Vertical Merger Legality
“If the FTC investigates vertical and horizontal mergers, will it now take the position that efficiencies are irrelevant, even if proven? If so, the FTC will suffer embarrassing losses in court. Vertical integration through internal expansion is not vulnerable to legal challenges. However, if vertical integration is achieved through a merger, it may a priori be open to challenge under antitrust law. The U.S. Supreme Court has ruled on only three vertical merger cases under Section 7 of the Clayton Act since 1950. In the first case, United States v. E. I. du Pont de Nemours & Co., 353 U.S. 586, 77 p.
Ct. 872, 1 L. Ed. 2d 1057 (1957), the Court rejected the general assumption that section 7 did not apply to vertical mergers. After the court found that du Pont`s acquisition of 23% of General Motors (GM) shares had prevented the sale to GM by other suppliers of automotive paints and materials, the court ruled that the vertical merger had an illegal anti-competitive effect. Vertical mergers are subject to the provisions of the CLAYTON ACT (15 U.S.C.A. § 12 et seq.), which govern transactions that fall within the scope of antitrust law. Vertical integration through merger does not reduce the total number of economic entities operating at market level, but it can change industry behaviour. Suppliers may lose a market for their products, retail outlets may be deprived of supply, and competitors may find that supplies and outlets are blocked.
Vertical mergers can also be anti-competitive, as their well-established market power may deter new firms from entering the market. A horizontal merger eliminates a competitor and can change the competitive environment, making it easier for the remaining firms to coordinate prices, output, capacity or other competitive dimensions. As a starting point, agencies consider market concentration as a measure of the number of competitors and their relative size. Mergers in industries with high market shares typically require additional analysis. At its public meeting today, the Federal Trade Commission (FTC) repealed its guidelines on vertical mergers. These guidelines were jointly issued by the Department of Justice (DOJ) and the FTC in June 2020 and were used to “describe the DOJ`s and FTC`s key analytical techniques, practices, and enforcement policies with respect to a range of transactions, often referred to as vertical mergers and acquisitions.” The FTC also rescinded its December 2020 comment on the application of vertical mergers. The FTC has not issued any replacement guidance. Instead, the majority statement states that at some point in the future, the FTC “will issue updated guidelines or rules to ensure that our merger analysis is consistent with market realities.” The Clayton Act 7 makes certain mergers and acquisitions illegal.
In principle, an entity may not acquire (or otherwise combine with another entity) the shares or assets of another entity if there is a reasonable likelihood that the merger will substantially lessen competition or tend to create a monopoly. Such activity may also be illegal under the Sherman 2 Act if it results in a company acquiring monopoly power after the transaction. Mergers are generally classified as horizontal, market expansion, vertical or conglomerate. This type of merger takes place between non-affiliated companies. These companies do not compete or operate in the same retail chain. This type of merger is illegal if it makes it more difficult for new competitors to enter the market. The Guidelines also recognize that vertical mergers are often pro-competitive and can lead to lower prices by eliminating double marginalization (EDM): “Due to the removal of double marginalization, mergers of vertically related firms often result in lower input costs for the merged entity than the downstream entity would have paid without the merger. Indeed, the merged entity will have access to upstream inputs at cost, whereas the downstream entity would often have paid a price that includes a premium. The benefit of these lower costs can then lead to lower downstream prices.
In addition, the Directives recognise that vertical mergers can lead to efficiency gains, as they “streamline production, inventory management or distribution” and can also lead to the creation of “innovative products in a way that is unlikely to be achieved by arm`s length agreements”. Third, the FTC`s majority statement relied on flimsy economic arguments to try to explain why it removed the 2020 VMGs. The majority criticized “the misguided discussion of VMG 2020 on the purported pro-competitive advantages (i.e., efficiencies) of vertical mergers, particularly the treatment of elimination of double marginalization (“EDM”).” This “could be difficult to correct if the courts rely on it.”  See United States v. AT&T, Inc., 916 F.3d 1029, 1045 (2019) (“At this time, the Court does not consider that quantitative evidence of a price increase is necessary to prevail in a section 7 challenge. Vertical mergers can cause harm to consumers beyond higher prices, including lower product quality and reduced innovation. This development follows President Biden`s July 9 executive order to promote competition in the U.S. economy, which called on the FTC and DOJ to “review” and “revise existing agency policies on horizontal and vertical mergers.” At the time, the agencies said they would “jointly launch a review of our merger policies with the goal of updating them to reflect a rigorous analytical approach consistent with applicable law.” Shortly after today`s FTC vote, the DOJ issued a statement stating that the vertical merger guidelines “remain in effect at the DOJ,” but that it has “identified several aspects of the guidelines that merit careful consideration” and that it will “work closely with the FTC to update the vertical and horizontal merger guidelines as appropriate.” However, it should be noted that the courts are the final arbiters of the legality of mergers and that the guidelines for agency mergers themselves do not have the force of law. As such, it is unclear what practical implications, if any, the repeal of the FTC will have on courts hearing merger disputes. Since the release of the vertical guidelines last summer, no court has ruled on the content of a vertical merger, and challenges to vertical mergers have been rare in the past.