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Public Contract Law
The DoD Review of Mergers and Joint Ventures Is Not Just for Antitrust Lawyers
Craig S. King
Approximately three years have passed since the Department of Defense began to participate more actively in the government’s review of mergers and joint ventures involving defense contractors. During that period, the center of gravity for the government’s review has shifted materially in the direction of the Pentagon—and the substantive "antitrust" analysis of effects on competition has, in significant measure, taken on the vocabulary and style of legal practice under the procurement laws. The DoD review process has matured—as have relationships among DoD, the antitrust enforcement agencies, and private practitioners.
Views are mixed regarding the success of DoD’s foray into the antitrust review process. For contractors that have received prompt, unequivocal support from DoD, the department’s involvement is viewed as a giant step forward. The investment of resources in dealing with DoD is viewed as returning significant benefits in the form of quicker, more enlightened review by the antitrust enforcement agencies. Indeed, in no case where DoD has affirmatively supported a transaction has an antitrust enforcement agency taken a contrary position.
DoD Standards of Review. As the starting point for review of mergers and joint ventures, DoD officials generally ask three questions:
• What are the benefits to the government?
• Can those benefits be achieved through other means?
• What are the effects on competition?
These questions are significant in understanding DoD’s focus, and in some instances lead to a standard of review that is not entirely consistent with traditional antitrust analysis or the antitrust laws.
Question #1: Benefits to the Government. DoD officials are keenly interested in whether the government will be better or worse off after a proposed transaction. Claims of benefits to the contractors are of some interest, but really only insofar as those benefits are to be passed to the government.
For mergers and joint ventures that involve major defense suppliers, DoD’s examination of potential benefits touches the full range of ways that the government may be affected by a transaction. DoD examines all aspects of its interests as a customer, e.g., effects on program performance, increased or reduced availability of key technologies, efficiency of proposed management structures, reductions in unused capacity, and other cost savings that will be realized by DoD.
DoD’s review generally is in line with antitrust focus on potential harm to the customer. However, in those transactions where there is no clear benefit or harm to the government, the department’s approach sometimes departs from traditional antitrust analysis and leads to unfortunate perturbations. Under the antitrust laws, a transaction proceeds if there is no harm to the customer—which means a transaction that is in the contractors’ interest but conveys no particular benefit to the government would be allowed to go forward. However, where no significant benefit or harm to the government is anticipated, DoD may falter. It sometimes appears to lose interest, thereby making it difficult to bring the review to closure.
Question #2: Whether Benefits Can Be Achieved Through Other Means. The question of whether the purported benefits to the government can be achieved through other means has greater application in joint ventures than mergers.
Due to concerns that two competitors may have difficulty managing a joint venture, DoD is cautious in its review of joint venture proposals. Defense joint ventures can be risky. The reasons relate to demonstrated difficulties associated with management of major defense programs: when management responsibility is shared between contractors, nobody is in charge; decision making is subject to stalemate; consequently, important management decisions are often avoided; and in research and development joint ventures, contractors have been unable to enforce necessary exchanges of intellectual property between the participants.
Accordingly, contractors proposing a joint venture must make the following showings to DoD—that:
• the same or similar benefits cannot be achieved through some other means—which generally means the benefits cannot be obtained through a prime-subcontractor arrangement (which is preferred because one contractor has responsibility); and
• the proposed joint venture structure eliminates the weaknesses of failed defense joint ventures.
With regard to the first showing, in order to persuade DoD to support a joint venture, contractors generally must document the positive results that derive from an ownership interest under a joint venture—and contrast them with the disincentives, uncertainties, and increased costs under a prime/subcontractor or other arrangement. As to the second showing, innovative joint venture structures now have been developed that address the problems of previous defense joint ventures through special board and management arrangements. In instances where the case otherwise is made for the joint venture, DoD has accepted these new joint venture structures.
With regard to DoD’s review of mergers, there is an analog to the examination of alternatives to a joint venture. In merger transactions, DoD has demonstrated a ready desire to examine alternative structures in areas of program "overlap." This involves a detailed examination of acquisition plans (including contract types and multiyear procurements) and the status of any ongoing source selections.
In program "overlap" areas, remedial measures (e.g., hold separate arrangements, divestiture) may be appropriate if the remaining competitors will not provide adequate competition. The question most often becomes not whether a transaction will be allowed to proceed, but rather, whether the contractors will agree to the remedial measures required to satisfy DoD and the antitrust enforcement agencies. DoD increasingly has undertaken detailed examination of program overlaps.
Question #3: Effects on Competition. DoD’s approach to analyzing effects on competition focuses on procurement considerations and in particular on the number of competitors anticipated to be available to submit proposals on individual programs.
The DoD approach is consistent with—and, indeed, is a shortcut to—essentially the same analysis as is done by antitrust enforcers. As discussed above, traditional antitrust analysis emphasizes market concentration and the lessening of competition through coordinated interaction or unilateral effects. In the defense context, this analysis devolves very quickly to an examination of the number of remaining firms.
The heart of DoD’s procurement business involves determining how many competitors are necessary for efficient competition for, and performance of, defense programs. The department has extensive experience—and a substantial database—that bear on the likely outcome of bidding under different competitive scenarios. In particular, DoD officials are likely to have strong views backed by historical data bearing on whether two, three or more competitors are necessary for meaningful competition for a given program.
There are no hard and fast rules relative to the number of remaining competitors necessary to receive favorable DoD review. Some observations may be helpful, however:
• Of course, obtaining DoD approval is most difficult when the two remaining competitors, or the two low-cost competitors, for a program propose to merge or form a joint venture. Contractors must present compelling justifications for such transactions—and prepare for a lengthy review process.
• At the same time, a merger or joint venture that leaves three or more viable program competitors usually will be allowed to proceed. In today’s shrunken defense environment, DoD generally is satisfied if a competition has three or more competitors.
• Where there are fewer than three remaining viable competitors for a program, contractors can anticipate a rigorous program-by-program review of effects on competition, and possible discussions regarding remedial measures.
Craig S. King is a partner with Arent Fox Kintner Plotkin & Kahn, serving in the firm’s government contracts and antitrust
This article is an abridged version of one that originally appeared in The Procurement Lawyer, Summer 1997 (32:4).