Reverse Payments Cases After Actavis

Economists Ink: A Brief Analysis of Policy and Litigation


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Barry C. Harris is EI’s Chairman of the Board and Matthew B. Wright is an EI Principal. This article is based on work done with EI Senior Vice-President Michael G. Bauman. With co-authors, they have written “Activating Actavis:  A More Complete Story,” Antitrust, Spring 2014, at 83 (available at www.ei.com/downloadables/Spring14_harris.pdf)

In FTC v. Actavis, Inc. the Supreme Court addressed settlements that sometimes occur when an incumbent pharmaceutical producer (the Brand) sues for patent infringement a firm that plans to begin selling a generic version of its product. Such suits are typically triggered when the generic producer (the Generic) files an Abbreviated New Drug Application under Hatch-Waxman with a Paragraph IV Certification, which involves a claim that the generic product does not infringe an enforceable patent. The Court in Actavis concluded that a patent settlement agreement involving a so-called reverse payment from Brand to Generic can sometimes unreasonably diminish competition by delaying entry by the Generic. (FTC v. Actavis, Inc., 133 S. Ct. 2223, 2227 (2013)) The Actavis Court, however, rejected the FTC’s view that settlements involving reverse payments should be deemed presumptively unlawful. The Court also rejected a “quick look” approach for evaluating such agreements, which would presume illegality unless the Brand could prove that the settlement agreement had procompetitive effects. Instead, the Actavis Court held that in cases involving settlements with a “large” reverse payment, “the FTC must prove its case as in other rule-of-reason cases.”

The Actavis decision leaves the FTC and the courts with the question of how to judge reverse payments settlements under the rule of reason. One recent article proposes that once the plaintiff establishes that the Generic agreed not to compete using the patented technology for any length of time, the plaintiff could establish a prima facie case by valuing the payment from the Brand to the Generic and establishing that the payment was greater than the litigation costs that the Brand avoided through the settlement. If the plaintiff makes such a showing, the defendant(s) must then prove that the excess reverse payment was reasonable consideration for services that the Generic provided to the Brand. Under this proposed rule, any reverse payment that cannot be explained by avoided litigation costs and the value of services provided by the Generic is understood to be a payment to the Generic for delaying entry and thus evidence the agreement is anticompetitive. That approach, however, fails to account for a variety of factors that indicate settlements with reverse payments can be procompetitive because they result in entry by the Generic occurring earlier than would have been expected without the settlement.

As the Court in Actavis recognized, an analysis of reverse payments in any particular settlement is complex. For a settlement to occur, both the Brand and the Generic must view it as preferable to their expected outcomes from litigation. If both the Brand and the Generic would incur costs to pursue a litigated outcome to their patent dispute, are risk-neutral, have the same time value of money, and share the same view about the likely outcome of litigation, there exist potential settlements without reverse payments that both parties should prefer to litigation. Settlements are possible under these circumstances because each party can agree on entry on or near the date that corresponds to the entry date that would be expected under litigation, while avoiding litigation costs. The factors that influence a negotiated settlement, however, are not limited to out-of-pocket litigation costs, and several of these factors may lead to a patent settlement involving a reverse payment. Such factors may include inter alia the risk tolerance of the parties, the level of the drug’s sales, differences in the parties’ expectations and information related to future competition for the drug, the parties’ subjective views of the likely outcome of the litigation, differences in the parties’ time-value of money, and the applicability of Hatch-Waxman first-filer exclusivity. Other factors that might affect the competitive analysis of a potential settlement are the size of the alleged net reverse payment, and the extent of the alleged delay and associated diminution of competition.

For example, if the Brand is risk-averse, then it may agree to a settlement that involves a reverse payment that exceeds out-of-pocket litigation costs but is procompetitive. Litigation is risky in that the outcome is uncertain. Given a choice between receiving a guaranteed payment and an uncertain outcome that has an expected value equal to that payment, a risk-averse Brand prefers the certain payoff and, thus, may be willing to accept a settlement that allows for Generic entry on a date before the entry date expected under litigation.  A settlement that allows for entry on this earlier date would benefit consumers and is considered to be procompetitive under the Actavis standards.

Consumers can only benefit from a procompetitive settlement if both the Brand and the Generic agree to it. Under certain conditions, mutually beneficial settlements may occur between the Brand and the Generic that do not involve reverse payments. When these conditions do not hold, reverse payments may be required for the parties to reach a settlement that enhances consumer welfare and therefore should be judged lawful under the Supreme Court’s rule-of-reason standard.

The clearest examples where a reverse payment may facilitate a procompetitive settlement occur when two conditions hold. First, absent a reverse payment, the latest entry date on which the Generic is willing to settle (the Generic’s reservation entry date) is earlier than the earliest entry date on which the Brand is willing to settle (the Brand’s reservation entry date). Second, the Brand’s reservation entry date is earlier than the expected entry date under litigation. Any increase in the reverse payment will delay the Generic’s reservation entry date by more than the Brand’s. Thus, a reverse payment may facilitate a settlement by moving the Generic’s reservation entry date later, so it no longer conflicts with the Brand’s reservation entry date. While a reverse payment will result in a later reservation entry date for the Brand, that date may still be earlier than the expected date under litigation. As a result, entry with the settlement may happen before it would have with litigation, and the settlement would be procompetitive.

The conclusion that anticompetitive effects can be inferred from reverse payments in excess of the Brand’s direct litigation costs holds only under specific circumstances. An economic model supporting that inference is a special case and does not support a generally applicable result. Furthermore, adopting that inference would prevent some procompetitive settlements from occurring.