27 July 2020
Synapse - July 2020 – 1 of 6 Insights
When licensing out a product to a bigger player, one of the risks is that the licensed product is shelved and the licensor never sees any revenue from it. This can happen for many reasons, and the licence agreement should anticipate that.
Granting a licence to a well-resourced licensee is a strategy commonly deployed by life sciences SMEs to realise the value of their products. The promise of a cash injection, steady income from milestone payments or royalties further down the line is the main attraction.
When done right, a deal of this type can be a win-win. The right licensing agreement can see the SME licensor benefit from the product development, marketing, and regulatory experience of the bigger partner who gets to market a profitable product without the risks associated with developing one from scratch.
However, product development in life sciences is a long game, and the licensee's strategy may change over time. Perhaps they acquire rights to a superior product, or macroeconomic or regulatory changes mean the licensed product isn't as profitable as previously thought. Maybe new management changes the strategy, and the licensed product is no longer a "core" part of the licensee's portfolio.
Either of these scenarios could have a detrimental impact on the licensed product and licensor's revenue stream. That's why these issues should be discussed when negotiating the licence agreement, and mitigated as far as possible.
In discussions with potential licensees, the licensor should apply the main rule of any successful negotiation – ie try to find out about the objectives of the other side, to address the risk of the licensed product getting shelved.
Questions that the licensor should ask to help them assess the risk of the licensed product ending up on a shelf include:
With this information, the licensor can consider whether they should create additional commercial incentives for the licensee. Milestones can be set up in a way that would incentivise the licensee to launch the product on time, or even early.
Once parties get down to drafting the licence agreement, one thing they'll need to consider is what should be the standard to which the licensee is to perform the product development activities.
When entering into the licence agreement, the licensee may not be in a position to promise that the product will get onto the market. Therefore, an absolute diligence obligation on the licensee to do just that is unlikely to ever be accepted. Instead, the licensor can use an obligation to use "reasonable efforts" or (if you are a more confident licensor) "best efforts" to achieve this goal.
However, just stating that the licensee will employ "reasonable" or even "best" efforts to put the product on the market is not good enough. Both phrases have been considered by the courts, but the conclusions on their meaning hinge on the circumstances of the particular case and the time when the relevant contract was executed. What constitutes "best efforts" in the context of one product, may fall short of "reasonable efforts" in the case of another. It may even not meet the reasonable efforts standard for the same product if the agreement was concluded at a different time.
The best way for the licensor to ensure that the diligence obligations effectively bind the licensee is to set out their expectations in a bit more detail, by including a definition of reasonable efforts in the licence agreement. A definition we frequently see offered up by licensees is something along these lines:
"'Reasonable efforts' means those efforts and resources which would be employed by the licensee for a product which is of similar market potential at a similar stage in its development or product life, as the product(s), taking into account issues of safety and efficacy, product profile, intellectual property situation, regulatory environment and other relevant scientific and commercial factors."
This drafting is going in the right direction, but is still not ideal from the licensor's point of view:
Other provisions in the licence agreement can help make the diligence obligations more meaningful and enforceable:
If the licence agreement does not go into much detail when it comes to the licensee's diligence obligations, and the licensee's performance is a concern, the licensor has a couple of options.
One option is to try and re-negotiate the licence agreement. Of course, at this stage, the licensor's negotiating position will be much weaker. However, there may still be other provisions in the licence agreement (eg termination) or commercial considerations which may provide some leverage. They may allow the licensor to either:
If all negotiations fail, it may be possible to sue the licensee for breach of their more general obligations under the licence agreement. Still, without express diligence provisions, the licensor will find it harder to prove parties' intentions regarding licensee's diligence obligations at the relevant time in court.
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