Bio-Science Law Review

Susie Middlemiss and Rebecca Sadlleir

Slaughter and May, London

Introduction

This article gives an overview of two of the principal types of relationship in which a company in the biotechnology sector is likely to be involved at some point in its lifecycle. It begins with a discussion of the reasons why a biotech company might benefit from entering into a licensing or collaborative arrangement, and then considers the principal legal terms which each type of agreement should contain.

There are many similarities between collaboration agreements and licences. The term ‘collaboration’ is generally used to mean an arrangement where two parties are conducting joint research, while ‘licence’ is used where the main purpose is the grant of intellectual property rights. However, as the former is likely to involve cross-licensing of IPRs and the latter often includes an element of co-operation between the parties, the boundaries between the two types of agreement are blurred.

Motivations for Licensing

There are a number of reasons why a bio-industry company may enter into a licensing arrangement. In any licensing situation, the licensor and licensee will have different objectives.

Licensor: the following are possible reasons why a biotech company may license-out its intellectual property rights:

• It does not use the technology itself;

• It only plans to develop a product or technology in one field (for example, pharmaceuticals), which may have applications in other areas (for example, plant breeding or cosmetics);

• It does not have the resources and/or expertise to exploit products itself. Most biotech companies follow the route of licensing product candidates to major pharmaceutical companies at the later stages of clinical development and for exploitation and marketing;

• Even if the company exploits a product in its home territory, it may license third parties in other territories to maximise the value of its IP portfolio; or

• A company may license out elements of its platform technology and/or software as a means of bringing in income in the short term, to fund long-term drug discovery and development plans.

Licensee: as a licensee, there are also a number of reasons why it may be desirable or necessary to obtain a licence to use third-party IPRs:

• Obtaining a licence allows a business to expand its portfolio of potential drug candidates quickly without the risks and costs involved in a substantial research and development programme;

• A business may also expand by licensing in technologies which are complementary to those developed in-house. For example, a business with a promising anti-cancer drug might seek a licence of a third party’s drug delivery technology to enhance its own product;

• Licensing enables a company to obtain rights in platform technologies and software products to assist in research and drug development. As the biotech industry becomes increasingly hi-tech, smaller companies do not have the resources to keep up with developments and may seek to license in technology to maintain a competitive edge. Larger companies often prefer to focus resources on the later stages of development and commercialisation once the potential of a product or technology has been identified, where the financial rewards are clearer; and

• It can be necessary to obtain a licence to avoid an infringement action by a third party. Every biotech business should be aware of the importance of searching for and avoiding infringement of third-party patents. However, it is not always possible to work around a patent and negotiating a licence can be the only way to avoid an expensive and potentially disastrous infringement claim.

Reasons for Collaborating

The reasons for biotech companies to collaborate are often very similar to those for licensing. For example, two companies may discover that they have complementary technologies, intellectual property rights and/or expertise which they would like to exploit, but cannot do so on their own.

Money is also a significant driving factor for many collaborations. Most biotech companies are keen to become involved in joint research projects with major pharmaceutical companies, not only to obtain funding but also to enhance their reputation and validate their technology in the eyes of the world.

Despite the well-publicised ‘brain drain’, it is still the case that many of the key scientific discoveries and inventions derive from universities in the United Kingdom. For this reason, and because many companies in the sector are university ‘spin-offs’, many biotech companies collaborate with academics in universities and/or hospitals.

Timing of Licence or Collaboration

Timing is a key element in the decision to license or collaborate with a large pharmaceutical company for product development. On the one hand, the biotech company can decide to take a product candidate through the early stages of development itself. This will involve substantial investment and risk up-front, but is likely to result in higher royalty rates in the long term. The earlier in the development process a collaboration partner becomes involved, the lower the returns are likely to be for the biotech company, because of the greater risk that the product will never reach the market and the greater level of investment made by the partner.

The following section considers in more detail the key issues which should be considered on entering into a licensing arrangement; the final section deals with the terms of collaboration agreements.

Key Terms in Licence Agreements

The key issues which any technology licence should address are as follows:

• Scope, including subject-matter, field of use, territory and exclusivity;

• Ownership of improvements and maintenance and enforcement of patents;

• Payment;

• Assignment, sub-licensing and change of control;

• Warranties, indemnities and limitations of liability; and

• Term and termination rights.

