The Probabilistic Nature of Patent Rights:
In Response to Kevin McDonald
Keith Leffler and Cristofer Leffler*
Presume I recently purchased a new car with a state of the art stereo system. I drove to
the mall and parked in the garage. When I returned to the car the stereo was gone! I replaced the
stereo and parked at the bus station – again, the stereo was stolen. Wise to the thieves, I added
alarms and pit-bulls to the car. Nonetheless, the stereo disappeared.
This scenario raises the following question – do I own the stereo in my car? To most
people the answer is simple and straight forward – of course I own the stereo: I paid for it and it
is in my car. Economically, however, things are more complex. Economically, "ownership of
resources means…that the owner can direct use of that resource."1 Clearly, my decisions did not
control the use of the car stereo. Therefore, economically, I did not "own" it.
Property rights are probabilistic. Whether I have the "right" to play my car stereo
depends on it not being stolen. While the probability may be very high that my decisions will
control the use of most things that I "own," the probability is not certain. This standard
economic proposition has secured its place in economic analysis for decades.2
Patents are property.3 A patent grants to its “owner” a set of “rights” that are
qualitatively no different than any other property rights – they are probabilistic.4 Indeed, patent
rights are far more uncertain than rights to tangible property.5 A patent owner can never be
*
Keith Leffler is an associate professor in the Department of Economics at the University of Washington
specializing in antitrust economics. Cristofer Leffler drafted this article while an associate at Townsend and
Townsend and Crew, LLP. He is currently a staff attorney in the Northwest Regional Office of the Federal Trade
Commission. The views expressed herein are the views of the authors and do not necessarily reflect the views of
their employers.
certain that it will be able to enforce its “right” to exclude others from use of the patented
invention. For instance, a patent owner cannot seize allegedly infringing goods; infringement
may occur without the knowledge of the patent holder; the costs of eliciting government efforts
to exclude an alleged infringer may not justify the effort; and – most importantly – attempts by
the patent holder to enforce its “rights” through the coercive power of the government may result
in a finding of invalidity or non-infringement.6
The fact that patent rights are uncertain, probabilistic rights formed the foundation of
prior analysis that we have published.7 In our previous research we began with the premise that
1) the “rights” of a patent holder are those substantive and procedural rights that Congress has
dictated and 2) the “right to exclude” others from a market and collect monopoly rents is an
uncertain right that can be represented by a probability that a patent will be found valid.
Given the probabilistic nature of patent rights, we analyzed the welfare consequences of
private parties agreeing to settle a patent dispute by agreeing to continue a monopoly and share
the monopoly rents. Such a settlement typically occurs by the patent holder 1) paying the
alleged infringer to stipulate to the patent’s validity and 2) agreeing not to enter the market. For
the remainder of this article we refer to such settlements as “lump sum patent settlements.”
It is obvious that lump sum patent settlements are dominated on a static welfare basis by
a licensing agreement which allows entry of the alleged infringer. There can, however, be
benefits from settlement, and in some circumstances, settlement of a patent dispute cannot be
accomplished via a licensing agreement. In our prior research, we show that it is exceedingly
rare that an efficient settlement of a patent dispute requires a lump sum payment from the patent
holder to the infringer.8 We also show that any benefits from efficient lump sum patent
settlements are minimal compared to the substantial losses from inefficient lump sum patent
2
settlements.9 As a consequence of this analysis, we reach the policy conclusion that lump sum
patent settlements should be per se illegal since this is a case in which "the great likelihood of
anticompetitive effects can easily be ascertained."10
A recent paper published in Antitrust Magazine by an attorney representing defendants in
lump sum patent settlement cases, Kevin McDonald, takes issue with our analysis.11 We here
show that Mr. McDonald's arguments rest on a misunderstanding of the nature of property rights
and of our arguments and analysis. We here also briefly consider some amendments to our
model that arose from a debate in the recent FTC K-Dur hearing.12 In that hearing, Professor
Robert Willig testified that risk aversion implies that lump sum patent settlements should be
evaluated on a rule of reason basis. Our original model did not include risk aversion. We here
consider the impact of risk aversion and find that our results and policy implications are robust to
the consideration of risk aversion.
