Will They Discourage Venture Capital Investment In The Biotechnology Industry?

According to National Venture Capital Association statistics, venture capital (VC) investing hit a fiveyear high in 2006 with $25.5 billion invested. Notably, the life sciences sector, which includes biotechnology and medical devices, accounted for 28% of VC money invested, the largest investment sector in 2006.

As life sciences venture capital investing has risen, the biotechnology industry has become increasingly dependent on such funding. This is particularly true for start-up companies that cannot rely on revenue from marketed biologics to fund their research and development pipeline. To cover the nearly $1 billion capital investment required to bring a biologic drug to market from discovery through clinical trials, early-stage companies rely on VC investing. Investing in emerging companies, however, is risky for a venture capitalist: Only one in ten drugs discovered actually makes it to market and, despite the more than $50 billion spent on biotech drugs in 2006, only about a quarter of biotech companies are profitable.

Given the high failure rates and enormous costs of bringing a biologic to market, companies and their investors look to successful drugs to reap sufficient revenue to compensate for both the research and development costs of the successful drug and the expense of failed biologics. In this landscape, intellectual property protection is critical to the startup biotech company and to its VC investors, with no assurance that there is adequate market exclusivity to allow a successful biologic product to earn adequate profits, VC investors have no guarantee of a return on investment and will be hesitant to direct their funds to the life sciences sector.

Unfortunately, recent proposals in Congress to create an abbreviated pathway for approval of "biosimilar drugs," in tandem with attempts to reform the patent system, may weaken intellectual property protection for emerging biologic companies to the extent that venture capitalists may be less willing to risk capital investment in the industry. For many early-stage companies, intellectual property is the only asset of value. Weakened intellectual property protection may stifle innovation and ultimately hinder patient access to life-saving new biological medicines.

Follow-On Biologics: Market Exclusivity Is Essential To Protecting VC Investment

Under current law, most biologics are licensed for marketing by the Food and Drug Administration (FDA) under the Public Health Service Act. By contrast, small molecule drugs are approved for marketing under the Federal Food, Drug, and Cosmetic Act. The landmark 1984 Hatch-Waxman Act created an abbreviated pathway for approval which allowed generic versions of brand drugs to be approved without clinical studies. If the generic company could show its product was bioequivalent to the brand compound, it could rely on approval of the brand drug as evidence that the generic drug was safe and effective and could therefore also be FDA-approved. There is no such pathway available under the Public Health Service Act for biosimilar products, but several pending proposals in Congress would create such an abbreviated pathway for biosimilars, also known as follow-on biologics (FOBs). Legislation introduced by Senators Hillary Clinton, Mike Enzi, Orrin Hatch, and Edward Kennedy appears to be the most viable, although it may change considerably before passage. In its current form, the Biologics Price Competition and Innovation Act (BPCIA), introduced and marked up in committee in June 2007, contains worrisome provisions affecting intellectual property.

The initial concern is that the proposal offers only 12 years of data exclusivity for a licensed biological product. "Data exclusivity" refers to a period of time during which an FOB applicant may not rely on clinical data from the innovator product as evidence of safety and effectiveness. Whether this exclusivity period is sufficient has been the subject of much debate in Congress and among stakeholders. Data exclusivity is necessary to assure an adequate, riskadjusted return on investment for the branded compound and to provide security for VC investors in the emerging biotech company. Too brief an exclusivity period could serve as a serious deterrent for VC investors if they believe the risk of early market entry of a biosimilar product will reduce the profitability of the branded compound. The loss of VC funding would seriously hinder, if notdestroy, biotechnology innovation. On the other hand, too generous an exclusivity period may inappropriately stifle competition.

Adequate exclusivity periods are particularly important for the biotech industry. Under Hatch-Waxman, a small molecule generic drug must be identical to the brand innovator drug for approval. Because the active ingredient of the generic and brand compound are identical, innovator patents generally protect the brand drug from generic infringers until expiration of the patent. On the other hand, given the complexity of large protein molecules and the manufacturing process for biologics, the standard for approval of FOBs under all pending legislative proposals including the BPCIA, is "similar," not identical. A biosimilar product that is "similar" to the innovator reference product may be similar enough under regulatory standards to obtain approval as an FOB, but different enough under intellectual property law to avoid infringing issued patents on the innovator product.

In fact, in the absence of assured market exclusivity for the innovative biologic, FOB manufacturers will be encouraged to design around innovator patents while still maintaining sufficient similarity to obtain FDA approval. This would be particularly worrisome for VC investors if "similar" FOBs could be substituted for the innovator biologic, yet, due to clever patent design, did not infringe the innovator's patents. In this scenario, the FOB applicant achieves maximum market penetration with minimum cost, to the disadvantage of the emerging biotech company and its VC investors.

The message here is that for VC investors, a sufficient period of market exclusivity is critical to support the capital invested in emerging biotechnology companies. VC investors should pay careful attention to Congress as members struggle to achieve the optimal exclusivity period.

Follow-On Biologics: Potential Weakening Of Patent Protection And Discouragement Of VC Investment

The nexus between market exclusivity and patent protection is clear: If exclusivity periods are inadequate for innovator biologics, this puts pressure on the patent system to protect capital investment in biotechnology. However, several provisions in the BPCIA could weaken, or even eliminate, intellectual property protection for biologic patent holders. If not corrected, these provisions could reduce VC investment in start-up companies and stifle innovation.

Limited Pre-Market Litigation Of Patents. The BPCIA confers an advantage on FOB applicants by permitting them to dictate which of the innovator's patents will be litigated before the FOB is commercially marketed. If the FOB applicant and the innovator company do not agree on which patents will be litigated in advance of market launch, each party is given authority under the BPCIA to list the patents it wishes to litigate. The FOB applicant is given a distinct advantage because the innovator may not list for early judicial resolution more patents than the FOB applicant lists (unless the FOB applicant lists no patents, in which case the innovator may choose to litigate just one patent). From the innovator's viewpoint, this gives the FOB applicant the ability to limit litigation to what it regards as the weakest patents in hope of achieving early judicial success. It also permits the FOB applicant to force an innovator company to bring suit on patents it does not wish to defend and to defer suit on patents it wishes to assert. These provisions weaken the value of the intellectual property portfolio of innovator biotechs and could deter VC investment in early-stage companies.

Potential For At-Risk Launch Of Infringing FOB. If the foregoing provisions are enacted, only a subset of relevant patents will be litigated in advance of the FOB applicant's market launch of the potentially infringing product. Under the BPCIA, the FOB applicant is required to provide only 180 days' notice to the innovator company before it commercially markets the FOB. Only then can the innovator sue on patents that were not listed for pre-market litigation. Six months is insufficient time to permit final resolution of all relevant patents or to obtain a preliminary injunction against marketing the FOB pending such resolution. This could allow the FOB applicant to launch its potentially infringing product at risk, before patent conflicts are resolved, possibly flooding the market with lower priced competing products and adversely impacting the market before the innovator's patents can be enforced.

Truncated Period Within Which To Bring Suit. A third problem to consider under the BPCIA is the limited time frame afforded to innovator companies to bring suit. After lists are exchanged identifying relevant patents on the innovator product and some form of agreement is reached regarding which patents will be litigated in advance of market entry, emerging biotech companies are given a mere 30 days to bring a patent infringement suit. