Opinion ID: 421082
Heading Depth: 1
Heading Rank: 4

Heading: canadian national's request for protective conditions

Text: 100 Canadian National carries freight from Danville and Yarmouth Junctions, Maine (where it connects with the Maine Central) west to Montreal and Chicago. The joint Maine Central/Canadian National line is the fastest route between Maine and Chicago. 101 The Canadian National's time advantage depends on close coordination of schedules and speedy interchange with the Maine Central at Danville and Yarmouth Junctions. Canadian National expressed concern to the ICC that after the merger, Guilford would refuse to cooperate with Canadian National on scheduling and interchanges, thus increasing transit time over the Maine Central/Canadian National route. This would lessen the attractiveness of that route and permit Guilford to divert more traffic to the currently slower Boston & Maine route. Canadian National also claimed that reduced traffic would force it to cut expenses by running fewer trains and reducing track maintenance, which would further increase transit time, which would lead to additional diversion of traffic to the Boston & Maine, which would force Canadian National to reduce service further, and so on in a vicious cycle that ultimately would lead Canadian National to abandon its Grand Trunk Eastern line between Maine and Montreal. 35 102 Guilford's traffic study, which assumed no increase in interchange time at Danville and Yarmouth Junctions, predicted that diversion of east-west traffic to the Boston & Maine would cost Canadian National $2 million in annual revenues. Canadian National counterestimated diversion losses of $8.1 million per year if Guilford did not downgrade the Danville and Yarmouth interchanges and $12.5 million if Guilford did downgrade the interchanges. 103 Canadian National asked the ICC to require Guilford to maintain present operating arrangements, schedules of service, [and] blocking and handling of freight traffic interchanged at [Danville and Yarmouth] [229 U.S.App.D.C. 38] junctions. Boston & Maine Merger app. B, 366 I.C.C. at 365. It claimed that fast service to Chicago is essential to shippers and that these conditions were needed both to preserve that service and to preserve competition for east-west traffic between it and the Boston & Maine. 36 104 In response, the ICC gave several reasons for believing that Canadian National's service would not be adversely affected by the merger. It did not reach the question whether that service is essential, nor did it discuss whether loss of the Canadian National's Grand Trunk Eastern line would significantly reduce competition for east-west traffic. 105 First, the ICC explained that Canadian National would not have to abandon its Grand Trunk Eastern line because even Canadian National's worst-case scenario of $12.5 million diversion represent[s] a mere fraction of 1 percent of CN's 1980 gross freight revenue. Id. at 352. 37 Second, there was no indication in the record that [Guilford] has any intention of downgrading this interchange relationship. Id. Third, Guilford would not have an incentive to downgrade since substantial traffic through these interchanges is nondivertible. Id. Finally, Canadian National possesses sufficient competitive leverage to adequately combat any possible diversions of traffic by virtue of its single-line system between [Maine and the midwest] and the ratemaking flexibility inherent in such a system. Id. 106 We have substantial difficulties with each of these arguments. Cumulatively, the weaknesses in the ICC's arguments lead us to remand to the Commission to reconsider whether Canadian National's service will be adversely affected by the merger and, if so, whether the public interest would be advanced by restricting Guilford's ability to downgrade its interchanges with Canadian National. 107
108 We consider first the ICC's belief that essential services would not be affected because the diversions from the Canadian National to the Boston & Maine represent a fraction of 1% of Canadian National's gross revenues and thus, presumably, Canadian National could underwrite any losses on its Grand Trunk Eastern line. We fail to see the relevance of Canadian National's system-wide revenues. 109 First, if Guilford downgrades interchanges at Danville and Yarmouth Junctions, shippers will lose the benefits of the best transit time between Maine and the Midwest. Boston & Maine Merger, 366 I.C.C. at 352. Canadian National's ability to absorb [229 U.S.App.D.C. 39] the resulting revenue loss will not change that fact. 110 Second, the ICC's emphasis on Canadian National's financial strength and neglect of the profitability of the Grand Trunk Eastern line ignores Canadian National's incentive to maximize profits by shedding money-losing operations. Nothing in the record supports the implausible proposition that Canadian National will indefinitely subsidize losses on its Grand Trunk Eastern line. On the contrary, undisputed testimony from Canadian National's President establishes that Canadian National treats its branches and subsidiaries as independent profit centers and will not subsidize a losing branch line. 38 111 Third, the ICC itself, as a policy matter, opposes on efficiency grounds the subsidizing of money-losing lines. For example, the Commission will not under any circumstances require one carrier to indemnify another carrier for losses due to traffic diversion, because [t]his transfer of funds would, in effect, be a massive cross-subsidization ... of inefficient operations of another railroad. Burlington Northern--Control--St. Louis-S.F., supra note 37, 360 I.C.C. at 952-53. 39 Similarly, in abandonment proceedings, the Commission analyzes primarily the profitability of the line sought to be abandoned and gives little weight to the profitability of the parent railroad. See, e.g., Illinois Central Gulf Railroad Abandonment Between Herscher & Barnes, 363 I.C.C. 690, 703 (1980) (Unprofitable operations ... burden [the carrier] and interstate commerce ... [and the carrier] should not be required to continue [such] operations ..., regardless of whether it is financially capable of doing so ....), aff'd sub nom. Bloomer Shippers Association v. ICC, 679 F.2d 668 (7th Cir.1982). 