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Executive Summary: A Court of Appeals decision in a patent infringement case between Merck's subsidiary Schering and Teva's subsidiary Barr relating to a $1B+/year brain cancer drug is expected within the next month or two. Although the trial judge below ruled in favor of Teva, opening up the possibility for them to launch a generic version of the drug this year, I expect Merck will win the appeal and thus be able to keep Teva's generic version of the drug off the market until 2013.

Background

Merck & Co. Inc. (NYSE:MRK), through its subsidiary Schering Corporation acquired in 2009, markets the anti-brain cancer drug temozolomide under the brand name Temodar®. Schering lists only one patent in the FDA's Orange Book for Temodar, U.S. Patent No. 5,260,291 (“the '291 patent”). Schering doesn't own the '291 patent (they didn't invent the drug). Rather, they have an exclusive license to it from Cancer Research Technology Limited (CRT), a London based charity that funds cancer research. In the second quarter of 2010, Merck had $271M in sales of Temodar, causing Merck to hail it as “again [a] standout” in the quarter. Annual U.S. sales of the drug in 2009 were almost $400M.

District Court Decision (January 2010)

In 2007, the generic drug manufacturer Barr, which was acquired by Teva Pharmaceuticals (NASDAQ:TEVA) in 2008, filed an ANDA (Abbreviated New Drug Application) with the FDA seeking approval to sell a generic version of temozolomide. Teva's generic version of the drug has been tentatively approved by the FDA, and all that's holding it up is the result of the litigation.

As per the Hatch-Waxman structure for brand-versus-generic pharmaceutical patent disputes, CRT and Schering sued Barr in July 2007 alleging Barr's proposed generic would infringe the '291 patent. In the litigation, which was filed in the District of Delaware, Barr conceded infringement, but argued the court should nonetheless disallow CRT and Schering from enforcing the patent because of alleged misconduct by CRT during the process of applying for the patent.

In particular, Barr alleged CRT had done two things wrong. First, Barr said CRT intentionally delayed the patent application process in order to extend the life of the patent so as to coincide with marketing approval of the drug. This argument is based on a 2002 Court of Appeals decision that created out of thin air a doctrine called “prosecution laches”, which said that even if a patent was valid and infringed, a court could choose to not enforce the patent if the applicant had intentionally caused “unreasonable and unexplained” delay during the application process.

Second, Barr argued CRT hid important information from the patent office during the application process. Through the rule of “inequitable conduct”, if a party makes materially misleading statements or omissions during the patent application process, the patent can be held unenforceable, even if the patent would still be valid even had the misleading statement or omission not been made by the applicant. In January, the District Court judge agreed with Barr that CRT had violated both of these doctrines and, as such, the '291 patent was unenforceable for both “prosecution laches” and “inequitable conduct.”

Some expected Teva might launch its generic version immediately, but Teva decided not to until the case was heard on appeal. This is frequently the case, because launching before a final appellate decision could put the generic manufacturer at risk of having to pay damages that are greater than the profits it would make during the interim period between the district court decision and the appeals court decision. This is because if the appeals court reverses the district court and the generic is found to actually be an infringer, then they have to pay the brand for any lost profits. Thus, since a generic that enters a market will usually not make as much profit on the sale of each unit of the drug as the brand name would have made had it made that sale, the generic could end up having to pay the brand name an amount of lost profits that is greater than the amount of profit made by the generic itself. This is why launching a generic product after a district court decision, but before an appeals court decision, is called “at risk,” because it is indeed a big gamble. You stand to win the profits you can make during that period of time (usually 6-12 months), but you stand to lose all those profits plus the additional amount of profit the brand would have made had you not entered the market. It's a tough business decision to make.

Merck Appeals (August 2010)

Merck/Schering/CRT appealed the District Court's decision to the Court of Appeals for the Federal Circuit, the exclusive Court of Appeals for patent cases, which heard argument in the matter on August 4. After reviewing the case, including the District Court's opinion and listening to the Court of Appeals oral argument (listen yourself, if you'd like, mp3), I've concluded that Merck is likely going to win a complete reversal of the District Court's decision on appeal, meaning both the prosecution laches and inequitable conduct holdings will be overturned. As a result, since Teva concedes the '291 patent is valid and infringed, Merck will win completely on the case and be able to keep Teva off the market until the patent expires in 2013. Below are my reasons for this conclusion.

