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How to Divorce Amicably - On Termination in a License Deal

License agreements are like prenuptial agreements: They are concluded for a long time and with great expectations - and people are reluctant to deal with their termination. Yet well-drafted termination clauses can significantly reduce the risk that the partners will later separate in a dispute.


Suppose a biotechnology company wants to license out a drug candidate to a pharmaceutical partner; the latter is to further develop the product and bring it to market. What points should the company pay particular attention to when drafting and negotiating the termination clauses in the license and development agreement with the pharma partner?


Termination for cause


As with any long-term contract, the following also applies to a license agreement: If one party breaches its obligations to a significant degree, the other party can terminate the contract. In practice, the contractual formulation of this right of termination often involves details: For example, how long should the period be within which the party in breach of contract can remedy the breach and thus still avert termination? Do certain escalation stages have to be passed through before termination?


A particularly important question from the biotech company's point of view is whether the pharma partner's 'diligence obligations' should be subject to termination. This means the following: typically, in the licensing deal, there is a risk that the pharma partner 'parks' the development of the out-licensed product (e.g., for corporate political reasons). In this case, the biotech company has no choice but to wait and hope that the outstanding remuneration components (i.e. in particular sales milestones and royalties) will be paid out later.


In order to contain this risk, minimum standards for development are regularly agreed in practice (the so-called diligence obligations), which, depending on the circumstances, can range from 'soft' development obligations to the agreement of annual development budgets to 'hard' development steps with corresponding deadlines. If the pharma partner violates these minimum standards, the biotech company should be able to terminate the contract (at least if the violation is of a certain duration or materiality). Only then will it have the opportunity to license out the project again, this time to a more active partner.


Termination of license rights


Upon termination, the license rights granted under the agreement normally cease to exist. But should this also apply if the biotechnology company breaches the contract and the pharmaceutical company therefore terminates the contract? Terminating the license rights seems 'unfair' in this constellation - after all, the 'blame' for the separation does not lie with the pharmaceutical company. Nevertheless, most license agreements also provide for an end to the licenses in this case, because of the following consideration: If the licenses were to continue to apply free of charge, the pharmaceutical company would have an enormous economic incentive to terminate the contract. It would therefore be tempted not to cooperate seriously with the biotech company at all, but instead to keep looking for 'hairs in the soup' until a reason is found to terminate the contract.


It seems more sensible to give the pharmaceutical partner a choice: Either terminate the contract and accept the loss of the license, or continue the contractual relationship and instead use other legal means to get the defaulting biotech company back on track (for example, by suing for performance and/or claiming damages).


Consequences of termination


If the biotechnology company terminates the agreement, it typically wants to re-partner the development project after termination or, if necessary, continue it itself. To make this possible, the license agreement should contain appropriate clauses. These include, for example, provisions relating to the transfer of patents and know-how, the transfer of documents, data and material, and the transfer of regulatory applications and approvals. Depending on the stage of development, the biotechnology company will also require so-called 'tech transfer assistance', i.e. (technical) help in transferring the project to itself or to the new partner. To what extent and at what cost the pharma partner can and should provide this assistance is often one of the most hotly contested negotiation topics in practice.


Conclusion


There is considerable leeway when it comes to drafting the termination clauses in the license deal. Smart negotiators take advantage of this leeway, address the conceivable termination scenarios early and openly in the contract negotiations, and seek compromises that both partners can live with - because that's how a marriage lasts the longest.



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(article by Börge Seeger, first printed in 'Going Public - Life Sciences', September 2016, p. 96 et seq.)