Updated from Dec. 24 to include new court filing from Staples.

The government continues to show it's not keen on having one dominant office supplies company in America.

But Staples (SPLS) is apparently not going to go away quietly in its bid to merge with smaller rival Office Depot(ODP) - Get Report .  In new court papers filed in Washington federal court by Staples on Dec. 23, the retailer said the Federal Trade Commission's claims that a merger would harm competition are "fundamentally flawed."  Staples asserted that the FTC's complaint is a "misguided application of the antitrust laws," adding that the businesses face "fierce competition today and in the future from a strong and expanding set of competitors."

Staples' opening shot against the FTC comes a few days after the agency dealt it another serious setback.  In a statement on Dec. 21, Staples said the FTC rejected its proposal to divest up to $1.25 billion of commercial contracts in an effort to gain approval by regulators to acquire Office Depot. According to Staples, the FTC did not issue a counter proposal. The company said it's still willing to continue negotiations with the FTC to reach a settlement that addresses antitrust concerns, while also noting that it's pursuing the transaction through litigation. 

"Staples and Office Depot have not shown the FTC that by divesting commercial contracts, it would create a meaningful competitor to their combined company," said Andrea Murino, co-chair of law firm Goodwin Procter's antitrust practice. "The FTC doesn't do its assessments in a vacuum -- it talks to customers, competitors and in this case, they have decided the market is not as diverse as Staples and Office Depot suggest."

On Dec. 7, the FTC filed a complaint charging that the proposed deal would violate antitrust laws by significantly reducing competition nationwide in the market for "consumable" office supplies sold to large business customers. Further, the complaint alleged that by eliminating the competition between Staples and Office Depot, the transaction would lead to higher prices and reduced quality.

"The commission has reason to believe that the proposed merger between Staples and Office Depot is likely to eliminate beneficial competition that large companies rely on to reduce the costs of office supplies," said FTC Chairwoman Edith Ramirez.

An administrative trial to decide on whether the deal can go through is scheduled to begin on May 10, 2016.

Explained Murino, "It is rare for the FTC to file a lawsuit to block a transaction like they did here -- several thousand deals receive clearance from the FTC and Department of Justice every year, and I would estimate that fewer than a dozen end up in court -- most clear without issue, while the vast majority where the government has concerns clear with remedies." 

To help temper the concerns of regulators and win approval, one remedy the companies have proposed is the sale of assets with revenue of up to $1.25 billion. In light of the latest developments, the FTC clearly wants Staples to fork over even more commercial contracts. According to Murino, the deal is not dead as the litigation process is very different from an antitrust review, with a judge looking at many other aspects to the transaction. "Staples best bet now is to put all of its eggs into the basket of the litigation," said Murino.

Nevertheless, Wall Street continues to be skeptical that the deal will proceed, with Office Depot's stock falling about 41% since Staples disclosed its offer.  Staples shares have lost roughly 45% since the deal was first announced.

With Staples likely to miss out on acquiring Office Depot for the second time (a previous bid in 1997 was squashed by regulators), Staples stands to lose on several fronts. Right off the bat, Staples would become poorer. As part of the merger agreement, if regulators do not approve the deal due to antitrust concerns, Staples would be forced to pay a $250 million breakup fee to Office Depot.

That's money that could be spent on continuing to close under-performing Staples stores in the U.S., or investing in lower prices for consumers. Instead, the money will fill the coffers of a smaller competitor, who may then seek to offer promotions on office supplies or ramp up their marketing to take business from Staples.

But the real concern for Staples stretches beyond having to cut a competitor a hefty-sized check.

Staples needs Office Depot to increase its market share in what has become a highly competitive office supplies market. Walmart (WMT) - Get Report  and Target(TGT) - Get Report are selling more office supplies now in physical stores and online, while Amazon(AMZN) - Get Report hawks office products to a growing base of customers on the web.

By becoming the dominant office supplies destination in the U.S., Staples would have a greater chance of competing with its brick-and-mortar foes such as Walmart and Target, and reversing otherwise dreadful same-store sales results. Shuttering overlapping Staples and Office Depot stores would also free up money for Staples to invest in more competitive prices both in stores and online, and thwart advances by Amazon.

Increased competition has taken a heavy toll on Staples. According to research firm Euromonitor, the U.S. market for office supplies sold in stores has been in a protracted decline since 2007 and totaled $11.7 billion in 2014. Staples' market share fell to 38.2% in 2014 from 40.6% in 2013, estimates Euromonitor.

Staples' U.S. same-store sales fell 2% in the third quarter on declines in tablets, computers, tech accessories, and ink and toner. For the year, Staples earnings -- excluding items -- have dropped to 63 cents a share from 66 cents year earlier, with sales lower by 6.2% to $15.7 billion.