Patents and Antitrust: Hovenkamp on the Rule of Reason and the Scope of the Patent

For anyone teaching or writing on patents and antitrust, I highly recommend Herbert Hovenkamp's new article forthcoming in the San Diego Law Review, The Rule of Reason and the Scope of the Patent. In recent years, patent law scholars such as Robin Feldman and Paul Gugliuzza in a forthcoming article, have argued that antitrust law's defensive doctrines – including a preference for "rule of reason" versus "per se" analysis, and immunities from antitrust enforcement such as the Noerr-Pennington doctrine and its infamously-hard-to-meet "sham" petition exception – are inappropriate for assessing misconduct involving patents. Hovenkamp emphasizes the opposite problem: the limitations of patent-based immunity for determining liability under antitrust law. In his view, the Supreme Court has now recognized this limitation with its decision in FTC v. Actavis (2013), at least with respect to reverse payment settlements given by drug patent holders to generics seeking to enter the market under the FDA's fast-track approval process.

Hovernkamp has written several articles on the Actavis decision and has made a similar point about the limits of patent-based immunity from antitrust in other pieces, such as Patents, Property, and Competition Policy, where he argued that antitrust authorities inappropriately assume that regulation is unnecessary once a patent has been reviewed for validity and issued by the Patent & Trademark Office, in part because patent boundaries are unclear and the "public notice" function of claims does not work as well as is assumed. But his new article is worth reading. Not only does it address the major change in patent/antitrust doctrine brought forth by Actavis, but it provides a history of the "beyond the scope" basis for immunity from within patent law and in-depth discussion of the limits of this approach for assessing conduct that might otherwise run afoul of antitrust law.

Prior to  Actavis the general rule was that patentees have broad immunity from antitrust liability when obtaining, licensing, or enforcing their patents so long as they remain "within the scope of the statutory patent," and that, absent "exceptional circumstances, a patent may confer the right to exclude competition altogether in more than one market." The two major exceptions to this rule are "sham" litigation, and Walker Process fraud, where a patent is obtained through fraud on the PTO. But these exceptions are rarely applied.

Drawing on the Patent Act and early case law, Hovenkamp meticulously traces the origins of the "beyond the scope of the patent" rule, and convincingly demonstrates that it is ultimately grounded in patent law and policy, not antitrust. The trope first appeared in the nineteenth century in cases delineating patent law's "first sale" doctrine (exhaustion), under which a patented good, once sold, is "no longer within the limits of the monopoly", and was employed by the Supreme Court in Coupe v. Royer (1895) in rejecting a patentee's overly broad proposed claim construction. ("When a claim is so explicit, the courts cannot alter or enlarge it. If the patentees have not claimed the whole of their invention, and the omission has been the result of inadvertence, they should have sought to correct the error by a surrender of their patent and an application for a reissue... . But the courts have no right to enlarge a patent beyond the scope of its claim as allowed by the Patent Office, or the appellate tribunal to which contested applications are referred.")

In the twentieth century, the "beyond the scope" rule was frequently used offensively in assessing various licensing practices, such as tying.  For example, in Motion Picture Co. v. Universal Film Co. the Court held that a defendant was not liable for patent infringement even though it acted outside the terms of a license conditioning use of the patented film projector on use with unpatented films because it "it is not competent for the owner of a patent by notice attached to its machine to, in effect, extend the scope of its patent monopoly by restricting the use of it to materials necessary in its operation but which are no part of the patented invention[.]"  Importantly, Motion Picture Co. was not an antitrust case but was firmly grounded in patent law itself, addressing the extent of the patentee's statutory "right to exclude others from making, using, offering for sale, or selling the invention ..." under the Patent Act (today, 35 U.S.C. § 154(a).)

Gradually, however, the the "scope of the patent" doctrine, in Hovenkamp's words, "found a different, defensive use – mainly, that a patent settlement or other licensing provision is lawful, even if facially anticompetitive, provided that the agreement did not extend the patent monopoly beyond its lawful scope..."

For example, in E. Bement & Sons v. Nat'l Harrow Co. (1902), the Supreme Court held that product price fixing contained in a license agreement, which would ordinarily give rise to an antitrust violation, was lawful so long as it did no more than "keep up the monopoly granted by the patent." In other words, what began as an offensive weapon for rendering a patent unenforceable was transformed into a grounds for immunity from antitrust liability defined by the scope of the statutory patent right.  Crucially, federal courts with exclusive jurisdiction over patent cases, and eventually the Federal Circuit with exclusive jurisdiction over all patent appeals, had a virtual monopoly over the authority to delineate this immunity.

