Potential Defenses

• Pages: 269-312

CHAPTER VIII

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).

269

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

market.9

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 LAW ¶ 951c (2d ed. 2006).