A cure for collusive settlements: the case for a per se prohibition on pay-for-delay agreements in pharmaceutical patent litigation.

• Author: Owens, Michael

1. INTRODUCTION

   The legal standard for evaluating reverse payments in pharmaceutical infringement settlements (or "pay-for-delay" settlements) has become a highly controversial issue over the past decade and a half. (1) Under a pay-for-delay agreement, a manufacturer of a brand-name pharmaceutical will settle patent infringement litigation by making payments to a defendant generic manufacturer in exchange for the generic manufacturer refraining from entering the market. (2) These agreements have important implications for both patent law and antitrust law because they can allow a potentially invalid patent to remain in effect and restrain competition. (3) Judges, commentators and antitrust enforcement bodies have all reached widely divergent conclusions regarding the appropriate antitrust treatment for these settlements, and while academic disagreement is certain to persist, a single legal standard has been established in FTC v. Actavis (4) (previously FTC v. Watson Pharmaceuticals), which resolved a circuit split created by the United States Court of Appeals for the Third Circuit's July 2012 decision, In re K-Dur Antitrust Litigation. (5) The K-Dur decision brought to head the conflict over of pay-for-delay settlements and, in holding such agreements to be presumptively illegal, rejected precedent established by three separate courts of appeals. (6) The Supreme Court's decision in Actavis announced the "rule of reason" as the controlling liability rule for what some commentators have called "one of the most important business decisions that the court will have issued in quite some time." (7)

   This Comment will examine how the particulars of the Hatch-Waxman Act, the regulatory scheme that governs generic competition in pharmaceutical industry, gives rise to reverse settlements in infringement litigation; (8) review existing analysis of the pay for delay problem in judicial decisions, in academic commentary, and amongst antitrust enforcement bodies; (9) and finally, draw upon a decision theoretic framework to propose per se illegality as the appropriate antitrust rule for pay-for-delay settlements. (10)

2. THE RECIPE FOR REVERSE PAYMENTS: OVERLAP OF ANTITRUST, PATENT LAW, AND PHARMACEUTICAL REGULATION

   1. Antitrust Law and the Prohibition on Agreements to Restrain Competition

      Reverse payments raise problems under Section 1 of the Sherman Act (Section 1), which prohibits "[e]very contract, combination ..., or conspiracy, in restraint of trade or commerce among the several States, or with foreign nations." (11) The rationale for antitrust enforcement is to promote "unfettered competition as the [fundamental] rule of trade." (12) This rationale

      rests on the premise that the unrestrained interaction of competitive forces will yield the best allocation of our economic resources, the lowest prices, the highest quality and the greatest material progress, while at the same time providing an environment conducive to the preservation of our democratic political and social institutions. (13) Justice Hugo Black has emphasized that "even were that premise open to question, the policy unequivocally laid down by the Act is competition." (14) The most commonly accepted policy goal underlying antitrust law's reverence for competition is protecting consumers from artificially reduced output and the resulting artificial price increases. (15) Proposed goals that have received less judicial recognition include: protecting small business from larger firms, preventing transfer of wealth from consumers to producers, and promoting innovation. (16) Though these goals are frequently in harmony with each other, these secondary goals will generally yield to the question of whether a given practice tends to increase or decrease output in a given market. (17)

      To this end, the Supreme Court has interpreted this broad language to apply only to "unreasonable" restraints on trade, rather than any agreement that literally restrains trade. (18) In applying Section 1, courts have developed three methods of inquiry: a "per se" rule of illegality for restraints that are blatantly anticompetitive; a "quick-look" analysis for restraints that appear anticompetitive but have plausible pro-competitive justifications; and a wide open "rule-of-reason" analysis for restraints that have ambiguous effects on competition and require a more extensive balancing of pro and anticompetitive effects. (19) As applied, these categories are not as rigid as they may initially appear, and "are best viewed, as a continuum on which the amount and range of information needed to evaluate a restraint varies depending on how highly suspicious and how unique the restraint is." (20)

