The Supreme Court Holds That Settlements of Paragraph IV Litigation Are Subject to the Rule of Reason

On June 17, 2013, the U.S. Supreme Court ruled in FTC v. Actavis, Inc. that settlements of patent infringement suits brought in response to a Paragraph IV certification under the Hatch-Waxman Act (frequently called “Paragraph IV,” “reverse payment,” or “pay-for-delay” settlements) are subject to the rule of reason. Writing for a five-to-three majority, Justice Breyer rejected the view adopted by the Eleventh Circuit below (as well as the Second and Federal Circuits) that settlements of Hatch-Waxman Act litigation that are within the scope of the brand’s patent are per se lawful. The Court also rejected the FTC’s position (also supported by the Solicitor General) that such settlements should be presumed unlawful. Instead, the Court held that such settlements must be evaluated on a case-by-case basis, under the rule of reason, to determine if the procompetitive benefits of the settlement outweigh any anticompetitive effects.

The Court’s decision in FTC v. Actavis, Inc. settles a long-running debate regarding the appropriate standard that should apply to Paragraph IV settlements. As the Court itself has previously noted, however, the rule of reason involves a fact-bound balancing test that does not provide the type of bright-line guidance that both sides sought. Companies contemplating Paragraph IV settlements will therefore need to evaluate whether their proposed settlement’s procompetitive benefits outweigh any potential anticompetitive effects resulting from the possibility of a reduction in generic competition. Whether the decision will reduce the incentives to settle costly patent litigation because of the risk of costly follow-on antitrust litigation — an outcome the dissent foreshadows — remains to be seen.

Background on the Androgel Litigation

The Hatch-Waxman Act allows branded drug owners to sue for infringement when a generic drug company makes a Paragraph IV certification that the brand company’s patent is either invalid or not infringed. The typical settlement includes at least two components: (1) the brand company compensates the generic company in the form of a cash payout or other commercial benefits and (2) the generic agrees to delay its entry into the market until a later date closer to patent expiration.

For more than a decade, the FTC has claimed that these settlements violate the antitrust laws by altering the incentives Congress put in place in the Hatch-Waxman Act to create generic drug competition. The Hatch-Waxman Act offered generics the opportunity to challenge invalid or non-infringed patents (in the form of a Paragraph IV certification) without the need to actually enter the market and risk litigation. To promote such challenges, the Act also provides 180 days of marketing exclusivity to the first generic filer. The Act was silent as to the settlement of the resulting infringement litigation. In practice, branded drug companies have sometimes paid generics significant settlements that created incentives for the generic firm to agree to a delayed entry date and also removed any risk of an invalidity or noninfringement ruling.

The FTC’s position historically rested on the assumption that, because the typical pattern in litigation to enforce a strong patent is for the infringer to pay the patent owner and not the other way around, a substantial payment by the brand owner to the generic raised a suspicion that the payment was to avoid a declaration of invalidity or non-infringement of a weak patent. Thus, in the FTC’s view, the payment represents a sharing of profits from an improperly prolonged monopoly protected by the patent, when the more appropriate outcome would involve elimination of the patent’s exclusionary power and unrestricted new entry by one or more generics. This led the FTC to argue in the early cases that Hatch-Waxman Act settlements should be per se illegal (except for minimal payments by brand owners to compensate generics for litigation expenses). Following a string of losses in the federal appellate courts, the FTC eventually moderated its position and adopted the view that Hatch-Waxman Act settlements should be subject to a rebuttable presumption of illegality because they delay generic entry, resulting in higher prices and less choice for consumers.1

Pharmaceutical companies long have disputed the FTC’s view and contend that these settlements should be per se lawful because: (1) patent rights include the right to limit the extent and conditions under which the patent holder licenses its intellectual property (including the right to refuse to license), and (2) the efficiency and innovation of the industry (and ultimately the health of patients and economic well-being of consumers) benefit from the ability to settle in a way that provides finality and avoids both protracted and costly patent litigation as well as any follow-on antitrust litigation (equally if not more protracted and costly than patent litigation) challenging such settlements.

In January 2009, the FTC filed suit against three companies, Solvay Pharmaceuticals Inc., (a brand pharmaceutical company), and Watson Pharmaceuticals and Paddock Laboratories, (both generic companies), alleging they had violated Section 5 of the FTC Act by entering into allegedly anticompetitive settlements regarding the product Androgel, a topical medication to treat male testosterone deficiency. In each settlement, in exchange for a payment, the generic companies agreed to enter the market at a later date than they would have had they prevailed in the patent suit, but an earlier date than patent expiry. The agency alleged that the Androgel patent was weak, that Solvay would likely have lost at trial, and that consumers would have benefitted from generic entry much sooner absent the settlement. The district court granted the defendants’ motion to dismiss because, although the settlement delayed generic entry nine years, the settlement still allowed for generic entry five years before patent expiry, and thus did not “exceed the scope” of the patent.2

