In a new paper “Confronting Myths and Myopia on the Road from Doha,” Daniel Cahoy, associate professor of business law at Penn State’s Smeal College of Business, looks at recent patent compulsory licenses issued by Thailand in terms of balancing access and innovation in essential medicines.

The WTO’s Doha round of trade negotiations expanded the rights governments to issue patent compulsory licenses, which allow countries to manufacture cheaper versions of patented pharmaceuticals for non-commercial use or in cases of health care emergencies.

For example, the government of Thailand announced in 2006 that it intended to issue several “compulsory licenses” for patents related to AIDS and heart medications. The move was directed specifically to reducing the price of branded drugs; the licenses set compensation to patent owners at a mere 0.5% royalty on generic sales.

Unfortunately, international laws supporting access to medicines appears to be ambiguous with few limitations on which countries can “break” patents simply to control costs, what circumstances create a necessary condition, or even what level of remuneration is required.  Chief among his concerns is the level of compensation owed to a patent owner for the loss of exclusivity given the lack of standards in international law.

A lack of a clear floor or ceiling to compulsory license compensation can make patent property rights less predictable, encourage gamesmanship by developing or developed countries wishing to cut expenditures and even stifle access.

He suggests an innovative licensing framework that separates countries into three economic development tiers with different royalty mechanisms.  Such a nuanced system, the article argues, will lead to more predictability and effective institutional mechanisms, ensuring continued innovation and greater access to essential medicines.

The recent fear of an explosion of avian influenza could impact both the developed and developing world equally harshly, and at the same time, making the need for effective medicines urgent.  Therefore, should all nations — rich and poor — be able to benefit from lower costs as a result, perhaps to the detriment of innovation incentives?

Cahoy discusses multiple remuneration myths that have led many to overlook the potential of a remuneration-based approach to compulsory licenses.

Myth One: Equitable Compulsory Licenses Must Offer a Savings from the Market.  Although compulsory licenses have been imposed to achieve many different ends over the years, recent attention has focused on licenses to “break” the patent owner’s power to impose monopoly pricing for a greater good.

The underlying belief is that fair remuneration or compensation is inevitably restricted to a small royalty figure. Cahoy argues that there is a very rational argument for requiring market compensation for compulsory licenses that does not completely undermine their use.

Myth Two: Pharmaceutical Companies should be Indifferent to Compulsory Licensing so Long as “Reasonable” Remuneration is Available.  Regardless of whether there are justifications for the market compensation model of remuneration, many compulsory licensing advocates would argue that this high level of payment is simply not necessary.  That is, so long as a pharmaceutical company can make back its costs, it will break even and not face a disincentive to future investment.

However, determining the adequacy or reasonableness of a license is a difficult analysis since the reasonableness of any payment depends on one’s perspective. Given the global nature of the market for a particular pharmaceutical, any attempt to value the impact of a single license on a drug’s investment return would be largely speculative and arbitrary.

Myth Three: Antitrust Compulsory Licenses Provide a Reliable Royalty Benchmark.  Cahoy notes that essential in understanding remedial licensing is that the rates act as part of a corrective measure for bad behavior on the part of a patentee

Often as a consequence of monopolistic acquisition or licensing behavior, a patentee will be compelled to offer access to the patented invention to competitors on favorable licensing terms.  Such terms could be based on a relatively small royalty, or even royalty free depending on the severity of the triggering offense. For proponents of greater use of low-cost licenses, remedial rates look attractively low. The nature of this remedial form of licensing casts doubt on whether such rates contribute much to the debate.

Using a remuneration-oriented approach, Cahoy’s proposes licensing schemes that keeps
innovation incentives intact, but also ensures that developing countries have access to pharmaceuticals.  During public health crises, he argues for a three-tiered arrangement, in which remuneration is based on the economic status of the country issuing the compulsory license. Industrialized nations will be required to pay full market price, even during a pandemic.

To permit the most equitable accounting of the burden of public health expenses while ensuring relative ease of administration, the three-level system would provide: (1) a high compensation state for industrialized nations, (2) a development-factored royalty state for developing countries, and (3) a zero-royalty state for least developed countries.  The strata might be initially defined by the WTO’s grouping of nations, which would be subject to change as a nation’s economic state either improves or declines.

Cahoy also identifies the adoption of a national exhaustion rule, which would limit importation into non-licensing countries, and manufacturing limits as important elements to any new compensation system. The likelihood that industrialized markets will yield reduced profits as a consequence of compulsory license negotiations is due to price-limiting strategies such as (1) parallel importation and (2) reference pricing.

Clearly, the issue of compulsory licensing requires further debate.  Hopefully, we can all arrive at more equitable solutions.

See Cahoy’s entire article: “Confronting Myths and Myopia on the Road from Doha”

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    […] idea of breaking patents is not new but compulsory licensing has to date only been used in emergency (or pseudo-emergency) situations where patent-protected […]