California v. Sutter

IN THE UNITED STATES DISTRICT COURT

FOR THE NORTHERN DISTRICT OF CALIFORNIA

STATE OF CALIFORNIA,

Plaintiff,

v.

SUTTER HEALTH SYSTEM, ALTA BATES MEDICAL CENTER, and SUMMIT
MEDICAL CENTER,

Defendants. /

No. C99-03803 MMC

MEMORANDUM OF DECISION RE: ORDER DENYING PLAINTIFF’S

MOTION FOR PRELIMINARY INJUNCTION; FINDINGS OF FACT AND

CONCLUSIONS OF LAW







Before the Court is the motion of plaintiff State of California for preliminary injunction to enjoin
the merger of defendant Alta Bates Medical Center (“Alta Bates”), owned by defendant Sutter
Health System (“Sutter”), and defendant Summit Medical Center (“Summit”). The matter came
on regularly for hearing on October 25, 26, 27, and November 1, 1999. Appearing for plaintiff
State of California were Bill Lockyer, Attorney General of the State of California; John Donhoff,
Jr., Deputy Attorney General; Pamela Cole, Special Deputy Attorney General and Charles M.
McGay, Special Deputy Attorney General. Appearing for defendants Sutter and Alta Bates were
George T. Manning, Robert C. Jones, Adrian Wager-Zito and Toby G. Singer, of Jones, Day,
Reavis & Rogue. Appearing for defendant Summit was Maureen McGuirl of Crosby, Heafey,
Roach & May. The matter was deemed submitted as of November 10, 1999, upon receipt of
final post-hearing filings.1




Having considered the papers filed in support of and in opposition to the motion as well as the
evidence and arguments of counsel presented at the hearing, the Court hereby issues the
following findings of fact and conclusions of law and rules as follows:




I. BACKGROUND




A. Bay Area Health Care Market




1. Hospitals




Defendants Summit and Alta Bates are hospitals located respectively in the cities of Oakland and
Berkeley in Alameda County. Alameda County is located in what is commonly referred to as the
East Bay, which in turn is part of the San Francisco Bay Area.




The East Bay includes the population centers located along the eastern side of the San Francisco
Bay. The San Francisco Bay separates this population from Marin, San Mateo, and San
Francisco counties, located to the west of the East Bay. Transportation across the San Francisco
Bay in an east-west direction is confined to four bridges, one of which is the San Francisco-Oakland Bay Bridge (the “Bay Bridge”). The other bridges are located either to the north or
south of San Francisco and Oakland. The Oakland and Berkeley hills separate the main
population of the East Bay from the inland communities of the East Bay such as Walnut Creek
and Concord in Contra Costa County. In the immediate Oakland/Berkeley area, transportation
across the Oakland and Berkeley hills to these inland cities is limited to the Caldecott Tunnel.
The East Bay is separated by the Carquinez Strait from Solano County to the north.




A wide variety of hospitals exist in the San Francisco Bay Area, and range from general acute
care hospitals such as John Muir Medical Center (“John Muir”) in Walnut Creek, which offers
a full range of primary, secondary, and tertiary care,2 to specialized hospitals such as Children’s
Hospital in Oakland, which offers only pediatric services. The size and capacity of the hospitals
in the Bay Area also vary widely, from Alameda Hospital, located on Alameda Island, which
maintains 135 licensed beds, to Laguna Honda Hospital & Rehabilitation Center in San
Francisco, which maintains 1,457 licensed beds.




At least twenty hospitals, including defendants Summit and Alta Bates, are located in the East
Bay. (Defs.’ Ex. 1001, Economic Report of Margaret E. Guerin-Calvert (Defendant’s Expert)
?? 26, 42 & Tab I.) Alta Bates, the second largest hospital in the East Bay with over 500 licensed
beds, is a comprehensive community hospital that enjoys a reputation for quality health care
services. Alta Bates is a general acute care hospital that offers a wide range of primary,
secondary, and tertiary services, and is the sole provider of high-risk obstetrical services in
Alameda County. (PX1082, Langenfeld Report, Ex. 2.)




Sutter, a nonprofit corporation based in Sacramento, California, currently operates twenty-six
hospitals in Northern California, and is the largest operator of general acute care hospitals in
Northern California. Sutter entered the San Francisco and East Bay health care market through
its acquisition of California Healthcare System in 1996 and currently operates six hospitals in
the San Francisco Bay Area, including Eden Medical Center (“Eden”) in Castro Valley, with
over 250 licenced beds, and Alta Bates in Berkeley. (PX1082, Langenfeld Report, Ex. 4, 57.)




Summit, also a nonprofit corporation, was formed in 1992 by the merger of two Oakland
hospitals, Providence Hospital and Merritt Peralta Medical Center. Summit is comprised of five
separately incorporated entities: Summit Hospital (the “Hospital”); Health Ventures, Inc., which
owns Summit Health Clinic, an outpatient clinic; Adolescent Treatment Centers, Inc., a
substance abuse program; Samuel Merritt College, a nursing college; and Summit Medical
Center Foundation (the “Foundation”), a charitable foundation.




Summit Hospital is a general acute care hospital in an inner-city neighborhood of Oakland,
located approximately three miles from Alta Bates. Summit also offers a wide range of inpatient
and outpatient services and is currently the third largest hospital in the East Bay with over 500
licensed beds. (PX1082, Langenfeld Report, Ex. 57.) Summit tends to charge lower rates than
Alta Bates, and its patient mix includes a large percentage of Medicare and Medi-Cal (the
California equivalent of Medicare) patients. (PX1082, Langenfeld Report, Ex. 2.)




The largest hospital in the East Bay is Alameda County Medical Center (“ACMC”). Located in
the Berkeley/Oakland area, ACMC maintains over 600 licensed beds and primarily provides
medical services to indigent and low-income residents of Alameda County. ACMC offers most
primary and secondary services plus some, but not all, tertiary services. (PX1082, Langenfeld
Report, Ex. 2; PX15, Decl. of Michael Smart (CEO, ACMC) ?? 2-6, 8.)




Also located in Oakland is Kaiser Hospital-Oakland (“Kaiser-Oakland”), operated by the Kaiser
Foundation Health Plan (“Kaiser”). Kaiser-Oakland maintains 394 licensed beds and offers a full
range of acute inpatient services comparable to those offered at Alta Bates and Summit. Kaiser-Oakland has been scheduled to close due to the expense of seismic upgrades required under the
Alquist Hospital Safety Act of 1983 (the “Alquist Act”). Cal. Health & Safety Code ? 130000
et seq. (Deering 1997). (PX20, FTC Transcript of Jerry Fleming (Senior VP, Kaiser
Permanente), May 4, 1999, at 56:15-19.) In connection with the scheduled closing, Kaiser has
contracted to send its patients to other hospitals under what has been termed the “Alameda
Alliance”. Kaiser has been sending patients for inpatient obstetrical services, mainly childbirth,
to Alta Bates. Kaiser has also executed contracts with Summit for adult non-obstetrical
medical/surgical services, and with Children’s Hospital for pediatric services. (PX20, Fleming
Tr. at 46:9-25.) In April 1999, Kaiser requested a “standstill” agreement to defer implementation
of its contracts with Summit, as discussed below. Kaiser also operates two other hospitals in the
East Bay: Kaiser-Richmond with 50 licensed beds, and Kaiser-Hayward with 244 licensed beds.

Approximately thirty miles to the south of Alta Bates and Summit at the outer edge of the East
Bay lies Washington Township Hospital (“Washington Township”) in Fremont, which maintains
308 licensed beds and offers services comparable to Alta Bates and Summit. Washington
Township recently opened a new building with expanded cardiac and pulmonary services, and
is located in an area with a growing population. (Def.’s Ex. 995, Dep. of Kimberly Hartz at 81-87.)




Eight hospitals are located on the Contra Costa County side of the Caldecott Tunnel, east of
Summit and Alta Bates, and within the general East Bay area. (Def.’s Ex. 916.) John Muir in
Walnut Creek, for example, maintains 327 licensed beds and is a sophisticated regional medical
center that offers, as noted above, a full range of primary, secondary, and tertiary care similar
to the services offered at Summit and Alta Bates. (Def.’s Ex. 119 at BLUECR0000025; PX1082
Langenfeld Report, Ex. 3.) John Muir has a a stated strategy of expanding “outside of [its] core
service area,” and has recently received approval for an 833,000 square foot addition to its
facilities. (PX57, John Muir/Mt. Diablo Strategic Plan 1998-2001, Nov. 11, 1997, at
JMMDH5005283; Def.’s Ex. 1029, City Approves John Muir Master Plan, Walnut Creek
Journal, Jan. 22, 1998 at 1.). In 1997, John Muir merged with Mount Diablo Medical Center
(“Mount Diablo”), located in Concord, also through the Caldecott Tunnel, which currently
maintains 254 licensed beds. Mount Diablo offers a variety of acute inpatient services and its
areas of distinction include cardiac care, oncology services, and obstetrics. (PX1082, Langenfeld
Report, Ex. 3.)




At least nine hospitals are located in San Francisco, across the Bay Bridge from Summit and Alta
Bates. (Def.’s Ex. 916.) Many of these hospitals, such as the University of California San
Francisco/ Mount Zion Medical Center, offer a wide variety of high quality health care services
at least comparable to those offered at Alta Bates and Summit.




2. Health Groups




The Bay Area is characterized by strong, sophisticated health care plans. Managed care
organizations (“MCOs”) in the East Bay cover nearly 60% of the population, one of the highest
levels in the country. (Def.’s Ex. 1013, Expert Report of Michael Pugh ? 44; Def.’s Ex. 997,
Dep. of Warren Foon at 56; Def.’s Ex. 982, Dep. of Richard Scheffler at 67-68.) Managed care,
which has increasingly taken the place of traditional indemnity-based insurance, can be defined
as a system in which the financing and delivery of health care is integrated to achieve the goals
of disease prevention and efficiency in the provision of health care services. (Def.’s Ex. 1013,
Pugh Report ? 7.)




There are three broad types of MCOs. Health maintenance organizations (“HMOs”) integrate
the financing and delivery of a comprehensive set of health care services to an enrolled
population which must obtain medical care from within the HMO network of health care
providers. Such services are generally offered on a “capitated” or flat monthly-fee basis with low
or no co-payments instead of through deductibles and claim forms. There is generally no
coverage, however, for services from providers outside of the HMO network. Preferred provider
organization insurance plans (“PPOs”) are fee-for-service health care benefit plans built on
indemnity insurance platforms which offer financial incentives to enrollees to acquire medical
care from a predetermined (“preferred”) network of physicians. Finally, HMO point-of-service
(“POS”) plans allow members to go outside of the HMO network for health care services. Care
is managed in a traditional HMO fashion within the HMO network, but if a member seeks care
outside the HMO network, the plan levies significant out-of-pocket costs on members in the form
of deductibles and co-payments similar to a PPO. (Def.’s Ex. 1013, Pugh Report ? 17.)




By far the largest health care plan in the Bay Area is Kaiser, with more than 800,000 members.
Kaiser currently covers 40% of the insured population and enjoys a 50% share of health plan
enrollment in the East Bay. (Def.’s Ex. 1001, Guerin-Calvert Report ? 30.) Kaiser is distinct
from other HMOs in the market because it is a “vertically integrated” health care system,
meaning that member patients are generally required to use Kaiser physicians and Kaiser
hospitals, and Kaiser hospitals primarily serve only those patients that are enrolled in the Kaiser
health plan. (PX1082, Langenfeld Report at 46.) The second largest health plan in the East Bay,
in terms of membership volume, is Health Net, with 185,000 members. Other health plans
include PacifiCare, Aetna, Lifeguard, CIGNA, Blue Cross, and Blue Shield. (Def.’s Ex. 379,
Deloitte & Touche Consulting, Materials for August 12, 1998 Alta Bates/Summit meeting at
SUT0781660; Def.’s Ex. 494, List of Companies Providing HMO and PPO Products in the East
Bay at 003941.)




