I.    INTRODUCTION

¶ 1         The patent bargain has been described as a balance between the public good that results from full disclosure of scientific research and a private property right.¹ Physical property rights are well-defined and as a result the economic and legal concerns surrounding them are well-understood.² However, the property right at issue in the patent bargain is not readily fenced off to prevent trespass.³ There are only two ways to uphold such a property right: by "keeping it under the mattress" or by providing legal remedies to the owner against trespassers.⁴ Intellectual property law encourages both types of protection, but the prospect of reverse engineering provides a powerful incentive to enter the patent bargain.⁵

¶ 2         An increasing body of data supports the notion that disclosure is economically beneficial. These studies go beyond the anecdotal observation that cultures with strong intellectual property rights protections have historically excelled technologically and economically.⁶ More recent studies of growth in the developing world support theoretical and historical approaches to the patent bargain as a growth engine.⁷ Although dissent remains as vigorous as ever,⁸ the idea that some balance of individual property rights and public disclosure increases the benefits to society and is economically efficient has prevailed.⁹

¶ 3         However, one area where the public has had relatively free reign is in conducting research that builds on the inventions disclosed in granted patents. The reason for this right to research arises from two theories of innovation - one is analogous to the fair use doctrine in copyright law and one based on the ultimate value that arises from improvement innovations.¹⁰ These dual theories have given rise to two legal doctrines, each of which encompasses aspects of both theories — the common law research exemption and the statutory exemption.

¶ 4         This comment focuses on the recent Supreme Court decision in Merck KGaA v. Integra Lifesciences.¹¹ The decision primarily pertains to the exemption from patent infringement liability for research activities related to pharmaceutical development contained in 35 U.S.C. § 271(e)(1). Justice Scalia's unanimous opinion announced a textualist interpretation of the statute that overruled a narrow formalistic interpretation by a three-judge panel of the Federal Circuit in 2003.¹²

¶ 5         By examining the Federal Circuit's doctrinal development regarding both the common law and the statutory research exemption, it will first be shown how these doctrines informed the split panel decision. Second, the Federal Circuit's normative approach will be considered - particularly whether the decision was consistent with precedential interpretations of the research exemption. In this section, the decision is analyzed in terms of legal realism and the contentious circumstances of the case. Third, while the Supreme Court's decision is strictly based on the plain language of the statute, the economic realities of the research exemption support this interpretation over that of the Federal Circuit panel majority.¹³ Prospectively, Merck KGaA v. Integra Lifesciences indicates that textualism with respect to the patent law should be adhered to whenever possible - restricting policy decisions to the enacted statute. The modest conclusion is for the Federal Circuit to be mindful of normative tendencies, particularly when not in concert with textualist analysis, and recognize that economic realities often preclude such normative proscriptions.

¶ 6         The common law research exemption began with ­­­Whittemore v. Cutter, in which Justice Story now famously quipped "it could never have been the intention of the legislature to punish a man, who constructed such a machine merely for philosophical experiments, or for the purpose of ascertaining the sufficiency of the machine to produce its described effects."¹⁵ In 1813, Justice Story, sitting on the Circuit Court for the District of Massachusetts, recognized that two types of activities were not subject to the patent right to exclude: (1) innate human curiosity and (2) experiments to decipher the patented invention. Defining "philosophical experiments" and "ascertaining the sufficiency of the machine" has been the focus of the common law research exemption doctrine ever since.¹⁶

¶ 7         The Federal Circuit clarified its position with a decisively "pro-patent" opinion early in its history.¹⁷ In Roche v. Bolar,¹⁸ the court held that pure "scientific inquiry" was protected by the safe harbor, but only insofar as it lacks "definite, cognizable, and not insubstantial commercial purposes."¹⁹ The Roche court significantly narrowed the common law exemption and established a commercial purpose threshold.²⁰ The Federal Circuit affirmed its narrow commercial purpose interpretation six times in the twenty intervening years between Roche and Integra.²¹

