US v. Anthem: Key Takeaways of the Anthem-Cigna Opinion and Next Steps in Delaware

Practical Law Legal Update w-006-5804 (Approx. 8 pages)

US v. Anthem: Key Takeaways of the Anthem-Cigna Opinion and Next Steps in Delaware

by Practical Law Antitrust and Practical Law Corporate & Securities

The District Court's Findings

In enjoining the transaction, Judge Amy Berman Jackson found that the Department of Justice (DOJ) demonstrated likely competitive harm in the markets for:

The sale of commercial health insurance to national accounts (employers with over 5000 employees) in a single geographic market comprised of 14 states.
The sale of commercial health insurance to large-group employers (employers with over 100 employees) in Richmond, Virginia.

The court did not reach the DOJ's claims that the proposed merger would hurt competition in additional markets, including:

The sale of commercial health insurance to national accounts in a nationwide geographic market.
The sale of commercial health insurance to large-group employers in 34 additional local markets.
The purchase of healthcare services from hospitals and physicians in 35 local markets (known as a monopsony claim).

The trial was divided into two phases, dealing first with the national-accounts market and then the remaining markets. The trial lasted seven weeks and included 29 fact witnesses, two DOJ experts, and three experts for the defendants.

National-Accounts Market

The court found that the market shares and concentration levels in the national-accounts market far exceeded the thresholds in the 2010 DOJ and FTC Horizontal Merger Guidelines (Merger Guidelines) to show presumptive competitive harm. The court noted that the merger would reduce the number of significant competitors from four to three and that business documents showed that Anthem and Cigna were particularly close competitors.

The court also noted that Cigna was a particularly innovative competitor, whereas Anthem competed largely based on the larger discounts for healthcare services that it obtains by virtue of its participation in the Blue Cross Blue Shield association. The court found that the merger was likely to reduce innovation in the market as a result.

In finding likely competitive harm, the court observed that:

Anthem and Cigna did not have to be each other's closest competitors for the proposed merger to lead to unilateral effects, as long as they were close competitors.
Regional competitors, such as California's Kaiser, and new entrants were not sufficient to replace the competition lost by the merger.
National-account customers were unlikely to piece together multiple regional insurers (a practice known as slicing) as an alternative to the big four national insurers.

The court also rejected significant efficiencies claims. Anthem argued that Cigna customers would benefit from Anthem's lower pricing arrangements with healthcare providers, resulting in savings in consumer healthcare costs of $2 billion. The court found, among other things, that the proposed savings:

Were not merger-specific – or potentially were not efficiencies at all – because they did not arise from anything new, improved, or different that the merged company would bring to the marketplace. Instead, the court noted that the savings, at best, would result from the exercise of Anthem's market power.
Arose outside of the market where the competitive harm was likely to occur. The court held that the parties do not sell healthcare services and therefore savings in healthcare costs were not relevant to an analysis of the merger's effects.

The court also rejected arguments that integration would result in $2.36 billion in general and administrative savings, finding that the efficiencies were not verifiable. The court noted that the parties had made little progress in integration planning and that the antagonistic relationship between the parties made the efficiencies particularly hard to achieve.

Large Group Employer Market

The court also found that the DOJ had shown likely competitive effects in one of the local markets for the sale of commercial health insurance to large-group employers. The court noted that:

The large-group-employer product market was a valid separate market despite overlapping to an extent with the national accounts.
Local market definitions based around Core-Based Statistical Areas, an aggregation of zip codes frequently used in the healthcare industry, were appropriate.

The court found that the market shares and concentration figures established a presumption of competitive harm under the Merger Guidelines and that the defendants failed to rebut this presumption based on competition from new entrants and other local alternatives.

