STERIS: the limits of imagined competition

A strong factual defence undermines the FTC’s actual potential competition doctrine

Winning trial strategies ultimately rely on the factual record as developed in discovery, and how those facts are marshalled and presented in a compelling story at trial. That concept applies whether the case is a chronological series of events or a complex and multidimensional story, as is often the case in an antitrust trial. Our client STERIS Corporation’s successful defence of its acquisition of Synergy PLC in FTC v STERIS exemplifies the power of building and presenting a factual record calibrated to be more persuasive and more intuitive, and one that comports more closely with the incentives and expectations of businesses and individuals.

While there is no such thing as “standard” merger challenge litigation, STERIS was particularly idiosyncratic. First, the FTC brought the challenge under a rarely used (and lightly regarded) theory of future competitive effects, known as the “actual potential competition doctrine”. That doctrine conceded that STERIS and Synergy were neither present competitors in the medical device sterilisation market, nor did they presently constrain each other. Rather, the doctrine posits that at some point in the future, London-based Synergy would have become a competitor to STERIS in that market. While all Section 7 merger cases are dependent on predictions about the future, the actual potential competition doctrine is absurdly speculative. If the result in STERIS did not kill it within the agency, the wound might prove mortal in the courts.

Second, because the FTC’s case was brought under that doctrine, Judge Dan Aaron Polster determined that the requested injunction against the merger would turn on a single issue: whether “but for” Synergy’s prospective acquisition by STERIS, it would have entered the US with x-ray sterilisation services to compete with STERIS’s existing gamma sterilisation business. Thus, unlike “ordinary” merger challenge cases, the parties never got to litigate product or geographic market definitions.

This reimagined form of merger litigation led to our strategic focus on building a record of all the reasons why Synergy’s entry in the US with x-ray sterilisation was implausible and irrational. And that record was rich: it was too costly; there were no customers; and there was no available technology to make it economically viable.

The FTC decided to focus on a different issue. Their case was premised on the FTC’s incredulity over the explanations for why Synergy finally abandoned its faltering efforts to bring x-ray sterilisation technology to the US during the course of the FTC’s merger investigation. The FTC thought Synergy’s decision to end that project was an attempt to evade the FTC’s investigation. Convinced that where there was smoke there was fire, the agency built its case around the “suspicious” timing of Synergy’s exit. As we learned in STERIS – and have seen again in other recent cases – annoying the enforcement agencies is not a violation of Section 7. Rather, Section 7 requires at least some showing that the alleged conduct is against a merging party’s interest. Here, the record established that Synergy acted rationally when it abandoned exploratory efforts to assess the viability of bringing x-ray technology to the US. And the same facts that led Synergy to abandon those effects also answered Judge Polster’s questions about whether it would be a likely competitor in a timely and meaningful fashion.

The result was the first successful defence against a merger challenge brought by the FTC in four years.

The parties and the contract sterilisation business

On 13 October 2014, STERIS Corporation, based in suburban Cleveland, announced an offer to acquire Synergy Health, based in Swindon, United Kingdom. It seemed like a perfect match. STERIS was a leading provider of infection-prevention products and services and operated a business unit, Isomedix, that offered contract industrial sterilisation services in the United States. Synergy had complementary business units, including its own industrial sterilisation business, that offered the same services mainly outside the United States. Though they operated in different geographic markets, however, STERIS and Synergy were the second- and third-largest global providers of contract sterilisation services after Sterigenics.1

Contract sterilisation services are used in a variety of industries, including the pharmaceutical and medical device industries, where FDA regulations require products to meet strict sterility requirements. There are several sterilisation methods including steam, ethylene oxide, electron beam, gamma radiation and x-ray radiation. The latter three are all forms of radiation sterilisation. While myriad factors go into a manufacturer’s determination about which method to use for its products, the decision largely turns on the whether the method can sterilise the product to the manufacturer’s specifications.

