Judge Richard Posner of the 7th Circuit Court of Appeals, who has lately emerged as a persuasive critic of the U.S. patent system, believes patents are stifling innovation in this country, conferring unwarranted power on inventors who spend very little money to develop their creations. The one industry Posner exempts from this general rule is the brand-name pharmaceutical business, which he described in The Atlantic as "the poster child for the patent system." He gave three reasons why drug companies need patent protection: New drugs cost millions of dollars to develop; drug makers don't get to earn money from their inventions for the entire life of the patent because it takes years of post-patent testing to bring a new product to market; and it's cheap to copy drugs once someone else has invested heavily in developing them. Without patents, Posner wrote, drug developers would never recoup their costs.

Posner, however, has never had to decide a pay-for-delay case, which pits the interests of brand-name drugmakers against the interests of consumers who want to pay less for generic medications. On Monday, the 3rd Circuit Court of Appeals issued a shocker of a ruling in a pay-for-delay case against Schering-Plough (now owned by Merck). The three-judge appellate panel split with three other federal circuits and held that when a brand-name drug manufacturer pays a generic rival to drop its challenge to the brand-name drug patent, the settlement is prima facie evidence of an illegal restraint of trade. The decision throws down the gauntlet on the legality of pay-for-delay settlements, increasing the likelihood that the U.S. Supreme Court will have to take up the issue.

The controversy over pay-for-delay pharma settlements has been simmering for decades, since Congress attempted to balance the needs of brand-name drug manufacturers with the needs of consumers, who want access to cheaper generics, in the Hatch-Waxman Act of 1984. Hatch-Waxman established a regulatory framework for generics to bring their products to the market by filing new drug applications with the Food and Drug Administration, then litigating with brand manufacturers over the validity of brand-name patents. But lawmakers were quickly outsmarted by drug companies, which realized they could prolong their monopolies by paying generics to drop litigation over the validity of their patents. According to the Federal Trade Commission, which has spent years fulminating about these so-called "reverse payment" or pay-for-delay settlements, the deals cost American consumers something like $3.5 billion a year.

And one of the worst things about pay-for-delay settlements, in the eyes of the FTC, is that they have the blessing of the federal judiciary. After a couple of early rulings in which federal circuit courts called pay-for-delay settlements an illegal restraint of trade, the 2nd Circuit Court of Appeals, in a landmark 2004 opinion called In re Tamoxifen Citrate Antitrust Litigation, said reverse-payment deals do not violate antitrust laws. The 2nd Circuit set forth what has become known as the "scope of the patent" test, holding that such settlements are not anticompetitive as long as they don't block generics from entering the market after the brand-name manufacturer's patent rights expire (and as long as the patent wasn't fraudulently obtained). The FTC and antitrust plaintiffs fought in vain for a reversal of the Tamoxifen ruling, including an unsuccessful petition for certiorari at the U.S. Supreme Court. Instead, the 2nd Circuit confirmed the scope-of-the-patent test in a subsequent pay-for-delay antitrust case, this one involving the antibiotic Cipro. The Federal and 11th circuits, meanwhile, adopted the same scope-of-the-patent reasoning.

One of the 11th Circuit rulings upholding the legality of a pay-for-delay deal came in the FTC's challenge to settlements Schering-Plough reached with two generic manufacturers that filed applications to make versions of the drug K-Dur, a potassium chloride supplement used to treat side effects from blood pressure medication. The FTC claimed the settlements were an illegal restraint of trade that improperly preserved Schering's monopoly on the drug. In 2005, the 11th Circuit reversed the agency, holding that the agreements were permissible because they didn't exceed the scope of Schering's patent.

That wasn't the end of Schering's K-Dur litigation, however. Several pharmacies and a class of purchasers of the drug had also filed antitrust suits, asserting that they were forced to pay brand-name prices because Schering paid the generics to keep their equivalent products off the market. U.S. District Judge Garrett Brown of New Jersey tossed their cases under the scope-of-the-patent test. The individual pharmacies (represented by Hangley, Aronchick, Segal & Pudlin and Kenny Nachwalter) and the direct purchaser class (represented by Garwin Gerstein & Fisher and Berger & Montague) appealed to the 3rd Circuit.

The appeal drew considerable attention from amici, including the U.S. Justice Department and the FTC, which filed separate briefs supporting the antitrust plaintiffs. At oral argument on Dec. 12, Deputy Solicitor General Malcolm Stewart argued for the government. Steve Shadowen, then of Hangley, Aronchick, and David Sorenson of Berger & Montague argued for the plaintiffs; John Nields of Covington & Burling argued for Merck, which was also represented by Baker Botts and McCarter & English.

Monday's ruling, written by 3rd Circuit Judge Dolores Sloviter for a panel that also included Judge Thomas Vanaskie and U.S. District Judge Lawrence Stengel, sitting by designation, was a blockbuster. "After consideration of the arguments of counsel, the conflicting decisions in the other circuits ... and our own reading, we cannot agree with those courts that apply the scope of the patent test," the opinion said. "In our view, that test improperly restricts the application of antitrust law and is contrary to the policies underlying the Hatch-Waxman Act and a long line of Supreme Court precedent on patent litigation and competition."

The other federal circuits, the 3rd Circuit said, created an "almost unrebuttable presumption of patent validity" when they said it was permissible for brand manufacturers to pay generics to drop patent challenges. Reverse-payment deals, according to the 3rd Circuit, permit even weak patents to confer monopoly rights, which is contrary to public policy. "Reverse payments permit the sharing of monopoly rents between would-be competitors without any assurance that the underlying patent is valid," the decision said. "While such a rule might be good policy from the perspective of name brand and generic pharmaceutical producers, it is bad policy from the perspective of the consumer, precisely the constituency Congress was seeking to protect."

Instead of presuming that reverse-payment deals are legitimate, the 3rd Circuit said, courts should hold that they're an unreasonable restraint of trade. That would shift the burden of proof to the defendants to show that the payment to a patent challenger wasn't to delay the generic drug from entering the market or that it served a competitive benefit.

That's a titanic change from the state of the law under the scope-of-the-patent test endorsed by the 2nd, 11th, and Federal circuits. "It's a very significant opinion," said co-lead class counsel Barry Refsin of Hangley, Aronchick, who said the 3rd Circuit "applied general antitrust principles." Refsin said the next move in the case is up to Merck, which can seek a rehearing en banc from the entire 3rd Circuit or ask the Supreme Court to take the case. (I left a phone message requesting comment with Merck counsel Nields of Covington but didn't hear back.)

Antitrust lawyer Joseph Saveri of the Joseph Saveri Law Firm, who has a pay-for-delay case before the California Supreme Court, said the 3rd Circuit's decision can only help plaintiffs in other jurisdictions. "This decision lines up very well with arguments we've been making," he said. "The court said a reverse payment is evidence of anticompetitive behavior." Will the split among federal circuits end up at the Supreme Court? "There's certainly a Supreme Court issue here," Saveri said.

(Reporting by Alison Frankel)

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