It is too soon to tell whether deciding the fate of national health reform last year in National Federation of Independent Business v. Sebelius has generally emboldened the U.S. Supreme Court to resolve legal uncertainties affecting the health care system.  Nonetheless, 2012-2013 will be a busy year on this front for the Justices, who have already heard or agreed to hear seven relevant cases, including three involving the pharmaceutical industry.  The first six cases are FTC v. Phoebe Putney Health System, Inc. (hospitals and the “state action” exemption from antitrust liability); Sebelius v. Auburn Regional Medical Center (Medicare reimbursement for hospitals); Association for Molecular Pathology v. Myriad Genetics, Inc. (patenting of human genes), on which we wrote earlier at Health Affairs Blog; Mutual Pharmaceutical Co. v. Bartlett (state tort liability for drug injury), Sebelius v. Cloer (the National Vaccine Injury Compensation Program), and U.S. Airways, Inc. v. McCutchen (ERISA and insurance companies’ rights to recover tort settlements).

On December 7, the Supreme Court announced its decision to review the seventh and latest addition to the list, FTC v. Watson Pharmaceuticals.  The Court will look to resolve a disagreement between federal appeals courts over the legality of so-called “pay for delay” or “reverse payment” settlements, in which a settlement payment flows from a patent holder to an accused infringer rather than, as might normally be expected, the other way around.  Specifically, the Supreme Court will receive briefs and hear arguments regarding “[w]hether reverse-payment agreements are per se lawful unless the underlying patent litigation was a sham or the patent was obtained by fraud (as the court below held), or instead are presumptively anticompetitive and unlawful (as the Third Circuit has held).”

In answering this question, the Court will influence a much larger debate over innovation in health care markets.  Watson Pharmaceuticals’ piece of that puzzle will lie at the intersection of patent law, antitrust law, food and drug law, and civil procedure.  We hope that the Court’s review and judgment will improve our collective capacity to apply these legal tools, but we also think it very unlikely that the Court will rule definitively on any of them.

“Reverse Payment Settlements” Of Drug Patent Litigation

To the Federal Trade Commission, a reverse payment agreement between the maker of a patented drug and generic drug manufacturers creates a cartel in which potential competitors, rather than becoming actual competitors, share the spoils of patent-generated market power with a current monopolist.  The FTC therefore regards such agreements as likely to impede competition unless a defendant can prove otherwise.  Defenders of reverse payment agreements in these cases argue that there is no antitrust injury as long as the settlement of patent litigation does not generate greater exclusivity to a seller or sellers than patent law already presumptively affords.

Three U.S. Courts of Appeals — those for the Second Circuit, Eleventh Circuit, and Federal Circuit — have agreed with the defenders.  On the other hand, the court whose jurisdiction encompasses pharma-rich New Jersey and Delaware — the Court of Appeals for the Third Circuit — has held such agreements to be questionable.

The dispute involves the testosterone replacement treatment AndroGel, which enjoyed sales of over $400 million in 2007.  The FDA approved AndroGel in 2000 and granted Solvay Pharmaceuticals three years of market exclusivity.  Meanwhile, Solvay sought a patent on AndroGel, which it obtained in January 2003, a month before the FDA exclusivity period expired.  Later in 2003, other drug makers, including Watson Pharmaceuticals, filed applications with the FDA for approval of generic versions of AndroGel.  These applications certified that Solvay’s patent claims were invalid or would not be infringed by their proposed products.

This certification gave Solvay the right to sue for infringement.  Solvay exercised this right and thereby triggered a legally mandated 30-month stay of FDA approval for the generic drugs.  Unsurprisingly, litigation continued past the end of the regulatory stay, and the FDA approved Watson’s generic drug application in January 2006.  In September 2006, before Watson and its associates brought their products to market, they settled Solvay’s infringement claim by agreeing not to market their generic drugs until 2015.

On the same date, the parties signed additional agreements under which Solvay agreed to pay the generic manufacturers up to an estimated amount of $42 million per year, nominally for promotional services and backup manufacturing capacity.  The parties reported their settlements to the FTC, which investigated and then filed suit.  The FTC argued that reverse payment settlements should be presumptively illegal as an unreasonable restraint of trade under federal antitrust law.  A district judge in the Northern District of Georgia disagreed and dismissed claims that the parties’ settlements violated the antitrust laws.  On appeal, the Eleventh Circuit affirmed the district court’s decision.

Competing In A Regulated Industry

The principal health policy issue raised by FTC v. Watson Pharmaceuticals is the relationship between competition and regulation as both policymakers and the private sector attempt to transform the health care system to improve affordability, access, and quality.  Although we tend to regard our health care system as private, individualistic, and competitive (and we therefore resist “socialized medicine”), the system’s output has been heavily influenced and constrained by government regulation and professional self-regulation.  Patent law itself is commonly envisioned as assuring both continued innovation and its broad dissemination.  But no informed person believes that the patent system alone strikes an optimal balance between exclusion and competition for all technologies, industries, and types of private transactions.

Similarly, we tend to idealize federal antitrust law as setting firm rules in favor of free competition.  In practice, antitrust analysis is heavily influenced by other priorities established by federal or state governments.  Regulation is occasionally held specifically to preclude enforcement of federal antitrust law, either through application of the “state action” doctrine at issue in the Phoebe Putney case or, for federal law, as constituting “implied repeal” of the Sherman Act by Congress.  More often, however, regulation simply alters the competitive terrain in a way that is arguably relevant to the antitrust calculus.

