United States: New FTC Rules For Exclusive Pharmaceutical Patent Licenses

The Federal Trade Commission (FTC) has issued final rules under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (HSR Act) relating to the transfer of exclusive patent rights in the pharmaceutical industry. These new FTC rules go into effect on December 16, 2013. Importantly, these rules clarify when transfers of rights to a patent in the pharmaceutical sector are deemed a potentially reportable acquisition of assets under the HSR Act, and expand application of the HSR Act to exclusive licenses where the licensor retains limited patent rights to manufacture product for the licensee. Although these updated rules focus on and provide clarification with regard to exclusive licenses in the pharmaceutical area, it has been and will remain the position of the FTC that exclusive patent licenses (i.e., those that are exclusive even against the licensor) regardless of the industry are subject to the HSR Act, assuming the HSR Act reporting thresholds are met and no exemptions apply.

What Is the HSR Act?

Under the HSR Act, if certain thresholds are met and no exemptions apply (such as, for example, for non-U.S. assets without a sufficient U.S. sales nexus), acquisitions of assets, noncorporate interests and/or voting securities may not be completed until the parties file notification forms with the Department of Justice and the FTC and a statutory waiting period expires or is terminated. Penalties for failing to file a pre-acquisition notification in compliance with the HSR Act include a civil liability of up to $16,000 a day for each day a party is in violation of the Act.

The "size of transaction" test

HSR Act reportability is not required unless the "size of transaction" test is exceeded. As of this writing, this test currently is satisfied if, as a result of the acquisition, the acquiring person would hold an aggregate total amount of voting securities, non-corporate interests and/or assets of the acquired person in excess of $70.9 million (a $50 million threshold figure now annually readjusted based on changes to GDP).

The value of an exclusive license or any other asset for HSR Act purposes is the greater of the acquisition price, if determined, or the fair market value. The acquisition price for assets includes the value of liabilities being assumed. The FTC has advised that in determining the acquisition price that the value of future payments should not be discounted to reflect a present value. However, if the acquisition price is too speculative to be reasonably estimated (e.g., speculative licensing royalties based on future sales and milestone payments based on events that may never be achieved), the acquisition price is considered undetermined and a good faith fair market valuation made in accordance with the HSR Act rules will determine if the size of transaction test is met. For these purposes, a fair market valuation considers the fair market value of a fully paid-up license.

The "size of parties" test

Under the current HSR Act thresholds, deals where the size of the transaction is less than or equal to $283.6 million (a $200 million threshold now adjusted annually) also have to meet the "size of parties" test. While there are some permutations, the current size of parties test typically is met if the acquiring or acquired person has annual net sales or total assets of $141.8 million or more and the other person has annual net sales or total assets of $14.2 million or more. In looking to see if the size of parties test is met, for each side you look at the ultimate parent and all entities controlled by that parent. The size of the parties test sometimes provides an out for reporting when one side to a licensing arrangement is a small startup.

What is and is Not New Under the Amended Rules?

It has been the longstanding position of the FTC Premerger Notification Office that the HSR Act's pre-acquisition reporting obligations apply to exclusive patent licenses, as well as assignments of intellectual property rights. The FTC has historically interpreted a license to be exclusive, and thus subject to the HSR Act as an asset acquisition, if a license (such as for a particular field of use) is exclusive in some aspect as to all parties including the licensor. If the license is not exclusive in any aspect, then it has not been considered an asset transfer and therefore is not subject to the HSR Act.

The historical FTC approach, although never codified, considered in looking at exclusivity whether the rights to "make, use and sell" under the patent were transferred with the license. However, the FTC has found that it is now more typical in the pharmaceutical industry for licensors to transfer most — but not all — rights to make, use, and sell a product, such that the FTC now views its historical approach to be inadequate. Thus, the new HSR Act rules will treat the transfer of "all commercially significant rights" to a pharmaceutical patent to be a potentially reportable act.

For example, the FTC has found that licensors often retain a right under the patent to manufacturer a product, provided that the licensor may only manufacture products for the licensee. Under the historical approach, this retention of limited manufacturing rights would render the license not reportable. In contrast, under the amended rules, a license would be regarded as transferring all commercially significant rights, and potentially reportable, despite the limited reservation of manufacturing rights to produce product for the licensee.

The FTC also has seen with increased frequency situations where licensors retain the right to co-develop, co-promote, co-market, and co-commercialize product along with the licensee. As discussed below, the amended rules codify the FTC approach that such "co-rights" to assist the exclusive licensee in developing and commercializing a product covered by a patent do not render a license non-exclusive. Although providing new definitions and clarification, the revised rules generally treat the reportability of exclusive license arrangements in the same way the FTC has for decades, with the exception that the retention of a limited right to manufacture exclusively for the licensee will no longer render a license non-exclusive.

As opposed to the licensor retaining co-rights, a co-exclusive license where a licensor retains full rights for its own use of a patent would not be viewed as transferring all commercially significant rights and accordingly would not be subject to potential reportability under the HSR Act.

The amended rules only address transfers of patent rights for patents covering products whose manufacture and sale would generate revenue within NAICS Industry Group 3254 (pharmaceutical and medicine manufacturing), including medical and botanical manufacturing, pharmaceutical preparation manufacturing, in-vitro diagnostic substance manufacturing, and biological product (except diagnostic) manufacturing.

The license transfers in these industries that are regarded as potentially reportable asset acquisitions under the amended rules are those that transfer "all commercially significant rights" — in other words, the exclusive rights to use the patent in a particular therapeutic area (e.g., cardiovascular use or neurological use) or a specific indication within a therapeutic area (e.g., Alzheimer's disease within a neurological therapeutic area). Thus, it is important to keep in mind that a patent license can be subject to reportability under the HSR Act even if it only transfers exclusive rights to part of a patent.

In short, the amended rules make explicit that "all commercially significant rights" are transferred even though the patent holder retains (i) limited rights to manufacture product under the patent for the licensee; or (ii) co-rights which for this purpose means shared rights that are retained by the patent holder to assist the party receiving exclusive patent rights in developing and commercializing the product covered by the patent. Such co-rights include, but are not limited to, co-development, co-promotion, co-marketing, and co-commercialization.

Important Points to Remember

Questions regarding how to value a license, whether or not certain exemptions to the filing requirements apply, whether exclusivity exists, whether or not the parties to an acquisition are of sufficient size to trigger a pre-acquisition filing requirement, and other questions can often require a full factual analysis. Given the complexity of the HSR Act's rules and in order to avoid the HSR Act's severe penalties for non-compliance, it is important in intellectual property transactions that parties are very careful in determining if the HSR Act is triggered.

It is also important to keep in mind that — even if an IP license is exempt from reportability under the HSR Act — the acquisition of an exclusive license or assignment of intellectual property (like any other acquisition) potentially may be investigated and challenged, even after closing, under Section 7 of the Clayton Act, which prohibits acquisitions the effect of which "may be substantially to lessen competition, or to tend to create a monopoly."

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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