The Bay Area, unlike many other areas of the country, is also characterized by the existence of
numerous large, well-organized, and competitive Independent Practice Associations (“IPAs”).
An IPA is a separate legal entity that has been formed by independent physicians and small
medical groups that band together, much like a co-op, to enter into contracts, which typically
include risk-sharing arrangements, directly with health care plans. (Hr’g Tr. at 509:8-13, 180:8-181:7; Def.’s Ex. 1013, Pugh Report ?? 56-57; Def.’s Ex. 989, Dep. of Steve McDermott at 19-20.) Risk-sharing arrangements give physicians incentives to admit patients to lower-cost
hospitals because physicians can share in cost savings if they do not expend all of the money
received from the insurance companies. (Hr’g Tr. at 509:8-13; Def.’s Ex. 1013, Pugh Report ??
56-57; Def.’s Ex. 989, McDermott Dep. at 19-20; Def.’s Ex. 982, Scheffler Dep. at 72-74.) IPAs
in the East Bay include Hill Physicians Medical Group, Alta Bates Medical Group, Affinity
Medical Group, San Leandro IPA, John Muir Health Network, and West County IPA, among
others. (Def.’s Ex. 37, Presentation Materials Re: East Bay Services Area at SUT0230887.)




In recent years, consolidation among various health care plans, such as the 1998 mergers of
Foundation Health of California with Health Net, and CareAmerica Health Plans with
CaliforniaCare, in addition to the strong emergence of IPAs, have led to a very competitive
environment in the health care market, and the pressure to reduce costs have resulted in
significant financial pressure on health plans and providers throughout California. (Def.’s Ex.
1013, Pugh Report ?? 49-50.)




B. Merger Discussions




In 1995, Summit began a process of seeking potential purchasers. Summit participated in
acquisition negotiations with Catholic Healthcare West (“CHW”) and retained an investment
banking firm, Morgan Stanley Dean Witter (“Morgan Stanley”), to identify other possible
affiliation partners. (Def.’s Ex. 811, Decl. of John Q. Landers, Managing Director, Morgan
Stanley, ? 4.) In consultation with Morgan Stanley, Summit developed a proposal process for
potential partners and, in February 1997, distributed an Offering Memorandum to the entities it
had identified as potentially interested in acquiring Summit. (Def.’s Ex. 811, Landers Decl. ??
5-6.)




In March and April 1997, Morgan Stanley received preliminary proposals from CHW,
Columbia/HCA, Sutter, and Tenet Healthcare Corporation (“Tenet”). CHW’s bid was eliminated
by Summit’s Board and Columbia/HCA subsequently decided not to pursue the acquisition of
Summit for internal reasons. (Dep. of John Landers at 15:16-20, 18:1-14, 45:17-25, 46:1-8.)
Therefore, by November 1997, the Summit Board had narrowed the field of potential acquirers
to two candidates: Tenet and Sutter.




Morgan Stanley and Summit management negotiated with Sutter and Tenet from December 1997
to March 1998, at which time the Summit Board decided to accept Sutter’s offer. By agreement
dated November 19, 1998, as amended on December 11, 1998, Sutter and Summit agreed to
merge the Summit and Alta Bates facilities into a single hospital business providing primary,
secondary, and tertiary inpatient care. (Pl. Mot. at 6, Ex. 67; Def.’s Ex. 810, Decl. of Irwin
Hansen ? 31.) The merger was to be consummated on August 11, 1999, but has been postponed
pending the resolution of the present action.




C. Summit Financial Situation




In fiscal year 1996, 3 when Summit first began to enter into merger negotiations, and in fiscal
year 1997, as negotiations continued, Summit enjoyed an operating income of $4.4 million and
$4.5 million respectively. In fiscal year 1998, Summit’s financial situation began to deteriorate
and Summit sustained an operating loss of $400,000. In fiscal year 1999, Summit’s losses
increased to $10.9 million, and as of August 31, 1999, the hospital’s operating income losses
amounted to $5.3 million. (Def.’s Ex. 809, Decl. of Vic Meinke ? 17; Hr’g Tr. at 594:13-595:18.)




A major reason for Summit’s deteriorating financial condition is the enactment of the Balanced
Budget Act of 1997 (the “Budget Act”), which reduced Medicare payments to hospitals.
Government payers account for a significant portion of Summit’s revenues. In Fiscal Year 1999,
Medicare accounted for 53.1% of its revenue (excluding charity care) and Medi-Cal accounted
for 21%. (Def.’s Ex. 809, Meinke Decl. ? 9.) Therefore, despite the fact that patient volumes
have increased slightly over the last two fiscal years – up 8% since fiscal year 1997 – and cost
cutting measures have kept Summit’s costs at or below local and national norms, Summit’s
patient revenue per adjusted discharge over the last two fiscal years has declined by 8.4%. (Hr’g
Tr. at 779:19-780:15; Def.’s Ex. 826, Expert Report of R. Bruce Den Uyl at 11-12.) As estimated
by Ernst & Young, an accounting firm, the Budget Act will reduce Summit’s revenues by at least
$52.8 million in fiscal years 1999-2002. (Def.’s Ex. 809, Meinke Decl. ?? 19-20; Def.’s Ex. 810,
Hansen Decl. ?? 16-17.)




Due to the Budget Act and other factors, Summit has not been able to generate sufficient cash
from its operations to meet its obligations. Consequently, Summit has been expending its cash
and short-term investments in addition to monies classified as “Board Designated-Plant Fund
Assets” (“Plant Fund”) in order to pay its trade debts. (Def.’s Ex. 826, Den Uyl Report at 12.)
The Plant Fund consists of funds set aside by the Board of Directors for specific capital
improvement projects in order to keep the hospital competitive in technology, equipment, and
facilities. (Def.’s Ex. 809, Meinke Decl. ? 26.) The Plant Fund has been depleted at a rapid rate.
At the end of February 1999, the Plant Fund contained $10.8 million. (Def.’s Ex. 707, at C-3.)
By the end of August 1999, the Fund had decreased to $2.3 million (Def.’s Ex. 772, Summit
Med. Center — Summary Stat. Info. at SUM05002021.)




An additional source of funding is the Uncompensated Care Fund, which consists of monies
donated to Summit to provide care for needy patients. Currently, $7 million of the $10.5 million
fund is available to offset losses. It is anticipated that amount will be exhausted by December
1999. (Hr’g Tr. at 777:1-17; 783:2-4.) The balance of the Uncompensated Care Fund will likely
become fully available for expenditure by the end of February 2000. Even with this amount,
however, and funds from Kaiser under the Capital Funding Agreement, as discussed below,
Summit will only be able to operate for one or two additional months past February 2000 before
it runs out of cash. (Hr’g Tr. at 777:1-7.)




At the end of February 1999, Summit was unable to pay over $6.4 million in vendor’s bills that
were due and payable. As of September 30, 1999, the amount of overdue bills has increased to
$8.9 million. Because Summit has not been paying its debts as they come due, some suppliers
have placed it on “cash-on–delivery” payment terms. (Def.’s Ex. 809, Meinke Decl. ? 22; Def.’s
Ex. 826, Den Uyl Report at 6.)




Summit also has a large amount of long-term debt. Summit borrowed the proceeds of tax-free
revenue bonds (“Revenue Bonds”) issued by the California Health Facilities Financing Authority
in 1985. This debt was refinanced in 1989 and again in August 1996 through the proceeds of
bonds issued by the Health Facilities Financing Authority. The total amount of bonds issued in
1996 was $75.92 million and the outstanding balance as of August 1999 was $68.7 million.
(Def.’s Ex. 809, Meinke Decl. ? 29.) The Revenue Bonds contain covenants that restrict
Summit’s ability to take on additional debt if Summit’s debt-service coverage ratio falls below
1.35. Summit’s present debt-service ratio is 0.62, less than half the required ratio. (Def.’s Ex.
809, Meinke Decl. ? 31.) By the close of this fiscal year, Summit will be unable to satisfy the
debt service ratio requirement without shutting down substantial portions of the hospital. (Def.’s
Ex. 826, Den Uyl Report at 18.)




Summit faces significant expenditures related to the seismic upgrades required by the Alquist
Act and that all inpatient hospital facilities must complete by 2008 or 2030, depending on the
nature of the upgrade. Much of Summit’s physical plant does not meet these seismic mandates
and, based on square footage, over 47% of Summit’s inpatient facilities need to be upgraded to
meet the state seismic mandates. The expected costs of making the required structural and non-structural improvements is estimated to total approximately $109.7 million. (Def.’s Ex. 809,
Meinke Decl. ?? 34-35.) The required structural expenditures, which exceed the book value of
the assets themselves, $103 million, have contributed to a fair market value of these assets at
significantly below book value as reflected on Summit’s balance sheet. (Def.’s Ex. 809, Meinke
Decl. ?? 34-35.)




In addition to the mandatory seismic upgrades, Summit has also been required to upgrade its
facilities pursuant to contracts entered into with Kaiser. In April 1998, Kaiser and the
Permanente Medical Group, based on Kaiser’s decision to close Kaiser-Oakland, entered into
a Hospital Services Agreement and a Capital Funding Agreement with Summit. Under the
Hospital Services Agreement, Kaiser agreed, excepting pediatric and Ob/Gyn cases, to transfer
patients to Summit that normally would have been treated at Kaiser-Oakland. (Def.’s Ex. 810,
Hansen Decl. ? 21; Def.’s Ex. 809, Meinke Decl. ? 48.)




To accommodate this increase in patients under the Hospital Services Agreement, Summit was
required to expand and renovate some of its buildings. Specifically, Kaiser required that Summit
complete seismic upgrades to two wings before Kaiser would transfer any patients. Under the
Capital Funding Agreement, Kaiser advanced most of the funding for these capital expenditures.
The loans under this agreement are to be repaid by credits against the invoices that Summit
would submit to Kaiser for services provided under the Hospital Services Agreement. (Def.’s
Ex. 809, Meinke Decl. ?? 49-50.) The Kaiser construction was estimated to cost $49.7 million,
of which Kaiser agreed to fund $33.5 million for construction and equipment and up to $5
million for seismic upgrades, while Summit bore responsibility for $11.2 million in construction
costs. (Def.’s Ex. 809, Meinke Decl. ? 51.) The Kaiser upgrades have not yet been completed.
Summit’s Emergency Room, for example, remains under construction and its condition has led
regulators to caution Summit that construction of the Emergency Room must be completed soon.
(Def.’s Ex. 809, Meinke Decl. ?? 43-44.)




In April 1999, Kaiser requested a “standstill” agreement which would defer implementation of
the Hospital Services Agreement while Kaiser considered options other than closing Kaiser-Oakland and sending its patients to Summit. (Def.’s Ex. 810, Hansen Decl. ? 25.) Kaiser
Chairman, David Lawrence, however, testified during the FTC investigation of the proposed
merger that he believes that the Hospital Services Agreement will not be breached and Kaiser-Oakland will certainly close within three years and perhaps as soon as one year. (PX32,
Statement of David Lawrence (Chairman, Kaiser Permanente) at 55:10-56:2.) Summit estimates
that the amount to be paid for work previously undertaken and to complete the construction
projects, on a modified basis if Kaiser will not implement the Hospital Services Agreement, will
be at least $11.7 million. (Def.’s Ex. 809, Meinke Decl. ?? 43-44.)




II. LEGAL STANDARD




A. Preliminary Injunction




On August 10, 1999, plaintiff State of California, represented by its Attorney General, Bill
Lockyer, filed this action in its parens patriae capacity for injunctive relief under Section 7 of
the Clayton Act. See 15 U.S.C. ? 26 (“Any person, firm corporation, or association shall be
entitled to sue for and have injunctive relief . . . against threatened loss or damage by a violation
of the antitrust laws . . . .”). See Hawaii v. Standard Oil Co., 405 U.S. 251, 261 (1972)
(recognizing parens patriae standing under the Clayton Act for injunctive relief).




