The opinion of the court was delivered by: MUNSON
MEMORANDUM-DECISION AND ORDER
Presently before the Court are two motions made by plaintiff Crouse-Hinds Company which are aimed at blocking a take over attempt by defendants InterNorth, Inc., and I N Holdings, Inc. (hereinafter referred to jointly as InterNorth). While both motions seek injunctive relief, they differ as to the grounds upon which such relief should be granted. The first motion asks that the Court declare InterNorth's tender offer null and void because it violates the summary advertisement and "twenty day" rules of the Securities Exchange Act, 17 C.F.R. §§ 240.14d-6(a)(2), and 240.14e-1(a). Crouse-Hinds' second motion for injunctive relief is based on other alleged violations of the securities laws principally disclosure requirements and the antitrust laws. Plaintiff has requested the Court to first resolve the summary advertisement and "twenty day" rule issue, since a favorable ruling for Crouse-Hinds would be dispositive of its request for injunctive relief. Upon examining the basis of these arguments, however, the Court is not convinced of their merits. A more detailed analysis of these claims will be found in the securities portion of this opinion.
The Court will begin its consideration of plaintiff's entitlement to injunctive relief with an assessment of its antitrust allegations. Yet before doing so, a brief background of the events leading up to this dispute will prove useful.
To fully appreciate the factual circumstances surrounding the instant motions, intimate familiarity is assumed with this Court's related Memorandum-Decision and Order, dated October 25, 1980. By way of introduction to the matters at hand, the pertinent facts are as follows. On September 12, 1980, InterNorth publicly announced a tender offer for 6,600,000 shares of Crouse-Hinds' common stock, or approximately 54% of the total shares outstanding, at a price of $ 40 a share. InterNorth planned to follow this offer with a "second step" merger in which the remaining Crouse-Hinds' shareholders would be issued InterNorth preferred stock in exchange for their Crouse-Hinds' common stock.
News of InterNorth's tender offer was not favorably received by Crouse-Hinds' board of directors, who had, only three days before, announced a merger agreement with the Belden Corporation. The reasons for the Crouse-Hinds board's unreceptive attitude seemed to stem primarily from its belief that the InterNorth offering price was inadequate, and that the central condition of the tender offer the termination or shareholder rejection of the Crouse-Hinds/Belden merger agreement worked a disservice to the interests of Crouse-Hinds because it put the success of the proposed Belden merger in doubt.
Consequently, on September 16, 1980, the board of directors of Crouse-Hinds recommended that its shareholders reject InterNorth's offer.
In the meantime, Belden moved to put an end to what it considered to be a threat to its interests by filing a lawsuit against InterNorth in Illinois Circuit Court on September 15, 1980. Belden asserted that InterNorth's offer tortiously interfered with the Crouse-Hinds/Belden merger and it sought to enjoin InterNorth's tender offer for Crouse-Hinds stock. A preliminary injunction was ultimately granted by the Circuit Court on October 1, 1980. It enjoined InterNorth from pursing its tender offer, pending a vote by Crouse-Hinds and Belden shareholders on their proposed merger agreement, or until December 1, 1980, whichever was earlier.
Subsequently, on November 10, 1980, an Illinois Appellate Court vacated the injunction, and remanded the matter to the Circuit Court.
On September 22, 1980, Crouse-Hinds responded to the InterNorth tender offer with this lawsuit for injunctive relief, alleging that the InterNorth offer violated the federal securities laws. Later by amendment to its complaint, Crouse-Hinds also asserts that, if consummated, an InterNorth/Crouse-Hinds merger would violate the antitrust laws. Crouse-Hinds promptly moved for injunctive relief,
and on October 7, 1980, this Court commenced an extensive hearing on this motion.
The hearing produced approximately one thousand pages of testimony, and a host of witnesses, exhibits, affidavits, and legal briefs.
While a hearing on plaintiff's motion for a preliminary injunction was completed on October 31, 1980, events continued to unfold. On November 12, 1980, InterNorth announced an amended offer. One of the principal differences between the amended offer and the original was that InterNorth modified its stance on the Belden/Crouse-Hinds merger. In its amended offer, InterNorth retained its original $ 40 offering price, but it stated that this price was conditional on the shareholders' rejection of the Belden/Crouse-Hinds merger. However, InterNorth stated further that, should that merger be approved by the shareholders of those companies, then InterNorth was prepared to pay $ 37 for each share of Crouse-Hinds stock. The legality of the terms of the amended offer was the subject of additional briefing and affidavits of the parties. In addition, on November 18, 1980, the Court heard oral arguments on this subject. The Court will begin its examination of the issues raised by plaintiff, by first considering its antitrust claims.
The thrust of plaintiff's antitrust claims is that a Crouse-Hinds/InterNorth merger will cause a drastic alteration in the market structure for certain Crouse-Hinds products, and thereby substantially lessen competition in those markets in violation of Section 7 of the Clayton Act, 15 U.S.C. § 18. Crouse-Hinds manufactures electrical, construction and lighting equipment, as well as aviation lighting, and traffic control signal equipment. InterNorth is a major energy company which is engaged in acquiring, transporting, and marketing, of natural gas and liquid fuels; the processing and production of petrochemicals; natural gas and oil exploration; and coal mining. According to Crouse-Hinds, InterNorth intends to use its "power" as both a purchaser of goods, and as a monopolist in the transportation and sale of natural gas, to coerce sales of Crouse-Hinds' products, and foreclose competition.
The prospect of antitrust violations in any industry must be carefully examined by the courts due to the stifling effect such conduct has in the marketplace. The Court views plaintiff's allegations with even greater concern because an "energy monopolist" is involved. For example, two celebrated legal commentators argue that a court need not employ the typically speculative methods of antitrust analysis when assessing the possible anticompetitive harm a monopolist can cause in a secondary product market. The threat of using the economic power of a monopoly of "an essential good or service necessarily produces monopoly of the second level." III Areeda & Turner, Antitrust Law, P 729 at p. 239 (1978) (emphasis in text); (hereinafter referred to as Areeda & Turner). Plaintiff's claims will be reviewed in greater detail in a moment. At this juncture, an analysis of Section 7 of the Clayton Act is in order.
An examination of the alleged anticompetitive effects of a merger must begin with Section 7 of the Clayton Act which in relevant part provides:
No corporation engaged in commerce shall acquire, directly or indirectly, the whole or any part of the stock ... of another corporation engaged also in commerce, where in any line of commerce in any section of the country, the effect of such acquisition may be substantially to lessen competition or to tend to create a monopoly.
