In April 1998, when the State of New York challenged a "virtual merger," we noted that hospitals should be cautious about the antitrust implications of loose, unintegrated affiliations with competitors. (See "State Challenges 'Virtual Merger' of Hospitals," Jones Day Health Care Commentaries, April 1998). We now know that at least one court agrees. On April 10, 2000, a federal district court agreed with the State of New York that a joint venture between two competing hospitals to operate and manage the sponsoring hospitals was per se illegal under the antitrust laws as a "naked" price fixing and market allocation agreement.

Background

The Poughkeepsie case, as it has come to be called, State of New York v. Saint Francis Hospital, Vassar Brothers Hospital and Mid-Hudson Health, 98 Civ. 0939 (WCC) (S.D.N.Y. April 10, 2000), arose out of a challenge to the activities of two hospitals in Poughkeepsie, New York, in connection with the formation of Mid-Hudson Health, a not-for-profit joint venture corporation formed by the two hospitals. Mid-Hudson was initially created by the two hospitals to oversee the joint operation of three clinical services for which the hospitals had received a certificate of need ("CON") from the State of New York — cardiac catheterization, MRI services, and lithotripsy. The hospitals delegated to the joint venture operational and management authority for new clinical services, for joint long-range planning, and for additional CON submissions. After the State of New York deregulated the hospital industry, the hospitals agreed to unify their operations through Mid-Hudson by creating a single parent board, merging their medical staffs, combining development of and control over clinical services, and other actions. Significantly, the hospitals did not agree to commingle their revenue streams or to change the ownership of their assets.

In this context, Mid-Hudson became the exclusive bargaining agent for the two hospitals for their dealings with third-party payers, and it began to coordinate the hospitals' decisions about what clinical services should be offered and where they should be located. These activities were challenged by the State of New York as per se illegal price fixing and market allocation. The State charged that this conduct amounted to collusion by the two hospitals and led to "exorbitant" prices for hospital services. To underline this message, the State's complaint stated: "[t]his action is not about the merger of two hospitals in Poughkeepsie. There has been no lawful merger. Instead, this is about a naked price fix and market allocation — the steadfast refusal of defendants to compete on the merits of their services."

Defenses Presented by the Hospitals

The hospitals defended the allegations on a number of grounds. Their principal defenses were:

  • the conduct was immunized from antitrust attack by the state action doctrine, due to the issuance of the CON for Mid-Hudson by the State of New York;
  • the conduct should be reviewed under a rule-of-reason standard, which requires an assessment of the actual market effect of the activities at issue, rather than being declared per se illegal, because the joint venture created efficiencies and improved the quality and availability of hospital services;
  • the lack of judicial experience with the health care industry and the hospitals' not-for-profit status should require a rule-of-reason inquiry; and
  • the Poughkeepsie community supported the joint venture.

Significantly, the hospitals did not argue that they were a fully merged, single entity, and therefore incapable of conspiring under the antitrust laws, nor did they argue that they had achieved sufficient financial integration to entitle the joint venture to rule-of-reason treatment under relevant case law.

The District Court Decision

In an opinion by Judge William C. Conner, the court disposed of all of the defendants' arguments in fairly short order, finding no state action immunity and no basis for application of the rule of reason, and rejecting the notion that the community's support of the joint venture was a defense to a charge of per se illegal conduct.

The court found that the defendants had not established the necessary elements of a state action defense. Under the state action doctrine, private parties may be exempt from application of the federal antitrust laws if they satisfy two requirements: (1) that their conduct was undertaken pursuant to a clearly articulated and affirmatively expressed state policy to replace competition with regulation, and (2) that their conduct is actively supervised by the state. California Retail Liquor Dealers Ass'n v. Midcal Aluminum, Inc., 445 U.S. 97 (1980). In this case, the defendants vigorously asserted that the approval of the establishment of Mid-Hudson by the New York State Department of Health satisfied both the clear articulation and active supervision requirements. The court evidently considered it to be a close question whether the clear articulation prong of the defense had been met, citing a number of statements in the record indicating that at least one branch of the State of New York had approved of the formation of Mid-Hudson. Accordingly, Judge Conner did not decide that point. The court did find, however, that the active supervision prong was not satisfied, citing Patrick v. Burget, 486 U.S. 94 (1988), and North Carolina ex rel. Edmisten v. P.I.A. Asheville, Inc., 740 F.2d 274 (4th Cir. 1984), cert. denied, 471 U.S. 1003 (1985), a case that had found that state action immunity did not attach where a CON was issued for a hospital merger but where there was no ongoing regulation (such as rate regulation) of the hospitals' conduct in the marketplace.

Next, the court classified the agreements entered into by the hospitals as the type of activities generally considered to be per se illegal, absent justifications sufficient to bring them within the purview of the rule of reason. The joint managed care negotiations were characterized as price fixing, and the service coordination was characterized as market allocation, antitrust offenses traditionally viewed as per se illegal. In particular, the judge pointed to the implementation of a "Fairness Formula" to ensure that the defendants' respective market shares would remain at 1991 levels. Pursuant to the formula, which was intended to "guarantee each hospital a fair share in the financial losses and gains resulting from alterations in services," the defendants had agreed to ask physicians to redirect patients from the hospital that was "advantaged" (by having more admissions) to the hospital that was "disadvantaged."

