Sharing IP, Sharing Risk

October 1, 2003
Paul J. Meyer, Jr.

,
Carol Cherkis

Carol Cherkis, PhD, is the life science consultant at NewCap Partners.

Pharmaceutical Executive

Pharmaceutical Executive, Pharmaceutical Executive-10-01-2003,

Thanks to growth in international trade, rapid technological innovation, and a willingness to share intellectual property (IP), the number of corporate cross border alliances has grown steadily.

Thanks to growth in international trade, rapid technological innovation, and a willingness to share intellectual property (IP), the number of corporate cross border alliances has grown steadily. Pharma, in particular, has embraced the practice, because the risks associated with commercialization of its products are so great and because the industry realizes the value of jointly developed IP. In fact, pharma has achieved some of the world's best cross-border collaborations. The most successful have been formed with careful legal planning that minimizes a company's chances for jeopardizing the alliance's greatest asset: the IP that goes into and comes out of it.

"We see more and more companies trying to aggressively tap into partnerships, in-licensing, and out-licensing and not letting IP issues get in the way of extending their reach into other companies," says Russ Hagey, managing director of the Los Angeles office of Bain & Company, a global business consulting firm."There has been a historic view that IP is the hurdle that has kept people away from alliances. But with a dearth of good opportunities in companies' product pipelines, there's a willingness to work through whatever historical stumbling blocks may have existed."

This article examines how pharma companies can use business and legal planning to protect their intellectual property and any that the alliance develops, while focusing on what really matters: the opportunities of collaboration.

Where in the World?

Alliances can be structured in several different ways. Several factors, including business, legal, liability, tax, accounting, and IP, dictate what the most appropriate form may be. An alliance may be implemented through a jointly owned entity or by contract. But before choosing a structure or even a partner, the initiating company should consider the benefits and risks of establishing a cross-border alliance in any given country. For a variety of reasons, such as tax incentives to companies that develop IP and commercialize products there, certain countries and regions may be more favorable to the project. Many countries in Asia, including Singapore and Taiwan, offer such incentives. Taiwan, for instance, may allow research and development costs to be deducted from income tax. Most European countries also offer such incentives.

Glossary of IP Terms

"The Irish tax laws will give you a break if you have a manufacturing site there, but the real break comes if you are an Ireland-based company earning royalty income from patents based on R&D that originated in Ireland-and that flow of royalty income is tax-free," explains Marla Church, former corporate patent counsel for Elan Pharmaceuticals Research, a US subsidiary of Dublin-based Elan. "In the early days, it gave [Elan] an edge in that we had all our R&D in Ireland and all the patents originated in Ireland."

Once a company targets a country or region for further inquiry, it must get answers to more specific questions that will uncover the potential risks of establishing an alliance there. For example:

  • What is the scope of IP protection in the region/country?

  • Do the country's patent laws adequately cover compositions and methods of treatment ?

  • If not, are there significant risks for entering the alliance partner's market?

  • Is there sufficient enforcement for violations of IP rights?

Most Western European countries and Canada have strong IP protection. However, the IP landscape of many other countries that companies might consider as a site for a collaborative effort present IP risks and challenges that should be closely considered before any deal is brokered. (See "At Your Own Risk-A Sampler" on page 64 for a representative list of such countries and examples of potential concerns.)

Some countries-China and Argentina are two examples-have a history of poor IP enforcement. According to Peter C. Richardson, Pfizer's senior assistant general counsel and general patent counsel, it can be difficult to determine how courts in those countries will handle patent disputes. He says, "China doesn't have a history of patent enforcement. They've enacted laws that provide for patent protection, but not many cases have been litigated. Argentina has a national pharmaceutical industry and they've had a system that tends to favor their own companies. They have historically not been ready to grant IP rights in the first place, and enforcing rights has been problematic."

Other countries have requirements that significantly reduce an alliance's value. For instance, Japan's patent law requires that companies provide "appropriate compensation" for discoveries made by employees. Over the last few years, there have been several high-profile lawsuits involving this requirement, as well as other issues related to the ownership of IP rights.

Worse yet, there may be compulsory license provisions, whereby a government can compel a patent holder to license rights to a third party to produce and sell a product with royalties determined by the government instead of the patent holder and the third party. Developing countries, with low or nonexistent levels of IP protection and limited access to new pharma products, are more likely to enact legislation permitting compulsory licensing under a broad range of circumstances, including loosely defined "national requirements." In the United States compulsory licensing is not permitted except in limited circumstances.