Key Takeaways from the District Court's Analysis

Anthem's appeal to the D.C. Court of Appeals is likely to turn on whether the appellate court agrees with the lower court's treatment of the healthcare cost efficiencies. In particular, Anthem's arguments on appeal against the district court's findings include that:

A merger that significantly lowers consumer medical costs counteracts any potential competitive effects and benefits consumer welfare overall. Consumer welfare is the ultimate aim of the antitrust laws.
Price discounts obtained from healthcare providers are part of the services that Anthem and Cigna sell to their employer customers. The district court instead found that the insurers buy healthcare services the same way a company buys supplies, which led it to conclude that healthcare cost savings were not relevant to the merger analysis.
The district court's standard for assessing whether the efficiencies are merger-specific was too high and unrealistic.

Relying on efficiencies is nonetheless a challenging argument for Anthem to make successfully, given that no court has found that efficiencies alone rescue an otherwise anticompetitive merger.

The district court opinion is also notable for:

Heavy reliance on ordinary-course-of-business documents. Among other things, the court turned to Anthem and Cigna's business documents to refute the defendants' arguments and expert testimony on issues such as:
- the definition of a national-accounts product market, including using 5000 employees as the threshold;
- the closeness of competition between Anthem and Cigna;
- Cigna's role as an innovator in the market; and
- the lack of integration planning and the deteriorating relationship between the parties.
Extensive citation to the Merger Guidelines. While most courts considering merger challenges turn to the Merger Guidelines to some extent, Judge Jackson repeatedly turned to the Guidelines to consider matters such as:
- the exclusion of relatively distant substitutes in a product or geographic market;
- the exclusion of smaller or insignificant competitors from a relevant market;
- the appropriate unilateral effects analysis in markets involving negotiated prices; and
- the treatment of efficiencies based on purchasing supplies rather than the sale of a product.

Litigation in Delaware

On February 14, 2017, Cigna announced that it had filed suit in the Delaware Court of Chancery seeking declaratory judgment of its right to terminate the merger agreement with Anthem. Cigna's complaint also seeks payment of not only a $1.85 billion reverse break-up fee, but an additional $13 billion in damages. The next day, Anthem announced that it had countersued in the Chancery Court, seeking a temporary restraining order to enjoin Cigna from terminating the agreement. Anthem also revealed in its announcement that it had extended the merger agreement's termination date to April 30, 2017.

The litigation in Delaware implicates several provisions in the merger agreement, a description of which may be useful for M&A practitioners. For a summary of the agreement and links to the underlying provisions discussed below, see What's Market, Anthem, Inc./Cigna Corporation Merger Agreement Summary.

The Reverse Break-Up Fee Is Not Always the Sole and Exclusive Remedy

Firstly, it is worth noting that the $1.85 billion reverse break-up fee is explicitly not a cap on potential damages payable by Anthem to Cigna. Section 7.3(e) of the agreement states the following:

"Notwithstanding anything contrary in this Agreement, if Cigna receives the Reverse Termination Fee pursuant to this Section 7.3(e) and Anthem has not Willfully Breached any of its obligations under this Agreement, such payment shall be the sole and exclusive remedy of Cigna against Anthem…"

This language is clear that the function of the reverse break-up fee as Cigna's sole and exclusive remedy against Anthem is conditioned on Anthem not having "Willfully Breached" the agreement. This conditionality is reinforced by Section 7.2, the "Effect of Termination" section of the agreement, which states that:

"…no party hereto shall be relieved or released from any liabilities or damages arising out of (i) any fraud by any party, (ii) the Willful Breach by any party of any representation or warranty on the part of such party set forth in this Agreement or (iii) the Willful Breach of any covenant or agreement set forth in this Agreement."

"Willful Breach" is defined in the agreement as, "a material breach of this Agreement that is the consequence of an act or omission by a party with the actual knowledge that the taking of such act or failure to take such action would be a material breach of this Agreement or as otherwise contemplated by the last sentence of Section 5.14(h)." Cigna will therefore need to prove not only that Anthem materially breached the agreement, but that Anthem understood that its misconduct was tantamount to a material breach of the agreement. If Cigna cannot prove that degree of intent, it cannot win supplemental damages—though it can still collect the reverse break-up fee. (The last sentence of Section 5.14(h) refers to a failure by Anthem to pay the cash consideration at the closing. This is not germane to the issues at hand.)

