Key Takeaways: District Court Enjoins JetBlue/Spirit Merger

Practical Law Legal Update w-041-9929 (Approx. 6 pages)

Key Takeaways: District Court Enjoins JetBlue/Spirit Merger

by Practical Law Antitrust

Background

JetBlue and Spirit entered into a merger agreement in July 2022. The DOJ and state attorneys general sued to enjoin the merger on March 7, 2023. The initial complaint was amended, and additional states were added on March 31, 2023. The complaint alleged that the merger would combine the sixth and seventh largest airlines in the US and the resulting firm would be the fifth largest airline. The airline industry is considered an oligopoly, dominated by the "big four" airlines, which includes legacy airlines American, Delta, and United along with Southwest. These airlines control approximately 80% of the industry. For more on the complaint, see Legal Update, Key Allegations in the DOJ JetBlue/Spirit Complaint.

JetBlue is a low-cost carrier (LCC), meaning it relies on point-to-point flying using fewer types of aircraft. JetBlue is known for having certain perks like greater legroom, wider seats, widely available internet and entertainment offerings, and variety of free snacks. Spirit is an ultra-low-cost carrier (ULCC), meaning it offers customers even lower fares than LCCs by lowering its costs further, such as by unbundling airline services. Spirit offers very low prices and is considered a disruptor, or a maverick, in the passenger airline market.

After a 17-day bench trial that started in October 2023, and involved extensive discovery and witness testimony, the court identified certain key findings, including that:

The airline industry is an oligopoly that has become more concentrated following a series of mergers. A merger of smaller players JetBlue and Spirit would allow the companies to grow in size to compete with the larger airlines, further consolidating that oligopoly.
The airline industry has solved increased demand through inorganic growth by acquisition, which is a tried-and-true strategy in this industry.
While post-merger, a combined JetBlue/Spirit would put competitive pressure on large airlines, the merger had significant likely anticompetitive effects, including:
- harm to consumers who rely on Spirit's unique low-price model; and
- elimination of head-to-head competition between JetBlue and Spirit, which benefits all consumers.

The court identified certain other potential effects of the proposed merger, including:

Decreased airline seats.
Increased concentration in a number of passenger routes.
Increased debt for JetBlue
Increased prices for customers.

The court found that the merger would substantially lessen competition in violation of the Clayton Act. The judge, the Honorable William G. Young, was very complimentary to both sides' presentation of their cases (noting in the opinion that "there are no 'bad guys' in this case" and that the two corporations were merely seeking to maximize shareholder value, as they are expected to do).

In addition, Judge Young emphasized that while the merger, as it was currently structured, violated antitrust law, he declined to place a restriction on the parties' ability to enter into another merger agreement in the future.

The Merger Agreement and Proposed Divestitures

The merger agreement includes a number of provisions designed to overcome antitrust challenges and allocate antitrust risk. Under the merger agreement, JetBlue is required to divest JetBlue and Spirit assets up to those that would have a material adverse effect on the combined firm. JetBlue has also agreed to certain specific, proactive divestitures of assets in Boston, the New York metropolitan area, and Fort Lauderdale to Frontier and Allegiant. The court identified some deficiencies in these proposals, including that they:

Do not replace capacity on all Spirit routes it would stop serving if the merger was consummated.
Do not require Allegiant or Frontier to maintain a particular level of service at the divestiture airports.
Only relate to airport-level assets and do not include, for example, additional airplanes or pilots to aid Frontier and Allegiant in managing their new routes.

The merger agreement includes a number of provisions to address potential delays or failure to close the merger due to antitrust laws, including:

An increase in the amount JetBlue will pay Spirit shareholders if the merger is not closed by December 2023, that apply as long as it closes by July 24, 2024.
A ticking fee.
A reverse break-up fee of $470 million.
A retention program to incentivize certain Spirit senior executives and other critical individuals on the management team to remain with the company during the transaction-review process.

For more on antitrust risk-shifting provisions and reverse break-up fees in merger agreements, see the What's Market, Antitrust Risk-Shifting Database and see Practice Notes, Antitrust Risk-Shifting Provisions: Overview and What's Market: Reverse Break-up Fees for Antitrust Failure. For more on the risk-shifting provisions in this agreement, see What's Market, Antitrust Risk-Shifting Provisions in JetBlue Airways Corporation/Spirit Airlines, Inc. Merger Agreement.

Relevant Markets

The parties agreed that the relevant product market is scheduled air passenger service, but disputed the scope of the relevant geographic market. The proposed geographic markets were:

Every route that Spirit or JetBlue currently flies, or plans to fly absent the merger, proposed by the government plaintiffs.
The US, proposed by the defendants.

The court noted that airlines do compete nationally, including by making decisions on route offerings, product offerings, and customer loyalty programs at a national level. However, a number of considerations support a route-by-route geographic market (sometimes described as passenger service origin and destination (O&D) pairs) including:

Many decisions are made on the route-by-route level, including both pricing and network planning and decisions to enter or exit a route are made with specific, local customers in mind.
Airlines compete at the route level and track one another's actions at that level.
Customers generally consider O&D pairs within the geographic region where they intend to travel and so would not usually consider other O&D pairs as a viable alternative.
Historically, O&D pairs have been used to evaluate competition between airlines in the market for scheduled air passenger service.

The court held that the relevant geographic markets are each individual O&D pair (or route) where the defendants currently compete (this excludes routes where the plaintiffs alleged Spirit planned to enter). The court noted that it would continue to consider the impact of the merger on the national geographic market as well. The relevant markets include the following routes:

Nonstop overlap routes, which are routes on which both JetBlue and Spirit currently fly.
Connect routes, which are the routes where both Spirit and JetBlue fly connecting service.
Mixed routes, which are the routes on which one of the defendants flies direct service and the other offers connective service.
Spirit-only routes, which are routes that Spirit currently flies, but JetBlue does not.