¶ 8         While technically in line with the Federal Circuit's focus on commercial purposes, Madey v. Duke represents a severe limitation of the experimental use doctrine, wherein even non-profit and educational research is infringement when a distant commercial purpose exists.²² The court's ruling merely reverses summary judgment, but the decision lays out a legal framework wherein "the experimental use defense persists albeit in the very narrow form articulated" in Embrex and Roche,²³ which "clearly do[] not immunize use that is in any way commercial in nature."²⁴ The court eviscerated the educational use defense, stating that the "business" of Duke University was educational.²⁵ This established a subjective test that looks to "the alleged infringer's legitimate business, regardless of commercial implications."²⁶ The experimental use principle has been refined to the proposition that experimental, educational, or non-profit uses do not infringe patent rights when the damages and gains realized by these uses are de minimis²⁷— a proposition that accomplishes what many view as its purpose within the patent bargain.²⁸

¶ 9         In 1984, partly in response to what it perceived as problems with the Federal Circuit's application of the common law research exemption,²⁹ Congress enacted the statutory safe harbor for experimental uses related to the development of generic drugs.³⁰ The "Drug Price Competition and Patent Term Restoration Act of 1984," also known as the Hatch-Waxman Act, enacted two major statutory revisions that together represented a compromise between generic drug manufacturers and large pharmaceutical companies - the "innovators."³¹ The generic drug manufacturers were given earlier entry to the market by exempting the research necessary for them to submit an abbreviated new drug application (ANDA) from patent infringement.³² And patented pharmaceuticals that are the subject of a new drug application (NDA) could apply for an extension of the standard patent term by the amount of time required by the FDA to approve the application.³³

¶ 10         The Hatch-Waxman amendment to the infringement provisions of the Patent Act is fairly ambiguous.³⁴ Section 271 generally creates a Federal cause of action against "whoever without authority makes, uses, offers to sell, or sells any patented invention, within the United States or imports into the United States any patented invention during the term of the patent therefor, infringes the patent."³⁵ One of the main exceptions to this rule is contained in § 271(e),³⁶ which states

It shall not be an act of infringement to make, use, offer to sell, or sell within the United States or import into the United States a patented invention (other than a new animal drug or veterinary biological product (as those terms are used in the Federal Food, Drug, and Cosmetic Act and the Act of March 4, 1913) which is primarily manufactured using recombinant DNA, recombinant RNA, hybridoma technology, or other processes involving site specific genetic manipulation techniques) solely for uses reasonably related to the development and submission of information under a Federal law which regulates the manufacture, use, or sale of drugs or veterinary biological products.³⁷

¶ 11         This language provides considerable latitude in statutory interpretation. It opens with the inclusive language "make, use, offer to sell, or sell" which has become equivalent to every commercial act of infringement.³⁸ The final clause is clearly directed to the Federal Food, Drug, and Cosmetic Act (FDCA), but is textually not so limiting — "a Federal law which regulates the manufacture, use, or sale of drugs."³⁹

¶ 12         The intervening language is the most ambiguous in the statute and the subject of the Merck dispute, at least at the Supreme Court. What is the plain meaning of "solely for uses reasonably related to the development and submission of information"?⁴⁰ "Solely" would seem to indicate that a narrow set of acts qualify for the exemption. However, the "reasonably related" requirement broadens the exemption and introduces jurisprudential flexibility.⁴¹ Qualifying acts are further limited to "the development and submission of information." The "submission of information" under a law regulating drugs is relatively unambiguous, but the development of that information encompasses a broad swath of activities that are not easily definable, and not clarified by a reasonableness test.

¶ 13         Past opinions have delineated certain uses that fell under the reasonably related test for the development of information. In 1994, the New Jersey district court gave considerable latitude to the statutory language and focused on the specific research involved in the product and patent at issue.⁴² The Federal Circuit upheld the research exemption when the patented invention was primarily used to develop a generic formulation of the patented drug.⁴³

¶ 14         An alternative structural interpretation of § 271(e)(1) has also been advanced by some district courts. In 2001, the Southern District of New York held that the text of the Hatch-Waxman amendment did not indicate a Congressional intent to restrict its application to generic drugs, or drug patents in general.⁴⁴ Absent Congressional intent to the contrary, other subsections of § 271 support an interpretation of § 271(e)(1) to apply to all inventions - the limiting factor being whether the information is ultimately developed for or submitted to a Federal agency.⁴⁵