In enacting this provision, Congress sought to curtail what appeared to be the continuous and unrestrained trend of the economy towards economic concentration. Brown Shoe Co. v. United States, 370 U.S. 294, 317, 82 S. Ct. 1502, 1519, 8 L. Ed. 2d 510 (1962). To a great extent, corporate expansion through mergers was causing this trend. Congress responded to the problem by enacting Section 7, in order to arrest a merger that was perceived as being anticompetitive in its "incipiency," before the full force of its harm would be felt in the marketplace. Id. at 317-18, 82 S. Ct. at 1519-20.
Nevertheless, not every merger was intended by Congress to be excluded as undesirable. To screen out those that would likely produce anticompetitive effects, Section 7 provides that the competitive effect of a particular merger is to be judged in the context of a specific product market ("line of commerce"),
and in an economically significant geographic market ("section of the country"). Id. at pp. 320-21, 82 S. Ct. at pp. 1521-22.
At the same time, Congress recognized that such an analysis must be "functionally viewed, in the context of its particular industry." Id. at pp. 321-22, 82 S. Ct. at pp. 1521-22. Various factors need to be considered to assess the probable competitive effect of a merger. The Court in Brown Shoe summarized these elements thusly:
whether the consolidation was to take place in an industry that was fragmented rather than concentrated, that had seen a recent trend toward domination by a few leaders or had remained fairly consistent in its distribution of market shares among the participating companies, that had experienced easy access to markets by suppliers and easy access to suppliers by buyers or had witnessed foreclosure of business, that had witnessed the ready entry of new competition or the erection of barriers to prospective entrants, all were aspects, varying in importance with the merger under consideration, which would properly be taken into account.
Id. at 322, 82 S. Ct. at 1522. While statistics were viewed as being a useful tool in a court's endeavor, Congress intended that a court go beyond a mere analysis of economic data when assessing the market power of a firm and the likely anticompetitive effect of a merger. "(Only) a further examination of the particular market its structure, history and probable future can provide the appropriate setting for judging the probable anticompetitive effect of the merger." Id. at p. 322 n. 38, 82 S. Ct. at p. 1522 n. 38.
Finally, the phrase "may be substantially to lessen competition" as used in Section 7, indicates that the concern of the Clayton Act is not with the economic consequences of a merger in terms of "ephemeral possibilities," but with its probable competitive impact.
Id. at 323, 82 S. Ct. at 1522. "Taken as a whole, the legislative history illuminates congressional concern with the protection of competition, not competitors, and its desire to restrain mergers only to the extent that such combinations may tend to lessen competition." (Emphasis in text) Id. at p. 320, 82 S. Ct. at p. 1521. See United States v. Marine Bancorporation, Inc., 418 U.S. 602, 94 S. Ct. 2856, 41 L. Ed. 2d 978 (1974); United States v. Pabst Brewing Co., 384 U.S. 546, 86 S. Ct. 1665, 16 L. Ed. 2d 765 (1966); United States v. Von's Grocery Co., 384 U.S. 270, 86 S. Ct. 1478, 16 L. Ed. 2d 555 (1966); United States v. Aluminum Co. of America, 377 U.S. 271, 84 S. Ct. 1283, 12 L. Ed. 2d 314 (1964); United States v. Philadelphia National Bank, 374 U.S. 321, 83 S. Ct. 1715, 10 L. Ed. 2d 915 (1963); United States v. E. I. duPont deNemours & Co., 353 U.S. 586, 77 S. Ct. 872, 1 L. Ed. 2d 1057 (1957).
There are three basic types of mergers that are covered by Section 7 of the Clayton Act. These are horizontal mergers, or the acquisition by a producer of the stock or assets of a firm producing an identical product or close substitute and selling it in the same geographical market; vertical mergers, or the acquisition of the stock or assets of a firm that buys the product sold by the acquirer or that sells a product bought by the acquirer; and conglomerate, which are characteristically without appreciable economic relationship between the business of the acquiring and the acquired firm. "Mixed" or quasi-conglomerate mergers involving elements of a horizontal or vertical merger are also included within the scope of the Clayton Act. IV Areeda & Turner, supra, P 900 at p. 1. See also, Brown Shoe Co. v. United States, 370 U.S. at 317, 82 S. Ct. at 1519.
Before examining the competitive "setting" of the instant merger, the standard for issuing a preliminary injunction in the Second Circuit bears repeating. In order to be entitled to a preliminary injunction, a plaintiff must successfully demonstrate:
(a) irreparable harm and (b) either (1) likelihood of success on the merits or (2) sufficiently serious questions going to the merits to make them a fair ground for litigation and a balance of hardships tipping decidedly toward the party requesting the preliminary relief.
Seaboard World Airlines, Inc. v. Tiger International, Inc., 600 F.2d 355, 359-60 (2d Cir. 1979); Jackson Dairy, Inc. v. H.P. Hood & Sons, Inc., 596 F.2d 70, 72 (2d Cir. 1979) (per curiam); Jack Kahn Music Co., Inc. v. Baldwin Piano & Organ Co., 604 F.2d 755, 758 (2d Cir. 1979); Caulfield v. Board of Education, 583 F.2d 605, 610 (2d Cir. 1978); Triebwasser & Katz v. American Telephone & Telegraph Co., 535 F.2d 1356, 1358 (2d Cir. 1976).
The Court will begin its "functional" analysis of the market structure at issue here with an overview of the business activities of InterNorth. In a nutshell, InterNorth is a diversified, integrated energy conglomerate with net income of $ 185.5 million and operating revenues of.$ 2.5 billion.
It is possessed of five operating groups, which are all substantially related to natural gas and its derivative products. They are: the natural gas group, liquid fuels, petrochemical products, exploration and production, and coal. InterNorth's natural gas group acquires, transports, and sells natural gas to both wholesale and retail customers. More than half of the operating revenues and over 40% of the net income of InterNorth are derived from the natural gas group. The natural gas group operates a 34,276 mile network of pipeline, which services its 71 utility customers for distribution to 1,094 communities. The retail division, called "People's," is one of the country's 25 largest and services 319 cities and towns. It receives deliveries for sale to 238 of those communities from InterNorth's own wholesale division. In 1979, 61% of the natural gas group's total volume of gas sales to others was to residential, commercial and small volume industrial consumers, and 36% (sic) to large volume commercial and industrial consumers and pipeline companies. For the most part, the natural gas group services a cold weather geographic region, in which natural gas is a comparatively inexpensive form of energy for domestic purposes.
