Since 2012, as a result of the America Invents Act, biopharma companies have had to deal with an incredibly unfair situation regarding patent defense, in the form of the inter partes patent review process. This past week, however, Allergan plc Ordinary Shares (NYSE:AGN) stood up for its rights and those of all biopharma companies by striking a unique arrangement with the Saint Regis Mohawk Tribe.

AGN transferred the patents for its dry-eye solution, Restasis, to the Tribe. In turn, the Tribe has licensed back commercial rights for the drug to AGN and will receive $15 million in annual royalties.

Most importantly, Allergan believes (and I agree) that this will insulate Restasis from the unfair patent challenge that the IPR process permits, while still allowing generic challenges through the tried, tested and fair Hatch-Waxman pathway. If successful, this may lead to every other bipharma company doing the same — protecting hard-earned intellectual property while still fostering generic competition and incentivizing innovation.

AGN Stock: Some History Behind the Story

Back in 1984, Congress created a way for generic companies to challenge biopharma patents in federal district court. This has come to be known as the Hatch-Waxman approach to patent challenges, and roughly 40% of them are successful. The idea was to provide a method to foster generic competition without undermining incentive for biopharma companies to spend billions in R&D. It seems to have worked, since R&D hasn’t flagged despite generic drug sales gobbling up 90% of the market.

However, Congress threw a needless wrench into this process with the Inter Partes Review (known as “IPR”). The intent of the IPR was actually intended to help the technology industry fend off patent trolls. However, like much of what Congress does, there were unintended consequences.

The first consequence was that both generic manufacturers and hedge fund managers realized the barrier to invalidate patents was much lower with the IPR process, resulting in some 70% of patents being thrown out. Generic suppliers piled into the IPR process. In addition, short-sellers like Kyle Bass hid behind public relations fronts called “Coalition for Affordable Drugs”, to challenge patents using IPR while simultaneously shorting the stock of the biopharma company whose patents were being challenged.

The IPR process is also wholly unfair. With Hatch-Waxman, patents are given the benefit of the doubt, so to speak, in that they begin with the presumption of validity. The challenger must prove its case.

However, the IPR process is ridiculously unfair in that it does not begin with that same presumption. There is no grant of validity — despite the fact that the U.S. Patent Office issues patents for the drugs under question.

But that’s not all.

A patent that has been challenged under Hatch-Waxman and been upheld can still be challenged under the IPR process. It’s the equivalent of double jeopardy, yet the IPR process is allowed to stand.

Hatch-Waxman has existed for 33 years and nobody’s complaining. The IPR process is a threat to holders of legitimate intellectual property that is upsetting the balance, and pushes biopharma companies away from taking on the risks of R&D.

So AGN decided that it had enough of the IPR process, and made the deal with the Tribe.

I think this is an outstanding maneuver.

Upside for Allergan and Other Biopharma Stocks

There are two legal arguments that support AGN’s move. The first is that the Patent Trial and Appeal Board, which administers IPR, twice dismissed challenges to patents held by state universities. The Board said that because state universities are considered sovereign entities, they are insulated from the IPR process. Allergan probably looked at these cases as precedent.

State universities have sovereign immunity, and certain Native American tribes do too. Having now completed the transfer, the Tribe will seek to have the upcoming IPR challenge dismissed, but it will not challenge the Hatch-Waxman case presently going on.

AGN has said that it welcomes challenges via that pathway, just as it always has.

The entire IPR process is also going to be reviewed by the Supreme Court. Critics of Allergan’s patent transfer argue that if the company believes IPR is unconstitutional, why not wait until the Court sorts it out? But with its intellectual property under immediate assault, AGN acted quickly to defend itself and deliver on its fiduciary responsibility to shareholders. Hopefully similar moves like this won’t be necessary in the future, after the Supreme Court rules against the constitutionality of IPR.

For investors in dividend-paying biopharma stocks, this is a key development. Patent expiration means less revenue, as generic competition takes over some of the branded market. But more importantly, it casts a cloud over the future of pharmaceutical innovation. The IPR process is clearly stacked against innovators, and it may have a chilling effect on future R&D investment. That has probably put pressure on biopharma stocks. It has also reduced revenues for companies that have lost IPR challenges.

Thus, if either the AGN maneuver is upheld, or IPR is struck down by SCOTUS, there should be a relief rally in biopharma stocks — and plenty more revenue to boost the bottom lines going forward.

As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities.