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

In agreements settling patent challenges in the drug industry, the plaintiff brand commonly licenses the defendant generic to sell prior to patent expiry. Some agreements require the generic to pay the brand royalties. Despite the superficial flow of profits, 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 there are two initial 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 and potentially inducing it to delay its entry. Our simple model shows that royalties usually have no place in a brand-generic agreement between rational actors. However, when royalties are conditioned on the brand’s AG launch, a range of royalty rates exists that both conveys net value to the generic and deters the brand from rationally introducing an AG. Declining royalty terms in a brand’s settlement with a first-to-file generic thus raise a red flag that the agreement is a pay-for-delay. Although the numbers are small, empirical analysis based on publicly available materials corroborates this conclusion.