To obtain a preliminary injunction, a plaintiff “must show either (1) a combination of probable
success on the merits and the possibility of irreparable injury or (2) that serious questions are
raised and the balance of hardships tips sharply in its favor.” United States v. Odessa Union
Warehouse Co-op, 833 F.2d 172, 174 (9th Cir. 1987). As explained by the Ninth Circuit, “[t]hese
formulations are not different tests but represent two points on a continuum in which the degree
of irreparable harm that must be shown increases as the probability of success on the merits
decreases.” Oakland Tribune, Inc. v. Chronicle Publishing Co., 762 F.2d 1374, 1376 (9th Cir.
1985).




B. Clayton Act




Section 7 of the Clayton Act prohibits mergers or acquisitions “in any line of commerce or in any
activity affecting commerce in any section of the country, [where] the effect of such acquisition
may be substantially to lessen competition or to tend to create a monopoly.” 15 U.S.C. ? 18.
Section 7 was enacted to prevent anticompetitive mergers “in their incipiency.” United States
v. Philadelphia Nat’l Bank, 374 U.S. 321, 362 (1962). Therefore, “[a]ll that is necessary [under
Section 7] is that the merger create an appreciable danger of [anticompetitive] consequences in
the future. A predictive judgment, necessarily probabilistic and judgmental rather than
demonstrable, is called for.” Hosp. Corp. of America v. Fed. Trade Comm’n., 807 F.2d 1381,
1389 (7th Cir. 1986).




To establish a prima facie case under Section 7 of the Clayton Act, a plaintiff must first define
the relevant market, and then establish that the proposed merger will create an appreciable
danger of anticompetitive consequences. Philadelphia Nat’l Bank, 374 U.S. at 362. The relevant
market consists of two components, the “product market,” and the “geographic market”. See
United States v. Marine Bancorporation, Inc., 418 U.S. 602, 618 (1974) (“Determination of the
relevant product and geographic markets is a ‘necessary predicate’ to deciding whether a merger
contravenes the Clayton Act.”); Fed. Trade Comm’n v. Staples, Inc., 970 F. Supp. 1066, 1072
(D.D.C. 1997) (holding elements of prima facie case for violation of Section 7 are: “(1) the ‘line
of commerce’ or product market in which to assess the transaction; (2) the ‘section of the
country’ or geographic market in which to assess the transaction; and (3) the transaction’s
probable effect on competition in the product and geographic markets”).




After defining the relevant market, a plaintiff may establish a presumption that the proposed
merger will substantially lessen competition by making an initial statistical showing that the
transaction will lead to undue concentration in the market. United States v. Baker Hughes, Inc.,
908 F.2d 981, 982 (D.C. Cir. 1990). See also State of California v. American Stores Co., 872
F.2d 837, 842 (9th Cir. 1989), rev’d on other grounds, 495 U.S. 271 (1990) (“Statistics that
indicate excessive post-merger market share and market concentration create a presumption that
the merger violates the Clayton Act.”); United States v. Syufy, 903 F.2d 659, 664 n.6 (9th Cir.
1990) (holding evidence of high market share establishes prima facie case).




If the plaintiff successfully establishes a presumption of anticompetitive effect through market-share statistics, “[t]he burden of producing evidence to rebut this presumption then shifts to the
defendants.” Baker Hughes, 908 F.2d at 982. See also Marine Bancorporation, 418 U.S. at 631
(“To meet this burden, the defendants must show that the market-share statistics give an
inaccurate prediction of the proposed acquisition’s probable effect on competition.”); American
Stores, 872 F.2d at 842 (holding defendant may rebut prima facie case by “demonstrating that
statistics on market share, market concentration, and market concentration trends portray
inaccurately the merger’s probable effects on competition”). Finally, upon a defendant’s
successfully rebutting the presumption of anticompetitive effect, “the burden of producing
additional evidence of anticompetitive effect shifts to the [plaintiff] and merges with the ultimate
burden of persuasion, which remains with the [plaintiff] at all times.” Baker Hughes, 908 F.2d
at 982, citing to Kaiser Aluminum & Chem. Corp. v. Fed. Trade Comm’n., 652 F.2d 1324, 1340
n.12 (7th Cir. 1981).




III. ANALYSIS




A. Product Market




The first step in analyzing the competitive effects of a merger under Section 7 of the Clayton Act
is to define the relevant product market. In Brown Shoe v. United States, 370 U.S. 294 (1962),
the Supreme Court set forth the rule for determining the product market, stating “[t]he outer
boundaries of a product market are determined by the reasonable interchangability of use or the
cross-elasticity of demand between the product itself and substitutes for it.” Id. at 325. Product
markets are defined by the ability of consumers economically to switch from one product or
service to a substitute. A properly defined product market consists of all goods or services
“reasonably interchangeable by consumers for the same purposes.” United States v. E.I. du Pont
de Nemours & Co., 351 U.S. 377, 395 (1956). See also Thurman Indus., Inc. v. Pay ‘N Pak
Stores, Inc., 875 F.2d 1369, 1374 (9th Cir. 1989) (holding the relevant product market to include
“the group or groups of sellers or producers who have actual or potential ability to deprive each
other of significant levels of business.”) (citations omitted).




In the present case, the parties agree that the relevant product market consists of the cluster of
services comprising acute inpatient care. (Hr’g Tr. at 1070.) While the treatments offered to
patients within this cluster of services are not substitutes for one another (for example, one
cannot substitute a tonsillectomy for heart bypass surgery), the services and resources that
hospitals provide tend to be similar across a wide range of primary, secondary, and tertiary
inpatient services. Accordingly, courts have consistently recognized the cluster of services
comprising acute inpatient services as the appropriate product market in hospital merger cases.
See United States v. Long Island Jewish Medical Center, 983 F. Supp. 121, 138 (E.D.N.Y. 1997)
(noting weight of authority in hospital merger cases supports use of general acute inpatient
services as appropriate product market); Santa Cruz Medical Clinic v. Dominican Santa Cruz
Hosp., 1995 WL 853037 at *5 (N.D.Cal. 1995) (noting near unanimity in applying cluster
market concept to inpatient care in hospital merger cases).




This product market includes not only services provided by hospitals that offer the full range of
general acute inpatient services, but also those available at “niche” hospitals, such as Children’s
Hospital, that compete with Sutter and Alta Bates in providing only part of the “cluster of
services” that constitutes general acute inpatient care. See Forsyth v. Humana, Inc., 114 F.3d
1467, 1476 (9th Cir. 1997) (“Specialty shops which offer only a limited range of goods are
generally considered in the same market with larger, more diverse, ‘one-stop shopping’
centers.”).




Although the parties agree that the proper product market consists of the cluster of services
comprising acute inpatient care, they disagree as to whether the services provided by Kaiser
hospitals should be included in this market.




Plaintiff argues that the Kaiser hospitals should be excluded from the product market because
Kaiser’s services are “captive” in that Kaiser hospitals generally only provide care to Kaiser
members. Therefore, plaintiff contends, the Kaiser hospitals do not provide a practical alternative
for non-member consumers of acute inpatient services.




All forms of acute inpatient care, however, are substitutes for the services offered by defendants
because they all accomplish the task of delivering acute inpatient services to patients in the Bay
Area. See United States Dept. of Justice & Fed. Trade Comm’n, Horizontal Merger Guidelines,
4 Trade Reg. Rep. (CCH) ? 13,104, at ? 1.31 (1992 with 1997 revisions) (“Merger Guidelines”)
(including products and services offered by vertically integrated firms in product market).
Although Kaiser hospitals may not directly provide services to non-member patients, they do
provide viable substitutes for services offered at other hospitals in the region; if faced with an
anticompetitive price increase, patients may choose to join the Kaiser network for acute inpatient
services. As a leading treatise explains, “[i]nternal or captive transfers of a product should be
included in the market. It is a part of supply, and control over supply determines the existence
of market power . . . .”Areeda & Hovenkamp, Antitrust Law, IIA ? 570g (1995) (“Areeda”). See
also Reazin v. Blue Cross and Blue Shield of Kan., Inc., 899 F.2d 951, 959 n.10 (10th Cir. 1990)
(holding “self-insurance” is part of market for private health care financing). Accordingly, the
Court finds the Kaiser hospitals to be part of the relevant product market.




B. Geographic Market




1. Legal Standard




After defining the relevant product market, the plaintiff bears the burden of proving the proper
geographic market in which to analyze the competitive effects of the proposed merger. United
States v. Connecticut Nat’l Bank, 418 U.S. 656, 669 (1974). The proper geographic market is
“that geographic area ‘to which consumers can practically turn for alternative sources of the
product and in which the antitrust defendants face competition.'”Fed. Trade Comm’n. v.
Freeman Hosp., 69 F.3d 260, 268 (8th Cir. 1995) (citations omitted). A determination of the
proper geographic market must be based on the “commercial realities of the industry,” Brown
Shoe, 370 U.S. at 336, and therefore, must involve a dynamic as opposed to static analysis of
“where consumers could practicably go, not on where they actually go.” Freeman Hosp., 69 F.3d
at 268. See also Fed. Trade Comm’n v. Tenet Health Care Corp., 186 F.3d 1045, 1052 (8th Cir.
1998) (A “properly defined geographic market includes potential suppliers who can readily offer
consumers a suitable alternative to the defendant’s services.”). Although the geographic market
must be “well-defined,” courts do not compel “scientific precision” in its definition. Connecticut
Nat’l Bank, 418 U.S. at 669.




The Merger Guidelines, set forth the standards by which the Federal Trade Commission decides
whether or not to challenge a merger, and define a geographic market to be the smallest region
“such that a hypothetical monopolist that was the only present or future producer of the relevant
product at locations in that region could profitably impose at least a ‘small but significant and
nontransitory’ increase in price [“SNIP”], holding constant the terms of sale for all products
produced elsewhere.” Merger Guidelines at ?1.21. Although the Merger Guidelines are not
binding, courts have often adopted the standards set forth in the Merger Guidelines in analyzing
antitrust issues. See Tenet, 186 F.3d at 1053 (referencing Merger Guidelines analysis in
evaluating geographic market); United States v. Mercy Health Services, 902 F.Supp. 968, 980
(N.D.Iowa 1995) (utilizing Merger Guideline SNIP analysis in determining geographic market).




2. Current Market Analysis: Elzinga-Hogarty Test




a. Service area analysis




The basic question to be asked in determining the relevant geographic market is where can
patients practicably go for acute inpatients services. Freeman Hosp., 69 F.3d at 268. The first
step in answering this question is to determine where patients currently go for acute inpatient
services. See Fed. Trade Comm’n v. Freeman Hosp., 911 F.Supp. 911 F.Supp. 1213, 1217
(W.D.Mo. 1995) (“The first step in evaluating the relevant geographic market is to determine
where the patients of [defendants] come from.”). The analytical process generally begins with
an application of the Elzinga-Hogarty test (“E-H test”), a two-part test which examines current
market behavior through an analysis of hospital service areas and patient flow data. See Mercy
Health, 902 F.Supp. at 978 (“[T]he Elzinga-Hogarty test is . . . a starting point — it states where
[the merging hospitals] are currently attracting patients. . . .”).




As explained by the Eighth Circuit in Freeman Hosp., 69 F.3d at 263, “[t]he first prong of the
Elzinga-Hogarty test requires a determination of the merging hospitals’ ‘service area,’ that area
from which they attract their patients.” In the second step, two measurements are taken of the
flow of patients into and out of the test market. The Little In From Outside (“LIFO”)
measurement calculates the percentage of patients who reside inside the test market that are
admitted to those hospitals located within the test market. A LIFO of 100% would indicate that
all hospital admittees in the test market are residents of the test market. The Little Out From
Inside (“LOFI”) measurement calculates the percentage of patients who reside in the test market
who obtain inpatient services from the hospitals in the test market. A LOFI of 100% would
indicate that all hospital patients who are residents of the test market are admitted to hospitals
in the test market. A LIFO and LOFI of 75% is considered a weak indication of the existence of
a market and a LIFO and LOFI of 90% is considered a strong indication of a market.




