Diligence obligations in partnering agreements

January 2013

One of the biggest risks for a life sciences company in partnering a product, whether it be a drug, medical device, diagnostic or research tool, is the possibility that for a range of reasons the licensee may not develop or commercialise the product with the necessary diligence. This article explores the risks and the contractual and commercial means that can be employed to minimise them.

The Partnering Imperative

Given the cost of developing products life science companies, which have particular difficulties in accessing funding from the public markets, must increasingly look to partners for the commercialisation of their products. Although substantial partners can provide development expertise, assistance with the regulatory process, funding and access to markets, partnering a product with another company always results in a loss of some measure of control and the full value of the partnered technology can fail to be realised for one or more of the following reasons:

  • There may be a management change or strategic change of direction on the part of the licensee which means that the licensee no longer places the emphasis on the licensed product that it previously did.
  • The licensee may experience financial difficulties such that it cannot fund the development or commercialisation to the extent it did initially.
  • A change in market circumstances, regulatory problems or difficulties with development may mean that the original terms of the partnering agreement are less attractive for the licensee resulting in a reduced level of commitment to the product.
  • The licensee may prefer a competing internal program for the same indication or application (whether for objective commercial reasons or for less objective "not invented here" reasons), or may acquire a competing program following the execution of the original partnering agreement.

revenueAny of these situations can have serious negative consequences for a licensor, ranging from a complete loss of revenue to a forced renegotiation of the financial terms of the licence agreement.

Precautions for a prospective licensor

The standard protections available to a prospective licensor will be well understood and can be summarised as follows:

  • Conducting detailed due diligence on the potential licensee to determine to the extent possible that a lack of diligence by the licensor is unlikely to arise.
  • Including specific contractual diligence obligations in the agreement.
  • Seeking to impose milestones on the licensee which need to be met for the retention of the licensed rights.
  • Providing financial incentives for early launch of the product or the meeting of commercialisation milestones.

It is the contractual approaches which will be considered in more detail in the remainder of this article. The simplest of these is the inclusion of a briefly worded diligence obligation such as the employment of "(commercially) reasonable endeavours", or occasionally, "best endeavours".  Such undefined expressions have been the subject of consideration by the courts under the law of a number of jurisdictions (read more on the considerations in the UK, Austria, and Germany.) but it is fair to say that there is no standardised measure of such diligence obligations as it will depend to a major extent on the facts of the case. If such an approach is adopted, then the licensee will not be under an absolute obligation and there is effectively a contractual "get out" for the licensee which shifts the risk of non-performance onto the licensor.

Detailed drafting issues

In order to minimise such uncertainty a common approach, particularly in the licensing of pharmaceuticals, is to define in detail what is meant by the wording employed.  In the case of licensing a product with the uncertain potential of a pharmaceutical or medical device with all the development, regulatory and commercial risks involved, it is rare indeed for a licensee to agree to a higher level of diligence than"“commercially reasonable efforts". A common form of wording proffered by pharmaceutical companies is along the following lines:

    "Commercially Reasonable Efforts means those efforts and resources which would be employed by the licensee for a product or compound which is of similar market potential at a similar stage in its development or product life as the Product(s) taking into account, without limitation, issues of safety and efficacy, product profile, intellectual property situation, regulatory environment and other relevant scientific and commercial factors."

Such an approach has a number of drawbacks for the licensor.  The first is that the measure is defined by reference to the efforts and resources of the licensee for its other products and thus allows the licensee in any dispute to adduce evidence of its own activities which it is likely to be difficult for the licensor to challenge.  One way to address this is to define the measure of diligence by reference to the more objective efforts that would "be employed by a well funded pharmaceutical company in the industry for a product of compound which is of similar market potential".  As a result the licensee would at least be able to adduce evidence from independent experts as to what efforts would be likely to be employed in relation to a similar product.

'on the shelf'The second drawback of such wording is that in determining the level of efforts and resources the licensee would be able to argue that the range of commercial and other factors to be taken into account should include the fact that it may be developing a product for the same application or indication which it makes commercial sense to prefer.   While this might be logical, a company licensing one of its major assets may only be prepared to do so on the basis that the licensee should return the program or product to the licensor (or at the least not be able to put it "on the shelf") in the event that it concludes another opportunity is to be preferred.  This can be achieved by providing that in determining the level of efforts and resources to be employed the licensee shall not be permitted to take into account a competing product being developed or commercialised by the licensee.

Finally, the wording set out above is short on detail as to the actual activities which should be undertaken by the licensee.  It is fair to say that the earlier the stage of development of a program or product being licensed, the more difficult it is to impose specific timelines for the achievement of milestones and when it comes to pre-clinical and clinical development, licensees will almost invariably insist that it is unrealistic for timelines to be imposed given the level of uncertainty with regard to development and regulatory risks.   Nevertheless, it is not unreasonable for a licensor to seek some specific measures against which the efforts and resources of a licensee can be judged and wording along the following lines can be employed:

    "Without limiting the foregoing, Commercially Reasonable Efforts requires that the licensee, its Affiliates or Sublicensees:  (a) promptly assign responsibility for research, Development, Manufacturing and Commercialization activities with respect to Product(s) to specific employees or contractors who are held accountable for progress and monitoring such progress on an on-going basis, (b) set and consistently seek to achieve specific and meaningful objectives and timelines for carrying out such research, Development, Manufacturing and Commercialization activities, and (c) consistently make and implement decisions and allocate resources designed to advance progress with respect to such objectives and timelines."


If a diligence obligation is to be of real value to a licensor then evidence of progress by the licensee will be of key importance.  Where it has been possible to set out in detail specific milestones or specific measures to be taken by the licensee, the licensor should seek very clear obligation for the regular detailed disclosure of what has been undertaken and achieved as this will greatly enhance the ability to enforce appropriate diligence.  From the licensee's perspective it is good practice to ensure that a very clear record of the efforts employed in order to be able to demonstrate compliance with its obligations.  

Dispute resolution

Carefully drafted contractual provisions can assist in determining whether diligent efforts have been employed but it is also essential to consider the various tribunals which might be requested to decide on the issue.

dispute resolutionIt may often be considered preferable by a licensor seeking to challenge the efforts of a major licensee for the issue of diligence to be determined in a court of law, and therefore in the public domain, on the basis that a major corporations have reputations to be tarnished as partners of choice if they are seen to be less than appropriately diligent in the role of licensee.

The two major alternatives are arbitration and expert determination, both of which are generally confidential, but other factors should also be considered.  Both arbitration and the courts can have similarly protracted procedures which play into the hands of a well funded licensee.  A licensor is more likely to have funding constraints and if it is to prevail or recover its licensed assets, it will normally wish to do so within as short a space of time as possible in order to minimise the damage to its business.  Without a rapid decision the potential life of the product will be significantly shortened and the perception of the asset by other prospective licensees will be further tarnished.  By contrast, the timetable for binding expert determination can be specifically set out in advance to ensure that resolution is obtained as soon as possible.

Expert determination can also have advantages in that it allows for the appointment of experts with very specific skills including individuals with long experience of product development within a pharmaceutical or medical device company.

Read more on the meaning of endeavours obligations in the UK, Austria, and Germany.

If you have any questions on this article or would like to propose a subject to be addressed by Synapse please contact us.

Piecing the puzzle together

"Given the cost of developing products life science companies, which have particular difficulties in accessing funding from the public markets, must increasingly look to partners for the commercialisation of their products."

"It may often be considered preferable by a licensor seeking to challenge the efforts of a major licensee for the issue of diligence to be determined in a court of law."