Recently, Argentina's compulsory licensing provisions have been criticized as "overbroad," because they allow the government to compel licenses without a legitimate market rationale. And Malaysia's Ministry of Health has been moving toward compulsory licensing of HIV therapies so it can obtain the lowest possible price.

Run a Background Check

Successful alliances ensure that legal and IP issues are addressed up front and that both parties share an understanding of the value of IP before establishing a formal relationship. Because cross-border alliances often include companies with drastically different corporate cultures, it is important to recognize beforehand if there are differences regarding IP. According to Frederick F. Giarrusso, vice-president of business development for Santen Holding U.S., "It's almost impossible to negotiate with someone who has no idea about, or respect for, IP."

At Your Own Risk -- A Sampler

It is likewise imperative to conduct a formal due diligence analysis of the IP. In fact, due diligence analysis, which is the hallmark of avoiding pitfalls in most alliances, may also assist the parties in valuing both the technology and the IP.

In certain regions of the world, valuing technology presents specific problems. Melvin Rodriguez, director of Willamette Management Associates' inter-company transfer pricing practice in New York, points out,"It is not easy to do valuations in Latin America because reliable information about comparable companies or transaction data is hard to come by.

"That is true there and elsewhere, as few countries require exchange-traded companies to publicly disclose financial information. Likewise, Europe tends to be an area of concern because partners outside that region may find their products subject to 'gray markets'-loss of protection because products can be sold under a different or similar label by distributors in other jurisdictions that seek to enhance free trade."

Taking care of due diligence up front means that partners understand what IP the other party has and that they know whether the partner can make good on the technology or IP they promise. There must be a thorough analysis of the partner's technology. Due diligence also reveals the value of the partner's IP as well as the strength of the proposed partner's IP portfolio, which may include experience in blocking patents and other important knowledge assets.

Any investigation should also include a risk assessment to see whether the proposed partner is involved in, or is likely to be involved in, any high-stakes IP litigation. If patents are the alliance centerpiece, companies should consider counsel's opinion addressing potential infringement, validity, and enforceability issues. For instance, if there is any chance that the alliance could be sued for patent infringement in the United States, obtaining a "freedom to operate" opinion can establish the necessary written record to avoid a successful claim of willful infringement.

Dig Deeper

The due diligence process can also include a search and analysis of state-of-the-art developments in the pharma industry, including a careful review of related and competitive technologies, and a legal analysis of whether the technology and IP can be conveyed to the alliance: that is, whether they are owned by, or are free to be licensed by, the contributing partner. "You don't want to enter into negotiations with somebody, get too far down the road, have an agreement, and then find out that the whole thing is going to die because somebody else has the patent rights and they are just going to stop you from developing the product," says Richardson. "We often find that we need to do a fair amount of independent evaluation to determine what rights there are and to make sure that there are no third-party rights. We don't want to be in the position where we take a license and then find out that we can't market the product because somebody else has a patent and we are unable to negotiate a further license."

If the alliance will be structured as a co-development deal, the company will want to make sure that the potential partner can deliver what it proposes. The best way to determine a partner's capabilities is to visit its facilities in-person-especially if the alliance will be structured as an R&D alliance. "You want to see their labs, you want to see how they're set up, you want to see that they have the equipment necessary to carry out the experiments that they say they are going to do," cautions Corinne Marie Pouliquen, senior counsel in the Washington DC office of Epstein, Becker & Green. "If you walk in and they have no venting system, that's not a good thing.

I have seen places where they have loose leaf papers flying around the bench and they're just taking notes. If I think there's going to be a problem, I will spell it out [in the agreement]."

It also matters who conducts the due diligence. Those doing so should have an in-depth knowledge of the applicable technology and broad knowledge of technology management, implementation, and deployment, ideally including expertise in pharma or a related industry. For some purposes, even companies with sophisticated in-house technological capacities require that independent experts conduct technology assessments to avoid the potentially negative impact of hidden agendas and vested interests. Although it can be easy to get bogged down in the due diligence process, once it is completed, the alliance partners have valuable information about how best to structure the alliance and address any anticipated IP challenges.

Protect Interests

For a company contributing IP to an alliance, nothing is more important than retaining maximum control over its IP. Likewise, both parties must consider ownership of IP generated by the alliance. The agreement should be flexible enough to account for changes in the competitive and IP landscape that the alliance is targeting.

