Federal Appellate Court: Pay-for-Delay is “prima facie evidence of an unreasonable restraint of trade.”

On Monday, July 16, 2012, the Court of Appeals for the Third Circuit ruled that pay-for-delay agreements between branded pharmaceutical companies and generic manufacturers are prima facie evidence of anticompetitive behavior. In so holding, the court noted that permitting such reverse payments results in “protect[ing] intellectual property, not on the strength of a patent holder’s legal rights, but on the strength of his wallet.” The Third Circuit remanded the case to the lower court in line with the rule that reverse payment in exchange for a generic manufacturer’s delayed entry into the market is prima facie evidence of unreasonable restraint of trade. Such a presumption can be rebutted by a showing either that the payment was for a purpose other than delayed entry or is a rare case where such payment offers some pro-competitive benefit.

The particular facts of the case stem from the drug K-Dur 20 (“K-Dur”), a brand name sustained-release potassium chloride, used to treat potassium deficiencies. Potassium chloride itself is not patentable, but the Defendant-Appellee, Schering-Plough Co., received a patent for the formulation of the controlled release coating.

In August 1995, generic manufacturer, Upsher, filed an Abbreviated New Drug Applicant (ANDA), a short-form application that relies on the FDA’s prior determination of safety and efficacy, a process permitted by the Hatch-Waxman Act. 21 USC 355(j). Upsher alleged a Paragraph IV certification of non-infringement, asserting that there were chemical differences between its generic version and the brand name product. As the first-filer of an ANDA, Upsher was eligible for a 180-day exclusivity period. By statute, Upsher was required to notify all patent holders of its Paragraph IV filing and, upon notice of the filing, Schering instituted a lawsuit against Upsher. The lawsuit triggered an automatic stay of either 1) thirty months, or 2) a court decision that the patent is either invalid or would not be infringed.

Upsher and Schering reached a settlement agreement where Upsher agreed not to market its generic potassium chloride supplement until September 1, 2001. At that point, Upsher would receive a non-royalty, non-exclusive license to make and sell a generic form of the drug and agreed to dismiss its patent action. Upsher granted Schering licenses to make and sell several pharmaceutical products that it had developed, including Niacor-SR, a drug used to treat high cholesterol. In return, Schering agreed to pay Upsher $60 million over the next three years, with additional sums paid depending on its sales of the Niacor-SR. Schering entered into a similar agreement with a company known as ESI, also with regard to action over K-Dur. Schernig agreed to pay ESI $5 million upfront and would grant ESI a royalty-free license on K-Dur beginning on 2004. In addition, Schering would pay ESI an amount ranging from $10 million if ESI’s ANDA was approved before 1999 to $625,000 if it was not approved until 2002. Due to an amendment of the Hatch-Waxman Act in 2003, settlement agreements involving reverse payments from branded pharmaceutical companies to generic manufacturers must be filed with the Federal Trade Commission and the Department of Justice for antitrust review. 21 USC 355(j).

Upsher and Schering allege that the $60 million was paid as royalties for Niacor-SR. The FTC, however, argued that the Upsher license was a sham and that the so-called royalties were actually compensation for the agreement to delay entry of the generic form of K-Dur. In 2001, the FTC filed a complaint arguing that the pay-for-delay settlements between Schering, Upsher and ESI resulted in unreasonable restraints of trade, violating Section 5 of the Federal Trade Commission Act, 15 USC 45. The FTC alleged that the reverse payments intended to delay generic entry of K-Dur into the market and improperly preserved the Schering monopoly on the product.

Case History

In June 2002, an Administrative Law Judge dismissed the FTC’s complaint. There, the ALJ found that there was no reverse payment in the Schering-Upsher agreement because the sum paid represented royalties for the licensing deal. It also found that the Schering-ESI agreement was not designed to unlawfully preserve Schering’s monopoly power over K-Dur.

The following year, the FTC unanimously reversed the ALJ’s decision. The FTC found that both deals violated antitrust law. In its decision, it stated that where a brand-name pharmaceutical company pays a generic manufacturer as the result of a settlement agreement, “[a]bsent proof of other offsetting consideration, it is logical to conclude that he quid pro quo for the payment was an agreement by the generic to defer entry beyond the date that represents an otherwise reasonable litigation compromise.” In essence, the FTC suggested that pay-for-delay programs were prima facie evidence of an unlawful, anti-competitive agreement. Schering appealed the ruling to the Court of Appeals for the Eleventh Circuit which reversed the FTC’s finding in 2005.

Other parties–plaintiffs include Louisiana Wholesale Drug Co., CVS Pharmacy, Rite Aid, Walgreens, Eckerd, Safeway, Kroger, Albertson’s, Hy-Vee, Maxi Drug–also filed antitrust suits, alleging that the Schering settlement agreements were anticompetitive. These other suits, independent of the FTC action (though FTC and the DOJ filed as amici in the case), were consolidated in the District of New Jersey. A Special Master was appointed and the subsequent report issued adopted the “scope of the patent test” where reverse payments are permitted as long as the exclusion does not exceed the patent’s scope, the patent holder’s claim of infringement was not objectively baseless, and the patent was not procured by fraud on the PTO. The district court ultimately adopted a Special Master report and recommendation, that “applied a presumption that Schering’s . . . patent was valid and it gave Schering the right to exclude infringing products until the end of its term, including through reverse payment settlements.” The suit was then appealed to the Court of Appeals for the Third Circuit.

Third Circuit Decision

The Third Circuit rejected the lower court’s test, finding that such a presumption would unreasonably reduce the applicability of antitrust laws. The court noted that:

In our view, that test improperly restricts the application of antitrust law and is contrary to the policies underlying the Hatch-Waxman Act and a long line of Supreme Court precedent on patent litigation and competition.

