The Kenneth J. Germeshausen Center, created in 1985 through the generosity of Kenneth J. and Pauline Germeshausen, is the umbrella organization for Pierce Law's intellectual property specializations. Today the Germeshausen Center is a driving force in the study of international and national intellectual property law and the transfer of technology. It acts as a resource to business as well as scientific, legal and governmental interests in patent, trademark, trade secret, licensing, copyright, computer law and related fields.

The Center bears the name of its benefactor Kenneth J. Germeshausen, one of New England's pioneering inventors and professor of electrical engineering at Massachusetts Institute of Technology. Germeshausen was also co-founder of the international high technology firm of EG&G.

Remedies for Unfair Trade and Patent Circumvention Caused by Pharmaceutical Price Controls by Dave Connaughton

If we do not find better ways to share the burden of developing new drugs and biologics, all of us will suffer. [i]

President Barack Obama, in his State of the Union Address, noted: We cannot afford another so-called economic expansion like the one from last decade . . . where the income of the average American household declined while the cost of health care . . . reached record highs. [ii] On this point, he is certainly correct. Yet, while politicians are busy trying to create new regulations to lower health care costs, it seems that they are missing one of the root causes of high healthcare costs: the prices of drugs in the United States (US) are artificially inflated by price controls imposed on drugs in foreign countries. Most notable are the significant price control schemes imposed by those European Union (EU) member countries with average income levels comparable to those of the US. The US government has identified the issue in the past, yet little definitive action has been taken against this unfair trade practice.[iii]

The lack of action against pharmaceutical price controls will hopefully soon change. In a recent report,[iv] the Obama Administration has committed to policing and enforcing international agreements and international intellectual property (IP) far more than in the past. Pharmaceutical price controls immediately come to mind as an ideal target for this commitment because they are an unfair trade practice[v] designed to circumvent patent protection.[vi] Action against such unfair trade practices could be approached by alleging violation of international treaty, or through powers granted to the executive branch by Congress. Whatever the remedy chosen, the practice must be addressed to ensure not only fair drug prices in the US, but also continued drug innovation worldwide.

I.   The Importance of Patents in the Pharmaceutical Development Industry

The huge cost of drug development coupled with the ease with which a drug can be copied make patent protection essential to the pharmaceutical industry. Pharmaceuticals products (drugs) are unique in two ways: first, they are chemical compounds that have special effects on the human body, and as such they are fairly easy to replicate. Second, they cost a tremendous amount of money to develop. The enormous cost of drug development is caused by the extreme difficulty of predicting drug efficacy and safety, coupled with the complex government regulatory hurdles that must be overcome before a drug can be introduced to the market.[vii] As of 2008, for each drug that was brought to market, the amount spent on research and development (R&D) and testing ranged from $800 million to $2 billion.[viii] These two unique features cause innovative pharmaceutical companies to rely heavily on patent protection. A patent allows the patent holder to temporarily control sale of the patented drug, allowing them to charge enough to recover their R&D costs without fear of their drugs being replicated without their permission. This heavy reliance on patent protection means that patent-limiting unfair trade practices such as price controls have a particularly negative impact on drug developers.

II. Price Controls

A. What Are Pharmaceutical Price Controls?

Price controls are government controlled pricing schemes that lower the price of an article from what a manufacturer would normally charge. In the case of patented articles such as pharmaceuticals, price controls allow the government to circumvent a patented drug developer s right to charge a price that allows it to recover its R&D costs and make a profit. The implementation of drug price controls is nearly universal in the EU, and while the structures vary, most countries have a regime that significantly restricts the pricing of pharmaceuticals.[ix] Notably, even those countries with income levels near that of the US implement price controls on drugs.[x] The extent of price controlling does not correspond to the average income of a country. For example, the wealthy countries of France and Germany implement more restrictive pricing schemes than does the relatively low income country of Poland.[xi]

B. Why Are Price Controls Implemented?

Generally, price control schemes are government responses to government created problems over the last thirty years.[xii] They are, by and large, implemented to curb the rising costs of drugs. However, these increased costs are primarily a consequence of government regulations relating to drug approval, rather than any sort of corporate greed. Additionally, as socialized medicine has become more pervasive throughout Europe, the need to limit government spending has emerged. One solution chosen to curb this spending has been for government administered health care to pay less for pharmaceuticals.

