Third Circuit Decision Endorses FTC's Faulty Logic on "Pay for Delay"

The U.S. Court of Appeals for the Third Circuit handed down a decision on Monday holding that reverse payment - or so-called "pay to delay" - patent settlement agreements between innovator and generic drug manufacturers may constitute antitrust violations. (The New York Times and Pharmalot offer their views at the links.) That decision sets up a Circuit split that now seems ripe for Supreme Court review, as the Federal Circuit, Second Circuit, and Eleventh Circuit appeals courts have previously ruled that, in most cases, these settlement agreements are not anticompetitive.

To review, current law provides incentives for generic producers to challenge potentially weak drug patents in court. But when faced with the uncertainty of patent litigation, brand manufacturers sometimes offer to settle the lawsuits by paying the challengers to drop the litigation. The patents remain in place that way. But as part of the settlements, the brand manufacturers usually agree to let the generics on the market a few years before the patents in question expire.

The Third Circuit case involves the use of a patented extended-release formula for coating otherwise unpatented potassium chloride drugs. In 1995, two different generic manufacturers (Upsher-Smith Laboratories and ESI Lederle) submitted generic approval applications with the FDA claiming that their formulations did not infringe the patent held by Schering-Plough. Schering sued, alleging that the generic products did in fact infringe. And shortly before the federal district court was set to issue an opinion, the parties settled. Schering paid Upsher $60 million for various things, including an agreement to drop the suit, and it paid ESI Lederle $15 million.

The Federal Trade Commission hates these deals (see here and here) and calls them anti-competitive because successful patent challenges would get generics to market sooner still. That assumes, however, that all or even most such challenges would succeed, a point I address below. Since 2003, federal law has required that any such settlement must be reported to the FTC for antitrust review. And the agency has challenged dozens of these cases in court, almost invariably losing.

In an interesting turn of events, both the FTC and several private plaintiffs (mostly drug wholesalers and retailers) filed separate antitrust challenges to the same Schering-Upsher and Schering-ESI settlements, alleging the identical violations. The FTC case was brought in the Eleventh Circuit; the private plaintiffs filed in the Third Circuit. The Eleventh Circuit ruled in 2005 that the agreement was not anticompetitive, and the Supreme Court refused the FTC's request to hear an appeal (In 2011, the high court also refused to hear an FTC appeal from a loss in a different case.). But organizing the class action in the Third Circuit took a bit longer, so that court has only now issued its opinion.

In the FTC's view, the mere fact that a brand manufacturer paid a generic company to drop litigation should be viewed as evidence that the patent was probably invalid. And the Third Circuit seems to have bought that argument hook, line, and sinker. The court cites two studies (one conducted by the FTC) finding that generic manufacturers prevail in over 70 percent of these patent challenges.

Both conclusions have serious problems, though. For example, the FTC figure combines many dissimilar cases, and the methodology for calculating the figure is never revealed. The second study, conducted by RBC Capital Markets, concluded that generics win 76 percent of cases "when you take into account patent settlements and cases that were dropped". That, of course, presumes the truth of the matter in question: that the generic would have won if there was no settlement. When you count only the cases examined in the RBC study that actually resulted in a court decision, the generic challengers lost a bit over half of the time. And in a slightly older study published in the Michigan Law Review, the generic won only 42 percent of cases.

Thus, prior to reaching a settlement, it is not at all clear whether the patent holder or the generic challenger would prevail. That's why, in six cases decided by the Federal Circuit (here), Second Circuit (here and here), and Eleventh Circuit (here, here and here) Courts of Appeals, federal judges concluded that "a court must judge the antitrust implications of a reverse payment settlement as of the time that the settlement was executed," to quote the Eleventh Circuit in a decision handed down in April of this year.

The mere fact that a patent granted by the U.S. Patent Office might actually be invalid does not mean that a brand manufacturer's decision to settle should be seen, ipso facto, as anticompetitive. Indeed, the Supreme Court long ago held that, even though the PTO does err on occasion, and many granted patents are later found to be invalid or far narrower than their holders imagine, patent holders are entitled to presume that their patents are valid until a court finds otherwise. Thus, federal courts have repeatedly concluded that reverse payment agreements should not automatically be suspect, but are only illegal in certain circumstances.

What's more, as U.S. Seventh Circuit Judge Richard Posner wrote in a 2003 district court decision (it's a long story why a circuit judge was hearing a district court case), these settlement should often be seen as PRO-competitive, not anticompetitive, because the patent holder generally agrees to let the generic product come to market several years before the patent would expire. (In the Schering case, the agreements gave permission for the generic drugs to be sold a full five years before the patent expiration.) In that regard, given what is known at the time of the settlement, these agreements actually tend to accelerate the introduction of generics, not delay them.

Moreover, Posner wrote that U.S. courts, including the Supreme Court, have long believed that out-of-court settlements are an appropriate way for parties to resolve litigation, and "a ban on reverse-payment settlements would reduce the incentive to challenge patents by reducing the challenger's settlement options." He therefore argued that it was the proposed ban on settlements, not the settlements themselves, "that might well be thought anticompetitive."

The Third Circuit Court of Appeals rejected all of these arguments, and it agreed with the FTC and the private plaintiffs that an issued patent should not be entitled to a presumption of validity. Curiously, though, the Third Circuit also argued that it should not matter whether the patent in question was valid or not. All that mattered was the fact that the patent holder paid a challenger to postpone manufacturing a drug (regardless of whether the patent holder did or did not have the legal right to use the patent to do exactly that).

Decisions of various Circuit Courts are not binding on other Circuits, but they are seen as persuasive authority. So, in order to explain away the prior decisions by the Second, Eleventh, and Federal Circuits, the Third Circuit trotted out two decisions from the D.C. Circuit Court of Appeals in which that court held that settlements in which the generic agreed to postpone commercialization were found anticompetitive. But in those cases, the settlements did not resolve the underlying patent disputes, making them entirely unlike the case in question.

In the end, the Third Circuit's decision in this case is a house of cards built on faulty assumptions, circular logic, and inappropriate analogues. The only bright spot is the fact that, by establishing a circuit split (a condition in which two or more Circuit Courts of Appeals have adopted contradictory rules), the Supreme Court may well finally agree to take an appeal in order to settle the matter once and for all.

Given the overwhelming weight of evidence that these settlements are not typically anticompetitive, and the fact that nearly every Circuit Court of Appeals to hear such cases has found them to be lawful in most circumstances, one would expect the Supreme Court to validate the practice. That surely will not end the FTC's vendetta against reverse payment settlements. But it may well put an end to much costly and unnecessary litigation.

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