First, we take issue with teh scope of the patent test’s almost unrebuttable presumption of patent validity. This presumption assumes away the question being litigated in the underyling patent suit, enforcing a presumption that the patent holder would have prevailed. We can identify no significant support for such a policy . . . Moreover, the effectively conclusive presumption that a patent holder is entitled to exclude competitors is particularly misguided with respect to agreements–like those here–where the underlying suit concerned patent infringement rather than patent validity: In infringement cases it is the patent holder who bears the burden of showing infringement. See Egyptian Goddess, Inc. v. Swisa, Inc., 543 F.3d 665, 679 (Fed. cir. 2008).

The Third Circuit suggested that a patent merely represents a “legal conclusion” by USPTO and noted that many issued patents are later found to be invalid or not infringed. The Third Circuit noted a study by the FTC that in Paragraph IV cases under Hatch-Waxman, “the generic challenger prevailed seventy-three percent of the time.”

The Third Circuit also rejected suggestions by other courts that these settlements to initial challengers do not reduce the ability of other generic challengers to challenge and eliminate weak patents. The court noted that the initial challenger is generally the most motivated and also that the high-profits of branded pharmaceutical companies enables such companies to pay off numerous challengers.

In rejecting the settlements, the Third Circuit, relying on several rulings of the Supreme Court, suggested that “the public interest supports judicial testing and elimination of weak patents.” The Supreme Court stated in the case Edward Katzinger Co. v. Chicago Metallic Manufacturing Co., 329 U.S. 394 (1947), for example, that “It is the public interest which is dominant in the patent system and . . . the right to challenge . . . is not only a private right to the individual, but is founded on public policy which is promoted by his making the defence, and contravened by his refusal to make it.”

Applying this Supreme Court precedent, the Third Circuit found that

This logic is persuasive with respect to the situation at bar because reverse payments permit the sharing of monopoly rents between would-be competitors without any assurance that the underlying patent is valid. See also United States v. Studiengesellschaft Kohle, m.b.H., 670 F.2d 1122, 1136 (D.C. CIr. 1981) (suggesting an agreement might be antitcompetitive if it “give[s] potential competitors incentives to remain in cartels rather than turning to another product, inventing around the patent, or challenging its validity”). It appears that these aspects of the Supreme Court’s general patent jurisprudence had been overlooked by the Special Master and others adopting the cope of the patent test.

The Third Circuit found that the pay-for-delay settlements in the present case undermined potential generic competition, the purported goal of the Hatch-Waxman Act. It further noted that the primary beneficiaries of pay-for-delay agreements are those branded pharmaceutical companies that hold “weak or narrow patents that are unlikely to prevail in court.”

The court acknowledges that while courts generally support settlements because of their amicable nature and a reduction in federal court caseloads,

the judicial preference for settlement, while generally laudable, should not displace countervailing public policy objectives or, in this case, Congress’s determination–which is evident from the structure of the Hatch-Waxman Act and statements in the legislative record–that litigated patent challenges are necessary to protect consumers from unjustified monopolies by name brand drug manufacturers. We also emphasize that nothing int he rule of reason test that we adopt her limits the ability of the parties to reach settlements based on a negotiated entry date for marketing of the generic drug: the only settlements subject to antitrust scrutiny are those involving a reverse payment from the name brand manufacturer to the generic challenger.

Rejecting the district court’s ruling, the Third Circuit directs the lower court to

treat any payment from a patent holder to a generic patent challenger who agrees to delay entry into the market as prima facie evidence of an unreasonable restraint of trade, which could be rebutted by showing that the payment (1) was for a purpose other than delayed entry or (2) offers some pro-competitive benefit.

In holding that a reverse payment is prima facie evidence of an unreasonable restratint of trade, we follow the approach suggested by the DC Circuit in Andrx and embrace that court’s common sense conclusion that “[a] payment flowing from the innovator to the challenging generic firm may suggest strongly the anticompetitive intent of the parties entering the agreement . . . .” 256 F.3d at 809 (internal quotation marks and citations omitted).

We agree, moreover, with the FTC that there is no need to consider the merits of the underlying patent suit because “[a]bsent proof of other offsetting consideration, it is logical to conclude that the quid pro quo for the payment was an agreement by the generic to defer entry beyond the date that represents an otherwise reasonable litigation compromise” In re Schering-Plough Corp., Final Order, 136 F.T.C. at 988. Of course, a patent holder may attempt to rebut plaintiff’s prima facie case of an unreasonable restraint of trade by arguing that there is in fact no reverse payment because any money that changed hands was for something other than a delay in market entry. Alternatively, the patent holder may attempt to rebut the prima facie case by demonstrating tha the reverse payment offers a competitive benefit that could not have been achieved in the absence of a reverse payment. This second possbile defense attempts to account for the –probably rare–situations where a reverse payment increases competiton.

The case will now be remanded back to the District Court of New Jersey which will re-determine the case applying the rule set forth by the Third Circuit.

Ultimately, this issue could be ripe for Supreme Court review. The Third Circuit noted, in discussing precedent from other federal circuit courts, that the Supreme Court has yet to weigh in on the legality of reverse payment settlements. Five other Courts of Appeals have rendered opinions on the issue and, when taking into account this recent Third Circuit decision, there is a three-to-three split. According to the Third Circuit’s discussion of prior case law, two other courts (the DC Circuit and the Sixth Circuit) found that pay-for-delay agreements should come under strict antitrust scrutiny while the Eleventh, Second and Federal Circuit applied the “scope of the patent” test.