Why Do Patent Holders Sometimes Pay Patent Copiers?

(Photo: e-Magine Art)

Like a lot of products, pharmaceuticals get knocked off. And when that happens to a drug that’s protected by a patent, the next event is unsurprising: a lawsuit brought by the patent holder. But there is a very unusual twist in the pharma world. When the dust settles, quite frequently it is the major pharmaceutical firm that is paying the company that has knocked off their patented drug.

In one recent case involving Cipro, a widely-used antibiotic with annual sales exceeding $1 billion, Bayer (the patent owner) paid $400 million to a generic drug maker, Barr Laboratories, to settle their patent dispute. Why would the patent holder make such a huge payment to the knockoff artist, and not the other way around?

The answer turns on the particularities of the drug market and the regulatory system drug makers operate in. Generic drugs are those that are copies (legal copies) of once-patented products. A common example is Ibuprofen. Once the patent ran out, generic makers entered the market in droves.

Generics are regulated by the Hatch-Waxman Act, a law passed back in 1984.

Generics makers often try to get into the market before the expiration of the relevant patents. Under Hatch-Waxman, a generic manufacturer can file something called an “Abbreviated New Drug Application” (ANDA) with the Food and Drug Administration seeking the FDA’s approval to market a generic version of a patented drug prior to the patent’s expiration.  Once the ANDA is filed, the patent holder can sue the generics maker. 

From the moment a complaint is filed, the FDA automatically delays approval of the generic’s ANDA for 30 months. If the patent is declared invalid or not infringed by the generic firm’s drug, the automatic delay in FDA approval terminates, and the generic firm can start selling its knockoff drug. Hatch-Waxman gives the first generic entrant a 180-day period of exclusivity — no other firm making generic equivalents of the same drug can enter the market during this time.   This six-month exclusivity period can be very lucrative – generic manufacturers often price their knockoffs just under the price of the branded drug.  Even a small price break can yield substantial market share. For a widely used drug, that adds up to real money.

Hatch-Waxman has one additional – and unfortunate – quirk. Once the first generic firm’s ANDA is approved, it may enter the market. But nothing in the law requires that it do so.

Working together, these rules are a recipe for mischief. Think of the incentives that the law creates for both the patent holder and the would-be generic entrant.  The generic drug firm stands to make a lot if it enters. But the patent holder stands to lose even more.

That is, unless the parties make a deal.  Which is why we see patent holders paying generic firms to settle the patent lawsuits that the patent holder initiated in the first place. In return for the money they hand over, the generic firm promises to stay out of the market until the patent expires. And because the first generic firm has agreed to stay out of the market, no other generic firm can enter.  Why? Because if the first approved generic firm does not enter the market with its knockoff, the start of its statutory 180-day exclusivity period is not triggered.  And so other would-be generic entrants are frozen out.

In effect, the patent holder agrees to share with the generic firm some of the booty its patent monopoly gives it, in return for certainty that the monopoly will continue (at least until the patent expires).

The generic may not win the suit, so it’s also buying itself some certainty. But even if the generic is quite confident that it will win in court, it may still prefer to settle. Why?  Because once its 180-day period of exclusivity expires, other generic firms may enter. And once there is more than one generic drug available, prices tend to fall – a lot. The Federal Trade Commission estimates that prices fall as much as 90% following entry by the second generic competitor. Given the major price declines that come with real competition, the generic firm may prefer to share the patent holder’s monopoly indefinitely over the prospect of significantly reduced revenues beginning six months after it enters.

Are agreements like these illegal collusion? We think so – although it’s not an easy question. If you consider the merits of each of these settlements individually, then antitrust liability seems like a stretch.  The patent lawsuits are settled, not litigated, and in the absence of a final verdict, it is very difficult to say in any particular instance whether the patent is valid or if the generic would have been able to enter.

Yet taken as a whole, these sorts of patent litigation settlements are quite likely to harm competition.

To see why, consider the findings of a 2002 FTC study, which reveals that the generic firms prevail in almost two-thirds of the cases that actually go to trial.  This suggests that in many instances, the underlying lawsuit, if litigated to a final judgment, would lead to market competition.  In this light, many of the settlements are nothing more than a strategy to avoid competition that otherwise would occur.

