United States: Drug Company Patent Settlements Subject To Rule Of Reason Antitrust Scrutiny

Last Updated: July 1 2013
Article by Laura Shores and Alexander G. Bomstein

This week, the Supreme Court announced that "reverse payment" settlements of patent litigation between branded and generic pharmaceutical companies are, when challenged in a subsequent antitrust case, to be judged under the rule of reason. Reconciling a split among the circuits, the Court rejected both the majority "scope-of-the-patent" test, which upheld such settlements as long as they did not foreclose competition any more so than the patent would have, and the minority "quick look" approach urged by the Federal Trade Commission (FTC), under which they were deemed presumptively unlawful. The Court's ruling promises to generate more—and more complex—disputes about the legality of reverse payment settlements.

The FTC v. Actavis case (formerly captioned FTC v. Watson Pharmaceuticals, Inc., 677 F.3d 1298 (11th Cir. 2012)), together with the decision in In re K-Dur Antitrust Litigation, 686 F.3d 197 (3d Cir. 2012), presented the Supreme Court with its first clear opportunity to address the standard for judging the legality of reverse payment settlements between brand-name drug makers and generic companies. Reverse payment patent settlements are those in which the patent holder (the brand-name drug manufacturer), in addition to agreeing to let the allegedly infringing generic firm to enter before patent expiration, makes some form of payment to the generic firm. This is termed a "reverse" payment because settlements of other patent disputes typically involve payments going the other way: the alleged infringer pays the patent holder for a license permitting it to enter before patent expiration. Critics of these settlements call them "pay-for-delay" settlements, based on the assumption that the brand-name company pays in exchange for the generic firm's agreement to postpone marketing of its product. The supposition is that but for the payment, the generic firm would have entered earlier—either after a victory in the patent case or under a different settlement in which the generic had insisted on an earlier entry date.

In Actavis, the Eleventh Circuit, in keeping with its ruling in prior cases1and in harmony with decisions by the Second and Federal Circuits,2 held that such settlements are lawful so long as they fall within the exclusionary scope of the patent—meaning that they restrain competition to no greater extent than the patent itself. In the subsequent K-Dur case, the Third Circuit departed from the majority rule. The Third Circuit held that reverse payment settlements should be subject to a "quick look" analysis, which deems the settlements presumptively unlawful and puts the burden on the settling parties to show that they are procompetitive or otherwise justified. In Actavis, the Supreme Court rejected both tests and held that the traditional rule of reason analysis governs the settlements—with a catch.

Background

Reverse payment settlements are a byproduct of the Drug Price Competition and Patent Term Restoration Act, better known as the Hatch-Waxman Act of 1984. Hatch-Waxman sought to speed generic entry by incentivizing generic firms to challenge patents covering the brand-name drug. It did this in part by creating a fast-track "abbreviated new drug application" (ANDA) process for Food and Drug Administration approval of generic versions of brand-name drugs for which the patent has not yet expired.3 When notified that an ANDA has been filed for a patented drug, the branded company typically sues the would-be generic manufacturer for patent infringement. Settlements of these cases sometimes provide for generic entry before patent expiration along with a "reverse" payment to the generic firm.

The FTC, charged with enforcing the federal antitrust laws, has long viewed these settlements as unlawful agreements not to compete. Most circuit courts have recognized the importance of the patent, which gives the inventor an exclusive right to sell its invention—or not to. These courts have applied the "scope-of-the-patent" test: if the agreement does not delay competition beyond patent expiration or apply to products not covered by the patent, it is within the patent's scope; and so long as the litigation to enforce it was not a sham, the settlement is lawful. A few courts,4 however, have scrutinized the agreements more closely or rejected them outright. In 2012, a clear split emerged from the divergent standards used by the Third Circuit in K-Dur and the Eleventh Circuit in Watson.

The legacy of unsettled law regarding reverse payment settlements owes its existence in large part to the tension between antitrust and patent law. A valid patent gives its owner monopoly rights to its invention. It limits competition by definition. Critics of reverse payment settlements argue that because those lawsuits ended without a determination of validity, there is no reason to presume it. Thus, whether the settlement rightfully forecloses competition under patent law or wrongfully does so in violation of the antitrust laws depends on whether the underlying patent is valid.

But since the settlement deprived the patent court of the opportunity to decide the question of validity, the question remains about how to judge the merits of the settlement. Giving the task of determining validity to the court in a subsequent antitrust case seems a poor solution; doing so would effectively mean that the patent settlement settled nothing.

Both critics and advocates of reverse payment settlements have proposed to avoid this conundrum by way of differing presumptions. The FTC, harboring a natural wariness toward agreements between competitors, favors a rule whereby the patent is presumed to be invalid. This would amount to a ban on virtually all reverse payment settlements; an agreement between competitors that provides for anything short of immediate entry would be deemed anticompetitive. Pharmaceutical companies advocate a rule whereby patents are presumed valid5 which would dictate that any settlement providing for generic entry before patent expiration is procompetitive, not anticompetitive. Neither rule leaves way for much middle ground, lest courts have to dive into the very patent litigation the settlement was meant to avoid.

