Who’s Afraid of Section 1498?: Government Patent Use as Versatile Policy Tool

Guest post by Christopher Morten & Charles Duan

Chris Morten (@cmorten2) is the Clinical Teaching Fellow and Supervising Attorney in NYU’s Technology Law and Policy Clinic. Charles Duan (@Charles_Duan) is Director of Technology and Innovation Policy at the R Street Institute.

From vaccines to ventilators to diagnostic tests, technology has dominated response strategies to the ongoing COVID-19 pandemic. Where technology leads, patent law and policy follow. Recently, some attention has turned to federal government patent use under 28 U.S.C. § 1498. Jamie Love of KEI has called on the federal government to explore use of section 1498 in its response to COVID-19, to reduce prices, expand supplies, and ensure widespread, equitable access to patented technologies. (We have, too.) There is a long line of scholarship, including Amy Kapczynski and Aaron Kesselheim, Hannah Brennan et al., Dennis Crouch, Daniel Cahoy, and others discussing the relevance of section 1498 in a variety of contexts.

Yet others have encouraged the government to “tread lightly” and described use of section 1498 as a “nuclear option”—potent but dangerous—because it can be used to make massive interventions in the market for patented products—e.g., by issuing compulsory licenses to patents on high-priced brand-name drugs, “breaking” patent monopolies and accelerating the entry of numerous generic competitors. One recent example: a few years ago, Gilead’s high prices on hepatitis C drugs exacerbated a different public health crisis and prompted a chorus of voices, including Senator Bernie Sanders and the New York Times editorial board, to call on the federal government to exercise its section 1498 power to “break” Gilead’s patents in just this way, which might have saved tens of billions of dollars in public spending. (The federal government did not do so.)

Irrespective of the merits of 1498 as a general matter, in the context of a crisis such as the COVID-19 pandemic we see real value in bold, “nuclear option” use of section 1498 to save billions on high-priced prescription drugs and maximize their availability. But that is not the only way section 1498 can be used. It can also be used in modest, incremental, unexceptional ways—it can be as much as a scalpel or a Swiss Army knife as a nuclear weapon, and some of its virtues in this regard have gone underappreciated.

Accordingly, we highlight four particularly valuable features of government patent use under section 1498 in a crisis like the present one: (1) speed, (2) flexibility, (3) ex post determination of the appropriate compensation, and (4) determination of that compensation by an impartial adjudicator. In particular, we compare section 1498 with an alternative policy tool, patent buyouts, which can also expand public access to patented technologies, and identify several reasons why section 1498 may be the preferable tool.

Two Options for Responding to Patents in a Crisis

Section 1498 and patent buyouts are two tools that the government may use in response to a patent that covers technology relevant to a national crisis such as COVID-19. A brief description of each is provided below.

Section 1498 permits the federal government to “use[] or manufacture[]” technologies protected under current U.S. patents without the permission of the patent holder and provides the patent holder with an action “for the recovery of his reasonable and entire compensation.” In other words, when the federal government infringes, patent owners receive monetary compensation rather than an injunction. Application of section 1498 could immediately achieve various public benefits—lowering prices, expanding supply, and shielding socially useful activity (like diagnostic testing) from the risk of liability or injunction. The federal government could do this, for example, by purchasing COVID-19–fighting technologies through the Strategic National Stockpile (which qualifies as “manufacture[] by or for the United States” protected by section 1498, as Alex Wang and Aaron Kesselheim have noted) and then using them, or redistributing them to states and localities in need.

Under section 1498, the government will pay “reasonable and entire compensation” proportionate to the patent holder’s injuries. Both the Federal Circuit and the predecessor Court of Claims have deemed reasonable royalty awards to be “the preferred manner” of compensation under section 1498; in Tektronix Inc. v. United States, the Court of Claims expressed doubt that lost profits could ever be awarded except “after the strictest proof that the patentee would actually have earned and retained those sums in its sales to the Government.” That royalty is no pittance: In Hughes Aircraft v. United States, the successful patent claimant won “millions of dollars in compensation” from the government based on patents questionably infringed and used just 81 times.

Patent buyouts can also expand public access to patented technologies. As Daniel Hemel and Lisa Ouellette have written, “[g]overnments can offer strong incentives to drug makers while ensuring affordability by committing to patent buyouts for effective treatments. In a buyout, the government purchases the patents on a new drug—typically at a price that matches or exceeds what the patent holder otherwise would have earned—and then allows makers of generics to produce and sell low-cost versions.”