The three appeals court judges on the case were Judges Newman, Lourie and Prost. On a meta level, Judge Newman is generally thought to be relatively pro-patent, and especially pro-chemical-patents. Judge Lourie has a PhD. in chemistry and is also generally thought to be relatively pro-chemical-patents. Judge Prost is a relative patent outsider (she has a labor focused background). All three are very good judges and we're very lucky that they have chosen to serve us in that capacity (FYI, as an aside, Federal Judges get paid less than most first year law associates at major firms). The District Court judge in the case, Judge Sue Robinson, is also a very good judge, but she has been reversed by the Court of Appeals in big cases before, especially where she had ruled against the patent holder, so it would not be surprising if that happens again here. Thus, even before looking at anything specifically, the general trends based on the judges involved are in Merck's favor.

Another important meta issue here is that everyone agrees the patented drug was new. Teva does not even try to argue the patent is invalid or not infringed. Everyone also agrees that all the practical rules for applying for a patent were followed. Teva does not argue a deadline was missed or something like that. Teva's only arguments are based on feelings of fairness in that they argue it is unfair to let Merck enforce the patent against them. However, once it's realized that the patent here was really on something new, that this is the only patent Merck has listed in the Orange Book on the drug, that Teva wants to make the same exact drug, and that CRT (the patent applicant and actual owner) was a small non-profit cancer research organization at the time it applied for the patent, then it starts to actually seem quite unfair to take the patent away if they did not do anything clearly wrong. Again, the fairness bias has to lie with Merck, not against them.

My last meta issue is that the lawyer representing Merck here, Matt Powers, is a very well respected and excellent patent attorney. It would not be unreasonable to call him the Kobe Bryant of patent law. I don't say this in anyway to detract from the lawyer representing Teva, George Lombardi, who also did a good job. I merely point out that the appellants here had a rock star arguing their case on appeal, which always helps. It's hard to find someone who can match up against Kobe Bryant, either.

My Prediction: Appeals Court Will Reverse District Court

Now, as to the specific issues, on the prosecution laches argument, as I say above, this doctrine didn't even exist until 2002, when the Court of Appeals basically created it out of thin air. What the court wanted to do is prevent applicants from filing very broad applications, then intentionally delaying the review of those applications so that they can then see what's happening in the marketplace, and then modify their patent claims to cover precisely whatever has been adopted by consumers. This "submarine patenting" as it has been called was an issue the Court of Appeals felt compelled to stop.

But that's not what happened here. CRT didn't file a broad amorphous application and then later try to get claims to a particular product that was already in the marketplace. Therefore, allowing them to enforce the patent doesn't raise the same fairness concerns that underlie the prosecution laches doctrine. Teva didn't make investments in a product to then later have a patent issued that covered it. Here, they want to copy Merck's product, something I doubt the Court of Appeals will think is unfair to prevent them from doing. This is especially true when the reason for the delay during the prosecution of the patent here was that the Patent Office required CRT to provide data that the drug would work on humans. CRT had to keep the patent application pending while it figured out how to address that demand, else it would lose its rights to get any patent at all. So, here, even if there was delay, it was caused, at least in part, by the PTO. The mechanisms used by CRT to keep the application pending for a long period of time were all allowed and legal steps. They didn't do anything that violated any rules.

To make an analogy, at the end of a football game, if the team with the ball is winning, they intentionally run out the clock by running the ball, keeping the ball in bounds, and even taking knees and waiting for all the time on the play clock to expire first. All of this is legal and allowed. For someone to argue it's unfair and thus, they should lose the game, just doesn't make sense. The rules are the rules. If they provide for unfairness, then change the rules. But, you can't do that retroactively and say new rules apply to games played under the old rules. That would be unfair to those who won games under the old rules and abided by them. These are the same sentiments that underlie my prediction that the District Court's prosecution laches finding will be reversed by the Court of Appeals. CRT did not do anything that was not allowed at the time.

