This article was first published in the October 2007
Intellectual Property Supplement to The Legal Intelligencer.
Owning a U.S. patent is not what it used to be. A series of federal court decisions over the past year and a half have eroded away much of the leverage traditionally offered by patents. Significant changes began in May, 2006, when the U.S. Supreme Court’s holding in eBay v. MercExchange took away what many considered to be a patent owner’s strongest weapon: the threat of an automatic injunction against infringers. Patent owners saw their bargaining position worsen after MedImmune v. Genentech, which held that patent licensees can challenge the validity of the patent without breaching their license and risking willful infringement. Then, the Federal Circuit’s decision in SanDisk v. STMicroelectronics put a damper on patent licensing, suggesting that “friendly discussions” about a license can land a patent owner in a declaratory judgment suit. Finally, Seagate II and bills pending before Congress have suggested that patent owners will see lower damages awards and a tougher standard for collecting enhanced damages for willful infringement.
Local governments have also weighed in on patents. In Biotechnology Industry Organization, et al. v. Dist. of Columbia, (Fed. Cir. 2007), patent owners successfully challenged a local law that imposed price restrictions on patented prescription drugs. Patent owners scored a badly needed victory with the decision, which emphasized the importance of rewarding innovation.
THE DRUG PRICING CONTROVERSY
Drug pricing in the United States has been challenged by consumer advocates for decades. By some estimates, prices of patented prescription drugs in the U.S. are as much as 30% higher than in Canada, and as much as 40% higher than in Europe. There are many theories for the price differential. Advocates for drug companies claim that drug prices charged in the U.S. reflect high R&D costs. They contend that lower prices in other countries are caused by foreign government regulations that cap the price of drugs in those countries, forcing U.S. consumers to shoulder most of the R&D costs. Opponents argue that higher U.S. drug prices subsidize the drug companies’ expensive marketing practices, rather than actual research. There are many opinions on the issue, and plenty of finger-pointing to go around.
THE D.C. ACT
In September, 2005, the District of Columbia’s City Council passed “The Prescription Drug Excessive Pricing Act”, D.C. Act §§ 28-4551 et seq., (“D.C. Act”). The D.C. Act prohibited manufacturers and licensees of drug manufacturers from selling patented drugs in the District of Columbia for an “excessive price.” Point of sale retail sellers were excluded from enforcement of the D.C. Act. The term “excessive price” was not specifically defined, but the statute stated that a prima facie case of excessive pricing was established where the wholesale price of a patented drug in the District was over 30% higher than a comparable price in any high income country in which the product is protected by patents or other exclusive rights. If prima facie excessive pricing was shown, the burden shifted to the defendant manufacturer to prove that the drug was not excessively priced “given demonstrated costs of invention, development and production of the prescription drug, global sales and profits to date” and other factors.
If the defendant could not meet its burden, and the court found that excessive pricing was the result of the manufacturer’s wholesale pricing, the court could apply a number of remedies, including temporary, preliminary or permanent injunctions against sales of the patented drugs in the District, fines for each violation, damages, attorney’s fees and costs of litigation.
The D.C. City Council explained the purpose of the legislation, noting that excessive prices of prescription drugs sold within the District of Columbia threatened the health and welfare of its residents. City Council relied on traditional police powers, which included protecting and promoting the health, safety and welfare of its residents, regulating monopoly pricing of goods and services, assuring consumer protection, and preventing unfair trade practices. The D.C. Act took effect on December 10, 2005.
THE DISTRICT COURT CHALLENGE
Opponents to the D.C. Act were quick to pounce. In fact, two organizations filed suit to challenge the D.C. Act before it became effective. Pharmaceutical Research and Manufacturers of America (PhRMA) filed suit in the U.S. District Court for the District of Columbia, alleging that the D.C. Act was facially unconstitutional under the Supremacy and Foreign Commerce Clauses. PhRMA also challenged the D.C. Act under the Interstate Commerce Clause as it applied to transactions occurring wholly outside the District. At the time, PhRMA was a non-profit organization whose members included companies who manufactured and sold patented prescription drugs from facilities mainly outside the District of Columbia, and who sold mostly to wholesalers that were located outside the District. PhRMA filed a motion for a temporary restraining order and a preliminary injunction against the District of Columbia, its officials and its representatives.
Shortly after PhRMA filed suit, the Biotechnology Industry Organization (“BIO”) filed a similar suit. At that time, BIO was a biotechnology organization whose members included companies manufacturing and selling patented prescription drugs to entities mainly outside of the District of Columbia. Members of both PhRMA and BIO occasionally sold patented drugs and products directly to parties within the District.