For years, the FTC's view was that reverse payment settlements are per se illegal. Until the Third Circuit's 2012 decision in K-Dur, almost all courts of appeals to address the issue rejected application of a per se rule. The scope-of-the-patent test prevailed instead. As articulated by the Eleventh Circuit in Actavis, "absent sham litigation or fraud in obtaining the patent, a reverse payment settlement is immune from antitrust attack so long as its anticompetitive effects fall within the scope of the exclusionary potential of the patent.6 In K-Dur, the Third Circuit flatly rejected the scope-of-the-patent test, declaring reverse payment settlements presumptively unlawful. The Third Circuit contested the proposition that all patents should enjoy a presumption of validity, protesting that "reverse payments enable the holder of a patent that the holder knows is weak to buy its way out of both competition with the challenging competitor and possible invalidation of the patent.7

The Third Circuit, however, rejected calls for a per se ban, instead adopting a "quick look" rule of reason test. Specifically, the court directed the fact finder to "treat any payment from a patent holder to a generic patent challenger who agrees to delay entry into the market as prima facie evidence of an unreasonable restraint of trade, which could be rebutted by showing that the payment (1) was for a purpose other than delayed entry or (2) offers some pro-competitive benefit.8 K-Dur did not define the sort of benefit that might justify the settlement, though it gave as an example "a modest cash payment that enables a cash-starved generic manufacturer to avoid bankruptcy and begin marketing a generic drug.9 Evidence concerning the patent's validity does not seem to be what the Third Circuit had in mind.

Actavis Sets the Stage

In Actavis, generic manufacturers Watson Pharmaceuticals, Inc. and Paddock Laboratories, Inc. filed ANDAs after developing their generic versions of the billion-dollar testosterone drug AndroGel.10 AndroGel manufacturer and patent holder Solvay sued the generics for infringement and, precisely as contemplated by Hatch-Waxman, the generics challenged the validity of Solvay's patent. The parties entered into a settlement whereby Solvay would make annual payments of between $19 million and $30 million for help with its marketing of AndroGel. The parties split the remainder of the patent life, allowing the generic to come on the market five years before the patent expired.11

The FTC challenged the drug companies' settlement on antitrust grounds, but the district court dismissed the complaint for failure to allege that the agreement went beyond the scope of the patent. As described earlier, the Eleventh Circuit upheld the dismissal as proper under the scope-of-the-patent test, since the generic launch would come before the Solvay patent expired. Rather than denouncing the scope-of-the-patent test outright—an unwise course given its affirmation in two prior Eleventh Circuit cases, in one of which the FTC was the losing party—the FTC asserted that the "scope" of the patent depended on its strength. The Eleventh Circuit gave the FTC's argument short shrift.12 In particular, the court noted the impracticality of litigating the underlying patent's strength, as the FTC's position required. "If we did that we would be deciding a patent case within an antitrust case about the settlement of the patent case, a turducken task.13

The FTC filed a petition for certiorari in Actavis in October 2012, two months after the losing class action plaintiffs in K-Dur filed their own certiorari petitions. The Supreme Court chose to review the issue as framed in the Actavis case. In Actavis, unlike K-Dur, the FTC was a party and its position on the issue was accordingly represented. Actavis also presented more straightforward facts, involving a straight cash payment. The legal question was arguably cleaner as well; it questioned the soundness of the majority scope-of-the-patent test rather than the Third Circuit's novel quick-look approach.

Arguments to the Supreme Court

The FTC—as the Supreme Court majority was later to do—gave little importance to the patent. Rather, the FTC put the reverse payment dispute into a purely antitrust framework: "Federal competition law generally prohibits an incumbent firm from agreeing to pay a potential competitor to stay out of the market." The FTC characterized as "misconceived" the argument that the federal patent laws "implicitly legitimize conduct that would ordinarily be viewed as a paradigmatic antitrust violation.14

The FTC abandoned its long-standing position that reverse payment settlements are illegal per se. Instead, it embraced the Third Circuit's holding in K-Dur that reverse payment settlements should be subject to a quick-look level of scrutiny.15 The FTC proposed that the settling parties might rebut the presumption of illegality by showing that the settlement payment was (1) not in exchange for delay, or (2) commensurate with the litigation expenses avoided by settling.16 Like the Third Circuit in K-Dur, the FTC ignored whether a defendant might introduce evidence of the patent's validity in rebutting the presumption.

While the oral argument did not clearly signal where the eight justices (Justice Alito recused himself) would end up in Actavis, the questions aimed at the litigants revealed unease with any of the proffered solutions to the reverse payment issue.