The federal courts have split on the propriety of these deals.. The most recent court to weigh in is the federal appeals court in Philadelphia, which covers New Jersey, Pennsylvania and Delaware, states in which many pharmaceutical companies have located their headquarters. The federal court in Philly held that reverse payment deals were anticompetitive on their face. 

The Supreme Court has yet to weigh in on this issue.  But it’s probably only a matter of time before the high court takes a look.   If you’re feeling anxious about this, you’re not alone. The prospect of antitrust liability for reverse payment settlements has a lot of pharma executives reaching for that bottle of (branded) Xanax.

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  1. frankenduf says:

    “the FTC estimates that prices fall as much as 90%”- gee, i wonder why healthcare in america is so much more expensive than anywhere else on the planet

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    • James says:

      Yeah. Though one might also think about the number of say new antibiotics developed in the US versus the number developed elsewhere, and wonder if the rest of the planet might not be freeloading on the US.

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      • alex in chicago says:

        Exactly,

        Other countries simply refuse to recognize patent rights, or in some cases, severely limit them. For instance, you tell the drug manufacturer to take 20 cents on the dollar, or compete in a “fair” market where you can make 10 cents.

        If not for the United States’ enforcement of patent rights for pharmaceuticals, there would be almost no financial incentive to develop a new drug and go through the expensive and long FDA approval process.

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  2. Molly says:

    Aaaaannnnd the consumer loses.

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  3. robopanda says:

    And when the generic company won’t take the payment, sometimes the company is bought out by the large cap pharmaceutical which then dismantles the smaller company. Sometimes these generic manufacturers take the payment because they know it’s better than being dismantled, throwing all employees and their local community into financial peril. There’s always that implied threat, because it’s happened to so many little companies along the way, but it’s not a RICO violation of course. “Just business.”

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  4. Paul says:

    The irony of talking about collusion — what else is patent law besides collusion? This might be one of the only kinds of situations where the kind of collusion anti-trust laws were designed to oppose actually happens. In a free market, these two colluders would get crushed by the competition (like what happens when the patent monopoly ends).

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  5. generics says:

    You are missing the generic’s incentive to settle. The penalty for losing a patent case can be triple damages. Even in the exclusive 180 days, there will likely be an authorized generic and the erosion to the product can be at least half. The triple damages (of brand value) are usually a much higher multiple than 3 of what the generic can hope to make. The weight of the potential damages can cause the generic company to settle. But, removing the ability to settle would be like removing the flush from poker. If the generic companies have less outs, they will have less incentive to challenge the patents in the first place. Generics would likely continue to win two thirds of patent cases, but the number of cases would decrease. That would be the harm to competition.

    The brand company many times will use an authorized generic to drive the market price down significantly, also impacting the 180 days’ value. The authorized generic is also a hot button as an anti-competitive issue. The brand simply relabels their product and charges different amounts to disrupt the market and skirt Hatch-Waxman.

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  6. Brandon says:

    This kind of stuff is our (Americans) own fault. We demand that the government protect us from “evil” corporations because we are too lazy or ignorant to try making our own informed choices. But the government can’t protect its citizens from themselves. Add to this the demand for free health-care and cheap pharmaceuticals, and you’ve got a recipe for litigation nightmares and corruption from within. This looks like nothing more than natural cause and effect, and cats don’t bark.

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  7. Peter says:

    I’m not sure this is entirely unique to medicine- the recent Microsoft/ Barnes and Noble patent trial had a similar outcome.

    The problem is the current patent system creates a “tragedy of the commons” problem. This sort of non-sense is needed in order to balance out a broken system.

    When faced with a patent lawsuit, a company can choose to settle upfront, or take it to court. The downside to taking the case to court- triple damages and legal fees- is born by a single infringing company. But the upside, -the patents being invalidated- accrues to everyone who wants to make an infringing product, even those that previously played it safe by settling!

    Unless the infringer can turn right around and extort the patent-holder into a settlement, or has a similar patent of their own, the risks of taking even a bad patent to court far outweigh the rewards. That’s why there is so much complacency towards even the most absurd patents.

    Assigning the bogus patent to the challenger is actually a good idea- it effectively puts a bounty on bogus patents. But they should couple that with mandatory FRAND licensing.

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  8. Helen says:

    Great read for my assignment; Great explanation of issues; keep up the good work!

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