In 1979, 701 billion cubic feet of natural gas were sold at wholesale by InterNorth, and another 173 billion cubic feet of natural gas was sold at retail. Total revenues of more than $ 1.5 billion were derived from the natural gas sales. Also in 1979, production from InterNorth's own reserves was 787 billion cubic feet. Its certified proven reserves were 7.2 trillion cubic feet or an 8.7 year supply, not including 6 trillion cubic feet under contract awaiting regulatory approval and pipeline construction. Moreover, InterNorth has entered into contracts for the importation of 775 billion cubic feet from Canada. InterNorth is participating as a partner and operator in various joint ventures which will enable it to secure gas supplies in the future. These include the Alaska Northwest Natural Transportation Company, and the Trailblazer Pipeline, which extends from the Overthrust area of Wyoming to eastern Nebraska. Plans also call for construction of approximately 160 miles of additional pipeline in southeastern Texas. InterNorth's wholesale division, in common with the interstate pipeline operations, has faced a supply problem in the past ten years causing it to curtail or cut back service to its customers. Passage of the Natural Gas Policy Act has solved many of InterNorth's supply problems, by establishing equality between interstate and intrastate pipelines. No curtailment is forecasted for 1980, and generally the supply picture has improved. As an industry rule of thumb, however, there will be a decline in overall industry production of 3% a year.
By virtue of its pipeline ownership, InterNorth enjoys a position of monopoly power over natural gas supply throughout most of its geographic area of operation. Even where it is not the sole supplier of certain customers, InterNorth possesses monopoly power because customers cannot practicably turn to others for their supplies.
Still, InterNorth is a regulated monopolist, and operates under the supervision of the Federal Energy Regulatory Commission (FERC). This regulation offers a countercheck on InterNorth's "monopoly power." As a result, InterNorth is very sensitive to the needs, desires and opinions of its customers, whose support is solicited by InterNorth and viewed as necessary by it to obtain regulatory approval of such matters as rate increases, new construction, curtailment proceedings,
and the transportation of gas for third parties.
InterNorth's desire to curry the good will of its customers is reflected in the frequent "customer meetings" it holds around the country.
In this regard, InterNorth believes that it enjoys good customer relations, and it feels the need to be careful to conduct itself in a manner that will not endanger that good will.
While much of InterNorth's conduct is regulated, nonetheless, it is able to exercise discretion in a variety of matters, such as in the formulation of rates to be presented to FERC for approval.
InterNorth also may, in its discretion, agree to transport excess supplies of gas purchased from a source other than InterNorth, and negotiate its own transportation price.
Furthermore, InterNorth may use its discretion in implementing curtailment plans,
and in offering new and additional supplies of gas to its wholesale and retail customers. Two caveats must be added for the sake of completeness. Under its regulatory "tariffs" InterNorth agrees to make its best efforts to make gas available if it has the supplies. InterNorth may not, moreover, discriminate in its service among its customers.
The liquid fuels group is engaged in the extraction, purchase, transportation and marketing of liquid hydrocarbons, principally propane, butanes, ethane, and fuel oil. It is one of the largest vertically integrated producers of liquid fuels in the United States. In addition, the liquid fuels group operates natural gas processing plants which separates liquid hydrocarbons from dry gas. In 1979, it produced 734 million gallons of liquid products and purchased an additional 1.1 billion gallons from other companies. Its operating revenues for that same year exceeded $ 787 million, which was 28.7% of InterNorth's total revenues.
InterNorth's petrochemicals group produces and processes over one billion pounds of petrochemical products each year. In 1979, the petrochemicals group had sales in excess of $ 327 million, reflecting 13% of InterNorth's total revenues. The exploration and production group conducts extensive exploration and drilling activities to provide new supplies of natural gas for InterNorth's other operations, and holds over one million acres of gas and oil leases. Also in 1979, this group produced 14 billion cubic feet of natural gas and 91,000 barrels of crude oil and condensate, and had operating revenues in excess of $ 51 million. The recently established coal group has a total of approximately 340 million tons of recoverable reserves under lease and has begun operation in two mines in Colorado. In 1979, operations of the coal group resulted in a 14 cents per share loss. As a final note, InterNorth's interdivisional sales of the various groups in 1979 amounted to over $ 219 million.
The present size of InterNorth is in part attributable to the fact that it has made over 100 acquisitions during the past twenty years.
InterNorth is organized into profit centers which have a "dotted line" relationship with the corporate development staff to coordinate future capital expenditures for expansion.
Capital expenditures by InterNorth for 1979 were $ 384.8 million, and it estimates slightly higher expenditures in 1980, increasing to $ 650 million by 1983. Actual expenditures on capital plants as distinguished from, for example, expenditures on gas contract payments, would amount to approximately $ 100-$ 150 million annually. Over the three year period from 1981-83, approximately 59% of InterNorth's proposed.$ 1.8 billion in capital expenditures are for the natural gas area, and the rest is allocated with approximately 10% for liquid fuels, 7% for petrochemicals, 22% for exploration and production, and 2% for coal.
Due to conservative investing in the past several years, InterNorth will have $ 150 million a year for the next three to five years to spend on further acquisitions. InterNorth views itself as somewhat at a turning point in its corporate development. While parity has been established between the intrastate and interstate pricing of natural gas, and as a result supplies have increased. For the most part, however, traditional sources of natural gas supplies are in a declining stage, with the possibility of the industry moving into more "exotic" forms of production to make up the difference. In its outlook for the future, InterNorth is interested in expanding into the synthetic fuels business, as a means of positioning the company in a growth industry, and guaranteeing earnings of 10% a year.
Crouse-Hinds is the leading company in the manufacture and marketing of electrical construction materials, which is composed of protective fittings and enclosures for the safe use of electricity by industry; load centers, circuit breakers, meter mounts and safety switches; indoor and outdoor lighting fixtures and aviation ground lighting equipment; electrical wiring devices, specialty switches and industrial controls; vehicular traffic control systems; and electrical distribution equipment such as switchboards, panelboards, switchgear, motor control centers and bus ducts.
