The Economics of Pay To Delay Deals

(by Farasat Bokhari) On Friday 12 Februrary 2016, the UK’s Competition and Markets Authority (CMA) issued drug manufacturer GlaxoSmithKline (GSK) a £37.6 million fine with an additional £7.4 million imposed on partner drug manufacturers for engaging in a so-called ‘pay for delay’ or ‘pay to delay’ deal that lasted from 2001 to 2004 for its antidepressant drug Seroxat. As discussed in a recent blog by my colleague, Sven Gallasch, GSK have not admitted wrongdoing and may challenge the findings by arguing the arrangement was pro-competitive. Between 2000 and 2010 there were 57 pay to delay deals in the EU, and 66 just between 2008 and 2010 in the US. The US Federal Trade Commission (FTC) says these deals cost US consumers $3.5 billion a year, but have attempted to challenge them with mixed results.[i] Pay to delay cases are relatively new in Europe and the GSK case is the first fine for the practice to be imposed by the CMA.

This blog discusses some of the key issues and incentives surrounding pay to delay deals and is aimed at stimulating further discussion.

A branded drug manufacturer with an active patent has a right to market exclusivity for a number of years, but this can be challenged by generic drug manufacturers who wish to question the validity of a patent and enter the market. A pay to delay deal, also known as a reverse payment, is where the branded firm settles with the generic by paying it to acknowledge the validity of the patent and to stay out of the market for a number of years. In addition to this payment, the generic firm may also gain an authorized entry under license from the branded firm into the market at a later date but before the patent expiration itself.

As such, patented drugs are protected by laws that allow their manufacturers to market their product as a monopolist for up to 20 years from the grant of the initial patent. This monopoly helps the innovator to recover research and development costs and incentivizes them to undertake additional risky projects. To give a sense of costs and risks involved, the development and clinical trials process can easily take seven to ten years of the patent life, and – accounting for all the failed drugs that do not reach the market – the average cost of a new drug can be $800 million.[ii]  Thus, it is important that we try to protect innovation via patent laws.

On the flip side, not all patents that protect a drug against market competition are necessarily that innovative – either in terms of prior science or because their innovative step is too modest. If the patent is not valid, we would not want the branded firm to have exclusivity, but challenging the validity of a patent is not straightforward, which is why the patent holder will sue the generic manufacturer even where the patent is weak.

Generic companies can challenge the patent by contesting its validity or by arguing that their generic version is not violating the patent. If successful at defending against litigation, the generic manufacturers can gain entry and prices can drop significantly – sometimes up to 70% of the original branded price soon after generic entry takes place. In fact, in the US, generic manufacturers are incentivized via a clause in the Hatch-Waxman Act of 1984, known as the “para 4 challenge”, which states that the first generic to successfully challenge a patent is to be granted a six-month exclusivity period; i.e., if you challenge a patent and win, no other generic will be allowed to enter the market for another six months from the entry date of the of the winning generic firm.

The branded firm can prevent this through a pay to delay deal: a pay off to the generic firm to drop the patent challenge and stay out of the market and, in return for withdrawing the challenge, the generic firm receives a payment and/or an authorized licensed entry for a later date, but before the expiration of the patent itself. Apart from preventing entry by the generic challenger, these deals prevent the validity of the patent from being fully scrutinised by the court. This would be desirable, as a finding of an invalid patent would encourage other generics to enter the market and cause prices to drop. It is for this reason that pay to delay deals can violate Antitrust laws in the US and the EU and are subject to increasing scrutiny by competition authorities.

Based on the reasoning that a settlement should leave consumers at least as well off as the ongoing patent litigation, several authors have argued that pay to delay settlements should carry the presumption of per se anticompetitive behaviour. Others have argued that as long as the settlement does not exceed the original period/scope of the patent, such a reverse payment should not be per se illegal and, in fact, may even be pro-competitive given the complex nature of such deals. In the US, the legality issue eventually reached the Supreme Court and in a 5-3 split decision in Federal Trade Commission v. Actavis, Inc. (2013), the Court found that such settlements were not presumptively illegal per se. However, it also favoured the “rule of reason” approach and reversed an earlier decision by the Eleventh Circuit, which had upheld the pay to delay agreement involving Actavis as legal and restricted the application of antitrust law under the “scope of the patent test”.

To consider policy options regarding pay to delay deals, one has to begin by considering why such deals are stable in the first place: if the originator is paying a generic firm to avoid a challenge to the patent, how much do they have to pay and why do other generic challengers not grab the opportunity to also get paid off? And if indeed this is possible, then how is the initial deal profitable for the branded firm if there is a very large number of potential generics each looking for a pay off? In a recent paper, my colleagues and I investigate this issue and specify conditions under which a branded firm needs to pay off just one or a handful of generic challengers so that the remaining choose to stay out of the market.[iii] In particular, we show that if there is a large first mover advantage in the generic segment of the market, then the branded firm can credibly threaten to launch an authorized generic via one of the firms it has already reached a pay to delay deal with. In this case, the remaining generic firms will choose not to challenge the patent validity and the initial pay to delay deal will be profitable for the parties involved. This is because if the branded firm can launch an authorized generic, it deprives the potential entrant of the large profit associated with first entry, and so if the expected profit becomes smaller than the litigation costs, the later challengers will choose to stay out.

Our work suggests that changing the law where a generic is no longer awarded a six-month exclusivity is not necessarily going to solve the problem of pay-to-delay deals in the US. In fact, this reform proposed in the US Congress may make things worse, since it takes away the incentives to challenge weak patents. Instead, other policy options – particularly those targeting a patent holder’s ability to launch an authorized or pseudo generic against a winning challenger – are much more promising for both the US and EU in terms of removing the possibility of pay to delay deals when the underlying patent is weak.

[i] See (1) FTC, “Pay-for-delay: How drug company pay-offs cost consumers billions,” An FTC Staff Study Washington, D.C. January 2010; (2) FTC, Agreements Filed with the Federal Trade Commission under the Medicare Prescription Drug, Improvement, and Modernization Act of 2003: Summary of Agreements Filed in FY 2010”, A Report by the Bureau of Competition Washington, D.C. May 2011; (3) EU, “3rd Report on the Monitoring of Patent Settlements,” European Commission (Directorates General, Competition) Brussels, Belgium July 2012.

[ii] The figure has recently been updated to $2.6 billion. See Grabowski, Vernon and DiMasi (2002). “Returns on research and development for 1990s new drug introductions”, PharmacoEconomics, 20, pp.11-29.

[iii] Copy available on the working papers page of the CCP website. See Bokhari, Mariuzzo & Polanski, (2015), “Entry limiting agreements for pharmaceuticals: pay-to-delay and authorized generic deals“, CCP Working Paper 15-5.

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