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UNITED STATES v. PENICK & FORD

May 21, 1965

UNITED STATES of America, Plaintiff,
v.
PENICK & FORD, LTD., Incorporated, a Delaware Corporation and R. J. Reynolds Tobacco Co., a New Jersey Corporation, Defendants



The opinion of the court was delivered by: COOLAHAN

On April 6th, 1965 at 1:10 P.M., the United States of America filed a complaint against the defendants, Penick & Ford, Ltd., Incorporated (hereinafter referred to as Penick) and R. J. Reynolds Tobacco Company (hereinafter referred to as Reyonds) claiming jurisdiction under 15 U.S.C.A. §§ 4 and 25. In addition to the complaint the Government sought a motion for a temporary restraining order to prevent the defendants from taking any action in furtherance of a purchase agreement whereby Reynolds was to acquire the assets and business of Penick. This acquisition was to be closed on April 6th, 1965 at 2:00 P.M. However, when advised of the fact that the suit had been authorized by the Attorney General the parties voluntarily agreed to defer this closing until the Court could set the matter down for hearing. Therefore, the temporary restraint application became unnecessary and the matter was scheduled for presentation upon the motion for a preliminary injunction before the United States District Court for the District of New Jersey on May 11, 1965.

Prior to the hearing date all parties submitted full and complete briefs outlining their factual contentions and the legal propositions upon which they rested. The bulk of the material to be submitted into evidence was filed with the Court prior to the actual hearing. In addition the Court was provided with a transcript of the proceedings on a daily basis so that the entire record would be considered in reaching a decision.

 At the hearing the Government presented six witnesses and many documentary exhibits in support of their motion for a preliminary injunction to restrain the acquisition referred to above. The witnesses were all active executives in the starch business and had first hand knowledge of the industry. The defendant Penick presented affidavits by its officers in opposition to the motion together with certain statistical data (Ex.D.P-F. 1-6) and its president, M. J. Martin, testified at the request of the Court. The defendant Reynolds produced Spencer B. Hanes, its executive vicepresident and a member of the Board of Directors, and introduced certain exhibits into evidence reflecting figures on their purchases and financial condition in general (Ex.D.-R.1, 2 & 3). At the close of the testimony and after full oral argument, this Court took the matter under advisement to study all materials submitted.

 Penick is a corporation engaged in a business consisting of two main facets, production of corn derivatives (which accounts for 60% Of its sales) and grocery products (which accounts for the remaining 40%). It is the corn derivatives portion of the business which is the subject matter of the instant action. More particularly it is the corn wet milling division of this business with which we are immediately concerned herein (apparently 30% Of the entire business -- Tr. Pg. 255). This industry is composed of ten firms engaged in the production from raw corn and sorghum grain of starch, dextrin, corn syrup and other by-products by a process known as wet milling. Penick is approximately fourth in size among the ten producers which compose the industry. In addition there are two large nonproducers who purchase starch from the producers (at a price less than that available to consumer purchasers) and who resell the same in competition with the industry. Penick's share of the overall market from its fourth position is approximately 12.8% (Tr. Pg. 279, which figure apparently excludes starch sold by Grain Processing Company and would therefore be a smaller percentage of the market). In addition to this makeup of the competive market there exists an importation of tapioca from outside the United States which accounts for approximately 10% Of the total starch purchased in the market for use in the paper industry (Tr. Pg. 276).

 The largest single use of starch produced by this corn wet milling process is found in the corrugated box and paper industry. It is utilized as an adhesive substance in the manufacture of those products. It is competition in the sale of starch and dextrin to these paper companies and the reciprocal trading practices found in this relationship which the Government contends will be grossly impaired should Reynolds acquire control of Penick.

 The witnesses produced by the Government and the bulk of the documents introduced into evidence tend to establish that the starch producers and the paper company consumers engage in the practice of trade relations which fosters reciprocity. Reciprocity is basically the policy of favoring one's customers in purchasing commodities sold by them. When further refined this policy blossoms into a practice where a company's sales may be allocated directly to the amount of purchases made by them from its customers, and may develop into relationships whereby seller A is urged to purchase from concern C which is in turn a customer of A's direct purchaser B. See 78 Harv.L.Rev. 1386 (1965). This latter process has been termed as secondary reciprocity.

 The evidence indicated that the sale of starch and dextrin to the paper industry was highly competitive in the sense that there were many producers each having a fair share of the total available market. Testimony was offered that the market conditions were favorable and that an expansion was in the offing. The sales organizations and the research teams of the various competitors were considered prime factors in each company's ability to compete and maintain itself in this highly competitive market. However, all witnesses freely admitted that reciprocity was a definite industry factor and that on certain occasions business had been lost or obtained in this manner. The witnesses testified that although they did not favor this practice they were compelled to follow same by necessity. It is apparently a well grounded practice in this area and has been for several years, although in recent years it has been abating. It is interesting to note, however, that although reciprocity plays an important role in industry competition, there is great emphasis on research and sales techniques since the competitive makeup of the industry requires these factors be given prime consideration regardless of any reciprocal overtones mentioned previously.

