Bylined Articles

Third Circuit's Reasoning on Hershey-PinnacleHealth Merger

By Seth A. Goldberg and Alison T. Rosenblum
October 13, 2016
The Legal Intelligencer

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Seth A. Goldberg
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Alison T. Rosenblum

In a closely watched case, the U.S. Court of Appeals for the Third Circuit recently moved to halt the proposed merger of Penn State Hershey Medical Center (“Hershey”) and PinnacleHealth System (“Pinnacle”) (collectively, the “Hospitals”).  Fed. Trade Comm’n v. Penn State Hershey Med. Ctr., No. 16-2365, slip op. (3d Cir. Sept. 27, 2016).  Since December 2015, when the Federal Trade Commission (“FTC”) and the Commonwealth of Pennsylvania (collectively, the “Government”) joined forces to formally oppose the merger in court, healthcare industry stakeholders have eagerly awaited developments in the case.  In May, the District Court for the Middle District of Pennsylvania issued a sharp rebuke of the FTC, denying its request for a preliminary injunction.  Fed. Trade Comm’n v. Penn State Hershey Med. Ctr., No. 1:15-cv-2362, 2016 WL 2622372 (M.D. Pa. May 9, 2016).  The tides turned on September 27, 2016 however, when the Third Circuit reversed the decision and ordered the lower court to preliminarily enjoin the proposed merger pending completion of the FTC’s administrative review of the merger. 

Within two weeks of the Third Circuit’s decision, the hospitals announced on Oct. 14, that they had decided to end their plans to merge. Although the hospitals’ decision effectively ends the judicial and administrative reviews of the merger, the Third Circuit’s decision to overturn the District Court’s May decision and stay the merger provides important insight into the appellate court’s approach to antitrust analysis in the health care arena.

This article details the court’s reasoning.

The Third Circuit's Decision

The Third Circuit sided with the FTC in finding that the proposed merger was likely to have anti-competitive effects in violation of Section 7 of the Clayton Act, 15 U.S.C. Section 18. That section prohibits mergers whose impact "may be substantially to lessen competition, or to tend to create a monopoly." The court held that, although the district court had correctly identified the "hypothetical monopolist" test, i.e., whether a hypothetical monopolist could impose a small but significant nontransitory increase in price (SSNIP) in the proposed market, as the appropriate means of analyzing the geographic markets proposed by the parties, it had improperly formulated and applied the test.

While Third Circuit precedent suggests that a decision on market definition is often a factual question that is subject to the clearly erroneous standard of review, the Third Circuit determined that the application of the hypothetical monopolist test invokes a legal standard, the application of which is subject to plenary review. Thus, the Third Circuit afforded to the government a favorable standard of review. Moreover, in contrast to the District Court, which approached the case with a somewhat holistic view that considered the merger in light of the realities of the ever-changing health care industry, the Third Circuit took a more formalistic approach focused on traditional antitrust jurisprudence and economics.

The court had rejected the government's proposed market of the four-county Harrisburg area. In reversing the district court's decision, the Third Circuit pointed to three specific errors the lower court made in its analysis.

First, the lower court had improperly focused on the number of patients entering the proposed market for hospital care in order to determine the bounds of the geographic market that should be used in considering the impact of the merger on the price of hospital services. The court pointed to the "silent majority fallacy," noting that "patient flow" is not an accurate test because patients often choose hospitals outside their immediate geographic area "based mostly on nonprice factors, such as location or quality of services."

Second, the Third Circuit ruled that the district court had improperly focused on the likely reaction of patients in the proposed market to the merger, without considering the likely reaction of insurers in the proposed market. It noted that, while patients are unlikely to respond to hospital price increases because they are relatively insulated from those increases, insurers directly bear the brunt of such increases. Moreover, it credited testimony in the record from insurers that they would be unable to offer a viable insurance product that did not include the hospitals within their network. As the court explained: "Patients are relevant to the analysis, especially to the extent that their behavior affects the relative bargaining positions of insurers and hospitals as they negotiate rates. But patients, in large part, do not feel the impact of price increases. Insurers do. And they are the ones who negotiate directly with the hospitals to determine both reimbursement rates and the hospitals that will be included in their networks.

