Patent law and antitrust law are both intended to promote innovation, but function through different methods. Competition is a primary driver of innovation as rival firms strive to make better and cheaper products, and antitrust law limits anticompetitive behavior that prevents the free market from rewarding the true winner.

The Sherman Antitrust Act, the bedrock of US antitrust law, states very simply, “Every contract, combination … or conspiracy, in restraint of trade or commerce … is declared to be illegal.”  By contrast, there may be occasions where free competition may not be an optimal environment for innovation, particularly for products that can require substantial up-front investment but can then be easily copied after they reach the market.  In such cases, the government grants patents to innovators to protect their intellectual property from being appropriated by free riders.  Patents are particularly useful in the pharmaceutical market.

The tension between patent law and antitrust law in the pharmaceutical market was on display in the Supreme Court’s decision from June 17th in Federal Trade Commission v. Actavis.  The case reviewed one outcome of patent litigation between brand-name and generic drug companies.  Brand-name drugs are usually approved after years of research and can involve an investment of hundreds of millions in preclinical and clinical trials.  Since most small-molecule drugs are relatively easy to copy once they are shown to be safe and effective, unfettered competition is not realistic. Instead, the brand-name pharmaceutical industry relies on patents to provide periods of market exclusivity during which manufacturers can charge high prices to recoup their investments in research and development.

This exclusivity period is considered to be an important driver of innovation to create new medicines for patients.  After the period ends, generic drug manufacturers making bioequivalent products can enter the market and automatic substitution laws in all 50 states permit vigorous competition that quickly drives down drug prices, which is of course of great benefit to consumers.

A delicate equilibrium therefore exists between patent law and antitrust law in the interplay between brand-name and generic drugs.  Too much market exclusivity and too high of a barrier to entry would reduce generic competition and lead to extended periods of market exclusivity and excessive spending on drugs.  There would be no incentive for brand-name pharmaceutical companies to innovate further and invest in the next generation of therapeutics.  Too little market exclusivity and too low of a barrier to entry would limit the incentive for for-profit companies to invest in innovation in the first place, because no company would be able to recoup its costs.

The Issues In The Actavis Case

The Federal Trade Commission v. Actavis case was generated by a threat to this delicate equilibrium from controversial business dealings between brand-name and generic drug manufacturers known as “reverse payments.” These payments were attached to some pharmaceutical patent litigation settlement agreements and are characterized by a licensee receiving money from a patent holder. The transaction was so named because the flow of money ran opposite from the typical exchange between licensee and patent holder.

The existence of settlements involving these payments in the pharmaceutical market can be traced back to the 1984 Hatch-Waxman Act that created the bioequivalence pathway for regulatory approval of generic drugs.  Brand-name drug companies frequently do not only receive a single patent on the active chemical ingredient in their drug, but rather obtain additional (“secondary”) patents relating to peripheral aspects of their drug products—such as the coating of the pill, or alternate physiochemical structures of the molecule—to try to extend their market exclusivity periods as long as possible and keep generic competitors off the market.  So the policymakers who designed the Hatch-Waxman Act created a system to allow generic manufacturers to challenge brand-name manufacturers’ patents in court to weed out any weak or invalid secondary patents and permit generic competition after a reasonable period of time.

However, some of these challenges were settled in a way that seemed to defeat the intent of the Hatch-Waxman Act because they included substantial payments from the brand-name to the generic company in exchange for the generic agreeing to delay entry of its competing product (hence reverse payments also became known as “pay-for-delay”).  Settlements with a payment attached to them suggested that the parties may have agreed to anticompetitive terms that could involve inappropriate delays to generic market entry.

These payments made economic sense to the brand-name manufacturers because they permitted maintenance of market exclusivity and high prices.  They also made economic sense to the generic drug manufacturers, especially if the payments involved more revenue than the generic drug manufacturers could have earned by selling their products.  Consumers hoping for lower drug costs after a reasonable period of brand-name monopoly time without interminable exclusivity extensions related to weak or invalid secondary patents, however, were left out in the cold.  By contrast, settlements without a reverse payment more likely represented a legitimate compromise between the parties.