Supporters of price controls may claim that a patent holder has strong monopoly power and therefore price controls on drugs are justified, but they fail to consider the substantial design around innovation in the pharmaceutical industry.[xiii] In the case of drugs, there are often multiple compounds that can treat the same ailment.[xiv] Designing around patents results in competition even with patented drugs; competition causes prices to fall, and further increases innovation.[xv]

   Price control supporters may also note that drug developers are not forced to sell a product in a given market, but for many life-saving drugs it is unlikely that a drug producer could refuse sale without facing serious consequences. Threats of non-sale may be effective during price negotiations, but if a major drug developer were to refuse to sell its drugs in a particular country, while still maintaining patent protection, the potential public outcry could be enormous.[xvi] The press would no doubt vilify the company as heartless and evil. The Cipro controversy following the anthrax scare after 9/11 is an example of one such response.[xvii] Moreover, there is a potential that a country could respond to the non-sale of a life-saving drug with a compulsory license.[xviii] Thus, in reality, the ability of a patent holder to refuse to sell certain drugs in a given market is quite limited.

III. The Result of EU Price Controls

As is the case with most unfair trade practices, the EU s drug price controls result in a series of negative consequences. Price controls on patented articles circumvent the economic incentive provided by patent protection and therefore substantially limit the value of a patent and the benefits it provides. For example, the result of the decreased value of EU drug patents caused by price controls is inflated U.S. prices, and decreased pharmaceutical innovation worldwide.[xix] EU price controls prevent drug developers from earning adequate profits in that market, and the result is that prices are shifted to the unrestricted U.S. market to compensate.[xx] Moreover, because price controls limit a drug developer s ability to recover costs, there is a decreased incentive to invest up to two billion dollars to develop a new drug. Less investment in drug development results in fewer health enhancing drugs being developed, and a lower potential quality of life worldwide.

The substantial exodus of drug R&D from the EU to the unrestricted U.S. is one striking consequence of price controls since the imposition of price controls in the EU.[xxi] EU drug R&D accounted for 49% of worldwide drug R&D in 1990, however this number dwindled to 37% by 2000. Another impact of EU price controls is that there are far fewer new drugs introduced each year. It has been estimated that with the additional revenues that a free market would provide, the pharmaceutical industry could introduce at least three to four new, potentially life-saving drugs annually, a 10.0 13.3% increase.[xxii]

IV. Price Controls Violate the Spirit and Letter of International Law

Many unfair trade practices have been addressed in international treaties. Drug price controls circumvent patent protection in violation of an international intellectual property law treaty. The Trade Related Aspects of Intellectual Property Rights Agreement (TRIPS) provides the minimum standards that a signatory country may provide regarding intellectual property protections. In the case of price controls on drugs, the practice results in patent protection that falls below these minimum standards. Pharmaceutical price controls violate the spirit of TRIPS as stated in Article 7, and fail to meet the minimum standards of TRIPS under Articles 28, and 66.2. It is worth noting that all of the countries at issue in this paper (US and EU countries) are TRIPS signatories. Based on the plain language of the TRIPS agreement, pharmaceutical price controls are in violation of both the spirit and letter of the agreement.

Pharmaceutical price controls implemented by EU countries violate the spirit of the TRIPS agreement as set forth in the objectives: Article 7.[xxiii] This article states:

The protection and enforcement of intellectual property rights should contribute to the promotion of technological innovation and to the transfer and dissemination of technology, to the mutual advantage of producers and users of technological knowledge and in a manner conducive to social and economic welfare . . . . (Emphasis added).

