US v. EU: Pay-for-delay Settlements

Reverse payment settlements exist at the intersection among antitrust, patent and healthcare laws. Also known as pay-for-delay agreements, these occur when a patent holder agrees to pay a potential patent infringer to settle litigation and delay its entrance to the market. The payment is called a reverse one because, in the ordinary patent litigation scenario, the patent infringer must pay a fine to the patent holder.

While U.S. courts have ruled on this issue over the course of the past decade, the European Courts have not yet spoken. One case on appeal has begun its journey through the European Courts. Companies and regulatory authorities are left waiting with uncertainty as the General Court examines the best way to approach pay-for-delay agreements in the EU.

Differences between the EU and U.S. analyses

The U.S. and the EU differ in their approach to antitrust cases. The text of article 101 of the Treaty on the Functioning of the European Union (TFEU) states that the two types of agreements that are prohibited under the EU law are those that restrict competition by their (1) object or (2) effects. A violation “by-object” occurs when the practice is anticompetitive by its very nature, determined by simply looking at the content and the aims of the activity. If the agreement is not found to be restrictive by-object, the authorities must then determine if the practices in question have actual negative effects on competition in the market. Under the “by-effects” test, one must demonstrate anticompetitive effects by undertaking a factual investigation involving economic and legal analysis. Once the restriction is proven, a defendant company can justify its restrictive practices under 101(3) TFEU by satisfying a four-condition test; however, the applicability of this defense is frequently presumed to be only a theoretical rather than a real one. (See The slow death of article 101(3)).

By contrast, the U.S. per se illegality rule creates an irrebuttable presumption that certain practices – such as price-fixing – are anticompetitive. In this scenario, there is no equivalent to the 101(3) TFEU under which a party can justify its behavior. If a practice does not fall under per se illegality, courts must apply rule-of-reason analysis. This approach is similar to that of the EU’s by-effects test; courts balance pro- and anti-competitive aspects of the practice in order to determine whether a behavior in question is unreasonably in restraint of trade.

EU position towards pay-for-delay agreements

In 2008, the European Commission (EC) launched an investigation to examine the EU pharmaceutical industry. The aim was to uncover the underlying reasons for the absence of competition in the market. The report provided that one of the main causes is the absence of generic companies and that the culprits are pay-for-delay settlements. What is worse, the inquiry confirmed that the postponed entries of the generics resulted in huge public expenditures, the reason being that the prices at which generic companies enter the market are substantially lower than the ones fixed by the brand companies.

In 2013, the EC imposed fines on the Danish pharmaceutical company Lundbeck and the generic companies that were parties to such pay-for-delay settlements. The EC found that the reverse payments that Lundbeck made to four generic companies to delay their market entry restricted competition by-object under article 101 TFEU — that is, the settlements restricted competition by their very nature. By finding a by-object restriction in this practice, the EC enlarged the so-called “object-box” – meaning, authorities will now be able to use a lower standard of proof to condemn these practices.

Procompetitive rationale for the EU

The EC’s decision in Lundbeck was based on the theory of harm in the area of pay-for-delay settlements — that by delaying the market entry of the competitors, the patent holder will be able to keep its earnings at the monopoly level. But this theory does not hold true in all pay-for-delay scenarios, particularly in those cases that carry high litigation costs.

To begin with, it is important to note the peculiarities of patent systems in general. Stanford Law Professor Mark A. Lemley and Berkeley-Haas Professor Carl Shapiro have argued that unlike an ordinary property right, a patent does not provide its owners with an absolute right to simply exclude the others; what the patent actually grants is the right to try and exclude the others through litigation. Even though the patent holder may be certain that the registration of the patent was successful and that the patent should still be valid, under the process of litigation there is always a possibility that the patent holder may lose.

In this situation, the loss for a brand company is more detrimental than for a generic.  Said simply, brand companies have more to lose. Once the litigation begins the brand company loses significant sales to the generic companies. The problem lies with the fact that approximately 50% of the patent holders in the EU are unable to get approval for interim relief, while the litigation is ongoing.  This means that once the generic company starts selling medicines and the litigation process begins, in approximately half of these instances the brand company cannot stop the generic from selling its medicines.

What is more, once the generic enters the market with its lower prices, the Regulatory Authorities within the EU member states adopt the lower price points. As a result, even if the court upholds the validity of a patent, the brand company will have to persuade the Authorities to raise the price levels again. These arguments often fail.