Scope of Licence

Subject-matter: what rights are to be licensed? It is vital that the licensed rights are defined as clearly and accurately as possible, to avoid disputes in the future. A smaller, younger company may have less bargaining power but should resist calls for a wide licence since this may be perceived as reducing the value of key assets. On the other hand a licensee will not want to run the risk of being sued for infringement of a relevant patent which is outside the licence. If registered rights such as patents are to be licensed, these should be listed in a schedule. If the licence includes know-how, reaching an agreed definition can be more difficult. For example, does the licence include the right to technical assistance from the licensor or to access its internal records? Special attention will also have to be given to confidentiality arrangements. Trade marks may be relevant: will the licensor and licensee sell the product under the same name (the licensor will probably own the mark) or under different names (each will own their mark)? If relevant patents are close to expiry a trade mark may be crucial.

Field of use: the field in which the licensee may use the licensed rights is often the most contentious and heavily negotiated part of a licence. It can also be a difficult concept to reduce to words. The licensor will want the field to be drawn as narrowly as possible, whereas the licensee will argue for a wide definition.

Territory: it is important for a licence to set out expressly the territories in which a licensee may exercise its rights. Competition law may impose restrictions on the extent to which a licensee can be prevented from dealing outside that territory. Where patent protection has limited territorial coverage, know-how may still provide a basis for a licence.

Exclusivity: the parties must decide whether the licence is to be exclusive, non-exclusive or sole. There is often confusion over the meaning of the terms ‘exclusive’ and ‘sole’: ‘exclusive’ means that only the licensee can use the licensed rights, ‘sole’ means that both licensee and licensor can use the rights. Different exclusivity restrictions can be combined with fields of use and territories, so a licensee can have, for example, exclusive rights to develop a drug for a particular type of cancer in the United States and Europe, and a non-exclusive licence for another indication in the rest of the world. Exclusivity may be limited so that, for example, if the licensee fails to meet certain commercial targets, its licence may become exclusive. Exclusive licensees have certain automatic legal rights, so it is important that these are appreciated and, if appropriate, expressly varied in the contract. Clearly, the grant of exclusivity, even in a limited field, reduces a company’s ability further to commercialise the technology and it is important for a young company to balance the need to secure agreements and revenue against the risk of restricting its future activities.

Rights in Improvements

The basis of a licence is that the licensor retains ownership of the licensed rights. However, there is often a question of who has the right to use and exploit any developments made to the technology during the licence term.

Depending on the circumstances, a technology licence may permit the licensee to use any improvements which the licensor may make to the technology. Alternatively, the licensee may be given a first option to acquire rights to any developments made by the licensor. More importantly from the licensor’s perspective, the licensee may make improvements to the licensed technology, which the licensor will want the right to use. There is a temptation for a licensor to seek an exclusive licence or outright assignment of any improvements made by the licensee. However, the parties need to be aware that provisions of this type generally offend against competition rules and are likely to be unenforceable. However, it is permitted (and very common) for the licensor to have a non-exclusive licence-back to use licensee improvements.

There is also the question of whether a right to use improvements should continue after the licence is terminated. This is likely to depend on why the agreement was terminated and by whom.

Maintenance and Enforcement of Patents

In negotiating a patent licence, the parties must consider who is to assume responsibility for, and bear the costs of, maintenance and enforcement. In the case of a worldwide licence of a number of patents, maintenance costs will be considerable. Generally, the obligation to maintain the licensed patents will remain with the licensor as owner, but the responsibility and/or part of the cost is sometimes borne by the licensee, particularly in the case of an exclusive licence. An exclusive licensee will also want the right to take enforcement proceedings against third-party infringers, although a licensor should bear in mind that this is likely to include defence of an invalidity attack and may therefore wish to retain control. Whichever party bears primary responsibility, the agreement should provide that if it does not wish to maintain or enforce the licensed rights, the other has the right to do so. It is also advisable to include a provision for reciprocal notification of infringements of which either side becomes aware.

Payment

Long lead times on biotechnology products make for difficult financial calculations. There are several elements to licence funding:

• Up-front payment: for the licensee, this is the cost of buying into a licence or project. For the licensor, it is an opportunity to recoup its initial investment and thereby create the potential to diversify.