In Response to McDonald
We believe that confusion is endemic to analysis of patent settlements because of the
inherent static, anticompetitive nature of patents. To have value, patents limit competition.13
Therefore, if having patents is a desirable policy, aren’t private agreements that strengthen
patents also a good thing? Of course, patents can be welfare-enhancing because they promote
dynamic efficiency through increased innovation at the expense of static efficiency. The
balancing of the static-dynamic efficiency tradeoff associated with patents is, however, properly
a subject for Congress.14 Given the tradeoff decided by Congress, private agreements that extend
the monopoly of a patent holder should be viewed as any other private agreement that reduces
consumer welfare. The existing patent rules reflect Congress’ balancing of dynamic and static
efficiency and the extension of those rules to all types of patents in all industries. Because that
3
single set of rules is extended to the entire marketplace, there certainly will be instances in which
the existing rules can be shown to be inefficient as applied to a particular case. Such a
possibility does not however override the decision of Congress as to the bounds of the rights
owned by the holder of a patent.15
Kevin McDonald takes issue with our analysis supporting a per se treatment of lump sum
patent settlements arguing that we fail to properly consider "false positives," or what we termed
"institutional failure."16 McDonald’s essential idea is that a federal court adjudicating a patent
dispute might erroneously conclude that the patent is invalid. According to McDonald, the risks
of such erroneous conclusions can cause sub-optimal investments in research and development,
and, accordingly, the patent holder should be permitted to pay the challenger to recognize the
validity of the patent.17 McDonald suggests that a proper resolution of the possibility of false
positives is to require an antitrust plaintiff challenging the lawfulness of a lump sum settlement
to establish in the antitrust litigation that the patent, in fact, is invalid.18 However, McDonald
ignores a number of issues we raised that counter this argument.19
First of all, the right that Congress gave to patent holders as a reward for their invention
was the right to seek redress in the federal courts.20 Congress expressly designated the federal
courts as the body with institutional authority to determine patent validity and infringement.21
Moreover, Congress did not provide, as it might have, that a patent once issued by the PTO is
conclusively presumed to be valid. Congress provided that patents shall enjoy only a rebuttable
presumption of validity.22 McDonald nevertheless asserts that there is an "objective reality" as to
whether a patent is in fact valid, regardless of what a federal court may say.23 This simply
ignores the fact that patent rights are probabilistic rights – the only objective reality is that
decided by the courts. That this set of rights is probabilistic does not mean that the patent “does
4
not really exist until you go to court” or that the patent is “unborn.”24 Rather, in any patent
dispute, until determined by a federal court, there is a probability of invalidity and/or nonfringement.
If we accept the notion that there is an "objective reality" independent of the court’s
decision, why wouldn’t a patent holder be justified in avoiding an "erroneous" federal court
decision by paying the challenger to confess validity and infringement after a federal court has
adjudicated the patent to be invalid? If there is an "objective reality" indicating that a federal
court's determination of patent invalidity represents an instance of "institutional failure," that
objective reality exists regardless of whether the payment is made to avoid an erroneous federal
court decision in advance or to avoid it after it has been rendered. McDonald's theory of
institutional failure thus implies that a patent holder should be permitted to pay a challenger to
stay out of the market even after a federal court has found the patent to be invalid.25
Contrary to McDonald’s view as to the objective reality of a patent’s validity, the actual
objective reality is that Congress prescribes the rights given to patent holders for innovation, and
Congress has given the right to have patent infringement and validity determined through a
defined process of federal court litigation.26 A proper antitrust analyses must take those
Congressionally-defined rights as a given -- it cannot decree the results of that process to be
"erroneous" because they fail to measure up to an "objective reality" that exists in some lawyer's
or economist's head. Thus, we claim that for purposes of antitrust analysis, there are and can be
no "erroneous" decisions reached by courts in patent litigation.
McDonald's argument also ignores real world “transactions costs” in attempting to
demarcate efficient outcomes.27 It is a well-known economic proposition that absent transactions
costs, society reaches efficiency regardless of the allocation of rights.28 We would agree that
5
absent any cost of examining all aspects of a patent claim and a patent settlement, a rule of
reason analysis would be appropriate, and efficient lump sum patent settlements should be
allowed. Yet, how is society to identify those cases given the real world of transactions costs?
Under McDonald’s conception of patent rights, federal courts reach "false positives." In this
environment, how does McDonald propose to ascertain "objective reality?" He suggests that the
"objective reality" that a federal court adjudicating the patent litigation “failed” to ascertain is to
be determined by . . . a federal court!29 He asserts that the need to avoid an erroneous decision
by a court in the underlying patent litigation requires that the validity of the patent be determined
as one part of the subsequent antitrust litigation conducted in federal court.30 This is not, in our
opinion, a satisfactory way to rectify any "false positives" reached by those very courts.