¶ 15         The most important decision to interpret § 271(e)(1) prior to Merck KGaA v. Integra Lifesciences concerned whether medical devices fell under the statutory exemption.⁴⁶ In Eli Lilly & Co. v. Medtronic, the Federal Circuit held Class III medical devices are within the scope of the statutory exemption.⁴⁷ Judge Nies wrote the decision for a unanimous panel that looked to the legislative history, specifically the fact that Congress intended to overrule Roche by enacting § 271(e)(1).⁴⁸ The court went on to reason that neither Roche nor the FDCA were restricted to drug research and approvals. Thus, the statutory exemption is likewise not restricted to drug approvals.⁴⁹

¶ 16         The Supreme Court agreed to hear Eli Lilly to consider the scope of the statutory research exemption.⁵⁰ The Court agreed with the Federal Circuit's broad interpretation of the statutory exemption after finding no Congressional purpose to limit the doctrine in the legislative history and, more importantly, no reason to limit the doctrine based on the text of the enacted law.⁵¹ Under this backdrop the Federal Circuit and the Supreme Court considered the matter at hand. Once again the highest patent court and the supreme judicial body were set to determine whether a certain type of research — in this case pre-clinical developmental drug research — is exempt from patent infringement liability.

II.    Merck KGaA, Integra Lifesciences, and RGD Peptides

¶ 17         The use of the RGD tripeptide - named such because it consists of arginine (R), glycine (G), and aspartic acid (D) — was initially discovered in 1982 by Dr. Michael Pierschbacher at the La Jolla Cancer Research Foundation (LJCRF).⁵² The first paper and corresponding patent did not specify the RGD domain as the critical component of the cell adhesion method.⁵³ Rather, the Pierschbacher paper described the primary structure of a novel protein known as the cell attachment factor of human plasma fibronectin.⁵⁴ The specific mechanism of cellular adhesion was not known at this time.⁵⁵

¶ 18         The oldest patent in the chain at issue was for a biologically derived cell surface receptor capable of binding to a peptide containing RGD.⁵⁶ Subsequent LJCRF patents claimed the use of RGD-containing peptides in promoting cell adhesion.⁵⁷ The most expansive patent claims alleged against Merck's use of RGD peptides were issued in 1997 in U.S. Patent No. 5,695,997.⁵⁸

¶ 19         In 1987, Dr. David Cheresh of the Scripps Research Institute⁵⁹ reported the recognition of RGD peptides by cell surface receptor proteins, also known as "integrins," in a line of human cancer cells.⁶⁰ In 1988, Merck KGaA began funding Dr. Cheresh's research into the role of integrins in angiogenesis.⁶¹ As a result of this research, Cheresh discovered that blocking a_Vß₃ integrins on endothelial cells inhibits angiogenesis and, ultimately, tumor growth.⁶² The blocking agents, or antagonists, reported by Cheresh were a murine monoclonal antibody and a cyclic RGD peptide,⁶³ which was provided by Merck.⁶⁴ These preliminary results led Merck to renew its funding for three years beginning in 1995, with a specific goal of developing potential drug candidates.⁶⁵ This research identified two cyclic RGD peptides,⁶⁶ for which Merck began the process of obtaining regulatory approval in 1996.⁶⁷

¶ 20         In 1996, Telios Pharmaceuticals,⁶⁸ Integra, and Burnham learned of the Merck-Scripps research agreement and approached Merck to negotiate a mutually beneficial license agreement.⁶⁹ After Merck declined the license, the patent owners filed suit in the Southern District of California against Merck, Scripps, and Cheresh for patent infringement.⁷⁰ After the district court denied Merck's motion for summary judgment based on the statutory research exemption,⁷¹ a jury trial was held.⁷² The district court denied Merck's post-trial motion to dismiss,⁷³ but agreed that its pre-1995 basic research activities fell under the common law research exemption.⁷⁴ The jury then awarded Integra $15 million in damages based on a reasonable royalty calculation.⁷⁵ After the district court denied Merck's post-trial motion for a judgment as a matter of law, Merck appealed to the Federal Circuit.⁷⁶

