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It seemed like a logical plan. A pharmaceutical giant that wanted to expand and strengthen its cancer treatment offerings found a small biotech company with an innovative drug that was on the fast track for Food and Drug Administration approval. The two established a strategic alliance under which the biotech company would complete the drug registration and the pharma partner would then distribute the drug through its vast sales organization. But months later, the biotech company was embroiled in charges of false statements made to the investing public, faulty execution of clinical trials, alleged misrepresentation to the FDA, self-dealing, and insider trading. The pharma partner faced guilt by association. It found itself the subject of FDA and congressional review and a defendant in shareholder suits seeking to impute to it the misconduct of its smaller partner. How did such a promising partnership go so wrong? After all, strategic alliances in the life sciences industry are rarely established with simple good faith and a hearty handshake. Both sides retain legal and technical teams to investigate each other thoroughly. So why didn’t all that due diligence uncover the biotech company’s many issues? The answer is the very nature of these alliances. Typically they focus on early-stage drug compounds and technologies, which are difficult to value and must make it through a lengthy, uncertain, and costly development cycle and rigorous regulatory review. Companies with complementary skills and intellectual property are natural collaborators but also natural rivals. Often science drives the alliance offshore, requiring collaborations across multiple time zones, locations, and languages. Partners vary in size and maturity and thus possess different expectations, internal controls, business practices, flexibility, and wealth. A pharma partner may demand blockbuster profits, for example, while a biotech company wants to validate its science and survive financially. Moreover, as companies are increasingly aware, failure can be costly. The FDA recently entered into an arrangement with securities and antitrust authorities under which companies making inflated claims about a drug’s clinical benefits and approval status may be referred for prosecution. These heightened enforcement policies, combined with new oversight under the Sarbanes-Oxley Act, may force companies to monitor and report a partner’s misconduct. In the suits noted here, shareholders are trying to impute to Bristol-Myers Squibb alleged misrepresentations made by ImClone — and, by so doing, impose upon one alliance partner a duty to protect the public from being misled by the other. In short, strategic alliances between pharmaceutical partners are usually complicated and sometimes risky. Yet they’re on the rise. Why? LET’S DEAL Between 1996 and 2001, pharma and biotech companies formed more than 7,000 alliances worldwide. Alliances are seen as a highly flexible means of extending technical capabilities, leveraging assets, sharing costs, and managing risks, without requiring the permanent changes in ownership, management, and personnel associated with mergers and acquisitions. Alliances come in a variety of forms, from licensing arrangements to joint development, sponsored research, equity investments, spinouts, and joint ventures. They are used at all stages in the product development cycle, from the earliest research, through clinical development, regulatory approval, and marketing and distribution. Alliances have targeted single compounds and technology platforms. Larger companies have used these collaborations to fill technical or product-line gaps quickly, and small companies have found funding outside the increasingly conservative venture fund community. However, the benefits of an alliance can also be its weaknesses. Because of the agreement’s limited scope, controlling the other partner’s business is difficult. Reasonable restrictions upon access to confidential information make it hard to predict or even monitor a partner’s activities. Try asking a pharma giant for a copy of its five-year research-and-development plan or a list of its acquisition targets during due diligence review for a future alliance. The request is likely to produce little of use. Yet a biotech company seeking an alliance must still make sophisticated predictions about the big company’s future actions and propose contract language that might protect it in the event of a loss of commitment by the partner. Of course, alliance due diligence involves IP audits and other M&A-like queries, with all the standard warranties and representations. Yet because the success of an alliance depends upon optimizing a relationship over time, due diligence and related deal making must also focus on factors such as compatibility, trust, and communication — issues too often minimized as “soft.” An assessment of compatibility not only looks at the present, but also attempts to judge the “fit” of the partners in five or more years. THE PLAN BEFORE THE PLAN Step one in effective alliance diligence requires a large step backward. Before a company settles on a deal, it must be clear about its own profile and goals. Self-delusion can be fatal, especially for the smaller partner. Therefore, a company should prepare a detailed and realistic development plan for the alliance. The biotech company must recognize the weaknesses, as well as the strengths, in its own science and organization. It should identify the needs of the customer (initially, the pharma partner) and the clinical benefits of the potential product. The company should map out how, where, and by whom the work is to be performed. The plan should also consider the extent of integration required between the partners, the realistic costs and the time lines for such expenditures, the nature of anticipated inventions and which party is likely to be the inventor, the limitations on information sharing and reporting, the process for making decisions, and the company’s own likely areas of growth and potential competition. Counsel