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A critical step in the life of many biotech companies is the licensing of core technology from other entities. A poorly written in-licensing agreement can unnecessarily burden a startup in its early stages and come back to haunt the company just when its promising research looks ready to pay off. So biotech startups should handle in-licensing with care. Third parties that invest in, collaborate with, or simply sublicense from biotech companies should also closely review the company’s in-license agreements to make sure that in-licensed rights justify the cost of the deal. By recognizing potential issues, counsel for all sides can appropriately assess and manage risk. Key provisions that can affect the value of in-licensed technology are discussed below. DEFINITIONS Definitions are the building blocks of any license. These are some of the most important terms to be defined in a biotech agreement: Intellectual property. The intellectual property rights being licensed must be defined to include all patent rights, as well as associated trade secrets and know-how (including materials), needed for commercialization of the ultimate product. Critical rights may be missed if counsel does not thoroughly understand both the in-licensing company’s business plan and the underlying technology. Product. The definition of product or licensed product typically has two important purposes: (1) to limit the licensee’s use of the technology and/or (2) to define when royalties and milestone payments accrue. Products can be broad scope (any product that relates to or otherwise is connected with the licensed technology), intermediate scope (any product the manufacture, use, or sale of which infringes the licensed patents), and narrower scope (a specifically defined product or one that specifically incorporates licensed technology). Licensed patents. A fair definition encompasses all relevant patents and patent applications of the licensor that are necessary to commercialize the defined product. Although a licensee is wise to do so, obtaining rights to the licensor’s future improvements and later-acquired, third-party patent rights likely will be difficult. A licensor’s resistance to such expanded grants is understandable, especially where the improvements and later-acquired technology result from a substantial investment and possibly carry third-party royalties. Improvements. Including future technological improvements in a license is often a contentious issue and depends on the equities of the deal. A licensor that grants improvement rights should narrowly define them so as to prevent an unintended loss of technology that is truly distinct from the licensed technology. Universities and research institutions may be prohibited from granting such rights absent a sponsored research agreement. Licensed field. Most agreements limit the licensee’s use of the licensed rights to a particular field. For the licensee, the definition should be broad enough (1) to permit the company to pursue its business plan and (2) to block the licensor from licensing the same technology for competing products. Difficulties arise when the field is imprecisely defined, which often happens with early-stage technology. For example, assume that Product Y for treating Disorder X is within the defined field. Later, it is discovered that Product Y works on Disorder X by actually treating Disorder Z. Absent clarification, both licensee and licensor suffer because it is unclear whether the license covers the use of Product Y for the treatment of Disorder Z. Hence, neither can safely commercialize the use of Product Y for Disorder Z for fear of a lawsuit by the other. LICENSE GRANT The license grant itself builds upon the definitions and typically includes the following provisions: Exclusivity/nonexclusivity. The licensee tends to want exclusive rights within the field, but exclusivity usually is more expensive. If rights are nonexclusive, then the licensee risks other competitors, including the licensor, entering the field. A nonexclusive license may nonetheless be acceptable if the licensee controls other intellectual property that can block potential rivals. “Make, use, offer to sell, sell and import.” A license grant should, at the very least, permit the licensee to “make, use, offer to sell, sell and import” the licensed technology, which rights coincide with those specified in 35 U.S.C. �271. Often, phrases such as “have made,” “develop,” and “distribute directly or indirectly” are included for clarity, especially where the licensee does not have an unrestricted right to sublicense the technology. Sublicense rights. Most biotech companies must sublicense their technology to partners in order to commercialize products. Licensors often demand what are reasonable encumbrances, including requiring sublicensees to abide by certain provisions of the master license, and prohibiting sublicenses to certain third parties that are competitors or potential licensees of the original licensor. PAYMENT OBLIGATIONS Payment obligations in license agreements can range from a one-time fee to upfront fees, to technology access fees, annual payments, milestones, royalties, minimum royalties, and option or extension payments, sometimes involving cash, stock, notes, or combinations of all three. Most often, the licensee will be obligated to pay running royalties on net sales of products, as well as milestone payments based on specified events during research and development. The following are a few key issues: Net sales. Running royalties are usually based on net sales. Therefore, every word in the definition of net sales can make a material difference to licensee and licensor alike. For example, it will clearly make a difference if net sales are calculated on amounts actually received from sales rather than on amounts invoiced, because uncollectible accounts and delays in payments are commonplace. A definition tied to generally accepted accounting principles is often preferred. If the licensee’s products are likely to be part of a combination product or therapy, then the definition of net sales should include a formula for calculating net sales on combination products. Also, because companies often must in-license multiple technologies to commercialize products, licenses typically include “stacking” provisions for decreasing royalties owed to the licensor if royalties must also be paid to third parties. Licensors should ensure, however, that licensees cannot artificially stack unnecessary royalties from affiliated parties. Sales by and other payments from sublicensees. Licensors typically want to extend a licensee’s obligation to pay royalties on net sales to all sublicensees. Alternatively, licensors may require a licensee to pay a percentage of sublicense revenues, including royalties, milestones, etc. Licensees often favor the latter approach because it gives them more flexibility. It is also better for licensees if the definition of sublicense revenues excludes equity investments in the company (except perhaps if a premium is