Canada: Biotech Licences — Sublicensing Revenue Considerations

Biotech licences are very often lengthy contracts running to 30, 50, 70 or more pages. This reflects the fact that the licences are usually long-term, worldwide and exclusive arrangements involving products of strategic importance to at least one of the parties.

Many topics must be covered in the contract for it to effectively form the basis of the parties' relationship. Two of the most important topics are the licence grant and the royalties. The parties are well-served to devote their maximum attention and thought to these clauses, since they will in large measure decide whether the parties receive the benefits they expect from the relationship.

This article considers some issues for licensors and licensees when structuring royalties on sublicensing revenue to licensees from the licensed technology.

Biotech licences very often charge royalties on 'net sales' by the licensee and its sublicensees. Net sales are typically defined as the gross invoice price of the products less any deductions that effectively reduce the selling price (e.g., discounts or returns) and any extraneous charges (e.g., insurance, duties or shipping). This royalty structure effectively creates a carrying charge on the products that must be collected on sales by both the licensee and its sublicensees. So long as the net sales royalties constitute a satisfactory return to the licensor, any other financial arrangements the licensee may make with its sublicensees are of no importance to the licensor.

The royalty situation becomes more complicated when the licensor also wants to share in the total revenues (from all sources) its licensees may make from the licensed technology. This is the case with profit-sharing arrangements, which have become more common in the biotech industry.

In these broader revenue-sharing arrangements, licensors are concerned that their licensees will make earnings from the licensed technology that fall outside what is royalty-bearing under the licence. Indeed, their licensees may actively devise ways to find such non-royalty-bearing revenues.

In addition to licence fees, milestone payments and royalties received by licensees, licensors will want the royalty provisions to cover 'all other consideration' received in connection with the 'licence, sublicense, assignment or transfer of rights' with respect to the licensed technology, as well as all 'other operating income' received with respect to the development and commercialization of the licensed technology. To guard against licensees avoiding royalties by taking non-monetary consideration, licensors will want the royalties to also capture the fair market value of any non-monetary consideration received.

Though these types of clauses protect the licensor, they may be problematic to licensees who do not want to pay royalties on certain technology development or commercialization arrangements with their partners.

One such arrangement is where the licensee sublicenses the technology to another biotech or pharmaceutical company, and receives back a research and development contract. Licensors will want to capture the research and development revenues to the licensee as monies earned from the licensed technology. However, with research and development activities come expenses, so licensees must be careful to ensure the royalty-bearing revenues are their research and development profits, and not their gross income from the research and development contract.

Another arrangement that licensees may use with sublicensees are equity investments in the licensee by the sublicensees. Licensees will typically want to ensure these equity investments are not captured by the royalty provisions of the licence. Licensors may resist this exclusion, however, since these investments may be done based on valuations that are very favourable to the licensee. The investments are really just a mechanism to either fund research in the licensee or to pay for the technology sublicensees.

McCarthy Tétrault Notes:

These examples illustrate the level of detail that needs to be considered in structuring royalty arrangements in biotech licences to ensure a fair bargain that protects both parties' interests. Lack of attention to royalty terms when negotiating biotech licences is a recipe for future disputes, due to the many ways — both closely related and not-so-closely related to the licensed technology — that licensees can make returns from licensed biotechnology.

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.

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