On inequitable conduct, the only argument Barr makes is that CRT failed to disclose a study on a different, but related, drug that questioned whether it had efficacy. First, the Court of Appeals has turned extremely hostile to the inequitable conduct doctrine recently, and is considering drastically changing it in another case to be heard later this fall. So, the odds of winning an inequitable conduct claim are getting lower by the day. Here, the information that wasn't disclosed to the patent office had nothing to do with prior art (i.e. proof that someone else had invented the drug first). Thus, it was not information highly relevant to determining whether the applicant deserved the patent. Second, the study of the related drug was published in a journal, so it is hard to argue they wanted to keep it secret, or thought it was something they had to hide. Thus, it's hard to support the district court's decision that the failure to provide that study to the patent office during the patent application process merits completely destroying the patent, especially when the patent is still undeniably valid in light of that information. For these reasons, I'm firmly convinced the Court of Appeals will reverse the District Court's inequitable conduct ruling.

WARNING: Please understand that the legal issues involved here turn largely on subjective factors of fairness and, thus, are highly unpredictable. So, I could be completely wrong and my opinions should be taken for just what they are, the opinions of one person. This is largely a beauty contest and we all know that beauty lies in the eye of the beholder. The '291 patent application process took roughly 10 years and during that time, CRT was not providing substantive responses to rejections being made by the PTO. The District Court judge was not unjustified in holding that such was an unreasonable delay. Just because I disagree with her, does not mean I think her finding was ludicrous or outlandish. It's a judgment call and reasonable minds can disagree. Similarly, the District Court judge's decision on inequitable conduct is based on how meaningful she thought the omitted study was to the merits of the patent application. She thought it was very meaningful, and I think not so much. The Court of Appeals judges could very well side with the District Court judge. And, in fact, Court of Appeals judges often give deference to District Court judges, because District Court judges spend much more time with a case when it is going through the trial stage than appellate court judges spend with it at the appeals stage, so often District Court judges have a better sense of all the details of the case and can make better judgment calls as to which witnesses are more believable, trustworthy, etc. So, again, while I am firmly confident in my predictions, I was also confident the Buffalo Bills were going to win a Super Bowl in the 1990s under Marv Levy with Jim Kelly, Thurman Thomas and Bruce Smith, but I was wrong, four painful times in a row. I've also debated this specific case with friends of mine that are also legal experts in the field, and we disagree with each other, very passionately. So, only time will tell who is right.

Effect on Corporate Valuations

Now that I've made my legal prediction, the interesting question is what, if any, impact will it have on the underlying valuations of the companies involved. Back in January, when the District Court decision was made, neither Merck nor Teva moved much on the news. Perhaps this means the companies are both too large and diversified for the single product involved to move them. It will be interesting to see how the Court of Appeals decision affects either stock, if at all. My best guess is that at most we'll see a slight positive impact on Merck and a slight negative impact on Teva. If I'm wrong, and the Court of Appeals upholds the District Court on either issue (Merck must win a reversal of both issues in order to be able to enforce the patent), then I would be surprised to see much of an impact on either stock, since that's already the status quo.

I note that at least one analyst raised his profit forecase for Teva by 6 cents a share after the District Court decision and Leerink Swann analyst Seamus Fernandez said at the time, “Teva's less-costly medicine would likely batter sales of the Merck brand and depress Merck's earnings by 4 cents to 5 cents a share this year, and for several years to come.” To the extent such expectations have been built into the models for these firms, a Court of Appeals reversal that keeps Teva off the market until 2013 would obviously alter them.

Since the Court of Appeals heard oral argument in the matter in early August, I would expect an opinion to be released by them later this month or in October. When released, the opinion will be available from the CAFC's website and they generally release opinions between 11 and 11:30am every day the court is open.

Disclosure: No positions

Source: Brain Cancer Drug Appeal Could Impact Merck, Teva