A threshold tension in Watson Pharmaceuticals derives from the civil justice system’s preference for private settlement of ongoing litigation.  Instead of government absolutes and judicial micro-management, U.S. law generally favors default rules and contractual solutions, a process sometimes called “bargaining in the shadow of the law.”  The Eleventh Circuit reasoned that as long as the private agreement between the patent holder and generic challengers did not exceed the presumed scope of the underlying patent rights, the agreement should be free from antitrust review.

The Eleventh Circuit was unmoved by the FTC’s reasonable economic argument that the settlement involved a patent that might or might not be valid, and therefore that the expected value of the fully litigated patent was less than the value of the patent if its validity were ironclad.  The court cited a variety of reasons to rely on a patent’s presumed scope: (1) neither private parties nor trial courts can reliably predict how a patent court would have ruled in a challenge that was never litigated; (2) efforts to do so for purposes of assessing antitrust liability would “impose heavy burdens on the parties and courts”; and (3) such prediction was beyond the competence of the Courts of Appeals that typically hear antitrust cases because Congress had given a specialized court, the  Court of Appeals for the Federal Circuit, essentially “exclusive jurisdiction over patent cases.”

But far more than patent law shapes the economic landscape on which reverse payment settlements operate.  The structure and conduct of pharmaceutical markets involves complex and overlapping regulatory considerations, including FDA oversight, state prescriptive authority, private insurance coverage, and administered pricing of drugs under Medicare and Medicaid.  A major impetus for reverse payment settlements was the fact that the Hatch-Waxman amendments to federal food and drug laws granted the first filer for approval of a generic drug 180 days of market exclusivity from the date that filer began marketing the drug.  The exclusivity period made contractual settlement with that competitor much more valuable to the patent-holder, particularly if settlement delayed the start date for generic exclusivity.

The exclusivity provision was subsequently modified to limit its tendency to stimulate collusive settlement, but processes of negotiation between patent holders and would-be generic drugmakers had already been normalized.  Because Hatch-Waxman establishes such detailed procedures for the introduction of generic competitors to patented drugs, including with respect to litigation, the law arguably expresses congressional intent to scrutinize the terms of private settlements.

Competing To Innovate?

How should the competitive-regulatory mix in health care be interpreted by courts so as to foster innovation?  The Eleventh Circuit’s opinion in FTC v. Watson Pharmaceuticals aligns with a division of labor in competition policy between static efficiency (price, quality, output) safeguarded by antitrust law and dynamic efficiency (innovation) encouraged by patent law.  The health care system is not fertile territory for this approach.  The Hatch-Waxman amendments are but one among many examples of how government activity beyond intellectual property law can affect how innovation proceeds.

Over the past half century, American health care has been very innovative in certain respects, notably the development of technologically sophisticated tests and treatments that command high prices from health insurers, and less innovative in other respects, such as organizing the delivery of care to promote reliability, safety, and affordability.  Patents and other forms of intellectual property undoubtedly have influenced this process.  But more health care-specific regulation — notably, Medicare coverage, subsidies for private health insurance, and public research funding — have largely determined where money is to be made by innovation.

Will the Supreme Court reverse the Eleventh Circuit and permit a more contextualized assessment of whether particular patent settlements violate antitrust law?  Patent law, with its aspirations to technological neutrality, cannot be expected to optimally incentivize innovation in health care given the latter’s substantial and constantly changing regulatory overlay.  We therefore believe there is a significant chance that the Court will accept the FTC’s invitation to apply an approach substantially like one that the Court endorsed in an earlier case brought by the same agency, but perhaps this time with the agency’s recommended presumption of anticompetitive effect.

In California Dental Association v. FTC (1999), a case ultimately lost by the government, the agency challenged rules issued by a professional association that collectively restricted advertising of dental prices and the quality of dental services by independent dentists on the grounds that consumers could not verify those claims.  The rules were similar to but more extensive than rules previously adopted by the California agency regulating professional dentistry.

The standard adopted by the Supreme Court, which can be described as a “not so quick look” rule-of-reason analysis, demanded that the FTC offer empirical evidence to show that the dental association’s collectively structured approach to consumer information was likely to harm rather than to improve competition for dental services based on price and quality.  Significantly, the test of the professional restriction was to be its effect on competition given other characteristics of the market, not its purported benefit to patients in the abstract.

Similarly, the issue in FTC v. Watson Pharmaceuticals can be cast as whether reverse payment agreements to settle patent-infringement suits improve consumer welfare by efficiently staging the introduction of generic alternatives given the regulatory context. In this respect, one might compare reverse payment agreements to another controversial practice in the same market.  Faced with potential competition from many generic manufacturers, patent holders are increasingly entering into agreements with a single producer, under which an “authorized generic” is marketed shortly before patent expiration, creating a quasi-branded, mid-priced substitute for the original proprietary drug.  This practice discourages other generic entrants by reducing their profit potential, but also promotes somewhat more competition than would otherwise exist during the patent term.  Although the economics of both practices have yet to be definitively understood, the Supreme Court might well agree with the FTC that reverse payment agreements should be regarded as presumptively anti-competitive, while (in a hypothetical future case) concluding that contracts for authorized generics should not be subject to such a presumption.

Regardless of the details of the Court’s eventual holding, the case offers the Justices an opportunity to reject the view that concerns of judicial competence and economy should exclude from antitrust scrutiny an important class of transactions that implicate the messy economics of health care innovation.  Particularly in health care and other heavily regulated industries, current incarnations of intellectual property law cannot be trusted to strike the right balance between competition and exclusion on their own.  On the other hand, there is also the possibility of a null result.  Because Justice Alito will not participate in deciding Watson Pharmaceuticals, the eight remaining Justices could divide equally, affirm the Eleventh Circuit’s ruling, but do nothing to clarify the law.