None of the arguments advanced by the defendants in favor of evaluating the conduct under the rule of reason was found persuasive. The court found that "claims of improved quality of service do not shield price-fixing and market allocation activities from per se treatment." The arguments that the joint venture promoted efficiencies and made new services possible were also rejected, because the new services could be offered independently of the challenged restraints. Judge Conner was quite skeptical of these claims, stating that "[d]efendants' argument boils down to an assertion that competition would result in financial hardship on defendants." This is not sufficient to overcome per se liability.

As for the defendants' arguments that their not-for-profit character and the judiciary's lack of experience with the health care industry meant that the rule of reason should be applied, the court found quite simply that these arguments have been rejected by the Supreme Court — in Arizona v. Maricopa County Medical Society, 457 U.S. 332 (1982), and National Collegiate Athletic Ass'n v. Board of Regents of University of Oklahoma, 468 U.S. 85 (1984). Finally, the support of the community was of no assistance to the defendants. Good intentions, even those favored by the citizens of Poughkeepsie, do not outweigh the policy to promote competition stemming from the antitrust laws.

The court has scheduled a hearing to consider proposed remedies. Meanwhile, the hospitals have vowed to appeal.

Conclusions

The Poughkeepsie case represents one end of the hospital affiliation spectrum — a "virtual merger" with little, if any, financial integration. Health care providers must therefore be careful about the conclusions they draw from Judge Conner's opinion. There are a number of potential defenses available for hospital affiliations that fall short of full integration or merger that were not addressed in the Poughkeepsie case. In particular, some affiliations may be structured to create a system sufficiently close to a merged institution to be considered a single entity in the eyes of the antitrust laws; other affiliations may be sufficiently financially integrated to justify rule-of-reason treatment.

With respect to single-entity treatment, if a hospital affiliation satisfies the criteria set forth by the Supreme Court in Copperweld Corp. v. Independence Tube Corp., 467 U.S. 752 (1984), it may be considered to be one economic entity and, as such, incapable of conspiring within the meaning of the antitrust laws. If, for example, a parent corporation of two competing hospitals has complete control of the hospitals' governance and operations, in a manner akin to a parent corporation that owns 100 percent of the shares of a subsidiary, or the hospitals can otherwise be shown to have a unity of economic interests (the Copperweld standard), it may be able to achieve single-entity status. Conduct by a single entity by definition cannot be an agreement in restraint of trade such as price fixing or market allocation.

Even if an affiliation does not create a single entity (and many, if not most, "virtual mergers" do not), it may be entitled to rule-of-reason treatment of its activities. For example, an integrated joint venture, as defined in Maricopa, that shares the risk of loss and the opportunity for profits, may be able to set prices and allocate services without risk of per se liability. In that case, the affiliation will be assessed in light of all of the competitive circumstances of the relevant market. (The entity must still guard against achieving undue market power.)

The above approaches are as yet untested. At least one government antitrust enforcer has expressed skepticism about whether virtual mergers can be considered to be single entities under Copperweld. "Comments on the Antitrust Aspects of Hospital Virtual Mergers," speech by Mark J. Botti, U.S. Department of Justice, Antitrust Division, at the American Health Lawyers Association Annual Meeting (July 1, 1998). The speech also indicates that joint managed care negotiations may not be justified by sharing profits and losses in the eyes of the antitrust authorities, in spite of the language in Maricopa. Nevertheless, we believe the better view is that financial integration (i.e., sharing a bottom line) should entitle a virtual merger to rule-of-reason treatment.

The Poughkeepsie case also illustrates a recent fact of life of antitrust enforcement. State antitrust enforcers may be even more aggressive than federal enforcement agencies, especially in the health care arena. The State of New York brought this case in spite of the clearance of the affiliation by the U.S. Department of Justice. Similarly, the State of California recently challenged in federal court (albeit unsuccessfully) a hospital merger that was allowed to proceed by the Federal Trade Commission. State of California v. Sutter Health et al., 84 F.Supp2d 1057 (N.D. Cal. 2000), aff'd mem., No. 00-15039 (9th Cir. May 2, 2000).

The lesson from the Poughkeepsie case is that health care affiliations that fall short of full mergers should be carefully reviewed to determine whether they are structured in a manner that may avoid per se illegality. As a practical matter, tighter integration may not only minimize antitrust exposure but also may lead to a more successful affiliation in the long run. The string of "de-mergers" occurring in the hospital industry in recent months has mostly affected hospital affiliations where no significant integration has taken place.

Further Information

For further information on the subject of this Health Care Commrentaries, readers are urged to consult its principal author, Toby G. Singer, in our Los Angeles Office (telephone: 202/ 879-4654), their regular contacts at Jones Day, or any of the following lawyers for specific legal advice regarding their own situations.

Thomas E. Dutton

Columbus

614/ 469 3897

Robert C. Jones

Washington

202/ 879 3876

Kevin D. Lyles

Columbus

614/ 469 3821

Ross Stromberg

Los Angeles

213/ 243 2463

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