Editor’s note: This is part 2 of a 4-part series on FTC v. Actavis: How Should the Supreme Court Rule on the Legality of Pay-for-Delay Settlements of Patent Disputes Litigated in the Shadow of the Hatch-Waxman Act? This series is adapted from a document that Professor Cotter coauthored while serving on ABA-Intellectual Property Law Section Task Force last fall. See http://www.americanbar.org/content/dam/aba/administrative/intellectual_property_law/leadership/agendabook_nov2012.authcheckdam.pdf, pages 39-55. The views expressed, however, are his own, and do not represent the views of the ABA or the Task Force.
Among the consequences of the Hatch-Waxman statutory framework described in my previous post are the following.
First, upon receiving notice of the Paragraph IV certification, the brand name manufacturer/patent owner has a powerful incentive to file a patent infringement action against the generic drug manufacturer in order to obtain the automatic 30-month stay.
Second, because the patent owner’s suit occurs prior to the generic manufacturer having sold any of its generic product to the public, the patent owner is not entitled to compensatory damages, in the form of lost profits or reasonable royalties, for past harms suffered as a result of the generic manufacturer’s technical infringement; at this point in time, no such harms have yet occurred. This is quite different from the typical patent infringement lawsuit, in which the plaintiff files suit only after discovering that the defendant is making, using, or selling possibly infringing products.
Third, the brand name manufacturer’s profit margin on sales of branded drugs tends to be higher than the generic manufacturer’s expected profit margin on sales of the generic drug. Economic logic suggests that, in the absence of generic competition, the brand-name manufacturer has the opportunity to derive monopoly profits from the sale of the branded drug (though subject to possible competition from other drug products that treat the same condition). Following the entry of generic competition, the brand-name manufacturer can expect, at best, to compete as a duopolist. Put another way, the brand-name manufacturer’s expected losses due to generic competition are likely to be greater than the generic manufacturer’s expected gains from selling the generic equivalent. The empirical evidence appears consistent with this analysis. See Federal Trade Commission, Pay-for-Delay: How Drug Company Pay-Offs Cost Consumers Billions 8 (2010) [hereinafter FTC Report], available at http://www.ftc.gov/os/2010/01/100112payfordelayrpt.pdf (asserting that “in a mature generic market, generic prices are, on average, 85% lower than the pre-entry branded drug price”).
Fourth, if the parties settle the patent infringement suit prior to the date on which the generic manufacturer begins selling generic versions of the approved drug, the resulting settlement may take the form of a payment from the brand-name manufacturer to the generic manufacturer, in exchange for the latter’s promise not to market its generic drug until some date later than the date on which it would be entitled to market the generic drug if it prevailed at trial. This consequence is both counterintuitive and controversial.
Reverse payment settlements are counterintuitive because, in the typical (non-Hatch-Waxman) patent infringement case, one would expect the defendant to pay the patent owner—and to agree either to exit the market or to license the patent in suit—in exchange for the patent owner’s agreement to dismiss the action. The unusual posture under which patent litigation takes place in the shadow of Hatch-Waxman, however, results in the patent owner potentially having much more to lose from going forward with the suit than does the infringement defendant. As noted above, if the patent owner were to lose the patent infringement suit, its lost profits would likely exceed the increased profits earned by the generic manufacturer from sales of its generic product. Alternatively, even if the patent owner were to win, victory would come only after (at least) several months of litigation, with its attendant uncertainties (and attorney’s fees). Under these circumstances, a rational response may be to settle the action on terms whereby the patent owner pays the generic manufacturer to exit the market for a period of time.
