Economics: Explaining Reverse Payments in ANDA Litigation

Guest Post by Ruben Jacobo-Rubio.  I asked Jacobo-Rubio to write a guest post on his recent article (along with John Turner and Jonathan Williams) on estimating the valuation of Paragraph IV patent litigation.  The basic results here are that brand firms value deterring entry by an order of magnitude more than generic firms value the right to entry.  That economic result helps to explain the incentive for reverse payments. The full paper is available here: http://ssrn.com/abstract=2481908

The 1984 Hatch-Waxman Act attempts to strike a balance between promoting innovation of new brand drugs and facilitating generic entry. One of its key provisions, the Paragraph (iv) Abbreviated New Drug Application (ANDA) certification process, creates a specific role for patent litigation in striking this balance. Specifically, the US Food and Drug Administration (FDA) permits generic firms to rely on brand-firm data on safety and efficacy in seeking approval to sell copies of brand drugs, but does not grant entry unless the generic firm successfully challenges all relevant brand-firm patents. As a reward, the first successful generic challenger receives a 180-day marketing exclusivity upon approval of its ANDA (iv). Effectively, the Paragraph (iv) ANDA process seeks an average level of competition, where early entry occurs against weaker patents that do not hold up in court and later entry occurs against stronger patents (Hemphill 2006).

In recent years, however, brand and generic firms have settled Paragraph (iv) litigations out of court with increasing frequency (FTC 2010). Such settlements often involve delayed generic entry and some form of payment from the brand firm to the generic. Economic theory suggests such settlements may be anti-competitive.

In order to inform the courts and stakeholders at large, we study such patent challenges. Counting only the first challenge, and restricting further attention to cases where first-time entry in the entire molecule market is at stake, we collect a sample of 93 cases litigated during 1988-2012. We begin our data capture by using all patents ever listed for approved drugs in the FDA Orange Book since the beginning of the Act. Next, we do an extensive search for lawsuits, first by using all of these patents, a second search using drug names, and a last search using firm names.

After our extensive data capture, we also develop a novel framework, using an event study of Paragraph (iv) litigation decisions and the probabilistic nature of such decisions, to identify key aspects of the distribution of surplus in the US pharmaceutical industry during the Hatch-Waxman era. We assume that the Efficient Market Hypothesis holds; that is, the stock prices of pharmaceutical firms incorporate all available information about firm value. Thus, when there is a decision in a Paragraph (iv) case, investors price the effect of that decision into their valuation of the firm. For example, the two figures below show the raw effects of decisions on brand and generic firm values. The effects are large, timed just after district-court decisions, and move in predicted directions. This gives us confidence in the event-study approach. We use standard event-study techniques to identify cumulative abnormal returns (CARs) from these decisions.

rubio1rubio2

The CARs and other firm information are insufficient for identifying firms’ stakes in the case, for two reasons. First, investors expect Paragraph (iv) challenges to succeed with some probability. Second, district-court decisions are sometimes reversed on appeal. Hence, the change in market value from a district-court decision reflects a change in the probability of an ultimately successful Paragraph (iv) challenge. It does not pin down the difference in firm value between an ultimate win and an ultimate loss. To identify this latter difference—the value of deterrence for the brand and the value of entry for the generic—we weight the estimated change in the firm’s stock-market value from the event study, using formulas incorporating estimates of the probabilities of brand wins and of the probabilities of appellate reversals.

We find that brand firms value deterring entry, on average, at $4.6 billion. In contrast, generic firms value the right to enter at $236.8 million dollars (all values in 2010 dollars). Hence, the value of entry is only five percent of the value of deterrence. This gap suggests that, by settling their disputes, firms would realize sizable additional surpluses. Indeed, we estimate the average bargaining surplus to be about $2 billion per Paragraph (iv) case. This estimate represents a lower bound for the additional consumer surplus realized by permitting patent challenges under the Paragraph (iv) ANDA process, versus blocking entry for the life of the brand firm’s patents.

