Diligence efforts

While many jurisdictions have their own case law interpreting the levels of efforts applied in carrying out “reasonable efforts” or “commercially reasonable efforts”, it may be preferable to specifically define those efforts contractually to reflect the parties’ intent with respect to their research, development and commercialization obligations. Accordingly, “Commercially Reasonable Efforts” (CRE) or “Diligent Efforts” (DE) are often heavily negotiated. Discussions often focus on (1) whether to apply an objective/industry standard or a subjective standard that takes into account the particulars of the party and (2) which specific factors to be included that are of concern to either party (i.e., whether to include payments under the agreement in assessing profitability).

Post-execution, parties often revisit this definition in assessing whether to continue with the same efforts or to decrease their level of efforts with respect to any particular obligation. As parties apply the definition within specific fact scenarios, they often discover certain factors they would have preferred to include within or exclude from the CRE or DE definition, such as the reference to payments due under the agreement. While parties aren’t always able to include their preferred factors or exclusions in the negotiated agreement, being cognizant of past concerns and applying such learnings will better position the parties for future transactions.

In a post-IRA world, specifying additional factors or carve-outs may be all the more important. For example, in light of the timeline for when a product becomes subject to the “maximum fair price” (MFP) under the IRA’s new drug price program, should there be an absolute obligation to launch a product in the U.S. within a specific time following regulatory approval, rather than a general CRE obligation? Alternatively, should the provision expressly acknowledge when it would not be commercially reasonable to develop or commercialize a product for another indication? In all events, each of the factors to be included or excluded should be carefully considered in assessing a party’s approach to negotiating CRE or DE in light of both prior transactions and the impact of the IRA.

Financial terms                         

Collaborations usually include milestone payments for development, launch, and sales activities, along with royalties, all of which are frequently modeled to a party’s development and commercialization obligations, including with respect to development of additional products and/or additional indications. Royalties may be paid as a percentage of net sales on “licensed products”, or in some instances, on a narrower subcategory of “royalty products”. While the duration of the royalty term will vary per agreement, parties generally use the last patent expiry as a step-down (or termination) point for their royalty obligations.

When operating under the agreement, questions often arise as to whether a milestone obligation may apply with respect to certain development activities or how to calculate royalties. For example, in calculating royalties where the royalty rate is based on tiered sales, the parties should consider whether the royalty rate should be tied to worldwide sales or limited to those cumulative sales within a specific country. In addition, licensees may second-guess or question the often rosier assumptions upon which they modelled their financial obligations. It may be advantageous to base payments on lower projections, with the possibility of supplemental or bonus payments for meeting the higher projected outcomes.

The IRA will also likely impact the royalty and other financial terms. Not only will the diligence efforts standard affect whether certain financials are met, but with a few limited exceptions (e.g., orphan drugs for a single rare disease), commercially successful products without a generic/biosimilar on the market will likely face a price reduction earlier in the product’s traditional life cycle. Accordingly, the parties should analyze and adjust their financial modeling to take account of a price reduction if the product is subject to an MFP. For example, should implementation of the MFP be treated as (in essence) the same as last patent expiry subject to a royalty rate step-down or termination of the royalty term? Or perhaps treated as a compulsory license that should trigger a different royalty rate? Should the definition of net sales or the treatment of combination products be modified? Again, the parties should consider appropriate modifications of their financial provisions to account for past issues faced and the potential impact of the IRA.

Dispute resolution

The life sciences industry is experiencing an increase in licensing and transactional disputes due in part to regret over heightened valuations, contract performance concerns (especially through the pandemic), and in some cases, an increased focus on the Environmental, Social, and Governance front. When it comes to resolving potential disputes, many parties either elect to provide for litigation, which is generally expensive, complex, and lengthy, regardless of forum selection, or by arbitration that has the benefit of heightened confidentiality, but which if not addressed properly, can also become expensive, complex and lengthy. This may be in addition to or in lieu of certain decision-making responsibilities allocated to a joint steering or other committee. Exercising either a litigation or arbitration right, however, can also bring the collaborative relationship to a halt. Therefore, parties may want to consider whether to build in additional alternative means for resolution based on the type of dispute, such as including the use of specialists or allowing expedited proceedings to help address the dispute while trying to minimize disruption to the collaboration.

