Reverse Payment Settlements Now Subject to Antitrust Scrutiny, But Lower Courts Left to Fill in the Blanks

Introduction

Earlier this week in FTC v. Actavis, No. 12-416 (U.S. Jun. 17, 2013), the Supreme Court handed down its long-anticipated ruling on “reverse payment” or “pay-for-delay” agreements, holding that these agreements—while not presumptively illegal—may violate the antitrust laws.  The Court’s opinion provides some clarity on an issue that has divided both the federal courts and antitrust enforcement agencies for over a decade, but the Court’s articulation of a heavily fact-dependent five-consideration inquiry for analyzing these agreements assures that it has not been put to rest.

Summary

When brand name pharmaceutical companies are embroiled in patent infringement litigation with generic manufacturers under the Hatch-Waxman Act—the federal statute that creates the structure in which generic drugs are approved and come to market with the first generic having limited exclusivity—the litigation can be resolved with an agreement in which the generic is permitted to enter the market for a period of time before the patent expires.  In many situations, however, settlement agreements call for the plaintiff brand name drug patent holder to pay the defendant generic a substantial sum of money, with market entry permitted only at, or just prior to, patent expiration.  These so-called “reverse payment” settlements, in which the plaintiff pays the defendant to settle a case, have been criticized and challenged by private litigants and the Federal Trade Commission as illegal agreements between competitors to extend—and then divide between them—the monopoly sales period granted by a potentially questionable patent.  Moreover, because of the incentives of the unique generic drug approval scheme, these settlements can effectively preclude other generic versions of drugs from making it to market for several years.
  
For a decade, the FTC has argued—mostly without success—that such deals violate Section 5 of the Federal Trade Commission Act.  Several courts of appeals, with the exception of the Third Circuit, have held that so long as the anticompetitive effects of a reverse payment settlement fall within the scope of the patent’s exclusionary period, the settlement is immune from antitrust attack. That has been the repeated position of the Eleventh Circuit, from which the Actavis decision originated.  On Monday, the Supreme Court held in a 5-3 ruling that these reverse payments are not, in fact, immune from antitrust scrutiny.
  
Justice Breyer penned the majority opinion, in which the Court ruled the antitrust laws apply fully to patent settlements even where the effect of the settlement is not to effectively extend the patent term.  The Court distinguished reverse payment settlements as creatures of the pharmaceutical industry, and was obviously concerned about the “unusual” settlement where a plaintiff agrees to pay the defendant large sums of money to stay out of its market for a negotiated period, even though the defendant has no counterclaim for monetary relief.  The Court was troubled by the possibility that two competitors would agree not to compete in order to divide the publicly conferred benefit of market exclusivity, even when the validity of the patent was being challenged.  This was an unacceptable construction of the antitrust laws, the Court concluded, especially when a more traditional settlement structure—one that preserved for the patent holder patent validity and a somewhat shortened period of exclusivity—was available.

With its concern that reverse payment settlements could have significant adverse effects on competition, the Court found it would be “incongruous” to determine the antitrust legality of these agreements by measuring the anticompetitive effects solely against patent law policy.  Indeed, it appeared to conclude that only antitrust law and policy should inform the analysis of this type of agreement.  That approach reverses the Eleventh Circuit’s analysis, which started at the other end, finding an agreement within the scope of a presumptively valid patent could not be unlawful.  The Eleventh Circuit had further supported its decision with the policy concern that a case-by-case review of reverse payment agreements would require the parties to engage in time-consuming, complex and expensive litigation to demonstrate what would have happened to competition absent the settlement.  The Supreme Court dismissed these policy concerns, and concluded the following five “sets of considerations” support direct application of the antitrust laws and that reverse payment agreements might, in fact, have significant anticompetitive effects:

  • Reverse payment settlements can artificially exclude from the market a generic drug manufacturer whose product poses a legitimate threat of competition and thus “has the ‘potential for genuine adverse effects on competition.’”
  • Nevertheless, anticompetitive consequences from reverse payment agreements will, at least sometimes, prove to be unjustified.  For instance, the Court offered the example of a reverse payment that reflects no more than a rough approximation of the litigation expenses saved through the settlement, or the value of services to be performed.
  • Where a reverse payment agreement threatens anticompetitive harm, the patent holder likely has the market power to bring that harm about in practice. The Court noted “the size of the payment from a branded drug manufacturer to a prospective generic is itself a strong indicator of power” to charge higher-than-competitive prices. 
  • It is not necessary to litigate a patent’s validity to resolve the antitrust claim, because a court may infer from an “unexplained” large reverse payment alone that the patent holder has questions about the validity of its patent and is thus paying to prevent the “risk of competition,” which is an anticompetitive harm.
  • Parties can settle in other ways, such as allowing the generic manufacturer to enter the patent holder’s market before the patent expires, without the patent holder paying the competitor to stay out of the market.

While categorical in its condemnation of a patent holder paying a challenger unjustified sums to stay out of the market, the Court did not find that reverse payment settlement agreements were presumptively invalid.  Indeed, the Court rejected the FTC’s call to take this very step and to apply a “quick look” test when analyzing reverse payment settlements, holding instead that lower courts are to apply some form of the traditional antitrust “Rule of Reason.”