Lastly, the Third Circuit found that the district court had improperly considered private agreements between the Hospitals and two of their largest payors to maintain steady reimbursement rates for five and 10 years, respectively. Such treatment of private agreements would essentially permit any merger to avoid antitrust scrutiny by using temporary private agreements to mask potential anti-competitive effects.

The district court and the parties agreed that the relevant product market was "general acute care services sold to commercial insurers." The Third Circuit held that the government had established its prima facie case in opposition to the merger by identifying a proper geographic market and showing that the merger would likely have an anti-competitive effect within that market. As to the first prong of the prima facie case, the court credited the government's argument that insurers would be forced to include the merged hospitals in their networks because the hospitals outside the Harrisburg area (but within a 65-minute drive) did not provide suitable alternatives to the hospitals in the proposed Hershey-Pinnacle network. As a result, the combined hospitals' increased bargaining power would enable the hospitals to impose significant price increases, which the insurers would be forced to accept. As to the second prong, the Third Circuit found that the merger would increase market concentration to a level that was presumptively anti-competitive.

Unlike the district court, the Third Circuit did not find persuasive the hospitals' arguments that increased efficiencies resulting from the merger would outweigh the merger's anti-competitive effects. In particular, it rejected the hospitals' claims that patients would see cost savings because Hershey would be able to forgo large capital expenditures that would otherwise be required for construction of a 100-bed tower and because the hospitals would be able to realize savings through a greater ability to engage in risk-based contracting. According to the court, the evidence of efficiencies was simply insufficient to overcome the presumption of anti-competitive effect.

Finally, the Third Circuit explained that consideration of a preliminary injunction involves "weighing the equities" to determine whether delaying the merger would harm the public more than allowing it to move forward. While the district court focused on the equities post-merger, the Third Circuit focused on "whether the injunction, not the merger, would be in the public interest." The court found that the public's interest in the effective enforcement of antitrust law far exceeded the harm that could result from a delay in the proposed merger. Moreover, because the record evidence demonstrated that the market's payors "could not successfully market a plan in the Harrisburg area without Hershey and Pinnacle," which the FTC argued would control 76 percent of the post-merger market, the likelihood payors would be forced to accept a SSNIP existed, thereby warranting the preliminary injunction. As the court noted, if the merger were allowed and were the FTC to be right about its effects, it would be "extraordinarily difficult to unscramble the egg." It found unpersuasive the hospitals' suggestion that they would have to forgo the merger altogether if it were enjoined, instead noting that if the merger moved forward but were later found to violate antitrust law, it would be nearly impossible to reverse.

Current Thinking on Hospital Mergers, Antitrust and The Affordable Care Act

Notably absent from the Third Circuit's analysis of the proposed merger was any mention of the Affordable Care Act, something which had been a particularly noteworthy aspect of the district court's decision. In contrast, the district court had discussed hospital consolidations in the context of coordination of care, noting, "We find it no small irony that the same federal government under which the FTC operates has created a climate that virtually compels institutions to seek alliances such as the hospitals intend here."

While the Affordable Care Act has resulted in market consolidation, including the repositioning of various hospitals and health systems in the Harrisburg area, the Third Circuit focused instead on how the merger might impact health care insurers, viewing their ability to negotiate pricing with the hospitals as having the greatest effect on pricing in the post-merger market.

As hospitals across the country continue to adjust to the mandates and goals of the Affordable Care Act, more mergers and acquisitions will undoubtedly draw federal antitrust scrutiny. The FTC's challenge to one such proposed merger, between Chicago-area hospitals Advocate Health Care Network and NorthShore University HealthSystem, is currently on appeal to the Seventh Circuit following the refusal of a district court judge to issue an injunction to halt the merger in Federal Trade Commission v. Advocate Health Care, No. 16-2492 (7th Cir., filed June 15). Despite the Third Circuit's recent decision on the Hershey-PinnacleHealth merger, this summer's district court losses for the FTC may indicate a potential shift in judicial approach to hospital merger antitrust cases. Health care and antitrust lawyers alike should continue to monitor how the courts will balance federal antitrust law with new health care initiatives. 

Reprinted with permission from The Legal Intelligencer, © ALM Media Properties LLC. All rights reserved.