On March 25, the Supreme Court will hear arguments in Federal Trade Commission v. Watson Pharmaceuticals, Inc.,[1] and take a step toward concluding a long-running and acrimonious dispute between the Federal Trade Commission ("FTC") and several Circuit Courts of Appeal regarding whether patent settlements under the Hatch-Waxman Act[2] containing "reverse payments" violate the Sherman Antitrust Act. For many years, the FTC has taken the position[3] that such payments presumptively violate the Sherman Act, only to be rebuffed by the Second, Sixth, Eleventh, and Federal Circuits[4] as well as by the Supreme Court's refusal to hear the issue until now.

Background: A Quick Look at the Hatch-Waxman Act

Although brand-name (i.e., "pioneer") pharmaceutical manufacturers must invest heavily in new drug development as well as in safety and efficacy trials to gain Food and Drug Administration ("FDA") approval, the Hatch-Waxman Act permits, and indeed encourages, generic competitors to "piggyback" on the FDA's prior approval of a new drug if the generic competitor establishes that the generic drug is chemically identical and will be prescribed for the same indications.[5] Congress intended the use of such Abbreviated New Drug Applications ("ANDA") to stimulate competition between pharmaceutical manufacturers, thereby providing consumers with reduced prescription drug costs.[6] However, because the FDA cannot approve an ANDA application that would infringe a pioneer drug's patent, the generic manufacturer must certify that the patent in question either: (1) has not been filed; (2) has expired; (3) will expire on a certain date, or; (4) is invalid or will not be infringed by the generic drug.[7] If the generic applicant certifies under the latter provision, commonly known as a "paragraph IV certification," the brand-name patent holder has 45 days to file a patent infringement lawsuit against the applicant to prevent generic market entry.[8] Upon the filing of the patent infringement suit, the FDA stays ANDA approval for 30 months.[9] Although paragraph IV certification almost inevitably provokes patent litigation, the first successful ANDA applicant is entitled to 180 days of generic exclusivity, during which time the FDA postpones the approval process for all other generic applicants.[10]

Why Reverse Payments?

Most litigation ends in negotiated settlement agreements among the parties and Hatch-Waxman litigation is no different. However, Hatch-Waxman settlements often include a payment from the patent holder to the generic company, which is not typically seen in traditional patent infringement lawsuits. Such payments from the patent holder to the generic company are called "reverse payment settlements."[11] In such settlements, the first generic challenger typically agrees to delay or forego marketing its generic product in exchange for monetary consideration from the patent holder, thereby reversing the typical flow of consideration from the patent infringer to the patent holder.[12]

The existence of "reverse payment" settlements in Hatch-Waxman litigation can be attributed to the Act's redistribution of patent litigation risks by giving the patent holder the right to sue the generic (ANDA) challenger for infringement and allowing the ANDA filer to challenge patent validity even though the generic company has not incurred the cost of market entry or the risk of incurring damages.[13] Accordingly, the patent holders' upside from litigation is relatively small: preserving only what they already possess (a statutory monopoly) but without an award of infringement damages, while their downside (as in any infringement suit) is enormous: the invalidation of the patent. Conversely, the ANDA infringers' upside is large: invalidation of the patent with immediate exclusive generic market entry as the first ANDA filer, while their downside is small: an injunction preventing them from doing what they have not yet done (enter the market) without any damages owed to the patent holder.[14] Given that the generic company has not incurred liability for damages, there is no reason a payment would flow to the patent holder, whereas it may be economically rational for the patent holder to pay the generic company to settle the litigation and avoid the risk that the challenged patent will be found invalid.[15]

The Scope of the Patent Standard

Most Circuit Courts of Appeal that have considered the issue have held that reverse payments which do not delay generic entry beyond the expiration date of the patent grant do not implicate the antitrust laws' prohibitions on unreasonable restraints of trade.[16] This is known as the "scope of the patent" test. The rationale underlying this standard is that because a patent by definition lawfully excludes competition,[17] "the anticompetitive effect is already present."[18] Thus, the mere existence of anticompetitive effects cannot be the basis for antitrust liability.[19] Instead, antitrust liability attaches only when the anticompetitive effects exceed the exclusionary potential of the patent, or when the infringement suit is brought knowing that the patent is invalid.[20] Thus, while a reverse payment might be "suspicious," it is not unlawful to receive a substantial sum of money "so long as the patent litigation is neither a sham nor otherwise baseless"[21] and the settlement does not extend the scope of the patent monopoly.[22]