Plaintiff’s economic expert, James Langenfeld, Ph.D., performed a geographic market analysis.
Dr. Langenfeld, however, did not begin his analysis with an examination of hospital service areas
as prescribed by the E-H test methodology. Instead, he first examined the geography of the Bay
Area and the perceptions of market participants to arrive at a proposed geographic market
consisting of what plaintiff describes as the “Inner East Bay”, encompassing the area between
the San Francisco Bay on the west and the Caldecott Tunnel on the east, and running from the
Carquinez Strait in the north to Union City in the south. (PX1082, Langenfeld Report at 4.)




After proposing this market, Dr. Langenfeld proceeded to determine the service area of Summit
and Alta Bates through a methodology that would most closely replicate his proposed market.
In that regard, Dr. Langenfeld began by examining 1997 government data compiled as to patient
discharges and residence as indicated by zip codes. Dr. Langenfeld then rank ordered those zip
codes to include first those zip codes from which Summit and Alta Bates drew the largest market
share of patients and continued to add zip codes in this order until he had accounted for 85% of
the hospital’s patient discharges. (Hr’g Tr. at 407:11-20.)4




Through this method, Dr. Langenfeld determined that the 85% patient service area, or draw area,
of Summit and Alta Bates encompassed his proposed Inner East Bay geographic market as well
as the area located just east of the Oakland Berkeley Hills, through the Caldecott Tunnel,
comprised of the cities of Layfayette, Moraga, and Orinda, often referred to as “Lamorinda.”
(PX1082, Langenfeld Report at 28-34.)




Defendants’ expert, Margaret Guerin-Calvert, derived the hospitals’ service area from the same
data, but chose a 90% threshold level of significance for inclusion. As a further difference in
methodology, Guerin-Calvert rank ordered zip codes by the total number of residents who sought
acute inpatient services from a particular hospital.5 The zip code from which Summit and Alta
Bates drew the greatest number of patients was ranked first and zip codes from which fewer
numbers of patients were drawn were added thereafter in descending order. (Hr’g Tr. at 667:19-668:8.) Based on this methodology, Guerin-Calvert determined that the service area of Summit
and Alta Bates encompassed not only plaintiff’s proposed geographic market (including
Hayward and Union City) and Lamorinda, but also cities located east of Lamorinda in Contra
Costa County, such as Pittsburgh, Antioch, and Pleasanton.




In evaluating the different methodologies utilized by the parties’ respective experts in deriving
their service areas, the Court finds a service area based on the 90% level of significance utilized
by Guerin-Calvert to be more appropriate than one based on an 85% threshold as proposed by
plaintiff. Courts have generally acknowledged the 90% level of significance. See Tenet, 186 F.3d
at 1047 n.4 (“A ‘service area’ is generally defined as the area from which a hospital derives
ninety percent of its inpatients.”). Indeed, in conducting his analysis of hospital service areas,
Dr. Langenfeld determined a service area based on a 90% threshold. He did not, however,
provide the results of that test in his expert report or at the hearing, nor did he provide any
economic justification for his decision to use a percentage lower than 90% in constructing his
service area.




The Court also finds that Dr. Langenfeld’s method of ordering zip codes by market share does
not portray the area from which hospitals currently draw their patients as accurately as Guerin
Calvert’s method of ordering zip codes by the actual numbers of patients that seek inpatient
services. Dr. Langenfeld’s methodology can result in the inclusion of less significant zip codes,
such as the Presidio, from which Alta Bates draws only one or two patients but has a 100%
market share, while at the same time excluding zip codes in which the hospital may have a
relatively low market share but from which it actually draws hundreds of patients. (Hr’g Tr. at
671:2-14.)




Guerin-Calvert’s method, on the other hand, ensures that zip codes with significant numbers of
patients will be included while excluding those zip codes in which relatively few patients reside.
This method more accurately reflects the importance of a zip code to the area from which a
hospital draws its patients, and is also the manner in which hospitals determine their own service
areas. (Hr’g. Tr. 670:7.) See Freeman Hosp., 911 F.Supp. at 1221 (approving “method of
building the service area by including zip codes according to the number of patients each
contributes. . . .”). Although on occasion its use may result in the exclusion of sparsely populated
zip codes located close to the hospitals in question, Guerin-Calvert’s approach is superior to Dr.
Langenfeld’s, which is more likely to exclude zip codes that are more significant to an analysis
of current market conditions than those excluded by Guerin-Calvert’s methodology.




In comparing the service areas as determined by the parties’ respective experts, it becomes
readily apparent that the most significant difference between the two is that Dr. Langenfeld’s
service area excludes all zip codes located in Contra Costa County, with the exception of
Lamorinda. (Hr’g Tr. at 402:9-25.) Through the use of an 85% threshold and by rank ordering
zip codes by market shares, Dr. Langenfeld excluded those Summit and Alta Bates patients that
reside in Contra Costa County to the east of the proposed geographic market, and in Fremont,
Newark, and Livermore/Pleasanton, located to the southeast of the proposed market. (Hr’g Tr.
742:17-24; Def.’s Ex. 1001, Guerin-Calvert Report, Ex. F.) Because a test market includes all
hospitals within the relevant service area, Dr. Langenfeld’s methodology excluded Valley
Memorial Hospital (“Valley Memorial”), Sutter Delta Memorial Hospital (“Sutter Delta”), and
Kaiser Hospital-Walnut Creek (“Kaiser-Walnut Creek”) as practical alternatives to which
patients currently seeking acute inpatient services at Summit or Alta Bates could turn.




Further, even though his own 85% service area included Lamorinda, encompassing the three zip
codes located just east of the Caldecott Tunnel, Dr. Langenfeld excised this region from his test
market, reasoning that its exclusion would not fundamentally change his analysis because
relatively few patients reside in Lamorinda and no hospitals are located there. (Hr’g Tr. at
313:10-24.) Conversely, Dr. Langenfeld extended his test market beyond the southern border of
his 85% service area in order to include Hayward and Union City, “to be conservative and
consistent with some market participant’s views.” (PX1082, Langenfeld Rep. at 30-31.)




The Court questions these two decisions to alter the test market from that indicated by the
merging parties’ service area. The three zip codes that comprise Lamorinda represent 5% of Alta
Bates’ total patient discharges and account for more than four times as many patients as
comparably sized Hayward, a zip code which Dr. Langenfeld chose to include in plaintiff’s test
market. (Def.’s Ex. 1001, Guerin-Calvert Report ? 36, n.31.) Further, although no hospitals are
located within Lamorinda itself, the region is nonetheless significant because it includes patients
who currently seek acute inpatient services at Alta Bates and Summit. Patients that reside in
Lamorinda would be affected by an anticompetitive price increase by hospitals located within
plaintiff’s test market, and accordingly must be considered in addressing the issue of where in
that proposed market patients could practically turn for acute inpatient services. In this regard,
the Court notes that Dr. Langenfeld did include the zip code encompassing Union City, which,
like Lamorinda, does not contain any hospitals.




The Court finds that eliminating residents of the Lamorinda area while at the same time
including Hayward and Union City in the test market, in an apparent effort to conform to a
preconceived proposed market, tends to misrepresent current market conditions. See Freeman
Hosp., 911 F.Supp. at 1218 (criticizing plaintiff’s expert’s decision to exclude zip codes that
contributed significant numbers of patients to market area hospitals from service area).




For all of the reasons expressed above, the Court finds that the proper scope of the merging
parties’ hospital service area is more accurately reflected by the methodology employed by
defendant’s expert. This area encompasses the Inner East Bay and extends east into Contra Costa
County to include those zip codes in which Valley Memorial, Sutter Delta, and Kaiser-Walnut
Creek are located.




b. LOFI-LIFO results




Because plaintiff’s expert failed to follow the prescribed methodology for deriving and utilizing
the service area of the merging hospitals to construct a test market, but rather constructed a test
market to conform to a predetermined market, plaintiff’s test market does not accurately reflect
those patients that currently seek acute inpatient services at Summit and Alta Bates, or the area
in which they reside. See United States v. Rockford Mem’l Corp., 717 F.Supp. 1251, 1267
(N.D.Ill. 1989) (“[T]he court is wary of the defendants’ application [of the Elzinga-Hogarty test].
In particular, the court perceives a rather result-oriented bent in the defendants’ application of
the Elzinga-Hogarty test; using the numbers to confirm a predetermined market rather than to
help determine a market in the first place.”).




The purpose of the E-H test is to determine current market conditions by examining the area
from which the merging hospitals currently draw their patients. Mercy Health, 902 F.Supp. at
978. As stated, the use of an 85% service area, rank ordering zip codes by market share, the
exclusion of Lamorinda from the test market coupled with the inclusion of Hayward and Union
City in the test market, all serve to skew the true numbers and locations of patients that currently
seek acute inpatient services at Summit and Alta Bates, and who therefore would be affected by
a future anticompetitive price increase.




Even with these deviations from standard methodology, however, plaintiff’s test results still fail
to meet the preferred 90% threshold for a strong showing that a market exists. Dr. Langenfeld’s
LIFO and LOFI calculations based on his proposed geographic market both yielded figures of
approximately 85%. (PX 1082, Langenfeld Report at 31-34.) These results indicate that 15% of
patients admitted to hospitals in plaintiff’s proposed Inner East Bay market, or 18,000 patients,
reside outside the Inner East Bay and the remaining 85% are residents of the Inner East Bay.
Similarly, 15% of the patients who reside in the Inner East Bay, or 11,000 patients, are admitted
to hospitals outside the area and the remaining 85% seek hospital treatment within the area.




Plaintiff argues that these 85% results are well within the 75% – 90% range of results that,
depending on the percentage, indicate to a greater or lesser extent the existence of a market.
Although initially Elzinga and Hogarty were of the view that results of 75% constitute at least
weak evidence of the existence of a market, they subsequently revised their evaluation and
determined that a 90% result, rather than a range, more appropriately indicates the existence of
a geographic market. See Elzinga & Hogarty, The Problems of Geographic Market Delineation
Revisited: the Case of Coal, 23 Antitrust Bulletin 1 (1978); Rockford Mem’l, 717 F.Supp. at
1267 (“In other words, the Lofi and Lifo figures should ideally yield at least percentages of 90%
or greater.”).




Plaintiff’s E-H test results do not end the Court’s analysis, in any event, as the E-H test is only
a starting point in analyzing a geographic market. E-H test results reflect only current market
behavior, and are insufficient to determine where patients could practically turn for acute
inpatient services if faced with a future anticompetitive price increase. See Mercy Health, 902
F.Supp. at 978 (“[the E-H test] does not pretend to answer the question of what would happen
if there was an attempt to exercise market power by one of the market participants.”). Patients
who are currently unwilling to seek acute inpatient services at certain hospitals outside of the test
market may view such hospitals as practical alternatives if faced with an anticompetitive price
increase. Consequently, hospital service areas may not encompass the full range of practical
alternatives open to consumers. See Tenet, 186 F.3d at 1051 (holding relevant geographic market
was larger than merging hospitals’ service areas).




Accordingly, the Court now turns from its analysis of current market conditions to consider
factors which influence the alternative hospitals to which patients practicably may turn if faced
with a post-merger anticompetitive price increase.




