Chillin'Competition

We start the series of posts from Harvard Law students with a great introduction to the antitrust issues that arise in connection with “pay-for-delay settlements”/”reverse payments” in the pharma industry.  The post is authored by Paul B, and builds on the relevant readings in the syllabus. We have also included other students’ reactions in the “comments section”.

For those short on time and already familiar with the topic, go ahead and click on the link below to skip to “Questions for discussion”.

Pay-for-delay (PFD, “reverse payments”)

The issue is tricky because it lies at the intersection of patent, food/drug and antitrust (AT) law, and its unclear to which of these we should look to address abuses that arise from the US generic drug regime.  In short, when a pharmaceutical company develops a new (branded) drug, it first seeks a patent.  The initial problem is that the PTO grants patents fairly generously, in a largely non-adversarial process, so in many cases the branded drug will be patented even though it is arguably not novel, non-obvious, etc.  The drug then goes through a lengthy and expensive testing and Federal Drug Agency approval process (a New Drug Application, or NDA), which may eat up a sizable share of the patent protection period.

Once the drug is FDA approved and hits the market, the Hatch-Waxman amendments to the Food, Drug and Cosmetics Act kick in.  Consistent with the themes we’ve discussed throughout the term, Hatch-Waxman attempts to balance the fostering of innovation (by protecting the patent-granted monopoly for truly innovative new drugs) against the desire to foster competition by allowing low-cost generics on the market as soon as possible.  For a normal (i.e., non-pharma) patent, the way to challenge a disputed patent would be for an alleged infringer to place his product on the market, and for the patent holder to sue for infringement damages and an injunction against future sales.  If the parties settle, the infringer might pay the patent holder part of the alleged damages (a higher share the more likely they are to get an adverse verdict, based on the probability that a court will find that the disputed patent was both valid and infringed by the defendant)  and/or there may be some sort of licensing or contract manufacturing agreement.  Such agreements typically do not raise serious AT concerns.

In the case of pharmaceuticals, by contrast, Congress decided in Hatch-Waxman for various reasons to set up a regime in which the legal challenge comes before the infringement.  So a company which develops a generic version of a branded (and patented) drug begins by filing an abbreviated new drug application (ANDA), which is much easier to approve than an NDA (the company must only show that the drug is bioequivalent to the branded drug).  As part of the ANDA, the generic company informs the branded drug manufacturer that it intends to challenge the legitimacy of its patent.  Assuming the branded company wishes to defend its patent and challenge the ANDA, a 30-month delay is automatically imposed before the generic can go to market, during which the companies may litigate the claim.  If (as happens surprisingly often) the generic wins, it is granted a 6-month exclusivity period to market its generic version (creating a market duopoly) before other generics may enter the market.  During that period, the generic will typically price its drug below the price point of the branded drug (which has been charging the monopoly price) but well above the competitive market price which will obtain once other generics enter the market (roughly 15% of the monopoly price, on average).  This system (1) rewards the first firm to challenge potentially weak patents which are wrongly imposing monopoly pricing on consumers (2) allows the issue to be resolved prior to costly commercialization of a potentially infringing product, (3) preserves and expedites the patent monopoly of truly innovative drugs, and (4) ensures that market pricing is achieved within 4 years of the filing of a legitimate pharma patent challenge.

UNLESS, the parties settle.  Here, because no infringement has yet occurred, proper settlement damages will in theory be “reverse”; that is, if there is a 50% likelihood that the generic has been kept off the market by an invalid patent, the branded drug holder may offer to pay the generic 50% of what it could have made by marketing the drug during that period (rather than the normal process of the infringer paying the patent-holder 50% or some other share of what it actually did earn from infringing).  The concern here is that both parties have an incentive for this payment to reflect more than just their  best estimates of patent validity, damages or litigation costs (all legitimate considerations in a settlement), but rather to split up the monopoly profits.  That is, if there are 6 years remaining on the branded drug’s patent, and the parties agree it is 50% likely that the patent is invalid, they could agree to a settlement that the generic would just wait 3 years to enter the market.  When the branded company instead pays the generic “reverse damages” in return for an agreement to stay off the market for the full 6 years, there is a concern that the firms are essentially maintaining a bogus monopoly at the expense of consumers.  If, say, BrandX sells for $100 per pill, and the market price under full competition is $20, brand and generic may agree to a pay-for-delay settlement in which brand pays generic $30 for each unit of BrandX sold for the remainder of the patent life.  This allows them to split monopoly rents:  brand makes $70 per pill, still well above the market price, for a drug that arguably should not have patent protection, and generic earns $30 per pill for doing nothing, much better than it could have done at market.  This same sort of agreement can be done with generic performing some contract manufacturing for brand, also at those prices.

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