On Aug. 5, the Antitrust Division of the U.S. Department of Justice surprised some industry observers when it filed suit to challenge the merger of US Airways and American Airlines. On Tuesday, the DOJ reached a preliminary agreement to settle the suit through divestiture of gates and slots at seven airports across the country. When American and US Airways announced the merger, many thought (including the merging parties) that this was the last piece of the legacy airline consolidation story after the Continental-United (2010) and Delta-Northwest (2008) mergers.

The DOJ disagreed. The assistant attorney general, in prepared remarks coinciding with the filing of the suit, said: “We simply cannot approve a merger that would result in U.S. consumers paying higher fares, higher fees and receiving less service.” The airlines fired back with one of the lawyers for the airlines, stating, “We are litigating this case, period.” The trial was scheduled to begin in federal court in Washington, D.C., on Nov. 25 before Judge Colleen Kollar-Kotelly. The trial was expected to last 10-15 days with the court making a ruling in January after the parties submitted post-trial briefing. The government’s lawsuit and the defendants’ answer to the complaint set forth the issues. Briefly summarized, the competing views of a post-merger world were:

The DOJ’s Position

“In recent years … the major airlines have, in tandem raised fares, imposed new and higher fees, and reduced services. … By further reducing the number of legacy airlines and aligning the economic incentives of those that remain, the merger of US Airways and American would make it easier for the remaining airlines to cooperate, rather than compete, on price and service,” the complaint said. The DOJ suit also focused on Ronald Reagan Washington National Airport: “Passengers to and from Washington, D.C., are likely to be particularly hurt. [T]he combined airline would have a monopoly on 63 percent of the nonstop routes served out of the airport.”

The Merging Airlines’ Position

‘The government approval of these two mergers [United-Continental and Delta-Northwest] created airlines with much larger and more comprehensive networks than either American or US Airways, leaving both American and US Airways at a competitive disadvantage which cannot be overcome on a standalone basis. US Airways and American Airlines seek to merge so that they can … compete with the new Delta and United,” the defendants’ answer to the complaint said. And the airlines blasted the DOJ for failing to take into account the competition from Southwest Airlines and other discount carriers: “The complaint’s focus on legacy airlines causes it to ignore the most meaningful competitive development in the airline industry since deregulation: the emergence of low cost carriers. The complaint inexplicably ignores their profound and permanent effect on industry competition.”

The Settlement

On Tuesday, the DOJ announced that the parties had reached a settlement agreement that would be submitted to the court for approval. The settlement requires US Airways and American Airlines to divest slots and gates at seven key constrained airports across the country to low-cost carriers such as Southwest, JetBlue and others. It was always clear that to reach a deal, the merging airlines would have to divest slots and gates at Ronald Reagan Washington National Airport. The settlement, however, also requires divestitures to low-cost carriers at Boston Logan International, Chicago O’Hare International, Dallas Love Field, Los Angeles International, Miami International and New York LaGuardia. According to Attorney General Eric Holder: “This agreement has the potential to shift the landscape of the airline industry. By guaranteeing a bigger foothold for low-cost carriers at key U.S. airports, this settlement ensures airline passengers will see more competition on nonstop and connecting routes throughout the country.” Assistant Attorney General Bill Baer of the Department of Justice’s Antitrust Division added: “The extensive slot and gate divestitures at these key airports are groundbreaking and will dramatically enhance the ability of low-cost carriers to compete systemwide. This settlement will disrupt the cozy relationships among the incumbent legacy carriers, increase access to key congested airports and provide consumers with more choices and more competitive airfares on flights all across the country.” Doug Parker, chairman of US Airways, characterized the divestitures as “pretty modest.” Thomas Horton, chief executive of AMR, American’s parent company, said: “This is an important day for our customers, our people and our financial stakeholders.”

The Path to Settlement

Like any high-stakes case, as trial approaches the parties reassess their positions and weigh the risks. In this case, the DOJ had run into an unusually high level of criticism for its decision to challenge the merger. Philadelphia Mayor Michael A. Nutter, along with the mayors of six other cities that serve as hubs for US Airways and American, urged Holder to reconsider the “ill-conceived lawsuit.” The mayors’ letter claimed, “The failure to clear the combination of American Airlines and US Airways will put our cities at an unnecessary competitive disadvantage to [cities] that directly benefit from the Delta and United mergers.” Various chambers of commerce across the country, including Philadelphia’s, had written letters urging the DOJ to settle the suit. Many other interested parties, including the pilots’ union and other unions, had requested permission to file amicus briefs outlining their views of the benefits of the merger.