It has been established that price controls fail to conform with the TRIPS objectives set forth in Article 7 in three respects: they do not promote technological innovation;[xxiv] they do not provide mutual advantages to the producers and the users;[xxv] and they are not implemented to be conductive to social or economic welfare, even for the countries who implement the controls.[xxvi]

   Price controls unreasonably prejudice and interfere with the patent holder s right to sell, granted in TRIPS Article 28.1, because a drug patent holder is forced to sell its product at a set price, and thus is limited to realizing a negligible profit.[xxvii] It is generally recognized that innovative pharmaceutical companies make the vast majority of their profits in the United States.[xxviii] The corollary to this is that only a negligible profit is made by selling pharmaceuticals in the EU and elsewhere. A principle value of a patent is to allow recovery of R&D costs through sale. While TRIPS Article 30 allows limited exceptions to the exclusive rights conferred by a patent under Article 28, these exceptions cannot unreasonably prejudice the legitimate interests of the patent owner. [xxix] Price controls unreasonably prejudice a drug patent holder s legitimate interests of recovering its R&D costs and making a reasonable profit.

  Price controls are, in fact, disincentives to enterprises and institutions and discourage technology transfer to least developed countries, in violation of TRIPS Article 66.2. [xxx] Article 66.2 states:

Developed country Members shall provide incentives to enterprises and institutions in their territories for the purpose of promoting and encouraging technology transfer to least-developed country members in order to enable them to create a sound and viable technological base.[xxxi]

Price controls discourage technology transfer to least-developed country members by limiting profits, and thus limiting the freedom of drug companies to provide assistance to developing countries in the form of drug donations or low cost drug pricing. If fair prices were paid by those able to pay them, pharmaceutical companies could have the flexibility to suffer a losses by providing low cost new drugs to the least-developed countries.

V. Governmental Recourses Against Unfair Trade Practices

In following through on their commitment to police international agreements and international IP, the Obama administration has a number of options at their disposal. One option is to assert that a particular unfair trade practice is in violation of a treaty. In addressing drug price controls, the US can assert that the EU countries are not TRIPS compliant by filing a complaint with the WTO Dispute Settlement Body (DSB). Another option is via the U.S. Trade Act, which allows the U.S. Government to take retaliatory action against unfair and unreasonable trade practices. Finally, the Bipartisan Trade Promotion Authority Act provides the President substantial power to enter into trade negotiations and agreements to remedy unfair trade practices. Hopefully the Administration will utilize these options to remedy the issue of EU drug price controls in order to promote fair health care worldwide.

The U.S. would be well within its rights to file a complaint with the WTO DSB for the EU s violations of TRIPS Articles 7, 28.1 and 66.2. The WTO dispute settlement process is fairly complex and beyond the scope of this discussion.[xxxii] The WTO dispute settlement process is governed largely by the WTO Dispute Settlement Understanding (DSU), which sets forth guidelines for handling the dispute.[xxxiii] In brief, a complaint would be filed by the U.S. against another country. This complaint would then be considered by the DSB. Once a decision is rendered, the DSB s decision should be followed by any WTO member.

It is important to remember that as a matter of international law, any country can make whatever laws they wish. Because EU members price control practices have been ongoing for 20 30 years,[xxxiv] and no action has been taken in the WTO, it seems unlikely a remedy will come through this process. That said, with a strong enforcement policy, perhaps the possibility is not so farfetched.[xxxv]

Another attractive avenue for recourse against price controls is through the U.S. Trade Act, particularly section 301.[xxxvi] The full power of this act is beyond the scope of this discussion, but section 301 and related provisions will be discussed in regards to their application to pharmaceutical price controls.[xxxvii] To begin, each year the Office of the U.S. Trade Representative (USTR) releases a report, called the Special 301 Report, based on the provisions set forth in section 301 and related provisions of the Trade Act.[xxxviii] The Special 301 Report identifies countries that are violating, disregarding, or circumventing IP protection, and publicly reports on what these countries are doing.

