Reverse payment settlements in the European Union after the Generics (UK) judgment – perplexing legal uncertainty

On January 30th, the Court of Justice (“the Court”) released its judgment in the Generics (UK) case. In a preliminary ruling procedure, the UK Competition Appeal Tribunal asked the Court to provide guidance on how to interpret Article 101 TFEU with regard to patent settlements between pharmaceutical companies. The judgment has considerable legal significance as it represents the very first judgment by the highest judicature of the European Union in so-called ‘reverse payment settlement’ cases (also referred to as ‘pay-for-delay agreements’).

In short, a reverse payment settlement occurs when an originator (or the patentee), the party holding the patent, pays a generic pharmaceutical company for refraining from challenging its patent(s) and thus, delaying its market access or not entering the relevant market in the first place. Therefore, in a reverse payment settlement, the patentee remunerates the potential infringer of the patent rather than the inverse. The concept of ‘reverse payment settlements’ involves a patented drug or, more precisely, an active pharmaceutical ingredient (which are protected by compound patents) and/or a specific process for its manufacture (which are protected by process patents), the patentee and a generic producer of pharmaceutical goods.

The aim of this blog post is to discuss whether reverse payment settlements should be regarded as restrictions of competition ‘by object’. Particular focus will be put on the transfer of value from an originator to a generic, as the amount of value transferred seems to play a decisive role in ironing out anti-competitive patent settlements from the legitimate ones. Thus, this blog post will focus on whether the legal framework as set forth by the Court has become too unpredictable as there seems to be no clear guidelines on how much originators are allowed to remunerate generics and further, whether the Court has focused on the right aspects of reverse payment settlements.

Restriction of competition ‘by object’

In the Generics (UK) case, the question was whether an agreement between an originator and a generic could be considered as a restriction of competition ‘by object’, when during the lifespan of the agreement, the generics agreed (i) not to enter the market, and not to manufacture and/or import the generic medicines manufactured under the patent at issue, and not to persist in their litigation against that patent, (ii) to the conclusion of a distribution agreement enabling them to enter the market with a limited quantity of the relevant generic medicine produced by the originator, and (iii) to receive payments from the originator which were significantly higher than the costs of litigation avoided and which do not constitute payment for goods or services supplied by the generics to the originator (para 75).

Undoubtedly, the focus of the judgment with respect to ‘by object’ restrictions must be on the findings regarding the transfer of value from the originator to the generics. The Court asserted that “a characterisation as a ‘restriction by object’ must be adopted when it is plain from the analysis of the settlement agreement concerned that the transfers of value provided for by it cannot have any explanation other than the commercial interest of both the holder of the patent and the party allegedly infringing the patent not to engage in competition on the merits” (para 87). Although the originator may demonstrate overwhelming pro-competitive effects of such agreements as a defence, the Court missed the opportunity to provide any guidance on what these may be.

When assessing whether a value transfer ‘can have no explanation other than the commercial interests of the parties’, one must assess (i) all transfers of value between the parties (pecuniary and non-pecuniary), (ii) whether the net gain of the value transfer may be justified by legitimate and proven quid pro quo or waivers, and (iii) whether the net gain is a sufficiently large incentive for the generics to refrain from entering the market (paras 90, 92 and 93). Moreover, in such an assessment the scope or duration of a patent is irrelevant as, even when an agreement is strictly within the scope of a patent, that intellectual property right does not give its holder the right to enter into contracts that violate Article 101 TFEU (para 97).

Analysis

It is of fundamental importance to begin by briefly discussing the relationship between competition law and intellectual property rights. In particular, with regard to the pharmaceutical sector and reverse payment settlements, it must be emphasised that both competition law and the system of intellectual property rights promote innovation by design. For the system of intellectual property rights this is more obvious as the whole concept is based on rewarding innovation by granting novel utilities or designs legal protection from competition. Competition law also aims to promote innovation: consumers benefit from competition when it leads to new or better products and more affordable prices, none of which materialises without innovative market players.

