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Following Actavis, California Supreme Court Crafts “Structured Rule of Reason” Test for Evaluating Pay-for-Delay Settlements

Last Thursday the Supreme Court of California decided In re Cipro Cases I & II, No. S198616 (Cal. May 7, 2015), holding that reverse payment, or “pay-for-delay,” settlements can be challenged as unreasonable restraints on trade.  In so doing, it followed the U.S. Supreme Court’s 2013 decision in Federal Trade Commission v. Actavis, Inc., 133 S.Ct. 2223 (2013).  But the California court went a step further.  It laid out a “structured rule of reason” test for assessing when pay-for-delay settlements are anticompetitive – an issue left open in Actavis.

Reverse payment settlements are used to dispose of challenges brought by would-be generic manufacturers against brand manufacturers who hold pharmaceutical patents.  Instead of fighting the suit, the patentee pays the generic manufacturer (sometimes in cash, often in other benefits) to drop the patent challenge.  In exchange, the generic manufacturer agrees that the patentee can continue marketing the brand drug for a period of time.  The patentee pays, and the generic manufacturer delays its attempted entry into the market.

The risk of these settlements is that a patentee may be using monopoly profits to avoid the risk that its patent will be held to be invalid or not infringed.  As the Cipro court observed, such settlements can “effectively establish a cartel,” where the interests of the patentee and the generic manufacturer “align in favor of maximizing their combined wealth by extending the monopoly for as long as possible.”

In Actavis, the U.S. Supreme Court held that the patent at issue in a reverse payment settlement cannot be presumed valid, leaving such agreements open to challenge under the Sherman Act.  The California Supreme Court embraced this logic in Cipro, holding that such settlements were subject to antitrust challenge under California’s Cartwright Act as well.

The Cipro court went further, crafting a “structured rule of reason” test for determining when a pay-for-delay suit imposed an unreasonable restraint on trade – a question the Supreme Court expressly left open.  Under this test, to make out a prima facie challenge to a reverse payment settlement, a third-party plaintiff must show:

(1) the settlement includes a limit on the settling generic challenger's entry into the market; (2) the settlement includes cash or equivalent financial consideration flowing from the brand to the generic challenger; and the consideration exceeds (3) the value of goods and services other than any delay in market entry provided by the generic challenger to the brand, as well as (4) the brand‘s expected remaining litigation costs absent settlement.

The plaintiff bears the burden of proof on each of these elements, particularly in showing that the payment from the patentee exceeds the sum of “(3) the value … provided by the generic challenger” and “(4) the brand’s expected litigation costs.”

Defendants bear the burden, however, to produce evidence showing the value of these third and fourth elements.  If they fail to do so, the plaintiff is entitled to an assumption that their combined value is exceeded by the patentee’s payment.

Notably absent from this prima facie case is any required showing that a patent is invalid.  “Agreements must be assessed as of the time they are made …, at which point the patent‘s validity is unknown and unknowable.”  The question is one of math, not validity.

In theory, defendants can rebut Cipro’s prima facie case by showing “legitimate justifications and … evidence that the challenged settlement is in fact procompetitive.”  The court did not rule out the possibility that a defendant could make such a showing, stating that the “theoretical possibility that a settlement in excess of litigation costs and collateral services could be procompetitive … is nevertheless sufficient for us to reject a categorical rule.”   But the court expressed skepticism that a defendant would carry this burden, making clear that not just “any justification will do.”

It will be interesting to see if any defendant is ever able to successfully rebut a prima facie case, or whether the plaintiff’s showing will effectively be dispositive.  We will also watch to see if other courts, particularly federal ones, follow Cipro’s “structured rule of reason” framework in filling in the gaps left by Actavis.

The Cipro decision is available here.