The district court consolidated the two actions, and held that PhRMA and BIO demonstrated standing to make a pre-enforcement challenge to the D.C. Act. The district court went on to hold that the D.C. Act clearly violated the Supremacy Clause, finding that the Act was an obstacle to the purposes behind federal patent laws, particularly the Drug Price Competition and Patent Term Restoration Act of 1984, or “Hatch-Waxman Act”. The Hatch-Waxman Act allows pharmaceutical manufacturers to, among other things, extend their patent term to compensate for marketing time that is lost during the development and approval phase of a patented drug. Although this isn’t related to pricing, the general objective of the Hatch-Waxman Act, as viewed by the district court, is to encourage and reward the innovation, research and development of new drugs. Because the D.C. Act forced drug manufacturers to lower prices or face expensive litigation, the district court held that the D.C. Act conflicted with the objectives of the Hatch-Waxman Act, and therefore was preempted.
The district court also held that the D.C. Act violated the Interstate Commerce Clause. The D.C. Act was not invalidated on its face, but only as it applied to sales occurring entirely outside the District. The district court further held that the D.C. Act did not violate the Foreign Commerce Clause. The plaintiffs’ claims for declaratory and injunctive relief under the Supremacy and Interstate Commerce Clauses of the Constitution were granted.
APPEAL TO THE FEDERAL CIRCUIT
The District of Columbia appealed the district court’s declaratory judgment decision under the Supremacy and Foreign Commerce Clauses. The appeal was filed with the U.S. Court of Appeals for the District of Columbia Circuit and transferred to the Court of Appeals for the Federal Circuit.
Before addressing the Supremacy Clause issue, the Court addressed an interesting question concerning subject matter jurisdiction. The Federal Circuit has exclusive jurisdiction over appeals from final decisions in district court actions arising under patent laws. The problem was that the decision on appeal was not a typical patent law issue, e.g. infringement, validity or unenforceability of a patent. The Court cited to a 1988 Supreme Court Opinion holding that the Federal Circuit’s jurisdiction extends to: (1) causes of action under federal patent law or (2) where the plaintiff’s claim “necessarily depends on resolution of a substantial question of federal patent law.” The Court concluded that it had proper subject matter jurisdiction under the second ground, relying on two prior cases where it exercised subject matter jurisdiction over appeals concerning state law tort claims involving patents. Interestingly, the outcomes of the two tort cases depended on whether the involved patents were valid, enforceable and infringed – substantial questions of patent law. In PhRMA, no substantial questions of patent law were really involved, only an examination of congressional policy behind federal patent laws. Nevertheless, subject matter jurisdiction was found.
On the preemption issue, the Court affirmed the district court’s judgment, agreeing that the D.C. Act was an “obstacle to the federal patent law’s balance of objectives as established by Congress.” The Court acknowledged that the District of Columbia has general police power within its borders, but cautioned that general police power must yield to specific Congressional enactment. According to the Court, the D.C. Act specifically targeted patented products, acting exclusively within the scope of patent laws. Moreover, the D.C. Act penalized high prices and limited a patent owner’s exercise of market power derived from the patent. Because the D.C. Act impermissibly altered the statutory incentive scheme, the Court held that federal patent law preempted the D.C. Act in its entirety. The Court did not need to address the Foreign Commerce Clause argument, in view of its holding under the Supremacy Clause.
In contrast to the district court, which looked to federal laws relating to patented drugs, the Federal Circuit started its analysis with the U.S. Constitution. Citing to Article I, Section 8 and prior decisions, the Court noted that the fundamental goal of patent law is to promote the progress of science and useful arts. According to the Court, innovators are encouraged to take on the investment and risk of developing new technologies because of the pecuniary rewards that stem from patent rights. Congress’s purposes of encouraging innovation are reflected through the statutory incentive scheme. The Court refers to legislative history behind the Hatch-Waxman Act, but only as it pertains to the importance of promoting innovation generally. Therefore, the Court’s analysis emphasizes the broader purposes of the federal patent laws generally, and not just those laws favoring drug manufacturers. The Federal Circuit’s decision is therefore an important policy victory for all patent owners. While the Hatch-Waxman Act was pertinent to the plaintiffs, the broader objectives of the federal patent laws were considered just as important, and perhaps more so in view of the Court’s emphasis on Article I, Section 8.
Those reading between the lines will realize that the PhRMA case is about drug pricing, not patents. Drug pricing is a problem for many Americans, and legislators will continue to search for ways to make prescription drugs more affordable. Only now, they will have to come up with ways that steer clear of the statutory incentive scheme, and the progress of science.
Christopher A. Rothe is an associate in the Valley Forge office of RatnerPrestia. Mr. Rothe specializes in IP risk management and patent prosecution. He can be reached at 610-407-0700 or firstname.lastname@example.org.