Evaluating the Size of Reverse Payments In Light of the Supreme Court’s Decision in FTC v. Actavis

James Langenfeld, Sep 30, 2013

Patent settlement agreements that involve payments from brand-name drug manufacturers to generic drug manufacturers (so called “reverse payments” or “pay for delay”) have been hotly contested in the courts. Last year, two U.S. Courts of Appeals reached opposite verdicts regarding the legality of “reverse payment” agreements.

In April 2012, in FTC v. Actavis, Inc., the Eleventh Circuit held that payments made by brand-name patent holders to potential generic entrants in exchange for the latters’ delayed market entry in settlement of Paragraph IV litigations were virtually per se legal if such settlements fell within the bounds of the so-called “scope of the patent test.” In effect, the Eleventh Circuit assumed that the patent should be treated as valid until proven otherwise.

Three months later, the Third Circuit in Louisiana Wholesale Drug Co., Inc. v. Merck & Co. et al. (“the K-Dur case II”), in stark conflict with the Eleventh Circuit, held that such settlements are, in effect, presumptively illegal. From an economics perspective, this decision assumed the likelihood of a patent being found valid in these circumstances is typically very low, and the harm to consumers is likely very high.

On June 17, 2013, the U.S. Supreme Court issued its ruling on the reverse payment agreements in Federal Trade Commission v. Actavis, Inc. et al. The Supreme Court reversed the Eleventh Circuit’s decision that reverse payments from patent holders to generics are legalif within the scope of the patent. At the same time, the Supreme Court also rejected the FTC’s urging and the Third Circuit’s findings that reverse payments were virtually per se illegal. Instead, the Supreme Court found that such payments should be evaluated under a rule of reason. In particular, the majority of the Court wrote:

[T]he likelihood of a reverse payment bringing about anticompetitive effects depends 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. The existence and degree of any anticompetitive consequence may also vary as among industries. These complexities lead us to conclude that the FTC must prove its case as in other rule-of-reason cases.

The Court’s majority decision seems to find that the probability of a patent being valid in a reverse payment case should not be assumed to be 100 percent (as implied by the Eleventh Circuit) or necessarily near zero (as implied by the Third Circuit). However, determining whether a patent would have been found to be valid in the context of a settlement can be challenging. In part to address this issue, the Court majority placed great emphasis on the size of the reverse payments. For example, the Court stated:

In sum, a reverse payment, where large and unjustified, can bring with it the risk of significant anticompetitive effects; one who makes such a payment may be unable to explain and to justify it; such a firm or individual may well possess market power derived from the patent; a court, by examining the size of the payment, may well be able to assess its likely anticompetitive effects along with its potential justifications without litigating the validity of the patent[.]

Although the Supreme Court acknowledges there may be other justifications for reverse payments, it appears that the Court believes that if the reverse payments are larger than litigation costs and do not reflect the value of other services rendered by the generics, a large payment may provide strong evidence that the agreement is anticompetitive.

The rest of this article (1) provides some background on the economics of reverse payment settlements, (2) explains why the size of the reverse payment alone is not a sufficient indication that a reverse payment agreement is anticompetitive, (3) discusses some economic tests that can be implemented to assess the competitive effect of a reverse payment agreement under a rule of reason approach, and (4) shows the potential detrimental impact on innovation if reverse payments are condemned as illegal based on the size of payment alone.

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