Third Circuit Extends Reverse Settlement Agreements Involving Noncash Consideration

November 25, 2015Articles New Jersey Law Journal

Reverse payment, also called pay-for-delay, is not an uncommon strategy in a settlement between a pharmaceutical brand-name patent holder and a generic patent challenger.

A reverse payment can be a cash payment from the patent holder to the challenger or a discounted compensation from the challenger to the patent holder. Other forms of reverse payment include noncash incentives, such as exclusive licensing or early entry to the market prior to the expiration of the patent at dispute. Regardless of the form of a reverse payment, proponents defend it for allowing both parties to avoid lengthy and costly litigation and remove uncertainties related to the dispute. Opponents, however, attack reverse payment as an illegal instrument to protect weak patents from invalidation and thus eliminate the risk of competition.

In disputes involving pharmaceutical patents, additional complexities arise due to regulatory procedures unique to pharmaceutical products. The Hatch-Waxman Act, seeking to encourage competition from generic companies, provides the first challenger of a patent-protected drug an exclusive right to sell a generic version of the brand-name drug for 180 days after the invalidation or expiration of the challenged patent. (The brand-name drug company may market an authorized generic product.)

Meanwhile, any generic company attempting to enter the market of a brand-name product under patent exclusion, if sued by the patent holder, will have to wait for approximately 30 months before the FDA may approve the application of its generic product. Because of the availability of the 180-day exclusivity to only the first challenger and the substantial delay in FDA approval, a patent holder of a brand-name drug will have less concern of provoking other challengers by settling the dispute. Some opponents of reverse payment even advocate that a brand-name drug producer is motivated to settle on a weak patent with a first challenger to fend off competition from the broader market.

For years, the courts were split on the issue and implication of reverse payment. For example, the Eleventh Circuit took a "scope of patent" approach and held that a reverse settlement is immune from antitrust attack so long as its anticompetitive effects fall within the exclusionary scope of the patent.FTC v. Watson Pharmaceuticals, 677 F.3d 1298, 1312 (11th Cir. 2012). The Third Circuit, by contrast, viewed reverse payment presumptively unlawful. In re K-Dur Antitrust Litigation, 686 F.3d 197 (3d Cir. 2012).

The split between courts on reverse payment was addressed by the 2013 Supreme Court in FTC v. Actavis, where the court held that a large, unexplained reverse payment can bring with it significant anticompetitive effects. FTC v. Actavis, 133 S. Ct. 2223, 2227 (2013). In reaching its decision, the Supreme Court adopted a rule of reason approach, which analyzes various factors associated with a reverse payment, including 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. Id. at 2237. The Supreme Court recognized that there "may be justifications for reverse payment that are not the result of having sought or brought about anticompetitive consequences" and noted that such "payment may reflect compensation for other services the generic promised to perform—such as distributing the patented item or helping to develop a market for that item." This ruling essentially rejected the "scope of patent" approach of the Eleventh Circuit and the "presumptive anticompetitive" approach of the Third Circuit but left to the lower court the structuring of the rule of reason analysis.

Post Actavis, the Third Circuit stated in King Drug Co. of Florence v. SmithKline Beecham Corp. (No. 14-1243 (3d Cir. 2015)), that an unexplained transfer of large value in the form of a no-authorized generic (no-AG) agreement from the patent holder to the alleged infringer, may be subject to antitrust scrutiny. A no-AG agreement between parties of the settlement provides that the patent holder will not sell a generic version of the patented product during the 180-day exclusivity period. In the Third Circuit's opinion, not only "the brand's monopoly remains in force" due to the delayed entry of the generic, the generic also "faces no competition with other generics at all" resulting from the no-AG agreement. Therefore, such an agreement leads to a continued monopoly by a single company and triggers antitrust concern. Clearly, the Third Circuit did not limit the reverse payment of Actavis to a cash payment and focused its analysis on the effect of the no-AG agreement. It is concluded that an unexplained transfer of considerable value can be inferred as a payment for eliminating the risk of competition. The Third Circuit went on to reject the argument that the no-AG agreement is an exclusive license exempt from antitrust scrutiny. Again, the court emphasized the anticompetitive effect of the agreement in the analysis. Leading to its conclusion about the impact of the no-AG agreement, the Third Circuit also discussed the legislative intent of encouraging competition and advancing the public interest behind the Hatch-Waxman Act. Here, the license is used to "induce a patent challenger's delay" for the purpose of eliminating the risk of competition.