National Harrow was later overruled in a landmark patent/antitrust case, United States v. Line Material Co. (1948), along with United States v. General Electric Co. (1926), a case upholding an egregious patent-related price fix involving a licensing agreement under which Westinghouse was licensed to manufacture lamps covered by General Electric's patents so long as Westinghouse agreed to sell the lamps at prices fixed by General Electric. But although Line Material suggested that patent-based immunity from antitrust was not unlimited, the "beyond the scope" rule continued to be used by the Supreme Court in antitrust case law addressing practices like product-to-patent tying, and was robustly adopted by the Federal Circuit in addressing whether patent package licensing constitutes patent misuse. The "key inquiry," the court wrote in US Philips Corp. v. International Trade Com'n,"is whether, by imposing conditions that derive their force from the patent, the patentee has impermissibly broadened the scope of the patent grant with anticompetitive effect."

According to Hovenkamp, strictly adhering to this rule is likely to lead to bad competition policy, and acting within the scope of the patent right should therefore not be automatic grounds for immunity from antitrust enforcement. "While the 'scope of the patent' metaphor might remain useful for assessing conduct thought to be inconsistent with patent law," he writes, "it is generally not a helpful antitrust tool." The general reason he identifies is that the "scope of the patent" rule is under-inclusive in identifying the types of conduct that should be a concern for antitrust regulators; yet so long as the rule is employed, such practices cannot be properly assessed until a judicial determination of patent validity.

Hovenkamp gives a variety of examples of the rule's under-inclusiveness, involving both vertical and horizontal conduct. The early cases permitting price fixing, mentioned above, are his most egregious example. In his view, a rule invalidating a product price fix only if the patent is likely to be invalid does not adequately address the problem posed by price fixing from the perspective of competition policy. In fact, he observes, "[t]he patent could be perfectly valid but worth very little to the licensee, or at least worth only a small fraction of the markup contained in the product price fix." Indeed, in his assessment, cartel overcharges are frequently up to ten times higher than patent royalties. Focusing only on patent validity may simply distract from the real issues: does the patentee have sufficient market power to affect market competition, and does the challenged practice threaten competition by facilitating either collusion or anticompetitive exclusion? If these are shown to be true, only then should the court worry about whether the patentee has a legitimate objective or justification. Assessing patent validity may, but need not, be necessary for this analysis.

Hovenkamp suggests that many reverse payment settlements fall into the same category as price fixing in the sense that they should be reviewed under the rule of reason prior to, or even irrespective of, determinations of patent validity. In his view, at least some members of the Supreme Court agree with this assessment. Prior to Actavis, nearly all appeals courts to examine reverse payment settlements concluded that they do not represent an antitrust concern. As Michael Carrier has documented, the mere existence of a patent, regardless of validity, justified any payment.

But in Actavis, the Court expressly overruled the Eleventh Circuit's holding that a reverse payment settlement agreement generally is "immune from antitrust attack so long as its anticompetitive effects fall within the scope of the exclusionary potential of the patent," and that the FTC therefore cannot logically evaluate reverse payment settlements without a court first determining the validity and scope of the patent.  In a scathing dissent, Justices Roberts, joined by Justices Scalia and Thomas (Alito took no part in the decision), wrote that the Court should have followed the usual rule that a patent provides an exception to antitrust law and that "the scope of the patent — i.e., the rights conferred by the patent — forms the zone within which the patent holder may operate without facing antitrust liability."

Hovenkamp astutely identifies the underlying incommensurability of these two approaches. In the majority's view, evaluating a reverse payment settlement by applying antitrust principles and assessing likely anticompetitive effects is not impossible prior to determining patent validity – especially when the payment is exceptionally large, which potentially itself suggests the patent's underlying weakness. But to the dissent, for whom liability is predicated only on acting outside the bounds of a valid patent, assessing antitrust liability prior to assessing patent validity is impossible since "a patent holder acting within the scope of its patent has an obvious defense to any antitrust suit: that its patent allows it to engage in conduct that would otherwise violate the antitrust laws."

Based on the fascinating history summarized in Hovenkamp's article, we can read Actavis as a clash of two incompatible paradigms for approaching the patent/antitrust interface that is akin to the Court's defining moment in Line Material. Ironically, the members of the Actavis Court both drew on the Line Material case to support their position–though completely disagree in their interpretations of the case's holding. While the majority suggests that Line Material stands for the principle that patent and antitrust law can be reconciled by first “considering traditional antitrust factors such as likely anticompetitive effects, redeeming virtues, market power, and potentially offsetting legal considerations ... related to patents[,]” the dissent rejoins that “Line Material did no such thing. Rather, it explained that it is 'well settled that the possession of a valid patent or patents does not give the patentee any exemption from the provisions of the Sherman Act beyond the limits of the patent monopoly.'"