¶ 21         The panel of Judges Newman, Rader, and Prost heard arguments and then issued a split decision that upheld the trial court, with Judge Rader writing for the majority and Judge Newman dissenting in part.⁷⁷ The majority opinion takes up the issue of whether 35 U.S.C. § 271(e)(1) should be extended to provide a safe harbor for pre-clinical research on experimental drug compounds. The majority engaged in textual interpretation with a focus on the limiting word "solely":

At the outset, this statutory language strictly limits the exemption "solely" to uses with a reasonable relationship to FDA procedures. The term "solely" places a constraint on the inquiry into the limits of the exemption. The exemption cannot extend at all beyond uses with the reasonable relationship specified in § 271(e)(1).⁷⁸

¶ 22         Thus, the court narrowly interpreted the operative language, "reasonably related to the development and submission of information," to "[a]ctivities that...directly produce information for the FDA," with limited exceptions for "activities that are not themselves the experiments that produce FDA information."⁷⁹ The court held that Dr. Cheresh's work did not qualify, because it "was not clinical testing to supply information to the FDA, but only general biomedical research to identify new pharmaceutical compounds."⁸⁰

¶ 23         Despite this narrow statutory interpretation, the majority opinion was clearly informed by the legislative history of the Hatch-Waxman Act. Judge Rader declared that "the express objective of the 1984 Act was to facilitate the immediate entry of safe, effective generic drugs into the marketplace upon expiration of a pioneer drug patent."⁸¹ Ultimately, Judge Rader countered Merck's interpretation by stating that § 271(e)(1) "was meant to reverse the effects of Roche under limited circumstances . . . ."⁸²

¶ 24         Judge Newman dissented from the majority's interpretation of the common law and statutory research exemptions.⁸³ Her approach was based on the following factors: (1) policy concerns centered on the roots of the patent system; (2) stare decisis of both the common law and statutory research exemption; and (3) a textual interpretation of the statute in view of the legislative intent.

¶ 25         In Judge Newman's view, the basic policy behind the patent system is the fundamental patent bargain.⁸⁴ She admonishes the majority for "disapprov[ing] and essentially eliminat[ing] the common law research exemption":⁸⁵

The requirement of disclosure of the details of patented inventions facilitates further knowledge and understanding of what was done by the patentee, and may lead to further technologic advance. The right to conduct research to achieve such knowledge need not, and should not, await expiration of the patent. That is not the law, and it would be a practice impossible to administer.⁸⁶

¶ 26         Judge Newman, herself a research chemist, appears deferential to the considerable scientific progress made by Dr. Cheresh, which significantly improved the biological understanding of cell adhesion, the role of RGD peptides, and angiogenesis.⁸⁷

¶ 27         The basic structure of the argument is that the common law research exemption promotes the progress of science and technology by "requir[ing] full disclosure of the invention, including details of enabling experiments and technical drawings and best modes and preferred embodiments, even commercial sources of special components."⁸⁸ However, Judge Newman recognizes that there must be a limit to the common law research exemption.⁸⁹ In this respect, Judge Newman analogizes the common law exemption to the fair use doctrine in copyright law, and is particularly adverse to restricting the doctrine purely on the basis of "an ultimate goal or hope of profit."⁹⁰

¶ 28         Returning to Justice Story's famous words in Whittemore, Judge Newman explains that "philosophical experiments" in this context "was referring to 'natural philosophy,' the term then used for what we today call 'science'."⁹¹ The allowance of a flexible common law exemption for research that falls under one of the two Whittemore categories has become a fundamental aspect of our patent system.⁹² Historically, the courts "have applied the research exemption when no commercial purpose was demonstrated for the research."⁹³ Since the exemption has been a part of the common law for nearly 200 years, presumably its doctrinal effects have been incorporated into the economics of the patent system.⁹⁴ Furthermore, "[a] rule that this information cannot be investigated without permission of the patentee is belied by the routine appearance of improvements on patented subject matter . . . ."⁹⁵

