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Changing Pay-For-Delay Will Hurt Everyone

By Brian Orelli, PhD - Updated Apr 6, 2017 at 12:45PM

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Congress and the FTC could be poised to make a big mistake.

Whether you're an investor in brand-name drugs or in companies that make generics, Jon Leibowitz is not your friend.

The Federal Trade Commission chairman moved one step closer to gaining more power over pay-for-delay deals last week, when the House passed a measure allowing the FTC to fine companies for entering into such deals.

Not all patents are created equal
So-called pay-for-delay deals are compromises between companies that sell brand-name drugs and those that want to sell cheap knockoffs.

Pharmaceutical companies try to get away with patenting anything and everything they can: the active ingredient, how to make the active ingredient, how to use the active ingredient, and so on. Generic-drug companies, on the other hand, want those patents thrown out, so they can launch their knockoffs as quickly as possible.

It would be nice if the legality of patents and their validity were cut and dried. Instead, there's plenty of grey area, with companies on both sides of the issue not knowing exactly how a judge will rule.

Rather than rolling the dice and living with an all-or-nothing outcome, pharmaceutical companies will often give up some of their patent life -- allowing generic-drug companies to launch early -- in exchange for dropping the case. Just last week, Teva Pharmaceuticals (Nasdaq: TEVA) launched a generic version of Pfizer's (NYSE: PFE) Effexor before the final patent expired, after a compromise between Teva and Wyeth.

The FTC takes issue with some of the deals that result in generic-drug companies benefiting financially. Sometimes there's an outright payment to keep generic versions off the market, but there are other non-cash ways generic-drug companies like Teva, Mylan (Nasdaq: MYL), and Novartis (NYSE: NVS) can benefit. For instance, the brand-name manufacturer can agree to not launch its own generic version, allowing the generic-drug company to reap higher profits during its first-to-file 180-day exclusivity period.

The courts have sided in favor of the companies in these cases, but that hasn't kept Leibowitz and the FTC from trying to gain the power by changing the law.

At least you'll save money on generics ... maybe

Leibowitz argues that the delay in generic-drug launch costs consumers money. If generic-drug companies didn't accept compensation as part of the deal, he asserts, they'd negotiate an earlier launch date.

The Congressional Budget Office estimates that eliminating pay-for-delay deals would save the government $2.4 billion over 10 years, assuming that government programs -- Medicare, Medicaid, and the like -- could get generic versions earlier. The FTC has made similar calculations, concluding that pay-for-delay's cost to all Americans totals about $3.5 billion per year.

But remember, we're talking about a grey area here. If companies shun pay-for-delay deals to avoid being fined, there's no guarantee that they'll reach any patent settlement. Taking away an important aspect of negotiations may spur more companies to leave the negotiating table and let courts rule on a patent's validity. And who knows which way the courts will decide?

In some cases, the generic drug companies may not even bother challenging the patents in the first place, because the potential benefits may not be worth the cost of litigation. And then where are the savings?

It's not over
The power over pay-for-delay cases given to the FTC was part of the House's war-spending bill, H.R. 4899, which the Senate hasn't passed yet. There's still a possibility that the provision won't make it into the Senate's version of the bill; at least a few Senators have spoken against it.

If pay-for-delay is outlawed completely, it's tempting to say that brand-name drugmakers including Merck (NYSE: MRK), Eli Lilly (NYSE: LLY), and Bristol-Myers Squibb (NYSE: BMY) will benefit more than their generic counterparts, since some patents may never be challenged. But it could also mean that more cases will go to court, where brand-name drugmakers have historically lost more times than they've won.

The real losers are investors. This situation will only increase the uncertainty over patent validity, an area that most investors find hard to predict already.

Understanding companies and their risks helped Peter Lynch destroy the market.

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 has a disclosure policy.

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Stocks Mentioned

Merck & Co., Inc. Stock Quote
Merck & Co., Inc.
MRK
$89.52 (1.16%) $1.03
Eli Lilly and Company Stock Quote
Eli Lilly and Company
LLY
$303.02 (0.17%) $0.52
Pfizer Inc. Stock Quote
Pfizer Inc.
PFE
$49.78 (0.42%) $0.21
Viatris Inc. Stock Quote
Viatris Inc.
MYL
Novartis AG Stock Quote
Novartis AG
NVS
$87.15 (1.41%) $1.21
Bristol Myers Squibb Company Stock Quote
Bristol Myers Squibb Company
BMY
$74.96 (1.57%) $1.16
Teva Pharmaceutical Industries Limited Stock Quote
Teva Pharmaceutical Industries Limited
TEVA
$11.00 (-0.27%) $0.03

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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