Are Reverse Payments Really a Game?

Dr. Jeremy I. Bulow, Richard A. Stepp Professor of Economics, at Stanford Institute for International Studies is author of The Gaming of Pharmaceutical Patents.

Paragraph IV of the Hatch-Waxman Act provides a mechanism for the litigation of pharmaceutical patent infringement disputes. Many of these cases have been settled with “reverse payments” by the brand to the generic in return for delayed generic entry.  The FTC has contested a number of these settlements with good but not complete success.  This paper argues for per se illegality of settlements that include side payments or deals which are beneficial to the generic. Further, the paper shows a number of additional strategies beyond side payments, some highly questionable from an antitrust perspective, that brands have used to keep out generics.

Agreements between brand name pharmaceutical companies and potential generic entrants that purport to settle patent litigation have been the subject of much antitrust scrutiny over the last several years. These agreements, referred to as “Hatch-Waxman Agreements,” share several features:

1. Each occurred in the context of patent litigation between branded and generic pharmaceutical companies that arose under the complex regulatory provisions of the Hatch-Waxman Act.
2. Each involved substantial payments from the brand name incumbent to the potential generic entrant.
3. Each involved the potential generic entrant agreeing to stay off the market for a defined period of time. The stakes are sometimes quite large; in the biggest settlement a brand with annual sales of over $750 million kept a generic off the market for over six years.

The analysis of this paper implies that:

• Hatch-Waxman Agreements in which a brand-name manufacturer pays a potential generic entrant more than nominal consideration in return for staying off the market will harm consumers and welfare would be increased if such agreements were presumptively unlawful.
• Hatch-Waxman Agreements in which a brand-name manufacturer and a potential generic entrant agree upon an entry date for the generic product, and at the same time the brand-name manufacturer pays the generic for (seemingly) unrelated rights, will inevitably lead to delayed entry --- unless the payment to the generic for the unrelated rights is clearly not more than the generic could have received selling the rights independently. Making such agreements presumptively unlawful would increase welfare.
• Hatch-Waxman Agreements in which a brand-name manufacturer and potential generic entrant agree upon an entry date for the generic product, but in which no payment is made from the brand-name manufacturer to the generic entrant, can enhance consumer welfare and therefore cannot be presumptively unlawful.
• However, an agreement with no side payments may create an antitrust violation if, because of its interaction with Hatch-Waxman rules on generic exclusivity it delays entry of other competitors. Additionally, even if the agreement involves royalty payments by the generic to the brand and does not deter other entry, an antitrust problem may exist if the generic’s marginal per pill licensing fee exceeds its average per pill licensing fee. Similarly, “pseudo-generic” entry as part of a settlement can be problematic if it blocks other entry.

The paper:

1. Provides a brief overview of the key Hatch-Waxman provisions.
2. Summarizes the major litigation partially through 2003.
3. Summarizes the results of the 2002 FTC study of Hatch-Waxman cases.
4. Discusses the economics and game theory issues that arise in settlements, ultimately incorporating the key special Hatch-Waxman provisions.
5. Discusses problematic settlements that would be anticompetitive in patent lawsuits more generally, not just under Hatch-Waxman.
6. Concludes with suggestions for reforming the main provisions of the Act.

In concluding, Dr. Bulow states, "Like many, I am deeply skeptical of any “reverse payments” from the licensor to the licensee. Also, since the value to the brand of keeping the generic out is vastly greater than the value to the generic of getting in, it is clear that if we allow complex settlements the overwhelming incentive of the parties will be to game the system by transferring resources to the entrant in return for a postponed entry date."  Take a look at his article and let me know, if you agree that these complex settlements are indeed reverse payment games and should be disallowed.

A PowerPoint presentation addressing this topic is also available as part of a course syllabus from Professor John Morgan of the Haas School of Business and Department of Economics at the University of California at Berkeley.