Patents, Antitrust, and the Rule of Reason

Posted by Social Science Research Network

Patents, Antitrust, and the Rule of Reason – Herbert J. Hovenkamp (University of Iowa – College of Law)

ABSTRACT: Antitrust law has historically immunized many patent agreements if they fell within the “scope of the patent.” Three dissenting Justices in the Actavis case advocated this test: a pharmaceutical pay-for-delay settlement falls within the scope of the patent if it delays a competitor’s entry no longer than the remaining life of the patent. In that case the patentee will not be obtaining any more than it would from a valid patent — namely, the right to exclude infringers for the full patent term.

The “scope of the patent” test is not useful for defining the boundaries of antitrust immunity in most cases, however, including Actavis itself. One problem is that it forces judges to assess patent validity in cases where such assessments are costly, indeterminate, and unnecessary. It also leads to different results when the patentee is vertically integrated and when it is not.

A pervasive problem of the scope of the patent test is that it confuses patent value with product value. For example, both product price fixing and product market division agreements contained in patent licenses have been found to fall within the scope of the patent. If the price fix or market division lasts no longer than the duration of the patent, then it is no more harmful to customers than a patentee’s simple solo production under its patent.

Recognizing this, several courts have concluded that product price fixes should be unlawful under the antitrust laws only if the patents involved are very likely invalid, making the patent license nothing more than a cover for collusion. The important question is not patent validity, however, but rather patent value. Many perfectly valid patents have little value because they add little to a licensee’s technology, or alternative patents or technological routes exist that serve the same purpose. Further, this phenomenon is ubiquitous. Cartel markups in industries prone to collusion run in the range of 20% to 40% over the pre-cartel price. By contrast, average royalty rates on licensed patents average around 3%, and this value is much greater than that of the great majority of patents, which are never licensed. The real problem of product restraints in patent licenses is that they are attempts to attribute the full cartel markup to the patents being licensed. Only a tiny percentage of patents do anything like that.

Pay-for-delay settlements of pharmaceutical patents raise similar issues, permitting the parties to capture the full cartel value of the market rather than the value that the patent, if licensed, would produce. In such settlements the parties bargain along two vectors: the generic entry date and the size of the payment from the pioneer to the generic. The entry date establishes the size of the monopoly pie, and the size of the payment represents how the pie is to be divided up. Being able to bargain along these two vectors simultaneously enables the parties to select an entry date as remote as the antitrust authorities will accept, maximizing overall gains, and then bargain over the size of the payment in order to resolve issues about patent validity, risk aversion, and anticipated litigation costs. The parties have no significant adversity on the question of entry date: the longer the delay the better, provided that they keep it short of patent expiration. Indeed, under the “scope of the patent” test that the Actavis dissenters urged, the equilibrium entry date would be just prior to the patent expiration date. Consumers would be heavy losers, particularly if the patent is relatively weak.

A better rule for identifying the boundaries of antitrust liability than the “scope of the patent” formulation permits antitrust intervention in the case of post-issuance patent conduct that is not explicitly authorized by the Patent Act. Of course, only a relatively small proportion of such conduct will actually violate the antitrust laws. With immunity off the table, assessing the competitive and innovation effects of challenged practices involves questions of antitrust law, not of patent law. Outside of damages measurement, patent law has no tool kit for assessing either the market or even the innovation effects of a particular practice.

While that criticism may seem harsh, the reality is that patent law has developed in relative isolation from any significant inquiry into how patents function in the marketplace. The result gives antitrust policy a comparative advantage, not only for assessing competition effects but ironically, even for assessing innovation effects.