Gamma sterilisation is performed by exposing products to the radioactive isotope Cobalt-60. The benefit of gamma sterilisation is its ability to penetrate dense products, like certain medical devices and thicker packaging. E-beam is not capable of the same depth of penetration as gamma. In the US, e-beam only accounted for 15% of all contract sterilisation.2

X-ray radiation, like gamma, is capable of penetrating dense products and, according to the FTC, was a true functional substitute for gamma sterilisation.3 X-ray also offered benefits over gamma because it was not dependent on Cobalt-60, a radioactive material subject to significant regulation (including the risk of being banned), with additional uncertainty over its future availability. Sterigenics, the world’s leading gamma-radiation provider, also owned the world’s leading provider of Cobalt-60.

Despite these potential benefits, however, x-ray sterilisation had one important defect: nobody used it. All of the healthcare and medical device companies that might benefit from using x-ray sterilisation services over gamma simply would not switch. The world’s sole commercial-scale contract x-ray sterilisation facility is in Daniken, Switzerland.4 Synergy acquired it in 2012 from Leoni Studer, and its experience with Daniken was illustrative of the challenges x-ray faced everywhere.

Daniken had both an x-ray facility and a gamma facility. When Synergy bought the plant, the gamma facility was operating at 75% of capacity while the x-ray facility was operating at 22% capacity.5 Though Synergy expected to triple utilisation of Daniken’s x-ray operations by 2016, the plant operated at 25% capacity in 2015 – just 3% more than when Synergy acquired it.6

Despite no real-world evidence that x-ray would ever become a viable alternative to gamma anywhere in the world, the FTC challenged STERIS’s acquisition of Synergy in the belief it would, and that Synergy would be the party that brought it to the US.

Actual Potential Competition Doctrine: imagining competition where none exists

The FTC alleged that the merger of STERIS and Synergy would substantially lessen competition in the market for “contract radiation sterilisation services” and, more narrowly, “the sale of contract gamma and x-ray sterilisation services to targeted customers that cannot economically or functionally switch to e-beam sterilisation”.7 It was undisputed that Synergy and STERIS were neither present competitors nor competitive constraints on each other in the alleged relevant market.

STERIS was one of two providers of gamma radiation in the US, with the other being Sterigenics. Synergy had significant gamma radiation operations outside the US, but it did not offer the service in the US.8 It had no infrastructure to do so, nor was it ever likely to develop that infrastructure.9

Instead, the FTC’s market definition imagined a world where Synergy entered the US not with gamma but with x-ray. “Imaginary” is the right adjective to describe the FTC’s market definition. When the FTC filed its complaint, there was not one commercial x-ray sterilisation facility in the United States. There was not a single commercial x-ray contract sterilisation facility under construction in the United States. There was not one commercial x-ray sterilisation customer in the US. X-ray sterilisation imposed no competitive constraint on gamma sterilisation services in the US. Literally, there was no market.

Nonetheless, the FTC filed the complaint and moved for a preliminary injunction based on the future existence of a product (x-ray sterilisation) that it imagined would compete in the same market as an existing product (gamma sterilisation). While Section 7 litigation is inherently speculative, it must still be grounded in real-world facts and data to make accurate predictions about the future. The FTC’s claims in STERIS went beyond the ordinary predictive nature of Section 7 into the land of make-believe.

The FTC brought its Section 7 claim in STERIS under the actual potential competition doctrine. According to theorists, the elements of a Section 7 violation under this doctrine are: (1) a highly concentrated market; (2) the non-incumbent party likely would have entered the market either de novo or through a toehold acquisition within a reasonable time; and (3) such entry is likely to deconcentrate the market or have some other significant pro-competitive effect.10

It sounds intriguing, but the Supreme Court twice refused to endorse the theory.11 And, with one notable exception – the Eighth Circuit in Yamaha12 – courts mainly swatted back attempts to advance actual potential competition claims.13 While we pressed (and many members of the antitrust defence bar hoped) to have the court reject the theory, Judge Polster assumed its validity for purposes of resolving the FTC’s motion for a preliminary injunction.14

A bad theory runs into good facts

Even though the court accepted the validity of theory, the FTC still had the burden to establish that Synergy “probably”15 would have entered the US with x-ray “but for” the merger. It was undisputed that Synergy did explore the possibility of bringing x-ray to the US: it had allocated money for a down-payment on project equipment; assigned human capital to develop the plan; and solicited customer interest in it. It was also undisputed that Synergy formally terminated that exploration during the FTC’s merger investigation. The central issue in dispute was whether Synergy had checked its swing or followed through. That is: were Synergy’s development efforts merely exploratory, as the defendants argued, or was x-ray entry a fait accompli, as the FTC argued.