While some justices seemed persuaded that reverse payment settlements are likely anticompetitive, several expressed discomfort with the idea that a special rule should be created to analyze them. The questions and commentary of Justices Breyer, Scalia, and Sotomayor seemed to favor application of the standard rule of reason test—a standard not argued for by any party—whereby courts would have to consider the circumstances of the allegedly anticompetitive conduct without the benefit of any initial presumption of illegality. Justice Breyer, who was later to write the majority opinion, discounted the suggestion that courts need a new, burden-shifting rule to assess the legality of settlements. Foreshadowing his opinion, he proposed instead that guidance be given courts in applying the traditional rule of reason:

[W]hy isn't the government satisfied with an opinion of this Court that says, yes, there can be serious anticompetitive effects; yes, sometimes there are business justifications; so, Judge, keep that in mind. Ask him why he has this agreement; ask him what his justification is, and see if there's a less restrictive alternative.

In other words, it's up to the district court, as in many complex cases, to structure their case with advice from the attorneys.

Justice Scalia also questioned why the Court should "overturn understood antitrust laws." He blamed the problem on Congress, calling reverse payments a "mistake" that Congress had the responsibility to fix. The FTC, as Scalia explained it, was trying to do Congress's job by arguing for "a new interpretation of antitrust law that did not exist before."

The Supreme Court: The Rule of Reason Governs

Writing for the majority in a 5-3 split decision, Justice Breyer declared the rule of reason to govern reverse payment cases, finding neither the scope-of-the-patent test nor the quick-look approach appropriate. The majority disputed the proposition that the patent should be presumed valid, given that the settlement foreclosed any opportunity for a court determination on that issue. The Court observed that in a settlement, the patent may or may not be valid, and since only a valid patent carries with it the right to exclude, the scope-of-the-patent test was too forgiving.

The majority's opinion listed a number of "considerations" that led it to reverse the Eleventh Circuit's dismissal of the FTC's complaint: (1) "the specific restraint at issue has the 'potential for genuine adverse effects on competition';" (2) "these anticompetitive consequences will at least sometimes prove unjustified;" (3) "where a reverse payment threatens to work unjustified anticompetitive harm, the patentee likely possesses the power to bring that harm about in practice;" (4) "an antitrust action is likely to prove more feasible administratively than the Eleventh Circuit believed;" and (5) "the fact that a large, unjustified reverse payment risks antitrust liability does not prevent litigating parties from settling their lawsuit.17

The Court acknowledged that in some cases valid reasons might exist for such reverse payment settlements. "An antitrust defendant may show in the antitrust proceeding that legitimate justifications are present, thereby explaining the presence of the challenged term and showing the lawfulness of that term under the rule of reason.18 The Court's opinion thus leaves room for defendants to present evidence of procompetitive justifications. But it seems that evidence of the patent's validity is not to be considered. This is important for future cases, as proving that a settlement is procompetitive logically entails some showing that without the settlement, the patent holder might have prevailed and prevented competition altogether.

The fourth consideration—an oblique reference to the "turducken task" of litigating the patent merits in the antitrust case—is especially important. The Court dispensed with the need to make any assessment of the strength of the patent by using the size of the reverse payment as a proxy: "[I]t is normally not necessary to litigate patent validity to answer the antitrust question (unless, perhaps, to determine whether the patent litigation is a sham ...). An unexplained large reverse payment itself would normally suggest that the patentee has serious doubts about the patent's survival.19 Thus, the Court reasoned that anticompetitive intent might be inferred from the existence of a sizeable payment: "The payment may ... provide strong evidence that the patentee seeks to induce the generic challenger to abandon its claim with a share of its monopoly profits that would otherwise be lost in the competitive market."20 The patentee will likely possess market power, and thus be able to parlay its competitive position into continued high prices for consumers, the Court reasoned.21 The Court provided no guidance as to what might constitute a "large" payment; large in comparison to what?

Nonetheless, the majority assured that settlement remains possible. "They may, as in other industries, settle in other ways, for example, by allowing the generic manufacturer to enter the patentee's market prior to the patent's expiration, without the patentee paying the challenger to stay out prior to that point.22

While the opinion gives no guidance on how to determine whether a payment is too large, it does seem to contemplate a monetary payment of some sort, as opposed to some other form of consideration. The first paragraph defined a reverse payment by giving an illustration in which the patentee agrees "to pay [the alleged infringer] many millions of dollars." The opinion abounds with references to "large unexplained" payments. This might support an argument that settlements without monetary payments are exempt from scrutiny under the rule of reason altogether.

The Dissent Would Uphold the Scope-of-the-Patent Test

In dissent, Chief Justice Roberts, joined by Justices Thomas and Scalia, criticized the majority's disregard for the patent.