¶ 29         Judge Newman's dissent further criticizes the majority opinion for basing its decision heavily on 35 U.S.C. § 271(e)(1) when both parties conceded that the statutory exemption applies to Merck's Investigational New Drug (IND) Application.⁹⁶ Nonetheless, she agrees with Judge Rader that "the § 271(e)(1) safe harbor [does not] reach back down the chain of experimentation to embrace development and identification of new drugs,"⁹⁷ but disagrees with the application of this principle.⁹⁸ Judge Newman also reads into the statutory exemption a legislative intent to restrict its application to generic drugs,⁹⁹ but finds this inconsistent with the Supreme Court's decision in Eli Lilly,¹⁰⁰ which significantly broadened the reasonableness test.¹⁰¹

¶ 30         Consistent with his broad textualist reading of 35 U.S.C. § 271(e)(1) in Eli Lilly,¹⁰² Justice Scalia, writing for a unanimous court, reversed the Federal Circuit majority opinion.¹⁰³ Scalia interprets the reasonableness test without the deference Judge Rader gave to the limiting modifier "solely."¹⁰⁴ With respect to the appropriate interpretation of the reasonableness test, the court "decline[s] to read the 'reasonable relation' requirement so narrowly as to render § 271(e)(1)'s stated protection of activities leading to FDA approval for all drugs illusory."¹⁰⁵ Justice Scalia gives short shrift to any myopic reading of legislative intent,¹⁰⁶ instead establishing:

Properly construed, § 271(e)(1) leaves adequate space for experimentation and failure on the road to regulatory approval: At least where a drugmaker has a reasonable basis for believing that a patented compound may work, through a particular biological process, to produce a particular physiological effect, and uses the compound in research that, if successful, would be appropriate to include in a submission to the FDA, that use is "reasonably related" to the "development and submission of information under...Federal law."¹⁰⁷

¶ 31         Justice Scalia finds support for his interpretation in economic policy concerns and the nature of the FDA and the pharmaceutical industry. He notes the uncertainty attendant to the development of new drug compounds,¹⁰⁸ wherein the only way to "know at the outset that a particular compound will be the subject of an eventual application to the FDA [is] if the active ingredient in the drug being tested is identical" to an FDA approved drug.¹⁰⁹ This uncertainty has been recognized by the FDA, whose regulations "provide only that '[t]he amount of information on a particular drug that must be submitted in an IND'" depends on many factors.¹¹⁰ Furthermore, Justice Scalia cites the Government's amicus brief, on behalf of the FDA, in support of the proposition that "the use of patented compounds in preclinical studies is protected under § 271(e)(1) as long as there is a reasonable basis for believing that the experiments will produce 'the types of information that are relevant to an IND or NDA.'"¹¹¹ Justice Scalia also discounts Judge Rader's normative policy arguments with respect to the extension of the rule to research tools, because the issue was never raised by Integra and need not be a focus of this case.¹¹²

III.    A Realist Approach to Merck and the Statutory Exemption

¶ 32         The statutory research exemption has been a contentious issue ever since Congress intervened in what it perceived as a narrowing of the common law doctrine by the Federal Circuit.¹¹³ In light of the Supreme Court's decision, it is important to reassess the state of the statutory and common law research exemptions and the gloss imparted to the doctrines by the Federal Circuit. The Supreme Court's holding has broad implications that should inform the Federal Circuit's view of this and similar doctrines going forward. As the number of articles published in the two years between the Federal Circuit's decision and the Supreme Court ruling attests, the importance of the decision cannot be underestimated for its legal and economic impact.

¶ 33         Most of the scholarly research on the research exemptions has been concerned with the positive effects of changes in the patent law, assuming that any changes in the law result in behavioral changes in the market for patented inventions. In Integra Lifesciences v. Merck KGaA, the Federal Circuit panel majority adopted the positive view that its decision would change the manner in which research would be conducted.¹¹⁴ The majority explicitly stated that they were trying to protect "the exclusive rights of patentees owning biotechnology tool patents."¹¹⁵ Returning to the original conception of the common law exemption, as reflected in the legislative history,¹¹⁶ the Federal Circuit applied a de minimis test to Merck's actions.¹¹⁷

