November 6, 2012
LES Insights
By John C. Paul; D. Brian Kacedon; Robert C. MacKichan III
Authored by D. Brian Kacedon, Robert C. MacKichan III, and John C. Paul
Reverse-payment settlements result from "abbreviated new drug application" (ANDA) litigation, in which a patentee, name-brand drug manufacturer pays a generic-drug producer to delay its entry into the market. Several federal courts of appeal have addressed such settlements and found them permissible. In In re K-Dur,1 however, the Third Circuit refused to follow the more lenient standard of antitrust scrutiny applied by three other courts of appeals and instead held that the analysis must consider such settlements prima facie evidence of an unreasonable restraint on trade. The Third Circuit's holding creates a circuit split with the Second, Eleventh, and Federal Circuits.
Reverse-payment settlements are agreements to resolve litigation with payment flowing in reverse—from the patentee to the accused infringer. These agreements have arisen from litigation under the Hatch-Waxman Act, which governs patented drugs. The Act seeks to encourage generic-drug availability in part by fast-tracking the FDA approval process for generic drugs by using abbreviated applications—ANDAs—that rely on the FDA's prior determination of safety and efficacy made for the corresponding branded drugs. Applicants filing an ANDA must certify that the proposed generic drug does not infringe any patent listed with the FDA as covering the branded drug. Applicants do this either by certifying that the patent covering the drug is expired or is set to expire or by filing a "paragraph IV" certification that the underlying patent is invalid or will not be infringed by the generic. The paragraph IV certification is deemed by the law as an act of infringement, allowing the patent holder to immediately sue the generic applicant.
As an incentive for generic-drug manufacturers, the first ANDA filer with a paragraph IV certification receives a 180-day period of exclusivity. This 180-day period begins when the first filer commercially markets its drug and is only available to the first filer, regardless of whether that first filer ultimately markets the generic drug. As noted by the Third Circuit in K-Dur, this unique benefit gives the first filer the most incentive to challenge the patent.
In this setting, reverse-payment settlements arise when the patent holder pays the generic challenger to drop its challenge and also to refrain from entering the generic market for a specified period. Worried about the potential anticompetitive effects of these so-called pay-for-delay settlements, Congress has since amended the law to require that they be filed with the Federal Trade Commission and the Department of Justice for antitrust review.
K-Dur is a potassium-chloride supplement produced by Schering for treatment of potassium deficiencies. Schering held a patent, set to expire in 2006, covering the controlled release coating used to make K-Dur. More than ten years before that expiration, generic-drug manufacturers Upsher and ESI Lederle filed ANDAs with paragraph IV certifications seeking approval to produce generic versions of K-Dur. Schering responded by suing Upsher and ESI separately for patent infringement. Both suits were resolved through settlements that included payments from Schering to the generics makers and promises by the generics makers to delay their entry into the generic market.
The Schering-Upsher settlement had two distinct components. First, Upsher would not enter the generic K-Dur market until a specified time over four years later, at which time Schering would grant Upsher a nonroyalty, nonexclusive license to make and sell a generic version of K-Dur. Second, Upsher granted a license to Schering to make and sell several pharmaceutical products Upsher had developed. In return, Schering promised to pay Upsher $60 million over three years, plus additional smaller sums depending on its sales of the Upsher-developed drug.
The Schering-ESI settlement was a much more straightforward reverse-payment agreement. It called for Schering to grant ESI a royalty-free license under the patent beginning on a specified later date and to pay ESI $5 million up front plus a varying sum depending on when ESI's ANDA was approved by the FDA.
The settlements at issue in K-Dur were first challenged in a separate action by the Federal Trade Commission in March 2001. After an initial determination by the Administrative Law Judge finding no antitrust violation, the FTC unanimously reversed the ALJ's finding, holding instead that both agreements unreasonably restrained commerce. Schering appealed the FTC's ruling to the Eleventh Circuit, which reversed.
K-Dur originated as a number of consolidated antitrust suits brought by various drug wholesalers and retailers that purchased K-Dur directly from Schering. The district court found Schering's patent not invalid and gave Schering the right to exclude infringing products until its expiration.
In K-Dur, the Court addressed the issue of whether reverse-payment settlements constitute unreasonable restraints on trade in violation of the Sherman Antitrust Act. Courts take a variety of approaches to evaluating whether a restraint qualifies as unreasonable. Normally, they apply the "rule of reason" approach, with the plaintiff bearing the initial burden of proving anticompetitive effects of the challenged conduct. This initial burden can then be overcome by a showing that the challenged conduct promotes a sufficiently procompetitive objective. Some restraints, however, like price-fixing and output limitations, are considered to have such "predictable and pernicious anticompetitive effect, and such limited potential for pro-competitive benefit," that they are deemed unlawful per se. An intermediate approach occurs in cases where the plaintiff has shown that the defendant has engaged in practices similar to those subject to per se treatment. This "quick look" or "truncated rule of reason" approach relieves the plaintiff of the burden of making a full showing of anticompetitive effects within the market and instead places the burden on the defendant to demonstrate procompetitive justifications.
