Reverse Payments, Perverse Incentives

Murat C. Mungan

Florida State University - College of Law

February 8, 2013

Harvard Journal of Law and Technology, Vol. 27, No. 1, 2013
FSU College of Law, Public Law Research Paper No. 674
FSU College of Law, Law, Business & Economics Paper No. 14-2

Issuing and enforcing prescription drug patents requires courts and legislatures to strike a delicate balance. A patent gives drug manufacturers a legal, if temporary, monopoly on sales of a drug; this encourages manufacturers to engage in costly research and development of new medicines. But not all patents issued by the Patent Office are ultimately deemed valid – generic drug manufacturers can infringe the patent, and, when sued, attack its validity in court on a variety of grounds, including obviousness. In recent years, patent holders have begun to settle these suits (which they initiated) by paying the alleged infringer. Not surprisingly, these reverse payment settlements (“RPSs”) have been challenged on antitrust grounds. The federal courts of appeals split over whether this practice is presumptively an illegal restraint of trade, and in December 2012 the Supreme Court agreed to decide the issue, granting a writ of certiorari in FTC v. Watson Pharmaceuticals. In light of the importance of the issue to both drug consumers and manufacturers, it is crucial to understand the economic effects of RPSs. Many courts, including the Second Circuit and the Eleventh Circuit, commentators and scholars have suggested that restricting RPSs would necessarily retard technological progress, by reducing the expected returns of becoming a patentee. In this Article, I show, with the help of a game-theoretical model, that this conclusion is unwarranted. Restricting RPSs has the effect of chilling generic entry when – and only when – the underlying patent is strong, or likely to be held valid and infringed. Therefore, restricting RPSs increases the expected returns of holding a strong patent by eliminating potential payments to generic entrants, while at the same time eliminating the possibility of monopoly profit-splitting between branded and generic manufacturers when the patent is weak. This reward shifting effect implies that restricting the use of RPSs is likely to foster more revolutionary innovations, which lead to stronger patents, while lowering R&D towards relatively obvious inventions, which lead to weaker patents. This reward shifting effect of restrictive rules on RPSs, to the best of my knowledge, has gone unnoticed in the past, and it should play an important role in the Supreme Court’s cost benefit analysis.

Number of Pages in PDF File: 48

Keywords: Reverse Payment Settlements, Patent, Drugs, ANDA, R&D

JEL Classification: K19, K21, O31, O32, O34

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Date posted: February 10, 2013 ; Last revised: March 8, 2014

Suggested Citation

Mungan, Murat C., Reverse Payments, Perverse Incentives (February 8, 2013). Harvard Journal of Law and Technology, Vol. 27, No. 1, 2013; FSU College of Law, Public Law Research Paper No. 674; FSU College of Law, Law, Business & Economics Paper No. 14-2. Available at SSRN: http://ssrn.com/abstract=2214170 or http://dx.doi.org/10.2139/ssrn.2214170

Contact Information

Murat C. Mungan (Contact Author)
Florida State University - College of Law ( email )
425 W. Jefferson Street
Tallahassee, FL 32306
United States
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