The use of specialists can be especially helpful in addressing disputes involving highly technical issues such as scientific failure or patent prosecution issues. In such instance, the parties should consider whether to build in an expedited process before a mutually agreed upon expert or panel of experts (such as patent counsel in the case of patent prosecution), which would allow the parties to overcome the bottleneck in a shorter timeframe. Similarly, the use of expedited or “baseball” arbitration, which requires the arbitrator to select only the position provided by either party on an issue, can also help expedite resolution of the dispute. It also has the added benefit of forcing both parties to provide reasonable positions to reduce the likelihood of the arbitrator selecting the other party’s position. These additional mechanisms can help resolve disputes before they land in litigation or arbitration, with potentially less adverse impact on the parties’ relationship.

Termination

Given the uncertain product development timelines in the life sciences industry, it is no surprise that many desired technologies fail to come to fruition. Licensees generally have the flexibility to walk away in such situations given that most agreements grant them a right to terminate for convenience. While licensors do not have the same flexibility, those who limit their ability to terminate the agreement to solely material breach or bankruptcy of the licensee can find themselves unable to get out of an agreement where the licensee is not in breach of the agreement, but is not adequately progressing research, development or commercialization and/or there are scientific concerns with respect to the collaboration. While a termination for convenience right is not realistic, licensors may want to consider other termination triggers to help protect against specific situations, recognizing that one can’t protect against all unforeseen scenarios. For example, the licensor should consider including a termination right for scientific failure based upon certain criteria and/or potentially a failure to conduct any or minimal activities for a specified period of time without good cause. The licensor may also want to consider a termination or other modification right in the event that certain financials drop below a specified threshold. This latter point may be of special interest given the potential impact of the IRA on the financials. Regardless of the cause of termination, the parties should also carefully tailor the timing of any such termination right and the implementation of any relevant wind-down and transition provisions to minimize disruption to the program.

Next steps

Given the long duration of many collaborations, it is important to assess from time to time whether historical provisions in those agreements are still meeting your current business needs and which provisions, if any, should be modified to address issues that have arisen or changes in the legal landscape. This may involve potentially modifying current agreements and/or staking out different positions for future transitions. This article has touched on a few provisions, though we advise analyzing all provisions in an agreement for such purpose. For example, parties to agreements that involve or may involve European patents should consider the impact of the UPC on both their patent portfolio strategy as well the relevant patent prosecution and enforcement rights under the collaborations, as we have discussed elsewhere. Accepting the default position may not necessarily be in the party’s interest. Assessing your agreements and adjusting impacted provisions accordingly will not only help mitigate issues and risks in future transactions, but hopefully help strengthen the collaboration relationship and allow the parties to better focus on their shared goal of bringing life-saving medicines to patients.

Please contact the authors or the Hogan Lovells attorneys with whom you regularly work to discuss your specific licensing and commercial transactions needs. 

This is an article in our 2023 series, “Life Sciences Transactional Insights,” which aims to provide key practical takeaways for our transactional colleagues by anticipating the needs of their regulatory, intellectual property, and business stakeholders. Our dedicated team of life sciences and health care licensing and commercial transactions lawyers understand the challenges and opportunities that strategic alliances and other partnering relationships present. We draw on the depth of our life sciences practice and work seamlessly with our regulatory experts to provide unparalleled transactional support. Ensure you are subscribed to Hogan Lovells Engage to receive our insights on the IRA, UPC, and beyond.

Authored by Anishiya Abrol and Penny Powell.