• ‘Milestone’ payments: milestone payments are sums payable on the happening of predetermined events. Common milestones are when a compound enters into a new stage, for example, the move from research to pre-clinical development, pre-clinical to Phase I, Phase I to Phase II, and so on. Other milestones can be linked to regulatory consents in major territories or first marketing of a product. It is important that technical milestones are clearly identifiable. The licensee will need to be satisfied they are achievable in the set timetable. If not, is the penalty financial and/or a right of termination?

• Royalties: the objective for the majority of bio-industry product licensing arrangements is the payment of a double-digit royalty on product sales. It is perhaps the easiest sum for the licensee to agree to pay, in that it is only due if sales are made. However, the level and scales will be heavily dependent on the other payments that are negotiated. Another issue will be whether there are to be minimum royalties. The licensee will need to be satisfied that these leave adequate margin for error, failing which a change in circumstances may lead to loss of the licence. The receiving party should ensure that the party making the payments keeps adequate records and that there is a right to examine the information on which royalty information is based.

The tax implications of any payment structure should also be considered.

Who Can Use the Licensed Rights?

The parties should agree at the outset who will be permitted to use the licensed rights. The three areas to consider are sub-licensing, assignment and change of control provisions. In general, a licensor will wish to be able to control who has access to its IPRs, whereas the licensee will seek to negotiate as much flexibility as possible.

A common compromise is for the licensee to be able to assign and/or sub-license to affiliates without the consent of the licensor and to other parties with consent, not to be unreasonably withheld or delayed. This allows the licensor to object if, for example, the licensee proposes to assign the licence to a competitor of the licensor. Change of control is usually dealt with in the termination provisions (see ‘Term and Termination’, below).

Warranties, Indemnities and Limitations of Liability

The licensee will often ask for warranties from the licensor in the following areas:

• That the licensor has the authority to enter into the licence;

• That the grant of the licence by the licensor will not conflict with any of the licensor’s existing contractual obligations;

• That the licensor owns and has the right to license the rights (for example, it has not already granted exclusivity to another party); and

• That the licensee’s exercise of the rights granted will not infringe the intellectual property rights of any third party. This is perhaps the most significant warranty, and the licensee may request that it is supported by an indemnity from the licensor.

A licensor which is giving warranties will wish to limit its potential exposure under the agreement, by excluding liability for consequential loss (for example, loss of profits) and/or by imposing a liability cap. Product liability may also need to be considered; to what extent should the party marketing the product bear all liability for defects? Can insurance be obtained for any residual risk?

A licence will generally also contain obligations on the licensee. These may include a warranty that the licensee has the authority to enter into the agreement, an obligation to use best endeavours to maximise sales and/or an agreement not to take any action to damage or impair the licensed rights. A prohibition on the licensee challenging the validity of the licensed rights may in some cases offend competition rules but a challenge can, generally speaking, legitimately be made a ground for termination. There may also be obligations in relation to maintenance and enforcement of the licensed rights as discussed above.

Term and Termination

The duration of a licence will be a matter for negotiation between the parties. As a licensee, it may be desirable to seek an automatic roll-over at the end of the initial term, or at least a contractual right of renewal, to allow for development of its business plans.

In any event, the parties should ensure that the licence term does not exceed the term of protection of the licensed patents, except to the extent that know-how is also licensed. In addition to being commercially undesirable from the licensee’s perspective, attempts to restrict the licensee beyond the expiry of the licensed rights are likely to be unenforceable as being in conflict with EU competition law rules. Restrictions on licensees in respect of know-how must not exceed certain specified periods if they are to avoid falling foul of the same competition rules. For example, a licence of know-how with a term which exceeds ten years from first marketing of the product is considered to be potentially restrictive of competition and could be unenforceable.

While both parties will accept the need to include the right to terminate the agreement short of full term in certain circumstances, the situations when this right can be exercised and the consequences of doing so will be heavily negotiated. There are four grounds which are commonly considered (these apply equally to collaboration agreements):

• Insolvency: this is the standard right for either party to terminate if the other party becomes insolvent or ceases to carry on business etc.

• Breach: the right to terminate for ‘material breach’ is considered by many to be standard. However, it is desirable to define at least some relevant events to avoid introducing a trigger which is uncertain and to ensure that key obligations are clear.