Section 301 of the Trade Act identifies those acts that require mandatory action by the USTR, or acts that allow action at the USTR s discretion. Action must be taken by the USTR under section 301 part (a)(1)(B) if:

            an act, policy, or practice of a foreign country

       (i) violates, or is inconsistent with, the provisions of, or otherwise denies benefits to the United States under, any trade agreement, or

(ii) is unjustifiable and burdens or restricts United States commerce; [xxxix]

   Action may be taken by the USTR under part (b) of Section 301 if:

     (1) an act, policy, or practice of a foreign country is unreasonable or discriminatory and burdens or restricts United States commerce, and

     (2)   action by the United States is appropriate . . . .[xl]

It has been shown that the practice of pharmaceutical price controls satisfies all parts of both sections (a) and (b), and therefore the USTR does have the authority to take action. Section 301 goes on to state that the USTR and the President have the authority to do anything within their power with respect to trade or Any other area of pertinent relations with the foreign country. [xli] Such actions may include: suspending concessions of a trade agreement, imposing duties or import restrictions, or entering into agreements with the countries that remedy or compensate for the problem.[xlii] While a complete elimination of price controls is unlikely, it is probable that the negative economic impact could at least be lessened to the point where more profit could be realized in the EU.

In fact, pharmaceutical price controls have been addressed in Special 301 reports since 2005, though it seems little progress has been made.[xliii] It is time for the President, through the USTR, to bring the issue of drug price controls to the forefront of US-EU relations, and put serious pressure on EU members to remedy the practice.

Finally, the Bipartisan Trade Promotion Authority Act identifies a number of goals that are essential to fair trade, allocates a substantial amount of power to the President, and directs the President to act.[xliv] The Act specifically addresses price controls as an act of unfair trade in any market.[xlv] Accordingly, it is noteworthy that while Congress has directly stated that price controls constitute unfair trade, the practice by EU countries continues unimpeded.

The Act continues, stating that with fair trade goals in mind, the President has the power to negotiate for more fair provisions, or for the elimination of offending provisions.[xlvi] The Act further describes the powers allocated to the President; stating that if the President determines that any distortion of international trade adversely affects the U.S. economy, and the purposes of the act will be promoted, the President may enter into negotiations and trade agreements to remedy the issue.[xlvii]

Utilizing the Bipartisan Trade Promotion Authority Act is the most probable process to remedy EU drug price controls since it is the most diplomatic of the three options available. While the Act does not authorize the President to impose penalties on offending nations, it is a powerful tool to engage these nations in negotiations and dialogue in the hope of coming to a mutual resolution in the form of a trade agreement. A trade agreement may not be the perfect solution, but it could be a good start to alleviating the damage of drug price controls.

VI. Conclusion

Pharmaceutical price controls are one example of a particularly egregious unfair trade practice that results in decreased drug development, and shifts costs to U.S. consumers. In following through with its enforcement commitment, and to address the increasing cost of health care, the Obama administration should use all of the tools at their disposal to remedy this practice. Such tools include enforcement of international treaty, and powers granted to the executive branch in the US Trade Act, and the Bipartisan Trade Promotion Authority Act. In addition to pharmaceutical price controls, however, there are certainly other unfair trade practices and violations of international IP that should be addressed using the strategies described above. However, it is particularly important that the above listed options be pursued in regards to drug price controls, not only to lower U.S. drug prices and ease the healthcare funding crisis, but also to ensure that new drugs continue to be developed, thereby increasing the quality of life worldwide.

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* David Connaughton, J.D. 2010, received a B.S. in Chemical Engineering from the University of New Hampshire.  Upon graduation, he plans to practice patent law.  David also mantains a blog titled "1.8.8. The IP Policy Blog" that focuses on intellectual property policy at http://188ip.wordpress.com.

David Connaughton (J.D. '10) David received a B.S. in Chemical Engineering from the University of New Hampshire.  At this time, David, like many graduates of the class of 2010, is searching for employment as a patent attorney.  David mantains a blog titled "1.8.8. The IP Policy Blog" that focuses on intellectual property policy at http://188ip.wordpress.com.