In addition, the analysis in the McDonald paper purportedly addresses the possible
efficiency of a lump sum settlement.31 However, the evaluation of the efficiency of the
settlement is based on an implicitly costless determination of the validity of the patent – that is,
the settlement is evaluated only after all uncertainty as to the patent is eliminated. This approach
simply avoids the issue of the efficiency of alternative settlements. If a patent is known to be
valid, the patent holder will agree to a settlement only if it results in the full monopoly profit.
Lump sum transfers are then not relevant to efficiency. If a patent is known to be invalid, then
no settlement limiting competition in any way should be allowed. Hence, implicitly McDonald’s
approach implies “settlements” are of no consequence, rather, the courts just decide whether the
patent is valid or invalid (or there is or is not infringement.)
Our approach to analyzing the problem of the efficiency of settlements is quite different
than Mr. McDonald’s. We base our analysis on the premise that Congress has created a system
balancing static and dynamic efficiency in a way that implies uncertainty as to the validity of a
6
patent.32 Through a process of infringement litigation or declaratory judgment, courts can decide
the validity or invalidity of a particular patent, and thereby the extent of competition that will be
present in a market. If a patent is in dispute, we presume that the proper forum for determination
of the extent of competition is the court.33
Given the ever present uncertainty of the validity of a patent, the expected result from
(costless) litigation necessarily increases consumer welfare.34 Litigation is, however, not
costless. Therefore, settlements of patent litigation can be efficient. Of course, the incentive of
settling parties is to limit competition and share any available monopoly profits. However,
settlements that license the alleged infringer in a way that allows effective entry by the infringer
necessarily reduce the price and thus increase consumer welfare compared to the monopoly
position. Hence, it is appropriate to address such licensing agreements via a rule of reason. A
rule of reason analysis can balance the certainty of the increased consumer welfare from the
settlement and the savings in litigation costs against the reduction in consumer welfare if the
patent had been found invalid.
Unlike a settlement that licenses the alleged infringer, a lump sum patent settlement
perpetuates the monopoly situation – thereby decreasing consumer welfare. Therefore,
compared to a lump sum settlement, a licensing settlement more closely approximates the
expected result from having the courts judge the validity of the patent. This underlies our basic
conclusion that lump sum patent settlements should not be allowed.35 However, there are cases
in which a licensing settlement cannot occur because of the disparate beliefs of the disputing
parties. Recognizing that litigation is costly, in these cases it is possible that a lump sum
settlement is efficient because of savings in litigation costs.36 Hence, in our view, the relevant
questions concern the likelihood of such efficient lump sum patent settlements, the expected
7
benefits from such settlements, and the costs of determining what are efficient and inefficient
lump sum patent settlements.
In our prior research we present a model of patent litigation. We show that nearly all
cases in which a lump sum payment, rather than a licensing fee, is needed for patent settlement
are situations in which litigation is preferable on a welfare basis to settlement.37 We find that the
likelihood that a lump sum payment is needed for an efficient resolution of a patent dispute is
substantially less than one percent.38 Since the adverse welfare effects of lump sum patent
settlements substantially dominate any benefits, and since court determination of whether a
particular lump settlement is one of those rare cases of an efficient lump sum settlement, we
concluded per se illegality is appropriate.39 Mr. McDonald’s paper simply raises no issue
contrary to this conclusion.
Risk Aversion and Lump Sum Settlements
In the recent K-Dur case before the FTC, both the government’s expert economist, Tim
Bresnahan, and the complainant’s expert economist, Robert Willig, evaluated the efficiency of
lump sum patent settlements.40 As we have also shown, both testified that an efficient settlement
could possibly require payment from the patent holder to the alleged infringer. Professor Willig
argued that this possibility justified a rule of reason approach towards lump sum patent
settlements. In essence, Professor Willig found that the efficiency of settlement increases if the
disputing parties discount the benefits from litigation because of risk aversion. He therefore
concluded that the benefits from those settlements which can occur only if there are lump sum
payments are greater with risk aversion. 41
We do not find Professor Willig’s opposition to a per se rule against lump sum patent
settlements compelling. Professor Willig provides no analysis of the quantitative significance of
8
any efficiency-increasing lump sum patent settlements versus efficiency-decreasing lump sum
patent settlements as a consequence of any relevant risk aversion.42 Just because it is possible
that a lump sum payment from a patent holder to an infringer may be necessary for an efficient
settlement, this does not inform us as to the appropriate policy towards such settlements. Per se
rules result from the courts’ judgments that certain economic practices are almost always
anticompetitive.43 For example, it is certainly possible that price fixing may in rare and unlikely
situations increase welfare. 44 This does not imply that the courts ought to examine each case on
a rule of reason basis. Rather, any possible losses from preventing efficient price fixing will be
swamped by the costs of evaluating each case, and the costs of allowing, by mistake, inefficient
price fixing. Therefore, if risk aversion should be considered in a welfare evaluation of lump
sum patent settlements, it is important to determine how much it matters.