3. Dynamic Analysis




As stated, the chief task in determining a geographic market is to identify the msuppliers to
whom consumers could practically turn if faced with anticompetitive pricing. Freeman Hosp.,
69 F.3d at 268. Accordingly, the next step in the determination of a geographic market is to
“identify other hospitals to which patients residing in the service areas could turn if they were
dissatisfied with the prices or services of the merging hospitals. These hospitals, in conjunction
with the [hospitals within the merging hospitals’ service area] constitute the competitors in the
relevant geographic market.” Freeman Hosp., 911 F.Supp. at 1220. See Tenet, 186 F.3d at 1051
(“In order to determine the actual geographic market, current market behavior must be put into
a dynamic analysis. . . . “). In the present case, three factors are evaluated in conjunction with
current market data to determine which hospitals would serve as practical alternatives available
to patients in the event of an anticompetitive price increase: (1) service area overlap between
hospitals inside the test market and hospitals outside the test market; (2) geography and travel
times, and (3) the perceptions of market participants. Once all practical alternatives are
identified, the geographic market is constructed by adding such hospitals to those already located
within the test market to encompass the full range of hospitals to which a patient could turn for
acute inpatient services if faced with an anticompetitive price increase. See Freeman Hosp., 911
F.Supp. at 1220.




a. Service area overlap




One important factor to consider at this stage of the analysis is the degree of overlap between the
service area of the merging hospitals and the service areas of hospitals located outside of the test
market. Where a hospital outside of the proposed geographic market draws patients from the
same region from which the merging hospitals draw their patients, the hospital located outside
of the test market is considered a practical alternative to which patients residing in the area of
overlap can turn for acute inpatient services. See Freeman Hosp., 911 F.Supp. at 1220, “[i]f the
service area residents currently use other hospitals, then those hospitals are considered
alternative to the [hospitals within the proposed geographic market].”




The first area of overlap between the service area of the merging parties and hospitals located
outside of the test market is in Contra Costa County. Based on Guerin-Calvert’s service area
analysis, Summit and Alta Bates currently draw patients from numerous zip codes throughout
Contra Costa County including Lamorinda and the cities of Pittsburgh, Antioch, and Pleasanton.
These zip codes within the merging parties’ service area overlap with the service areas of
virtually every hospital located in Contra Costa County including John Muir, Mount Diablo,
Kaiser-Walnut Creek, San Ramon Regional Medical Center (“San Ramon Regional”), Contra
Costa Regional Medical Center, and Valley Memorial Hospital (“Valley Memorial”). Thus, if
patients in Contra Costa County who currently seek acute inpatient care at hospitals located
within the merging parties’ service area were faced with anticompetitive pricing, the service area
overlap in these zip codes indicates that those patients could practically turn to any of the
hospitals located east of the Caldecott Tunnel that offer acute inpatient services, such as John
Muir and Mount Diablo.




The next area of overlap, again using Guerin-Calvert’s 90% service area calculations, appears
in those zip codes encompassing Hayward and Union City, from which the merging parties and
Washington Township, located in Fremont, both draw their patients. Washington Township is
a taxpayer-funded hospital dedicated to serving the needs of the people who live within its
district, comprised of Fremont, Union City, and Hayward. (PX20, FTC Transcript of Jerry
Fleming (Senior VP, Kaiser Permanente), May 4, 1999, at 84:2-85:3; PX7, Decl. of Dena
Maddox (Director of Network Operations, United Healthcare), ? 16.)




Dr. Langenfeld concluded, however, that despite the service area overlap in Hayward and Union
City, Washington Township would not serve as a practical alternative for patients within his
proposed market because Washington Township is geographically isolated. Although
Washington Township may not serve as a practical alternative for patients that reside in the
northern parts of the Inner East Bay, it certainly does serve as an alternative for patients located
within its district. Indeed, Washington Township currently obtains 80% of its discharges from
Fremont, Union City, and Hayward, the latter two located within plaintiff’s proposed market.
(PX20, FTC Transcript of Jerry Fleming (Senior VP, Kaiser Permanente), May 4, 1999, at 84:2-85:3; PX7, Decl. of Dena Maddox (Director of Network Operations, United Healthcare), ? 16.).
Accordingly, the Court finds that Washington Township serves as a practical alternative for
those patients located in the southern portion of the merging parties’ service area.




Finally, Dr. Langenfeld did not present evidence of the service areas of San Francisco hospitals
either in his expert report or at the hearing. By contrast, Guerin-Calvert’s service area analysis
indicates that the service areas of San Francisco hospitals overlap with essentially every zip code
within the merging parties’ service area. (Def.’s Ex. 907.) Although both experts determined that
neither Alta Bates nor Summit drew a significant number of patients from San Francisco, the
question in this case is whether hospitals in San Francisco serve as practical alternatives for
patients who reside in theInner East Bay. The fact that the combined service area of San
Francisco hospitals overlaps completely with the combined service area of Summit and Alta
Bates indicates that patients located within the merging parties’ service area could practically
turn to San Francisco hospitals for acute inpatient services in the event of an anticompetitive
price increase.




b. Geography




Despite the existence of service area overlap with hospitals located in Contra Costa County, San
Francisco, and Fremont, Dr. Langenfeld opines that those hospitals do not serve as practical
alternatives to which patients could turn in the event of an anticompetitive price increase, due
to traffic congestion and the amount of time required to travel east through the Caldecott Tunnel
and west across the Bay Bridge to San Francisco. Courts have recognized that geographic
proximity and travel times are important factors to consider in determining the practical
alternatives available to patients in the event of an anticompetitive price increase. See Freeman
Hosp., 911 F.Supp. at 1220 (recognizing importance of distance between hospitals in
determining scope of relevant geographic market).




In support of its position that geographic barriers constrain the ability of patients residing within
the proposed market to practically turn to hospitals located in San Francisco and Contra Costa
County, plaintiff offered a survey of travel times required to reach various hospitals located in
San Francisco and in Contra Costa County. For example, plaintiff’s traffic engineer determined
that the average time required to travel from the intersection of Pleasant Valley Avenue and
Piedmont Avenue, located in the center of Oakland, to St. Francis Memorial Hospital (“St.
Francis”) in San Francisco, located in relatively close proximity to other San Francisco hospitals,
was approximately thirty-two minutes. The average time required to travel to John Muir in
Walnut Creek, and Mount Diablo in Concord, both located on the other side of the Caldecott
Tunnel, was twenty-five minutes. (PX1082, Langenfeld Report at 24-26, Ex. Ex.11.)




Plaintiff’s own study indicates, however, that in many instances, it took less time to travel to
hospitals outside the proposed geographic market from plaintiff’s chosen point of eparture, than
to hospitals within the proposed market. For example, during the morning rush hour or during
midday traffic, it took less time to travel to John Muir or Mount Diablo, both located through the
Caldecott Tunnel and outside of plaintiff’s proposed market, than it took to travel to St. Rose
Hospital in Hayward, located within the proposed market. (Hr’g Tr. at 412.) During the
afternoon rush hour, it took less time to travel to St. Francis in San Francisco or to San Ramon
Regional, John Muir and Mount Diablo, located outside of the proposed market in Contra Costa
County, than it did to travel to Doctors Hospital Pinole, located within the proposed market.
(PX1052, Pl. Travel Time Study at 1-3; Hr’g Tr. at 411:13-413:23.)




Further, plaintiff’s travel time calculations do not accurately represent the times that patients
within the proposed market would need to travel to hospitals outside the proposed market
because plaintiff assumes that every patient in the market lives in the center of Oakland, and
ignores those residents that live on the northern or southern ends of the proposed market. As Dr.
Langenfeld admitted at the hearing, for those patients, seeking acute inpatient services at
alternative hospitals outside the Inner East Bay may be as convenient as seeking such services
at Summit or Alta Bates. (Hr’g Tr. at 411.) This is particularly significant with regard to those
patients located in the southern end of the merging hospitals’ service area, where patients in
Hayward and Union City are actually located closer to Washington Township than to Summit
and Alta Bates. (Def.’s Ex. 900.)

Finally, a review of patient flow data, including the destination of patients who leave the
merging parties’ service area, indicates that large numbers of patients travel across the Bay
bridge to hospitals in San Francisco and through the Caldecott Tunnel to hospitals located in
Contra Costa County despite the alleged geographic barriers. Data available for the combined
service area of Alta Bates, Summit and Eden, an area similar to that of plaintiff’s proposed
market, reflects that in 1996, over 8,500 patients traveled across the Bay Bridge to seek acute
inpatient services at hospitals located in San Francisco, and approximately 7,200 patients
traveled through the Caldecott tunnel to seek acute inpatient services at hospitals located in
Contra Costa County. (Def.’s Ex. 260 “Environmental Trends and Factors”, Deloitte & Touche
Consulting Report.) Further, as shown by plaintiff’s own E-H test results, 15% of the patients
residing in the proposed market, or 11,000 patients, sought acute inpatient services at hospitals
outside of the market, despite the time involved in crossing the Bay Bridge or traveling though
the Caldecott tunnel. This data indicates that, currently, more than one out of every seven
patients who reside in the proposed market chose to seek care at a hospital located outside of the
proposed market, even in the absence of anticompetitive pricing.




Accordingly, the Court finds that the Bay Bridge and the Caldecott Tunnel do not serve to
constrain patient mobility in the East Bay to such an extent that patients who currently reside in
the proposed market would not travel to hospitals located in San Francisco or Contra Costa
County for acute inpatient services if faced with an anticompetitive price increase.




c. Market participant perceptions




A final factor considered by Dr. Langenfeld consists of the perceptions of market participants
as to their competitors. If hospitals located within the test market perceive a hospital located
outside of the test market to be a significant competitor, the implication is that the hospital
located outside of the test market may in fact constitute a practical alternative to which patients
could turn if faced with an anticompetitive price increase. Conversely, if participants within the
proposed market do not perceive a hospital located outside the proposed market to be a
competitor, one may infer that such hospital is not a practical alternative. Although courts have
considered this factor to be relevant in determining a geographic market, the perception of
market participants is afforded considerably less weight than quantitative data addressing the
practical alternatives available to patients. See Freeman Hosp., 69 F.3d at 270 (discounting
persuasiveness of market participant perceptions in determining geographic market).




In support of its argument that market participants view the main competitors of Summit and
Alta Bates to be hospitals located within plaintiff’s proposed market, plaintiff relies primarily
on an Official Statement released by Summit in 1996 in connection with its Revenue Bond
offering. In that statement Summit identified its primary competitors, making no reference to
hospitals located outside plaintiff’s proposed geographic market. (PX46, at A-9, A-11; Hr’g Tr.
at 271:12-275:9.)




Defendants argue that this document never purported to be an exhaustive review of Summit’s
relevant market, and, in turn, produce documents that defendants argue are more probative in
that they reflect Summit’s perception that its prices are constrained by hospitals outside
plaintiff’s proposed market. For example, in a Summit presentation to the California Medical
Assistance Commission, Summit compared Summit’s rates to those of hospitals located outside
the Inner East Bay, including Washington Township, John Muir, and Mount Diablo, all of which
plaintiff excludes from its proposed geographic market. (Def.’s Ex. 383, Presentation from
Summit to Calif. Med. Assistance Comm’n (Aug. 25, 1998) at SUM008002790.)




Upon review of the various documents produced by both plaintiff and defendants from hospital
administrators in the East Bay, the Court discerns no common or prevailing perception by market
participants regarding the scope of Summit and Alta Bates’ competition. In light of statistical
data showing defendants’ patient draw area overlaps significantly with that of hospitals located
in Contra Costa County, San Francisco, and Fremont, the Court determines that observations of
these market participants are insufficient to support a finding that any of the hospitals with which
Summit and Alta Bates currently compete for patients should be excluded as practical
alternatives to which patients could turn if faced with an anticompetitive price increase. See
Freeman Hosp., 69 F.3d at 270 (holding that in the absence of economic or statistical data
indicating geographic market, district court was justified in refusing to credit market participant
testimony).




d. Critical loss test




The final method by which plaintiff attempts to prove its proposed geographic market is through
the application of what is known as a “critical loss test.” The critical loss test is a quantitative
analysis of patient flow data and is based on the Merger Guidelines, which define a geographic
market “to be a region such that a hypothetical monopolist . . . could profitably impose at least
a ‘small by significant and nontransitory’ increase in price [“SNIP”]. . . .” Merger Guidelines at
? 1.21. The critical loss test addresses the question of whether the geographic market has been
properly defined by analyzing the number of patients that must leave the market, if faced with
an anticompetitive price increase, before

a hypothetical monopolist would abandon its attempts to impose a SNIP. See Tenet, 186 F.3d
at 1053 (emphasizing importance of the critical loss test in defining geographic market); Coastal
Fuels of Puerto Rico, Inc. v. Caribbean Petroleum Corp., 79 F.3d 182, 198 (1st Cir. 1996) (“The
touchstone of market definition is whether a hypothetical monopolist could raise prices”).




