California, Rest In Peace: Pharmaceutical Companies, Keep Your Settlement Discussions Out of California

For nearly a decade, the Supreme Court’s FTC v. Actavis decision has guided pharmaceutical litigators and advisors exploring the antitrust risks inherent in settling pharmaceutical patent lawsuits, especially when such settlements could be viewed to include large and unjustified payments to an alleged infringing ANDA filer (or biosimilar manufacturer).  But settlements that touch the California sun—those negotiated, completed, or entered within the limits of the Golden State—are now governed by a different, more restrictive standard, and one that may impose individual liability, under Assembly Bill 824 (“AB 824”).  While a federal district court preliminarily enjoined the law to the extent it sought nation-wide application, AB 824 still governs all pharmaceutical “settlement agreements negotiated, completed, or entered into within California’s borders[,]” altering the calculus for all future pharmaceutical settlements.

For over two decades, Hatch-Waxman litigation settlements in which the patent holder pays the alleged infringer in exchange for the infringer’s agreement to “delay” market entry have been targeted as anticompetitive.  Such settlements, typically referred to as “reverse payment” or “pay-for-delay,” more broadly involve a brand manufacturer or NDA holder providing something of value (beyond an early entry date) to a generic ANDA filer to stay off the market until some later date.  These payments have been labeled “reverse” because, unlike traditional patent settlements where the alleged infringer compensates the patent holder for a release of infringement damages, these payments flow the other way from the patent holder to the infringer.

After years of legal uncertainly and split appellate decisions concerning the legality of reverse payment settlements, the Supreme Court took up the split and issued its seminal decision, FTC v. Actavis, Inc., in 2013.¹  In, Actavis, the Court ruled that reverse payment settlements may violate the antitrust laws.  The Court neither adopted the Federal Trade Commission’s proposed “quick look” analysis nor defendants’ “scope of the patent test,” which effectively presumed patent settlements lawful if they did not affect competition in products not covered by the patent.  Rather, the Court held that “a reverse payment, where large and unjustified, can bring with it the risk of significant anticompetitive effects.”²  The Court also held that such challenges must be assessed under the fact-intensive rule of reason analysis.³  The Court left to lower courts to flesh out how exactly to apply the rule of reason in weighing pro-and anti-completive affects.⁴  But the Supreme Court did give lower courts some guidelines, focusing on the requirement that a reverse payment must be “large,” and “unexplained” to trigger scrutiny.⁵  Whether the payment is anticompetitive, the Supreme Court held, was not merely a matter of whether it was reverse, but “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.”⁶

On October 7, 2019, California signed into law AB 824.⁷  In passing AB 824, California became the first state in the nation to outlaw reverse payment agreements, separate and in addition to the general restraint imposed by Actavis.

Like Actavis, AB 824 seeks to curtail anticompetitive reverse payment settlement agreements.  But AB 824 defines “reverse payments” far more broadly than the Supreme Court did.  Specifically, whereas the Supreme Court’s landmark ruling applies to “large and unjustified payments,” the California Act applies to payments of any size, subject to specified exceptions.⁸  One of those exceptions is saved litigation expenses, but rather than permitting an assumed amount—such as the $7 million that the FTC and courts have said is presumptively too small to trigger scrutiny⁹—AB 824 requires direct evidence of cost savings from contemporaneous litigation budgets.¹⁰  This aspect alone creates risk for many settlements that include some small saved-litigation-expense payments.

The Act is tougher than federal law in many other ways.  While Actavis holds that such reverse payment settlements should be analyzed under the rule of reason with courts weighing the potential benefits from the arrangements against harm to competition, AB 824 pushes the boundaries, presuming the deals are anticompetitive unless the companies can prove otherwise (as the FTC had originally argued for).  Indeed, under AB 824, any settlement where a generic-drug maker accepts anything of value or agrees not to compete for a period of time will be assumed to be anticompetitive.¹¹  AB 824 also allows treble damages against the individuals involved in such settlements, with a minimum fine of $20 million, in addition to traditional damages available under any other existing California law (such as the overcharge resulting from purchasing brand drugs during a period of generic delay).¹²

The Association for Accessible Medicines (“AAM”)—a generic manufacturers’ trade organization—sought to enjoin AB 824.¹³  It made both the historic defense of reverse payment settlement—that Hatch Waxman settlements allow generics to enter the market sooner than they would absent the agreements, bringing lower-cost options to consumers sooner, but also argued that AB 824 is unconstitutional as it seeks to regulate out-of-state commerce, in violation of the Constitution’s dormant Commerce Clause.

U.S. District Judge Troy L. Nunley agreed in part with AAM, granting a preliminary injunction and finding that AB 824 affects settlements with no connection to California.¹⁴  “The court therefore finds persuasive plaintiff’s hypothetical: ‘If two parties settle a patent suit in Delaware on terms that A.B. 824 deems unlawful, the settling parties (and every person who merely assists) would be liable for severe penalties under California law”.¹⁵  Judge Nunley also took issue with AB 824’s penalty provision, finding that AB 824 “could be used to levy substantially significant civil penalties on parties that do not have any connection with California” and could “hypothetically reach a corporate officer of a Delaware company entering into a settlement agreement with another Delaware company regarding pharmaceutical sales in only Delaware[.]”¹⁶

The California AG sought to modify the injunction which he argued went too far and asked that the court allow California to enforce the law with regard to patent settlement agreements directly connected to pharmaceutical sales in California and settlements negotiated, completed, or entered in California.  Judge Nunley agreed, in part, and lifted the injunction to the extent California sought to regulate those settlements reached within California, finding that even AAM does not contest “whether the state can enforce AB 824 with respect to settlement agreements negotiated, completed, or entered into within California’s borders[.]”¹⁷  As such activity is “compliant with the dormant Commerce Clause because they regulate conduct occurring wholly within California’s borders[,]”¹⁸ Judge Nunley preserved the law.

Judge Nunley rejected, however, the AG’s request that California be allowed to reach those settlements that were signed elsewhere and merely impact California drug sales.¹⁹  Such a ruling, Judge Nunley found, would effectively roll back the injunction in its entirety, given that California is the country’s largest drug market and all generic drugs approved by the FDA are sold in the state, running afoul of the dormant Commerce Clause.²⁰

With Judge Nunley’s preliminary injunction of the Act now in place and more litigation certainly to come (as well as the potential for additional legislation), life science companies would be wise to both comply with the California and to stay out of California, in all respects, during the negotiation and settlement of such disputes.

First, parties should be mindful of AB 824’s requirements, including some that require action prior to or during a litigation (e.g., contemporaneous litigation budgets), and prior to settlement discussions.  The freedom to include small payments up to the amount of litigation cost savings provide settling parties with flexibility that is still attainable under AB 824 with proper planning.

Second, the best way to avoid the teeth of AB 824 is for all parties negotiating a settlement to stay away from California while engaging in any work or communications related to the settlement or negotiations, if possible.  There will likely be ongoing litigation to address what it means to “negotiate, complete, or enter” a settlement in California, but the mantra going forward, where possible, should channel Red Hot Chili Peppers’ Dani California: “California, rest in peace.”