In our earlier research, we considered the case of an alleged patent infringement with
various possible expectations as to the validity of the patent. We performed a simulation
analysis of many alternative assumptions of patent validity and alternative assumptions about the
costs of litigation. We found that that it was extremely unlikely that a lump sum payment was
needed to reach an efficient settlement, and that typically lump sum settlements were
inefficient.45 Hence, our conclusion that lump sum payments from the patent holder to the
alleged infringer should be per se illegal.
Our analysis did not include risk aversion. We have now considered risk aversion.46 As
expected, risk aversion does reduce the likelihood that a patent dispute will not be settled.
However, it does this mainly by increasing the probability that one or the other party will not
pursue litigation. Contrary to Professor Willig’s conjectures about the impact of risk aversion on
the value of lump sum patent settlements, we find that efficient lump sum patent settlements are
9
even rarer in the presence of risk aversion. For the risk aversion situation considered, efficient
settlements are achieved with lump sum payments from the patent holder to the alleged infringer
with only about a one tenth of one percent probability. And the welfare losses from the far more
likely inefficient lump sum settlements are over ten times greater than any possible welfare
gains, and this comparison ignores the additional and substantial welfare losses that would occur
if lump sum patent settlements were allowed because of the many cases that otherwise would
have settled with a welfare enhancing licensing fee.
We therefore have concluded that the inclusion of risk aversion does not alter in any way
the appropriate policy towards lump sum payments from a patent holder to an alleged infringer.
These payments should be treated just like any payment to a competitor to cease entry efforts –
they should be per se illegal.
Concluding Remarks: The Per Se Rule is Particularly Important in the Pharmaceutical
Industry
The conclusion that lump sum patent settlements should be per se illegal is particularly
compelling in the circumstances of challenges to pharmaceutical patents. In 1984, Congress
passed the Hatch-Waxman Amendments to the Federal Food, Drug, and Cosmetic Act, 21
U.S.C. § 301, et seq. (1994) (the “Act”) "after concluding that the Act's 'cumbersome drug
approval process delayed the entry of relatively inexpensive generic drugs into the
marketplace.'"47 Through the Hatch-Waxman Amendments, Congress intended "to make
available more low cost generic drugs."48 Congress attempted to "balance two conflicting policy
objectives: to induce name-brand pharmaceutical firms to make the investments necessary to
research and develop new drug products, while simultaneously enabling competitors to bring
cheaper generic copies of those drugs to market."49
10
In furtherance of the first objective, to induce name-brand pharmaceutical firms to make
the investments necessary to research and develop new drug products, the Hatch-Waxman
Amendments provide that in the context of certain patent litigation between brand-name and
generic drug manufacturers, the FDA is prohibited from approving the generic manufacturer’s
application to market the allegedly infringing product until 30 months after the initiation of the
patent litigation.50 In this context the brand-name manufacturer has received from Congress an
automatic 30-month preliminary injunction without the necessity of meeting the usual
requirements.51 By including this "30-month preliminary injunction" in the Hatch-Waxman
Amendments, Congress granted additional, highly valuable, exclusion rights to patent holders in
the pharmaceutical industry.