Five other circuits have addressed the legality of reverse-payment settlements in the Hatch-Waxman context. The first two—the D.C. Circuit and the Sixth Circuit—applied strict antitrust scrutiny to a reverse-payment agreement that was also found to manipulate the 180-day exclusivity period in order to block all generic competition. The courts found the agreements suspect because they did not resolve the pending litigation but instead paid the generic to delay selling its drug after it received final approval from the FDA. The three most recent reverse-payment decisions—by the Eleventh, Second, and Federal Circuits—have applied a more lenient standard to find reverse-payment agreements permissible so long as (1) the agreements do not exceed the potential exclusionary scope of the patent, (2) the patent holder's claim of infringement was not objectively baseless, and (3) the patent was not procured by fraud on the PTO. The rationale for this "scope of the patent" test relies on the presumption of patent validity and thus any injury to the market falls within the scope of the patent grant authorized by Congress. Although the Second Circuit acknowledged that the scope-of-the-patent test benefits patent holders more in cases where the patent monopoly is less justified due to an unsound patent or unclear case of infringement, it reasoned that this risk was balanced by the judicial preference for settlements. The Eleventh Circuit addressed the same settlements at issue in K-Dur and held that the $60 million payment to Upsher was not a reverse payment but rather a payment for the licenses Schering obtained; the court acknowledged that the payment to ESI was a reverse payment but held that it was a reasonable implementation of the protections afforded by patent law and furthered the judicial policy favoring settlements.
In K-Dur, the Third Circuit first extensively rejected the scope-of-the-patent test as practically devoid of scrutiny. The court reasoned that the test (1) improperly applies an almost unrebuttable presumption of patent validity, (2) relies on an unfounded assumption that later generic challenges will suffice to eliminate weak patents, and (3) contravenes Supreme Court precedent on patent litigation and competition. Of these, the court directed its sharpest criticism at the test's "almost unrebuttable" presumption of validity of the underlying patent, finding no support for this presumption and distinguishing the presumption of validity in patent litigation as merely a procedural device rather than "a substantive right of the patent holder." In the Third Circuit's view, courts must keep in mind that a patent merely represents a legal conclusion of the Patent and Trademark Office—a determination often found to be incorrect later on. The court also cited two studies regarding the high rate of success of generic challengers in ANDA litigation to support its view that reverse payments allow a patentee to avoid both competition and invalidity.
The Third Circuit also took issue with the Second Circuit's view that later challenges by other generic manufacturers will eliminate weak patents, noting that only the first challenger enjoys a 180-day exclusivity period and therefore has the most motivation. It also reasoned that patentee drug manufacturers may be able to serially avoid challenges to validity.
Finally, the court reasoned that the scope-of-the-patent test conflicts with the Supreme Court's general patent jurisprudence—specifically, a line of cases supporting the judicial testing and elimination of weak patents. The Third Circuit found especially compelling case law holding that a patent licensee cannot be contractually prevented from challenging the validity of a patent in a licensing agreement that also contained a price-fixing term. In that case, Edward Katzinger Co. v. Chicago Metallic Manufacturing Co., the Supreme Court held that an invalid patent would mean that the price-fixing provision violated federal antitrust law, rendering the entire agreement invalid. In particular, the Third Circuit noted the Supreme Court's emphasis on the public's interest in avoiding trade restraints from invalid patents. Thus, the Third Circuit concluded that reverse-payment agreements should likewise be subjected to similar judicial testing.
Further, the Third Circuit was careful to limit its decision to reverse payments in the Hatch-Waxman context, recognizing that Congress, through the Act, drew a line between intellectual-property protection and the need to provide incentives for competition in the pharmaceutical industry. According to the Third Circuit, the goals of the Act (to increase the availability of low-cost generic drugs by encouraging litigated challenges) was frustrated by the scope-of-the-patent test, which benefits those with weak and narrow patents and harms the very consumers Congress intended to protect.
The Third Circuit acknowledged that it was rejecting a test that encourages settlement—a generally favored judicial principle—but that the preference is outweighed by public policy objectives and Congress's determination that litigated patent challenges are necessary to protect consumers. The court emphasized that its holding related only to reverse payments and that parties remain free to settle based only on a negotiated entry date for the generic drug.
In place of the scope-of-the-patent test, the Third Circuit directed the district court to use an antitrust analysis based on the "quick look" rule of reason, under which any payment from a patent holder to a generic patent challenger who agrees to delay entry into the market is prima facie evidence of an unreasonable restraint on trade. The Third Circuit recognized two narrow exceptions to this general rule. First, the patent holder may rebut the prima facie case of an unreasonable restraint on trade by showing there was no reverse payment—that is, that money changed hands for something other than delayed market entry. Second, the patent holder can demonstrate that the reverse payment offers a competitive benefit by, for example, providing money to a cash-starved generic manufacturer so that it may avoid bankruptcy and begin marketing a generic drug that might have an overall effect of increasing competition in the market. The Third Circuit further held that it need not consider the merits of the underlying suit because of the logical conclusion that payment flowing from the innovator to the challenging generic firm is for an agreement by the generic to defer entry beyond the date that represents an otherwise reasonable litigation compromise.
K-Dur is significant both to pharmaceutical companies considering reverse settlements and private plaintiffs looking for a forum to bring a viable antitrust challenge to such settlements. Merck (now the owner of Schering-Plough) filed a petition for certiorari in K-Dur in August. An October 24 deadline was set for the opposition brief. Meanwhile, the FTC has filed a petition for certiorari in the Eleventh Circuit reverse payment case of Federal Trade Commission v. Watson. It is possible, if not likely, that the Supreme Court will review at least one of these cases. The possibility of Supreme Court review of the issue has also caused a number of district courts to stay reverse-payment lawsuits until the Supreme Court decides whether it will hear K-Dur.
Copyright © Finnegan, Henderson, Farabow, Garrett & Dunner, LLP. This article is for informational purposes, is not intended to constitute legal advice, and may be considered advertising under applicable state laws. This article is only the opinion of the authors and is not attributable to Finnegan, Henderson, Farabow, Garrett & Dunner, LLP, or the firm's clients.
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