In FTC v. Actavis, 133 S.Ct. 2223 (2013), a decision that has captured the attention of both antitrust and intellectual property lawyers alike, the U.S. Supreme Court recently held in a 5-3 vote that reverse-payment settlements resolving Hatch-Waxman Act patent litigation are not immune from antitrust liability simply because they fall within the scope of the patent being challenged in the litigation. Instead, courts must now assess the legality of such settlements under traditional antitrust principles by applying the rule-of-reason standard and analyzing the agreements on a case-by-case basis.

The Actavis decision has the potential to create antitrust issues in the context of settlement agreements that were previously viewed as lawful private agreements subject only to restrictions established under patent law. It could also have broader implications for settlement agreements and patent and other intellectual property rights generally.

Foremost, Actavis creates new risk and uncertainty in the area of reverse-payment settlement agreements because the decision instructs trial courts to consider the potential anti-competitive effects of such agreements, rather than simply upholding them if they are within the scope of the patent. Accordingly, in the wake of the court’s ruling, any party seeking to resolve Hatch-Waxman Act litigation out of court should take care not only to consider the business and intellectual property implications of the settlement but also to engage in a comprehensive antitrust analysis before finalizing any settlement agreement. In practice, intellectual property litigators will need to work hand-in-hand with antitrust experts in developing the terms and conditions of any agreement to settle Hatch-Waxman Act litigation, or other litigation involving exclusive patent rights.

In May 2003, certain generic drug manufacturers, including Actavis, submitted ANDAs and paragraph IV certifications for a generic formulation of the brand-name drug AndroGel, the patent for which was held by Solvay. Solvay filed timely infringement actions against the generic drug manufacturers. The generics argued that Solvay’s patent was invalid and, therefore, they were entitled to bring their generic versions of the drug to market.

In 2006, the companies settled the dispute by agreeing that the generics would not go on the market until 2015 — more than five years before the patent’s expiration date — and that the generics would assist Solvay in the marketing of AndroGel in exchange for payments exceeding $100 million. The Federal Trade Commission challenged the settlement and the U.S. Court of Appeals for the Eleventh Circuit, applying the “scope of the patent” test, upheld the settlement agreement. On June 17, the Supreme Court reversed the Eleventh Circuit and remanded the matter to the lower court, with instructions to review the settlement under the rule of reason.

By introducing an alternative approach and adopting the rule of reason as the governing standard, the court rejected all existing lower-court precedent regarding Hatch-Waxman settlement agreements, thereby resolving a circuit split in which the U.S. Court of Appeals for the Third Circuit held such agreements presumptively unlawful, while the Eleventh, Second and Federal circuits essentially immunized the agreements provided they were within the scope of the patent at issue.

The court acknowledged that the settling patentee may have had certain exclusionary rights under the patent but emphasized that the underlying patent “may or may not be valid, and may or may not be infringed.” Given that the underlying litigation was never actually decided (and thus the validity of the patent never judicially determined), the court stated, there remained “reason for concern” about the potential anti-competitive effects of a settlement in which the “plaintiff agreed to pay the defendants many millions of dollars to stay out of its market, even though the defendants did not have any claim that the plaintiff was liable to them for damages.”

Though the court conceded that application of the rule of reason might sometimes require antitrust trial courts to determine the validity of the underlying patent, it reasoned that such antitrust analysis usually will not be required, because the size of the reverse payment can serve as a “workable surrogate for the patent’s weakness.” Therefore, the court stated, trial judges should evaluate the anti-competitive effects of a particular reverse payment by considering “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.”

In doing so, the court rejected the scope-of-the-patent test that had been adopted by the Eleventh, Second and Federal circuits and declined to immunize a reverse-payment settlement from antitrust scrutiny even when “the agreement’s anti-competitive effects fall within the scope of the exclusionary potential of the patent.”

In a crucial departure from the Eleventh Circuit’s decision and Chief Justice John G. Roberts Jr.’s strongly worded dissent, both of which urged that patent validity and infringement issues should be the exclusive historic domain of patent law, the court pointed to a long line of precedent and the pro-competitive policies underlying the Hatch-Waxman Act to assert that “patent and antitrust policies are both relevant in determining the ‘scope of the patent monopoly.’”

The majority of the Actavis court criticized the Eleventh Circuit for measuring the scope of the agreement’s restriction solely against the length of the patent’s term or its earning potential, instead of “considering traditional antitrust factors such as likely anti-competitive effects, redeeming virtues, market power and potentially offsetting legal considerations present in the circumstances, such as those related to patents.”

The court conceded that its rule-of-reason approach could run counter to judicial policies favoring settlement and lead parties to the antitrust dispute to litigate patent validity. Nevertheless, the court set forth five considerations supporting its conclusion that the FTC should have an opportunity to prove its antitrust claim under the rule of reason.

First, “the specific restraint at issue has the potential for genuine adverse effects on competition.” That is, according to the court, the “payment in effect amounts to a purchase by the patentee of the exclusive right to sell its product,” leading the patentee and the alleged infringer to split monopoly profits between themselves at the expense of consumers. The court found this particularly likely in the Hatch-Waxman Act context, where the 180-day exclusivity and 30-month stay provisions enable branded manufacturers to exclude most competition by offering a sizable reverse-payment settlement to the first-to-file generic.

Second, “these anti-competitive consequences will at least sometimes prove unjustified.” The court identified some potentially valid justifications for a reverse payment, such as avoided litigation costs or services provided by the settling generic to the patentee. Recognizing that antitrust defendants may be able to establish such justifications in some cases, the court noted that a rule of reason analysis would enable them to do so.