A hypothetical monopolist is a theoretical firm that encompasses all of the production capacity
for the relevant product in a proposed geographic market, or alternatively, all firms in the
relevant market acting in concert. See Rebel Oil Co, Inc. v. Atlantic Richfield Co., 51 F.3d 1421,
1434 (9th Cir. 1995) (“A ‘market’ is any grouping of sales whose sellers, if unified by a
monopolist or a hypothetical cartel, would have market power in dealing with any group of
buyers.”) (citing to Areeda ? 518.1b at 534.). If all firms within the proposed geographic market
could, together, profitably impose an anticompetitive price increase in the market, this would
mean that customers within the market would be forced to accept the price increase because they
would not have sufficient practical alternative hospitals outside of the market to which to turn.6




The critical loss test involves two steps: (1) determining the critical loss number of patients who
would have to leave the proposed market in order to defeat a SNIP by a hypothetical monopolist,
and (2) determining whether that critical loss number of patients would actually leave the
market if faced with a SNIP. If fewer patients than the critical loss number would leave the
proposed market, this implies that all practical alternatives have been included in the proposed
market.




(1) Critical loss




In applying the critical loss test, the Court must first determine the number of patients necessary
to defeat a SNIP imposed by a hypothetical monopolist. When hospitals in a market charge a
higher price for services, they increase their profits per patient, but also lose revenue as patients
shift to other hospitals. If enough patients leave the market, the price increase will cease to be
profitable, and presumably will be abandoned. The first step in determining the critical loss
figure is calculating the contribution margin of the hypothetical monopolist. The contribution
margin represents the difference between the revenue obtained in treating an additional patient
and the cost incurred in treating that patient. Expressed as a percentage, it is revenue less variable
costs divided by revenue. Utilizing this contribution margin, one can determine the number of
patients who would need to leave the hospital before a price increase would cease to be
profitable. (PX1082, Langenfeld Report at 35.)




In applying this formula, Dr. Langenfeld performed calculations using both a 5% and a 10%
price increase, or SNIP. In arriving at his opinions, however, he relied upon a SNIP of 10%. The
Merger Guidelines specify that “[i]n attempting to determine objectively the effect of a ‘small
by significant and nontransitory’ increase in price, the Agency, in most contexts, will use a price
increase of five percent lasting for the foreseeable future.” Merger Guidelines, at ?1.1 (emphasis
added). Although the Merger Guidelines also state that the value of a SNIP may be larger or
smaller than five percent depending on the nature of the industry, Dr. Langenfeld failed to
provide, either in his report or at the hearing, any basis for deviating from the prescribed 5%
figure. Moreover, leading commentators have adopted the 5% figure as the appropriate value of
a SNIP. See Areeda, ? 527b at 200-201 (“[T]he government’s 5 percent test seems more
appropriate than, say, a 10 percent test . . . . [W]e emphasize that the 5 percent test of
significance will govern the great preponderance of cases.”). See also Mercy Health, 902 F.Supp.
at 980 (applying 5% critical loss test).




Accordingly, based on the lack of any proffered basis for deviating from the 5% SNIP as
prescribed by the Merger Guidelines and other authority, the Court finds a price increase of 5%
to be the appropriate value for a SNIP in the present case. Based on a 5% price increase, Dr.
Langenfeld calculated that if 5,133 – 13,187 patients, representing 4% -10.5%7 of all patients
currently seeking acute inpatient services at hospitals in the proposed Inner East Bay market, left
to seek acute inpatient services at hospitals outside that market, such price increase would be
rendered unprofitable.




(2) Diversion analysis




In the second step of the critical loss test, plaintiff must show that the critical loss number of
patients, between 4% and 10.5% of the patients that currently seek acute inpatient services at
hospitals located within the proposed market, would not seek such care at hospitals located
outside the proposed market if faced with a 5% price increase. See Mercy Health, 902 F.Supp.
at 981 (holding plaintiff failed to prove a geographic market because of its failure to prove, inter
alia, that enough people would leave the market to pass the critical loss test.).




Particularly important in analyzing the extent to which patients will seek acute inpatient services
at hospitals outside of the proposed market if faced with an anticompetitive price increase is the
market behavior of MCOs and IPAs. Because MCOs cover nearly 60% of the patient population
in the East Bay, these organizations are to a large extent, the true consumer of acute inpatient
services. See Fed. Trade Comm’n v. University Health, Inc., 938 F.2d 1206, 1213 n.13 (11th Cir.
1991) (holding true customers of acute inpatient services were third party payers).




When faced with price increases, there are numerous mechanisms through which health plans
can discipline hospitals. (Defs.’ Ex. 1021; Defs.’ Ex. 1012, Decl. of Jay M. Gellert at 14-15;
Hr’g Tr. at 716:18-718:17.) The simplest, but rarely used, is to exclude hospitals from the plans’
provider networks. (Defs.’ Ex. 1026, Dep. of John Sweeney at 17-21.) The primary mechanism
by which MCOs and IPAs keep prices low is through the “steering” of patients. In managing
their patients’ illnesses, physicians are often responsible for deciding the components to be used
in providing treatment, including the hospitals to which their patients are admitted. In steering,
MCOs or IPAs provide incentives to or direct physicians to refer their patients to certain
hospitals. Such incentives may include direct financial incentives as well as more general risk-sharing arrangements that reward physicians for providing care in the most cost-effective
environment. When faced with rising prices, MCOs can attempt to steer patients to lower cost
health care providers and away from the hospital imposing a price increase, thereby pressuring
the hospital to eliminate the price increase. (Defs.’ Ex. 1013, Pugh Report ? 57.) As one witness
who has been on both sides of the table explained, “there is a discipline going both ways”
because “we need them, but simultaneously they need us.” (Defs.’ Ex. 1012, Gellert Decl. at 18,
40.)




Hospitals, in general, have high fixed costs, both in terms of the physical plant and equipment
as well as the high cost of maintaining a highly skilled staff. At the same time, their profit
margins are thin. (Hr’g Tr. at 508:3-12; 706:21 – 707:17; Defs.’ Ex. 1013, Pugh Report ? 59;
Defs.’ Ex. 1001, Guerin-Calvert Report ? 63.) Steering has been quite effective in disciplining
prices because hospitals are sensitive to declines in volume. (Defs.’ Ex. 1001, Guerin-Calvert
Report ?? 63-64; Defs.’ Ex. 1013, Pugh Report ?? 59-61; Defs.’ Ex. 1012, Gellert Decl. at 14.)
This is especially true of high-value specialty services such as cardiac care, neurosurgery, and
oncology, due to the large capital commitments required for such programs and their higher
profit margins. (Defs.’ Ex. 1013, Pugh Report ? 59; Defs.’ Ex. 1012, Gellert Decl. at 15.)




Despite the proven ability of MCOs and IPAs to steer patients to lower cost hospitals, however,
plaintiff argues that patients currently seeking acute inpatient servicesat hospitals located within
its proposed market would not leave the market, if faced with a 5% price increase, because: (1)
physicians can only admit patients to hospitals at which they have admitting privileges and few
doctors that practice within the proposed market have admitting privileges at hospitals outside
of the market; (2) patients are reluctant to leave their physicians to travel to new hospitals
because of physician loyalty; (PX12, Sankary Decl. ? 15; PX13, McDermott Decl. ? 8; PX14,
Declaration of Dr. Peter Candell (Co-Medical Director, Alameda – Affinity Medical Group) at
8; Hr’g. Tr. at 135:11-24.), and (3) patients are unwilling to travel to hospitals located across the
Bay Bridge and through the Caldecott Tunnel. (PX5, Declaration of Arthur Kummer (VP,
Prudential), ? 12; PX8, Hobbs Decl. ? 9; PX29, FTC Tr. of Mark Hyde (CEO, Lifeguard), June
16, 1999, at 67:25-68:20.)




In support of this assertion, plaintiff relies almost exclusively on the testimony of Bay Area
health plan administrators.8 In countering plaintiff’s evidence, defendants first show that many
physicians with privileges at hospitals within the Inner East Bay already have admitting
privileges at other East Bay hospitals. (Hr’g Tr. at 559:2-6; Def.’s Ex. 980, Sloan Dep. at 63;
Def.’s Ex. 1016, Lovett Decl. ? 2.) For example, 59 physicians, who collectively admitted 2,372
cases to Alta Bates in 1998, also had privileges at John Muir, and 43 physicians who admitted
2,053 cases to Summit, also had privileges at John Muir. (Def.’s Ex. 10, Sutter Presentation to
FTC and AG, Tabs A and B.)




Further, the evidence shows that physicians who do not currently have admitting privileges at
other hospitals can easily obtain admitting privileges; hospitals are receptive to credentialing
qualified specialists at their facilities because such physicians bring in patient volume. Although
the time required to gain admitting privileges varies from hospital to hospital and may, in some
cases, take as long as three to four months, other hospitals grant admitting privileges much more
quickly. Moreover, as the Director of Cardiac Surgery at Alta Bates testified, those hospitals that
take relatively more time to grant admitting privileges still grant courtesy privileges pending the
processing of permanent privilege applications. (Hr’g Tr. at 510:11-17; 573:6-574:16, 511:3.)




Next, physician loyalty does not necessarily constrain patient mobility because many patients
do not have an established physician relationship and, more important, many of those patients
who have an established physician-patient relationship are admitted to hospitals by a specialist,
rather than the patient’s family practitioner. (Defs’ Ex. 989, McDermott Dep. at 64-66, 117-18.)
Moreover, patient loyalty has its limitations. For example, in the experience of the CEO of the
Alameda Alliance for Health (“AAH”), a local health plan with approximately 78,000 members,
operating in Alameda County and serving the Medi-Cal population, approximately 1,000 of its
members switch primary care physicians each month. (Defs’ Ex. 983, Ibarra Dep. at 24-25; Tr.
at 143:8-14; Tr. at 209:5-14; 210:2-6; 210:21-211:1; Def.’s Ex. 996, Sankary Dep. at 138.)




Finally, neither plaintiff’s witnesses nor plaintiff provide any quantitative evidence to support
the assumption that patients are unwilling to travel to hospitals located in San Francisco or
Contra Costa County for acute inpatient services. Indeed, many of plaintiff’s witnesses appear
to be testifying based on pure conjecture. As an example, albeit a rather extreme one, when asked
“[w]ould you be able to shift patients north, say, as far as Pinole?”, the CEO of one health care
plan operating in the Bay Area responded, “I don’t even know where Pinole is, but I doubt it.”
(PX29 at 67:25-68:20.) As stated by the court in Freeman Hosp., “[w]hile such non-empirical
data may have some probative value as a starting point to evaluate this market, such data will not
carry the [plaintiff’s] burden. Informal, off-the-cuff remarks and anecdotal evidence concerning
the marketplace are no substitute for solid economic evidence.” Freeman Hosp., 911 F.Supp. at
1220.




Here, in concluding that patients would not leave the proposed market due to the existence of
geographic barriers and travel times, plaintiff’s witnesses ignore patient flow data that shows that
none of the factors upon which plaintiff relies in fact significantly constrain patients from
seeking acute inpatient services at hospitals outside of plaintiff’s proposed market. Based on
plaintiff’s own E-H test results, currently 11,000 patients, or one out of every seven patients
residing in the Inner East Bay, already leave the Inner East Bay for acute inpatient services even
in the absence of a 5% price increase and steering by MCOs and IPAs. (Hr’g Tr. 689; Def.’s Ex.
1001, Guerin-Calvert Report ? 44; Hr’g Tr. 703:14-704:7; 503:20-504:2.) Further, based on
1996 patient discharge data for the combined service area of Alta Bates, Summit and Eden, an
area similar to that of the plaintiff’s proposed market, defendants show that over 8,500 patients
traveled across the Bay Bridge to seek acute inpatient services at hospitals located in San
Francisco, and approximately 7,200 patients traveled across the Caldecott tunnel to seek acute
inpatient services at hospitals located in Contra Costa County. (Def.’s Ex. 260.)