By asserting that a ‘restriction by object’ must be found when it is plain from the analysis of the settlement agreement concerned that the transfers of value provided for by it cannot have any explanation other than the commercial interest of both the holder of the patent and the party allegedly infringing the patent not to engage in competition on the merits, the Court is creating a somewhat legally uncertain test by not providing any purposeful guidance on the allowed limits of such value transfers. This lack of clarity is exacerbated as such assessments require all transfers of value between the parties (pecuniary and non-pecuniary) to be taken into consideration to conclude whether the net gain is a sufficient incentive for the generics to refrain from entering the market. In practice, the enforcing competition authorities/courts/tribunals and the involved undertakings may have vastly differing theories on what constitutes a sufficient incentive for refraining from participating in the market.

‘Competition on the merits’ – will the Court ever clear it up?

The concept of ‘competition on the merits’ has been predominantly used in the Court’s case-law with regard to Article 102 TFEU cases, not Article 101 TFEU cases. This concept has never been given a conclusive definition. Still, from an abundance of case-law, we know that, for instance, using regulatory procedures in a misleading way to hamper with the entry of competitors on the market and “adopting pricing practices that have an exclusionary effect on competitors considered to be as efficient as it is itself” have been found not competing on the merits. Therefore, it may be concluded from the case-law that it not only covers activities that are strictly unlawful, but also those that may be considered nefarious.

The notion of ‘competition on the merits’ has been criticised by many for its ambiguity (to name some, see an article by Damien Geradin and an OECD Policy Brief). The Generics (UK) judgment gives no explanation whatsoever as to this definition in reverse payment settlement cases. Despite already being a vague concept, the authors argue that the Court has gone further in the wrong direction in the case at hand, by assessing that competition without merit may only be found where the only explanation for is the commercial interest of both the holder of the patent and the party allegedly infringing the patent. This is particularly so as for any potential agreement between an originator and a generic, only commercial interests will play a decisive role. Such parties will never agree to an agreement which is commercially less beneficial for them than a more lucrative, alternative solution if one is available. In light of the duration and costs related to the development of new medicine, defining the commercially most lucrative option at any given time before or during patent litigation requires detailed and comprehensive economic and strategic risk-benefit market analysis, the conduction of which the parties should play a decisive role for reasons of legal certainty and rights of defence. Such an analysis may also entail market-specific investigations in order to understand certain factors leading to the parties’ desire to settle.

A sufficient incentive for the generics to refrain from entering the market

With regard to what constitutes a sufficient incentive for the generics to refrain from entering the market, the Court simply asserts that “taking into account the uncertainty as to the outcome of those proceedings, there is no requirement that the transfers of value should necessarily be greater than the profits which the manufacturer of generic medicines would have received from a successful outcome by following through with the patent proceedings. The sole test applied by the Court is that of the value of the transfer being shown to be sufficiently beneficial to encourage the manufacturer of generic medicines to refrain from entering the market concerned and not to compete on the merits with the manufacturer of originator medicines concerned.” (para 94)

Earlier in the judgment, the Court emphasised that value transfers in reverse payment settlements may be justified, in particular, when the sums correspond to compensation for the costs of or disruption caused by the litigation between the parties, or to remuneration for actual supply of goods or services from a generic to an originator (para 86). It can thus be deduced that the red line for pharmaceuticals is somewhere between the actual costs of litigation and the potential profits a generic is expected to make upon successful market entry.

On the one hand, this seems to give the Commission a considerable amount of leeway when enforcing reverse payment settlements. On the other hand, this constitutes a rather large grey area for the pharmaceuticals in which they will feel comfortable to operate. The Court fails to provide any clear indication as to the extent (if any) originators are indeed allowed to compensate generics beyond mere litigation costs. This is problematic especially in light of the costs, time and risk involved in the development of new medicine as originators may be inclined to settle even if they believe that they have a strong chance of succeeding in the litigation process, and a generic in turn may wish to settle due to a multitude of reasons, such as lack of belief in the litigation process or the need to concentrate funds and efforts elsewhere.

