Abstract
We distinguish standard settlements, in which the status quo is preserved, and injunctive settlements, which prohibit the defendant’s activity. The reverse (payment) settlement is a special type of injunctive settlement. We examine the divergence between private and social incentives to settle and policies that would minimize socially undesirable injunctive and reverse settlements (e.g., banning reverse settlements). The results are applied to competition-blocking litigation, such as patent infringement and antidumping.
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Notes
Favoring legality: In re Tamoxifen Citrate Antitrust Litig., 466 F.3d 187, 190 (2d Cir. 2006) (refusing to impose antitrust liability where generic accepted payment in exchange for agreement to delay entry); Schering-Plough Corp. v. FTC, 402 F.3d 1056, 1076 (11th Cir. 2005) (same); In re Ciprofloxacin Hydrochloride Antitrust Litig., No. 08-1097 (Fed. Cir. Oct. 15, 2008) (same), available at http://www.cafc.uscourts.gov/opinions/08-1097.pdf. Opposing legality: In re Cardizem CD Antitrust Litig., 332 F.3d 896, 908 (6th Cir. 2003) (finding per se antitrust violation in agreement to delay generic entry); Andrx Pharm., Inc., v. Biovail Corp. Int’l, 256 F.3d 799 (D.C. Cir. 2001) (same).
The model of settlement applied here is from Hylton and Cho (2010).
This conclusion is in opposition to that taken by the FTC in federal court litigation and of several commentators, see Crane (2002), Cotter (2004), Hovenkamp et al. (2003), and Hemphill (2006). In addition, the European Commission has issued a report on patent practices, including settlements, that suggests the possibility of legal action against major pharmaceutical companies that have entered into reverse settlement agreements with generic sellers, see http://europa.eu/rapid/pressReleasesAction.do?reference=MEMO/08/746&format=HTML&aged=0&language=EN&guiLanguage=en. On February 3d, 2009, US senators Herb Kohl and Chuck Grassley introduced legislation to ban reverse patent settlements in pharmaceutical patent disputes, see http://kohl.senate.gov/press/09/02/2009203B19.html.
This is an admittedly simple version of competition between an incumbent and a generic seller. In many instances the generic entrant sells to price-sensitive consumers while the incumbent sells to brand-loyal consumers. As a result, the entry of a generic is sometimes followed with a price increase by the incumbent seller, see Blair and Cotter (2002).
On the Byrd Amendment, see “Byrd’s Bad Idea is Back, Wall Street Journal, Opinion Section, Monday, August 11, 2008, at A14. Although repealed in 2005, there have been efforts to reenact the Byrd Amendment”.
This follows from P p (G p + D) − C p < P d (L d + D) + C d . This assumes that the probability of an injunction is the same as the probability of an award of damages. That may not be valid in all cases. To keep the model simple, we will stick with this assumption. The results are easily changed for the case in which the probabilities differ.
The current antidumping statute permits domestic producers to petition relevant government agencies to investigate alleged dumping practices by foreign producers. 19 U.S.C. § 1673a(b)(1).
19 U.S.C. § 1673b(b).
Petitioners can expect the government to absorb most of the litigation costs under the statutory proceeding, see Calvani and Tritell (1986).
An antidumping proceeding imposes enormous costs on the defendants, see Music Centers S.N.C. Di Luciano Pisoni & C. v. Prestini Musical Instruments Corp, 874 F.Supp. 543, 547 (1995). Therefore, an antidumping petition itself can be a very effective method of non-price predation against small yet efficient foreign producers. The existence of such non-price predation tends to facilitate an injunctive settlement between antidumping petitioners and respondents. Cho (2009)
Taylor (2001) observes that some antidumping cases withdrawn during the period 1990–1997 revealed the same pattern of changes in price and quantity as observed in collusive agreements.
It might seem at first glance that the standard settlement should be ruled out by the assumption of consistent beliefs (P d = P p = P). But even in the consistent-beliefs case a standard settlement may occur when L d > G p .
The entry constraint exploited in this model is emphasized in Higgins (2002).
On collusion and injunctive settlements of antidumping disputes, see Prusa (1992).
Prusa (1992) provides empirical evidence that settled antidumping disputes are associated with reductions in trade that are at least as large as those resulting from adjudicated disputes.
More precisely, the social cost will be a function of the probability that the patent is valid and that it was infringed, and it should be an increasing function in both variables. However, the marginal contribution of each variable to the social cost will not be the same. The social cost is also a function of the wealth generated by the patent incentive. The wealth generated by a patent is the sum of the consumer surplus and monopoly profits generated by the patent. Specifically, the term γΨ will be determined in part by the expected stream of patent profits forgone because of the discouragement effect. The remainder term (1 − γ)Ψ will be determined in part by the expected residual consumer welfare forgone because of the discouragement effect. These terms are capable of estimation.
P is the product of the probability of validity and the probability of infringement (assuming the two are independent). Treating it as an index of patent validity is clearly imprecise because it implicitly assumes that the probability of infringement is one.