Moreover, based on plaintiff’s own figures, 18,000 patients, approximately one out of every
seven patients that were discharged from hospitals located within plaintiff’s proposed geographic
market, actually live outside of the proposed geographic market and travel across the purported
geographic barriers to seek acute inpatient services at hospitals located within plaintiff’s
proposed market. (PX1082, Langenfeld Report at 31-34; Hr’g Tr. 689:5-10; Def.’s Ex. 1001;
Guerin-Calvert Report ?? 43, 48-50.) Thus, even accepting a critical loss figure of 10.5% (the
upper end of plaintiff’s critical loss range using a 5% price increase), if MCOs and IPAs were
able to steer only about two-thirds of the patients that currently travel into the proposed market
to hospitals that are actually located closer to those patients outside of the proposed market, this
loss of volume in and of itself would be sufficient to defeat a SNIP. (Hr’g Tr. 401:23-402:8.)
Such would be the case even if one were to assume that not a single patient that currently resides
within the proposed market would seek acute inpatient services outside of the market when faced
with a 5% price increase.




Accordingly, the Court finds that plaintiff has failed to show that enough patients that currently
seek acute inpatient services at hospitals located within plaintiff’s proposed Inner East Bay
market would not seek such services at hospitals outside of the market to defeat an
anticompetitive price increase. Plaintiff relies on testimonial evidence which in turn relies on
various assumptions concerning patient mobility. These assumptions are inconsistent with the
facts as shown by the patient flow data and ignore the fact that, based on plaintiff’s own figures,
a combined total of almost thirty thousand patients either enter or leave plaintiff’s proposed
market to seek acute inpatient services every year even in the absence of an anticompetitive price
increase or steering by MCOs and IPAs. See Tenet, 186 F.3d at 1054 (criticizing “the district
court’s reliance on the testimony of managed care payers, in the face of contrary evidence, that
these for-profit entities would unhesitatingly accept a price increase rather than steer their
subscribers to hospitals [outside the proposed market].”); Mercy Health, 902 F.Supp. 977
(rejecting, primarily because of defendant’s strong patient flow data, plaintiff’s market definition
based on views of MCOs and physicians).




As defendants’ counsel commented during his opening statement at the hearing, “[i]f you believe
the plaintiff’s market, you would believe that Conestoga wagons are still being used today, that
no one ever goes over the hills because the hills are too high and you have to build a boat to take
you across the Bay.” (Hr’g Tr. at 36:6-9.).




4. Geographic Market Summary




For the reasons set forth above, the Court finds plaintiff has failed to meet its burden of proving
a well-defined geographic market encompassing the practical alternative sources of acute
inpatient services to which patients can turn if faced with an anticompetitive price increase. See
Connecticut Nat’l Bank, 418 U.S. at 669 (holding that plaintiff bears the burden of proving
geographic market).




“Identification of a relevant market is a ‘necessary predicate’ to a successful challenge under the
Clayton Act and thus to establishing a likelihood of ultimate success for preliminary injunction
purposes.” Freeman Hosp., 69 F.3d at 272. Accordingly, the Court finds that plaintiff has failed
to prove its prima facie case that the proposed merger between Alta Bates and Summit would
substantially lessen competition in the acute inpatient services product market. See Id. at 268
(“Without a well-defined relevant market, an examination of a transaction’s competitive effects
is without context or meaning.”). For this reason, plaintiff cannot prevail on its motion for
preliminary injunction.




C. “Failing Company” Defense




Even if plaintiff had made the requisite showing as to plaintiff’s case, plaintiff would not prevail
on its motion for preliminary injunction, for the separate and independent reason that defendants
have successfully established their “failing company” defense.




In International Shoe Co. v. Fed. Trade Comm’n, 280 U.S. 291 (1930), the Supreme Court first
recognized the failing company defense as an absolute defense to an action under Section 7 of
the Clayton Act. The rationale behind the failing company defense, as explained by the Supreme
Court in United States v. General Dynamics Corp., 415 U.S. 486, 507 (1974), is that “the effect
on competition and the loss to the company’s stockholders and injury to the communities where
its plants were operated will be less if a company continues to exist even as a party to a merger
than if it disappears entirely from the market. It is, in a sense, a ‘lesser of two evils’ approach .
. . .”




In Citizen Publishing Co. v. United States, 394 U.S. 131, 137 (1969), the Supreme Court held
that, in order to satisfy the requirements of the failing company defense, defendants must show
that the resources of the acquired company are “so depleted and the prospect of rehabilitation
so remote” that it faces “the grave probability of business failure,” and that “the company that
acquires the failing company . . . is the only available purchaser.” Id. at 138. See Olin Corp. v.
Fed. Trade Comm’n, 986 F.2d 1295, 1306-7 (9th Cir. 1993) (applying Citizen failing company
test).




1. Financial Condition




The most important factor that courts have considered in determining whether a firm faces the
“grave possibility of business failure” is whether the firm is insolvent or on the brink of
insolvency either in the bankruptcy sense, that the firm has no net worth, or in the equity sense,
that the firm is unable to meet its debts as they come due. See International Shoe, 280 U.S. at 300
(finding failing company defense appropriate where the acquired business could not pay its debts
as they came due); Crown Zellerbach Corp. v. FTC, 296 F.2d 800, 831-32 (9th Cir. 1961), cert.
denied, 370 U.S. 937 (1962) (holding that firm was not in a failing condition were it had a
positive net worth); United States v. M.P.M., Inc., 397, F.Supp. 78, 100 (D.Co. 1975) (finding
firm passed first prong of failing company defense where defendant was insolvent in the equity
sense).




Defendants first argue that Summit meets the equity definition of insolvency, based on the fact
that it has been unable to meet its trade debt, and its inability to assume more debt to meet its
financial obligations as they come due. In United States v. Black & Decker Mfg. Co., 430 F.
Supp. 729, 778-81 (D. Md. 1976), the court relied upon several factors in holding that the
defendants had satisfied the first prong of the failing company defense: (1) the defendant firm’s
accounts payable had increased $5 million in almost two years to $10.8 million; (2) vendors had
imposed “a variety of sanctions . . . including stopping of shipments pending payment,” and (3)
the defendant firm was unable to comply with covenants in its loan agreements concerning debt
ratios and therefore had slight prospects for raising additional capital to meet its financial
obligations.




Similarly, in the present case, Summit, as of September 30, 1999, had $8.9 million in overdue
bills and has been subjected to sanctions by its suppliers such as “cash-on-delivery” terms.
(Def.’s Ex. 809, Meinke Decl. ? ? 17, 22.) Further, defendants have shown that Summit is unable
to comply with the minimum 1.35 debt service ratio requirement of its Revenue Bonds, and
therefore cannot assume more debt to meet its mounting financial obligations. (Def.’s Ex. 809,
Meinke Decl. ? 31; Hr’g Tr. at 777:1-7.)




Plaintiff argues that Summit has let its accounts receivable, a possible source of available cash,
grow too large. Plaintiff’s financial expert, Jamie Hopping, testified that if the Hospital had
collected on its accounts in a more timely manner, it would have more cash with which to pay
its bills. (Hr’g Tr. at 801:5-17.) This increase in accounts receivable, however, is not unique to
Summit, but is being experienced by hospitals nationwide. (Hr’g Tr. at 609:24-611:3.) Moreover,
the issue in this case is not whether the Hospital could have done a better job in managing its
finances in the past but, rather, whether it faces the grave risk of business failure today.




Plaintiff further argues that the Hospital has understated its available funds because assets of the
Foundation could be used to fund capital projects at the Hospital. The account balance of the
Foundation as of July 31, 1999 was $20.9 million. (PX 1090 at SUM 05000006.) As noted
earlier, however, the Hospital and the Foundation are separate legal entities. The failing company
defense does not require that a company deplete the assets of affiliated companies to meet the
requirement that it faces “the grave possibility of business failure.” Courts and the Merger
Guidelines have applied the failing company defense to failing divisions or subsidiaries of
companies that were otherwise profitable. See FTC v. Great Lakes Chem. Corp., 528 F. Supp.
84, 96 (N.D. Ill. 1981) (“The ‘failing company’ defense applies to a failing business . . . whether
or not it is a division of a larger corporation which is successful in other areas.”); United States
v. Lever Bros. Co., 216 F. Supp. 887, 898-901 (S.D.N.Y. 1963) (allowing sale of failing product
line despite other profitable product lines); Merger Guidelines, at ? 5.2 (acknowledging failing
division defense). Further, in this instance, virtually all of the Foundation’s funds are restricted,
in that the donors have specified the uses to which the money can be put. (Hr’g Tr. at 612:7-613:76; 780:25-783:9.)




The Court finds that the assets of the Foundation should not be considered in assessing the
Hospital’s financial condition. Accordingly, based on evidence that the Hospital has insufficient
funds to meet its debt payments as they mature, the Court finds that Summit is insolvent under
the equity definition of insolvency.




Next, defendants argue that Summit also meets the bankruptcy definition of insolvency because
the fair market value of its assets is less than the value of its liabilities. (Hr’g Tr. at 759:12-13.)
As of August 1999, the Hospital’s balance sheet reflected long term debt obligations and current
liabilities totaling $138.6 million, and assets of $191.3 million. (Def.’s Ex. 772 at SUM 050
02022; Hr’g Tr. at 770:23-771:4.) $104 million of the Hospital’s assets, however, represents the
book value of the Hospital’s property, plant and equipment, the fair market value of which is
significantly below its book value. This difference is due in large part to required seismic
upgrades, estimated to cost approximately $109.7 million, which is more than the book value of
the Hospital’s property, plant and equipment combined. (Def.’s Ex. 809, Meinke Decl. ? ? 34-35.) Based on these facts and the existence of various restrictions that limit the availability of up
to $24 million of the Hospital’s remaining assets, defendants’ financial expert, Robert Den Uyl,
concluded that the fair market value of the Hospital’s assets is significantly lower than the value
of its liabilities. (Hr’g Tr. at 759:18-20.)




In response, plaintiff’s financial expert testified that because Tenet had submitted a bid that
would have allowed Summit to satisfy all of its liabilities, the fair market value of Summit’s
assets necessarily exceeds the fair market value of its liabilities. (Hr’g Tr. at 819:10-18.) This
conclusion is based on an assumption that Tenet would make the same offer for Summit today
that Tenet made in March 1998, over eighteen months ago. There is no evidence, however,
indicating that Tenet would make a similar offer today, particularly in light of Summit’s
continued financial deterioration, or indeed, that Tenet would make any type of offer to purchase
Summit. Accordingly, the Court finds Summit also meets the bankruptcy definition of insolvency
as the fair market value of its liabilities exceeds the fair market value of its assets.




Finally, independent sources verify the grave nature of Summit’s financial situation. Summit’s
outside auditor, Ernst & Young, has refused to issue an “unqualified” or “clean” opinion that
Summit is a going concern and has demanded that Summit provide cash flow projections that
show it will be viable through February 2001. An independent auditor’s refusal to issue a clean
opinion is evidence of a company’s failing condition. See Black & Decker, 430 F.Supp. at 781
(noting “the company’s financial position was such that but for the merger, [defendant’s]
independent auditors would not have valued the company as a going concern”).