Moreover, it is the authors’ opinion that the Commission/national competition authorities may not be in the best, or even a suitable position to analyse what constitutes a sufficient incentive for a private company to settle a patent dispute. To avoid legal hazards in which companies are being fined for allegedly anticompetitive behaviour, which in reality is completely legitimate, or situations where companies escape the clout of competition rules due to a failed assessment of what is a sufficient incentive, it would be in the best interest of all concerned parties that the Court provide for more detailed analysis in this respect.

Alternative solutions

In the authors’ opinion, the most problematic aspect of a reverse payment settlement is not the payment alone, but the continuous absence of competition combined with the uncertainty related to the validity of a patent – both of factors which the Court fails to assess. Even so, the authors’ do not necessarily advocate strongly for a less nor more restrictive test to be introduced by the Court, but rather for one that sets a clear legal framework.

In the authors’ opinion, this could be achieved for instance by setting a more restrictive test in which any payment combined with a direct or indirect market exclusion clause would be considered a restriction of competition ‘by object’. This would inevitably result in more cases for the Commission and national competition authorities to assess, but also greater legal certainty for pharmaceuticals. Moreover, such practice is already being utilised in California. As per Californian law on Preserving Access to Affordable Drugs (AB-824), when “anything of value” is transferred from an originator to a generic, combined with a market exclusion clause, there is a presumption of anticompetitive effect.

Alternatively, greater legal certainty could be achieved by introducing a less restrictive test, in which the Court would provide for more detailed guidance on where precisely the limits lie. In this instance, such guidance would need to take into consideration the commercial aspirations of the concerned undertakings, who may very well be willing to commit to/accept large value transfers and still be competing on the merits.

A new type of restrictions of competition ‘by object’?

The divide between ‘by object’ and ‘by effect’ is central for reverse payment settlement cases. The Court has long held that the decisive factor in finding a restriction of competition ‘by object’ is that such an agreement reveals in itself a sufficient degree of harm to competition.  Arguably classic examples of restrictions ‘by object’, such as cases of horizontal price fixing, market sharing and exchange of commercially sensitive information reveal in themselves a great deal of harm to competition without going into great detail as to how significantly the prices have increased or what types of effects on the market these practices have led to. However, it is the authors’ opinion that the same does not apply to reverse payment settlements: under the current legal framework reverse payment settlements do not fit squarely within the traditional box of ‘restrictions by object’ as seemingly they do not reveal in themselves a sufficient degree of harm to competition, but require rather detailed analysis. Furthermore, settling disputes out of court is, after all, a legitimate and legal way of conducting business. Therefore, the Generics (UK) judgment seems to support a new divide between restrictions ‘by object’, namely (i) traditional restrictions ‘by object’ which reveal a great deal of harm to competition without carrying out a detailed assessment, and (ii) restrictions ‘by object’ which are found undoubtedly harmful to competition after an in-depth assessment of their legal and economic context and effects.

Conclusion

The Court has not introduced any meaningful definition for what constitutes an unlawful reverse payment settlement, thereby offering pharmaceutical companies nothing but legal uncertainty for their future endeavours with regard to patent litigation. If all the other facts of a case remain the same except for the amount of value being transferred from an originator to a generic, how can a restriction ‘by object’ be found only when that amount of value transferred exceeds a certain, largely ambiguous level? Is it not true that regardless of the size of the value transfer, the most contentious aspects of reverse payment settlements, which are the continued absence of competition and the ambivalence surrounded by the patent, still persist?

At the time of publishing, one of the authors, Tommi Lahtinen, was a Blue Book Trainee at the European Commission. This blog post has been written in a personal capacity. The views expressed are purely those of the writer and may not in any circumstances be regarded as stating an official position of the European Commission.

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Tommi Lahtinen

Tommi Lahtinen has studied at Tallinn University (LL.B.) and Leiden Law School (LL.M.). He has completed an internship with Stek’s Competition and Regulated Markets team in Amsterdam and is currently working as a Blue Book Trainee (DG COMP, B.4 – Mergers) at European Commission.

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