Patents carve havens from the antitrust laws. "This should go without saying, in part because we've said it so many times."23 The dissent cited ample Supreme Court precedent at the intersection of patent and antitrust law in which the analysis centered on whether the restraint went beyond the patent's scope—precisely the analysis at the heart of the scope-of-the-patent test.24

According to the dissent, the majority went astray by applying antitrust law to cases that courts should decide completely within the patent regime. "The majority points to no case where a patent settlement was subject to antitrust scrutiny merely because the validity of the patent was uncertain. Not one. It is remarkable, and surely worth something, that in the 123 years since the Sherman Act was passed, we have never let antitrust law cross that Rubicon."25 The dissent further serially challenged the majority's arguments, including those separating out settlements such as those in Actavis as unique or distinct in any meaningful way. "And I fear the Court's attempt to limit its holding to the context of patent settlements under Hatch-Waxman will not long hold.26

The dissent argued that the majority's framework for analyzing reverse payment settlements cannot apply equally well to all settlements, as the patent in question is truly valid or invalid depending on the case. The dissent lambasted the majority's framework by spotlighting those cases in which it would return bad results, i.e., when a large payment does not reveal the true economic value to the patent holder.27 It also rejected the idea that the patent holder's view of the strength of its patent could somehow be discerned by the size of the payment. The dissent pointed out that a risk-averse patent holder, even though confident of validity, might logically prefer "to pay a good deal of money to rid itself of the 5 percent chance of a finding of invalidity." In such a case, the size of the payment would have no bearing on anyone's view of the strength of the patent. And, Justice Roberts noted, determining the patent holder's true belief about the strength of its patent would pose another set of problems—it would likely require an inquiry into privileged communications between the patent holder and its lawyers.28

The dissent concluded by warning that district courts will have trouble applying the majority's loose framework: "Good luck to the district courts that must, when faced with a patent settlement, weigh the 'likely anticompetitive effects, redeeming virtues, market power, and potentially offsetting considerations present in the circumstances.29

The Fraught Path Forward

Despite the Actavis majority's assurances, this decision undoubtedly will complicate drug company settlements. In federal court circuits where the scope-of-the-patent test reigned, drug companies had a broad settlement arsenal, including the use of reverse payments, so long as generic entry was postponed no longer than the patent would otherwise allow. That option may still be legal, but it will now require careful analysis and explanation of the size and approriateness of any reverse payment and likely entail a protracted antitrust battle. Because the Supreme Court gave lower courts little guidance in how to interpret its ruling, years will likely pass before established rules in the circuits make judicial rulings on reverse payment settlements predictable.

Footnotes

1.Valley Drug Co. v. Geneva Pharms., Inc., 344 F.3d 1294 (11th Cir. 2003); Schering-Plough Corp. v. FTC, 402 F.3d 1056 (11th Cir. 2005).

2.Joblove v. Barr Labs., Inc. (In re Tamoxifen Citrate Antitrust Litig.), 466 F.3d 187 (2d Cir. 2006); In re Ciprofloxacin Hydrochloride Antitrust Litig., 544 F.3d 1323, 1336 (Fed. Cir. 2008).

3.See 21 U.S.C. § 355(j).

4.SeeAndrx Pharms, Inc. v. Biovail Corp. Int'l, 256 F.3d 799 (D.C. Circ. 2001); In re Cardizem CD Antitrust Litig., 332 F.3d 896 (6th Cir. 2003); In re K-Dur Antitrust Litig., 686 F.3d 197 (3d Cir. 2012).

5.Such an assumption enjoys support in the language of the Patent Act, which declares quite literally that patents "shall be presumed valid." 35 U.S.C. § 282(a).

6.Watson, 677 F. 3d at 1312. While most developed in the Eleventh Circuit, the rule has been widely adopted. See, e.g., In re Tamoxifen Citrate Antitrust Litig., 466 F.3d 187 (2d Cir. 2006) and In re Ciprofloxacin Hydrochloride Antitrust Litig., 544 F.3d 1323 (Fed. Cir. 2008).

7.K-Dur, 686 F. 3d at 215.

8.Id. at 218.

9.Id. at 218.

10.Watson, 677 F. 3d at 1304.

11.Id. at 1304-05.

12.Id. at 1312-15.

13.Id. at 1315. A turducken is a dish consisting of a chicken stuffed into a duck, which is in turn stuffed into a turkey.

14.See FTC Brief at 19.

15.Id. at 36.

16.Id. at 37-38.

17.Opinion at 14-19.

18.Id.

19.Id. at 18.

20.Id. at 15-16.

21.Id. at 18.

22.Id.

23.Dissent at 2.

24.Id. at 2-3.

25.Id. at 8.

26.Id. at 11.

27.Id. at 13-14.

28.Id. at 13.

29.Id. at 15-18.

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Alexander G. Bomstein
 
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