In addition, Crouse-Hinds' electrical construction materials products include components of secondary electrical power distribution systems required for the assembly of wiring systems by using rigid or flexible metallic conduits and power or control cables, such as cast metal boxes and outlet bodies, unions, couplings, terminators and other fittings for conduit and cable; enclosed lighting fixtures for all types of light sources; cast metal and fiberglass reinforced plastic enclosures for circuit breakers, motor starters, pushbutton stations and instrument and other control devices; and heavy-duty electrical plugs, receptacles and cord connectors.
The majority of these products are especially designed to provide mechanical protection against heavy or abusive use, and most provide environmental protection that makes them suitable for use in wet, dirty, dusty, corrosive, flammable or explosive atmospheres. All are designed to meet the applicable "code" requirements. Crouse-Hinds products are principally used by heavy industries and other operations having heavy service requirements, where physical abuse is common, or where the facilities are exposed to the elements, washed down, or subject to corrosive or explosive, flammable or conductive materials. These industries include: petroleum refining, chemical, petrochemical, steel, rubber, paper, pharmaceutical, flour milling and paint processing industries, as well as the petroleum pipeline and coal mining industries.
Crouse-Hinds' products are employed as part of an industrial facility, and as part of the capital equipment that has to be purchased to build that facility.
It is the only company in the hazardous product area that does research and introduces new products on a consistent basis.
The shear breadth of the Crouse-Hinds' electrical construction product line lends it a distinct advantage over its competitors.
Furthermore, Crouse-Hinds has a broad customer/product base and enjoys high brand recognition and allegiance.
This partially explains the reason why Crouse-Hinds continues to enjoy great marketing success, in spite of the fact that many of its competitors manufacture goods of comparable quality, and sometimes at less expense.
Its net revenues for the year ending December 31, 1979 were over $ 372 million.
It is not disputed that the relevant product markets in the instant case include: hazardous service electrical construction materials; industrial lighting; commercial lighting; aviation lighting; and traffic control signal equipment. Crouse-Hinds' products compete throughout the United States, and therefore, the United States as a whole should be considered the relevant geographic market. While the Court has not been provided with statistics indicating industry trends towards or away from concentration, Appendix I to this Opinion contains market share statistics that have been introduced, and these cover selected product markets and submarkets. It will be noted that the four-firm concentration statistics have not been introduced in most instances. The Appendix also includes a summary of the results of a 1979 brand preference study on electrical construction materials published by McGraw-Hill.
Crouse-Hinds markets its products primarily through the nation-wide networks of three major electrical distributor chains; General Electric Supply Company (GESCO); Westinghouse Electric Supply Company (WESCO); and Graybar Equipment Company. Moreover, Crouse-Hinds' products are marketed through approximately 1,000 independently-owned electrical and electronic distributors, in some cases assisted by commission agents and technically-trained employees of Crouse-Hinds.
Many of these distributors carry Crouse-Hinds products as their sole or primary line of electrical construction materials and industrial and commercial lighting.
These distributors are the supply source of Crouse-Hinds products to: end users (facility owners) for new construction and for maintenance, repair and operation (MRO) of existing facilities; manufacturers of electrical equipment for incorporation into their own products; and construction engineering and electrical contracting firms.
The marketing effort of Crouse-Hinds' field representatives is directed at these various levels of "buying influence," or at the "specifiers" of electrical construction equipment. The end user, engineers and contractors are called "specifiers" because industry custom requires that electrical construction plan drawings designate a type or standard of electrical product, or actual brand name to be used in a particular project. Sometimes plans are "specified" with a general "code" standard which enables the contractor to purchase any brand that satisfies a particular function, and meets the applicable code standards for equipment. More frequently, however, specifications are drafted in the form of a brand name product and one of the terms "or equal" or "approved equal."
Crouse-Hinds is usually specified in the brand name part of such specifications.
The term "or equal" means that a company's purchasing department may substitute products for the named brand without reference to the designer or engineer for approval. The phrase "or approved equal" denotes that the designer or engineer must be consulted.
With the advent of malpractice insurance, it has become a more frequent practice for a designer or engineer to specify one brand name only.
As is readily apparent, manufacturers like Crouse-Hinds are very interested in influencing the "specifiers" in the marketplace to specify its products. The first level of buying influence are the end users. They are the owners of the facility to be constructed, and have the final word on which products will be included.
A related level of buying influence would be the in-house design and procurement departments of the end users. The second level of buying influence is the design and constructing firm designated by the end user to design and build the proposed project. The engineering firms are the most frequent source of specifying and therefore a very important aspect of marketing electrical products. Crouse-Hinds often deals with the largest such firms in the country.
Much of such firms' specifying work is produced by computerized specifying list which are used to estimate the cost of a project, and reflect a given engineering firm's parts preference based on past experience.
For example, the Fluor Corporation, the country's second largest engineering firm, has already placed some Crouse-Hinds products on its vendor list, and these products will automatically be specified on all future jobs. The final level of buying influence is the installing contractor, who is typically given the job of specifying the hundreds of small cost items on a particular project.
Even where the material specification permits an equal or approved equal, an electrical construction materials manufacturer whose brand is not specified by name is at a profound competitive disadvantage. First, there is very little chance a specification will be changed once it is made. The change there is hardly any incentive for a contractor to spend the effort to persuade a designer or end user that a different company's product should be substituted.
Other practical considerations also work to place the nonspecified manufacturer at a competitive disadvantage, not only on the initial job, but on future jobs as well. Once a specifier selects a particular product for one job, it is likely that the same product will be specified in the future if it performs satisfactorily.
Moreover, after a manufacturer's products are specified and installed, it will have also captured the MRO business, since most users do not maintain parts for more than one manufacturer.
Electrical engineer vendor lists have already been discussed. It should be mentioned here that once a manufacturer's product is listed, a competitor's product will be foreclosed from future business with that specifier for all practical purposes.
Because the market for electrical construction materials and industrial and commercial lighting is organized by fairly rigid trade practices, it is difficult for a new entrant to break into this industry. A further obstacle is the established brand preferences of specifiers.
It is also difficult to establish the necessary national network of distribution inventory and service. Most major chains will stock only one primary line, which a new entrant could not realistically expect to displace. In sum, from the limited evidence introduced, the barriers to entry into the electrical materials construction industry are quite high.
The Court will now examine plaintiff's antitrust claims and the applicable law.
