Economic Analysis of Pay-for-Delay Settlements and Their Legal Ruling

Abstract

In this paper, we ask whether courts should continue to rule settlements in the context of pharmaceutical claims per se legal, when these settlements comprise payments from originator to generic companies, potentially delaying generic entry compared to the underlying litigation. Within a theoretical framework we compare consumer welfare under the rule of per se legality with that under alternative standards. We find that the rule of per se legality induces maximal collusion among settling companies. In comparison, the rule of per se illegality entirely prevents collusion and the rule of reason induces limited collusion when antitrust enforcement is subject to error. Contrary to intuition, limited collusion can be welfare enhancing as it increases companies' expected settlement profits and thus fosters generic entry. Generic companies obtain additional incentives to challenge probabilistic patents, which potentially leads to overall increased competition. We further show that generic entry is fostered more effectively by inducing limited collusion than by rewarding first generic entrants with an exclusivity right.

Optimal Incentives for Patent Challenges in the Pharmaceutical Industry

“…This at first is bad for consumers but results in higher settlement profits for the parties and higher challenging incentives overcompensating the negative effect. Gratz 2012 crucial assumption is that under a rule of reason regime courts make errors in assessing whether settlement agreements violate competition rules. An important implication from her model is, that firm's profits from entering into a settlement agreement and also their incentive to challenge patents increase in case the error interval increases as well.…”

“…Our model follows the general framework introduced by Gratz (2012 and enter the market are based on the rationale if the generated net profits from such a patent challenge, respecting challenge costs, are larger than zero. The firm's profits from a settlement consist of an even share of the settlement surplus, which is the additional profit compared to litigation, as well as the profits the firm can reap from ongoing litigation.…”

Patent Settlements in the Pharmaceutical Industry: What Can We Learn from Economic Analysis?

“…The structure of their model is partly based upon the model of Gratz (2012), who was the first to offer an integrated analysis of price and challenging incentive effects. In both models there are originator firms with patents of different strengths (0 ≤ θ ≤ 1) and two generic firms that can challenge patents (with fixed challenging costs) and enter sequentially the market at different future dates.…”

“…However, Gratz (2012) The policy conclusions that can be drawn from a specific economic model are always limited. We would not recommend that based upon the results of such a model competition authorities or the courts should allow for a specific additional period of collusion between originators and generics (and accept also the additional reverse payments).…”

“…that patent settlements with reverse payments might harm consumers through the delay of generic entry. However, relevant for consumer welfare are also the effects of patent settlements on innovation incentives (section 5) and the incentives for generics to challenge potentially invalid patents (section 5 Balto 2000, Crane 2002, Morse 2002, Janis/Hovenkamp/Lemley 2003, McDonald 2003, Bulow 2004, Leffler/Leffler 2004, Hemphill 2006, Ponsoldt/Ehrenclou 2006, Holman 2007, Leary 2007, Davis 2009, Carrier 2009, Brankin 2010, Gratz 2012, Edlin et al 2013, Piecht 2013, Carrier 2014b, Cotter 2014, Feldman 2014. 6 Hemphill 2006, p. 121, Dickey/Orszag/Tyson 2010, p. 375, Brankin 2010, p. 23, Addanki/Butler 2014 See, e.g., the "Actavis inference" as the most recent variant (Edlin et al 2015 Schildkraut 2004, Hemphill 2006, Carrier 2009, Davis 2009, Kobayashi et al 2015, Edlin et al 2015 Shapiro 2003, Lemley/Shapiro 2005, Farrell/Shapiro 2008, Encaoua/Lefouili 2009 Please note that this is a general paper about patent settlements in the pharmaceutical industry.…”