40 The ICC, to be true to this policy, should not expect Canadian National to operate an inefficient, money-losing line. 112 In sum, the ICC's belief that Canadian National's overall profitability would permit Canadian National to preserve existing service on its Grand Trunk Eastern line ignores Guilford's unilateral ability to downgrade interchange service, is unsupported by evidence in the record, and is contrary to Commission policy. 113 This is not to say that Canadian National's Grand Trunk Eastern line will be unprofitable once the Maine Central merges with the Boston & Maine. Canadian National asserts that the Grand Trunk Eastern line will sustain heavy losses as a result of diversion of traffic to the Boston & Maine, 41 but Guilford disputes this. 42 On remand, the ICC will have an opportunity to decide this factual question. 43 114
115 A second major factor leading the ICC to conclude that the merger would not affect Canadian National's service was that the record gave no indication that Guilford [229 U.S.App.D.C. 40] intended to downgrade service at the Danville and Yarmouth interchanges. 366 I.C.C. at 352. We think this factor is entitled to little if any weight. 116 First, the record shows only that Guilford has no present intent to downgrade interchange service. Guilford made no promises concerning the future. Thus, Guilford's owner, Mr. Mellon, when asked if he would give Guilford's assurance that it would preserve service at Danville and Yarmouth Junctions, gave an equivocal answer--[i]f the economic circumstances are somewhat what they are today. 44 Moreover, Guilford opposed Canadian National's request for conditions, thus reserving for itself the right to decrease service in the future. 117 Second, as the Commission itself has recently recognized, self-serving statements by a merging railroad's officers are entitled to little credence. See Norfolk & Western--Control--Detroit, Toledo & Ironton, supra note 27, 360 I.C.C. at 512 (promise by two competing railroads to operate independently a third competing line is self-serving and must be examined closely .... It is difficult to expect sacrificial behavior from profit seeking corporations into the indefinite future.). Guilford will, we expect, seek to maximize profits. If it can profitably downgrade interchanges with Canadian National, Guilford will have strong incentives to do so, notwithstanding its current disclaimers. Thus, Guilford's actual financial incentives, not its professed intent, must be the dominant concern. We consider those incentives next. 118
119 The ICC's third reason for rejecting protective conditions at Danville and Yarmouth Junctions was that it would not appear to be to [Guilford's] benefit for such deterioration [of interchange service] to take place, since substantial traffic through those interchanges is nondivertable. Boston & Maine Merger, 366 I.C.C. at 352. 45 We think that the Commission failed to analyze properly Guilford's incentives to downgrade interchange service. 120
121 The Maine Central is the only railroad providing east-west service to the Maine paper industry. Moreover, Canadian National claims, and the Commission does not dispute, that most of the Maine Central's traffic is captive to rail--trucks are not a significant source of competition. 46 Thus, the Maine Central has market power over rail traffic to and from Maine. As a theoretical matter, then, the Maine Central may be able to increase profits by altering its interchange service. 122 The merger of the Maine Central with the Boston & Maine is, in antitrust terminology, a vertical merger. Ordinarily, a vertically integrated monopolist has no incentive to use its monopoly power over one level of production (rail service in Maine) to increase profits at another level (rail service from Maine to the midwest). As the leading treatise puts it, there is but one maximum monopoly profit to be gained from a monopoly of one level of production, and that profit may be gained directly at the monopolized level (here, rail service in Maine) through appropriate pricing. 3 P. Areeda & D. Turner, Antitrust Law § 725b (1978). There is an exception to this rule, however, for a regulated monopolist, which may be able to obtain from a second level of production the monopoly profits which effective regulation of the franchised monopoly precludes. Id. p 726e (footnote omitted). 47 123 [229 U.S.App.D.C. 41] The Maine Central is, of course, a regulated monopolist. It is barred by the ICC from charging a monopoly price for rail service to Maine, 48 but may be able to use its control over service at Danville and Yarmouth Junctions to shift its potential monopoly profit to the Boston & Maine. Indeed, the ICC itself has recently recognized the risk of such conduct. See Union Pacific--Control--Missouri Pacific, supra note 21, 366 I.C.C. at 529: 124 [In an end-to-end merger], the consolidated system may profit by limiting the downstream competition [from connecting carriers] and routing traffic over its own lines from origin to destination.... This vertical foreclosure effect will occur, if at all, at the gateways served commonly by the consolidating carriers. 125 We do not know whether Guilford will in fact profit by downgrading interchange service, but the risk is substantial. Indeed, Areeda and Turner believe that the probability that a vertically integrated, regulated monopolist will abuse its market power is peculiarly high. Id. p 726e, at 218. They would forbid vertical integration by a regulated monopolist except in cases where regulatory authorities can more or less easily exercise the power to prohibit refusals to sell and to specify the price and other terms of sale. Id. p 726e, at 219 (footnote omitted). In this case, the ICC permitted vertical integration but declined to exercise its power to control the terms of sale between the Maine Central and the Canadian National. The question is whether that decision was reasonable.