Crouse-Hinds asserts that an InterNorth/Crouse-Hinds merger will drastically alter the market structure in the sale of electrical construction materials, industrial and commercial lighting for hazardous environments, and traffic control systems, and reduce the competitive dynamics in those product markets. Allegedly, this new structure will give Crouse-Hinds, as a division of InterNorth, a definite advantage over its competitors, and will, across the several markets affected by the merger, lock Crouse-Hinds into a position of dominance over all other competitors. Such a result, according to Crouse-Hinds, will be destructive of competition or tend to create a monopoly in violation of Section 7 of the Clayton Act, 15 U.S.C. § 18. More specifically, Crouse-Hinds complains that the proposed merger will create market structures that will increase the likelihood of such anticompetitive practices as reciprocal dealing, reciprocal effect, and tying arrangements. Plaintiff's reciprocity claims will be examined first.
While the basis of Crouse-Hinds reciprocity allegations are five-fold, the Court believes that two of these deserve separate treatment at this time. Crouse-Hinds asserts that, in keeping with past policies of inter-divisional purchasing, InterNorth would purchase all of its electrical construction materials from Crouse-Hinds if the companies merged. Its second claim is that an InterNorth/Crouse-Hinds merger would enable InterNorth to specify Crouse-Hinds products in all of its projects constructed by outside contractors. While plaintiff seeks to characterize these claims as reciprocal dealing and reciprocal effect, the Court cannot entirely agree. At issue is to what extent the disputed InterNorth/Crouse-Hinds merger is ascribed the vertical or conglomerate label. Throughout this lawsuit, plaintiff has referred to the proposed merger as having both vertical and conglomerate qualities. See Transcript at pp. 49, 804; Memorandum in Support of Plaintiff's Motion for a Preliminary Injunction; Antitrust Issues at p. 31. However, in its Post-Hearing Memorandum, plaintiff states that a vertical allegation was not even advanced as a basis of its preliminary injunction motion. Id. at p. 3.
Whether or not plaintiff views the instant proposed merger as being vertical or conglomerate, it will be recalled that a merger will at least have vertical characteristics if it involves the acquisition of the stock of a firm that sells a product bought by the acquirer. See supra, at p. 420. This seems to be the substance of plaintiff's first two claims as listed above. InterNorth's ability as a result of the merger, to purchase all of its electrical construction materials from Crouse-Hinds, or to specify only Crouse-Hinds products on its "outside" construction jobs, would not cross the borders of the doctrine of reciprocity, which is the practice by which a firm buys from those who buy from it. See e.g. FTC v. Consolidated Foods Corp., 380 U.S. 592, 594 & n. 2, 85 S. Ct. 1220, 1221 & n. 2, 14 L. Ed. 2d 95 (1965); V Areeda & Turner, P 1128 at p. 62. At least with respect to its first two claims, plaintiff does not speak to the possibility of two firms purchasing goods from each other. Rather, it posits a situation where one firm InterNorth will be able to meet its needs for certain products by buying those products from its subsidiary. Although it has been said that the doctrines of vertical integration and reciprocity are somewhat related in that they both require a finding of foreclosure of opportunities to rivals, see United States v. General Dynamics Corp., 258 F. Supp. 36, 56-58 (S.D.N.Y.1966); V Areeda & Turner, P 1122b at pp. 196-97; Bauer, Challenging Conglomerate Mergers Under Section 7 of the Clayton Act, 58 B.U.L.Rev. 199, 299 (1978), the Court believes that plaintiff's claims will require separate analysis under both of these doctrines.
Crouse-Hinds' "vertical" claims are summarized as follows. After merging with Crouse-Hinds, InterNorth would satisfy all of its needs for electrical construction materials, and industrial and commercial lighting for hazardous environments, from its newly acquired subsidiary. According to Crouse-Hinds, InterNorth's need for these types of products results from its ownership and interests in a variety of physical plants and energy-related projects. It cites as examples the fact that InterNorth is a substantial purchaser of natural gas and liquid fuels processing plants, natural gas and liquid fuels pipelines, offshore oil and gas production and exploration platforms, petrochemical plants, and will figure prominently in the construction of synthetic fuel production plants. In addition, as mentioned already, InterNorth has been designated the "operator" in joint ventures involving gas production and transmission. Crouse-Hinds argues that InterNorth will be able to influence the specification of Crouse-Hinds' products for these projects.
Crouse-Hinds further points to the fact that all of these capital projects use substantial amounts of electrical construction materials and industrial and commercial lighting. As an industry rule of thumb, approximately 1% to 4% of a plant total would represent the cost of electrical construction materials and industrial and commercial lighting for hazardous use.
As alleged by Crouse-Hinds, in the past two years InterNorth's purchases of these products has amounted to approximately $ 250,000 to $ 750,000 annually.
Total industry sales of electrical construction materials and industrial and commercial lighting for hazardous environments is approximately $ 600 million annually. Crouse-Hinds asserts that the proposed merger will foreclose its competitors from access to these sales and consequently will substantially lessen competition or tend to create a monopoly in violation of Section 7. In this regard, if the merger is allowed to proceed, Crouse-Hinds says that it will gain substantial competitive advantages that will entrench its position in a concentrated industry, raise barriers to entry, and discourage smaller competitors from aggressively competing.
InterNorth demurs that Crouse-Hinds' fears concerning the extent of foreclosure from a vertical integration are unfounded. It points to the statistics for present Crouse-Hinds' sales to InterNorth as not only being de minimis, but not likely to increase. Testimony of InterNorth officers reveals that, even though InterNorth purchases annually some $ 3.5 million of wire, cable, electrical equipment and supplies, only 20% of that, or $ 600,000 would represent products of the type manufactured by Crouse-Hinds.
InterNorth states that even considering this latter figure, its purchases from all suppliers would amount to 0.2% of Crouse-Hinds' $ 300 million annual sales, and 0.08% of total market sales based on Crouse-Hinds' 40% market share.
Aside from the alleged insubstantiality of the commerce at issue, InterNorth maintains that other factors to be considered in a vertical merger case militate against the finding of a Section 7 violation. It argues that Crouse-Hinds has adduced no proof which would demonstrate that an improper economic motive figured into InterNorth's decision to take over Crouse-Hinds. InterNorth claims that its purpose in acquiring Crouse-Hinds was not to secure a captive supplier of electrical products. In its words, "one simply does not make a $ 500 million acquisition to "capture' an unthreatened $ 600,000 supply." Defendants' Post-Hearing Memorandum: Antitrust Claims at p. 17.