The FTC believed that Synergy’s motivation for pulling back its exploratory efforts was to evade an enforcement action against the merger.16 Our observation over the course of the litigation was that FTC was highly sceptical of Synergy’s explanations of that decision, and of the individuals at Synergy responsible for it. That scepticism, moreover, pervaded the FTC’s litigation strategy. A central theme of its case presentation, both implicit and explicit, was that Synergy could not be trusted. The FTC pointed to company documents – such as an email by a Synergy employee during the merger investigation, who wrote: “This whole FTC inquiry is going down a rat-hole17 . . . we cannot proceed for the Americas” to establish that Synergy’s motivations for abandoning US x-ray entry was a cynical ploy to get the deal cleared.

However, the FTC over-relied on this type of evidence and misread how it would affect Judge Polster’s analysis. More importantly, the FTC’s reliance on the “don’t trust ‘em” theme left its case vulnerable. The FTC never developed a robust response to the voluminous record that showed how hard and risky US x-ray entry really was. Its response to evidence countering its narrative – even evidence that plainly showed how irrational entry would have been – was simply: Synergy didn’t care; it was entering no matter what. That did not ring true, and Judge Polster’s opinion evidences that.

For example, the FTC rejected as unsubstantiated the defence’s claim that Synergy’s governing board of directors had yet to engage in a robust financial review of all capital projects over a certain dollar threshold, which was called a “black hat review.” The FTC, as Judge Polster noted, not only contested that such a review would have resulted in the end of Synergy’s exploration of x-ray in the US, but even contested the fact that such a review existed. Here, the FTC’s cynicism went too far.18 Judge Polster called it out in a footnote of his opinion noting that evidence of the process for a “black hat review” existed and that, regardless of the name, “there cannot be a serious dispute that the type of financial review the team conducts (and the metrics its uses) to evaluate capital investments is not standard business practice in the industry.”

In another instance, the FTC took the court on a frolic to chase down the provenance of Synergy board-meeting minutes from September 2014 where the US x-ray project was under discussion. That exercise started as a moment of high drama during the first days of the hearing, but landed with a thud. The handwritten notes of Synergy’s corporate secretary established that the final version of those minutes, which was created months after the meeting, accurately reflected what had taken place. Judge Polster’s opinion suggested that the FTC’s focus on the minutes bolstered their importance, rather than diminished it as the FTC had hoped.19

In hindsight, the FTC’s efforts to make its case by discrediting Synergy fell flat with Judge Polster, and did not overcome the evidence supporting the defence’s argument that establishing an x-ray sterilisation business in the US would be irrational business behaviour.

Making the rational case

If the FTC’s trial strategy was to discredit Synergy and its executives, we wanted to present the case that – whether you trusted Synergy or not (and there was no reason not to) – no rational business would have signed on to the US x-ray entry plan. For Synergy to enter the US with x-ray, it had to commit around $40 million20 to the project – about as much as its entire capital budget for a fiscal year. The financial case that supported entry was littered with erroneous and unsupportable financial assumptions that could not survive scrutiny, and still did not even project revenue sufficient to meet Synergy’s internal requirements on minimum rates of return. Further, there was not a single committed, base-load customer to support the development of even one US x-ray facility – much less the multiple facilities that the FTC alleged Synergy was “poised” to open.

And then there was the “unicorn” – the Rhodotron TT1100 with mammoth x-ray and e-beam throughput capabilities. It was a machine that had never been built, never been tested and, at a price tag north of €5 million, was the largest single capital cost of the possible project. Our job was to bring life to those facts.