Next, we study the effect of a more permissive environment for “pay-for-delay” settlements. On June 27, 2002, an Administrative Law Judge ruled in favor of such a settlement in the closely-watched case Schering-Plough vs. FTC (40 LEXIS 244 [FTC 2002]). Since this decision, eventually upheld by the 11th Circuit Court of Appeals (402 F.3d 1056 [11th Cir. 2005]), there had been a surge in Paragraph (iv) settlements (FTC 2010).

When we divide our sample into cases before and after the 2002 Schering-Plough decision, our estimates show that for cases decided after Schering-Plough, the ex ante probability of an ultimate brand victory is 60%, versus just 40% for earlier cases. In addition, the average value of deterrence falls 60% after Schering-Plough, from about $8.8 billion to about $3.5 billion, while the average value of entry falls nearly 67%, from $532.0 million to $173.5 million. The average bargaining surplus falls from about $4.9 billion to about $1.3 billion, a 73% decrease.

Hence, since 2002 it has become increasingly rare for big-dollar Paragraph (iv) cases to complete patent litigation. They more typically settle. These settlements strongly reduce the (per-case) average consumer surplus delivered by Paragraph (iv) litigation.

The courts have yet to clearly delineate the antitrust implications of reverse payments, but the Supreme Court has made an important step. In a 5-to-3 decision on June 17, 2013 in FTC vs. Actavis et al. (133 US 2223 [2013]), the Court instituted a “rule of reason” for courts to apply to such cases (Hovenkamp). They instructed the 11th Circuit Court of Appeals to hear Federal Trade Commission (FTC) antitrust arguments in the Actavis case, and paved the way for the FTC to make such arguments in other cases.

We hope our study sheds light on the economics of these cases.

 

 

33 thoughts on “Economics: Explaining Reverse Payments in ANDA Litigation

  1. 4

    “In recent years, however, brand and generic firms have settled Paragraph (iv) litigations out of court with increasing frequency (FTC 2010). Such settlements often involve delayed generic entry and some form of payment from the brand firm to the generic. Economic theory suggests such settlements may be anti-competitive.”

    Ironically, if the parties didn’t settle and the brand wins, the brand enjoys the full term of its patent protection (which keeps competition off the market). So this article suggests that settlements that let generics on the market sooner may be anti-competitive. Would rather not have the brand/generic settle so that lower costs drugs com one the market sooner?

    1. 4.1

      Would rather not have the brand/generic settle so that lower costs drugs com one the market sooner?

      The article notes that “settlements often involve delayed generic entry”.

      this article suggests that settlements that let generics on the market sooner may be anti-competitive

      It’s important to define what you mean by “sooner” in this context (the term is relative, after all). A generic drug that is being kept off the market by an invalid patent is not coming into the market “sooner” that it should be when the patentee is paying the generic to sit on its ANDA filing and be quiet while it charges monopoly prices.

      While it’s true that a delayed ANDA filing can be marginally better than none at all from the perspective of consumers, the reverse payment scheme causes those filings to be delayed or, perhaps, never filed. It’s those delays — and the resultant higher drug prices over longer periods for consumers — that are problematic.

      1. 4.1.2

        Agree – “sooner” is relative. However, in my opinion any, any generic market entry prior to expiration of any of the Orange Book listed patents for the drug is pro-competitive.

        “A generic drug that is being kept off the market by an invalid patent is not coming into the market “sooner” that it should be when the patentee is paying the generic to sit on its ANDA filing and be quiet while it charges monopoly prices.”

        Your statement begs the question. The only way to know if a patent is “valid” (ignoring the deference given to the USPTO for doing its job) would be to litigate until a final decision is rendered. Only then could you tell whether the settlement would have been anti-competitive. Are we then placed in an chicken-and-egg situation?

        I am also curious to your thoughts on whether you would support removal of the 180 day exclusivity for the 1st generic filer? As you are probably aware, in the first 180 days, the generic price for the drug is marginally lower than the Brand. Only upon upon entry of the second or third generic do drug prices fall.

        1. 4.1.2.1

          in my opinion any, any generic market entry prior to expiration of any of the Orange Book listed patents for the drug is pro-competitive.

          “Any generic market entry” is “pro-competitive” when the only alternative is no early entry at all. But that’s not supposed to be the only alternative when the patent is invalid. That’s the point of Hatch-Waxman: encourage challenges to invalid patents to remove anti-competitive restrictions on the market. Invalid patents are certainly prime examples of anti-competitive restrictions on the market.