At the same time, reverse payment settlements are controversial because they appear to flout the general antitrust principle that a firm may not pay its competitors to exit the market. Typically, an agreement between competitors whereby one of them agrees not to compete in a specific product or geographic market constitutes a per se violation of Sherman Act § 1. See, e.g., Palmer v. BRG, Inc., 498 U.S. 46, 49 (1990); Copperweld Corp. v. Independence Tube Corp., 467 U.S. 752, 768 (1984). Nevertheless, there are some circumstances in which a reverse payment or pay-for-delay settlement of patent litigation conducted in the shadow of Hatch-Waxman can be benign. A settlement whereby the patent owner agrees to pay the defendant some portion of the patent owner’s projected litigation expense savings resulting from avoiding trial, for example, in return for the latter’s agreement to exit the market for a period of time, probably should not give rise to antitrust liability, since the amount of consideration flowing from plaintiff to defendant is consistent with the plausibly neutral justification of merely avoiding litigation expenses. In addition, in theory a reverse payment settlement could provide a means not only for avoiding litigation costs but also for reducing other risks, such as the defendant’s potential insolvency, or could reflect the parties’ different toleration for risk or asymmetric information in evaluating the likelihood of success at trial. See, e.g., Thomas F. Cotter, Antitrust Implications of Patent Settlements Involving Reverse Payments: Defending a Rebuttable Presumption of Illegality in Light of Some Recent Scholarship, 71 Antitrust L.J. 1069, 1073-74 (2004).
Nevertheless, it should be clear that reverse payment agreements also pose a substantial risk of being nothing more than an anticompetitive agreement to exclude competition. Both the FTC, which has litigated several reverse payment cases under § 5 of the FTC Act, and the Antitrust Division of the Department of Justice, which has filed briefs in some of these cases, have expressed concern that applying an overly lenient standard of antitrust scrutiny to these agreements threatens substantial harm to consumer welfare. Many of the nations’ most prominent antitrust scholars have expressed similar concerns. See, e.g., Michael A. Carrier, Innovation for the 21st Century: Harnessing the Power of Intellectual Property and Antitrust Law 370-82 (Oxford Univ. Press 2009) (arguing that reverse payment agreements should be presumptively illegal); Herbert Hovenkamp, Mark D. Janis, Mark A. Lemley & Christopher R. Leslie, IP and Antitrust § 15.3a1(C), at 15-47 to -49 (2d ed. 2010) (arguing that reverse payments should be presumptively illegal, but that the patent owner may rebut the presumption with evidence that, inter alia, the payment did not exceed expected litigation costs); Cotter, supra (arguing for presumptive illegality); Einer Elhauge & Alex Krueger, Solving the Patent Settlement Puzzle, 91 Texas L. Rev. 283 (2012) (arguing that reverse payments in excess of the patent owner’s anticipated litigation costs should be presumptively illegal); Scott Hemphill, Paying for Delay: Pharmaceutical Patent Settlement as a Regulatory Design Problem, 81 NYU L. Rev. 1553 (2006) (arguing for presumptive illegality). Indeed, a reverse payment settlement might seem particularly suspect if the consideration exceeds the amount the defendant could have expected to earn from marketing the generic drug over the relevant time period, or if the effect of the settlement is to create a bottleneck preventing other potential generic competitors from entering the market because the first applicant has not yet made use of its 180-date period of exclusivity. Although amendments to the Hatch-Waxman Act enacted in 2003 were intended to prevent such “parking” of the 180-day period, it does not appear that those amendments eliminated the bottleneck problem altogether. See Scott Hemphill, An Aggregate Approach to Antitrust: Using New Data and Rulemaking to Preserve Drug Competition, 109 Colum. L. Rev. 629, 660-61 (2009). More recently, a 2010 FTC Report estimated that, based on settlements filed with the FTC pursuant to terms of the 2003 Medicare Modernization Act, “[a]greements with compensation from the brand to the generic on average prohibit generic entry for nearly 17 months longer than agreements without payments,” and that “[p]ay-for-delay settlements . . . cost American consumers $3.5 billion per year—$35 billion over the next ten years.” FTC Report, supra, at 2.
The case law on the legality of these payments varies, a topic covered in the next installment.