 The Government produced Mr. Robert G. Rohwer who is the sales manager of the wet milling division for Grain Processing Corporation. He testified that his company entered the corn starch industry late in 1960. Since that time the firm has enjoyed tremendous success apparently due to the application of a new process exclusively developed by them which greatly reduced the price at which the product could be offered for sale. In their relatively short period of competition in the industry, this company vaulted to the number two spot in share of the market purely on a basis of price and quality competition. Although Mr. Rohwer testified that reciprocity prejudiced some of his company's efforts, it is readily apparent that while present in the industry, it is not so significant a factor as to preclude competition where other competitive means are not equivalent.

 Defendant Reynolds offered testimony as to its generally proscribed business approach to the problem of reciprocity. It was flatly and unequivocally stated that reciprocity plays no part at all in Reynolds' present business including its acquired corporations. There is no inter-relationship between its purchases and sales and the Government failed to prove or allege any deviation from this policy. Furthermore, Mr. Hanes testified that Penick would be an autonomously managed concern and would not have available materials from Reynolds which would enable utilization of data for reciprocity purposes. No proof was adduced by the Government to show that Reynolds had deviated from this policy in the conduct of its tobacco business or in the management of the corporations acquired by its efforts to diversify. Consequently, the record discloses Reynolds position to be that reciprocity on behalf of Penick would be abandoned as a sales policy and that competition along the lines of intensified research and increased efficiency in quality and suitability for needs would be the competitive factors upon which Penick would operate. Reynolds would supply the necessary capital to finance these proposed marketing, development and production improvements and facilities.

 Reynolds offered evidence as to the amount and breakdown of its purchases. Testimony established that Reynolds does not compete with Penick in any business activity nor does it buy from or sell to Penick. They do purchase an amount of corn starch in the $ 30,000. annual range from which they make adhesive to glue cigarette paper and apparently a quantity of corn syrup. Although Reynolds purchases encompass a great dollar volume in paper containers, bags, cardboard boxes and other containers there has been no policy of reciprocity practiced either currently or in the past. The purchasing and sales departments are unrelated and under the control of different executives. The cigarette paper utilized (in which no starch is used) can only be obtained from two companies with which Reynolds divides its purchases. The material used for cigarette cartons is currently only obtained from West Virginia Pulp and Paper Company since that firm has developed a light weight board which is not as yet available from other producers. However, Reynolds is attempting to encourage others to duplicate this process so that their sources of supply will be increased since it is their business policy to deal with as many suppliers as possible to insure lowest price and a readily available source.

 The above analysis of Reynolds purchasing and sales policy was offered as evidence of the effect on Penick's business position by the acquisition of that firm by Reynolds. It is their established policy not to engage in reciprocal arrangements. Reynolds has for years been successfully competing in an industry which features aggressive non-price competition. In order to successfully compete in such a market Reynolds must keep costs at a minimum if they are to maintain industry wide prices and still produce a favorable ratio of earnings to sales dollar. They are the leading cigarette sellers in many areas and attribute their favorable profit position to constant cost control. Such cost control dictates a policy of purchases on the basis of price, quality and suitability for needs rather than because of reciprocity. Furthermore, Reynolds gross business is far greater than Penick's and it would seem poor economic judgment to jeopardize such successful business policy in order to increase the sales of a newly acquired subsidiary, especially where the increase will only be in a small percentage of that subsidiary's entire gross business.

 It is the contention of the Government that the acquisition by Reynolds of Penick would violate Section 7 of the Clayton Act (15 U.S.C.A. § 18). Although this is a merger which may be classified as conglomerate rather than a vertical or a horizontal acquisition, the Government contends that other anticompetitive factors will come in to play if Reynolds is allowed to enter this field. It is urged that the presence in the industry of reciprocal trade policies and the degree to which they currently abound therein gives rise to the inference that should a major source of purchasing power be inserted into the existing structure, competition would be greatly injured as a result of the increased reciprocal power which could be generated by a corporation of great financial magnitude. The legal support for this proposition rests on the recent case of F.T.C. v. Consolidated Foods Corp., 85 S. Ct. 1220, 14 L. Ed. 2d 95 (1965). That case annunciated the underlying theory of the Government's position in the instant litigation. The Court stated that:

 'We hold at the outset that the 'reciprocity' made possible by such an acquisition is one of the congeries of anticompetitive practices at which the antitrust laws are aimed, if the probable consequence of the acquisition is to obtain leverage in one field or another.' (At page 122).

 Consequently, if the Government can sustain its burden of proof upon this motion, ample authority exists for the ...


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