Patent settlements: Ban or maybe tax instead?

The White House wants to ban settlements in patent litigation between brand name and generic pharmaceutical companies. These settlements occur when a generic company sues a company whose drug is on patent, challenging its validity. Sometimes the companies agree to settle, which typically results in some combination of a cash settlement and early introduction of the generic product. Since generics are typically priced lower than their branded counterparts, purchasers of the drugs such as health plans, consumers, and the government save money when a generic arrives on the market sooner. However, if the settlement just results in cash being paid from one party to the other, the benefits go to the companies and not the public.

Historically this had been a major area of abuse. About 15 years ago I saw the financial statements of a generic company that made much more profit by suing brand name companies than it did by actually making products. A freelance patent lawyer had a deal with the generics company whereby he pocketed millions a year in settlements. His alignment with the generic company allowed him to pose a credible threat when suing the brand name players. Those brand name companies quite willingly settled for millions to keep generics at bay. The most egregious abuses were ended as part of the 2003 Medicare Modernization Act (MMA), which gives the Federal Trade Commission (FTC) and Justice Department the opportunity to review individual settlements for anti-competitive elements.

Still, the FTC and Congressional Budget Office project that eliminating settlements could save the federal government at least a few billion dollars over the next decade, which is why the White House is pushing it. Both PhRMA (which represents branded companies) and GPhA (which represents branded companies) oppose this move and their arguments are fairly similar. That alone tells you there is likely to be something to the proposal. GPhA’s main points are:

  • Generic companies have won many patent challenges; few of the cases result in settlements
  • Settlements help bring products to market faster (although it may seem “counterintuitive”)

GPhA’s points are fairly straightforward and it’s easy to understand why they’re in favor. Certain of PhRMA’s arguments are a little harder to parse:

  • “Patent settlements are a vital aspect of the ability to protect intellectual property. PhRMA believes including the provision on restricting patent settlements can discourage pro-consumer settlements that often bring generics to market years before patent expiration.”
  • “PhRMA continues to believe that legislation that would impose a blanket ban on certain types of patent settlements or otherwise prevent them could decrease the value of patents and reduce incentives for future innovation of new medicines.”
  • “Settlements resolve costly and time-consuming patent litigation and often allow the generic version of a medicine to enter the market before the patent is due to expire. Basic economics shows us that this can help increase competition between brand-name and generic companies, lower costs for American consumers and increase access and choice for patients.”

It’s unclear why PhRMA would want to “bring generics to market years before patent expiration.” It’s a little unclear why bans would reduce innovation. And I don’t see why PhRMA is in favor of more competition.

From what I can tell, the reason both GPhA and PhRMA oppose bans on settlements is that the current system –even restricted as it is by MMA– still provides brand name and pharmaceutical companies a cozy little sandbox to play in. They can amicably agree on how to divide economic value for themselves while withholding that value from their customers. If settlements weren’t allowed it would mean certain deals never got done (leaving value on the table for both sides), and that litigation would transfer more value to attorneys and create also create uncertainty, lowering the value of the companies.

Here’s another solution: allow settlements to continue as is, at least for settlements where the outcome is a specific date for a generic drug to go on the market rather than a cash payment. For settlements that involve a cash component, place a large excise tax (something between one-third and two-thirds of the settlement amount) on the agreement. This solution will preserve the value of a settlement option, i.e., limiting attorney fees and reducing uncertainty, while allowing the customers to get some of the benefits of cash changing hands and increase the likelihood that the settlement will involve early introduction of a generic. It might result in somewhat less litigation –by reducing the expected payout– but if there’s a strong case to be made it should still move forward.

February 15, 2011

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