

failing or bankrupt condition from selling out. The committee

are [sic] in full accord with the proposition that any firm in such

a condition should be free to dispose of its stock or assets. The

committee however, do [sic] not believe that the proposed bill

will prevent sales of this type. The judicial interpretation on this

point goes back many years and is abundantly clear. According

to decisions of the U.S. Supreme Court, the Clayton Act does

not apply in bankruptcy or receivership cases. Moreover, the

court has held, with respect to this specific section, that a

company does not have to be actually in a state of bankruptcy to

be exempt from its provisions; it is sufficient that it is heading in

that direction with the probability that bankruptcy will ensue.

S. REP. NO. 81-1775, at 7 (1950), reprinted in 1950 U.S.C.C.A.N. 4293,

4299; accord H.R. REP. NO. 81-1191, at 6 (1949).

2.The failing company doctrine is applicable to mergers challenged under

either Section 7 or Section 5. See, e.g., Citizen Publ’g Co. v. United

States, 394 U.S. 131 (1969); United States Steel Corp. v. FTC, 426 F.2d

592 (6th Cir. 1970). Some dispute has arisen, however, concerning the

extent to which the doctrine is applicable to mergers challenged under

Section 1 of the Sherman Act. Compare American Press Ass’n v. United

204 MERGERS AND ACQUISITIONS

doctrine in International Shoe Co. v. FTC,3 which involved a horizontal

merger between two shoe manufacturers. The Federal Trade

Commission (FTC or the Commission) had found that the merger

violated Section 7 of the Clayton Act, but the U.S. Supreme Court

reversed on two grounds. First, the Court found that the parties to the

merger competed in separate markets and, thus, the merger would not

substantially lessen competition.4 Second, the Court found that Section 7

was not violated because the acquired company faced “financial ruin.”5

The Court postulated two rationales for the creation of the failing

company doctrine. The first rationale emphasized the social

consequences of business failure, noting the adverse impact on

stockholders, creditors, employees, and others. The second rationale

assumed that there would be less of an anticompetitive effect if a

States, 245 F. 91, 93-94 (7th Cir. 1917) (acquisition of failing company

does not violate Section 1 of Sherman Act), with Bowl Am., Inc. v. Fair

Lanes, Inc., 299 F. Supp. 1080, 1092-93 (D. Md. 1969) (doctrine

inapplicable to mergers challenged under Section 1). See also Ilene K.

Gotts et al., Transactions with Financially Distressed Entities,

ANTITRUST , Summer 2002, 64-70; Janet L. McDavid, Failing Companies

and the Antitrust Laws, 14 MICH. J. L. REFORM 229, 231-48 (1981).

3.280 U.S. 291 (1930). An earlier version of the failing company doctrine

was the basis for a 1917 circuit court decision permitting the acquisition

of a failing company in an action under Section 1 of the Sherman Act.

See American Press Ass’n, 245 F. 91.

4.International Shoe Co., 280 U.S. at 298-99.

5.The court stated:

In the light of the case thus disclosed of a corporation with

resources so depleted and the prospect of rehabilitation so

remote that it faced the grave probability of a business failure

with resulting loss to its stockholders and injury to the

communities where its plants were operated, we hold that the

purchase of its capital stock by a competitor (there being no

other prospective purchaser), not with a purpose to lessen

competition, but to facilitate the accumulated business of the

purchaser and with the effect of mitigating seriously injurious

consequences otherwise probable, is not in contemplation of law

prejudicial to the public and does not substantially lessen

competition or restrain commerce within the intent of the

Clayton Act.

Id. at 302-03. For a discussion of the financial condition of the acquired

company in International Shoe, see Marc P. Blum, The Failing Company

Doctrine, 16 B.C. INDUS. & COM. L. REV. 75, 76-81 (1974).

Possible Defenses 205

corporation that otherwise would fail were acquired, even by a

competitor, than if its assets were allowed to exit the market.6

1. Judicial Interpretation of the Failing Company Doctrine:

Elements of the Defense

Because the doctrine is an exception to the general rules governing

acquisitions, the courts have construed the requirements of the defense

narrowly. Under the traditional formulation of the failing company

doctrine, the acquiring company must prove two elements: the

probability of imminent business failure of the target company and the

unavailability of other purchasers with less anticompetitive impact.7

Some courts have also added a third element—that the failing firm could

not be reorganized successfully. The failing company doctrine is an

affirmative defense, and the parties to the acquisition bear the burden of

proving that these conditions have been satisfied.8 It is notable that,

although there are many cases involving acquisitions of bankrupt firms,

the failing firm defense is rarely applicable and thus, parties typically

must defend such transactions on the merits.9

6.See International Shoe, 280 U.S. at 302.

7.See, e.g., United States v. Greater Buffalo Press, Inc., 402 U.S. 549, 555

(1971) (acquisition by newspaper of printing company that was

profitable, but which owners chose to sell rather than modernize).

8.See Citizen Publ’g Co. v. United States, 394 U.S. 131, 138-39 (1969);

United States v. Third Nat’l Bank, 390 U.S. 171, 192 (1968); F. & M.

Schaefer Corp. v. C. Schmidt & Sons, Inc., 597 F.2d 814, 817-18 (2d Cir.

1979); FTC v. Harbour Group Invs., L.P., 1990-2 Trade Cas. (CCH)

¶ 69,247, at 64,914-15 (D.D.C. 1990); see also 4 PHILLIP AREEDA,

HERBERT HOVENKAMP & JOHN L. SOLOW, ANTITRUST LAW ¶ 951c (rev.

ed. 1998).

9.For example, in United States v. SunGard Data Sys., Inc., 172 F. Supp. 2d

172 (D.D.C. 2001), the defendants successfully defended against the

Division’s antitrust challenge to a proposed acquisition of a bankrupt firm

without asserting the failing firm defense. In SunGard, the Division

alleged that SunGard’s proposed acquisition of Comdisco would have

substantially reduced competition in the market for hotsite disaster

recovery services. At the time of the case, Comdisco had filed for

bankruptcy and its assets were being sold at auction pursuant to an order

of the bankruptcy court. At auction, Comdisco received bids from

SunGard and another firm, though SunGard’s bid was the highest.

Following the auction, the Division sued to enjoin the transaction. As

part of their defense, the parties did not assert that they were entitled to

the “failing firm” defense, presumably because another bid had been