Similarly, to encourage competitors to bring cheaper generic copies of brand name drugs
to market, the Hatch Waxman Amendments provide special benefits to generic manufacturers in
the form of a 180-day exclusive marketing period.52 This exclusive marketing period can, and
has, had severe and unintended anticompetitive effects. Several recent patent infringement cases
involving brand-name and generic pharmaceutical manufacturers have involved payments from
the patent holder to the challenger that, under the Hatch Waxman Amendments, had the effect of
preventing entry not only by the challenger who received the payment, but by all generic
manufacturers.53 This occurs because a generic manufacturer who possesses the right to the 180day exclusive marketing period can forego marketing its generic (in return for a cash payment)
thereby preventing the exclusive 180-day clock from running. This potential exponential entrydeterring effect of the payment provides additional motivation to settle and additional
anticompetitive impact from settlement. 54
11
The manner in which the special provisions of Hatch-Waxman Amendments
came about is instructive as to why courts are an inappropriate forum for the balancing between
dynamic and static efficiency inherent in patent issues. The additional exclusion right granted by
Congress to pharmaceutical manufacturers was the result of political bargains struck between the
generic manufacturers (who wanted faster and easier approval of their generic drugs) and brandname manufacturers (who were able to extract these valuable exclusion rights, in addition to
many others, as part of the bargain).55 Whether Congress got the balance between static and
dynamic efficiency right is not the issue. Rather, the point is that Congress is the
constitutionally-mandated forum in which such balancing occurs. Allowing purchase of
exclusion beyond that granted by Congress allows private parties to achieve rights not granted by
Congress.
1
Eugene Silberberg, Microeconomics 265 (2 nd ed. 1999)
2
See, e.g., Armen A. Alchian and W.R. Allen, University Economics (1st ed. 1964).
See, e.g. Jay Dratler, Jr., Licensing of Intellectual Property §1.01 (2002) (“[I]ntellectual property; is intangible
personal property in creations of the mind. In legal terms, intellectual property includes…patents.”); U.S.
Department of Justice Licensing Guidelines: 1995 Antitrust Guidelines for the Licensing of Intellectual Property, §
3.6. Intellectual Property Licensing Arrangements, (“For the purpose of antitrust analysis, the Department regards
intellectual property (e.g., patents…) as being essentially comparable to any other form of tangible or intangible
property.”)
3
4
See 35 U.S.C. § 262 (“[P]atents shall have the attributes of personal property.”)
5
See, e.g., Richard J. Gilbert and Willard K. Tom, Is Innovation King at the Antitrust Agencies? The Intellectual
Property Guidelines Five Years Later, 69 Antitrust L. J. 43, 47 n.8 (2001) ("the boundaries of intellectual property
defy accurate survey to a much greater extent than do those of tangible property"). Even in litigated cases, such as
the recent FTC K-Dur litigation (In the Matter of Schering-Plough Corp., Upsher Smith Lab’s, and American Home
Products Corp., FTC Docket 9297, June 27, 2002) (“K-Dur litigation”), the defendants' expert began his analysis
from the assumption that the rights embodied in a patent are properly viewed as "probabilistic." See, Testimony of
Robert Willig before the Federal Trade Commission, at p. 7194 (“Willig Testimony”); and id. at pp. 7151 and 7160.
This is the accepted view among economists and commentators regardless of the particular issue in dispute. See,
e.g., Mark A. Lemley, Intellectual Property Rights and Standard-Setting Organizations, 90 Cal. L. Rev. 1889 n.179
(2002) ("the effort to map the words of patent claims to products is inherently an uncertain one"); Michael A. Glenn,
Symposium Presentation: Business and Patents and Business Patents, 22 Hastings Comm. & Ent. L. J. 203, 206
(2000) ("The scope of coverage is uncertain .... So you don't really know what they cover until they're also tested in
court."); Steve P. Calandrillo, An Economic Analysis of Intellectual Property Rights, 9 Fordham Intell. Prop. Media
& Ent. L. J. 301, 333 (1998) (patents "are often uncertain as to scope"); Rebecca S. Eisenberg, Patents and the
Progress of Science: Exclusive Rights and Experimental Use, 56 U. Chi. L. Rev. 1017, 1083 (1989) ("the scope of
patent claims is often uncertain until the claims are construed in litigation.").
12
6
When a firm is granted a patent, there is a significant probability that a court, if asked, may declare the patent
invalid or not infringed. See, e.g., Kevin McDonald, Hatch-Waxman Patent Settlements and Antitrust: On
“Probabilistic” Patent Rights and False Positives, Antitrust Magazine, Spring 2003 at 68 (“McDonald”) (quoting
Seymour E. Hollander, Why ADR May Be Superior in Patent Disputes, 2 No. 1 Intell. Prop. Strategist 1, at *6 (1995)
(“it is always a ‘gamble…[to place] a technology case in the hands of a lay judge or jury’”); and Steven Z.
Szczepanski, Licensing or Settlement: Deferring the Fight to Another Day, 15 AIPLA Q.J. 298, 300-01 (1987) (the
“chances of prevailing in [patent] litigation rarely exceed seventy percent…even in that rare case with great
prospects.”).