If there is a strong correlation between Ψ and P, the social return from litigation should be expressed as (1–P)[W + L d − (ΔG p + Z) − Ψ(P)], which reflects the assumption of Crane (2002). If Ψ increases strongly in P, then the social return to litigation would not only approach zero as P increases, but is also more likely to be negative for high P values. Focusing on P might serve as a short cut to trying to determining the social return from patent litigation. In general, the relationship between Ψ and P is an empirical question.
If the penalty is set equal to (7) the plaintiff’s net reward will be G p − (G p + W – Z − (1 − γ)Ψ) = −W + Z + (1 − γ)Ψ. This implies that the private settlement condition will be equivalent to the social settlement condition. Specifically, the private joint payoff from litigation is (1 − P)(L d − G p − ΔG p − γΨ). The social payoff from litigation is (1 − P)[W + L d − (ΔG p + Z) − Ψ]. When the penalty is set according to (7), these payoffs are the same.
The Priest-Klein generates a plaintiff win rate prediction of 50%. This is consistent with the evidence on patent litigation. Plaintiff win rates in patent infringement litigation are roughly 50%, see Allison and Lemley (1998). Thus, the empirical evidence suggests that patent infringement trials can be described by the Priest-Klein model. However, this does not imply that half of patents are invalid. The evidence on win rates shows that only the most uncertain patents are litigated all the way to judgment, and that within the sample of litigated patents plaintiffs are no better than defendants at determining the validity of the patent.
For the formal analysis of waiver incentives in the context of ordinary litigation, see Hylton (2000).
To simplify we are ignoring the possible damage claim component, which would be purely speculative at the stage of a waiver negotiation. Moreover, under the Hatch-Waxman Act, pioneer drug developers can file infringement suits after being notified that a generic intends to enter the market (see, e.g., Blair and Cotter 2002, at 505–506). This model applies especially to litigation under the Hatch-Waxman provisions, which is the most common source of reverse patent settlements today.
The optimal penalty in the general standard waiver case is G p + W − (1 − γ)Ψ + [(λ nc − λ c )/(λ nc − λ c (1 − P))]L d . The last term is an additional charge to the monopolist because his contract has increased the rate of infringement and at the same time denied society the gain from that increased rate of infringement.
The optimal penalty in the general injunctive waiver case is G p + ∏W − (∏ − γ)Ψ − [(1 − 2P)/(1 − P))]L d , where ∏ = ([(λ nc − λ c (1 − P)]/λ c (1 − P)).
See Crane (2002).
Shapiro (2003)
If the stakes are sufficiently large, reverse payments will occur even though the likelihood of a finding of infringement is high. Moreover, if the dynamic efficiency cost is substantial, the reverse settlement may enhance social welfare. These are basic implications of the model in Part IV of this paper. It is in contrast to one of the most widely-accepted views in the patent-antitrust literature that a large reverse payment should be taken as a clear sign that the patent is invalid, see, e.g., Hovenkamp (2004, at 28) (“a firm willing to pay roughly $75 million per year to keep an alleged infringer out of the market when a successful preliminary injunction would have done the same thing for the cost of obtaining the injunction indicates that the prospects for a preliminary injunction were very poor.”).
In re Schering-Plough Corp., No. 9297, at 12 (F.T.C. Dec. 18, 2003), http://www.ftc.gov/os/adjpro/d9297/031218commissionopinion.pdf, vacated, 402 F3d 1056 (11th Cir. 2005).
For arguments against such an approach, see Brodley and O’Rourke (2002). One obvious problem with Crane’s proposal is that a “preliminary determination” of the patent infringement question could be such a costly and time consuming proceeding that it fails every test of its efficiency.
One factor that weighs in favor of Crane’s approach is the fact that the social cost of rejecting an infringement claim is likely to be positive correlated with the ex ante probability of infringement. In light of this Crane’s approach may be preferable because it comes close to the right answer in most cases without requiring an enormously difficult rule-of-reason analysis.
289 F.Supp. 986 (N.D. Ill 2003).
Id. at 992. Posner’s opinion indicate that courts also try to distinguish legitimate from illegitimate settlements, as suggested in the discussion in part III.A of this paper.
Professional Real Estate Investors, Inc. v. Columbia Pictures Industries, Inc., 508 U.S. 49, 60–61 (1993).
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Acknowledgments
For helpful comments the authors thank Scott Baker, Daniel Crane, Ben Depoorter, Michael Meurer, and Steve Shavell.
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An earlier version of this material appeared under the title “The Economics of Injunctive and Reverse Settlements”. After that earlier working paper grew to roughly 50 pages, we separated the material examining reverse settlements generally (e.g., in the torts setting) from the material examining competition policy implications. This paper focuses on competition policy implications.
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Hylton, K.N., Cho, S. Injunctive and reverse settlements in competition-blocking litigation. Eur J Law Econ 36, 243–269 (2013). https://doi.org/10.1007/s10657-011-9279-y
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DOI: https://doi.org/10.1007/s10657-011-9279-y
Keywords
- Litigation
- Reverse payment settlements
- Injunctive settlements
- Patent infringement litigation
- Waiver agreements
- Antidumping