InterNorth further states that its past business policies do not indicate that it is intent on illegally foreclosing Crouse-Hinds' competitors from the marketplace. It explains that its policy toward interdivisional sales of liquid fuels is designed to offset swings in the business cycle which may or may not favor having an internal or external supply source. This is one reason why, says InterNorth, it reduced by 50% its interdivisional sales of liquid fuels, which once supplied 100% of the petrochemical group's needs. InterNorth claims this policy was also changed to put the liquid fuels group in a better position to negotiate with petrochemical, and to take advantage of sales opportunities outside the company. Other than the feedstock of liquid fuels, InterNorth asserts it does not coordinate the business activities of the five InterNorth groups which, in fact, are run as independent profit centers.
InterNorth additionally argues that militating against the likelihood of foreclosure is the fact that it employs competitive bidding for "commodity" items such as Crouse-Hinds' products where purchases would exceed $ 3,000.00. Crouse-Hinds has not, according to InterNorth, offered any evidence to suggest that this procedure would be changed after the merger to enable InterNorth to favor the use of Crouse-Hinds' products.
By way of concluding its defense with respect to the vertical ramifications of an InterNorth/Crouse-Hinds merger, InterNorth points out that Crouse-Hinds has failed to offer proof on the critical issues of trends toward concentration, and vertical integration in the markets for electrical construction materials and industrial and commercial lighting for hazardous environments. Nor has Crouse-Hinds shown that the proposed merger would result in heightened barriers to entry in these relevant markets. InterNorth argues that Crouse-Hinds has already taken the position that it is virtually impossible for a new company to enter into its markets.
In sum, InterNorth argues that Crouse-Hinds has not demonstrated a probability of success on its vertical foreclosure claim. With the background of the previous sections of this Opinion in mind, the Court will proceed with an analysis of the law of vertical mergers and the merits of plaintiff's claims.
The potential anticompetitive significance of a vertical merger is the extent to which it may increase barriers to entry into the market, or reduce competition by (1) foreclosing competitors of the acquiring firm from access to sources of supply, or from access on competitive terms, by (2) foreclosing competitors of the acquired firm from access to the market or a substantial portion of it, or by (3) forcing actual or potential competitors to enter or continue in the market only on a vertically integrated basis because of advantages unrelated to economies attributable solely to integration. Brown Shoe Co. v. United States, 370 U.S. 294, 328, 82 S. Ct. 1502, 1525, 8 L. Ed. 2d 510 (1962); Fruehauf Corp. v. F.T.C., 603 F.2d 345, 352 (2d Cir. 1979) (Mansfield, C. J.); Mississippi River Corp. v. F.T.C., 454 F.2d 1083, 1091 (8th Cir. 1972); International Telegraph & Telephone Corp. v. General Telephone & Electric Corp., 449 F. Supp. 1158, 1173 (D.Ha.1978) (on remand).
As the Court held in Brown Shoe :
The primary vice of a vertical merger or other arrangement tying a customer to a supplier is that, by foreclosing the competitors of either party from a segment of the market otherwise open to them, the arrangement may act as a "clog on competition," Standard Oil Co. of California v. United States, 337 U.S. 293, 314 (69 S. Ct. 1051, 1062, 93 L. Ed. 1371), which "deprive(s) ... rivals of a fair opportunity to compete." H.R.Rep.No.1191, 81st Cong., 1st Sess. 8. Every extended vertical arrangement by its very nature, for at least a time, denies to competitors of the supplier the opportunity to compete for part or all of the trade of the customer-party to the vertical arrangement.
370 U.S. at 323-24, 82 S. Ct. at 1522-23. Accord Ford Motor Co. v. United States, 405 U.S. 562, 569, 570-71, 92 S. Ct. 1142, 1147, 1148, 31 L. Ed. 2d 492 (1972). This latter point was elaborated upon in Freuhauf, where Judge Mansfield stated:
(W)e are unwilling to assume that any vertical foreclosure lessens competition. Absent very high market concentration or some other factor threatening a tangible anticompetitive effect, a vertical merger may simply realign sales patterns for insofar as the merger forecloses some of the market from the merging firms' competitors, it may simply free up that much of the market, in which the merging firm's competitors and the merged firm formerly transacted, for new transactions between the merged firm's competitors and the merging firm's competitors. See 2 P. Areeda & D. Turner, Antitrust Law P 527a (1978).
Consequently, Section 7 of the Clayton Act requires a Court to assess the likely competitive effect of a vertical merger in specific product and geographic markets. To prove its case, a plaintiff must make a greater showing then simply that a vertical merger will result in a significant percentage of market foreclosure. Recalling the Court's general discussion of Section 7 at Section III of this Opinion, a plaintiff must demonstrate, in addition, some probable anticompetitive effect or impact. See 15 U.S.C. § 18; see also United States v. Marine Bancorporation, 418 U.S. 602, 623 n. 22, 94 S. Ct. 2856, 2870 n. 22, 41 L. Ed. 2d 978 (1974) ("loss of competition"); United States v. General Dynamics, 415 U.S. 486, 498, 94 S. Ct. 1186, 1194, 39 L. Ed. 2d 530 (1974) ("probability of anticompetitive effects"); Brown Shoe Co. v. United States, 370 U.S. 294, 332, 82 S. Ct. 1502, 1527, 8 L. Ed. 2d 510 (1962) ("probable future effect"); United States v. E. I. duPont deNemours & Co., 353 U.S. 586, 591, 77 S. Ct. 872, 876, 1 L. Ed. 2d 1057 (1957) ("effect may be substantially to lessen competition").
Thus, to isolate the probable anticompetitive effect of a merger, if any, the foreclosure that it will probably produce must be assessed within the context of the "various economic and historical factors" of the relevant product and geographic market. Brown Shoe Co. v. United States, 370 U.S. at 329, 82 S. Ct. at 1526. It will be useful to list some of the factors outlined in Brown Shoe once again; the nature and economic purpose of the arrangement, the extent of foreclosure, extent of concentration of sellers and buyers in the industry, barriers to entry, scale of operating efficiencies, trend toward vertical integration or oligopoly, and elimination of potential competition. 370 U.S. at 322, 82 S. Ct. at 1522. To this list the Freuhauf Court has added: market power possessed by the merged enterprise, and the strength and number of competing suppliers and purchasers. 603 F.2d at 353. See also, United States v. Columbia Steel, 334 U.S. 495, 530, 68 S. Ct. 1107, 1125, 92 L. Ed. 1533 (1948) (noting that it is natural for a subsidiary to deal with its parent); V Areeda & Turner, supra, at P 1130C. In this manner the Court may determine whether the vertical merger poses a real threat of competitive harm or merely the prospect of a realignment of selling patterns. The Court now turns to an examination of the evidence in view of these principals.