7
Keith Leffler and Cristofer Leffler, Want to Pay a Competitor to Exit the Market? Settle a Patent Infringement
Case, ABA Economics Committee Newsletter, Spring 2002 at 26 (“Leffler I”); and Settling the Controversy Over
Patent Settlements: Payment by the Patent Holder Should be Per Se Illegal, forthcoming, Research in Law and
Economics (“Leffler II”), available at http://www.econ.washington.edu/research/wkg_papers.asp.
8
See Leffler II, supra note 7 at 12-13.
9
See id. at 15.
10
California Dental Association v. F.T.C., 526 U.S. 756, 770 (1999).
11
McDonald, supra note 6.
12
K-Dur Litigation, supra note 5.
See, e.g., Courtney J. Miller, Patent Law and Human Genomics, 26 Cap. U. L.R. 893, 904 (“Intellectual property
("IP") is any product of the human intellect having commercial value derived from the owner’s ability to exclude
others from using it.”) (citing Stephen Elias, Patent, Copyright & Trademark 2 (Lisa Goldoftas ed, 1996); also
Const. Art. I § 8 cl. 8 (“To promote the Progress of Science and useful Arts, by securing for limited Times to
Authors and Inventors the exclusive Right to their respective Writings and Discoveries”).
13
14
See, i.e., Smithkline Beecham Corp. v. Apotex Corp., 2003 U.S. Dist. Lexis 2902, *108, *120 (Judge Richard
Posner explaining that Congress is the institution vested with the power to determine patent rules and policy).
15
If the appropriate policy is to allow private parties to alter the patent rules if they could show that the alteration
was efficient in a particular circumstance, symmetry would imply that consumers should be permitted to sue under
the antitrust laws whenever in a particular instance the patent laws grant too much exclusion, e.g., when economic
analysis shows that the “right” patent length is 5 years instead of 20.
16
McDonald, supra note 6 at 69-75
17
See id. at 74-75
18
Id. at 75.
19
Unfortunately, Mr. McDonald did not request, and apparently did not read our detailed analysis in Leffler II
before drafting his article.
See, 28 U.S.C. § 1338(a) (“The district courts shall have original jurisdiction of any civil action arising under any
Act of Congress relating to patents…”).
20
21
Id.
22
See 35 U.S.C. § 282.
23
See, e.g., McDonald, supra note 6 at 69.
24
See id. at 71.
Consideration of the notion of “objective reality” leads to even more troubling implications. For example,
suppose economic research shows that the optimal patent length for a particular invention is 25 years rather than the
20 decreed by Congress. In such a case, there has been an "institutional failure" resulting from Congress accepting a
"false positive" -- its false conclusion that the additional 5 years was inefficient and therefore should be disallowed.
Presumably, the theory of "false positives" or "institutional failure" would permit the patent holder to pay a potential
25
13
entrant to recognize the validity of the patent for an additional 5 years, and any antitrust plaintiff would be required
to prove that the additional 5-year term was in fact inefficient.
26
Supra note 20.
27
The most significant transactions costs in the current context are the costs of defining, policing and enforcing
property rights.
28
This is a form of the Coase Theorem. Ronald Coase, The Problem of Social Cost, Journal of Law and Economics
3, at 1-44 (1960).
29
McDonald, supra, note 6 at 69 & 75. Stephen Hawking relates the story of a well-known scientist (some say it
was Bertrand Russell) who, at the end of a lecture on the earth's place in the galaxy, was confronted by an elderly
woman who asserted, "What you have told us is rubbish. The world is really a flat plate supported on the back of a
giant tortoise." When the scientist replied, "What is the tortoise standing on?" the response was "You're very clever
young man, very clever, but it's turtles all the way down." See Steven W. Hawking, A Brief History of Time 1
(Bantam Doubleday Dell 1998). See also Roger C. Cramton, Demystifying Legal Scholarship, 75 Geo L. J. 1, 2
(1986) (examining the history of the turtle example, with William James as the correspondent of the tale). In
McDonald’s world, it’s the courts all the way down.
30
See, e.g., id. at 75.
31
See McDonald, supra note 6 at 74-75.
32
See, Leffler II, supra note 7 at 18-22 & 26-27.
33
See, supra, note 20.
34
See, Leffler II, supra note 7 at 4.
35
See, id. at 3-17.