      The harshest form of antitrust condemnation, "per se illegality," is reserved for practices so blatantly injurious to competition that further inquiry is unnecessary, even with respect to actual harm caused. (21) These generally include horizontal agreements between direct competitors in the same market, (22) horizontal market allocation, (23) and horizontal refusals to deal. (24) Horizontal restraints receive harsher treatment because they turn what would otherwise be a competitive relationship into a cooperative one, leading to higher prices and lower output without any offsetting consumer benefit. (25) Because pay-for-delay settlements constitute an agreement not to compete between would-be competitors, there is no question that these agreements meet the categorical criteria for per se illegality. (26) The question becomes whether the lawful right to exclude conferred by the patents underlying these disputes warrants a departure from per se illegality, and if so, to what extent.

   2. Patent Law and Its Unique Role in the Pharmaceutical Industry

      Despite the obvious antitrust concerns, reverse payments are plausibly a legal exercise of the exclusionary rights granted under the system of patent laws authorized by Article 1 of the U.S. Constitution. (27) This clause grants Congress the power to pass laws that "promote the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries." (28) There are two primary objectives of the patent system: to promote public disclosure of inventions and to encourage innovation by rewarding inventors with the time-limited right "to exclude others from making, using, offering for sale, or selling the invention throughout the United States or importing the invention into the United States." (29) By rewarding a patentee with monopoly power (i.e., the power to charge prices appreciably above the costs of production without incurring dramatic losses in sales), (30) the patentee realizes a level of return on its innovation greater than it would have absent patent protection. Simple economic theory predicts that a greater expected return on innovation will result in a higher level of innovative activities, such as research, development, and testing. (31) Economic theory also predicts that the availability of patent protection will result in lower output and higher prices than would occur in competitive markets. (32) Because the inventor enjoys this reward at the expense of efficient allocation of the patented subject matter, the inventor is required to disclose how to make and use the invention, enabling the public to have unrestricted access to the patent after the term expires. (33) The underlying rationale for granting patents to protect new innovations is simple enough: by conferring a legally protected monopoly for those who bring innovations into existence, the system encourages innovation-producing activities. (34) Patent policy therefore encompasses a set of legislative judgments about the proper long run balance between competition and innovation. (35)

      Patent prosecution begins with a prospective patentee filing an application with the United States Patent and Trademark office (USPTO). (36) There, patent examiners evaluate whether the claimed invention is novel and non-obvious as compared to relevant prior art. (37) The invention is patentable if it is a "new and useful process, machine, manufacture, or composition of matter, or any new and useful improvement thereof." (38) The scope of the exclusionary right conferred by a patent is defined by the "claims" of the patent, each of which must independently be novel, (39) non-obvious, (40) and described "in such full, clear, concise, and exact terms as to enable any person skilled in the art to which it pertains ... to make and use the [invention]." (41) If successful in prosecuting a patent, the applicant will be awarded a twenty-year right "to exclude others from making, using, offering for sale, or selling the invention throughout the United States or importing the invention into the United States," (42) which will generally commence on the date of the earliest filing of an application. (43)

      Perhaps more so than in any other industry, patents are recognized as a necessary driver of innovation within the pharmaceutical industry. (44) A new drug is best understood as an information good--a commodity that derives its main value from the information it contains. (45) It can take several hundred million dollars to discover, develop, and gain regulatory approval for a new drug. (46) Without patent protection, rival firms could simply free-ride off of the innovator's research, development, and FDA approval and offer the compound without the tremendous expenses incurred by the innovator to bring the drug into existence. (47) Because duplication costs for pharmaceuticals are extremely low relative to the innovator's costs of discovering and developing a new compound, the free rider problem threatens to drive research and development far below socially optimal levels. (48) Studies have estimated that, while 86% of innovations across all industries would have been developed even without patent protection, only 40% of...