Maximizing the value of license agreements

Value of License Agreements Maximizing The Value Of License AgreementsBy Louis P. Berneman, Todd C. Davis, D. Patrick O'Reilley and Matthew Raymond agreements appropriate ■ Louis P. Berneman, iopharmaceutical companies and not-for-profit to their commercial po- (academic) research institutions have become tential and inherent risks increasingly adept at structuring license and (including, proof of clini- related collaboration agreements. Year 2006 was the cal relevance, regulatory, Managing Director, most active year on record in nearly two decades with competition, intellectual Philadelphia, PA USA 1,615 licensing deals valued at $42.7 billion (see property, and pricing/re- Figure 1). But there has been a shift in strategy by imbursement). But licens- ■ Todd C. Davis, the large pharmaceutical companies, who continue to ing professionals, and the HealthCare Royalty Partners, lose patent protection on blockbuster products includ- attorneys that support Founding Managing Director, ing Lipitor, Plavix, and Seroquel. This has compelled them, need to structure Stamford, CT USA these companies to shift their dealmaking, licensing agreements that reflect efforts and dollars to later stage assets to bolster the goals and objectives E-mail: todd.davis@hcroyalty.com their pipelines. of the parties involved ■ D. Patrick O'Reilley, In recent years, there has been a gradual increase in today and well into the Finnegan, Partner, research collaborations, co-promotion and marketing future. In today's market Washington, DC USA agreements and royalty monetizations. In fact, these nothing is standard. In E-mail: pat.oreilley@finnegan.com transactions have outpaced licensing deal activity fact, it is often boilerplate every year over the past three years (see Figure 2). language or lack of com- ■ Matthew J. Raymond, PhD, Royalty monetizations in particular have risen sharply mon sense terms that Rush University Medical Center, in both volume and value with the sector experiencing can derail or hinder the IP Office, Director of a 40 percent CAGR (cumulative annual growth rate) use of licensed assets and Intellectual Property, from 2001 through 2012.
influence their long-term value. Flexibility, access, Chicago, IL USA However, the partnering landscape has become clarity and protection are more pressured, competitive and complex in critical when negotiating license agreements. terms of deal structure. Life sciences licensing professionals have learned to value, price, and craft Building a Valuable Agreement
Flexibility to Share
Figure 1. Biopharmaceutical Licenses Signed—Last Twenty Years Biopharmaceutical li- cense agreements are increasingly being used to support financing transac- tions. While confidential- ity provisions are standard and customary parts of the agreement, both parties should have the right to share critical pieces of the ransactions Signed# T agreement under confi- dentiality, with a potential acquirer or investor. This may include license terms, royalty and audit reports. Each is used to assess the underlying value of the intellectual property. 1. HealthCare Royalty Partners.
March 2014 Value of License Agreements Access to Critical
Pieces of Information
Figure 2. Biopharmaceutical Deals By Type—Last Twenty Years A license for commer- cialized technology is one of a licensor's most important assets. But without access to key pieces of information during the development and commercial stages it is difficult to monitor ransactions Signed and ultimately value the license. In the develop- ment stage, it is impor- tant not only to be able to validate how things are progressing but, at the most basic level, that the product is actually being developed. Once the product is on the market, a licensor should be Clarity of Payment Terms & Obligations
able to validate the calculation of the royalty rate and Uncertainty reduces the value of any asset. It's the estimated payments. Royalty reports by product and "ifs, ands or buts" in license agreements that make it geography; audit rights (before and after the first hard to decipher how much money is due and when; commercial sale) and reports; regulatory informa- what seems clear to those who hammer out the deal tion (annual report, 10-K, 10-Q); and license com- can often be confusing years later. At a minimum, the munications will give a licensor the tools to do this license should clearly specify the royalty rate (includ- and are indispensable parts of a well-crafted license ing what products are covered by the licensed patent rights), how it is calculated, when it will be paid and for how long. Clarity is critical when assessing how For each licensed product, the reports should much the asset is worth. include: • The number of licensed products The royalty base definition should anticipate constituting sales; different, relevant situations including: • Gross consideration invoiced, billed, • Trade channels (i.e. will the licensee sell or received for sales; directly, through distributors, and/or • Qualifying costs, listed by category of trading companies and how will royalties cost, for the calculation of gross to net sales; be calculated); • Product distribution schemes, including • Gross amount of any payments and other dosage vs. bulk form; consideration received by the licensee • Less than arm's length transactions; from sublicensees and the amount of any allowable deductions permitted under • Bundled products (i.e. licensed product the license in terms of sublicense revenue with other products); • Combination products with multiple • Royalties, fees, and other payments owed active ingredients. to the licensor, listed by category; • Calculations for any applicable currency Royalty Term: It is important to look at not only
the patents to be licensed, but the underlying value of what is being transferred as part of the agreement. • A model royalty report (as an appendix Leaving the know-how or other components unac- or attachment).
