Although district courts have split over the question whether non-cash settlement consideration may be unlawful, both the Third Circuit and the California Supreme Court recently ruled that non-cash consideration can be a reverse-payment under Actavis, and is thus subject to antitrust review. The Third Circuit also held that Actavis did not alter traditional rule-of-reason analysis of such settlements.
The Hatch-Waxman Act and the Rise of Reverse Payment Settlements
The phenomenon of reverse-payment settlements arose from enactment of the Drug Price Competition and Patent Term Restoration Act, known as the “Hatch-Waxman Act,” which provides a statutory framework for expediting FDA approval of generic drugs, and provides economic incentives for generic manufacturers to challenge patents held by the patentee.
Under Hatch-Waxman, a brand-name drug manufacturer must provide notice to the FDA in its new drug application (“NDA”) when the drug has been patented. A generic manufacturer is thereafter permitted to file an “abbreviated new drug application” (“ANDA”) under which it must show that the proposed generic has the same active ingredients as the FDA-approved brand-name drug and is biologically equivalent to it, without need to conduct the safety and efficacy studies required of a drug before it is approved. It must also declare that the generic will not infringe any brand-name patents, which it can do by certifying that the brand-name patent is invalid (a “paragraph IV certification”).
Merely filing an ANDA to market a generic drug prior to expiration of a brand-name drug’s patent constitutes an act of infringement. Thus the brand-name drug company can file a patent infringement suit, which prevents the FDA from approving the generic application for 30 months (or until the patent is held invalid, if earlier). Importantly, the first generic manufacturer to file an ANDA enjoys a 180-day period of marketing exclusivity if it is permitted to market the drug, during which time only a generic authorized by the brand-name company (“authorized generic”) may compete with the first-filer. This provides important economic advantages: when only the authorized generic and the first-filed generic are on the market, the generic price is significantly higher than when there are additional competitors. And if the brand-name drug company declines to market an authorized generic during the exclusivity period, the monetary benefits to the first-filer skyrocket.
Actavis: The Antitrust Legality of Reverse-Payment Settlements
In Actavis, the Supreme Court rejected a standard that reverse payments in conjunction with delayed generic entry are lawful so long as the generic competitor’s entry is delayed no longer than the expiration date of the patent—the so-called “scope of the patent” test. It held instead that such settlement payments can violate the Sherman Act when they are “large and unexplained” (e.g., by the cost of continued litigation or the value of services the challenger might perform for the brand name company) and result in unjustified anticompetitive consequences (i.e., there are no significant offsetting competitive benefits). Such payments, the Court reasoned, can indicate that the “patentee has serious doubts about the patent’s survival . . . suggest[ing] the payment’s objective is to maintain supracompetitive prices to be shared among the patentee and the challenger . . . .”
King Drug: Actavis Applies to Non-Cash Consideration in the Third Circuit Under a Traditional Rule of Reason Analysis
But what if the settlement agreement does not involve a cash payment, but instead confers some other financial competitive benefit to the generic challenger? In King Drug Co. of Florence, Inc. v. SmithKline Beecham Corp., the Third Circuit addressed just that circumstance.
There, Teva filed an ANDA for the generic of a brand-name drug manufactured by SmithKline (Lamictal), both in tablet and chewable form. SmithKline promptly filed a patent infringement claim. After the district court found the primary claim of one of the patents to be invalid, the parties quickly settled. The settlement involved no cash payment. Instead, it permitted Teva to enter the far less valuable chewables market 37 months prior to the patent’s expiration, and to enter the tablet market at the time of expiration. Importantly, SmithKline also agreed it would not launch its authorized generic in either form until six months after Teva’s entry into the tablet market (the “no-AG agreement”)—the exclusivity period in which Teva would also face no other generic competitors. Direct purchasers of Lamictal subsequently filed claims alleging the agreement violated the antitrust laws.
The district court dismissed the antitrust claims at the pleading stage, ruling that Actavis was limited to cash payments. Even if Actavis applied, however, it concluded that, under the rule-of-reason, plaintiffs had not pleaded an unlawful agreement.
The Third Circuit reversed. It reasoned that the Supreme Court’s concern in Actavis was not with the nature of the consideration, but whether the agreement “seeks to prevent the risk of competition. . . . [which] constitutes the relevant anticompetitive harm.”  It ruled that the no-AG agreement posed the same risks Actavis associated with reverse cash payments—the inducement of the generic challenger to abandon its patent challenge.
