Despite Setbacks in Court, California’s Ban on Pharmaceutical Pay-For-Deals Could Still Recover
For two decades, antitrust enforcers have been fighting so-called “reverse-payment” or “pay-for-delay” agreements under which pharmaceutical patent-holders pay the allegedly infringing, lower-cost generic competition to stay off the market. California has taken a unique legislative approach, passing Assembly Bill 824 (“AB 824”) to address skyrocketing prescription drug costs by subjecting pay-for-delay agreements to enhanced antitrust scrutiny. Big Pharma has waged a protracted battle against AB 824 in the courts, which has taken yet another turn.
In December 2021, Judge Troy L. Nunley of the U.S. District Court for the Eastern District of California granted the motion of a trade association of pharmaceutical manufacturers—the Association for Accessible Medicines’ (“AAM”)—to enjoin AB 824 on the grounds that it likely violated the U.S. Constitution’s dormant commerce clause because it unduly burdened interstate commerce. Less than two months later, the court partially reversed course, simultaneously reviving and gutting the law by modifying the injunction to allow enforcement but only with respect to settlements “negotiated, completed, or entered into within California’s borders.” While it remains to be seen what the California Attorney General will do next in his defense of the law, there are potentially valid legal grounds—and undeniable public interest grounds—for appeal.
The State of Play for Pay-For-Delay
Pay-for-delay agreements arise in the pharmaceutical sector under the regulatory framework of the Hatch-Waxman Act. Seeking to control branded drug prices, Congress passed the Act to facilitate the entry of generic pharmaceuticals. The Act provides that a generic company can provide notice of entry based on certification that the patent protecting the branded drug is either invalid or will not be infringed by the proposed generic drug. The branded company can then sue the generic company for patent infringement, thereby resolving the patent dispute before entry and before the generic company would incur damages that would otherwise be a disincentive to enter the market.
Like most actions, these Hatch-Waxman patent infringement cases mostly settle prior to trial. Unlike other litigation, however, these settlements often see the plaintiff (the branded company) provide money or other financial inducements to the defendant (the nascent generic competitor) to stay out of the market. In other words: one competitor (the brand) pays another competitor (the generic manufacturer) not to compete.
The impetus to agree to such a settlement is obvious. Litigating the validity of the patents allegedly covering the drug presents significant risks for both parties. But the result of these settlements is often, if not always, anticompetitive: the generic company drops its patent challenge and delays entry of a much lower cost alternative drug, while the branded company continues to charge monopoly prices on a drug with potentially invalid patents—resulting in higher costs for consumers, health plans, and federal and state governments.
One Federal Trade Commission (“FTC”) study found that pay-for-delay agreements cost consumers and taxpayers approximately $3.5 billion in higher drug costs per year. President Biden’s recent Executive Order on Promoting Competition in the American Economy expressly urges the FTC to exercise its rulemaking authority to ban pay-for-delay agreements as part of the White House’s effort to tackle lack of competition in the health care markets.
The legality of a reverse-payment settlement under federal antitrust law is analyzed under the U.S. Supreme Court’s landmark decision in FTC v. Actavis, Inc., 570 U.S. 136 (2013), which held that such payments are unlawful when they are “large and unjustified.” Id. at 158. What constitutes a “large” and “unjustified” settlement is a fact-intensive analysis that ultimately hinges on whether the “patentee seeks to induce the generic challenger to abandon its claim with a share of its monopoly profits that would otherwise be lost in the competitive market.” Id. at 154. The Actavis decision has engendered uncertainty in the law, however, with a significant divergence of opinion regarding the meanings of “large” and “unjustified.”
California Enters the Fray to Ban Pay-For-Delay
The uncertainty created by Actavis gave California an opening to clarify the legality of pay-for-delay agreements by regulating such settlements under state law. Building—and expanding—on Actavis, AB 824 treats pay-for-delay agreements as presumptively anticompetitive when the generic manufacturer receives “anything of value” from the settlement and agrees to delay generic competition. “[A]nything of value” can include “an exclusive license or a promise that the company will not launch an authorized generic version of its brand drug” to compete with the generic. Consistent with Actavis, “anything of value” does not include “compensation for saved reasonable future litigation expenses,” though such costs must be “reflected in budgets” that were “documented and adopted at least six months before the settlement.” Thus, the law shifts the burden of proof from plaintiffs to defendants to show that transfers of value from the patent-holder to the generic that delayed the generic’s entry did not violate the law.
To rebut the law’s presumption of anticompetitive effect, a party must demonstrate by a “preponderance of the evidence” that the generic manufacturer received “fair and reasonable compensation solely for other goods or services that [it] has promised to provide,” and “the agreement has directly generated procompetitive benefits . . . [that] outweigh the anticompetitive effects of the agreement.” This standard finds support both in the Actavis decision itself and the line of cases that impose the so-called “quick-look rule of reason” on a subset of anticompetitive conduct shown to have particularly pernicious anticompetitive effects.