counted for can leave the innovator empty handed les Nouvelles Value of License Agreements after delivering significant value. Historically, a customary and standard royalty term was "last to Standard categories of payments that are expire" of the patent rights. However, in the world excluded and/or deducted from GSR, and not of generic competition and biosimilars, it may be eligible for sharing include: no longer appropriate, reasonable, or necessary • Royalties paid to licensee, if licensee is for licensors to limit the royalty term to the last to obligated to pay licensor a royalty directly expire of the licensed patent rights. (pass-through); Take for example a license that ties specifically to • Amount received to fund or reimburse one cell line. The licensee ultimately changes cell licensee's prospective (future) R&D lines but still uses the additional art and know-how transferred as part of the deal. Unless the license • Amount received by licensee to fund requires payment for the "know–how," the licensor prospective (future) R&D activities by will receive no royalties. By defining the components of the value as broadly as possible, a licensor can • Amount received for the manufacture and maximize the long-term value of the asset.
supply of licensed products including Royalty Stacking: To preserve the long-term
licensed products for clinical trials; value of the license, licensors should avoid royalty • Equity investments in the licensee by a stacking or bundled discounts. The royalty rate (and sub-licensee up to the amount of the fair base) should be a unit or percentage of net sales. If market value of the equity purchased on royalty reductions and other discounts are essential, the date of the investment; an absolute floor or minimum royalty rate should • Loan proceeds paid to the licensee by be specified in the agreement. If the royalty rate a sub-licensee in an arm's length, full was initially set based on the perceived need for recourse debt financing, to the extent additional licenses, stacking language can be incor- that such loan is not forgiven. porated to account for the change. For example, the stacking royalty can be structured to not start until a Reversion/Termination Rights: While every li-
defined number of additional licenses are executed cense agreement is drafted when the parties expect and paid. The agreement should state that there success, a licensor should negotiate a reciprocal are no stacking penalties when additional licenses right to terminate under certain adverse condi- come from affiliates of the licensee or where cross tions, including conditions of significant product licensing is used. Stacking provisions should also underperformance. It is also essential to regain exclude third party licenses that have already been all of the rights owned prior to the agreement, taken by the licensee.
such as ownership of the intellectual property, Sublicense Revenue Sharing: License agree-
data generated by the licensee (and its affiliates ments will regularly delineate payments from sub- and sublicensees) and regulatory approvals, upon licensees that are considered gross sublicensing termination of the license. revenues ("GSR"). However, there is no customary If the intellectual property is sublicensed or may or standard language for GSR sharing obligations or be sublicensed in the future, the agreement should a set of generally agreed to deductions or exemp- specify the sublicensees' rights in the event of ter- tions for GSR. This makes it difficult for a licensor mination. This can be accomplished in a few ways. to define and justify their valuation expectations The licensees' rights to the intellectual property can for sublicense revenue sharing. Licensors of embry- be granted to the sublicensees or the sublicensees onic technology for example are now allowing for can be provided preferential rights to access the decreased tiers or ratchets of GSR based on how licensed patent rights. As simple example, a licensee much the licensee has contributed to the value of is paying a 3 percent royalty and the sublicensee a the product since the agreement was signed. This 6 percent royalty on net sales of the intellectual helps specify and use development milestones property. Assignment of the sublicense to the licen- and diligence obligations as the basis for tiered or sor would net the licensor twice the royalty rate on ratchet reductions of the shared GSR percentage in the intellectual property over an assignment of the license to the sublicensee.