Even though the Third Circuit stated that the no-AG agreement was used in King as a tool to induce the challenger to give up the validity challenge, the court did not label no-AG settlement as per se anticompetitive. Citing Actavis, the court reiterated that the proper approach is rule of reason analysis.

The rule of reason analysis involves a burden-shifting process. The plaintiff (patent challenger) bears an initial burden to show the anticompetitive effect of the alleged settlement. Because proof, such as reduction of output, increase in price, or deterioration in quality of goods or services resulting from the anticompetitive effects of the settlement is often difficult to ascertain, the market power of the defendant (patent holder) can be used as a surrogate for detrimental effects.

The burden then shifts to the defendant to explain "that legitimate justifications are present, thereby explaining the presence of the challenged term and showing the lawfulness of that term under the rule of reason." For example, a reverse payment roughly equivalent to the projected litigation expense may provide a legitimate justification. A payment to compensate for services a challenger has promised to perform is another ground to argue for the pro-competitiveness of the settlement. After the defendant meets its burden, the plaintiff will then have an opportunity to rebut the defendant's explanation.

While King relates to no-AG agreement in settlement, the Third Circuit's reasoning is not limited to the anticompetitive effect of such a particular form. Under the rule of reason analysis, a settlement even without a no-AG agreement may be subject to antitrust scrutiny in the Third Circuit if it can be inferred as eliminating the risk of competition.

Other Cases Involving Reverse Payment

Two cases pending in the Third Circuit, In re Effexor and In re Lipitor,bear certain similarities to King. Both of these cases involve non-cash payment from the patent holder to the patent challenger. The issue is whether a reliable estimate of the cash value of the nonmonetary payment is needed to survive a motion to dismiss.

The Third Circuit in King explained that under the substantive standard, the question at the pleading stage is whether the defendants "have acted unlawfully by seeking to prevent competition." At least in King, the Third Circuit did not specifically require a quantitative determination of the value transferred from the patent holder to the challenger to show an anticompetitive effect. Regardless of how the Third Circuit will rule on the pleading standard, a recent legislative proposal introduced by Sens. Klobuchar and Grassley may further change the litigation landscape involving reverse payments. The Klobuchar-Grassley proposal calls for designating no-AG agreements as being presumptively anti-competitive. Further, the defendant would have to meet a "clear and convincing" evidence standard as opposed to the current "preponderance" standard to justify the no-AG agreement.

In connection with the ruling on no-AG agreement in King, the Third Circuit will take up an appeal on a class certification order in an antitrust case between direct purchasers and parties of an earlier settlement. The lower court has refused to certify a group of consumers and other end-payors in the plaintiff class. A group of generic companies alleged that the class certification of 22 wholesales failed to satisfy the numerosity requirement for a class action lawsuit. The anticompetitive analysis in Actavis and the Third Circuit's analysis in King are not directed solely to the impact on a particular interest group such as generic companies. Instead, both opinions discuss the effect of a reverse payment on consumers. The Actavis opinion provides that the result of the reverse payment is that "[t]he patentee and the challenger gain; the consumer loses." The Third Circuit further describes the purpose of the Hatch-Waxman act as "so consumers can enjoy lower drug prices." This view will certainly lend support to including additional representative class members, such as consumer groups and end-payors in antitrust litigation.

In summary, the Third Circuit adopts a rule of reason analysis in litigations involving reverse payment. It is likely that settlement without cash payment or no-AG agreement, depending on the market and regulatory context, may also be subject to anticompetitive scrutiny. The longterm impact of such ruling on innovation and public interest is still yet to be seen.

Reprinted with permission from the November 25, 2015, edition of the New Jersey Law Journal © 2015 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For information, contact 877.257.3382 -[email protected] or visit