There are other notable provisions of the law. In rendering verdicts under the law, factfinders are instructed not to presume, among other things, that generic entry could not have occurred before patent expiration, or that settlement provisions allowing early entry before patent expiration were procompetitive. The law also defines the “relevant product market” as the brand drug and its AB-rated generic substitutes. And it contains civil penalties “up to three times the value received by the party that is reasonably attributable to the violation of this section, or twenty million dollars ($20,000,000), whichever is greater,” applicable not only to the settling companies, but also to individuals who “assist” with the settlement—language seemingly broad enough to include lawyers who negotiated the pay-for-delay settlements. No doubt the breadth of some of this language will become the locus of later litigation.
California’s Pay-For-Delay Ban Falls to the Dormant Commerce Clause
Although AB 824 is largely consistent with the analytical framework of Actavis, the district court enjoined the law after finding that AAM had established a likelihood of success on the merits that the law violated the dormant Commerce Clause by directly regulating out-of-state commerce.
Judge Nunley’s decision was predicated on what then-Judge Gorsuch in Energy & Env’t Legal Inst. V. Epel, 793 F.3d 1169 (10th Cir. 2015), referred to as “the most dormant doctrine in dormant commerce clause jurisprudence”: the extraterritoriality principal. The dormant commerce clause limits states’ regulatory powers by prohibiting discrimination against, and undue burdens on, interstate commerce.
One strain of dormant commerce clause jurisprudence focuses on extraterritorial regulation, with the “critical enquiry” concerning “whether the practical effect of the regulation is to control conduct beyond the boundaries of the State.” However, this strain of jurisprudence has seldom been applied, and many jurists and scholars have argued that it has either atrophied or should be abandoned. Regardless, as noted by then-Judge Gorsuch in Epel, in the few Supreme Court cases in which the extraterritoriality principle was used to strike down state laws, all dealt with price-control statutes that discriminated against out-of-staters. In other words, such laws were quite unlike AB 824.
Nevertheless, Judge Nunley held that AB 824 likely violated the dormant commerce clause’s prohibition on extraterritorial regulation because it could reach “an agreement in which none of the parties, the agreement, or the pharmaceutical sales have any connection with California.”
Of course, it is hard to imagine that any drug sold in the United States does not enter the stream of California commerce. Yet, the district court also rejected the California Attorney General’s argument that it should “allow California to continue to enforce AB 824 whenever a settlement agreement is made in connection with in-state pharmaceutical sales ‘if that agreement artificially distorts the pharmaceutical market in California.’” The court concluded that such an exception would essentially nullify the injunction because California is the largest consumer of prescription drugs in the country.
The current injunction makes it highly unlikely that AB 824 will achieve what California was hoping for—lower priced drugs for its citizens. Instead, drug companies will simply use their lawyers’ out-of-state offices to negotiate and finalize patent-infringement settlements in order to avoid enforcement actions under the law.
Given the important public interests animating AB 824; the fact that Judge Nunley’s decision rests upon a dated strain of jurisprudence; and that then-Judge Gorsuch now sits on the Supreme Court—the injunction should be appealed. AB 824’s fate affects not just California, but every state striving to operate as a laboratory for novel social and economic experiments regarding matters of great public concern.
Edited by Gary J. Malone
 Constantine Cannon partners Matthew Cantor and Ari Yampolsky submitted an amici curiae brief on behalf of the American Medical Association and California Medical Association in support of the California Attorney General’s successful defense of AB 824 before the U.S. Court of Appeals for the Ninth Circuit in a prior case that was dismissed for lack of standing.
 Ass’n for Accessible Medicines v. Bonta, No. 2:20-CV-01708-TLN-DB, 2021 WL 5853431, at *7 (E.D. Cal. Dec. 9, 2021) (“Bonta I”).
 Ass’n for Accessible Medicines v. Bonta, No. 2:20-CV-01708-TLN-DB, 2022 WL 463313, at *4 (E.D. Cal. Feb. 15, 2022) (“Bonta II”).
 Cal. Health & Safety Code § 134002(a)(1)(A).
 Id. at § 134002(a)(2)(C)(i)-(ii).
 Id.; Moreover, the costs cannot exceed the lower of either $7.5 million, or “five percent” of the generic manufacturer’s forecasted revenue from the first three years of generic sales. If revenue projections are unavailable, “reasonable” costs cannot exceed $250,000. Id. at 134002(a)(1)(C)(i)-(ii).
 Id. § 134002(a)(3)(B).
 Id. at §134002(b)(1) & (2).
 Id. at § §134002(e)(i)-(ii).
 Id. at §134002(e)(1)(A).
 Epel, 793 F.3d at 1170.
 Healy v. Beer Inst., Inc., 491 U.S. 324, 336 (1989).
 See, e.g., Chad DeVeaux, One Toke Too Far: The Demise of the Dormant Commerce Clause’s Extraterritoriality Doctrine Threatens the Marijuana-Legalization experiment, Boston College Law Review 58:3 (June 2017), at 959 Fn. 42, available at https://lawdigitalcommons.bc.edu/cgi/viewcontent.cgi?article=3591&context=bclr.
 Id. at 1173.
 Bonta I, 2021 WL 5853431, at *9.
 Id. at *3.