We often think of pharmaceutical companies and generic-drug companies as adversaries at each others' throats as they duke it out in the courtroom.

Except sometimes they're not. Never mind the fact that the line is blurring with companies like Novartis (NYSE:NVS) heavily into generic drugs, and others like Pfizer (NYSE:PFE) and Merck (NYSE:MRK) following suit. Sometimes branded- and generic-drug companies are willing to bite their tongues and hold hands for the good of both teams.

The enforceability of a patent is ultimately cut and dry; a judge -- or more likely, multiple judges at different levels of the court system -- determines whether a generic version infringes on a patent. But figuring out what a judge will decide is difficult, and risky, for both sides. For that reason, it's often in the best interest of branded- and generic-drug companies to settle their patent squabbles rather than rolling the dice and letting a judge decide.

The settlements usually take the form of a license to market a generic version of the drug before the patent's end. The amount is negotiated by how strong each side thinks their legal standing is. Sometimes, to compensate for the delay before the "allowed" marketing of the generic drug begins, the branded-drug company will pay generic drugmakers like Teva Pharmaceuticals (NASDAQ:TEVA) and Mylan (NASDAQ:MYL) to stay off the market.

Governments aren't particularly happy about that last part
Earlier this month, Federal Trade Commission Chairman Jon Leibowitz and members of Congress held a joint press conference denouncing the practice of so-called pay-for-delay deals. According to a study by the FTC, settlements that involve compensation for generic-drug makers delayed entrance of generics by 17 months longer than settlements that didn't involve such payments. The FTC argues that the practice costs Americans $3.5 billion per year, but that assumes that the rate of settlements would be the same if pay-for-delay wasn't available.

The House version of the health-care reform bill bans pay-for-delay deals, but it's missing from the Senate version. After a change in the balance of power in the Senate, it's anyone's guess whether or not such a ban will be in the final bill, or even if the bill will pass.

On the other side of the Atlantic, the European Union is equally concerned about the practice of delaying the onset of generic drugs. Pfizer, GlaxoSmithKline (NYSE:GSK), AstraZeneca (NYSE:AZN), and others have said that the EU commission contacted them about their patent settlements. Last month that contact came in the form of surprise inspections for some unnamed drugmakers.

What it means for investors
If pay-for-delay deals go away, the generic- and branded-drug companies will have three options for dealing with their patent disputes:

  • Some patents may not be challenged because generic drugmakers think it's not worth the trouble. Advantage: branded-drug companies.
  • Pharmaceutical and generic-drug companies settle without any pay-for-delay. Advantage: The agreed-upon launch date should be a draw for both companies, although they'll both presumably end up with less than they would in a pay-for-delay deal.
  • They go to court. Advantage: unknown.

Going to court will increase the risk for both sides, which will fall squarely on the shoulders of investors. Owning shares of pharmaceutical companies will be more risky, and the volatility of generic-drug companies will increase. The patent challenges will become binary events, just like Food and Drug Administration approvals for biotech companies, because successful patent challenges come with 180-days of exclusivity before other generic-drug companies can launch their own copycat versions.

Of course, investors can may use that added risk to their advantage. The volatility is likely to increase option prices, which would benefit investors who juice their returns by selling options.

Pay-for-delay settlements might not be as fun to watch as patent disputes or FDA approvals, but investors should keep an eye on changes to the system just the same.

Pfizer is a Motley Fool Inside Value pick. Novartis is a Global Gains recommendation. Try any of our Foolish newsletters today, free for 30 days.

Fool contributor Brian Orelli, Ph.D., doesn't own shares of any company mentioned in this article. The Fool owns shares of GlaxoSmithKline and has a disclosure policy.