The Right to Terminate the Merger Agreement

A preliminary dispute, however, revolves around whether Cigna has a right to terminate the agreement in the first place. If Cigna cannot terminate the agreement, it cannot trigger payment of the reverse break-up fee, let alone collect additional damages. There are two possible avenues in the merger agreement for terminating the agreement for reasons relating to failure to obtain antitrust approval. One is Section 7.1(g), which states that the agreement can be terminated:

"By either Anthem or Cigna, if the condition set forth in Section 6.1(a) [No Injunctions or Restraints] is not satisfied and the Legal Restraint giving rise to such non-satisfaction has become final and non-appealable; provided, however, that the right to terminate this Agreement pursuant to this Section 7.1(g) shall not be available to any party that has failed to perform fully its obligations under this Agreement in any manner that shall have proximately caused or resulted in the imposition of such Legal Restraint or the failure of such Legal Restraint to be resisted, resolved or lifted;"

At this point in time, Cigna clearly cannot use Section 7.1(g) to terminate the agreement, because the "Legal Restraint" caused by the district court's ruling is not "final and non-appealable"—it can be, and is being, appealed. This leaves Section 7.1(b), the termination-date provision. Section 7.1(b) states that the agreement can be terminated:

"By either Anthem or Cigna, if the Merger shall not have been consummated on or before January 31, 2017 (the "Termination Date"); provided, however, that the right to terminate this Agreement pursuant to this Section 7.1(b) shall not be available to any party that has failed to perform fully its obligations under this Agreement in any manner that shall have proximately caused or resulted in the failure of the Merger to have been consummated by the Termination Date; provided, further, that if all of the conditions to Closing shall have been satisfied or shall be then capable of being satisfied, other than the conditions set forth in Section 6.1(a) (but only if the applicable Legal Restraint constitutes a Regulatory Restraint) and Section 6.1(b), the Termination Date may be extended by Anthem or Cigna, by written notice to the other party, to a date not later than April 30, 2017;"

This provision is the source of the dispute brought before the Chancery Court. Before reading any of the provisos, Section 7.1(b) initially states that either party can terminate the agreement if the agreement has not closed by January 31, 2017. If that were the entire language of the provision, then Cigna would be allowed to terminate the agreement and, under Section 7.3(e), claim the reverse break-up fee (and sue for damages), as long as the reason why the agreement had not closed was because of antitrust failure. However, Section 7.1(b) is conditioned in two ways.

The first condition is that even after January 31, 2017, a party cannot terminate the agreement on the basis that the termination date has passed if that party's own breach of the agreement is itself the proximate cause of the failure to have closed. This is one path that Anthem can take against Cigna: demonstrate that the merger failed because of Cigna's own breach of the agreement. This could be difficult to prove, as the most obvious proximate cause of the merger's failure is that the district court determined that the merger would cause competitive harm. However, the decision did say, and Anthem highlighted in its press release, that the court could not ignore the "elephant in the courtroom" that Cigna had itself actively warned against the merger and sown doubt into the record. Anthem will likely use that language to make the case to the Chancery Court that Cigna's own efforts to "sabotage the merger" (as Anthem's press release put it) caused the merger's failure. In this regard, the case is somewhat reminiscent of the 2008 Huntsman v. Hexion litigation. In that case, the Chancery Court held that the buyer Hexion Specialty Chemicals, Inc. and its sponsor Apollo Global Management had breached Hexion's merger agreement with target company Huntsman Corporation, in large part by obtaining a solvency opinion to show that the combined company would be insolvent instead of exerting efforts to close the merger. Here, it is the buyer Anthem alleging that the target company Cigna is the party doing the sabotaging. (The Huntsman v. Hexion dispute is also an example of a case where the merger agreement's reverse break-up fee did not function as a cap on damages in the event of a willful breach. The parties ultimately settled for payment not only of the $325 million reverse break-up fee by Hexion, but of another $425 million by Apollo, plus a purchase of $250 million of bonds from Huntsman.)