Burden-Shifting Framework

The court analyzed the proposed merger under the traditional burden-shifting framework, which requires first that the plaintiff establishes a prima facie case to show a Section 7 violation. If a prima facie case is established, the burden shifts to the defendant to rebut that evidence. Finally, if the rebuttal evidence is sufficient to overcome the prima facie case, the court considers anticompetitive effects.

Prima Facie Case

The government offered evidence to support its prima facie case, including:

Presumptive illegality, as demonstrated by a post-merger HHI of over 2,500 or an increase in HHI of over 200 in 183 relevant markets.
Direct evidence of anticompetitive effects, including:
- elimination of head-to-head competition between JetBlue and Spirit on multiple routes, which would result in less competition over price and reduce the innovation of JetBlue as a smaller, maverick market participant;
- elimination of Spirit's competition with other airlines, which is particularly acute when considering the impact of removing Spirit as a disruptive and innovative competitor; and
- elimination of Spirit as a choice that consumers value as a unique, economical product option, which represents a cognizable harm.

The court held that the plaintiffs established a prima facie case under Section 7.

Defendants' Rebuttal

The court noted that the amount of evidence required of defendants to rebut a prima facie case is relatively low, but increases with the strength of the prima facie case presented. The court also explained that a defendant can rebut a prima facie case by doing either of the following:

Affirmatively showing why the merger is unlikely to lessen competition.
Discrediting the plaintiffs' evidence.

The court noted that the defendants attempted to do both in this case and also provided other evidence of the merger's potential procompetitive effects. The court ultimately found that the defendants met their relatively low burden of rebutting the government's prima facie case.

The court first considered the defendants' argument that potential entry could deter or counteract the merger's anticompetitive effects. The court considered whether such entry would be:

Timely. The court established that an appropriate timeline to consider entry timely would be two to three years after the merger. In that timeframe, the court felt that there would be some entry by other ULCCs, LCCs, or legacy airlines with unbundled, basic economy offerings into many of the markets that Spirit would be leaving as a result of the merger. The court noted that evidence supported this finding because the barriers to entry are fairly low, airplanes are mobile, and regular entry into some of these routes is nearly constant.
Likely. The court found that there was sufficient evidence of likely entry by other airlines to meet the defendants' burden at this stage. The court found that the proposed divestitures would assist with entry by other ULCCs into routes that Spirit recently left, and acknowledged that there was evidence that other ULCC were already entering routes Spirit had exited.
Sufficient. Acknowledging that the defendants had the hardest time proving this element, the court nevertheless emphasized that their burden is low. The court considered whether potential entrants would enter and expand beyond their own existing growth plans to fill the void left by the exiting airline. In addition, sufficient entry is harder to prove where the competitor being eliminated is a disruptor that historically disciplined larger companies. The court was not entirely convinced that entry would be sufficient to replace Spirit's current presence in the industry and so found that the entry evidence was not dispositive to rebut the prima facie case.

The court also considered the defendants' challenge to the government's market share data. The court found that the government failed to fully consider potential competition from airlines not currently active in the relevant market in their calculation of market share on routes. This failure undermined the predictive value of those calculations and the ability to rely on them to establish a presumption of illegality.

Finally, the court considered the alleged procompetitive effects of the merger, which included:

The merger would protect competition from a failing or weakened Spirit. However, the court found that this did not provide an affirmative defense to the government's case. Spirit had a long-term plan to return to profitability and there was not sufficient evidence that the financial situation was so dire that Spirit was facing imminent and irreversible collapse.
That the merger would create efficiencies that would result in procompetitive benefits. The court found that the defendants had provided strong evidence that the merger was procompetitive and would result in substantial benefits for consumers. These benefits included the ability for the merged firm to more vigorously compete with the big four carriers by expanding its offerings, increasing its ability to innovate, and enhancing the customer experience.

When considering all of the above evidence, the court held that the defendants met their burden to rebut the prima facie case.

Additional Anticompetitive Effect

Once the court found that the defendants successfully rebutted the government's prima facie case, the court turned to an analysis of additional evidence regarding the likely anticompetitive effects of the merger. The court held that if the anticompetitive effects of a merger are probable in any significant market, the merger is illegal. Despite the defendants adequately demonstrating that anticompetitive effects would be offset by new entry and procompetitive benefits, the court found that evidence failed to prove that the merger would not substantially lessen competition in at least some of the relevant markets.

In particular, the court held some customers who rely on Spirit would be harmed by its removal in at least some markets. The defendants failed to demonstrate that entry, even if it was exceedingly fast, would protect every consumer in every relevant market from harm. In addition, there was evidence that sufficient entry or takeover of Spirit routes would take more than 15 years to fully complete.

The court concluded that the government demonstrated, by a fair preponderance of the evidence, that the merger would substantially lessen competition in a relevant market.

Remedy

The court enjoined the merger. It did, however, reject the proposal from the government that future mergers also be enjoined. The court emphasized that the merger narrowly applies only to the proposed merger between JetBlue and Spirit as it currently stands and as it was agreed to by the parties in the merger agreement.

For more on the federal antitrust agencies' use of the loss of a maverick theory of competitive harm in merger enforcement actions, see Practice Note, What's Market: Loss of a Maverick Theory in Merger Enforcement Actions. For more on how the agencies analyze M&A generally, see Practice Note, How Antitrust Agencies Analyze M&A.

Key Takeaways: District Court Enjoins JetBlue/Spirit Merger | Practical Law