Four Valuable Features of Section 1498 in a Crisis of Infectious Disease

We now turn to the advantageous features of section 1498. Notably, many of these features derive from a key difference between section 1498 and patent buyouts: the difference between liability rules and property rules. And just as courts have increasingly recognized the value of monetary damages over injunctions in patent infringement cases under the eBay Inc. v, MercExchange LLC framework, we think government patent use under section 1498 will often be preferable to a buyout in a fast-moving crisis.

1. Speed

The U.S. government can exercise its powers under section 1498 instantly, without any procedure—not even notice to the holder of patent rights in the product being used or manufactured by the government. Indeed, the federal government can exercise its rights under section 1498 unwittingly—e.g., if it unknowingly purchases products from a supplier that turn out to be covered by another party’s patents. Section 1498 even arguably enables the government to absolve third parties’ liability for past acts of infringement: section 1498 applies to acts performed (1) “by or for” the government and (2) with the government’s “authorization or consent,” and in Advanced Software v. Federal Reserve Bank, the Federal Circuit recognized that “post hoc” consent may satisfy the second prong of that test and that “significant benefits to the United States” satisfy the first.

By contrast, a patent buyout with even a willing, good faith patent holder could take weeks to negotiate—weeks the government may not have to spare. Moreover, the government may not know all the patents it needs to buy. For example, many different firms are now developing—and likely patenting—new ventilator designs; “newly designed, cutting-edge ventilators may be on the way from the likes of tech giant Dyson, General Motors, MIT and a British consortium led by Airbus.” In situations like this, a wide-ranging search of active patents and full-fledged “clearance” (aka “freedom to operate”) study by the government would be necessary to identify all relevant patents and their owners before the government could confidently undertake buyout negotiations. Just a single such study on even a single product could take weeks or months.

In practice, the government may choose to try to negotiate a buyout or license first, in the same way that the government tends to attempt to negotiate a land purchase before invoking eminent domain. Section 1498 nevertheless serves as an important backstop to ensure that any patent holder cannot use feet-dragging as a negotiation tactic.

2. Flexibility

Section 1498 can be used flexibly, in numerous ways, some modest.

In past crises of infectious disease, suppliers that hold patents on important technologies have been unable to keep up with demand, even while they have declined to license their patents to competitor manufacturers—e.g., Bayer with ciprofloxacin (Cipro) in 2001 (to treat anthrax) and Roche with oseltamivir (Tamiflu) in 2009 (to treat swine flu).

The same is happening now. Abbott Laboratories has drawn praise for developing a relatively reliable, fast diagnostic test for COVID-19, but (at least as of mid-April 2020) its manufacturing capacity has been unable to keep up with demand. Similarly, 3M has apparently been unable to meet demand for its patented N95 respirators, leading Governor Beshear of Kentucky to call on 3M to license its patents to competitor manufacturers to increase supply.

Circumstances like these suggest an unusual use of section 1498 to increase supply: it could be used to make “surgical strikes” where there is a need move quickly to expand supply of patented products—e.g., ventilators to New Orleans, say, or diagnostic tests to emerging rural hotspots. HHS could, for example, purchase as many COVID-19 tests from Abbott as the company can manufacture while simultaneously soliciting bids for further supply of diagnostic tests that mimic Abbott’s. Assume that Abbott holds one or more patents on its tests and can manufacture up to about one million tests per week. Assume further that Abbott declines to license its patents voluntarily to competitor manufacturers (as, so far, it seems to have). Public and private demand for tests is now running much higher than one million tests per week; some public health experts now estimate that the United States must administer five million tests per day, or perhaps even more, before the lockdown can be lifted safely. Under these circumstances, Abbott might ordinarily sell its tests at a high price to the highest-bidding users as it gradually ramps up its manufacturing capacity, leaving everyone else without access to Abbott’s testing technology. HHS could expand supply more quickly by invoking section 1498 to enable generic manufacturing as it continues to buy kits at Abbott’s monopoly price (or simply lets Abbott sell kits to the highest bidder). Such use of section 1498 would protect Abbott’s returns, as Abbott would receive compensation under section 1498 for the government-authorized generic manufacturing in addition to its profits on all of the tests it is able to manufacture and sell at full price.

Section 1498 could also be used to shield specific socially useful activities from the threat of unexpected patent infringement liability. For example, in March 2020, a non-practicing entity filed a patent infringement suit seeking injunctive relief against a company whose equipment is used in some COVID-19 diagnostic testing, raising concern over the (admittedly remote) possibility that the lawsuit would reduce or delay testing. As Alex Moss and Elliott Harmon of EFF have argued, HHS could conceivably step in situations like this, authorizing the allegedly infringing activity under section 1498 and thereby ensuring the activity continues, as occurred in Advanced Software. (The authorization satisfies the second prong of that test; the for-the-government prong is likely satisfied by the benefit to the United States of more testing. “When the government requires private parties to perform quasi-governmental functions, . . . there can be no question that those actions are undertaken ‘for the benefit of the government.’”) This is something that a patent buyout cannot necessarily do, or at least do efficiently, when a patent has not been identified in advance of the infringing activity.