The Federal Trade Commission (FTC)—a regulatory body charged with enforcing US antitrust laws—considered settlements with reverse payment to be anticompetitive and challenged them in court. However, in 2005 a federal appeals court decision ruled reverse payments to be legal, and the number of agreements involving reverse payments started growing substantially.  Indeed, the FTC calculated in 2010 that banning them could lead to $35 billion less spending on prescription drugs over the next decade.  Finally, in 2012, the Supreme Court agreed to hear an appeal about the legality of settlements involving reverse payments in the context of Solvay’s brand-name version of a testosterone gel (AndroGel) and three potential generic competitors: Actavis (formerly Watson), Paddock, and Par Pharmaceuticals.

The AndroGel “Reverse Payment”

The dispute leading to the Supreme Court case began in 2000 when Solvay’s AndroGel was approved, protected by a patent on the formulation of testosterone.  In 2003, Watson and Paddock filed with the FDA their intent to produce bioequivalent generic versions of AndroGel, and in doing so, asserted that Solvay’s patent was invalid and not infringed by their versions (Par Pharmaceuticals later joined Paddock in a partnership).

In response, Solvay sued for patent infringement.  Under the Hatch-Waxman pathway, generic entry was then automatically stayed by 30 months to allow the litigation process to conclude. In court filings, Solvay claimed they anticipated losing 90 percent of their AndroGel sales within a year after generic entry, which would cut their profits by $125 million.

Instead of allowing the litigation to determine whether the patent was indeed valid or not infringed, Solvay and the generic manufacturers settled. According to the FTC legal filings, the settlement involved a payment from Solvay to Watson of $19-30 million annually until 2015.  During that time, Watson would not sell its version (unless another generic entered the market) and meanwhile would assist Solvay in marketing AndroGel to urologists. The settlement also allegedly called for Solvay to annually pay $2 million to Paddock and $10 million to Par over a six year period, ostensibly so that Paddock could be a backup supplier of AndroGel and Par could help market the drug to primary care physicians.

The FTC argued that these services had little actual value to Solvay, and that the real purpose of the settlement was to protect Solvay’s patent from being challenged and delay generic entry into the market. As a result, the FTC believed that Solvay had unlawfully extended its monopoly on AndroGel through settlements that included payments to its competitors.  This sort of agreement on its face would be a clear violation of the Sherman Antitrust Act, because the agreement between Solvay and the generic manufacturers resembled a horizontal agreement to suppress competition and extend a monopoly.  Thus, the FTC has consistently argued that settlements involving reverse payments should be made presumptively illegal.

In response, the pharmaceutical companies argued that the existence of a valid patent should immunize the settlement involving a reverse payment from antitrust scrutiny.  Patents gave inventors the power to exclude others from using their property. Therefore, unless the companies took action outside the “scope of the patent”—for example, by extending market exclusivity past the patent expiration date, or expanding the scope of the exclusivity beyond the patent claims—the fact that Solvay earned a patent should allow it to choose to exclude others from the marketplace at its discretion, including by settling cases with potential generic competitors using reverse payments.  In this case, since Watson agreed in its settlement to enter the market in 2015, 65 months before Solvay’s formulation patent on AndroGel ended, and since patents are legitimate exercises of market exclusivity, the manufacturers argued that there should be no concern about abuse of monopoly power.

The Supreme Court’s Decision In FTC v. Actavis

The dispute between the FTC and the pharmaceutical manufacturers reached the federal Court of Appeals for the Eleventh Circuit, which upheld the “scope of the patent” test as the proper one to evaluate settlement legality.  However, in its June 17 ruling, the Supreme Court disagreed.  Writing for the majority in a 5-3 decision (Justice Samuel Alito recused himself for reasons he did not explain), Justice Stephen Breyer found reverse payments in settlements of brand/generic patent litigation to be potentially problematic and not intended by the framers of the Hatch-Waxman Act.  Therefore, allowing all such payments as long as they fell within the scope of the patent—a patent that may not even be valid—was an improper outcome.