must then determine whether the internal planning has been sufficient to construct a win-win deal. That, in turn, means that counsel must be familiar not only with the technical requirements of the future collaboration, but also with potential implementation issues, likely disputes, and various outcome scenarios. Counsel’s diligence plan should be designed to obtain information as to each element of the development plan in a form enabling management to make appropriate risk assessments. All the standards of typical M&A diligence should be satisfied — comprehensive review of the potential partner and its IP, multiple documented meetings with responsible persons, interviews with lower-level employees, physical inspection of facilities and data, cross-checking of information, analysis of inconsistencies, and review of outside materials. But the focus must be on uncovering information upon which judgments can be made about the partner’s present and future intentions. Counsel should test the honesty of the partner without being offensive, consider the materiality of information not provided and differences in business practices, and assess the reliability of the partner’s sources of financing, materials, and technical support. Experience teaches that resistance or incompetence encountered during due diligence is often magnified during the course of the alliance. WHAT HAPPENS TOMORROW? The company’s planning and due diligence should help optimize the negotiation and drafting of the alliance agreement. Many alliances fail precisely because in crafting the agreement parties did not exploit what they learned from their due diligence. A party’s history of satisfying commitments, meeting milestones, litigating disputes, and retaining key personnel should all be factored into the final agreement. Because an alliance governs an ongoing relationship, the agreement must do two seemingly incompatible things: It must lay out clearly the expectations, roles, and responsibilities of the parties, and it must allow flexibility to respond to unforeseen events. At a minimum, it should establish precisely the obligations of the parties over the first year of the alliance, often the most critical period. A company’s forecast of likely discoveries should drive the agreement’s protections of intellectual property. To optimize its IP rights, the biotech partner might propose that jointly developed inventions must be reduced to practice before a party can exercise unlimited rights of use. The agreement should also anticipate how one partner’s core business might be affected by technology jointly developed or owned solely by the other partner. Finally, a well-written agreement should plan for life after the alliance. It should clearly assign risks and rights during the collaboration and upon its termination. Nonmonetary terms may be more important than upfront fees and royalty rates. Provisions should be carefully reviewed to avoid an uncompensated shift of risk to one partner. Risks might be changed by royalty reductions due to third-party IP licenses, allowable deductions in determining net sale prices (upon which royalties are calculated), triggers requiring price reductions for partner-supplied goods, punitive indemnification clauses, conditioning of milestone payments upon unrealistic deadlines, and excessively broad force majeure clauses. Each partner should determine where it wants to be at the end of the alliance and craft its negotiations accordingly. A well-planned termination can even benefit the smaller company — if it is accompanied by the assignment or royalty-free use of patents, trademarks, clinical data, and regulatory registrations. BEST INTENTIONS But no contract can provide for all occurrences. Counsel should therefore establish a factual record during diligence and negotiations with which a court, arbitrator, or mediator could later determine the intent of the parties. Courts have held that when one party states its intentions unambiguously, and the other does not object or offer a contrary understanding, the silent party is deemed to have accepted the declarant’s statements as the intention of both. U.S. West Inc. v. Time Warner Inc., a 1996 Delaware Chancery Court decision, is a good example of the importance of record-building between prospective alliance partners. A dispute arose over an unforeseen change in Time Warner’s competitive position relative to the alliance. The court held that Time Warner’s disclosure during due diligence and ensuing negotiations of its partial interest (and option to increase its position) in Turner Broadcasting Service was sufficient to shift to U.S. West the risk that Turner Broadcasting might someday acquire assets competitive with the alliance. The court dismissed U.S. West’s claim of fiduciary breach on the grounds that because the contract’s noncompete clause exempted Time Warner’s interest in Turner Broadcasting, it was reasonably foreseeable that Turner Broadcasting might acquire competing assets even though Time Warner was the alliance’s managing partner. Risks, wrote the court, should be allocated in favor of the party that had been the most “forthright” about its intentions. The unforeseen results of strategic alliances have given Bristol-Myers Squibb and U.S. West some uncomfortable days. To avoid a similar sinking feeling, companies should conduct due diligence and negotiations with two goals: to maximize the potential value of the alliance, and to reduce the risk of undue harm from changes in a future partner’s focus, the broader science, commercial markets, and a hundred other external factors that can undermine the best laid plans. N. Peter Kostopulos is a partner in the life sciences and IP litigation departments of Womble Carlyle Sandridge & Rice, resident in the Tysons Corner, Va., office. Kostopulos has represented development companies in national and transatlantic alliance transactions and related disputes. He has also chaired the Strategic Alliances Committee of the Licensing Executives Society. Kostopulos can be reached at [email protected].

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