InterNorth does not dispute that the relevant product markets for Crouse-Hinds' vertical claims are electrical construction materials and industrial and commercial lighting for hazardous environments. Nor is it disputed that the relevant geographic market is the entire United States. Although Crouse-Hinds seeks to cast the pale of evil monopolist over InterNorth's motivation to merge with Crouse-Hinds, the evidence most of which was offered by plaintiff suggests a far different scenario. InterNorth turned to the acquisition route principally to reap the benefits of diversification. For the most part, its financial future is tied to natural gas, which is a depleting natural resource. InterNorth viewed an acquisition at this time as a cheaper method by which to diversify as compared with building a business from the ground up, especially in a period with a depressed stock market. In addition, the timing of the merger was especially ripe for InterNorth from a capital surplus perspective, as it found itself with a large capital surplus for the next three to five years.
Based on its capital budget, its view of profitable future markets which centered mainly around energy and synthetic fuels and its future earnings goals, InterNorth systematically looked for an acquisition candidate. It was confident, due to its past experience, that it could manage a company that was technology and innovations oriented. Candidates were narrowed down by market positions, growth potential, likelihood of competitive offers, and insider holdings. Ultimately, the main concern was how the target company would "fit" with InterNorth's financial structure and management. Finally, five candidates were selected, and detailed market and financial studies were made. Eventually, these candidates were narrowed down to one Crouse-Hinds. Testimony of various InterNorth officers are consistent with this view of the purpose and motivation for InterNorth's proposed merger.
InterNorth's management looked upon Crouse-Hinds as a well run company,
a company that InterNorth could manage due to its orientation toward technology and innovation,
and a company that has a great future in a major growth market
energy. Furthermore, as planned by InterNorth's management, it was intended that Crouse-Hinds, as a sixth operating company of InterNorth, would be managed as an independent entity. Under InterNorth's plans, it thus would be capable of negotiating with other InterNorth operating groups and even InterNorth's rivals. In view of the generally independent operation of InterNorth's operating groups, this news is hardly surprising.
Moreover, such evidence must be given great weight because plaintiff has not offered any proof that would suggest that InterNorth looked upon a merger with Crouse-Hinds as a means by which to establish a captive source of supply. And, contrary to plaintiff's interpretation of the evidence it submits, the fact that both InterNorth and Crouse-Hinds have great expectations for future financial rewards in the synthetic fuels industry, does not prove InterNorth has an anticompetitive motivation. Such evidence falls well short of demonstrating that InterNorth sought to acquire Crouse-Hinds as a captive source before moving into these investments. Finally, though, it is not necessarily dispositive of this question, defendant's point that a reasonable and, the Court adds here, even unreasonable company would not make a $ 500 million acquisition to "capture" $ 600,000 worth of readily available electrical construction materials, has much to commend it.
The next factor to be considered is to what extent, if any, the InterNorth/Crouse-Hinds merger will cause market foreclosure. For its two "vertical" claims, Crouse-Hinds asks the Court to assess the amount of foreclosure resulting from InterNorth's purchases of electrical construction and industrial and commercial lighting for hazardous environments; and, secondly all specifications for InterNorth projects constructed by outside contractors. The Court notes at the outset that because of InterNorth's purchasing position as an end user, there would appear to be little difference between either of these claims. In any event, they will be construed by the Court to raise the question of foreclosure of InterNorth's MRO work, and new construction, including modifications and expansions.
The limited evidence adduced by plaintiff makes it difficult to even give a rough estimate of the degree of foreclosure that will probably result from InterNorth's purchases of hazardous electrical construction and lighting products of the type manufactured by Crouse-Hinds. However, the statistics that are provided do not indicate that a substantial foreclosure in terms of new construction would result from the merger. As a gross estimate, assuming that InterNorth's capital budget would enable it to purchase a $ 100-$ 150 million plant a year,
then the evidence shows that purchases of Crouse-Hinds products would account for between 1%-4% of the total, or between $ 1 and $ 6 million annually out of a market total of $ 600 million, or approximately 0.16 to 1.0% of total market sales. If InterNorth's statistics are used, the percentage becomes approximately half as great because InterNorth estimates that only $ 600,000.00 of sales could be foreclosed. Thus, should InterNorth continue to use competitive bidding and independent profit centers, and no evidence introduced would suggest otherwise, then after the proposed merger, Crouse-Hinds' share of the total market "foreclosed" from its competitors and InterNorth's rivals would be 0.6%. Yet, more significant is that absent from this record is any indication that InterNorth's rivals will be unable to purchase products from Crouse-Hinds after the merger or to find other sources of supply at competitive prices and quality. Nor even that Crouse-Hinds' competitors would be unable to adjust their selling patterns to account for the loss in sales. Moreover, no evidence has been introduced to suggest that scale economies or the ability of a potential competitor to enter the market would be effected by the merger in any way.
Crouse-Hinds also claims that because InterNorth will be building synthetic fuel plants and participating in other large joint ventures, it will be able to guarantee sales of Crouse-Hinds' products to the detriment of its rivals. But, based on the paucity of the evidence submitted here, it would be highly speculative to predict what effect such projects would have on Crouse-Hinds' competitive position or even total market sales. Almost as speculative would be a prediction on the extent of foreclosure of Crouse-Hinds' sales for MRO purposes. While the Court has not been provided with any evidence on this issue, it believes that this figure would be de minimus. Testimony at the hearing indicated that electrical construction and lighting parts cannot be summarily replaced by another brand due to considerations of inventory control. It is unlikely, then, that the MRO market represents a significant hidden market for Crouse-Hinds products, so as to significantly alter the accuracy of the $ 600,000.00 figure discussed above.
The market for hazardous electrical construction materials and lighting is quite concentrated.
