Post by Erik Hovenkamp.
When will private settlements advance the normative objectives espoused by the relevant area of law, as opposed to straying away from them? One sensible metric is to assess the similarity between (1) the positions the parties maintain post-settlement; and (2) the positions the parties would have maintained had they litigated (accounting for possible post-trial contracting). Given that the outcome of litigation can rarely be predicted with certainty, we can interpret the second prong as the expected result of litigation—as weighted by the relative likelihoods the parties assign to the different possible outcomes. To illustrate, suppose my doctor’s treatment of me causes me to suffer $1000 in harm, and there is a 50% chance that he will be held liable for negligence. Then we will settle for about $500, for we cannot mutually agree on anything else. This is precisely the expected result of litigation, and hence the settlement is representative of how the courts would apply the law to our dispute.
If we ignore things that might skew negotiations in one party’s favor (e.g. asymmetric ability to cover litigation costs), the above result is essentially a corollary of the Coase theorem. If the court’s judgment won’t affect the final allocation of rights, then the parties just bargain over the distribution of welfare. Neither party will accept less than it expects to get through litigation, which is a function of the legal standards that would be applied by a court. Thus, under these circumstances, private settlements will “emulate the law.”
But as I have emphasized previously, one important feature of the IP-antitrust interface is that the parties to a dispute are often prohibited from contracting out of a judgment that fails to maximize their (joint) profits. Competitors in a patent dispute cannot “undo” a holding that the patent is invalid or noninfringed in order to revive the patent’s exclusionary power; they are obligated to stick with open competition. The result is that rival firms often have a shared interest in settling an IP dispute on terms that deviate substantially from their expectations about litigation. Specifically, if they expect litigation to produce a relatively competitive result (e.g. because the patent is likely invalid), they prefer to evade that outcome by settling on terms that restrain competition substantially, resulting in higher prices and larger profits. The result is that these settlements do a very bad job of promoting IP and antitrust policy objectives; they do not emulate the law.
In my recent paper with Jorge Lemus, Proportional Restraints and the Patent System, we propose a comprehensive standard for evaluating patent settlements under the antitrust laws, along with a set of economic tools for administering it practicably. In what follows, I provide an overview of the underlying problem and our proposed solution.