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The American Airlines-US Airways Merger: Clearance for Takeoff Delayed or Denied?

Fall 2013

On August 13, 2013, the U.S. Department of Justice (DOJ) and seven attorneys general representing six states and the District of Columbia filed a Clayton 7 action in the DC District Court to permanently enjoin the proposed American Airlines-US Airways merger for being anticompetitive.  On September 6, the attorney general for Michigan also joined the action.  The merger, if permitted, would create the world's largest airline by traffic, but only slightly larger than United Airlines and Delta Air Lines, which are, in their current forms, legacy-carrier mergers of United Airlines and Continental Airlines, and Delta Air Lines and Northwest Airlines.  Together with Southwest Airlines, which itself is in the process of absorbing AirTran Airways, the four merged carriers would account for about 80% of the U.S. domestic air transportation market.  DOJ's attempt to block this latest effort to concentrate the airline industry took many observers by surprise, as it represents a departure from the government's most recent application of the antitrust laws to the legacy carriers' post-bankruptcy consolidations.  American, now also seeking to emerge from bankruptcy, seemed to be following a well-worn path.  This article will briefly recite the elements presented in DOJ's case, and offer a few observations on possible outcomes.

The Government's Case Against the Merger

Under Clayton 7, the plaintiffs bear the burden of demonstrating that a proposed merger will lessen competition or tend to create a monopoly in one or more relevant service markets or submarkets, as defined geographically and by the availability of service substitutes for consumers.  Unlike actions brought under sections 1 and 2 of the Sherman Act, which focus on past or current conduct of defendants, such as price-fixing or efforts to monopolize markets, Clayton 7 is predictive and requires a forward-looking inquiry into the probability of adverse consequences on consumer welfare (i.e., rising prices and/or reductions in services available in an identified service market) that would occur if the merger were allowed to proceed.  Importantly, plaintiffs need show such results in only a single relevant market in order to prevail.

In their 56-page complaint, DOJ and the several attorneys general identify three relevant markets in which consumers would allegedly suffer harm from an American-US Airways merger.

Their first concern is the national market for scheduled air services.  The complaint alleges that the remaining legacy carriers, post-merger, would engage in oligopolistic behavior, resulting in higher fares, increased fees for ancillary services, and reduced services.  The plaintiffs contend that there are now such high barriers to entry into the national air services marketplace that no new entrants would be able to discipline these very large network carriers, which have huge hubs, very large loyalty programs, dominance of high-yield business traffic, and the ability to engage in pricing practices that discourage any effective new entrants.  Similarly, the remaining existing carriers do not have the business size or models to mount effective network scheduled carrier services that consumers, particularly businesses, prefer.

As an example of the harm to consumers that will occur from further network concentration, the complaint alleges that the merger would cause US Airways to abandon its current practice of offering deeply discounted “Advantage Fares” that are designed to induce price-sensitive consumers to divert from more expensive nonstop services offered by American and the recently merged legacy airlines to US Airways' far less costly, but more time consuming, one-stop flights over its relatively small hubs in Charlotte, Philadelphia, and Phoenix.  To bolster this argument, the complaint shows how the merged legacy carriers no longer engage in similar pricing behavior because they have reached nationwide network size populated by large, robust hubs.  In that situation, according to the complaint, the recently merged carriers are no longer incentivized to run the risk of retaliation from engaging in such pricing tactics, citing some examples of tit-for-tat disciplinary pricing responses which tend to chill any such efforts.

The second relevant market is each of the discrete city-pairs in which American and US Airways compete.  There are 17 nonstop markets in which the two parties provide head-to-head competition.  This overlap would result in monopoly services in these markets that produced $2 billion in revenue.  Additionally, the complaint identifies more than 1,000 other city-pairs where the merger would lead to concentration levels in markets with single-carrier, but not nonstop, services that are presumptively unacceptable using DOJ's traditional Herfindahl-Hirschman Index (HHI) ratios.  These city-pair markets are listed in an appendix to the complaint showing the HHI ratio for each.