On customer commitments, members of the defence team spent weeks traversing the country to depose numerous parties that had been identified as ideal customers for the project. In the process, we built a clean record confirming that there was zero commitment to convert from existing gamma to x-ray. The FTC put on two customer witnesses at the hearing, presumably the best ones they had, and neither would commit to using x-ray in the future. In fact, an observer at the first day of the trial told us that the customer witnesses were de facto defence witnesses.

The financial story was built first through Synergy witnesses: former chief financial officer Gavin Hill and outside board member Constance Baroudel. Both could articulate the robust financial review process that Synergy conducted to approve capital projects, and how the x-ray entry plans had not, and could not, meet it. But, perhaps more importantly, they were just great trial witnesses. They were smart, affable and had the gravitas to ably and credibly reject the FTC’s assertion that Synergy was so committed to the project that it was willing to disregard the financial risks.

In addition to witnesses, we pored over the financial model that Synergy’s x-ray project team had put together to evaluate the investment. We learned the model backwards and forwards – even spending hours converting currencies. We drew on our understanding of the model to include in the court record testimony and documents of its underlying problems: the model made unsupported assumptions about revenue and capacity growth; it improperly double-counted revenue from an existing e-beam facility; and it was affected by the ever-changing prices and specifications for the Rhodotron TT1000 dual x-ray/e-beam machine. The effort to tell that story paid off, as it resonated in Judge Polster’s opinion.21

Aside from his overall finding that Synergy was not likely to enter the US with x-ray, one of the most satisfying individual findings in Judge Polster’s opinion was that the x-ray machine that was being considered by Synergy “had never been designed, built, tested or priced.”22 Developing the story of the Rhodotron TT1000 to present at the hearing was one of the most complicated tasks we had, and it was critical to tell it right. The machine’s story encompassed everything that doomed Synergy’s entry prospects (and the FTC’s case): it was too expensive, too uncertain and too reliant on customers that never materialised.

The machine had an enormous upfront capital cost, making it an anchor on the project’s finances. But to make x-ray financially viable, Synergy had to have a machine that could sterilise an enormous amount of instruments, which required a bigger, more expensive machine. It also required e-beam capacity to hedge against the risk that x-ray customer volumes would be low, at least initially, which further complicated the design of the machine. Interactions with the machine’s manufacturer showed shifting promises, deliverables and prices, and that the machine being discussed was experimental. Combine those factors together – the high cost of the machine, the uncertainty about its very existence, the absence of any base-load x-ray customers – and you have a strong factual basis to reject FTC’s assertion that Synergy was “poised” to enter the US with x-ray.

Marshalling these facts took a tremendous effort, including: a deposition in Belgium; untangling a history of correspondence between Synergy and the manufacturer; and learning about the technology, its history and how Synergy intended to use the machine.

All of that work led to one, sweet sentence in Judge Polster’s opinion, and undoubtedly had a profound impact in driving the outcome.

Why this result?

Judge Polster’s decision was compelled by the facts. We can take credit for making sure those facts got in front of him, but they were the facts. The FTC faced a difficult case under any circumstance because it was relying on a legal doctrine that has shown itself to be almost impossible to prove based on real-world facts. Moreover, the FTC’s case theme – that Synergy abandoned its plans to enter only because of the merger investigation – did not hold up against a wave of evidence that supported Synergy’s decision as a wholly rational business judgment. It is not enough for the enforcement agencies to show that parties to a merger take actions in order to cut off an investigation. Rather, their conduct in doing so must be against their long-term business interest “but for” the merger. Unable to establish that Synergy’s decision to abandon entry was irrational, the FTC’s case fell apart.

We did what we set out to do, which was to establish clearly for the court that US x-ray entry was implausible because it would be irrational. That carried the day.