          The only way to know if a patent is “valid” (ignoring the deference given to the USPTO for doing its job) would be to litigate until a final decision is rendered.

          I can’t parse this out, particularly when “valid” is in quotes. Let’s say the USPTO grants me a patent on aspirin tomorrow. It’s an invalid patent. It should never have been granted. Nevertheless, it’s mine (Yay, freedom! Yay, rule of law)! I then pay all the generics, who are somewhat irritated by my patent, to sit back quietly and not file an ANDA. And of course I raise my prices because … Freedom, baby! God bless America!

          But to prove I’m not “anti-competitive”, I’m going to allow the generics to start manufacturing again one week before my patent expires. You’re all very welcome, all you little people.

          You don’t see anything anti-competitive about this state of affairs? I’m pretty sure most consumers do.

          I am also curious to your thoughts on whether you would support removal of the 180 day exclusivity for the 1st generic filer? As you are probably aware, in the first 180 days, the generic price for the drug is marginally lower than the Brand.

          Right. That’s the reward given to the first challenger to encourage such challenges to be made earlier. Maybe we need to make that reward bigger to provide more incentive for companies (or private individuals) to invalidate bad drug patents.

          1. 4.1.2.1.1

            Malcolm, it simply strikes me Malcolm that the whole scheme of not filing an ANDA in exchange for money is illegal and has to be prosecuted criminally.

            The settlement of in an ANDA after it has been filed is a different matter.

            1. 4.1.2.1.1.1

              I think the Supreme Court and most Judges in the country would agree that’s a Sherman Act violation. As for criminal prosecution, that’s a different beast, because the DOJ has mostly focused on cartels. I’m not sure this would be a cartel in any sense of the word.

          2. 4.1.2.1.2

            MM – its appears your beef is with the PTO not with the policy reasoning behind H-W. You again beg the question that the patent is invalid.

            Lets look at your example. If the PTO granted a patent on aspirin, which all generics knew was invalid, why would they agree to be paid to be kept off the market? Why wouldn’t they litigate the patent to invalidate it thereby getting on the market? Alternatively, why now extort the brand? The generic could demand such a large payment from the patent holder that it essentially takes away the profit of the brand? The generic has the ability to extort any amount of payment from the brand on threat that they will take down an invalid patent. Settlement is an agreement between at least two parties, which must have economic benefit to both – the brand and the generic.

            Also – if your concern is truly anti-competitive pricing and behavior, why would you advocate for more government granted monopolies, i.e., a longer exclusivity period for the generic? Wouldn’t a longer period allow the generic to charge inflated economic rents on its generic product to the detriment of the consumer?

      2. 4.1.3

        Malcolm, and the more likely it is that the generic would win if an ANDA were to be filed the more likely the brand name manufacturer would pay to keep the ANDA from being filed in the first place.

        Again, at least under California law, what we have here is extortion. And from US law, what we have a potential antitrust violation.

  2. 3

    Perhaps it’s just my browser but I can only enlarge one of the two charts shown (the right-side one). If readers have the same issue, link below points to the left-side chart alone.

    Or click here: link to patentlyo.com

  3. 2

    If both the Brand and Generic firms each prefer to settle, does not that mean that it is in the best interests of both of them to do so? Overall, from an economic standpoint, this would mean both are acting in a more efficient or more profitable manner, etc.

    What does economic theory have to say about “efficiencies” and “profit”?

      1. 2.1.1

        My couple of antitrust-related courses were many moons ago, but there are numerous examples of business activities that unfettered freedom would promote, and which would increase efficiencies and profits, but which we (all together as a society) have determined will not be permitted because of an additional net effect of anticompetitively inflating prices to consumers.

        Overall it’s not bad here, though, as compared to the EEA.

        1. 2.1.1.1

          What are the consequences of “anticompetitive inflating prices to consumers” to we “all together as a society” which are economically speaking detrimental or non-beneficial?

          If consumers pay more for something, don’t companies hire more people and pay their employees more and don’t those employees buy more? or doesn’t the company invest more or buy more equipment etc?