The third relevant market identified is the one for “slots” at Washington's Reagan National Airport (DCA), which are the exclusive rights to take off and land at DC's close-in airport.  These slots are valued at about $2 million each.  The merged carrier would wind up controlling some 69% of the DCA slots.  In consequence, the merged American-US Airways carrier would be the only airline operating services on 63% of the DCA nonstop routes.  The complaint shows that competition by low-cost carriers on DCA routes, such as JetBlue, has historically resulted in much lower fares, benefiting consumers.  DOJ notes that JetBlue, an American slot lessee, could also find itself without those leased slots if the merger were consummated, making the merged carrier's dominance of DCA even more harmful to consumers. The complaint contends that DCA, because of its proximity to downtown businesses and government offices, is a distinct relevant market.  Services at Dulles International Airport and Baltimore-Washington International Thurgood Marshall Airport, both 25 miles from the city-center, are not good substitutes for business travelers.

The complaint also anticipates the defendants' responsive, countervailing argument that the merger will be pro-competitive and consumers will benefit from having another large carrier matching United and Delta with its new network services.  DOJ and its fellow plaintiffs argue that such promises have not panned out with the other mergers that have been approved.  Rather, these have resulted in rapidly rising fares, higher and less competitive ancillary fees, and cuts in service.  It also cites US Airways' internal management emails that promote the pricing power that would occur from further industry concentration and discipline on capacity (seats) to be offered in the national market.  The complaint contends that signaling among horizontal competitors has been a problem in the industry in the past, citing the misuse of the Airline Tariff Publishing Company's facility, which was the subject of an earlier DOJ section 1 Sherman Act price-fixing lawsuit, and makes the argument that oligopolistic behavior is only enhanced by a reduction in the number of key industry players.

To blunt defendants' likely response that the merger is the only way for American and US Airways to compete against United and Delta (which DOJ only recently allowed to merge with Continental and Northwest respectively), the government complaint points to the high profitability currently being reported by each carrier and cites to public statements made by the leadership of both carriers that each can continue to grow and prosper without the merger in today's competitive environment.  Indeed, American was well along in developing and implementing a high-growth plan of reorganization as a standalone carrier before that plan was overtaken by US Airways' merger alternative announced last February.

The Lawsuit Delays the Merger

The lawsuit against the American-US Airways merger was filed only two days before Judge Sean H. Lane of the Bankruptcy Court in New York was expected to confirm the merger plan favored by American's creditors committee, its shareholders, and unions of both airlines, paving the way for a closing this fall.  Judge Lane deferred action on the merger plan at a hearing on August 15, but at a subsequent hearing on August 29, he signaled that he may confirm the merger plan, notwithstanding the lawsuit.  The next hearing is scheduled for September 12, but Judge Lane could act by written order to confirm the merger plan before that date.

The DOJ case has been assigned to DC District Court Judge Colleen Kollar-Kotelly.  She has scheduled a trial date of November 25, and the parties expect that the trial will last 10 to 12 business days.  The plaintiffs intend to present about 15 witnesses, while the defense is contemplating only about six witnesses.  In the meantime, the plaintiffs plan up to 50 pre-trial depositions and the parties will exchange millions of documents according to reports on the matter.

American and US Airways have stated that they will vigorously defend the case.  The defendants can be expected to pursue the argument that the national market for scheduled services would not be adversely affected given consumer choice of services and that, in any event, the merger is actually pro-competitive.  That is, competition and consumer welfare will be enhanced by permitting American and US Airways to join together and compete on a nearly equal basis with United and Delta in terms of fleet size, hub strengths, loyalty programs, and lower costs produced by increased economies of scale.  The defendants could argue that if their merger is not allowed, consumers nationwide will ultimately be harmed because the larger legacy carriers will function as a duopoly, marginalizing American and US Airways and the other smaller carriers that would not have competitively sized networks and cost structures and, importantly, would not be able to obtain sufficient numbers of the all-important, high-yield corporate business accounts.

