Princeton Economics Group, Inc.

The Oxford University Press recently published a case study that was co-authored by Senior Economist John Bigelow of the Princeton Economics Group, Inc. The case study described an attempt by the Federal Trade Commission to challenge so-called "reverse payments" made by Schering-Plough to two generic drug manufacturers. A PEG team led by Dr. Bigelow worked with counsel for Schering to defend the company against FTC allegations that it was per se illegal for Schering to include payments to two generic manufacturers in settlements of patent litigation involving its potassium chloride product, K-Dur 20.

The FTC enforcement action was one of a series the agency had taken against settlements in the pharmaceutical industry that embody payments made by the patent-holder/brand manufacturer to the alleged patent infringer/generic manufacturer. The FTC describes these as "reverse payments" and "payments for delay" because, in the Schering case, as in others, the brand and generic manufacturers agreed to a future date at which the generic would enter the market. The agency alleged that the brand manufacturer protected its monopoly position by paying two potential competitors to delay entering the market.

As the FTC and its expert economist saw it, as a matter of economics, there is no reason why a patent holder like Schering should include a payment to an alleged infringer other than to "purchase" time on the market without competition. Therefore, the agency took the position that settlement agreements that combined reverse payments with a negotiated entry date should be per se illegal. That position was consistent with the agency's view that it is impossible for enforcement agencies or courts hearing antitrust cases to assess whether or not a negotiated entry date actually accelerated or delayed the likely date of generic entry, because it is impossible or impractical for them to evaluate the merits of the parties' cases in the underlying patent litigation.

Schering challenged the economic theory at the heart of the FTC's case for per se treatment. Schering's expert witness gave testimony developed with PEG economists and later elaborated upon in the academic literature explaining that when litigation is costly and the litigating parties are risk averse, they may find it mutually agreeable to include a reverse payment in a settlement that hastens generic entry relative to what may be expected from the litigation. Indeed, the analysis identified circumstances under which reverse payments are essential to achieving pro-competitive settlements that hasten generic entry. [See Robert D. Willig and John P. Bigelow, "Antitrust Policy towards Agreements That Settle Patent Litigation," The Antitrust Bulletin, 49 (Fall 2004): 655 - 98.]

An FTC Administrative Law Judge (ALJ) initially ruled against the FTC complaint counsel's case, rejecting per se treatment because the issues of reverse payments and patent splitting were too novel. The ALJ also ruled in favor of the defendants on a rule of reason analysis because he found there was insufficient evidence to show that the payments made by Schering to the generics were not commensurate with other consideration provided by the generics to Schering.

The full Commission reversed the ALJ, finding that the Schering payments were excessive for the purported consideration. In the absence of proof of some other offsetting consideration, the commission concluded that it was "logical to conclude that the quid pro quo" for the payments was entry delay. Accordingly, without conceding that they were fixing the burden of proof on the defendants, the commission held that absent proof of some "affirmative justification" for the payments, the complaint counsel's prima facie case against the settlements was sufficient to justify a ruling against the settlements.

The Commission, in turn, was overruled by the Eleventh Circuit Court of Appeals, which did not attempt to grapple with the competing arguments in economic theory: the FTC's theory that delay could be the only explanation for reverse payments, and the defendant's theory that a more complete analysis of incentives demonstrates instances in which reverse payments are essential to settlements that hasten generic entry. The Appeals Court took the position that Schering's patents were presumptively valid and that the negotiated entry dates, which occurred before patent expiration, fell within the "exclusionary effect of the patent."

A split developed over this case between the FTC and the Department of Justice (DOJ). In a certiorari petition, the FTC asked the Supreme Court to take the case and decide whether or not an agreement with a reverse payment made, as the FTC put the question, "for the purpose of delaying the challenger's entry into the market, is an unreasonable restraint of trade." The FTC continued to assume, as they had from the beginning of the case, that reverse payments were necessarily anti-competitive. The DOJ put the question in much more neutral terms, asking the court to determine if a brand-to-generic payment and an agreed-upon entry date within the life of the patent made a settlement illegal.

The Supreme Court declined to take the case, leaving an unresolved problem for policy makers where patent litigation settlements with reverse payments and negotiated entry are concerned. This problem arises from the four lessons the Schering-Plough case teaches:

1. The parties to litigation have a socially beneficial incentive to settle costly and risky patent lawsuits.
2. Economic logic teaches that such settlements could include combinations of payments and delay that would injure competition.
3. Economic logic also teaches that the ability to include payments and negotiated entry in settlements can be essential to achieving pro-competitive socially beneficial settlements.
4. Antitrust inquiry may be incapable of reaching reliable conclusions about the merits of the underlying patent litigation.

Simple rules, either those that per se forbid reverse payments and negotiated entry or those that would grant them a blanket safe-harbor are likely to be unwise. The chapter calls for a program of research that would equip policy makers and enforcers to distinguish between pro-competitive and anti-competitive settlements.

The case study is: John P. Bigelow and Robert D. Willig, "'Reverse Payments' in Settlements of Patent Litigation: Schering Plough, K-Dur, and the FTC." Case 9 in The Antitrust Revolution, 5th edition, John Kwoka and Lawrence White (ed.s); Oxford University Press, 248 - 75, June, 2008.

The Antitrust Revolution is widely used in undergraduate and graduate classes in Economics, Industrial Organization, and Antitrust at a variety of distinguished universities and colleges. More information about the book may be found at Oxford University Press.

For more information about our work on the Schering-Plough case or anything else concerning the Princeton Economics Group, Inc. contact Senior Economist, John Bigelow.