          1. 2.1.1.1.1

            If consumers pay more for something, don’t companies hire more people and pay their employees more and don’t those employees buy more?

            This is a peculiar notion. There are several things wrong with this idea. First, if consumers have to pay more for one thing (drugs, in this case), they have less to spend on other things, which would (according to your own logic) cause those other companies to hire fewer people and pay their employees less. Second, you don’t decide how many people to hire based on how much profit you’re making. You make hiring decisions based on how much of an item or service you can profitably produce and sell. In fact, if more is being charged for a particular item because of monopoly pricing power, then fewer of them are being produced and sold (basic supply and demand), which means that fewer people are needed to make and sell them.

            1. 2.1.1.1.1.1

              My point is the money does not disappear from the economy.

              So where is the detriment to the economy that higher prices for any particular good causes?

              1. 2.1.1.1.1.1.2

                So where is the detriment to the economy that higher prices for any particular good causes?

                I just told you. However, the problem is not just higher prices for any particular good, it’s prices that are artificially high because of economic rents. If more is being charged for a particular item because of monopoly pricing power, then fewer of them are being produced and sold, which means that fewer people are needed to make and sell them. At the end of the day, total incomes are equal to the total of what is produced and consumed. The behavior discussed here is directed to divvying up a pie in a way that’s particularly favorable to two entities, but that results in a smaller pie than what you’d otherwise have.

    1. 2.2

      (Not an economist)
      It probably says that efficiencies and profit may not always be aligned with the stated public policy of providing more cheaper meds faster in those cases where the branded med is covered by a less defensible patent.

      1. 2.2.1

        Query HOW the rate of discovery/research/testing/production of new medicines by Brand (who does all of the discovering/research/testing/production) in terms of “new molecule per unit time” are affected by imposition of inefficiencies and/or lost profit.

    2. 2.3

      Of course it’s in the best interest of these two firms to settle. But you’re talking about the efficiencies of divvying up a particular economic rent. Since the result that’s more beneficial to these particular companies is anti-competitive, it doesn’t promote overall efficiency, it decreases it.

    1. 1.1

      B’ness, Ned. But I’m not sure what complaint you mean here, that the generic approaches the brand with? (Or are you referring to an ANDA filing?)

      1. 1.1.1

        Sorry Ned, please disregard my question. I see you mean the ANDA filing and associated invalidity actions.

        It’s still “just business as usual” , though, right? Until they make such illegal per se under antitrust?

    2. 1.2

      No abuse of office or authority, no crime, no privacy violations or breach of implied relationship, so no extortion.

      Generic has every right to file the complaint, is offering Brand to make it more worth Generic’s while not to file. If it’s both more worth it to the Generic not to file, AND more worth it to the Brand to pay them not to file, then VALUE has been created.

      1. 1.2.1

        Anon2, whether they have a right to file suit or not is completely irrelevant. Under California statutory law, Generic has committed a crime of extortion.

          1. 1.2.1.1.1

            anon- thank you for the link.
            Ned – having read the Cali statute, I’m having trouble seeing how the description in Anon2’s post meets the definition of the crime.

            “…induced by a wrongful use of force or fear”

            What, specifically, makes it a “wrongful use” of force or fear? (Here are the sub-definitions for use of fear)

            519. Fear, such as will constitute extortion, may be induced by a
            threat, either:
            1. To do an unlawful injury to the person or property of the
            individual threatened or of a third person; or,
            2. To accuse the individual threatened, or a relative of his or
            her, or member of his or her family, of a crime; or,
            3. To expose, or to impute to him, her, or them a deformity,
            disgrace, or crime; or,
            4. To expose a secret affecting him, her, or them; or,
            5. To report his, her, or their immigration status or suspected
            immigration status.

            1. 1.2.1.1.1.1

              Consider Walker Process Equipment, Inc. v. Food Machinery & Chemical Corp., 382 U.S. 172, 86 S. Ct. 347, 15 L. Ed. 2d 247 (1965).

              The use of a patent that one knows to be invalid is patent misuse even if one never files suit.

              The ANDA is the flip. The threat to file a suit to invalidate a patent that is clearly invalid unless one pays money is wrongful in the same way.

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