36
Since the McDonald analysis ignores any costs of litigation, we see no possible benefits to allowing lump sum
patent settlements in the context of his approach.
37
See Leffler II, supra note 7 at 3-17.
38
See, id. at 16 & Table 4.
Contrary to Mr. McDonald’s assertion that the notion that reverse payments should be per se illegal has “faired
poorly” (McDonald, supra note 6 at 68), many thoughtful commentators appear to support the rule that such
payments should be per se unlawful (see, e.g., Remarks of FTC Commissioner Sheila F. Anthony, Riddles and
Lessons from the Prescription Drug Wars: Antitrust Implications of Certain Types of Agreements Involving
Intellectual Property at p. 4 (June 1, 2000), available at www.ftc.gov/speeches/anthony/stip000601.htm; FTC
Commissioner Thomas B. Leary, Antitrust Issues In the Settlement of Pharmaceutical Patent Disputes, Part II (May
17, 2001), available at www.ftc.gov/speeches/leary/learypharmaceuticalsettlement.htm; and David Balto,
Pharmaceutical Patent Settlements: The Antitrust Risks, 55 Food Drug L.J. 321, 334 (2000)); Indeed, most cases -including one in which Mr. McDonald serves as defense counsel -- have concluded that a finding of patent invalidity
is not necessary to a finding of antitrust liability (see, e.g., In re Ciprofloxacin Hydrochloride Antitrust Litig., 166 F.
Supp. 2d 740, (E.D.N.Y. 2001); Eon Labs Manufacturing, Inc. v. Watson Pharmaceuticals, Inc., 164 F. Supp.2d 350
(S.D.N.Y. 2001); In re Terozosin Hydrochloride Antitrust Litigation, 164 F. Supp.2d 1340 (S.D. Fla. 2000); See,
also, McGrew v. Schering-Plough Corp., No. 01-2311-GTV, 2001 U.S. Dist. LEXIS 12205, at *9 (D. Kan. Aug. 6,
2001) (“Plaintiff’s claims do not require the court to determine whether Schering-Plough’s patent on K-Dur 20 is
valid, and if so, whether Upser-Smith and/or ESI infringed upon Schering-Plough’s patent. Instead, plaintiff’s
claims require the court to determine whether defendants entered into one or more conspiracies with the intent to
prevent or restrain competition of the sale of K-Dur 20 in Kansas.”); Altman v. Bayer Corp., 125 F. Supp. 2d 666,
674-75 (S.D.N.Y. 2000) (“Here, the plaintiff has alleged that defendants acted with an impure heart when Bayer
brought litigation against Barr for patent infringement; entered into the Stipulation to extend the 30-month waiting
period; signed the Agreement in which Barr agreed not to market its generic Cipro in exchange for $24.5 million;
and entered into a consent judgment acknowledging the validity of Bayer’s patent. Following Christianson [v. Colt
39
14
Indus. Operating Corp., 486 U.S. 800, 809 (1988)], plaintiff’s alternate theories make it unnecessary to resolve any
substantial question of patent law for plaintiff to prevail.”)).
40
The models used by Professors Bresnahan and Willig evaluated the welfare of settlements based on the expected
time of entry under litigation and under settlement. We have reviewed the testimony of the experts but have not had
access to the details of their models due to confidentiality constraints. Based on their testimony, the qualitative
implications of their analysis are the same as those in our analysis
41
See, e.g., Willig Testimony at pp. 7149, 7169-70, 7182, 7191, 7208, and 7227.
42
It is certainly not obvious that the risk preferences of the managers of the companies involved in a patent dispute
are relevant to the welfare evaluation of a settlement. Most patent settlements concern agreements between
publicly-traded corporations. The risks such firms face from patent litigation should be easily diversifiable through
a portfolio including the litigating parties. While corporate managers may or may not exhibit risk aversion in
making their decisions (contrary to the interests of the owners of the firms), it certainly is not clear that competition
policy should account for such preferences at the expense of consumer welfare. Indeed, we are unaware of any
economic or legal literature concerning the rule of reason that considers risk aversion in a balancing of pro and
anticompetitive impacts.
See, e.g., Arizona v. Maricopa County Medical Soc., 102 S.Ct 2466, 2473 (1982) (“Once experience with a
particular kind of restraint enables the Court to predict with confidence that the rule of reason will condemn [the
conduct], [the Court] has applied a conclusive presumption that the restraint is unreasonable.”)