Among other considerations, the Third Circuit panel noted that although the agreement permitted Teva to enter the chewable market years prior to the patent’s expiration (providing some pro-competitive benefits), the tablet market, in which entry was delayed, was orders of magnitude more valuable than the tablet market. It also concluded that the no-AG agreement was of significant monetary value to Teva because it eliminated the only generic competitor Teva could have faced during its exclusivity period, when, as the first-filer, it reaped the bulk of its profits. This monetary value rendered the agreement sufficiently distinct from an early entry agreement lacking a no-AG agreement because agreements regarding only entry dates might merely reflect the parties’ assessments of the strength of the patent. SmithKline’s decision to forgo marketing its authorized generic was contrary to its interest, the court observed, since SmithKline would have otherwise enjoyed duopoly profits during Teva’s generic exclusivity period. Additionally, the court presumed that because of the no-AG agreement, Teva agreed to a later entry date than it would have absent the right to six-months of monopoly profits. Given these circumstances, the Third Circuit declared that the no-AG agreement may represent the same “unusual, unexplained reverse transfer of considerable value” that the Supreme Court reasoned in Actavis created an “inference that it is a payment to eliminate the risk of competition.”
Significantly, the Third Circuit rejected the defendants’ argument that the no-AG agreement was nothing more than an exclusive license that any patentee has the right to grant. The Court expressed considerable skepticism that the deal represented such a license because SmithKline could still market the brand name drug; it merely gave up the right to compete in the generic market. It nevertheless ruled that even if the agreement was an exclusive license, it still failed antitrust scrutiny.
The Third Circuit also declared that Actavis did not create a modified rule-of-reason analysis or new pleading burdens for plaintiffs. It adopted the traditional rule-of-reason standards: once plaintiffs prove anticompetitive harm, defendants must demonstrate legitimate justifications, rebuttable by plaintiffs.
King Drug does, however, create some ambiguities regarding the parties’ burdens under the rule of reason in reverse payment cases. King Drug was decided at the pleading stage. The Third Circuit identified plaintiffs’ burden as proving anticompetitive effects (as under the traditional rule of reason standard) in the form of “payment for delay, or, in other words, payment to prevent the risk of competition.” It then added that the “‘likelihood of a reverse payment bringing about anticompetitive effects depends upon its size, its scale in relation to the payor’s anticipated future litigation costs, its independence from other services for which it might represent payment, and the lack of any other convincing justification.’” It is unclear, however, whether that rubric requires plaintiffs to specifically address each of these factors in a complaint, and which of the parties will have the burden to prove or disprove each factor.
In re: Cipro Cases I & II: California Supreme Court Adopts Actavis for Claims Involving Non-Cash Consideration
The California Supreme Court’s In re Cipro Cases I & II decision involved an agreement for delayed entry in exchange for both cash and non-cash consideration. There, Bayer, the brand-name drug manufacturer brought a patent suit against generic challenger Barr Laboratories, but settled under the following terms: Barr agreed to delay generic entry until the expiration of the applicable patent; Bayer agreed to supply its drug to Barr at 85% of its purchase price and to permit Barr to market it during that period; and Bayer agreed to make payments to Barr totaling about $400 million over a six year period (or slightly less than half of what Bayer’s profits would have been during the six-month period in which it permitted Barr to market Cipro). The cash, in combination with Barr’s pre-expiration entry into the branded market, “mirrored the 180 day duopoly the Hatch-Waxman Act would have provided Barr if it had succeeded in showing invalidity” by providing Barr with half of Bayer’s profits, while Bayer preserved its supracompetitive prices and profits through the patent’s expiration. After the settlement was challenged as anticompetitive under California’s Cartwright Act, the district court denied the claims on summary judgment, adopting the pre-Actavis “scope-of-the-patent test, and the state appellate court affirmed.
The California Supreme Court reversed, adopting the rationale of Actavis, and concluding that “an agreement to exchange consideration for elimination of any portion of the period of competition that would have been expected had a patent been litigated is a violation of the Cartwright Act.” Importantly, the Court declared that Actavis was to be given significant weight because federal law establishes the contours of patent law and is the final arbiter of the extent to which state law must yield to patent law. The Court rejected attempts to distinguish Actavis on grounds that the patent was weaker there, ruling that the decision in Actavis did not depend on the level of uncertainty associated with the patent.
Importantly, the California Supreme Court adopted a rule-of-reason for analysis of such agreements, laying out the elements of a reverse-payment claim and each side’s burdens. Plaintiffs bear the burden of proving each element of the claim: delayed entry; reverse financial consideration; an amount greater than the patentee’s remaining litigation costs in the patent matter and in excess of the value of products or services that the generic challenger may be providing to the patentee. But plaintiffs’ burden of production is merely proof of payment and delayed entry; defendants bear the burden of producing evidence of litigation costs or value of services and products provided by the challenger, or other evidence of the agreement’s pro-competitive effect. If defendants satisfy this burden, plaintiffs bear the burden of persuasion that the costs or values is less than the reverse consideration. The court noted that an adequate justification may not be that the challenger was permitted to enter earlier than if the patent had been upheld, ruling that the applicable baseline is the period of exclusion had the litigation continued.