The Eleventh Circuit affirmed, holding that the “scope of the patent” standard previously adopted by the Second and Federal Circuits was appropriate unless there was evidence of sham litigation or fraud in obtaining the patent.3 The Court noted that from the brand’s perspective, “no rational actor . . . would take [the] risk” of investing “more than $1.3 billion” on a potential drug where “[o]nly one of every 5,000 medicines tested . . . is eventually approved for patient use” “without the prospect of a big reward” in the form of a guaranteed right to recoup monopoly profits. The court further observed that while agreements among competitors to eliminate competition would be barred under the antitrust laws, reverse payment cases were “atypical” because “one of the parties [owns] a patent.” This “makes all the difference” to the court, because the patent holder “has a lawful right to exclude others from the marketplace.”

Shortly thereafter, in In re K-Dur Antitrust Litigation, 686 F.3d 197, 218 (3d Cir. 2012), the Third Circuit split from the Second, Eleventh, and Federal Circuits and adopted the FTC’s view that reverse payment settlements should be subject to a “quick-look” rule of reason, under which they are presumed to be illegal. The Supreme Court granted the FTC’s petition for certiorari in the Androgel litigation on December 7, 2012.

The Supreme Court’s Decision

The five-Justice majority rejected the Eleventh Circuit’s view that settlements within the scope of the brand’s patent should be per se legal and concluded that the proper test for examining such settlements is the rule of reason. This reversal means that, going forward, the burden will be on the FTC or private plaintiff to show that the likely anticompetitive effects of the agreement outweigh its procompetitive benefit. The ruling contained a number of noteworthy points.

First, the Court rejects the theory that the patent holder’s conduct is immune from antitrust scrutiny absent evidence of sham litigation or fraud in obtaining the patent. The Court reasons that the Paragraph IV litigation “put the patent’s validity and preclusive scope at issue” and that it would be “incongruous to determine antitrust legality by measuring the settlement’s anticompetitive effects solely against patent law policy, and not against procompetitive antitrust policies” because both factors “are relevant in determining the scope of monopoly and antitrust immunity conferred by a patent.”

Second, the Court is unmoved by the defendants’ and dissent’s concern that the practical effect of allowing antitrust challenges to settlements will re-open the underlying invalidity and/or infringement litigation in order to demonstrate what would have happened to competition but for the settlement. Bottom line, the Court appears to conclude that the risks of relitigating the patent suit would be offset by the ability to root out settlements that threatened “unjustified anticompetitive harm.” The Court notes that a settlement which simply allowed later entry without a payment would not risk antitrust liability and leaves open the door to settlements with “justified” payments.

Third, and finally, the Court rejects the FTC’s claim that Paragraph IV settlements should be treated as “presumptively unlawful” under a “quick look” rule of reason approach. The Court concludes that the settlements do not meet the standard for a “quick look” approach because a settlement’s anticompetitive effects depend “upon its size, its scale in relation to the payor’s anticipated future litigation costs, its independence from other services for which it might represent payment, and the lack of any other convincing justification.” That fact-bound inquiry, the Court reasons, could not be squared with the default rule of liability required by the quick look analysis.

Chief Justice Roberts authored a strong dissent joined by Justices Scalia and Thomas. The dissent characterizes the majority as “announc[ing] a new rule” given that the Court has historically struck a balance between antitrust and intellectual property rights with the rule that when — and only when — an intellectual property holder “steps outside the scope of the patent, he can no longer use the patent as his defense.” The dissent observes that “the majority points to no case where a patent settlement was subject to antitrust scrutiny merely because the validity of the patent was uncertain.”

Implications

Structuring Paragraph IV Settlements Going Forward. Although the Court’s decision settles the long-running debate on the legal standard that should apply to Paragraph IV settlements and permits the agencies to attack settlements that are within the scope of the patent, the Court’s choice of the rule of reason standard means that the advice to brand and generic firms settling Hatch Waxman litigation does not change demonstrably: firms should continue to evaluate whether, on balance, a settlement agreement can be explained as something other than a payment from the brand to the generic to stay out of the market.

The Court identifies three aspects of Paragraph IV settlements that should receive increased scrutiny. First, the Court notes that settlements for “large and unjustified amounts” will raise significant questions. The Court clarifies that settlements for amounts that exceed the amount the generic would have earned had it entered the market following favorable resolution of the Paragraph IV litigation are likely to be the most problematic. Second, the Court observes that settlements with first filers are more likely to attract scrutiny. Third, settlements with a generic entry date closer to the end of patent expiry are also most likely to be problematic. To those familiar with this area, these observations are familiar and do not demonstrably alter the settlement landscape.