As for the DCA slots market, defendants are likely to argue that DCA is only one of three major airports serving the Washington geographic area, thus giving consumers ample choices in terms of service and price—i.e., arguing that DCA slots should not be treated as a relevant market or recognized as a relevant sub-market under Clayton 7.  The defendants can also be expected to make a showing that DOJ has not traditionally regarded other-than-nonstop city-pair services and pricing to be an alternative for higher-quality nonstop services in the same city-pair markets, thus attempting to overcome the “Advantage Fare” part of the plaintiffs' case on relevant-market definitional grounds as well, while also contending that markets defined by single-carrier, other-than-nonstop services are too variable to measure using HHI ratios.

The filing of the lawsuit and the timing have caused some to believe that this effort is merely a gambit to force the merger parties to divest a significant number of slots at DCA.  That is, to compel a negotiation over perhaps the most visible problem with the merger from a political (local Washington insider) point of view, leading DOJ to withdraw its other objections.  DOJ has denied any such intention, citing the breadth of the case and concerns about the harm to consumers nationwide.

Going Forward

What, then, are the choices for American, which was hoping to soon emerge from the bankruptcy that began almost two years ago with its chapter 11 filing in November 2011? One option, of course, would be to fall back to its standalone plan and abandon the merger. This step would present enormous difficulties for American, its creditors, and other stakeholders, according to the arguments that they have made to force an early trial date.  Ultimately, exercising that option would be a matter of timing.  The terms of the merger agreement, fiduciary undertakings, and expensive break-up fees require American to defend the merger at least until the agreement expires on December 13, at which point the parties could walk away or extend the agreement by mutual consent.  However, should the bankruptcy court decide not to confirm the merger plan pending the results of the DOJ action or a settlement, and if the DC District Court action should be unexpectedly delayed, American may come under increasing pressure to move forward with its own plan.  It goes without saying that lengthy delays would only contribute to uncertainty about the merger itself, and could further adversely affect American's standalone planning and retention of key personnel.

The second option is to attempt to negotiate a way out of the lawsuit.  This, too, is problematic, even though both sides have advised Judge Kollar-Kotelly that they are willing to engage in settlement negotiations (although DOJ has remarked that it has received no proposal from the defendants).  Divestiture of DCA slots would no doubt be very much on the table.  Any such negotiations would be a numbers game, both in terms of how many slots and at which times (not all slots have equal utility because of the timing and pairing of takeoff and landing slots and aircraft size and perimeter rule limitations).  One would expect DOJ and the other plaintiffs to seek a heavy price in terms of slot divestiture if meaningful low-cost alternative services at DCA are to be put in place. The net beneficiaries could be Southwest, JetBlue, Sun Country, Spirit, or Virgin America.  Another piece of the negotiation puzzle would perhaps be an undertaking by the merged airline to continue low-cost pricing in markets served on less than a nonstop basis against nonstop services by others in those markets.  The complaint focuses heavily on this issue and its impact on consumer welfare.  Whether this subject even admits of a settlement in a form that would be acceptable to the court and enforceable (Which markets? What discount levels? For how long?) seems highly problematic.  Lastly, there is the matter of the overlapping markets and high HHI concentration levels.  This subject is arguably more manageable, because the nonstop overlaps are relative few in number and probably could be ignored because of likely new entry by another carrier, and the 1,000-plus other-than-nonstop markets could be dealt with as part of a global settlement on grounds that consumer choice and entry in such markets still would remain high enough to ensure that consumer welfare is protected.

Failing abandonment of the American-US Airways merger or a settlement, the DC District Court will decide the matter following a bench trial on the merits.  DOJ's new Assistant Attorney General for Antitrust, William Baer, has made post-filing statements to the press that he believes strongly in the positions that are set forth in the complaint.  DOJ will clearly rely heavily on the Hart-Scott-Rodino merger-notification record it has compiled, its internal economic analyses, and the information to be obtained from the numerous depositions it will take (including third parties) before the November 25 trial date.  Defendants have been equally adamant about the strengths of their positions.  Whatever the outcome, it is clear that the future structure of the U.S. air transportation marketplace will be determined by application of the antitrust laws and not by an expert agency applying national transportation policy—just as Congress foresaw when it deregulated the industry 35 years ago.