¶ 34         This rationale is a normative interpretation that values strong protections for patent rights and recognizes the role industry-forcing doctrines can have.¹¹⁸ By protecting the rights of research tool patent owners, the Federal Circuit extended its research exemption rule through dicta to "express a view about whether, or to what extent, § 271(e)(1) exempts from infringement the use of 'research tools' in the development of information for the regulatory process."¹¹⁹ Therefore, the Supreme Court's ruling should be a boon to companies "willing to use patented research tools without a license while the research tool industry is left wondering what value remains in their patents."¹²⁰

¶ 35         In line with the majority decision at the Federal Circuit, many commentators viewed the Integra decision through a positivist lens.¹²¹ Professor Dreyfuss argues that the decision encroaches on the norms of scientific research and proposes a waiver system in response.¹²² The positivist component of this argument builds on Professor Eisenberg's theory that the norms of science, e.g. the societal benefits obtained from an open exchange of ideas, are damaged by overzealous patent protection.¹²³ The proposed waiver system is similar and complementary to compulsory licenses proposals,¹²⁴ except the waivers would only be available to academic institutions and would be subject to limitations on future disclosure and commercialization of innovations.¹²⁵

¶ 36         An alternative proposal by Professor Strandburg sides with Judge Newman's dissenting opinion in Merck, particularly the distinction drawn between "experimenting with" and "experimenting on" patented technology.¹²⁶ The focus of this proposal is again a positivist view that the panel majority decision will significantly affect research activity and unnecessarily resorts to "linguistic gymnastics" to protect research tools.¹²⁷ Professor Sandburg's analysis finds that research tool patent owners would be able to control the progress of research to the detriment of scientific progress under the panel majority's decision.¹²⁸

¶ 37         The imparting of a de minimis qualification to § 271(e)(1) represents the normative consideration that a patent is an absolute property right for which easements should not be granted unless they are de minimis. The Federal Circuit's language in this respect can only be read as a normative proscription, because the statutory text contains no references to the extent of the alleged infringement. In the context of the legislative history, de minimis infringement is neither the more general statutory purpose nor the justification and explanation of any single provision of the statute.¹²⁹ Generic drug approval certainly does not have a de minimis impact on the pharmaceutical industry. Rather, the de minimis argument is raised as one among a few counterarguments to the contention that § 271(e)(1) violates the takings clause of the Fifth Amendment.¹³⁰ Presumably this view assures patent owners that their rights are secure and encourages patenting activity.¹³¹

¶ 38         The Federal Circuit should take heed of the second Supreme Court opinion to interpret this paragraph of the patent law with a strict textualist approach.¹³² Table 1 illustrates the level of disagreement among the court's judges over the appropriate interpretation of this doctrine.¹³³ For example, one of the initial cases at the Federal Circuit to deal with the research exemption and generic drugs noted:

We do not read the statute as implying any such limitation. In the first place, if the language is clear, the plain meaning of the statute will be regarded as conclusive. While legislative history may aid our understanding of the function and purposes of the statute, and in cases of doubt assist in interpretation of the language, when the legislature has clearly spoken the law, the court's duty is to enforce it as written. The statute at issue here only requires that the making, using or selling of the patented invention be solely for uses reasonably related to FDA approval.¹³⁴

¶ 39         Table 1 illustrates that this view has been the norm in the Federal Circuit's interpretation of the statutory exemption since 1990. The Integra decision was an outlier in narrowing the applicability of the research exemption. In every other case, the Federal Circuit has acknowledged the broad textualist view it announced and the Supreme Court affirmed in Eli Lilly.¹³⁵

¶ 40         Perhaps in Integra the Federal Circuit saw potential abuse of a broad research exemption by innovator pharmaceutical companies,¹³⁶ or was concerned about diminishing the utility of research tools patents.¹³⁷ Regardless of the rationale, the court looked to facts beyond whether the Cheresh data was reasonably likely to be submitted to the FDA, which was conceded by the parties.

¶ 41         If one accepts the positivist approach to the research exemption, will Merck v. Integra lead to a boom in fearless innovator research? Infringement liability will still protect the patent owner after FDA approval and will limit outright decisions to infringe.¹³⁸ In fact, the product in question would likely have infringed according to the district court's claim construction, but Merck had not marketed it yet.¹³⁹ This raises the interesting question of whether Merck's due diligence was inadequate. Very few firms will take advantage of the ruling's expansion of the doctrine, because the threat of post-clinical litigation is too great to risk expending resources on development. Therefore, the positivist view, while technically accurate, is of little consequence to the pharmaceutical industry.

