Fifth Circuit Largely Upholds FTC’s Order In Illumina/Grail Case, Giving FTC a Victory in Litigated Vertical Merger – But Providing Merging Parties an Easier Path to “Litigate-the-Fix”

The saga of DNA-sequencing firm Illumina’s quest to acquire cancer detection-test maker Grail ended last month when the Fifth Circuit largely upheld the Federal Trade Commission’s decision to block the deal. The appellate decision is significant on several levels.  First, it is the first time in decades that either federal antitrust enforcer has succeeded in blocking or forcing the abandonment of a vertical merger after litigating to a decision.

Second, the decision clarifies several important issues regarding how merging parties can “litigate-the-fix,” an increasingly common defense approach in this era of agencies preferring full-stop injunctions rather than settlements. Unlike Judge Nichols in United/Change and Judge Reves in ASSA ABLOY/Spectrum, the Fifth Circuit held that the merging parties bear the burden of showing their proposed remedy rebutted the government’s prima facie case. Additionally, the Fifth Circuit held that Illumina did not need to show that the proposed remedy fully maintained the premerger competitive landscape, but only that the remedy sufficiently mitigated competitive concerns “such that [the transaction] was no longer likely to substantially lessen competition.”

Third, the Fifth Circuit rejected the parties’ Constitutional arguments, finding that the FTC’s administrative process did not run afoul of Article I and II and did not deprive Illumina of its due process rights.

Background

Illumina first announced its bid to acquire Grail in the Fall of 2020. In March 2021, the FTC sued to block the proposed acquisition—the FTC’s first vertical merger litigation in decades. The FTC alleged that the transaction would provide Illumina with the ability to harm Grail’s multi-cancer early-detection (MCED) test competitors by foreclosing, raising the cost of, or otherwise deteriorating their access to Illumina’s next-generation gene sequencing (NGS) platform, a necessary input for running MCED tests. Illumina closed the transaction in August 2021.

In September 2022, an administrative law judge rejected the FTC’s challenge, finding, among other things, that there was insufficient evidence that Grail had viable rivals that would be negatively impacted by merger and that Illumina’s “Open Offer” to continue to supply its NGS platform at the same price and with the same access as Illumina provided to Grail would address any competitive concerns. The FTC staff appealed the decision to the full Commission, which in April 2023 reversed the ALJ’s decision, ordering Illumina to unwind the deal. Illumina appealed the Commission’s decision to the Fifth Circuit.

Fifth Circuit Opinion

The Fifth Circuit ruled in the FTC’s favor in several important respects:

Constitutional Claims. The appellate court quickly dispensed with Illumina’s arguments that the FTC acted unconstitutionally on several grounds. The court held the FTC acted properly through the administrative litigation process under Supreme Court precedent, and that Illumina failed to show any actual bias that raised due process concerns.

Product Market. The court found that the FTC adequately defined a relevant product market for the “research, development, and commercialization” of MCED tests, based largely on factors set out in Brown Shoe, a 1962 Supreme Court case that has played an increasingly prominent role in merger enforcement by the Biden antitrust agencies. The Fifth Circuit rejected Illumina’s argument that the relevant product market should be limited to the “existing commercial market for MCED tests.” Instead, the court held that there was sufficient evidence that the relevant product market included MCED test companies that are not presently in the consumer market, but are in the research and development stage. Interestingly, the FTC uncharacteristically argued for a broader product market, so as to include potential competitors that could be harmed.

Vertical Merger Analysis. In the court’s view, the FTC also sufficiently demonstrated that the merger was likely to substantially lessen competition under both a Brown Shoe standard and “ability-and-incentive” to foreclose rivals standard. Under the first test, courts consider a variety of factors identified in Brown Shoe, including likelihood and size of any market foreclosure, the nature and purpose of the transaction, the merged firm’s market power, and barriers to entry to assess the potential for competitive harm. The “ability-and-incentive” test assesses whether the merged firm will “have the ability and incentive to foreclose rivals from sources of supply or distribution.” The court did not, however, resolve a disagreement about whether a Brown Shoe standard even existed—a point debated in the FTC’s underlying opinion—finding that agency has established its prima facie case under either standard.

With respect to the Brown Shoe test, the appeals court determined that not all factors under the test need be present for it to be satisfied, and found that the FTC had shown substantial evidence of four such factors—likely foreclosure, nature and purpose of the transaction, degree of merged firm’s market power, and entry barriers.

With respect to the ability-and-incentive test, the court found that, “[g]iven Illumina’s monopoly power and shifting business priorities, it was reasonable for the Commission to conclude that Illumina would likely foreclose against Grail’s competitors . . . to pursue its long-term goal of establishing itself (via Grail) as the market leader in clinical testing.” Notably, the Fifth Circuit stated, in a footnote, that the merger itself need not give or increase the merged firm’s ability to foreclose rivals; it suffices if the merged firm has the ability and incentive, even if one of the merging parties already had the ability to foreclose rivals.

Efficiencies. Regarding Illumina’s other defense, the Fifth Circuit agreed with the FTC that the efficiency claims were not cognizable. The Fifth Circuit held that Illumina did not meet its burden to support these claims as merger-specific, verifiable, and likely to be passed through to consumers. With respect to claimed elimination of “double marginalization” and operational cost savings specifically, the court faulted Illumina for not providing any models to explain how it calculated these efficiencies. The court stressed that “an efficiency defense is very difficult to establish.”

Remedy Analysis: Impact on Litigating-the-Fix

One of most significant aspects of the Fifth Circuit’s decision relates to the legal standard for litigating proposed merger remedies. The opinion addresses two key questions regarding how courts should evaluate remedies offered by the merging parties: (1) who bears the burden (the agencies or the parties) of showing that the remedy is inadequate or adequate (respectively) to address the alleged anticompetitive harm; and (2) what is the test courts should apply when evaluating remedies?

Regarding the first question, the FTC asserted that defendants had the burden of proof to show that the Open Offer, a long-term supply agreement that Illumina offered to MCED-test developers, cured all competitive concerns from the transaction, and only after a finding of liability. Illumina countered that the burden instead rests with the FTC, as part of its prima facie case, to show the deal, as modified by the remedy, was still unlawful. Illumina’s position was supported by Judge Nichols’s ruling in the UnitedHealth/Change merger that the burden of proof to show that the proposed transaction—including the merging parties’ proposed divestiture—would lead to substantial competitive harm rests with the government. Judge Reyes also made clear during a pre-trial conference in the ASSA ABLOY/Spectrum Brands challenge that she would follow Judge Nichols, and squarely put the burden on DOJ to prove that defendants’ proposed divestiture did not adequately address the allege anticompetitive harm.

The Fifth Circuit rejected both options, instead holding that, as part of the liability phase, Illumina bore the burden to show the remedy rebutted the government’s prima facie case. The court explained that Illumina “was required to do more than simply put forward the terms of the Open Offer.”

The court next considered the exact standard that should apply when evaluating remedies. The FTC argued that the remedy should have to restore competition to premerger levels or otherwise not lessen competition at all, a “total-negation standard,” which has been adopted in prior cases including in United States v. Aetna and FTC v. Sysco.

The Fifth Circuit distinguished Aetna and Sysco, noting that the proposed divestitures in those cases were either court-ordered or conditioned upon the court finding liability. Here, the Open Offer was not conditioned on a finding of liability—in fact, the Open Offer came into effect over a year before the FTC determined liability. Therefore, the court held that Illumina need only demonstrate that the proposed fix sufficiently mitigated competitive concerns “such that [the transaction] was no longer likely to substantially lessen competition,” citing the language of Section 7.  The court remanded the case to the FTC to analyze the Open Offer under the proper legal standard.

The Fifth Circuit’s opinion regarding remedies is a “mixed bag” for merger litigants. On the one hand, the court’s ruling places the burden of proof regarding pre-litigation remedies back on defendants. But the opinion also rejects the antitrust agencies’ long-held stance that remedies must totally redress competitive harm, instead holding merging parties to a more lenient “substantial lessening of competition” standard. The impact of this ruling is unclear given the apparent split with district courts in other circuits. But it certainly reinforces the advisability of merging parties considering effective pre-litigation fixes and being prepared to defend those fixes in court.

After the Fifth Circuit opinion, Illumina announced its plans to unwind its merger with Grail.

Key Takeaways

• The court’s treatment of Illumina’s proposed fix will likely influence the continuing debate about how courts should evaluate remedies proposed by the merging parties in advance of litigation. Although some courts have required the government to “litigate the fix”—i.e. to show that the proposed merger and the fix viewed together still may lead to a substantial lessening of competition—Illumina holds that the burden to show that the fix is adequate remains with the merging parties.
• The opinion does clarify that this burden is limited to demonstrating that the proposed fix would prevent a substantial lessening of competition. The merging parties need not prove that the remedy completely eliminates any and every competitive effect of a transaction. This decision thus may provide more leeway for merging parties to engage in early fixes to address competitive concerns.
• The case will likely buoy antitrust agencies’ increased interest in both challenging vertical mergers and pursuing theories of harm related to potential competition, including transactions involving products at increasingly earlier stages of development. Although the agencies have a mixed record of success to date on both, the Fifth Circuit opinion, which the agencies incorporated into their new Merger Guidelines, shows their continued interest in and focus on these types of cases.
• An efficiency defense remains difficult to prove in litigation, but the new 2023 Merger Guidelines continue to recognize it albeit with a high burden of proof. The Fifth Circuit’s decision indicates that burden may well include modeling and quantification of claimed efficiencies as a perquisite to making efficiency claims.
• Constitutional challenges to the FTC’s authority are unlikely to subside, as efforts are currently underway to generate a conflict between appellate courts and force the Supreme Court to resolve the debate. But the FTC will point to this case in the Fifth Circuit and likely in other circuits where parties raise this claim.