The second condition in Section 7.1(b) is that either party has the right to extend the termination date, once, to April 30, 2017. It is this extension right to which Anthem referred in its press release when it said it had extended the merger agreement through April 30. For its part, Cigna stated in its press release that it had asked the Chancery Court to determine that Anthem is not permitted to extend the termination date. Cigna's argument here is that the extension right can only be exercised if all closing conditions except for antitrust approval have been met. If, as Cigna alleges, Anthem has materially breached the agreement, then the closing condition of Anthem's compliance with its covenants (a condition under Section 6.3(b)) has not been satisfied, and Anthem cannot extend the termination date.

Payment of the Reverse Break-Up Fee after Termination

To this point, then, there are two areas of dispute:

Whether Cigna can terminate the agreement in the first place to trigger the reverse break-up fee (and damages).
Whether Cigna can collect damages from Anthem on the basis of Anthem's "Willful Breach."

There is also a third point of contention. Even after the agreement is terminated (for example, after April 30, 2017), Cigna's right to collect payment of the reverse break-up fee is conditional on its own compliance with the merger agreement. Section 7.3(e) states that:

"… Anthem shall pay to Cigna a fee, by wire transfer in immediately available funds to an account specified by Cigna, in the amount of $1,850,000,000 (the "Reverse Termination Fee"); provided, however, that no Reverse Termination Fee shall be payable pursuant to this Section 7.3(e) in the event that (A) the failure of the condition set forth in Section 6.1(a) (but only if the applicable Legal Restraint constitutes a Regulatory Restraint) or Section 6.1(b) to be satisfied is caused by Cigna's Willful Breach of Section 5.3 or (B) Anthem has waived the condition set forth in Section 6.1(b) and Cigna refuses to effect the Merger on the basis that the condition set forth in clause (iii) or (iv) of Section 6.1(b) has not been satisfied."

The focus here is on clause (A). Anthem can avoid paying the reverse break-up fee if it can demonstrate that the Legal Restraint was caused by Cigna's own "Willful Breach" of Section 5.3, the antitrust-efforts covenant in the merger agreement. Anthem's arguments here will be the same as its arguments against Cigna terminating the agreement in the first place: that Cigna's own conduct was the cause of the merger's failure. Through Section 7.3(e), Anthem can marshal those arguments against payment of the reverse break-up fee, even after the agreement is eventually terminated.

Collecting a Lost Premium

It is worth noting one other issue that should not be a significant source of dispute. The $13 billion in damages that Cigna seeks should be recoverable under Delaware law, as long as that sum represents Cigna's lost premium and not special or consequential damages. When a contract delineates a specific payment amount and the timing for that payment (in the case of a merger agreement, the consideration payable at closing), and when that payment embodies a premium, the loss of that premium can be considered direct damages.

There is a potential lingering issue under New York law as to whether the premium essentially belongs to the stockholders, not the target company itself, and that only the stockholders have an expectation to the premium (see Consolidated Edison v. Northeast Utilities, 426 F.3d 524 (2d Cir. 2005)). Delaware law, though, likely does not subscribe to that understanding (see IBP, Inc. v. Tyson Foods, Inc., 789 A.2d 14 (Del. Ch. 2001)). In any event, Section 8.5(b) gives Cigna the right "to seek equitable relief or to pursue damages suffered by Cigna (including claims for damages based on loss of the economic benefit of the Mergers to Cigna's stockholders…) in the event of the wrongful termination of this Agreement or Willful Breach of this Agreement by Anthem."

Schedule

On February 15, 2017, the Chancery Court granted Anthem the temporary restraining order, preventing Cigna from terminating the agreement and allowing Anthem enough time to appeal the district court's decision. A hearing has been scheduled for April 10.

On February 17, 2017, the United States Court of Appeals for the District of Columbia Circuit granted Anthem's emergency motion to expedite and ordered a briefing schedule that contemplates hearing oral argument on March 24. The appellate court's order adds that "no requests for extensions of time will be considered."

US v. Anthem: Key Takeaways of the Anthem-Cigna Opinion and Next Steps in Delaware | Practical Law