To be sure, patent buyouts could also be used flexibly. For example, the government could negotiate a customized license to a patent that provides few rights or many, for a short time or in perpetuity, etc. Our point here is simply that section 1498 has more, and more modest, applications than may be widely appreciated.

3. Ex Post Determination of the Appropriate Compensation

Under section 1498, the appropriate compensation due to the patent owner is determined ex post, when the injured patent holder brings a claim for compensation in the Court of Federal Claims, perhaps long after the government’s first use. In our view, this has numerous benefits in a crisis like COVID-19. Sober patent valuation is hard amidst a pandemic. For example, estimates of the fair market value of a vaccine or treatment may be wildly variable until its therapeutic properties—e.g., its side effects, its efficacy, and (in the case of a vaccine) its duration of effect—are fully established, years after first approval. (As the FDA has stated, “the true picture of a product’s safety actually evolves over the months and even years that make up a product’s lifetime in the marketplace.”) In that sense, section 1498 may actually end up offering the patent holder a better deal in the end, if the pandemic takes a turn substantially for the worse or the invention turns out to be especially useful.

Of course, if a patent holder in fact thinks it would get a better deal from an ex post determination, it could achieve the same result—or any of a flexible array of outcomes—through a patent buyout. For example, the patent holder for an effective COVID-19 treatment could offer rights to its drug for $X upfront plus $Y per use plus $Z on the basis of patient outcomes (as determined through, say, an arbitration process). But such a negotiation would take time—and would thus cost additional lives—to reproduce an effective ex post evaluation system that already exists under section 1498.

4. Determination of Compensation by an Impartial Adjudicator

When the government uses patents under section 1498, the appropriate compensation is adjudicated not by the government or the patent holder but by impartial judges. As noted above, this makes section 1498 a liability rule: the value of the patent is objectively determined (by a court) rather than subjectively determined by the patent holder and the executive branch negotiator. Many of the entities likely to hold important patents on COVID-19 technologies are the same set of pharmaceutical, medical device, and biotechnology companies accused for decades of regulatory capture, price-gouging, strategic gamesmanship of the patent and data exclusivity systems, and antitrust violations. (And others may be non-practicing patent assertion entities like the one noted above.) There is a real risk of gamesmanship and hold-up by patent holders in the event of a rushed negotiation precipitated by an ongoing public health crisis—as in 2001’s anthrax scare, when Bayer refused to budge on the price of ciprofloxacin until HHS threatened to use section 1498.

Other benefits flow from section 1498’s use of a court as impartial adjudicator to determine compensation. Judges are not susceptible to the same degree of industry lobbying as government negotiators, and government IP negotiators are apparently so inexpert that Congress in the 2018 National Defense Authorization Act called for formation of an IP “cadre” to help. (While courts certainly make errors in patent damages cases, they seem more likely to set compensation appropriately than an official in a Department of Health and Human Services that has made notable blunders in its pandemic response so far.) Discovery in litigation will disgorge otherwise secret information relevant to the calculation of compensation—on R&D costs, clinical properties, and so on. And the critical issues of patent validity, enforceability, and infringement can be properly ventilated and decided. (Like any defendant in standard infringement litigation, the government owes no compensation whatsoever if the asserted patent turns out to be invalid, unenforceable, or not infringed.) Patent holders perhaps benefit from this independent adjudicator, too, insofar as the government cannot use its vast media and regulatory powers, or its sometime monopsony purchaser status, to strong-arm an unduly cheap deal.

Conclusion

In our nation’s response to COVID-19, we haven’t yet confronted a powerful patent controlling access to critical medical technologies, but as new vaccines, treatments, devices, and other products inch closer to FDA approval, that day may come. For all the reasons we’ve laid above, we think section 1498 merits a careful look from federal policymakers as they work to end the pandemic. In particular, in view of the discussion above, section 1498 appears to be especially useful to deal with at least four possible scenarios during a pandemic: (1) a dilatory or intransigent patent owner, (2) a critical technology covered by a large and/or unknown set of patents, (3) a technology of uncertain value, and (4) a holdup caused when a surprise patent is asserted against an already-deployed technology.

In light of the potential value of using section 1498 to solve crisis-borne patent problems quickly, policymakers ought to direct some attention to the question of when and how section 1498 should be put into practice. As Daniel Cahoy recognized almost a decade ago, the failure of nations to consider policies like section 1498 in their emergency plans “creates a danger that a bureaucratic hurdle will prevent a nation from acting as quickly as it otherwise could.”