paid) and amounts paid for research and development. Valid claim. A licensee typically pays decreased or no royalties if a product is not covered by a valid claim of a licensed patent in the country where the sale takes place. (Otherwise, the licensee might not be able to price its product competitively.) The definition of valid claim typically excludes patent application claims that have been pending for more than a defined period — e.g., five years — without issuance (and, of course, subject to re-inclusion upon issuance). Milestones. Milestone payments are a common form of rewarding licensors for sharing the risk of development. If they are intended to represent an advance to the licensor on future royalties, then such payments may be credited against royalty obligations. Alternatively, milestones often are characterized as payments for prior or future research and development. Many licenses require the licensee to share a portion (often significant) of revenue received from sublicensees except for R&D payments received. Hence, characterizing milestones from sublicensees as R&D payments can allow the licensee to retain the entire milestone instead of sharing a portion with the licensor. To avoid disputes over whether a milestone payment is due, milestone-triggering events must be defined as precisely as possible. Because milestones are typically tied to U.S. and/or European regulatory activities, consulting a regulatory expert will help ensure precise wording. It is important that milestone payments not hamstring the company. Biotech startups often cannot afford significant milestones for each Phase I or Phase II study, many of which fail. Also, counsel should try to ensure that a particular milestone event is reached and a milestone payment is paid only once per product, even if multiple clinical trials are required. DILIGENCE REQUIREMENTS Licensors may reasonably set such diligence requirements as periodic development plans, minimum activities or budgets, periodic updates, and the right to periodically audit the licensee’s activities. But licensor and licensee should bear in mind that the drug development process is unpredictable, and diligence requirements tied to specific time lines, however generous, can become problematic. Even with the right to extend deadlines upon a showing of good cause, the licensee may risk termination or face penalty payments if deadlines are not met. Diligence provisions that specify only the use of “reasonable commercial efforts” — never “best efforts” — are better for licensees. PATENT ISSUES Where a license is for core technology, the licensee will naturally want the rights to prosecute and maintain the relevant patents. Yet the licensor is unlikely to grant such rights if the license is nonexclusive or exclusive only for a limited field. At the very least, however, an exclusive licensee of a limited field should have the right to consult on the prosecution and maintenance of patent rights and to prosecute and maintain patent rights abandoned by the licensor. The right to bring suit against infringers of the licensed patent rights is often heavily negotiated — in terms of which party has the right or obligation, who pays, who gets any recoveries, and what happens if the licensor does not take action. Where the licensor retains control of enforcement in particular countries and then fails to defend the patent in those countries, the licensee is entitled to have royalties reduced or eliminated. Similarly, defense of third party claims of infringement can be important, but often is not addressed in license agreements. Licensees may seek indemnification, but usually cannot obtain it unless the deal involves large dollar amounts. Indemnification from small-company licensors is rare, and is usually limited to defined intellectual property rights held by identified third parties and defined dollar amounts below the value of the deal. Most early-stage technology, especially from universities and research institutions, is licensed “as is” with no representations or warranties. TERMINATION Once-desirable technology can prove to be of limited or no value down the road, and business plans can change. Accordingly, a licensee of early-stage technology will want the right to unilaterally terminate with or without cause. Conversely, licensors of early-stage technology must often settle for little more than the right to terminate for an uncured material breach. Licensors of later-stage technology often have more clout and can insist on some financial compensation upon termination by the licensee. It is critical to delineate what happens to sublicenses if the master license is terminated. Involuntary termination of a sublicense can subject the licensee to massive liability from sublicensees. The licensee should insist, therefore, that its sublicenses be convertible to direct licenses upon termination of the master license. Conversely, the ability to terminate sublicensees can be a powerful weapon for licensors seeking to motivate noncompliant licensees. MISCELLANEOUS So-called boilerplate provisions can actually have dramatic consequences and so must be carefully reviewed by licensees and licensors. Potentially important provisions include the following: Assignment. The license agreement may prohibit the company from assigning the agreement without the licensor’s prior written approval. This is generally a reasonable requirement that allows licensors to control their licensees and potential competitors. But licensees need some flexibility to pursue exit strategies and deals without licensor approval. A common middle ground is a licensee right to freely assign if substantially all of the assets to which the license applies are sold or transferred. In such cases, the licensor may except certain companies by name or by field description. Governing law and venue. An agreement should specify which law will govern the resolution of disputes arising under the license. Universities are often inflexible on these provisions and, for that reason, licensees sometimes avoid specifying the state law and forum, leaving that issue to the litigators. Dispute resolution. Many agreements provide for alternative dispute resolution. If chosen, the procedure should provide a quick resolution because a delay creates a cloud over both licensee and licensor. That’s a short course on in-licensing technology for biotech startups. While we’ve touched on many key issues, counsel should remember that this is still just the starting point to a smart deal. Stephen C. Ferruolo is a partner in the San Diego office of Heller Ehrman White & McAuliffe, where he serves as co-chair of the life sciences national practice group. Colin G. Sandercock is a partner in the firm’s D.C. office, practicing in the areas of life sciences and intellectual property. David A. Charapp is an associate in the firm’s San Diego office, practicing in the areas of life sciences and corporate law. They can be reached at [email protected], [email protected], and [email protected], respectively.

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