The Court also identifies circumstances or settlement features that will diminish the likelihood of antitrust scrutiny. The Court writes favorably about potential agreements where, as part of a settlement, the brand compensates the generic for providing various services such as distribution and marketing. The decision notes that “where a reverse payment reflects traditional settlement considerations, such as avoided litigation costs or fair value for services, there is not the same concern that a patentee is using its monopoly profits to avoid the risk of patent invalidation or a finding of infringement. In such cases, the parties may have provided for a reverse payment without having sought or brought about the anticompetitive consequences.” This opinion arguably suggests that settlements which include these types of agreements will pass muster under the rule of reason.

Finally, the Court concludes by offering some broad observations regarding the size of the payment and its connection to the other settlement terms. The Court notes “the likelihood of a reverse payment bringing about the anticompetitive effects depends on its size, its scale in relation to the payor’s future litigation costs, its independence from other services for which it might represent payment, and the lack of any other convincing justification.”

More Antitrust Litigation? A key question on the horizon is how the FTC and private plaintiffs will react to the Court’s decision and what that means for assessing the risk of possible investigations and litigation arising out of settlements. At least initially, potential plaintiffs may pay increased attention to Paragraph IV settlements. The Court’s decision observes that while evidence of “traditional settlement considerations, such as avoided litigation costs or fair value for services” may indicate that a settlement should survive rule of reason scrutiny, this “possibility does not justify dismissing the FTC’s complaint.” This sentence could prove significant if it is meant to suggest that — the Supreme Court’s decision in Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007), notwithstanding — the threshold for pleading an antitrust violation based on a reverse payment settlement may be relatively low. How much deference courts will give this observation at the motion to dismiss phase will be an important development to watch.

Realistically, however, the FTC will not want to create bad law and will want to bring the cases the agency is most likely to win. Since the FTC will still bear the burden of proof, only the most aggressive settlements will attract their sustained attention. Thus, while potential plaintiffs may perceive that they will have an easier time in the courts given the Court’s refusal to adopt the scope of the patent test it is not evident that their case selection will change.

The decision could perhaps spur more private class action litigations, given the majority’s suggestion that the factors relevant to the rule of reason analysis are best evaluated following discovery. However, because private plaintiffs historically have relied on the FTC to decide for them which cases to bring, predicting whether or not the decision will have any demonstrable effect would be premature.

More Intellectual Property Litigation? Perhaps the biggest unanswered question is what role a patent’s questionable validity should play in antitrust litigation over Paragraph IV settlements going forward. Should the parties conduct an abbreviated trial on the merits of the patent? A full trial? Does the fact that the parties entered into a settlement suggest that while the settlement is not presumptively unlawful, the patent is presumptively invalid? The Court notes that “it is normally not necessary to litigate patent validity to answer the antitrust question” given that “an unexplained large reverse payment itself would normally suggest that the patentee has serious doubts about the patent’s survival.” This leaves unresolved, however, how courts and litigating parties should address questions that raise a closer call — namely, where the payment is large, the delay is significant, but the payment and delay may very well be justified, both because of the anticipated litigation costs and also because the settlement reflects compensation for a considerable services agreement. In these cases, courts will still need to resolve how to address the fact that validity may be “called into question” by the antitrust action but the validity is not definitively resolved.

Effects Beyond Paragraph IV Litigation. The Court’s decision is also likely to factor in the analysis that the antitrust agencies and federal courts apply in evaluating antitrust claims brought against branded firms for Hatch-Waxman related conduct alleged to cause harm to generic firms. Ongoing examples of such litigation include Mylan Pharmaceuticals, Inc. v. Warner Chilcott Public Limited Company, No. 12-3824 (E.D. Pa.), which concerns the legality of “product hopping” and Actelion Pharmaceuticals, Ltd. v. Apotex, No. 12-05743 (D.N.J.), which addresses the legality of brand firms’ alleged exploitation of REMS programs to eliminate potential generic competition.

A frequent issue in those cases is whether the branded firm’s intellectual property rights should shield it from antitrust liability. The Court’s broad pronouncements regarding the interplay between a brand’s intellectual property rights, on the one hand, and the policies and objectives of the Hatch-Waxman Act and antitrust law, on the other, will likely cause plaintiffs in these cases to press these arguments with renewed vigor.

More generally, perhaps the most significant effect of the Court’s decision over the long run may be the extent to which it charts a middle ground in the long-running debate over the extent to which a defendant’s rights (intellectual property or otherwise) shield it from antitrust claims. Spurred in part by the Court’s decisions in Verizon Communications, Inc. v. Law Offices of Curtis V. Trinko, LLP, 540 U. S. 398, 408 (2004), and Credit Suisse Securities LLC v. Billing, 551 U.S. 264, 275 (2006), courts have had a tendency to assume that antitrust claims should yield to other bodies of law. How courts will evaluate the opinion’s discussion regarding the role that antitrust law should play in analyzing an intellectual property holder’s conduct in non-Hatch-Waxman Act contexts remains to be seen. Going forward, companies should expect, however, that the FTC and the DOJ Antitrust Division, as well as private plaintiffs, will embrace the decision in their advocacy in cases involving challenges to the conduct of intellectual property holders.