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Eli Lilly and Company has filed a $500 million investor-state case [PDF] against the Canadian government over invalidated patents, alleging that Canada has violated its obligations under the North America Free Trade Agreement by allowing its courts to invalidate patents for two of its drugs.

Investor-state disputes allow companies to initiate proceedings against foreign governments under provisions of international trade treaties—usually because of the expropriation of property. This is the first time, however, a company has argued that a patent invalidation amounts to an expropriation.

The drug maker maintains that decisions issued by Canada’s courts to invalidate the patents for the two drugs—Strattera and Zyprexa—after they were challenged by generic drug manufacturers violate Canadian obligations under NAFTA. Lilly says Canada’s courts invalidated the patents on the ground that they were not “useful,” applying a “promise utility doctrine” that requires a company to provide an unreasonable amount of scientific data in order to secure a patent.

“Canada’s ‘promise utility doctrine,’ applied by Canadian courts to invalidate the Strattera and Zyprexa patents, is contrary to Canada’s treaty obligations to protect patent rights and has resulted in the unlawful expropriation of Lilly’s intellectual property,” Lilly wrote in its Notice of Arbitration. “The retroactive, arbitrary, and discriminatory application of the promise utility doctrine to Lilly’s patents also contravenes the minimum standard of treatment owed to Lilly as an investor in Canada.”

In November 2012, the pharmaceutical company filed a “Notice of Intent to Submit a Claim to Arbitration” with regard to one of its drugs, Strattera, seeking $100 million in compensation. But in June of this year it filed a second notice regarding its patents for both Strattera and Zyprexa, increasing the amount to $500 million, plus the cost of legal proceedings. Strattera treats attention-deficit hyperactivity disorder (ADHD), and Zyprexa is used to treat schizophrenia and related psychotic disorders.

Lilly is being represented by John Veroneau, a partner at Covington & Burling, who was Deputy U.S. Trade Representative from 2007 to 2009 and who previously served as the USTR’s general counsel, responsible for U.S. trade law and litigation.

“Canada’s courts have conflated the questions that Health Canada (the equivalent of the FDA in the U.S.) would ask about a drug’s usefulness with what the patent office would ask,” Veroneau told CorpCounsel.com. “The patent office test for usefulness has always had a lower bar and that’s what it should be applying.”

Veroneau said Canada has invalidated 18 patents in the last 8 years on the grounds of utility and is the only country that has set the utility bar so high.

But Richard Gold, a patent law professor at McGill University, and Ben Beachy, research director at Public Citizen Global Trade Watch, both told CorpCounsel.com that Eli Lilly is wrong in its assertion that Canada has a different standard. Gold said Australia and New Zealand’s utility doctrine is almost identical to the utility doctrine in Canada. Beachy noted that written into NAFTA is a provision that there will be flexibility for each country on how it interprets usefulness.

Under the Canadian Patent Act, an invention can be patentable only if it is new, inventive, and useful. Over the last decade, the Canadian courts have interpreted "useful" to mean that the utility of the patent as described in the application must be demonstrated as of the filing date.

Both a Canadian federal court and a court of appeals ruled that the evidence Lilly presented in its patent applications to demonstrate the promised benefit of the drugs in question was insufficient. The Supreme Court of Canada denied leave to hear appeals for both drugs, issuing its decision regarding Zyprexa in May of this year.

That was Lilly's last hope. The request for arbitration filed last week will probably take at least two years to resolve. It will be decided by a panel of three people versed in international law and chosen by the two disputing countries.

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