California Dreaming Part 2: The Constitutional Challenge

January 29, 2020By Sara W. Koblitz

Back in September 2019, California passed AB 824: Preserving Access to Affordable Drugs.  That law sought to discourage “reverse-payment agreements” in which a brand manufacturer enters into a patent settlement agreement with a potential generic sponsor that involves a transfer of value from the brand to the generic without authorizing immediate generic market entry.  As we explained in our last post, AB 824 does not ban these types of agreement per se, but instead presumes that such agreements are anticompetitive where the ANDA sponsor receives “anything of value” from the brand manufacturer as part of a Paragraph IV litigation settlement.  As a result, AB 824 effectively shifts the government’s usual burden of proving anticompetitive effect to the drug sponsors, who now must show that a given settlement is not anticompetitive.  This shift is significant: It not only requires pharmaceutical companies to prove a negative, but will require the affected parties to disclose substantial proprietary information about these settlements to the California Attorney General.  At the time AB 824 was passed, we asked whether AB 824 would actually have any effect on these types of settlements (or whether California was merely dreaming).   And given the considerable impact AB 824 likely would have on the pharmaceutical industry, we also suggested that AB 824 likely would be subject to a constitutional challenge from industry.

Industry did not disappoint.  In November 2019, the Association for Accessible Medicines (“AAM”) sued the California Attorney General and sought both preliminary and permanent injunctions staying the implementation of AB 824 on January 1, 2020.  AAM is no stranger to this type of litigation: it successfully sued the Maryland Attorney General’s Office back in 2017 over a Maryland law addressing generic drug pricing.  Like its suit against Maryland, AAM’s challenge to AB 824 alleges that AB 824 violates the dormant Commerce Clause because it extends far beyond California entities and agreements.  Further, AAM alleged that federal law preempts AB 824—specifically alleging that the state law is inconsistent with the federal patent laws, federal antitrust law as set forth in FTC v. Actavis, and the delicate balance between innovation and competition that Congress established in the Hatch-Waxman Amendments and Biologic Price Competition and Innovation Act.  AAM also argued that AB 824’s imposition of a minimum penalty of $20 million violates the Excessive Fines Clause in the Eighth Amendment of the U.S. Constitution.  Finally, AAM maintained that AB 824 contravenes the basic notions of procedural due process because the presumption that any settlement is anticompetitive provides no meaningful opportunity for rebuttal.

On December 31, 2019, the U.S. District Court for the Eastern District of California denied AAM’s request for preliminary injunctive relief “due to the nature of Plaintiff’s pre-enforcement attack on AB 824.”  But despite this headline “loss” for the industry challengers, the district court all but agreed with AAM’s central constitutional challenge by making clear that the enforcement of AB 824 to settlements executed outside of California and between non-California entities almost would certainly be unconstitutional:

if the [California] Attorney General were to enforce the terms of AB 824 against two out of state parties that entered into a settlement agreement outside of California, having nothing to do with California, such conduct would likely violate the Dormant Commerce Clause.

Nevertheless, the Court explained, “invaliding or even preliminarily enjoining the law on this basis would force the Court to not only assume the Attorney General will apply the law unconstitutionally, but also make a constitutional determination before it is necessary to do so.” The Court refused to presume that California would apply AB 824 in such clearly unconstitutional fashion, and therefore found that AAM could not establish the elements necessary for an as-applied pre-enforcement challenge—namely, the existence of a concrete plan to violate AB 824, a communicated threat of prosecution under AB 824, and/or a history of past prosecution or enforcement of AB 824.  In short, while the Court effectively held that AAM likely would prevail if California applied AB 824 to the vast majority of patent settlements (which are executed outside of California, by companies domiciled outside of California), the Court simply found it premature to enjoin the statute given uncertainty about whether the State would attempt to apply the statute in such an unconstitutional fashion.

The Court also opined on AAM’s likelihood of success under the three other cited causes of action: field preemption, the Excessive Fines Clause, and procedural due process.  Because AB 824 does not address the validity of patent law, the Court determined that federal patent law does not preempt AB 824.  The Court also explained that because Actavis permits enforcement of antitrust law on patent settlements rather than foreclosing enforcement, federal antitrust law does not preempt state antitrust law.  And because the effect of AB 824 on generic drug applications cannot be discerned until AB 824 has been implemented, the Court determined that it was impossible to know whether AB 824 actually conflicts with the Hatch-Waxman Amendments, stating:

Because AB 824 has not been enacted, nor has any other similar law been enacted in another state, it is impossible to know if this law will have its intended effect, or as Plaintiff argues, will backfire, causing generic drug companies to cease filing ANDA applications and challenging patents held by brand-name drug companies. The Court is not in a position to predict the future impacts of AB 824 before it is enacted and enforced. At this time, it is too speculative for the Court to find one way or another that AB 824 will frustrate or further the aims of the Hatch-Waxman Act.

The Court further determined that AAM’s Excessive Fine Clause and procedural due process counts suffered from the same speculation issue.  Noting that the imposition of $20 million penalties (or three times the value at issue in the settlement agreement) could be appropriate in certain circumstances, the Court determined that AAM’s facial attack on the penalty failed.  And because an as-applied analysis requires a balance of the penalty against the infraction, the as-applied pre-enforcement challenge on the penalty provision was too fact-specific to address in the abstract.  Similarly, the procedural due process challenge was also premature because AB 824 provides a mechanism by which a party can rebut the anticompetitive presumption of a Paragraph IV settlement, which the Court cannot assess for meaningfulness until it has been employed.

The Court briefly addressed the other elements necessary for an injunction—irreparable harm, public interest, and balance of harms.  With respect to irreparable harm, the Court stated that AAM failed to establish that irreparable harm is both likely and imminent.  Further, the Court explained that “the question of balance of harms and public interest are too speculative at this point for the Court to find that either factor favors Plaintiff, sharply or otherwise.”

While this decision is a procedural setback for AAM, who has already submitted its Notice of Appeal, it is one that AAM has faced before.  In its Maryland challenge, the U.S. District Court for the District of Maryland dismissed AAM’s dormant Commerce Clause claim and denied AAM’s motion for injunctive relief (while allowing a vagueness claim to proceed).  AAM appealed, and the Fourth Circuit reversed the district court, holding that the Maryland provision was unconstitutional under the dormant Commerce Clause “because it directly regulates transactions that take place outside of Maryland.”  There’s no reason, therefore, for AAM to give up hope just yet.  As we noted, the District Court agreed that the same issue arises here.

Clearly, AAM has signaled its intent to fight here.  However, while the appeal is pending, AB 824 technically already has gone into effect.  So while we wait to see if how the Ninth Circuit reacts to the pre-enforcement challenge argument, we will also be waiting to see how California actually does enforce AB 824.  Given the Court’s strong warning about AB 824’s constitutionality in the mine run of cases, we suspect that any enforcement actions taken under AB 824 will be subject to further litigation.  But like we said back in September: we will have to wait to see whether AB 824 will survive pre-enforcement litigation, whether it will be considered constitutional when actually applied, and whether it will have any effect on pay-for-delay settlements—or whether California is only dreaming.