Third, “where a reverse payment threatens to work unjustified anti-competitive harm, the patentee likely possesses the power to bring that harm about in practice.” The court explained that the size of the reverse payment might be a good indicator of the branded-drug manufacturer’s ability to charge supra-competitive prices and, therefore, of market power.

Fourth, “an antitrust action is likely to prove more feasible administratively than the Eleventh Circuit believed.” Although litigating the patent’s validity is a possibility, according to the court it is “normally not necessary” to “answer the antitrust question,” unless, perhaps, to “determine whether the patent litigation is a sham.”

Instead, the court viewed “the size of the unexplained reverse payment” as a “workable surrogate for a patent’s weakness.” “An unexplained large reverse payment itself would normally suggest that the patentee has serious doubts about the patent’s survival.”

Finally, “the fact that a large, unjustified reverse payment risks antitrust liability does not prevent litigating parties from settling their lawsuit.” The parties, according to the court, can settle in other ways — for example, “by allowing the generic manufacturer to enter the patentee’s market prior to the patent’s expiration, without the patentee paying the challenger to stay out prior to that point.” Significantly, the court declined the FTC’s invitation to find reverse-payment settlements presumptively unlawful, as had the Third Circuit in In re K-Dur Antitrust Litigation, 686 F.3d. 197 (3d Cir. 2012). The court explained that such a rule, sometimes described as a “quick-look” analysis that shifts the initial burden onto the antitrust defendant to justify its conduct, “is appropriate only where an observer with even a rudimentary understanding of economics could conclude that the arrangements in question would have an anti-competitive effect.” Reverse-payment settlements do not meet that test, the court ruled, “because the likelihood of a reverse payment bringing about anti-competitive 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.”

While majority of the court concluded that reverse-payment cases should be decided using the same standard applied in other rule-of-reason cases, it also prescribed a flexible approach under which not all litigants will be required to dispute patent validity or the overall merits of the patent system.

The court stated, “as in other areas of law, trial courts can structure antitrust litigation so as to avoid, on the one hand, the use of antitrust theories too abbreviated to permit proper analysis, and, on the other, consideration of every possible fact or theory irrespective of the minimal light it may shed on the basic question — that of the presence of significant unjustified anti-competitive consequences.”

In his strongly worded dissent, Roberts, with Justices Antonin Scalia and Clarence Thomas, said the court’s decision has the potential to create novel and problematic issues for settlement agreements in the intellectual property arena and perhaps beyond.

As the dissent said, a patent necessarily and by design creates a limited monopoly and “in doing so it provides an exception to antitrust law, and the scope of the patent — i.e., the rights conferred by the patent — forms the zone within which the patent holder may operate without facing antitrust liability.”

Roberts stressed that the court had never previously applied the antitrust laws to limit the ability of a patentee to act within the scope of its patent, including resolving a dispute by paying a competitor not to challenge its patent prior to expiration. Subjecting settlement agreements to such antitrust scrutiny, Roberts wrote, could undermine the ability of patent laws to serve their intended purpose and discourage out-of-court settlement of disputes — outcomes that ordinarily are considered institutionally desirable and efficient. Justice Samuel A. Alito Jr. did not take part in the court’s decision.

Significantly, by holding that settlement of a patent claim by means of a “large” payment to an alleged infringer results in potential antitrust liability exposure for the settling patentee, the dissenting opinion stated, the court effectively opened the door for antitrust law to encroach on what was previously the exclusive domain of patent law because “a patentholder acting within the scope of its patent has an obvious defense to any antitrust suit: that its patent allows it to engage in conduct that would otherwise violate the antitrust laws.”

Under the court’s ruling, however, the settling patentee “is not immunized by the fact that it is acting within the scope of the patent,” Roberts observed. In the dissenters’ view, this represents a departure from precedent in that patent settlements were previously not subject to antitrust scrutiny provided that they “confer to the patentholder no monopoly power beyond what the patent itself conferred — unless, of course, the patent was invalid, but that again is a question of patent law, not antitrust law.”

The majority’s decision, Roberts said, has dramatically altered the patent law landscape.

According to the dissent, therefore, the majority’s decision “will discourage settlement of patent litigation” because “there would be no incentive to settle if, immediately after settling, the parties would have to litigate the same issue — the question of patent validity — as part of a defense against an antitrust suit.”

Roberts further predicted that “the court’s attempt to limit its holding to the context of patent settlements under Hatch-Waxman will not long hold,” suggesting that the majority’s decision could have repercussions for other types of patent settlements or even settlements of other types of exclusive-rights claims altogether in other industries and contexts.

In this respect, the court’s decision should prompt parties to evaluate more carefully the risks and benefits of resolving any intellectual property dispute out of court when a proposed settlement agreement includes provisions regarding exclusive rights or competition. By holding that reverse-payment settlement agreements are subject to antitrust scrutiny even when the conduct of the patentee is within the scope of the patent, the decision may ultimately have far-reaching consequences not only for patent disputes but also for other disputes involving intellectual property rights or other exclusive rights.

Simply stated, careful antitrust analysis of any patent settlement in the Hatch-Waxman context and even in the broader intellectual property context is well advised, to the extent that the settlement has any potential anti-competitive effects as outlined by the court.

Carl W. Hittinger is the chairman of DLA Piper’s litigation group in Philadelphia, where he concentrates his practice in complex commercial trial and appellate litigation with a particular emphasis on antitrust and unfair competition matters.

Lesli C. Esposito is a partner with the firm in Philadelphia, where she focuses her litigation practice on antitrust and unfair competition matters. She was formerly a senior attorney with the Federal Trade Commission’s bureau of competition.