Potential Defenses

There are several potential defenses for transactions that may
otherwise violate Section 7 of the Clayton Act (Section 7).1 Some
defenses arise from federal statutes, while the courts have created others.
The statutory defenses, such as antitrust immunities granted to certain
activities of railroad operators,2 apply to specified conduct and are based
on the regulatory scheme applicable to that industry. In contrast,
judicially created exemptions, such as the failing firm doctrine and the
state action doctrine, require fact-specific analysis to determine whether
the required elements of the defense are met.
A. The Failing Firm Doctrine
The “failing firm doctrine” is a judicially created defense to actions
challenging otherwise unlawful mergers or acquisitions.3 The failing firm
1. 15 U.S.C. §18.
2. See 49 U.S.C. §§ 11323-11325.
3. Though the failing fir m doctrine is judicial ly created, congress ional
legislative history has recognized it. The Senate Report on the 1950
amendments to § 7 stated:
The argument has been made that the proposed bill, if passed,
would have the effec t of preventing a co mpany which is in a
failing or bankrupt condition from selling out. The committee
are [sic] in full acco rd with the proposition t hat 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 Supreme Court, the Clayton Act does not
apply in bankruptc y 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).
270 Mergers and Acquisitions
doctrine applies to mergers challenged under either Section 7 of the
Clayton Act or Section 5 of the FTC Act.4 The Supreme Court first
articulated the failing firm doctrine in International Shoe Co. v. FTC.5
Although the Federal Trade Commission (FTC or the Commission) had
found that the proposed merger of two shoe manufacturers violated
Section 7, the Court reversed on two grounds. First, the Court found that
because the parties to the merger competed in separate markets, the
merger would not substantially lessen competition.6 Second, the Court
found that the merger did not violate Section 7 because the acquired
company faced “financial ruin” absent the proposed transaction.7 The
4. The failing firm doctrine is applicable to mergers challenged under either
§ 7 of the Clayton Act or § 5 of the FTC Act (15 U.S.C. § 45). See, e.g.,
Citizen Publ’g Co. v. United States, 394 U.S. 131, (1969); U.S. Steel
Corp. v. FTC, 426 F.2d 592 (6th Cir. 1970). Some dispute has arisen
concerning the extent to which the doctrine applies to mergers challenged
under § 1 of the Sherman Act. Compare American Pre ss Ass’n v. United
States, 245F. 91, 93-94 (7th Cir. 1917) (acquisition of failing company
does not violate § 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 u nder § 1). See also Ilene K. Gotts et al.,
Transactions with Financially Distressed Entities, ANTITRUST, Spring
2002, at 64, 70; Janet L. McDavid, Failing Companies and the Antitrust
Laws, 14 MICH. J. L. REFORM 229, 231-48 (1981).
5. 280 U.S. 291 (1930). An earlier version of the failing firm doctrine was
the basis for a 1917 circuit court decision permitting the acquisition of a
failing firm in an action under § 1 of the Sherman Act. See American
Press Ass’n, 245 F. 91.
6. International Shoe Co., 280 U.S. at 298-99.
7. 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 t he effect of mitigatin g seriously injurio us
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.
Potential Defenses 271
Court postulated two rationales for the creation of the failing firm
doctrine. The first emphasized the social consequences of business
failure, noting the adverse impact on stockholders, creditors, employees,
and others.8 The second assumed that there would be less of an
anticompetitive effect if a corporation that otherwise would fail were
acquired, even by a competitor, than if its assets were allowed to exit the
1. Judicial Interpretation of the Failing Firm Doctrine: Elements of
the Doctrine
Because the failing firm doctrine is an exception to the general rules
governing acquisitions, the courts, and the agencies, have construed its
requirements narrowly. Under the traditional formulation of the doctrine,
the acquiring company must prove two elements: the probability that the
target company will fail imminently and the absence of any other viable
purchaser that presents less anticompetitive effect.10 Some courts have
also added a third element requiring a demonstration that the failing firm
could not be reorganized successfully.11 The failing firm doctrine is an
affirmative defense, and the parties to the acquisition bear the burden of
proving that these conditions have been satisfied.12 Notably, although
many cases involve acquisitions of bankrupt firms, the failing firm
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).
8. See International Shoe, 280 U.S. at 302.
9. See id. For a discussion of alternative rationales for the failing firm
doctrine, see Derek C. B ok, Section 7 of the Clayton Act and the Merging
of Law and Economics, 74 HARV. L. REV. 226, 339-47 (1960).
10. See United States v. Greater Buffalo Press, 402 U.S. 549, 555 (1971).
11. See Citizen Publ’g Co. v. United States, 394 U.S. 131, 138 (1969).
12. See id. at 138-39 (“[t]he burden of proving t hat the conditions of the
failing company doctrine have been satisfied is on those who seek refuge
under it.”); United States v. Third Nat’l Bank, 390 U.S. 171, 192 (1968);
F. & M. Schaefer Corp. v. C. Schmidt & Sons, 597 F.2d 814, 817-18 (2d
Cir. 1979) (per curiam); FTC v. Harbour Grp. Invs., 1990 U.S. Dist.
LEXIS 15542 (D.D.C. 1990); see also 4 PHILLIP E. AREEDA & HERBERT
HOVENKAMP, ANTITRUST LAW951c (2d ed. 2006).

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