This level of lobbying in favor of the merger would give the DOJ pause to re-examine the strength of its case. A unique feature of a merger trial is that the parties would be trying to convince the court of what will likely happen in the future, not about trying to prove something that happened in the past. With political pressure to settle the suit, the risk to the DOJ of going to trial and losing was substantial.

The airlines, of course, had reason of their own to seek a settlement. American Airlines was attempting to climb out of bankruptcy and had an approved bankruptcy plan that depended on the merger going through. US Airways felt it needed the merger to compete effectively against the larger legacy carriers. And, the airlines had to concede, at least to themselves, that they had given the DOJ some of the best evidence it planned to use at trial. The DOJ complaint quoted liberally from airline documents and statements made by airline executives such as:

• US Airways CEO in 2011: “Three successful fare increases—[we are] able to pass along to customers because of consolidation.”

• And, “Consolidation has also … allowed the industry to do things like ancillary revenues” (e.g., checked bag and ticket-change fees).

• And commenting on a commitment to maintain service levels by two other airlines seeking approval for a merger in 2010, the US Airways CEO said: “I’m hopeful they’re just saying what they need … to get this transaction approved.”

The DOJ complaint contained numerous other harmful statements for the merger proponents, which they would have dealt with at trial by claiming they were off-handed comments, not a serious analysis of the merger. But, there was a serious risk to American and US Airways that the entire merger plan could be shot down if they did not reach a settlement and went to trial.

Both sides had enough ammunition to wring concession from the other side, and knew that a trial was unpredictable enough that each side could be the loser. A settlement gives both the DOJ and the merging parties a chance to claim victory. The DOJ has touted the strengthening of the low-cost carriers, such as Southwest and JetBlue, that should help them compete not only with the new gates and slots they will obtain, but also in the industry generally. Southwest is actually the largest domestic airline, and the settlement should increase “the Southwest effect” of offering lower fares (which competitors match) wherever it flies. The government noted that low-cost carriers Southwest and JetBlue had significantly reduced fares whenever they were able to enter a market. When Southwest and JetBlue acquired gates as a result of previous merger settlements, fares dropped significantly.

But the airlines can also claim victory: With the merger going through, the new American will still become the largest airline in the world and the expected revenue will be minimally impacted.

Only those privy to the negotiations between the parties before the DOJ filed suit would know if these concessions were available before the suit was filed, or pried from the airlines facing a prospect of a winner-take-all trial. And only time will tell if the divestures under the settlement will “open up the marketplace as never before.”

The Philadelphia Story

As mentioned earlier, both Nutter and the Philadelphia Chamber of Commerce lobbied for the DOJ to allow the merger to proceed. But Pennsylvania Attorney General Kathleen Kane had joined the DOJ, with six other states, to block the merger. The state attorneys general also settled the suit and the new American has agreed to maintain its hubs with historical operations for a period of three years at Charlotte, N.C., New York (Kennedy), Los Angeles, Miami, Chicago (O’Hare), Phoenix and Philadelphia. In addition, for a period of five years, the new American will continue to provide daily scheduled service from one or more of its hubs to each plaintiff-state airport that has scheduled daily service from either American or US Airways. There were no agreements on gate divestiture at any airport in Pennsylvania.

Court Approval Seems Certain

The settlement agreement still needs to be approved by the court. But, court approval appears to be a near certainty. American had already won approval for its plan to emerge from bankruptcy, subject to the merger being approved. Kollar-Kotelly had asked the parties to accept a mediator to try to facilitate a settlement (though it’s unlikely the parties had much need of a mediator). Moreover, most judges would not look forward to a highly publicized trial that could potentially exceed two weeks and involve lengthy testimony from competing economists. The airlines expect the merger to be consummated in mid-December, though full integration of the two airlines, as we know from past mergers, will take some time.

Robert E. Connolly is of counsel at DLA Piper’s Philadelphia office, focusing on antitrust and unfair competition matters. He was previously with the DOJ’s Antitrust Division, including 20 years as the chief of the division’s Middle Atlantic Office. He can be reached at 215-656-3318 or robert.connolly@dlapiper.com.

John D. Huh is an associate at DLA Piper’s Philadelphia office, and focuses his practice on complex commercial litigation, and government investigations, concentrating on antitrust and consumer protection. He can be reached at 215-656-2450 or john.huh@dlapiper.com.