126 We do not think that the Commission gave Guilford's possible incentives to downgrade interchange service the scrutiny they deserve. As we understand its terse explanation, the Commission's conclusion that Guilford has no incentive to downgrade rests on two premises, the first explicit, the second implicit. First, Guilford will continue to transfer substantial amounts of traffic to Canadian National at Danville and Yarmouth Junctions. Second, if Guilford downgrades interchange service, it will earn less profit on nondivertible traffic. 127 The first premise is undisputed in the record, though Guilford and Canadian National disagree on how much traffic will be diverted. 49 There is no record evidence regarding the second premise. The premise is plausible, if only because reduced service will lead some shippers to switch to trucks or produce fewer goods. But the magnitude of this effect is uncertain and may well be small. Little traffic will be lost to trucks because, for most of the Maine Central's shippers, trucks are not a feasible alternative to rail. And the record is silent on how much business Maine producers will lose to competitors elsewhere in the country if they lose fast service to the midwest. 50 128 The Commission not only failed to quantify Guilford's costs from downgrading interchange service at Danville and Yarmouth Junctions, it also ignored the benefits to [229 U.S.App.D.C. 42] Guilford from increased diversion. The Commission does not dispute that some additional diversion will occur. We can only speculate as to the amount of diversion and how profitable the diverted traffic will be to Guilford. 129 Without quantifying the costs or even discussing the benefits to Guilford from downgrading interchange service, the ICC could not rationally conclude that Guilford will not have an incentive to downgrade. On remand, the Commission must ascertain more carefully where Guilford's incentives actually lie. 130 We do not suggest that the Commission will be able to predict Guilford's future behavior with absolute accuracy. Rather, Guilford's incentives or disincentives to downgrade will be primarily a question of probabilities, and thus peculiarly subject to the expert experience, discretion, and judgment of the Commission. Missouri-Kansas-Texas Railroad v. ICC, 632 F.2d 392, 406 (5th Cir.1980), cert. denied, 451 U.S. 1017, 101 S.Ct. 3004, 69 L.Ed.2d 388 (1981). But our deference to its ultimate choice does not relieve the Commission of the duty to explain, based on substantial evidence in the record, whether Guilford will or will not have an incentive to downgrade interchange service.
131 The ICC's final reason for believing that Guilford would not downgrade interchange service was Canadian National's power to take effective opposing steps. The Commission explained: 132 [Canadian National (CN) ] possesses sufficient competitive leverage to adequately combat any possible diversions of traffic. The CN-[Maine Central] connection still affords shippers the best transit time between Maine and the Midwest. By virtue of operating a single-line system between these two regions of the country, and the ratemaking flexibility inherent in such a system, CN is able to assert a great deal of influence in the routing of traffic. 133 Boston & Maine Merger, 366 I.C.C. at 352. This reasoning is none too clear, but we understand the Commission to suggest two sources of Canadian National's competitive leverage. First, Canadian National's route is the fastest. Second, Canadian National's long haul over a single system gives it ratemaking flexibility. 134 We fail to understand the first claim. That Canadian National can potentially provide the fastest route to the midwest will not do it much good if Guilford unilaterally destroys that advantage. As for ratemaking flexibility, we are not sure what the Commission means by the term, but we can see two possibilities. First, Canadian National can recoup lost traffic by cutting its prices to shippers. Second, Canadian National can pay Guilford to maintain current interchange service by giving Guilford a larger share of the total Maine-to-midwest freight charge. 135 Price cuts to shippers, however, will not restore the Canadian National's current fast, efficient service to the midwest. Moreover, price cuts offer scant promise of returning the Grand Trunk Eastern to profitability. In the long run, if the Grand Trunk Eastern loses money, Canadian National will presumably close it down. 136 Canadian National may temporarily preserve fast service by giving Guilford a larger share of joint revenues. Such payments, however, can only reduce the Grand Trunk Eastern's profitability, which in the long run is essential to service of any kind, let alone fast service. 51 We conclude, therefore, that the Commission unreasonably relied [229 U.S.App.D.C. 43] on Canadian National's competitive leverage to preserve existing service. 137
