Allergan's (AGN) fight with generic rivals pursuant to its Restasis patents took another twist Monday. Judge William Bryson ruled Restasis patents were invalid due to obviousness:

A federal judge ruled today that patents protecting Allergan's $1.5 billion blockbuster dry-eye drug, Restasis, are invalid due to obviousness. The international drug company's stock dropped about five percent on the news.

The ruling by US Circuit Judge William Bryson could have wide effects on the patent landscape because the Restasis patents are at the center of a novel legal strategy that involves using Native American sovereignty rights to avoid certain types of patent reviews, called inter partes reviews, or IPRs.

Monday's decision caught me totally unawares. I did not expect a ruling until the end of October. AGN fell as much as 7% before finishing the day lower by over 3%. I had the following takeaways on the news.

Judge Bryson Likely Damaged Allergan's IPR

The federal case had no impact on the inter partes review ("IPR") brought on by Mylan (MYL) and expected to take place weeks later. Allergan transferred the patents to the St. Regis Mohawks who was to use it sovereign immunity to dismiss the IPR. Mylan called the Mohawk deal a "sham" since there was no real change in ownership. The theory went that if Judge Bryson allowed the Mohawks to be co-plaintiffs in the federal case it could potentially embolden Allergan's chances to win an IPR. The judge allowed the Mohawks as co-plaintiffs, yet expressed serious concerns about the Mohawk deal:

Earlier today, Bryson decided that the St. Regis Mohawk Tribe should be joined to the case. But he didn't add the tribe because he thought the deal was valid—rather, he did it as an insurance policy to make sure that his decision to invalidate the patents couldn't be challenged on the grounds that the wrong parties were named.

But Judge Bryson's opinion (PDF) on the matter makes clear that he does not endorse or validate the deal to essentially purchase sovereign immunity from the St. Regis Tribe.

"The court has serious concerns about the legitimacy of the tactic that Allergan and the Tribe have employed," Bryson writes. In his view, Allergan has paid the Tribe to "rent" its sovereign immunity at the US Patent Office.

Allergan claims to have transferred the patents to the Mohawks to avoid the "double jeopardy" of facing a federal trial and an IPR. The Mohawks were to use sovereign immunity to dismiss the IPR, yet Allergan was to keep the majority of the economics from Restasis. Judge Bryson's concerns over the legitimacy of Allergan's tactics could hurt its chances of winning an IPR. The loss of the IPR could clear the way for generic Restasis.

The Play For Investors

The big question is "What is the play for investors?" A lot depends on when generic Restasis will actually hit the market. Well Fargo's (WFC) David Maris believes generic Restasis will not be launched before Allergan's appeal is finished - 2019 at the earliest. However, Bernstein analysts previously predicted generics would launch on appeal if they won the federal court case and the IPR:

In addition to the District Court trial, Allergan faces an inter partes review at the U.S. Patent and Trademark Office next month. Bernstein analysts believe that, if Allergan loses both the District Court trial and the September review, generics will launch upon approval even if the branded drugmaker appeals. If the cases split, Bernstein analysts believe generics firms will wait for an appeal to launch.

The federal court case has been won. If generics firms win the IPR and generic Restasis is eventually approved, then investors should brace themselves for generics firms to launch even on appeal. In my opinion, the bottleneck for generic Restasis is not the IPR but FDA approval; an announcement that generic Restasis has been approved by the FDA could punish AGN.

My previous article highlighted how from 2002 - 2014 the price of medicines was reduced by 51% in the first year generics entered the market. To get the full impact of the hit to Restasis investors must price in [i] a decline in price and [ii] a loss of market share. Restasis represents 15% of Allergan's total income. In my opinion, a major hit to Restasis would be devastating given the company's $30 billion debt load that exceeds 4x run-rate EBITDA. That is a long-winded way of saying I believe AGN could fall further.