For biotech companies, licensing is a very common, if not the dominant, commercialization strategy. Biotechnology licenses are very often exclusive and worldwide, or else encompass large territories incorporating many countries. Royalty structures in biotechnology licenses accordingly have become increasingly sophisticated to deal with territorial issues. This article examines the key issues and techniques used in structuring royalties in international biotechnology licenses.
Patent or No Patent
The most basic question when considering royalty rates for different territories is whether or not the technology is patented in a particular jurisdiction. Patents are the dominant form of intellectual property protection for biotechnology, conferring a monopoly on the patent owner for the manufacturing and sale of the patented technology. There is potentially great value in the existence of patent protection that is reflected in the royalty rate. However, patents are territorially-based, being granted on a country-by-country basis, and time-limited, expiring after a period of time. It is therefore common to provide for different royalty rates on a country-by-country basis within the licensed territory depending on whether the technology is patented in the particular country, with higher royalty rates for the patented countries. It is also common for the royalties to expire completely, or else step-down, as patent protection ceases on a country-by-country basis in the licensed territory. Part of the reason for this approach is case law in the U.S. that says it is patent misuse for royalties to extend past the life of patent protection. Note also that, in some jurisdictions, such as the European Union through its Supplementary Protection Certificate system, government monopoly protection can be extended past the life of patents, for example, in order to compensate for the long time needed to obtain regulatory approvals for medicinal products. In those jurisdictions, the differential royalty rates may be tied not to the life of the patents, but to the period of monopoly protection under any government regime.
Generics and Local Competition
Royalties may also be reduced where generic drugs or other competitive products exist or come to exist in particular jurisdictions within the licensed territory. For example, royalties may be reduced where generics or competitive products acquire a certain percentage of the volume or value of sales in particular parts of the licensed territory.
The use of royalty tiers for different geographic areas is commonly used for biotech licenses. Under a royalty tier system, different royalty rates apply depending on sales volumes within a territory. There are two types of royalty tier systems: tipping and cumulative. Under a tipping system, the higher rate applies only to sales in the particular marginal band in the royalty tiers. Under a cumulative system, once the next tier of sales is reached, the higher royalty rate applies to all sales. Tiered royalties are also sometimes used to approximate the effect of the existence of generic drugs or competition in local markets on sales of the licensed products. In other words, the lower royalty rates that apply to the lower sales volume tiers are used to approximate the effect of dropping sales in a territory due to the introduction of generic or other local competition.
Major and Minor Markets
Different pharmaceutical markets vary greatly in terms of how lucrative the market is. Accordingly, it is common to use higher royalty rates for so-called major markets (typically, U.S. and the E.U.) and lower rates for less important markets (the so-called ‘rest of the world’).
Profit-sharing appears to be a growing trend in biotech licensing, and can be tied to the parties making alternative arrangements for product commercialization in particular parts of the licensed territory. In these instances, the license agreements have both a royalty territory and a profit-share territory. In the royalty territory, the licensee assumes the costs and obligations of commercialization, and therefore the licensor’s remuneration is limited to royalties. In the profit-share territory, the parties more evenly allocate between them the costs, efforts and risks of commercialization; for example, through a co-promotion arrangement, and therefore also allocate between them shares of the profits, typically in the same proportions as the parties have agreed to share the costs and efforts of commercialization. Since profit sharing usually brings with it increased costs, obligations and risks to the licensor, these arrangements may be structured as options to the licensor, with a territory converting to and from a profit-share territory and a royalty territory based on an election by the licensor. When using both a profit-share territory and a royalty territory, the license must include a mechanism for allocating a party’s development and commercialization costs for the profit-share territory to the profit-sharing formula, while ensuring that costs that are specific to the royalty territory are not recovered against revenue in the profit-share territory.
Royalty structures in biotechnology licenses have adapted to account for territorial differences and commercialization strategies, and also to provide flexibility and fairness to the parties in how they share revenues from the commercialization based on local conditions and the parties’ respective obligations in local markets. Given these drivers of royalty structures, one would expect creative and differentiated royalty structures to continue as a mainstay of biotechnology licensing.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.