The Simple Math of Royalties and Drug Competition During the 180-Day Generic Exclusivity Period

In drug patent litigation settlements, the plaintiff brand commonly licenses the defendant generic to sell before patent expiry. Some agreements require the generic to pay the brand royalties. Despite the superficial flow of payments, royalty terms may function as part of an anticompetitive “reverse payment” made to the generic in exchange for delayed entry. Typically, the brand launches its own authorized generic (AG) during the first-to-file generic’s 180-day exclusivity period so initially there are two generic competitors. A royalty structure that deters the brand’s AG launch reduces the number of entrants to one, conveying net value to the generic by allowing it to capture the entire generic market, potentially inducing it to delay its entry. Royalties usually have no place in a brand–generic agreement between rational actors. However, our simple model shows that when royalties are conditioned on the brand’s AG launch, a range of royalty rates exists that conveys net value to the generic by deterring the brand from rationally introducing an AG. Royalty terms that are conditioned on the brand’s AG launch thus raise a red flag that the agreement is a pay-for-delay. Although the numbers are small, publicly available materials on industry experience corroborate this conclusion.