Although the evidence presented is far from complete, it appears that four firm concentration levels for various products range between 80%-90%. Crouse-Hinds has not presented evidence on the question of the concentration trends, if any, in the above markets. Entry barriers have been discussed elsewhere in this opinion, and it was said that they are relatively high in the product markets involved here.
Exactly how these barriers would be increased as a result of the proposed merger is less certain. Other than some mention that InterNorth may increase the budget for Crouse-Hinds' research and development activities, no evidence was presented by plaintiff that would tend to show that barriers to entry would thereby increase. In any event, the evidence on InterNorth's future expenditures for research and development are, in the words of one InterNorth officer, "strictly speculation."
For similar reasons, plaintiff's complaint that Crouse-Hinds' dominant position would be further entrenched as a result of the merger does little for its cause. Crouse-Hinds has not offered evidence on the issue of what competitive advantage it would receive due to a merger with InterNorth.
In conclusion, Crouse-Hinds has failed to demonstrate probable success on the merits, or sufficiently serious questions going to the merits so as to make them a fair ground for litigation, on its claim that the InterNorth/Crouse-Hinds merger may substantially lessen competition, due to vertical foreclosure in the marketing of electrical construction materials, and industrial and commercial lighting for hazardous environments. Plaintiff's "actual" reciprocity claims will be examined next.
Plaintiff asserts that if the InterNorth/Crouse-Hinds merger is permitted to go forward, InterNorth will induce reciprocal dealing with electrical engineers, contractors and construction firms (jointly referred to as contractors), which specify electrical construction materials and industrial and commercial lighting for hazardous environments. In addition, Crouse-Hinds maintains that it is also likely that InterNorth will engage in reciprocal dealings with manufacturers of gas turbines, which is an item used extensively on pipelines. These items also contain electrical construction materials. Even if InterNorth does not engage in reciprocity, Crouse-Hinds claims that reciprocity effect will result because gas turbine manufacturers will naturally begin to employ Crouse-Hinds' products in order to curry favor with InterNorth and to obtain sales. Finally, Crouse-Hinds says that WESCO and GESCO, two manufacturers of gas turbines and distributors of Crouse-Hinds products, will favor Crouse-Hinds products over other brands, and make it difficult for competitors to gain access to these distribution channels.
The term reciprocity refers to a seller's practice of utilizing the volume or potential volume of its purchases to induce others to buy its goods or services. Its counterpart, reciprocity effect, refers to the tendency of a company selling or desiring to sell to another company to channel its purchases to that company. FTC v. Consolidated Foods Corp., 380 U.S. 592, 594, 85 S. Ct. 1220, 14 L. Ed. 2d 95 (1965); Southern Concrete Co. v. United States, 535 F.2d 313, 317 (5th Cir. 1976), cert. denied, 429 U.S. 1096, 97 S. Ct. 1113, 51 L. Ed. 2d 543 (1977); Gulf & Western Industries, Inc. v. Great Atlantic & Pacific Tea Co., 476 F.2d 687, 694 (2d Cir. 1973); Allis-Chalmers Mfg. Co. v. White Consolidated Indus., Inc., 414 F.2d 506, 518-19 (3d Cir. 1969); Carrier Corp. v. United Technologies Corp., 1971 Trade Cases P 62,393 (N.D.N.Y.1977); United States v. International Telephone & Telegraph Corp., 306 F. Supp. 766, 781 (S.D.N.Y.1969); United States v. Northwest Industries, Inc., 301 F. Supp. 1066, 1088 (N.D.Ill.1969); United States v. Penick Ford, Ltd., 242 F. Supp. 518, 523 (D.N.J.1965). Generally, in the absence of reciprocity, buying decisions would be made solely on the competitive merits of the transaction. Reciprocity distorts buying and selling decisions, by injecting an "alien" factor into commercial transactions. FTC v. Consolidated Foods Corp., supra at p. 594, 85 S. Ct. at p. 1221; V Areeda & Turner, supra at P 1129a.
As a result, inferior products may be insulated from the full impact of competition, and deprive a superior product of access to a supplier. A potential competitor may suffer further because of the resulting foreclosure from access to a meaningful portion of the market. Id.
At the same time, a consideration of some fundamental economic principals yields the conclusion that not every reciprocal dealing will cause anticompetitive harm. Foremost among these principals is that a reciprocal dealing will not be entered into unless it is profitable to both parties. Thus, a supplier is unlikely to be "coerced" into a reciprocal dealing if the terms of the transaction would be inferior to those it was capable of bargaining with the acquiring company's competitors. Moreover, reciprocity cannot by itself increase the "power" of an acquiring firm. For example, an acquiring firm with purchasing power would be able to use that power to obtain a direct price concession from its supplier. In such a case it would be unnecessary for a large purchaser to engage in an indirect form of bargaining such as reciprocity, to increase the financial benefits of a deal. See V Areeda & Turner, supra, at P 1129c.
There may also be instances where a price concession will be disguised in the form of reciprocal dealing in order to keep this fact from the knowledge of the marketplace. This situation would normally occur in an oligopolistic market, where the oligopolist would be interested in concealing a price reduction on its part or by its supplier. In this sense, reciprocity is a form of indirect price competition, that, in the end, may stimulate price cuts by the other oligopolists. Nevertheless, in the case of a regulated monopolist, such as InterNorth, a court should be especially careful in its examination of the possibility of reciprocal dealing, which may be used as a method to avoid the price constraints imposed by the regulatory scheme under which it operates. See V Areeda & Turner, supra, at P 1129d2.
There are three prerequisites to a finding that a merger violates Section 7 on the grounds of reciprocity and reciprocity effect:
First, the merger must significantly increase the opportunities for reciprocal dealing by creating a market structure conducive to reciprocity or reciprocity effect;
Second, there must be a reasonable probability that those opportunities will be exploited; and
Third, the resulting reciprocal dealings, if any, must have a tendency substantially to lessen competition.
Carrier Corp. v. United Technologies Corp., 1978-2 Trade Cases P 62,393 at p. 76,371 (N.D.N.Y.1978); United States v. International Telephone & Telegraph Corp., 1971 Trade Cases P 73,619 at 90,545 (N.D.Ill.1971); See also, United States v. International Telephone & Telegraph Corp., 324 F. Supp. 19, 42 (S.D.N.Y.1970); United States v. Northwest Industries, Inc., 301 F. Supp. 1066, 1088 (N.D.Ill.1969); United States v. Penick & Ford, ...