Implications

The Actavis decision is best seen as an interim step taken by a Court that is highly suspicious of reverse payment settlements, but that wishes to be prudent in a difficult area of the law, and is conscious of the need to allow private litigants to settle their disputes on mutually acceptable terms.  The categorical approaches of courts of appeals holding reverse payment settlements per se lawful, or of the FTC applying the contrary conclusion, are out.  Very large payments that do not reflect traditional settlement considerations are probably also out, at least in connection with the simplified cash deals that were at the heart of the Court’s reasoning.  But the Court left the playing field more level than the FTC would have liked, and both industry participants and the lower courts are left to contend with a large middle ground of deals and an extensive and at times unclear or contradictory set of dicta against which to review them.  Indeed, the Actavis decision is a break from a line of recent Supreme Court decisions in antitrust that have sought to reduce uncertainty and litigation costs and to strengthen the tools available for dismissing non-meritorious suits early.  Challenges to reverse payment settlements will thus seemingly be able to breeze through the motion to dismiss stage; industry participants hoping for clarity and finality after all these years of litigation and controversy will likely be disappointed. 

But that is not the end of the matter.  If, as the Court suggests, patent settlements between brands and generics adapted to the regulatory scheme created by the Hatch-Waxman Amendments and the realities of the generic drug marketplace, so too will they adapt to the new rules of the road laid out in Actavis.  Looking to the future, it might be that the richer deals simply won’t get made.  The Court made no secret of the fact that it was suspicious of settlements creating consensual monopolies where settlements allowing earlier generic entry were possible.  And the dissent was not wrong in cataloguing the costs of being an antitrust defendant and the disincentives that creates to settlement.  But the Court’s opinion points the way to a new generation of reverse payments.  In closer cases, defendants may complicate their payment schemes to make them harder to attack under the Rule of Reason.  The real potential, however, lies in the Court’s specific endorsement of the legitimacy of paying a settling generic for “services” rendered, with the two examples listed being distribution and “helping to develop the market.”  Slip Op. at 17.  The defendants in Actavis argued that the “reverse payments” were indeed for “services,” id. at 6, but the FTC alleged the contrary, that those services were illusory, and in the procedural posture of a motion to dismiss that was the assumed fact.  What if that fact is not present?

The big opportunity for brands and generics wishing to settle claims is to develop the idea that payments to a generic for services (or for anything else, for that matter) may legitimately be made in connection with settlement, even if unrelated to the product at issue.  The agreements in such cases would have to be commercially reasonable and negotiated at arm’s length, but perhaps there would be no other requirement.  There is enough in the Court’s opinion to support the practice, even though it no doubt would attract critics.

Going forward, beyond the likelihood that few antitrust challenges to reverse payment settlements may be subject to an early dismissal, the key litigation question will be the grounds available to defend a settlement in which reverse payments are made.  As noted above, the Court identifies litigation costs and compensation for “services” as qualifying, and the ability of the latter category to expand might provide a playing field for litigation.  But at every turn the list of “legitimate” justifications for a reverse payment settlement is expressly left by the Court nonexclusive, even if no guidance is offered as to what other acceptable alternatives may be.  See, e.g., id. at 20 (concluding that the antitrust question turns upon a number of stated factors, including the absence of any other “convincing” justification). 

The elephant in the room is whether defendants can argue that the patent was valid, and thus that the patent holder should be found to have validly exercised its patent rights by settling for terms that are within the patent monopoly.  The Court glibly dismisses concerns that it is requiring mini-trials on validity by stating “it is normally not necessary to litigate patent validity to answer the antitrust question.” id. at 8.  And it finds an economically reasonable settlement based on a brand’s assessment of the strength of its patent to be illegitimate because it “seeks to prevent the risk of competition.”  Id. at 19.  But, ironically, it dismisses the Eleventh Circuit’s conclusion that settlements within the scope of a patent are per se lawful on precisely that ground, noting that the conclusion that a patent is legitimate and infringed had not yet been proved.  Id.  Further, the decision to require a full Rule of Reason analysis rather than a “quick look,” id. at 20, and to commit to the lower courts what theories to entertain, id. at 20, seem not to shut the door firmly on anything.  Although a defendant might find it an uphill climb to argue that the merits of its patent are relevant, a court sensitive to the concerns of the dissent that the policies of the patent system should not be totally sublimated to those of antitrust law may give it a go, especially if there is reason to believe that the patent is strong.  In such case—where a patent holder brand manufacturer could prove by a preponderance of evidence that it had a right to exclude the generic, the economic case against reverse payment settlements would itself be reversed, and the settlements seen as introducing competition earlier than otherwise likely.  Regardless, one may argue that the ability to say something about the merits of a patent in constructing the but-for world, if only for calculating damages, is necessary for a fair trial.

Ironically, the Court’s Rule of Reason examination of Hatch-Waxman litigation settlements may have an unintended consequence, which is to reduce the likelihood of settlement where the patent validity challenges are close.  The economic incentives driving the patent owner (to preserve years of highly profitable and exclusive branded sales), and the first generic (to obtain the 180-day exclusivity which may be worth hundreds of millions in revenue), may cause the litigants to roll the dice more often with trial.  Letting the litigation play out may ultimately deprive the public of benefits intended by the Hatch-Waxman Act— lower prices from generic competition—while preserving profitability for the patent holders and successful generic challengers.

One final note: Litigation will also determine whether the Actavis opinion has life outside of the pharmaceutical industry.  The Court’s seemingly offhand and sweeping assertion that settlements that prevent “the risk of competition” are anticompetitive comes as much as a surprise to many antitrust practitioners as it did to the dissent.  While it is likely that the dictum will be limited to the reverse payment context in which it appears, that conclusion could take years to be drawn.  More generally, it is prudent for any settlement of a patent dispute between competitors that leaves one competitor dominant in a market to be viewed with fresh eyes.