Generic supplier obtains substantial reduction in damages awarded against it

Earlier this month, we reported on the Full Court’s decision in Generic Health v Bayer [2018] FCAFC 183, in which the Full Court clarified that when estimating or valuing a lost opportunity or assessing a hypothetical counterfactual for any scenario short of certainty, some discount must be made to reflect that less than certain position.  In doing so, the Full Court accepted that the trial judge, Justice Jagot, fell into error by not allowing for any such discount at first instance and proceeded to reduce the damages award by 2%.

It is interesting therefore to now read, in a decision published a little less than a month after the Full Court’s Bayer decision, that Justice Jagot has allowed a generic pharmaceutical company a 30% reduction to account for risks associated with the past hypothetical cash-flows which underlie the assessment of damages in the case.  The decision is H Lundbeck A/S v Sandoz Pty Ltd [2018] FCA 1797 and is the culmination of many years’ litigation concerning Lundbeck’s patent for the antidepressant escitalopram.

Justice Jagot found that Sandoz had infringed the patent and was liable to pay damages to H Lundbeck A/S (Lundbeck) and its Australian subsidiaries.  While Justice Jagot’s decision canvasses a number of other interesting and important issues, this post will only deal with the damages aspects of the decision.  In awarding damages, her Honour grapples with a number of interesting issues including the level of generic substitution and necessary discount to be applied, transfer pricing arrangements between the patentee and its Australian subsidiaries, and the treatment of overheads.

Procedural history

The procedural history of the dispute will be familiar to many readers.  Briefly, after Lundbeck’s patent was found to have been invalidly extended, Lundbeck applied for a second extension of term on an alternative basis, and an extension of time in which to make that application.  Lundbeck made its applications on 12 June 2009, the day prior to the expiry of the standard term of the patent, at a time when Sandoz and other generic companies were preparing to and did, after expiry of the standard term of the patent, launch their own generic escitalopram products in competition with Lundbeck.

Lundbeck’s applications for an extension of time and second extension of term were subsequently granted, over the opposition of the generic companies, in 2012 and 2014.  This allowed Lundbeck and its Australian subsidiary, Lundbeck Australia Pty Ltd, to commence proceedings in 2014 for patent infringement against four generic pharmaceutical companies in connection with their launches and subsequent sale of generic escitalopram products for a period of approximately three and a half years (from the expiry of the standard term of the patent on 13 June 2009 to the end of its extended term on 9 December 2012).

For the damages claim, it is important to note that during the relevant period of infringement:

  • Lundbeck Australia, a subsidiary of Lundbeck, marketed and sold Lexapro, a branded escitalopram product.
  • CNS Pharma, a subsidiary of Lundbeck Australia, marketed and sold Esipram, another escitalopram product sold at a discount to Lexapro.
  • Her Honour found that Lundbeck Australia was the exclusive licensee of Lundbeck Denmark, and that Lundbeck Australia had authorised CNS Pharma to exploit the patent in Australia. (These matters were contested and are dealt with in another part of the decision, not discussed in this post.)

Lundbeck’s claim for damages

Lundbeck and Lundbeck Australia sought, and were awarded, damages for patent infringement.  The Lundbeck parties’ losses included:

  • losses associated with Lundbeck Australia charging lower prices for sales of Lexapro;
  • losses associated with CNS Pharma charging lower prices for sales of Esipram;
  • lost sales of Esipram to CNS Pharma;
  • loss of gross margin on sales by Lundbeck Denmark to CNS Pharma of Esipram and a lower year-end transfer of funds from Lundbeck AU as a result of lower gross margins earned by Lundbeck AU and CNS Pharma.

These losses occurred during both an ‘initial period’ (being the period of infringement prior to the expiry of the extended term of the patent) and a ‘springboard period’ (being a period after expiry of the patent during which time it is alleged that Sandoz had an established position in the market that it would not have otherwise had).

On the issue of generic substitution, the assessment proceeded from a starting point of one-for-one lost sales: every sale of a generic escitalopram product represented a lost a sale of Esipram.  However, her Honour was prepared to make a material discount to account for the probability that some Sandoz sales would have been sales of other generics’ escitalopram products rather than Esipram.  Her Honour reached this conclusion on the evidence that the market for escitalopram was crowded, with multiple generic products and that some sales of Sandoz’s products must represent lost sales of other generic products, and not Esipram (or Lexapro).

