The Department of Justice now recommends strict scrutiny of “reverse payments” – settlements of patent litigation lawsuits in which the plaintiff, a pioneer drug manufacturer, pays the defendant, a generic drug maker, and the generic drug maker agrees to stay out of the market for some or all of the remaining term of the patent. For legal context, see sidebar.

In its brief of July 6, 2009, the DOJ has proposed an antitrust standard that is neither fish nor fowl. It departs from the Federal Trade Commission’s view that such settlements are per se antitrust violations. Yet the DOJ also dissociates itself from judicial endorsement of reverse payments under a so-called rule of reason. Instead, it proposes a presumption of illegality that might be rebutted under a narrow set of circumstances. Such a standard is novel in antitrust jurisprudence.

The DOJ filed its brief with the Second Circuit Court of Appeals in the Ciprolitigation. In that case, consumer groups complained of a reverse-payment settlement in which Bayer paid nearly $350 million to Barr Laboratories to settle Barr’s patent challenge to Bayer’s drug, ciprofloxacin hydrochloride (Cipro). The Second Circuit had held, in a recent similar case–In re Tamoxifen — that reverse-payment settlements are not unlawful if they do not seek to expand the patent rights granted to the patentee.

In Cipro, the Second Circuit asked the DOJ to express its views on the matter, perhaps signaling second thoughts about its earlier reasoning. The DOJ offered the following perspective.

First, the DOJ observed that the patent laws present patentees with a risk when they seek to enjoin infringing activity: the risk that their patents may be found invalid, opening the field to all comers, not just the defendant in that particular case. The DOJ opined that reverse-payment settlements gain for the patentee the benefits of a favorable outcome, while eliminating the risk associated with fully litigating the case.

According to the DOJ, this result is contrary to a careful balancing of patent and antitrust policies embedded in prior statutes and case law, and deprives consumers of significant price competition in the pharmaceutical industry.

Second, the DOJ took issue with Tamoxifen’s reliance upon the statutory presumption of patent validity. It pointed to an FTC study showing that, in the context of Paragraph IV litigation, patent challenges have been successful nearly three-quarters of the time. In light of this track record, the DOJ believes that patentees who offer reverse-payment settlements should not have the full panoply of rights that a patentee who has litigated his patent to final judgment should have. (This stance of course would, paradoxically, leave greater settlement latitude only to those who do not settle.)

Finally, the DOJ proposed a new antitrust standard for reverse-payment settlements. Such settlements should be “presumptively unlawful,” unless there is evidence to justify the payment as reasonable. The DOJ suggested that it should be possible to determine both parties’ evaluations of the strength of their cases. In doing so, the DOJ distanced itself from a recommendation made in an earlier case, that the court conduct a “mini-trial” on the question of patent validity. Instead, the DOJ now recommends referring to the parties’ own internal evaluations of the case.

The DOJ suggests that the risk of patent invalidity should be expressed not in the form of a payment, but in the form of shortening the patentee’s period of exclusivity. Any payments to the generic drug maker should relate entirely to the value of avoided litigation costs (counting business disruption among those costs) and amounts necessary to “bridge the gap” between the parties’ differing views of the merits of the patent challenge. Parties should be given wide latitude in estimating the cost of litigation.

The DOJ also acknowledged that a settlement might be made in the context of a larger commercial arrangement, in which the defendant might receive legitimate consideration, such as by providing back-up manufacturing services. It is hard to reconcile the DOJ’s willingness to consider a payment for such services with its presumption that reverse payments are illegitimate, regardless of how they are characterized.

The DOJ’s stance eliminates one large problem set forth in its earlier position, but leaves new ones in its wake. Gone is the suggestion of a “mini-trial” on patent validity, to assess the strength or weakness of the patent, and thus the reasonableness of the patentee’s decision to pay the challenger.

Instead, the DOJ would review the internal evaluations of the parties. How this would be done without violating the attorney-client privilege or the work product immunity is not explained. Furthermore, while the DOJ states that it understands that patent litigation is an unpredictable process, its solution does not adequately take this into account.

Before the DOJ’s pronouncement, there were two competing viewpoints on reverse payments: one was that they are per se violations of the antitrust laws; and the other was that they are lawful, as long as the patentee does not seek to expand the scope of its patent rights. Both viewpoints have the virtue of clarity and simplicity. The DOJ perspective has neither.

Instead, the DOJ would have courts evaluate the reasonableness of reverse-payment settlements, but with a presumption of invalidity. If the Second Circuit takes up the DOJ’s proposed standard, it would be limited to the settlement of ANDA litigation. To avoid creating an entirely new strand of antitrust jurisprudence, the Second Circuit may decline to adopt the DOJ’s suggestion, leaving the construction of novel and detailed standards to Congress.

There are bills in committee that would ban reverse payments. These may become law, or perhaps a more nuanced treatment of this problem will come to light. One can conceive of amending the Hatch-Waxman Act to discourage reverse payments without banning them entirely.

The DOJ seems to believe that there is not sufficient motivation for a second ANDA challenger to emerge once the first lawsuit is settled because only the first ANDA challenger can benefit from the 180 day period of exclusivity, and because the patentee can, by paying off the first challenger, restart the 30-month period during which the FDA may not approve an ANDA.

To encourage second (and third) ANDA challengers in the wake of a reverse-payment settlement, the statute could provide that, if a reverse payment settlement terminates the first ANDA challenge, the 180-day period of exclusivity will be available to the next challenger. Perhaps, too, the 30-month period of delay could run from the first Paragraph IV challenger’s filing.

Consequences like these might make patentees think twice about paying off generic challengers. Such an approach would require Congress’s serious attention to this problem, which is long overdue.