Whether other states will adopt Cipro’s approach of both adopting Actavis’s standard, in part because of deference to the scope of federal patent law, and establishing a relatively light initial burden of production on reverse-payment plaintiffs, remains to be seen. In any event, in light of King Drug and Cipro, drug manufacturers and purchasers can expect to see more reverse payment claims, particularly those involving non-cash consideration, in the Third Circuit and California.
 133 S. Ct. 2223 (2013).
 Id. at 2227, 2237.
 Id. at 2238.
 Compare In re Aggrenox Antitrust Litig., No. 3:14-md-2516, 2015 WL 1311352, at *14 (D. Conn. Mar. 23, 2015) motion to certify appeal on other issues granted, No. 14-md-2516, 2015 WL 4459607, at *11 (D. Conn. July 21, 2015) (finding that even if an agreement to not market an authorized generic is tantamount to an exclusive license, such licenses still fall within Actavis); In re Niaspan Antitrust Litig., 42 F. Supp. 3d 735, 751-52 (E.D. Pa. 2014) (applying Actavis to non-cash consideration); In re Effexor XR Antitrust Litig., No. 11–cv-5479, 2014 WL 4988410, at *20-23 (D.N.J. Oct. 6, 2014) (concluding non-cash payments are actionable if plaintiffs plead a reliable estimate of their monetary value); United Food & Com. Workers Local 1776 & Participating Emps. Health & Welfare Fund v. Teikoku Pharma USA, Inc., 74 F. Supp. 3d 1052, 1069 (N.D. Cal. 2014) (applying Actavis to non-cash consideration); In re Nexium (Esomeprazole) Antitrust Litig., 968 F. Supp. 2d 367, 392 (D. Mass. 2013) (same); In re Lipitor Antitrust Litig., MDL No. 2332, 2013 WL 4780496, at *26 (D.N.J. Sept. 5, 2013) (finding “nothing in Actavis strictly requires that the payment be in the form of money”); with In re Loestrin 24 FE Antitrust Litig., 45 F. Supp. 3d 180, 192-93 (D.R.I. 2014) (limiting Actavis to cash consideration).
 Pub. L. 98-417, 98 Stat. 1585, 1585-1603, codified as amended in pertinent part in 35 U.S.C. § 27(e), 35 U.S.C. 282(c), and scattered sections of 21 U.S.C. § 355.
 Actavis, 133 S. Ct. at 2227-28.
 21 U.S.C. § 355(b)(1).
 Id. at § 355 (j)(2)(A)(ii), (iv).
 Id. at § 355(j)(2)(A)(vii)(IV).
 35 U.S.C. § 271(e)(2).
 21 U.S.C. § 355(j)(5)(B)(iii).
 Id. at § 355(j)(5)(B)(iv).
 See, e.g., Food and Drug Administration, Generic Competition and Drug Prices, http://www.fda.gov/AboutFDA/CentersOffices/OfficeofMedicalProductsandTobacco/CDER/ucm129385.htm (last viewed Oct. 15, 2015).
 Actavis, 133 S. Ct. at 2227.
 Id. at 2236 (the Actavis settlement permitted the generic to enter some five years prior to patent expiration).
 791 F.3d 388 (3d Cir. 2015).
 In re Lamictal Direct Purchaser Antitrust Litig., No. 12-cv-995, 2012 WL 6725580, at *2 (D.N.J. Dec. 6, 2012).
 King Drug of Florence Co. v. SmithKline Beecham, 791 F.3d 388, 393-94 (3d Cir. 2015).
 In re Lamictal Direct Purchaser Antitrust Litig., 18 F. Supp. 3d 560, 566 (D.N.J. 2014), vacated and remanded sub nom, King Drug, 791 F.3d 388 (3d Cir. 2015).
 Id. at 562
 Id. at 566-69.
 King Drug, 791 F.3d at 404 (quoting Actavis, 133 S. Ct. at 2236).
 Id. at 405, 408.
 Id. 405 n.23.
 Id. at 394.
 Id. at 406 n.27.
 Id. at 406-407.
 Id. at 412.
 Id. (quoting Actavis, 133 S. Ct. at 2237).
 348 P.3d 845 (Cal. 2015).
 Id. at 852.
 Id. at 865.
 Id. at 859.
 Id. at 865-67.
 Id. at 866-67, 869-71.
 Id. at 867, 871.