The uncertainty of the patent litigation system combined with the lack of interim relief might push companies to enter into these settlements for reasons beyond preserving their monopoly profits. Indeed, such settlements might bolster competitiveness, as compared to litigation.

US position towards pay-for-delay agreements

In the U.S. venue — where interim relief is available — the Supreme Court has permitted the brand companies to offer pro-competitive justifications. In the Actavis case, the Federal Trade Commission (FTC) argued that reverse payments are presumptively unlawful. But in 2013 the U.S. Supreme Court rejected the FTC position and held that pay-for-delay agreements should be analyzed under the rule-of-reason test rather than being named per se illegal activities. This case arose out of a settlement between Solvay Pharmaceuticals and three generic manufactures in which Solvay paid the generics not to market their less expensive product. The settlement also included a marketing contract under which the generics agreed to market branded AndroGel in exchange for a share of profits collected by Solvay.

Some argue that the U.S. rule-of-reason approach — similar to the EU’s by-effects test — is well-suited to the EU where the regulatory situation is even more complex.  In the U.S., for example, the brand company with the help of the regulatory force provided by the Hatch-Waxman Act can foreclose the whole market by entering into an agreement with one single generic company. In the EU, by comparison, the foreclosure effect can only be achieved if the brand company pays off every single generic that is planning to enter the market.

Moreover, if the patent holder sues the generic company in the U.S., the Foods and Drugs Administration withholds its grant of final approval of the generic for 30 months. This is a very significant difference between the jurisdictional approaches, since, as noted above, the interim reliefs in the EU are only approved in half of the cases. In light of these differences, University of East Anglia Lecturer in Law Sven Gallasch has argued that the EU should undertake case-by-case analysis in every scenario, rather than labeling these settlements illegal by their very nature.

Prons and cons of different approaches

The U.S. Supreme Court’s holding in Actavis that every pay-for-delay settlement needs to receive an effects-based scrutiny leads to issues of administrability. The amount of expenditure necessary to analyze all the patent litigation settlements from various economic and legal perspectives is extremely high. Moreover, the uncertainty caused to the parties would not be that different from the patent litigation process itself. Consequently, this new approach could disincentivize companies to reach agreements that would otherwise be beneficial to both parties.

Academics on both sides of the Atlantic proposed a possible indicator for anticompetitive conduct – the level of the reverse payment. UC Berkeley Professor of Economics and Law Aaron Edlin, Columbia Law Professor Scott Hemphill, Univ. of Iowa Professor of Law and History Herbert Hovenkamp and Berkeley-Hass Professor Carl Shapiro (EHHS) argue that the key source of the anticompetitive behavior’s inference should be a large reverse payment. This view is supported by the Supreme Court’s dicta in Actavis that it may be possible to evaluate the potential anticompetitive effects by examining the size of the payment. The larger the reverse payment, the stronger the presumption would be that the patent is no longer valid, or that the patent is very weak.

A problem that arises from the “inference” test is the regulatory differences in the jurisdictions. EHHS explain that the anticompetitive effects inference is applicable only when the payment in question exceeds the threshold, which equals the amount that would be spent on litigation costs and payment for services. However, this amount is incomplete in the EU context. In light of the regulatory differences discussed above — that interim relief is unavailable in half of the cases — the threshold in the EU should include losses of contracts to the generic companies.

To this point, Sven Gallasch further added that in the EU it would only be possible to undertake the inquiry regarding the size of the payment under the effects-based test. If the by-object test were applied, as in Lundbeck, all pay-for-delay agreements would be held to be anticompetitive by their very nature; there would not be the opportunity to take context (e.g. the size of the payment) into account.

Another possible approach to the analysis of reverse payments is the “quick-look” rule-of-reason/by-effects analysis. The “quick-look” is, in essence, a shortened version of the rule-of-reason/by-effects tests. Under this model, there is no requirement to analyze all the economic and legal peculiarities of the case, permitting courts to use some screening mechanisms while still ensuring administrability. While the U.S. Supreme Court in Actavis rejected the possibility of a “quick-look,” the EU’s Court of Justice has welcomed the possibility. (See Groupement des cartes bancaires, Allianz Hungária).

Both the European Commission and the Federal Trade Commission are highly skeptical of the pay-for-delay settlements. But different regulatory structures impose different limitations. Despite these dissimilarities, the European Commission may well land where the U.S. Supreme Court did in Actavis. Whether the U.S. approach is well-suited for a European venue remains to be seen, as more pay-for-delay settlements are reached and decisions related to their legitimacy are issued.