Other thoughts

The oddity of never reaching market definition

Ordinarily, the heart of every merger challenge is the alleged market definition, but in STERIS, as tried, it was not. Prior to the trial, the parties exchanged expert reports and depositions on a variety of topics, including market definition – both geographic and product markets. The case presented a number of interesting issues about whether and how x-ray sterilisation might compete with other forms of sterilisation, especially on certain types of medical products. And if it did, whether shipping costs and logistics might draw market boundaries since Synergy was initially only contemplating a handful of facilities. We did not ultimately litigate the proper definition of the relevant market because Judge Polster was content to assume that plants would only be built where competitive, and thus decided to narrow the question to likelihood of entry. Nonetheless, it begs considering in future merger challenge cases, perhaps even those brought under conventional theories of horizontal competition, whether there are mechanisms to identify dispositive, factual issues that can be resolved without need to turn the case into a battle of duelling experts. Further, narrowing or staging the litigation could benefit defendants who are at a severe disadvantage in discovery (see below) as they have to climb the information curve quickly. Limiting the scope of the case can level the playing field for defendants, who are often fighting against the clock to get their cases heard quickly before their merger agreements’ various blow-up provisions kick in.

Overcoming defendants’ discovery disadvantages

The Hart-Scott-Rodino (HSR) Act, and the information produced pursuant to it, purport to facilitate the antitrust enforcement agencies’ review of transactions. But when litigation ensues, it effectively becomes unilateral pre-suit discovery, including discovery from third parties that is not subject to the limitations of the Federal Rules of Civil Procedure and that is not overseen by a neutral judicial officer. It would be an understatement to say that defendants in merger challenge litigation start the typical expedited discovery at a disadvantage to the enforcement agencies.

In STERIS, the FTC had been reviewing the transaction since the autumn of 2014 and filed suit on 29 May 2015. For almost half a year before filing, the FTC was building its case. Once filed, the case went to the hearing on a preliminary injunction (effectively a merits trial) just two-and-a-half months later (17 August). That left defendants to do in a matter of weeks what the FTC had been doing for months: building their record. And once the case is filed and formal discovery begins, the enforcement agencies do not just rest on the record built during the HSR review. They are as aggressive in offensive discovery as any civil litigant who is not subject to reciprocal discovery demands.

To overcome that disadvantage, an essential component of our case strategy was to keep a tight focus on what record facts we needed and to target the most efficient means to get those facts. Unlike the agency, we did not have the luxury of meandering discovery.

Home-court advantage?

We have seen some statements by former FTC officials suggesting that Judge Polster’s decision was an outlier and, perhaps, they regret filing the case in the Northern District of Ohio, then home to STERIS. The FTC does not offer reasons for its choice of venue, but any suggestion that it entered a hostile jurisdiction would be post hoc rationalisation. Much of the case surrounded the actions and personnel of UK-based Synergy, and nothing in the opinion can even remotely be suggested as bias toward corporate residence. It may be interesting to contrast the many recent decisions that have come out of the District Court for the District of Columbia that have been in favour of the FTC and the DOJ’s Antitrust Division, but any hometown bias may run in that direction. The district has been observed to be a company town, and that “company” is the government.

In fact, STERIS was the FTC’s first merger loss in four years. The prior loss was in Ovation Pharmaceuticals, which was filed in Minnesota. Two decisions are just a slight trend, but given the agencies’ recent run of success in federal court in DC, it’s fair to wonder if they get more deference at home.

Long-term effect on actual potential competition claims

STERIS’s long-term impact is likely to be seen in the negative. If the FTC had won, it would have emboldened the enforcement agencies to bring more aggressive challenges to mergers that were previously either unassailable, or where competitive concerns about future markets were resolved through divestitures or other types of settlements. The FTC and DOJ need a case other than Yamaha if they hope to more firmly establish the viability of the actual potential competition doctrine. STERIS might have been that case. The FTC thought it had the facts to win. It did not. Given how infrequently the actual potential competition doctrine is already litigated it is hard to imagine that either agency would have the appetite to litigate another case like STERIS.

We think it is fair, in the light of Judge Polster’s ruling, to question the continuing validity of the actual potential competition theory. The FTC got every benefit of the doubt on the law – including its exceedingly low “probability” standard of proof. Still it could not prevail. If this case presented facts that the commission felt so strongly about that all five FTC commissioners voted in favour of bringing the action, one wonders if there is any set of facts that will state a viable actual potential competition claim.

We are not holding our breath waiting for one.