43
44
For example, price fixing will generally increase the incentive to engage in product enhancements and quality
increases. Since some product enhancements cannot be patented, under competition there may be sub-optimal
incentives to invest in such projects. It is, therefore, theoretically possible that a price fix may help in correcting an
inefficiency and, on net, increase welfare. Consider, alternatively, a case in which there are negative externalities
associated with the consumption of a good – for example, the generation of smog through the use of gasoline. In
that case, the private decisions concerning the consumption of gasoline will lead to more than the efficient amount
of gasoline being purchased. A price fix may then lead to an efficient reduction in consumption.
45
We considered those cases in which a welfare dominating licensing settlement could not be reached but settlement
was possible with a lump sum payment. Such cases were rare occurring only about 1 percent of the time, and in over
90 percent of such situations, the lump sum settlement was inefficient and the welfare losses from inefficient lump
sum settlement were many times any gains from efficient lump sum settlements.
46
The details of our results are available in Risk Aversion Appendix available at
http://www.econ.washington.edu/research/wkg_papers.asp. .
47
In re Cardizem CD Antitrust Litigation, 105 F.Supp.2d 682, 685 (E.D. Mich. 2000) (quoting Mylan Pharm., Inc.
v. Shalala, 81 F.Supp.2d 30, 32 D.D.C. 2000).
48
Id.
49
Id.
50
See 21 U.S.C. § 355(j)(5)(B)(iii); Mylan Pharm., Inc. v. Shalala, 81 F.Supp.2d 30, 32-33 (D.D.C. 2000)
51
Id.
52
21 U.S.C. 355(j)(5)(B)(iv) provides: "If the [abbreviated new drug] application contains a certification [that the
patent for the pioneer drug is either invalid or will not be infringed by the marketing of the generic drug] and is for a
drug for which a previous application has been submitted under this subsection continuing such a certification, the
application shall be made effective not earlier than one hundred and eighty days after--(I) the date the Secretary
receives notice from the applicant under the previous application of the first commercial marketing of the drug under
the previous application, or (II) the date of a decision of a court in an action described in clause (iii) holding the
patent which is the subject of the certification to be invalid or not infringed, whichever is earlier." Id.
"Accordingly, the 180-day period of exclusivity 'can be triggered in one of two ways -- either (1) when the generic
producer begins commercial marketing of its drug…or (2) when there is a court decision finding the pioneer drug
maker's patent invalid or not infringed.'" In re Cardizem CD Antitrust Litigation, 105 F.Supp.2d at 686 (quoting
Mylan Pharm., 81 F.Supp.2d at 33).
15
53
See, e.g., In re Ciprofloxacin Hydrochloride Antitrust Litigation, 166 F.Supp.2d 740 (E.D.N.Y. 2001); In re
Cardizem CD Antitrust Litigation, 105 F.Supp.2d 682 (E.D. Mich. 2000); In re Terazosin Hydrochloride Antitrust
Litigation, 164 F.Supp.2d 1340 (MDL 2000).
In his earlier work, Patent Settlements and Payments that Flow the “Wrong” Way: The Early History of a Bad
Idea, 15 ABA Healthcare Chronicle No. 4 at 2 (Winter 2002), Mr. McDonald correctly notes that the large disparity
in profit margins earned by pioneer and generic drug manufacturers increases the range in which settlement of the
patent litigation is likely. McDonald, Health Care Chronicle, at p. 10. But his conclusion, that “[t]hus we see that
Hatch-Waxman . . . dictates the direction in which the money is likely to flow in a settlement (because the generic
has so much less at stake),” is simply a non-sequitur. McDonald's analysis of the incentives to settle demonstrates
only that (1) settlement of the patent litigation can be rational for both parties in light of the probability that the
patent will be found invalid; and (2) the pioneer manufacturer may have a greater incentive than the generic
manufacturer to settle, even if both share the same view of the probability of a finding of invalidity. But HatchWaxman does not dictate that any money flow from the patent holder to the challenger. Instead of the patent holder
paying the challenger to eliminate that risk/probability, the parties can simply settle the patent litigation with the
challenger extracting from the patent holder a license whose royalty rate reflects the parties' respective views of the
risk/probability and the value of it to each. Nothing in Hatch-Waxman “dictates,” or even vaguely hints, that the
parties do the former rather than the latter.
54
55
See Alfred B. Engelberg, Special Patent Provisions for Pharmaceuticals: Have They Outlived Their Usefulness?,
39 IDEA 389, 403-06 (1999).
16