March 2014 Value of License Agreements Protection of the Intellectual Property
intellectual property by using security interests. A Bankruptcy protection clauses are a critical compo- security interest can be crafted to include rights nent of a license agreement. Product liability claims that arise under a license agreement including the and unanticipated changes in the market can prompt right to exploit the intellectual property without bankruptcy reorganization but the stakes change liability for infringement. For example, a licensor depending on which party files. Several potential can take a security interest in a license agreement scenarios should be addressed in the license agree- and the proceeds to secure the licensor's interest in the licensee's performance. A licensee can also The Licensor Goes Bankrupt
take a security interest in the licensed patents to secure their right to practice under the patents A licensee will typically want the license to con- tinue even if the licensor goes bankrupt. Licensees are generally protected in this scenario assuming While a security interest will not guarantee owner- there are no anti-assignment right provisions in the ship of the intellectual property upon bankruptcy, it agreement on the part of the licensor. They can elect may place the party ahead of unsecured creditors. to retain their license rights even if the contract is It may also prevent a trustee from assuming and as- rejected in bankruptcy court. However, this protec- signing the license to a third party. A licensee with a tion is not available under foreign bankruptcy laws. If security interest in the licensed patents may be able the licensor is a non-U.S. entity, the licensee should to acquire the patents instead of electing to continue have the right to terminate either for cause or for the under the license. licensor's bankruptcy. The parties should also mutu- Ownership Interests and Enforcement Rights
ally agree that the intellectual property is subject to For not-for-profit research institutions in particular, Section 365(n) of the Bankruptcy Code.
there are two additional legal considerations that The Licensee Goes Bankrupt
must be considered: perfecting their ownership rights Patent license agreements are not typically assumed in inventions; and structuring agreements in a manner or assigned by a trustee unless the patent owner gives that is consistent with their enforcement activities. permission. If the licensor's objective is to retain The U.S. Supreme Court recently reminded us control of the intellectual property, an assignment that patent ownership vests with inventors.2 Not-for- provision should be incorporated into the agree- profit research institutions require (by policy and/or ment which states that the licensee cannot assign contract) that faculty and staff assign work-related the agreement without approval from the licensor. inventions to the institution. But affirmative steps This approval can be qualified with specific language are necessary to ensure that all inventors assign (i.e. will not be unreasonably withheld, delayed, or their patent rights to their institutional employers conditioned). The provision can also specify that at the time they make and disclose their inventions. the licensee is unable to assign the agreement to a In cases where investigators are from different competitor of the licensor. laboratories or institutions, not-for-profits may need The Licensee Becomes Insolvent
to take additional action to ensure all inventors af- firmatively assign. A licensor with a potentially bankrupt licensee may want or need to terminate the license agree- Patent enforcement activities vary by institution. ment if the licensee becomes insolvent. But with no Some institutions are directly involved with licensees effective "ipso facto" clause, a licensor must rely on in times of enforcement litigation while others are other contractual methods to terminate the license involved to the extent required by licensees and the agreement prior to bankruptcy. For example, the courts. However, even licensors who have assigned licensor may be able to terminate the agreement if all their substantial rights to the licensee, may be the licensee pledges its assets used for performance required to participate in the litigation process. under the agreement; but, only for the benefit of For further protection, licensors can add in patent creditors, fails to make timely payments under the enforcement clauses including no right to sue or agreement, or takes actions that may indicate im- enforce; ability to enforce depending on actions of pending financial difficulty. exclusive licensees; obligation to join litigation if exclusive licensees seek to enforce; and sole right Other Legal Considerations
2. Stanford Junior Univ. v. Roche Molecular Sys., 131 S. Ct. Licensors and licensees can further protect their 2188, 2195 (2011) les Nouvelles Value of License Agreements tention to licensing terms will ease the due diligence Dealmaking is an essential element of the biophar- process and simplify future transactions but, most maceutical business model and licensing is critical to importantly, preserve the intended value of the deal product development. The baseline economic terms in the myriad circumstances that will inevitably occur following the execution of the agreement. The time in these agreements are important in terms of mea- to optimize a license agreement is prior to signing, suring and realizing the value of intellectual property, when the only certainty is the inability to predict but it is in negotiating the numerous key terms of the the future. Attention to these key terms will reduce agreement that the full range of value, such as the restrictions on the ability to respond to adverse situ- "know-how" value of the intellectual property, can be ations, and will help a licensor better navigate the exploited. Experience has shown that clarity and at- uncharted waters ahead. ■ March 2014

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