• Change of control: this is a provision allowing a party to terminate if the other company is acquired by a third party. The considerable merger and acquisition activity in the biotech and pharmaceuticals sector makes this a real issue. On the one hand, a pharmaceutical company will not wish to lose the licence or collaboration simply because its ownership has changed; on the other, the bioscience company will not wish its project to be suppressed by the new owner, or to find itself forced into a commercial relationship with a company which it would not have chosen and which may be a competitor. Complex issues may arise if the new owner of a licence or collaborator has similar projects within its own stable. Will they conflict? Should they be merged and on what terms?

• Unilaterally: the pharmaceuticals and biotech industries are in a state of flux. The significant merger and take-over activity in the sector has led to requests, particularly by pharmaceutical companies, that licences and collaborations be capable of termination at any time on notice. The position will depend on the balance of power, but where the pharmaceutical partner has the right to terminate at an early stage, the possibility of compensation to the biotech company should be considered.

Other key terms

Both licences and collaboration agreements will contain provisions in many other areas, including so-called ‘boilerplate’ clauses which although fairly standard, are nevertheless significant. These will deal with such matters as confidentiality, force majeure, governing law, dispute resolution procedures, exclusion of pre-contractual statements, variation of the agreement and so on.

Key Terms in Collaboration Agreements

Collaborations in the biotechnology sector can involve several different types of participant. In addition to the classic collaboration between biotech company and major pharmaceutical company, biotech companies also undertake joint research with university departments, individual professors (often acting in a supervisory or consultancy role), hospitals and other biotech companies.

The main points which a collaboration agreement should cover are as follows:

• Project management and control;

• Licensing of existing or ‘background’ IPRs;

• Treatment of IPRs arising from the project (‘foreground’ IPRs);

• Payment;

• Exclusivity; and

• Term and termination, including rights to IPRs.

Project Management and control

Determining who is to lead the project and have responsibility for decision-making can be the single most contentious issue. There is inevitably a tension between the bioindustry company’s wish to control the direction of the research and the collaborator’s need to have control over funding, with the balance of power generally resting with the funder. Often a project management team or committee is the most equitable solution. The quorum and voting rights on the committees can be different for different stages in the collaboration. A hierarchy of committees to resolve disputes is often effective as project managers may be reluctant to demonstrate to seniors that they are unable to resolve a problem. Where the participation of particular levels of staff or even particular individuals is critical, the agreement should cover selection and replacement and perhaps a right to terminate on loss of key personnel.

Background Intellectual Property Rights

These are the rights which each party brings to the project, namely IPRs which each collaborator has at the outset, or develops independently of the project. In a research and development collaboration agreement, the usual position is that each party retains ownership of its background IPRs and gives a licence to the other of those rights which are necessary for the purposes of the project.

It may be the case that the technology developed in the course of the collaboration is based on one or other party’s existing rights. In this situation, the party or parties exploiting the results will require a licence to use elements of the other party’s background IPRs to enable it to exploit the results. Thought should be given to the extent to which improvements to background IPRs are also licensed. The collaboration agreement should deal with this at the outset, otherwise the party exploiting the results may find itself in the position of being forced to negotiate a further licence from the other collaborator at a later stage.

Foreground Intellectual Property Rights

One of the key questions is who should own the intellectual property rights resulting from a project. In general, the parties will either agree that the rights are to be owned by the inventing party, or that ownership is split according to a predetermined formula. For example, one party may own rights in compounds developed and the other any developments made to platform technology, assays and so on.

However the ownership is split, a collaboration agreement will usually incorporate a cross-licensing structure to allow both parties to benefit from the results of the project. The scope of the cross-licensing provisions will depend on a number of factors, including who has primary responsibility for commercialising the results of the project.

Joint ownership is an alternative which is often raised. Generally speaking, joint ownership of patents is inadvisable under English law. This is because while joint owners may exploit the jointly-owned IPRs themselves, unless they agree otherwise neither can license or assign their interest in the technology without the consent of the other. These restrictions can lead to difficulties at a later stage on termination of the collaboration, or on a sale of one party’s business. Though the position can be dealt with by careful drafting, very extensive provisions are required to deal adequately with the issue. The position is different in the United States, where joint ownership is a more commonly favoured option and both parties have much greater freedom to exercise their jointly held rights.