However, Justice Breyer did not find reverse payments to be so unjustifiable that they warranted being evaluated under the “presumptively illegal” framework proposed by the FTC.  Instead, Justice Breyer—evoking the Judgment of Solomon—essentially split the difference and held that the FTC should have the right to review the decision and “prove its antitrust claim.” The Court applied an oft-used antitrust doctrine known as the “rule of reason” to this scenario.  The context of a reverse payment would determine its anticompetitive nature.

Justice Breyer pointed to a number of justifications for this overall conclusion.  For example, he found that reverse payments could have “genuine adverse effects on competition” by excluding competitors from the marketplace at the expense of the consumer.  He recognized that the anticompetitive consequences “will at least sometimes prove unjustified.”  It would be possible, Breyer acknowledged, for the reverse payment amount to be small enough such that it would not bring anticompetitive consequences—for example, if the payment represented only the costs in settling the litigation.

Breyer also pointed out that this ruling would not preclude the parties from settling their lawsuit in other ways. For example, it would be possible to allow early entry to a generic as part of a settlement. The core question would be whether such an arrangement would be anticompetitive and intended to maintain (and share) monopoly profits without any other justification.

In a dissenting opinion, Chief Justice John Roberts, joined by Justices Antonin Scalia and Clarence Thomas, supported the Eleventh Circuit’s application of the “scope of the patent” test. They argued that so long as the parties acted with a valid patent, the patent grant itself gave them the right to choose who could use their property.  That would include the use of reverse payments to settle litigation.  Notably, while Chief Justice Roberts acknowledged that the Hatch-Waxman Act was intended to encourage competition, he worried that the majority opinion would discourage settlements in patent litigation, which is often costly and time consuming to the parties involved.  He also wondered whether the costs of protracted litigation would paradoxically lead fewer generic manufacturers to challenge brand-name manufacturers’ patents in the first place.

The Impact Of The Decision

The FTC scored a victory in Justice Breyer’s ruling.  Since the first appellate court upheld reverse payments in 2005, the FTC had been arguing against them to little avail both in courts and in the legislature, where 11 bills banning reverse payments had been proposed in the House or Senate since 2006 but went nowhere.  Though the FTC did not get as strong a ruling as it wanted, the Supreme Court did validate that such payments pose an antitrust risk and can be challenged by the FTC.

Now, the courts will be faced with a difficult task in deciding which agreements are anticompetitive.  Justice Breyer gave some guidance on this determination.  He was particularly wary of a “large and unjustified” reverse payment and anticipated that the judgment about anticompetitive effects would be based on “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.” (Notably, the merits of the patent are not explicitly part of the calculus.)

Prevention of anticompetitive settlements will depend on the ability of the FTC to identify (and prove) when settling companies’ side deals–agreements for marketing (as in the Solvay case) or for providing manufacturing capacity–were window dressing for the reverse payment. Future settlements involving legitimate joint ventures should not be affected. This is a substantial improvement over the prior situation, in which any agreement passed muster as long as it was within the scope of the patent, and holds the promise of preventing settlements involving reverse payments that simply exist to prop up weak or invalid patents in the face of generic competition. As a result, consumers should see more low-cost generic drugs marketed in a timely fashion, which will reduce health care spending and promote positive health outcomes such as medication adherence.

Could the Supreme Court’s decision threaten innovation by reducing the confidence that brand-name drug companies have in their ability to rely on their drug product patents?  Empirical work by Sampat and Hemphill has shown that the majority of patent challenges occur in the context of secondary patents.  This was the case for Solvay’s testosterone gel, an updated formulation of a very old product.  By contrast, patents protecting new active ingredients have not attracted generic challengers as often.  Thus, if FTC v. Actavis has any effect on drug innovation, the more likely outcome would be to reduce pharmaceutical manufacturers’ incentives to create new formulations, line extensions, and follow-on products and increase the incentives to invest in novel products with a stronger patent monopoly—and a more transformative potential on health care delivery.

Editor’s note: The Entry Point feature of the August Health Affairs issue will focus on another major Supreme Court case from this term, Association for Molecular Pathology v. Myriad Genetics, in which the Supreme Court ruled unanimously that a naturally occurring human gene is a product of nature and not patent eligible merely because it has been isolated. You can read more on the Myriad Genetics and Actavis cases in Health Affairs Blog posts written last year, when the Supreme Court took the cases.