As to the materiality of the discount, her Honour noted that there was little evidence to assist in resolving this issue.  Her Honour accepted evidence from Sandoz that generic substitution rates were increasing over time and concluded that a deduction of 25% was appropriate to account for the fact that it is likely that some sales of Sandoz’s escitalopram products must represent lost sales not of Lundbeck ’s escitalopram products but of other generics’ escitalopram products.

Other important aspects of this decision concern her Honour’s findings that Lundbeck could recover losses associated with lower year-end transfer pricing adjustments from Lundbeck Australia to Lundbeck (because of lower gross margins earned by Lundbeck Australia and CNS Pharma) and the treatment of overheads.

The crux of the issue of concerning year-end transfer pricing adjustments centred around how Lundbeck framed its case on infringement.  Lundbeck’s claim for damages was based on the profit it would have received from CNS Pharma under inter-company transfer pricing arrangements but for Sandoz’s infringements.  These transfer pricing arrangements during the relevant period were put in place to ensure that subsidiaries of Lundbeck earnt an approximate 3% return on sales.

The Court found that Lundbeck was entitled to claim damages in this manner.  In reaching this conclusion, Justice Jagot rejected Sandoz’s argument that Lundbeck could not recover damages because Lundbeck Australia was the exclusive licensee and in granting it this licence, Lundbeck had effectively excluded itself from remuneration as the patentee in Australia, her Honour commenting that:

“…it is simply inaccurate to say that Lundbeck A/S had excluded itself from remuneration as patentee in Australia.  It had excluded itself from being able to exploit the invention in Australia, but that is a different matter from excluding itself from remuneration.  It obtained remuneration from Lundbeck AU and CNS Pharma in the form of gross margins on sales and the annual adjustments to ensure that those companies retained a return on sales of approximately 3%.”

Her Honour went on to explain that:

“…the rights which Lundbeck A/S yielded to Lundbeck AU were all rights in Australia to exploit the invention claimed in the 144 patent including the right to authorise others to exploit the invention.  The yielding up of these rights does not mean that Lundbeck A/S was no longer the patentee.  It may be accepted that the arrangements between Lundbeck A/S and Lundbeck AU did not include payment of a royalty either in respect of Lundbeck AU’s own exploitation of the invention or in respect of it authorising another entity to do so (which it did in the case of CNS Pharma).  The reality is obvious.  Lundbeck A/S did not need to require payment of a royalty because all three corporations were bound by the transfer pricing policy arrangements between them which had to be (and were in fact) consistently applied so the subsidiaries retained a rate of return on all sales of approximately 3%.  This policy was continuously and consistently implemented throughout and on a year-by-year basis.”

Her Honour also found that loss flowing from such arrangements was reasonably foreseeable, later commenting, “the circumstances are analogous to an arrangement for the payment of an annual royalty for the right to be exclusive licensee, despite not taking that form.”

Another issue between the parties concerned the treatment of overheads in the assessment of loss.  Ultimately, based on the evidence before her Honour and how the trial was conducted, Justice Jagot accepted the evidence of Lundbeck’s expert.

Further damages-related matters

In addition to its claim for damages, the Lundbeck parties also made a claim for additional damages.  The Court refused to award such additional damages finding that although Sandoz had made a calculated commercial decision, “the circumstances in which Sandoz’s infringements occurred are unusual, perhaps even unprecedented” and importantly, that there was no particular conduct of Sandoz to justify an award of additional damages.

Sandoz also argued that no damages should be awarded against it because it was an innocent infringer.  The Court rejected this argument.  As noted, her Honour found that Sandoz made a calculated commercial decision to launch its products at risk.  This was the factor to be given determinative weight, regardless of the unusual circumstances of the dispute and any arguments available to Sandoz concerning whether it might have been licensed under an earlier settlement agreement with Lundbeck.

Finally, while discussing what her Honour describes as some “non-issues”, Justice Jagot commented that the approach taken in the case to calculating damages meant that it was far easier for Lundbeck (and Lundbeck Australia) to prove the value of their loss than it was, by way of comparison, for the generic claimants to prove the value of their losses on a claim on an undertaking as to damages in Sigma Pharmaceuticals (Australia) Pty Ltd v Wyeth [2018] FCA 1556.  This presents both originators and generics in pharmaceutical patent disputes with a difficult choice.  Justice Jagot’s comments – and indeed now, her Honour’s experiences in both cases – are at odds with what had been the accepted position, namely, that calculating damages for infringement would be far more difficult that calculating damages for being held out of a market due to the grant of an interlocutory injunction.  It will be interesting to see if this comment is picked up and given any traction in subsequent interlocutory injunction disputes, particularly in relation to patents in the pharmaceutical field.