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.

Before you get to the agreement

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:

• Are there any potentially competing products that you have in the pipeline?
• What regulatory obstacles do you see arising in relation to the licensed product?
• Do you plan to undertake any big strategy overhauls any time soon? 

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.

Endeavour to be reasonable and (better still) best

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:

• This definition links reasonable efforts to the efforts the licensee undertakes concerning its own products, meaning the licensee would only need to produce evidence of the measures they normally take to prove they comply – regardless of whether those measures are objectively appropriate. One way to tackle this would be to make this criterion more objective, by linking the definition of "reasonable efforts" to efforts which would be employed by "a well-funded company in the pharmaceutical industry".
• It allows the licensee to take into account the full range of regulatory and commercial factors. The licensee can prefer a product they developed in-house – or pivot their strategy away from developing products like the licensed one – and still argue they are not in breach of their obligations under the licence agreement. To guard against this, the licensor should obtain a carve-out prohibiting the licensee from this kind of behaviour.
• It does not set out any details of actions the licensee should take to fulfil its diligence obligations. Within the life sciences sector, enforcing strict timelines concerning product development and bringing a product to market is challenging, given the uncertainties involved in clinical trials, regulatory and reimbursement processes. However, setting out a series of steps that the licensee must take in the licence agreement could set effective milestones for the licensee and give the licensor a cause of action in case of their breach. Such steps could include: promptly assigning the product to a development team, setting up specific and meaningful objectives and timelines to progress product development, allocating resources designed to advance the product, and regular progress update reports.

Look around

Other provisions in the licence agreement can help make the diligence obligations more meaningful and enforceable:

• Any reporting obligations on the licensee should include reporting on how the licensee is complying with its diligence obligations.
• Termination provisions should allow the licensor to terminate the agreement if the licensee is falling significantly behind.
• Dispute resolution clauses should allow the parties to quickly resolve disputes over the extent of licensee's diligence obligations. Here, expert determination can be a sensible option for licensors and licensees, as the timetable can be set out and decided upon in advance, removing the uncertainty and delays which are characteristic of litigation. This process also allows for the appointment of a highly skilled expert with specific industry knowledge to decide the case.

Now you're telling me!

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:

• compel the licensee to improve their performance, or
• claw the product back and try their luck with someone else.

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.