Conclusion

Litigating mergers is challenging, complex, incredibly fast and a lot of fun (for trial counsel). Winning is even more fun, and assisting STERIS in prevailing against the FTC’s challenge was a deeply rewarding experience for the entire defence team. As we look to the future of merger litigation, we think STERIS will affect the kinds of competition claims the enforcement agencies bring, and the theories they will rely on. From a practitioner’s perspective, STERIS is a lesson in the importance of facts. Facts overcome innuendo. In a fast-moving case, it is essential to have a clear plan of the facts you need and the story they must tell. That is what we did in STERIS. That is how we won.

* The authors are lawyers at Jones Day, which represented STERIS Corporation. The views expressed are solely theirs and should not be attributed to Jones Day or its clients.

Throughout this chapter, the authors’ use of pronouns refers to the entire defence team, including their colleagues at DLA Piper who represented Synergy PLC.

Notes

  1. FTC v. STERIS Corp., 1:15-cv-01080-DAP, Doc. 19, Plaintiff Federal Trade Commission’s Complaint for Temporary Restraining Order and Preliminary Injunction (“Complaint”) (N.D. Ohio June 4, 2015).
  2. FTC v. STERIS Corp., 133 F. Supp. 3d 962, 964 (N.D. Ohio 2015).
  3. See Complaint at ¶ 122.
  4. STERIS, 133 F. Supp. 3d at 964.
  5. STERIS, 133 F. Supp. 3d at 967.
  6. STERIS, 133 F. Supp. 3d at 977.
  7. Complaint at ¶ 30.
  8. STERIS, 133 F. Supp. 3d at 964.
  9. See Id. at ¶ 47.
  10. Tenneco, Inc. v. FTC, 689 F.2d 346, 352 (2d Cir. 1982). Some courts and commentators articulate a fourth element – a showing that barriers to enter the market are high or, stated differently, that the number of firms capable of entering is low. Compare STERIS Corp, 2015 US Dist. LEXIS 128470 at *9 with Tenneco Inc, 689 F.2d at 352. Whether stated as an independent element, or incorporated into the analysis of either the current level of market concentration or the competitive effects of the transaction, it is clear that in order to make out a prima facie actual potential competition claim, the plaintiff must present evidence that entry into the relevant market is unlikely for all but a small number of firms of which the non-incumbent merging party is one (or the only). See Tenneco Inc, 689 F.2d at 353 (considering the existence of high barriers to entry in its analysis of the first element – market concentration).
  11. U.S. v. Falstaff Brewing Corp., 410 US 526, 537-38; U.S. v. Marine Bancorporation, 418 US 602, 624 (1974).
  12. 657 F.2d 971, 977 (8th Cir. 1981).
  13. See, e.g., Tenneco, Inc., 689 F.2d at 352; FTC v. Atl. Richfield Co., 549 F.2d 289, 293 (4th Cir. 1977).
  14. STERIS, 133 F. Supp. 3d at 966.
  15. The FTC argued that it merely had to establish that Synergy “probably” would have entered the US with x-ray “but for” the merger. Again, the court again accepted this lenient standard for purposes of resolving FTC’s motion. We disagree that it was the proper standard under the governing case law – including the commission’s own precedent. In re BAT Indus Ltd, No. 9135, 1984 WL 565384 (FTC 17 Dec. 1984). But the result here, as discussed infra indicates that, regardless of the standard of proof applied, actual potential competition cases are almost impossible to prove in practice.
  16. STERIS, 1:15-cv-1080, Doc. 78, Plaintiff’’s Post-Hearing Brief at 1-2 (Aug. 208, 2015).
  17. The definition of a “rat-hole” is a waste of time and resources. So, from our perspective, the Synergy employee’s statement was a perfect response to the FTC’s investigation into hypothetical competition.
  18. STERIS, 133 F. Supp. at 978 n. 8.
  19. Id. at 983 (writing, “there is no doubt that the presentation was given, the discussion took place, and that the minutes contained in the middle of Turner’s handwritten book ‘exist and are real’.”).
  20. STERIS, 133 F. Supp. 3d at 972, 981.
  21. STERIS, 133 F. Supp. at 981-982.
  22. Id.

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