Further, should Summit not receive an “unqualified” opinion from its auditors, it will be in
default under its Revenue Bonds. (Def.’s Ex. 809, Meinke Decl. at ? 33; Hr’g Tr. at
604:23-605:8.) If Summit defaults on its bond obligations, the insurer can force Summit to close
parts of the Hospital or cease providing services. (Hr’g Tr. at 605:1-8.) The Chair of Summit’s
Audit and Finance Committee testified that Summit has been unable to provide the requested
cash flow projections to date, and is contemplating large (9%) and imminent cuts in the
Hospital’s workforce as well as a severe reduction in services. (Hr’g Tr. at 603:1-11.) He also
testified that in the absence of the proposed merger, the Hospital would be required to file a
petition in bankruptcy. (Hr’g Tr. at 620:5-8.)




The Court finds defendants have shown that Summit faces a “grave risk of business failure” and,
accordingly, that defendants have thereby satisfied the first prong of the failing company
defense.




2. Bankruptcy Reorganization




Plaintiff argues that in order to make the requisite showing that it faces a “grave risk of business
failure”, a defendant must show that the prospects of reorganization in bankruptcy proceedings
are dim or nonexistent. There is disagreement among the courts as to whether this element is an
actual requirement of the failing company defense. See Citizen, 89 U.S. at 138 (noting many
companies successfully reorganize in bankruptcy and requiring defendant to show prospects of
reorganization to be dim or nonexistent); United States Steel Corp. v. F.T.C., 426 F.2d 592, 608
(holding Citizen requires showing that prospects of Chapter 11 reorganization must be dim or
nonexistent) (6 th Cir. 1970); United States v. Phillips Petroleum Co., 367 F.Supp. 1226, 1259
(C.D. Cal. 1973) (acknowledging reorganization in bankruptcy requirement); Merger Guidelines
at ? 5.1. But see General Dynamics, 415 U.S. at 507 (omitting bankruptcy reorganization
requirement when setting forth failing company defense in dictum); Black & Decker, 430 F.
Supp. at 778 (“The weight of authority suggests that dim prospects for bankruptcy reorganization
are not essential to successful assertion of the failing company defense.”); M.P.M., 397 F. Supp.
at 96 (“We conclude that a [ ] defendant need not be required to show that reorganization
prospects under the bankruptcy act were dim or nonexistent in order to discharge its burden of
proof as to the ‘failing company’ defense.”). See also Richard Posner, Antitrust Law: An
Economic Perspective at 21 (1976) (criticizing requirement because the purpose of the defense
is “precisely to avert bankruptcy.”).




In the present case, defendants’ financial expert testified that the likely outcome of Chapter 11
proceedings would not be successful reorganization but rather liquidation, in that the causes of
Summit’s financial situation are systemic and will only increase the strain on its resources over
time. (Hr’g Tr. at 786:10-15.)




As noted in Section I. C. above, Summit has suffered from a large decline in revenues due to
reduced Medicare payments to hospitals under the Balanced Budget Act of 1997 and the fact that
more than 50% of Summit’s revenue comes from Medicare patients. These effects will only
increase over time as the reductions in reimbursement mandated by the act become fully
implemented. Indeed, as estimated by Ernst & Young, the Balanced Budget Act will reduce
Summit’s revenues by at least $52.8 million in Fiscal Years 1999-2002. (Trial Ex. 809, Meinke
Decl. ?? 19-20; Trial Ex. 810 Hansen Decl. ??16-17.) Moreover, as discussed earlier, Summit
faces large expenditures, estimated at $109 million, in order to comply with seismic upgrades
as required by the Alquist Act. This also has placed a large financial burden on Summit that will
increase over time as the first deadline for meeting the upgrade requirements approaches.




Accordingly, if Summit is required to show that its prospects for reorganization under Chapter
11 are dim or nonexistent, Summit has successfully made such a showing.




2. Alternative Purchasers




The second prong of the “failing company” defense requires that the defendant prove the
acquiring firm was the “only available purchaser”. See Citizen, 394 U.S. at 138; Golden Grain
Macaroni Co. v. Fed. Trade Comm’n, 472 F.2d 882, 887 (9th Cir. 1972) (holding that defendant
must be the “only available purchaser”);




In order to prove that no alternative purchaser exists, courts and the Merger Guidelines have
required the acquired company to conduct a good faith effort to seek offers from other potential
purchasers. See United States v. Diebold, Inc., 369 U.S. 654, 655 (1962) (reversing summary
judgment where material questions of fact existed as to whether defendant “was the only bona
fide prospective purchaser for [the acquired firm’s] business”); United States v. Pabst Brewing
Co., 296 F.Supp. 994, 1002 (E.D. Wis. 1969) (holding defendant must make “a sufficiently clear
showing” that it “undertook a well conceived and thorough canvass of the industry such as to
ferret out viable alternative partners for a merger.”); Merger Guidelines, ? 5.1.




In the present case, Summit did conduct an extensive good faith search for purchasers beginning
in 1995 and continuing through to 1998, during which period Summit and its investment banker,
Morgan Stanley, formulated a detailed and thorough proposal process and sought out numerous
potential partners. (Def.’s Ex. 811, Decl. Landers ?? 4-6.) As a result of this search, Summit
received bona fide offers from Sutter and Tenet, and in March, 1998, decided to accept the offer
from Sutter.




Plaintiff argues that Tenet should be considered a reasonable alternative purchaser because of
its March 1998 offer. Plaintiff does not contend there is any viable alternative to Sutter other
than Tenet. Tenet’s March 1998 offer, however, was made over eighteen months ago when
Summit was in substantially better financial condition than it is today, and before Summit
became a failing company. As Tenet’s Vice President of Acquisition and Development testified,
any possible offer that Tenet might make in the future would have to be based on an entirely new
investigation of Summit’s financial condition, including an analysis of “the reasons for [the
Hospital’s] operating deterioration since we started to talk to them.” (Hr’g Tr. at 174:2-8.)




Further, since March 1998, Summit representatives have repeatedly contacted Tenet, to
determine whether Tenet remained interested in acquiring Summit. Tenet failed to make any
offer in response to these inquiries, and stated that “[w]e’d take a look at it, but at this point we
are not in a position to make an offer . . . .” (Hr’g Tr. at 173:16-18.) Tenet’s vague expression
of interest is not sufficient to elevate Tenet to the status of a viable alternative purchaser. In
United States v. Culbro Corp., 504 F. Supp. 661 (S.D.N.Y. 1981), evidence that a firm had “a
very high level of interest in the possible acquisition” of the defendant was found insufficient to
establish that firm as an alternative purchaser, where its interest had “never been translated into
a viable offer.” 504 F. Supp. at 669. There, as here, the acquired firm’s availability f or purchase
has been well-known throughout the industry and in investment circles. See Id. Tenet, like the
putative alternative buyer in Culbro, has offered no more than generalized expressions of
interest; it has made no concrete proposal. As in Culbro, the likelihood of a purchaser other than
Sutter “is a mere will-o’-the-wisp.” Id.




Accordingly, due to the fact that Tenet, the only possible alternative purchaser of Summit, has
failed to make an offer to purchase Summit even in response to Summit’s attempts at soliciting
an offer, the Court finds that no reasonable alternative purchaser of Summit exists, and thus that
defendants have satisfied the second prong of the failing company defense. In sum, Summit
faces the grave risk of business failure, and given the lack of any alternative purchaser, if the
present merger is enjoined, Summit will be unable to continue as a going concern. The Court
therefore finds that defendants have made the showing required to establish their failing
company defense.




CONCLUSION




For the reasons set forth above, the Court finds that plaintiff is not entitled to a preliminary
injunction as it has failed to prove “either (1) a combination of probable success on the merits
and the possibility of irreparable injury or (2) that serious questions are raised and the balance
of hardships tips sharply in its favor.” Odessa Union, 833 F.2d at 174.




Specifically, plaintiff has failed to show probable success on the merits in that it has failed to
prove a well-defined geographic market and thereby has failed to prove its prima facie case of
anticompetitive effect. Further, defendants have successfully established their failing company
defense. The Court also finds that the balance of hardships tips sharply in favor of defendants
in this case. Allowing Summit and Alta Bates to merge will assure that Summit can continue to
serve its community, while enjoining the proposed merger will have the effect of causing the
third largest hospital in the East Bay to cease to exist.




In Tenet, under similar circumstances, the Eighth Circuit counseled: “[A] court ought to exercise
extreme caution because judicial intervention in a competitive situation can itself upset the
balance of market force, bringing about the very ills the antitrust laws were meant to prevent.’
This appears to have even more force in an industry, such as healthcare, experiencing significant
and profound changes.” Tenet, 186 F.3d at 1055 (citing Syufy Enter., 903 F.2d at 663). The
Court finds the Eighth Circuit’s observations to be particularly apt in the present case.




Plaintiff’s motion for preliminary injunction is hereby DENIED.




IT IS SO ORDERED.




Dated: MAXINE M. CHESNEY United States District Judge




FOOTNOTES:




FN1 Both plaintiff and defendants filed objections to the post-hearing proposed findings of fact
and conclusions of law submitted by the opposing parties in connection with the present motion.
To the extent that these objections concern matters addressed at the hearing conducted on
October 22, 1999, the Court relies on its earlier rulings. To the extent defendants object to
evidence in plaintiff’s post-hearing proposed findings of fact not included in plaintiff’s original
proposed findings of fact, the Court finds that such evidence was appropriately included in
plaintiff’s post-hearing papers. With regard to plaintiff’s hearsay objections, the Court sustains
to the extent the subject evidence is not derived from business records.




FN2 The services offered by hospitals are often grouped into three general categories. Primary
services include basic hospital services such as obstetrics, general medicine, and general surgery
involved in relatively simple procedures. Secondary services are more complex and require more
specialized equipment and personnel. Tertiary services involve the most complex and highly
specialized services such as heart bypass surgery and transplants.




FN3 Summit’s fiscal year ends on February 28 or 29. Thus, fiscal year 1996 encompasses March
1, 1995 through February 28, 1996.




FN4 For example, if all 100 patients that resided in a particular zip code went to Summit or Alta
Bates for acute inpatient services, that zip code would be included in Dr. Langenfeld’s service
area first because Summit and Alta Bates would have 100% of the market share of that zip code.
If, on the other hand, 100 patients sought acute inpatient services at Summit and Alta Bates from
a zip code that contained 200 patients, that zip code would be placed considerably further down
in Dr. Langenfeld’s ranking because Summit and Alta Bates would only have 50% of the market
share of that zip code.




FN5 Using the example outlined above, if two zip codes each contained 100 patients who
sought acute inpatient services from Summit and Alta Bates, both of those zip codes would be
included in Guerin-Calvert’s service area in the same order of preference regardless of the
number of patients residing in those zip codes that sought acute inpatient services elsewhere.
Similarly, if Summit and Alta Bates drew 100 patients from one zip code and 50 patients from
another, the former would be ranked higher than the latter, irrespective of the total patient
population of the respective zip codes.




FN6 Defendants’ expert calculated a critical loss figure based on an assumed SNIP imposed by
the merged Alta Bates/Summit entity as opposed to a hypothetical monopolist. (Def.’s Ex. 1001,
Guerin-Calvert Report ? 63-64.) Defendants’ critical loss analysis, although potentially relevant
on the issue of anticompetitive effects once a geographic market has been defined, is not relevant
in analyzing the scope of a proposed geographic market in the first instance.




FN7 The disparity between these figures stems from the fact that Dr. Langenfeld calculated
multiple critical loss figures using different sets of data and assuming different contribution
margins for: (1) only managed care patients and (2) all patients. (PX1082, Langenfeld Report,
Ex. 37.)




FN 8 It should be noted that plan administrators do not uniformly oppose the proposed merger.
For example, the president and CEO of Foundation Health Systems, the parent company of
Health Net, the second largest health plan in the East Bay, has testified that he believes the
possibility of a price increase due to the proposed merger is slight based on, inter alia, the ability
of MCOs to steer patients to lower cost facilities if faced with increased prices. (Def.’s Ex. 1012,
Decl. Gellert at 14-17)