The FTC's Position

The FTC has been an unrelenting critic of reverse payments challenging them in court, advocating against them in speeches to professional organizations,[23] and supporting Congressional legislation[24] that would ban them. The FTC has typically challenged reverse payment settlements when the settlements also contain an agreement not to enter the market prior to the expiration of the nominal term of the patent grant, describing such payments as "exclusion payment settlements"[25] or "pay for delay" and ruling on the agency level that they are presumptively illegal.[26] In the FTC's view, a settlement agreement that delays or prevents generic market entry in any way precludes consumer access to the more affordable generic product, resulting in consumer harm measured by "the difference between the brand's loss [of profits from generic entry] and the generics' gain."[27] According to a 2010 FTC report, reverse payments prevent downward price pressure caused by generic competition and account for $3.5 billion in annual profits for the pharmaceutical industry.[28]

Last summer, the Third Circuit adopted the FTC's position for the first time in In re K-Dur Antitrust Litig.[29] Rejecting the scope of the patent test's "almost unrebuttable" presumption of patent validity, the Third Circuit held that reverse payments were presumptively anticompetitive "because reverse payments permit the sharing of monopoly rents between would-be competitors without any assurance that the underlying patent is valid."[30] In place of the scope of the patent test, the Third Circuit mandated "a quick look rule of reason analysis based on the economic realities of the reverse payment settlement."[31] Rebuttal of the presumption of invalidity under the Third Circuit's test requires proof that the payment was for a purpose other than to delay entry or proof of procompetitive benefits.[32]

FTC v. Watson Pharmaceuticals

Following the Third Circuit's decision and the resultant circuit split, the FTC successfully petitioned the Supreme Court for review in Watson Pharmaceuticals, a case in which the Eleventh Circuit dismissed a FTC reverse payment challenge under the scope of the patent test.[33] In Watson, the Eleventh Circuit rejected the FTC's argument that Solvay Pharmaceuticals, the manufacturer of AndroGel®, unlawfully settled paragraph IV litigation by paying its generic challengers to postpone market entry.[34] Specifically, the FTC alleged that Solvay utilized reverse payments to extend its monopoly under patent law because it was "unlikely to succeed" in the underlying infringement action and maintain the patent's monopoly grant.[35] By doing so, the FTC argued that the defendants unlawfully restrained competition.[36] At the outset, the Eleventh Circuit cautioned that "[t]he difficulty at the heart of this case is in deciding how to resolve the tension between the pro-exclusivity tenets of patent law and the pro-competition tenets of antitrust law."[37] Turning to Eleventh Circuit precedent, the Court recognized that reverse payments that delay generic entry beyond the expiration date of the patent are illegal:

A patent holder and any of its challengers cannot enter into an agreement that excludes more competition than the patent has the potential to exclude. If a reverse payment settlement reduces generic competition to a greater extent than the patent grant potentially does, the holder of the patent has used the settlement to buy exclusionary rights that are not contained in the patent grant, and those additional rights are vulnerable to antitrust attack.[38]

Notwithstanding, the Court held, absent sham litigation or fraud in obtaining the patent, reverse payments are immune from antitrust attack so long as their anticompetitive effects fall within the exclusionary potential (i.e., temporal duration) of the patent.[39] Furthermore, the Watson Court declined the FTC's invitation to assess the legality of reverse payments based on the underlying infringement action's likelihood of success. The Court noted that "[p]redicting the future is precarious at best; retroactively predicting from a past perspective a future that never occurred is even more perilous."[40]

Seizing on the circuit split created by K-Dur, the FTC successfully petitioned for certiorari to the Supreme Court in Watson.[41] The FTC's petition argues that the Eleventh Circuit's decision is incorrect and negatively affects an issue of exceptional importance to the national economy.[42] The FTC further argues that if the circuit split is left unresolved, the divergence in substantive antitrust law will lead to extensive forum shopping wherein private plaintiffs attacking reverse payments will seek to lay venue in the Third Circuit, the location of numerous brand-name and generic pharmaceutical manufacturers, while brand-name manufacturers initiating paragraph IV litigation will lay suit in the Second and Eleventh Circuits.[43] Despite seeking review of the Eleventh Circuit's decision in Watson, in which its argument was premised on the likelihood of success in the underlying patent litigation, the FTC's petition endorses the Third Circuit's quick-look rule of reason approach, which holds reverse payments presumptively unlawful.[44] Interestingly, defendant Watson Pharmaceuticals, a generic drug manufacturer, argued in favor of certiorari in an attempt to uphold the scope of the patent test.[45]

Conclusion

The Supreme Court's decision in Watson is likely to have a profound effect on the economics of the pharmaceutical industry. The Hatch-Waxman Act has forged a marriage between patent and antitrust law whose competing priorities remain unresolved. Application of the scope of the patent test recognizes the primacy of intellectual property rights, while quick-look rule of reason analysis favors increased competition. Should the Third Circuit's approach to reverse payments prevail, the incentives for life-saving pharmaceutical innovation could be curtailed. On the other hand, adoption of the scope of the patent test will likely reduce downward price pressure on prescription drug prices. In the end, however, both antitrust and patent law seek to enhance the public welfare through innovation and the provision of new goods and services. In Watson, the Court's role will be to determine through which means this end is to be achieved.