"From a cross-border point of view, companies need to keep in mind the importance of arriving at flexible but workable arrangements that meet operational and tax objectives and provide them with the flexibility to adjust to changes in the IP environment," notes Rodriguez. "Flexibility can be understood as having a financial option, but one that is operational and embedded in the way the companies structure the transaction. These are called 'real options,' such as the option to abandon a project, given some new performance criteria, or to delay a project, given the presence or absence of a new economic condition in the marketplace. A few companies have cross-border arrangements that cannot be abandoned at a reasonable price because they failed to include in the negotiations the conditions under which the project would be abandoned and the cost of abandonment."

Once the alliance begins producing IP, the partners must determine how to protect and manage it. In many instances, pharma alliances should first look to patent protection in each country involved. That will generally allow both parties to fully realize the benefits and protection of their patent rights. The scope of patent protection is not uniform from country to country, however, and in some countries, patent protection may pose more risks than rewards. In a country where enforcement is weak, the cost and difficulty of procuring a patent and the requirement for disclosure of the technology may not be justified. In India, for example, it can take many years to obtain a patent, and once a patent is procured, it may have very little value because of the uncertain enforcement climate.

It may, in fact, be impossible to obtain a patent under a foreign country's patent law. Instead, the alliance may want to protect the invention as a trade secret, a form of protection that is at least equal in duration to a patent and that also maintains confidentiality. Richardson points to China as an example. "China is a young country from a patent law point of view [10–15 years], so it has had to develop systems and learn how to operate dispute resolutions. But the biggest issue in China is the long-term predictability. Nobody has had much experience in what that does to market exclusivity."

Moreover, the alliance should ensure that the party with the responsibility for generating and maintaining the IP is also well versed in proper IP development and documentation. That includes determining who will file patent applications before established bar dates and disclosures. Companies should also maintain accurate records and signed documentation to memorialize the IP production.

Enforce What's Protected

Vigorous enforcement of the IP by both partners is extremely important. Even with the increased focus on IP protection, countries with weak patent systems generally are less aware of the power that patents and IP could have if they were properly enforced. Fortunately, alliance partners in some of those countries are patent savvy.

"We seek patent protection for companies in more than 130 countries," Richardson says. "Patents are critical for us to be able to sell Pfizer products. So we have a whole staff of people obtaining patent rights for its inventions. We also enforce patents globally. But once you have a patent, it means something only if you're prepared to sue somebody who's copying your product."

At the same time, such enforcement should be coordinated so the action does not put either partner at a disadvantage. For instance, one partner could irreparably harm a relationship with a third party that is a valuable partner in another collaboration, or the enforcement action might harm other worldwide interests.

"We've got close to 300 cases of infringement litigations around the world, in which we are enforcing our patent rights," says Richardson. "Many of those have a cross-border aspect, because it's common to have litigation in more than one jurisdiction. So it's important to tie those together and to have the interaction between the law firms in different countries coordinated by the legal division's IP group. You can't say one thing in litigation in one country and something different in another. For patent enforcement, that is not a recipe for success."

When the Alliance Ends

Alliance partners should start their collaboration with the end in mind, because a well planned termination agreement makes for a smoother transition when it is time for the alliance to part ways.

In China, for example, Rodriguez cautions, it "could be difficult if you do not go with a very clear mind on what the terms of the transaction will be and who is responsible for ownership, development, and exploitation of property. It's very difficult to be successful in these arrangements if you don't have any strategies relative to exiting the arrangement." For instance, deciding which party owns any jointly developed IP should be a top priority. That includes any obligations that survive the termination, such as maintenance of licenses to use the IP that is produced by the alliance and maintenance of its value.

Looking Ahead

Throughout the world, IP is being recognized as the cornerstone of the pharmaceutical industry, even in countries and regions that have historically ignored its importance. As Giarrusso has said, "You can have a factory burn down, you can have a laboratory blow up, all kinds of things can happen. Your computers can go to heck. But if you own IP, you can pull it back together. You've got the core of your business. You can always build another building. You can always put up another lab. And you can always straighten up a computer mess."

Hagey expects cross border alliances to continue to grow in the coming years, despite concerns over IP protection. For starters, increasing numbers of companies need to fill pipelines with good products, which means they will reach beyond their traditional borders. Also, more companies are going to look across borders for talent, as the high tech industry has done to find engineers.

Finally, he expects more companies will view alliances as windows into international geographies. Bain's research finds that companies successful in international expansion use data-driven test market results to determine the likelihood of achieving commercialization before they invest directly. But alliance opportunities are the ultimate commercialization test in those markets. "Those geographies will provide growth options in the future," he says "and you have a range of companies that will be willing to make the long-term bet."

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