There is also the question of who pays to file and maintain patents arising from the collaboration and who has the right to enforce the foreground IPRs. The issues are similar to those already discussed above in the previous section.

Payment

The funding issues on a collaboration arrangement are broadly similar to those considered above for a licence and may involve up-front payments, milestone payments and royalties. In a collaboration, there is also the question of who funds the research project itself. In a classical collaboration, the pharmaceutical partner will invariably fund the project. Where universities or academics are involved, it is more likely to be the biotech company providing money and resources. In academic collaborations, it is worth considering the various governmental initiatives which have been set up to provide grants to encourage research and development, for example the European Union’s ‘Framework’ programmes.

Exclusivity

The majority of collaborations are exclusive arrangements. The effect of this is that neither party may conduct research and development in the designated field outside the collaboration, nor can they retain others to do so. The initial challenge is the definition of the field, which poses the problem of defining a new area using terminology which may be inapplicable when the results of the research are known. Commercially, there are risks in defining a field too narrowly or too widely. It is not uncommon for the bioscience company to reserve rights to commercialise developed compounds for indications not of primary interest to the major pharmaceutical company. Competition law issues need to be considered in relation to exclusivity.

A related and significant issue is how to handle rejected compounds. If control has been ceded to the funding party, the biotech company may not have the right to make decisions as to whether to proceed to the next stage, delay or reject the compound altogether. For this reason the biotech company may request that, if a compound is rejected against its wishes, it will be free to develop the compound itself, either alone or in conjunction with others. While such a request may appear reasonable, it immediately undermines the exclusivity and introduces a conflict of interest. However, to reject this concept altogether is to give the power to the funder to freeze the technology, which might be influenced by factors other than technical performance or consumer demand. This is another area where the competition rules may have an impact. In general, a prohibition on marketing products developed in the project is likely to be anti-competitive.

Term and Termination

The term of a collaboration agreement will depend on the nature of the activity. The project could be a nine-month screening programme or a development and marketing collaboration lasting until all the relevant patents have expired. Relationships are often formed in stages, for example:

• Stage 1: early stage assessment of a drug candidate by a pharmaceutical company;

• Stage 2: three-year research and development project; and

• Stage 3: full-scale collaboration to take the product through clinical trials and beyond. Each stage can be the subject of a separate agreement but if it is difficult to monitor whether technology has been used once it is disclosed, it may be desirable to negotiate full terms for a commercial licence prior to any substantive disclosure.

When the parties reach the stage of actually marketing a drug, there are many ways in which the relationship can be structured, for example as a licence, a commercial collaboration or a full-scale joint venture. It is unlikely to be possible at the outset to assess which structure will be the most appropriate, and the parties must endeavour to maintain a balance at the early stages between achieving certainty and retaining flexibility. Often an agreement will be amended or replaced before full term, and this is important where it no longer reflects commercial reality.

Rights on Termination

On termination of the collaboration or rejection of a single compound, issues arise as to who has the right to use and exploit the IPRs arising from the project. The following issues need to be considered at the outset and dealt with in the contract:

Does it matter who terminated and why?

• Who should have the rights to exploit the technology developed during the collaboration? Should a licence or cross-licence continue? Should rights be assigned from one party to the other?

• Should a different position be taken for foreground and background? Should the parties continue to have rights to background IPRs?

• What approach should be taken to know-how and clinical data?

• If sub-licences of technology (or licences of products resulting from a collaboration) have been granted to third parties, should these continue?

• Should the parties accept any post-term restrictive covenant? If not, should a more limited non-solicitation covenant be imposed?

Conclusion

A good agreement is clear and accurately reflects the commercial arrangement reached between the parties. It is important that the termination arrangements are appropriate and in particular give adequate protection to intellectual property rights, should the commercial reality be less rosy than anticipated.

Key agreements are part of the core assets of a biotechnology company. Investors will often require agreements which demonstrate that a company’s technology has been validated and give some promise of future revenue. In due diligence for all varieties of transactions the terms of agreements will be crucial and on an IPO may well be described in the prospectus. A young biotech company may have limited bargaining power but it is important to ensure that early agreements do not overly limit its ability to commercialise its technology in the future.

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