138 Having considered the possible need to preserve interchange service at Danville and Yarmouth Junctions, 52 we turn briefly to the possible harm from imposing protective conditions. Canadian National's requested conditions, as described by the ICC, were: 139 [Maine Central] shall preserve and continue at a minimum its practices existing on October 31, 1981 in connection with handling freight traffic over the routes with the Grand Trunk Eastern and at the interchange points at Danville Junction and Yarmouth Junction, ME. Changes in present operating arrangements, schedules of service, blocking and handling of freight traffic interchanged at these junctions shall be made only with the concurrence of Canadian National Railway. 140 Boston & Maine Merger app. B, 366 I.C.C. at 365. The ICC explained that these conditions were relatively narrow in scope and would have little effect on competition, but would reduce Guilford's ability to improve service on its own system: 141 They do not appear to affect rates or diversions [sic], but rather freeze existing practices with respect to operating arrangements, schedules, and the blocking and handling of freight moving over Danville and Yarmouth Junctions in Maine. While the competitive effect of these conditions is not clear, imposition of these conditions would at least reduce [Guilford's] flexibility in improving the service capabilities on its own system. Id. at 352. 53 142 Canadian National urges that its proposed veto over changes in operating arrangements would not freeze existing practices. Canadian National points out that if it used its veto, Guilford could appeal to the Commission, which could grant relief from the condition in a proper case. See Southern Pacific Co.--Merger--Pacific Electric Railway, 354 I.C.C. 100, 109-10 (1977). We see little force to this argument. Guilford would still be burdened by the delay involved in an appeal to the ICC. Thus, as a practical matter, Canadian National's veto would substantially reduce Guilford's flexibility. 143 On the other hand, the ICC is not restricted to choosing between Canadian National's requested conditions and no conditions at all. 54 On the contrary, if the Commission [229 U.S.App.D.C. 44] believes that an unconditioned merger would harm the public interest but finds a proposed condition inappropriate, its duty to advance the public interest requires it to devise appropriate conditions, if such conditions can be developed with reasonable effort. See Baltimore & Ohio Railroad v. United States, 386 U.S. 372, 430, 87 S.Ct. 1100, 1129, 18 L.Ed.2d 159 (1967) (Brennan, J., concurring) ([t]he ICC is not the prisoner of the parties' submissions and must weigh alternatives and make its choice according to its judgment how best to achieve [Congress' policy] goals) (footnotes omitted); Atlantic Coast Line R. Co. v. United States, 48 F.2d 239, 244 (W.D.S.C. 4th Cir.1931) (3-judge court) (It is not only the right but the duty of the commission to impose such conditions as will make the acquisition in the public interest ....), aff'd, 284 U.S. 288, 52 S.Ct. 171, 76 L.Ed. 298 (1932). See also Scenic Hudson Preservation Conference v. FPC, 354 F.2d 608, 620-21 (2d Cir.1965), cert. denied, 384 U.S. 941, 86 S.Ct. 1462, 16 L.Ed.2d 540 (1966). 55 144 The ICC can probably design conditions that will prevent significant deterioration in transit time on the Maine Central/Canadian National route without seriously burdening Guilford. At a minimum, the Commission can require Guilford to give Canadian National advance notice of service changes. It could then permit Guilford to make the changes after an expedited showing to the Commission that the changes will not disrupt joint service with the Canadian National. Alternatively, it could permit the changes unless Canadian National shows that the changes will disrupt its service to the midwest. If appropriate, the Commission can limit the duration of any conditions it imposes. 56 Other possibilities may also occur to the Commission.
145 All four of the ICC's reasons for finding no need to impose protective conditions are seriously flawed. Cumulatively, they show failure by the Commission to consider all of the relevant factors and demonstrate a reasonable connection between the facts on the record and the resulting policy choice. Sierra Club v. Costle, 657 F.2d 298, 323 (D.C.Cir.1981) (footnote omitted). We therefore remand to the Commission to reconsider the public benefit from protective conditions, taking into account the factors identified in this opinion. 57 146 [229 U.S.App.D.C. 45] We recognize the complexity of this endeavor. In all likelihood, the probability that Guilford will downgrade interchange service will be greater than zero and less than 100%. The magnitude of public harm from downgrading will be uncertain as well. From these two uncertainties, the Commission will have to compute a rough, perhaps unquantified estimate of expected public benefit from protective conditions, and weigh that benefit against the equally speculative cost of restricting Guilford's future flexibility. 147 Once that balancing has been done, we will not lightly disturb the Commission's ultimate conclusion. On the record before us, however, the Commission has both ignored relevant factors and reached conclusions unsupported by substantial evidence in the record. It has not, in short, exercised that modicum of care that would permit us to approve its decision as reasonable. 58