¶ 42         The Supreme Court's position is also supported by the economic realities of the pharmaceutical industry. While the Court did not cloud its textualist argument with economic concerns, there are overtones of these considerations. As it is with any bill that has a seminal impact on an important industry, Congress was clearly concerned about the economics of the pharmaceutical industry when it passed the Hatch-Waxman Act.¹⁴⁰

¶ 43         Four arguments support the premise that the Supreme Court's Merck decision is economically preferable to the Federal Circuit's approach to the research exemption. First, the facts of Merck and evidence from the industry demonstrate that licenses are not effective in pre-clinical drug research. Second, a broader research exemption will not significantly affect the future value of most drug patents. Third, the burden of a limited exemption stifles research into new drug uses, and the market value of innovator research is arguably more important than generic research. Finally, the concern about the impact on research tool patents is minimized by two factors: the sanctioned research is into, not using, patented technology and patents have a smaller impact on research tools and instruments than on drug development.

¶ 44         Licenses are a fundamental part of the rents obtained from intellectual property, but their appropriability is highly industry dependent. Merck KGaA sponsored the Scripps research without seeking a license from Integra or Burnham.¹⁴¹ This could have occurred because Merck believed that it could rely on the common law research exemption, which pre-Madey would have encompassed most investigational research at educational and non-profit institutions. It is also possible that Merck was not aware of the RGD patent portfolio. But that is difficult to rely on as a due diligence defense, because the specific RGD sequence was broadly claimed in the '734 patent and Dr. Cheresh's decision to use RGD peptides was clearly informed by the Burnham work.¹⁴² Presuming that Merck conducted the appropriate due diligence prior to launching its research program, we can assume that either the company held an honest belief that a research exemption would apply or the applicable patents were invalid or not infringed.

¶ 45         The costs of obtaining a license prior to investigational work were significant given the uncertainty associated with early stage drug development. Institutional costs and other externalities could have significantly increased the amount Merck expended over the ten years it supported Cheresh's research. Additionally, Merck would risk willful infringement if a license were sought and denied. The Federal Circuit decision would require Merck and Cheresh to obtain a license from the patent owners even before conducting experiments to determine whether RGD peptides inhibit angiogenesis. This presents a significant hurdle to the development of new applications for existing compounds, which is the precise issue attacked in the anti-commons approach.¹⁴³

¶ 46         Like many other industries, most of the innovation in the pharmaceutical industry depends on existing disclosures and represents incremental improvements to existing technology.¹⁴⁴ In recent years, innovation activity has shifted away from models of absolute novelty to a model of routine exploitation of existing technology, particularly in the biopharmaceutical context.¹⁴⁵ This type of innovation places greater emphasis on the interactive and collective nature of innovation processes, which are fueled by access to existing disclosures.¹⁴⁶ The research exemptions improve access to existing technologies and do not limit appropriability of existing patent rights once the innovative technology is marketed.¹⁴⁷ As Judge Newman notes, the prevalence of improvements to existing technology in the pharmaceutical industry belies the assumption that licensing activity increases appropriability of existing rights.¹⁴⁸

¶ 47         As noted by Landes and Posner, "incremental increases in patent protection are unlikely to influence inventive activity significantly and incremental reductions might actually enhance economic welfare."¹⁴⁹ Ultimately, if pharmaceutical firms do not seek licenses as part of their development models, the Federal Circuit's insistence on this behavior does not serve the patent owners or the public good. The patent owners will not be served because the industry is not likely to be forced into this behavior, as demonstrated by Merck's pre-development activities. Social welfare will be diminished by avoidance and circumvention of liability, which will not efficiently allocate the best resources, i.e. existing disclosures, to the task of new drug development.

¶ 48         In addition to the behavioral economic view, the present discount value of existing patent rights is relatively unaffected by the Merck research exemption. At a discount rate of 10%,¹⁵⁰ the present value of a patent right with a twenty-year term, assuming there is a market for the invention, is 85% of its value with perfect appropriability.¹⁵¹ However, one cannot assume that pioneer drug compound patents have a twenty-year term. Even with the patent-term restoration component of the Hatch-Waxman Act,¹⁵² the average effective term of a pharmaceutical patent is about eleven years,¹⁵³ which reduces the present value of the invention to 65%. Overall R&D costs make up about 30% of the present value of drug innovations, and the internal rate of return in the pharmaceutical industry is about 11% on R&D investments.¹⁵⁴ The issue is not whether this level of appropriability is fair to the patent owner, but whether the research exemption has a significant effect on the present value of the patent right. This issue concerns at least two important factors: incorporation of the exemption in the discount rate and effect on supply and demand elasticity.

¶ 49         Assuming the discount rate patentees use when assessing the market for a pharmaceutical treatment is relatively empirical, the research exemptions are incorporated. The most accurate and safest discount rate to apply - the one most relevant to investors - is the historical rate obtained from a regressive analysis based on empirical data, with fewer inherent assumptions than a rate obtained ab initio.¹⁵⁵ Since the research exemption has been a long-standing part of the existing law and is a de facto characteristic of the pharmaceutical industry, any historical analysis that incorporates data older than 2003, arguably until the Supreme Court's 2005 decision, will incorporate this assumption.

¶ 50         Residual demand elasticity, as a ratio of supply and demand elasticity to overall supply, is the most important factor in pricing models for patented products,¹⁵⁶ because uncertainty in demand determines the marginal cost for imitators — whether they nominally infringe the patent or circumnavigate the claims by designing around their scope. In general, demand elasticity is low in the pharmaceutical industry, presumably because of the difficulty of imitating a drug compound patent.¹⁵⁷ The situation in reality is not so simple, because the rules of patentability often restrict patent protection to a narrow family of compounds, thereby increasing potential for circumventing a patent's claim by developing a novel compound with comparable bioactivity.

¶ 51         The research exemption can increase the potential for designing around existing patents through decreased research and development costs when imitators take advantage of patent disclosures. This type of activity is not necessarily within the scope of Merck, because simply using a patented compound as a research tool without a reasonable expectation of a submission to the FDA was not considered by the Court.¹⁵⁸ Even so, it is not likely that this activity has a significant impact on supply and demand elasticity for the patented product. Consider the RGD peptide example: Whereas Integra employed RGD peptides as cell adhesion promoters, its competitors and imitators would experience a marginal cost commensurate with developing competitive cell adhesion promoters. The demand elasticity for cell adhesion promoters would be unaffected by Cheresh's research exemption.

¶ 52         Ultimately, the research exemption encourages the creation of new markets for already granted patents. This increases the future appropriability of unanticipated value as a result of the research exemption and does not affect residual demand elasticity in the existing market. The research exemption encourages innovation, which in turn increases social benefits, with little effect on the value of the private right. Scalia's decision establishes a more specific rule and sets forth a textualist position with respect to the patent laws that decreases the uncertainty the rent seeker will encounter. Uncertainty in experimental use doctrine discourages innovation and diminishes appropriability of patented inventions.¹⁵⁹

IV.    Conclusion

¶ 53         Merck KGaA v. Integra Lifesciences represents one case in a continuing struggle over the position of the research exemption in U.S. patent law. This issue may not be solved soon, with the common law doctrine perhaps dependent on panel composition, although a majority of judges favor a narrow interpretation.¹⁶⁰ In a broader context, Merck v. Integra also reinforces the Supreme Court's textualist interpretation of the Patent Act. This should be a welcome indicator to firms who were startled by the Federal Circuit's earlier decision.

¶ 54         In the future, the Federal Circuit should be mindful of the judges' normative tendencies and adhere to the plain language of the statute when it requires interpretation. The statutory research exemption is entrenched in the Patent Act and must be given its broadest interpretation within the Congressional design. Additionally, the court may consider economic rationales, because a patent is fundamentally an economic monopoly. Ultimately, the Supreme Court's decision in Merck is supported by the economic reality of the pharmaceutical industry, in which risk and capital costs are high and concomitant returns are realized by the most agile firms.

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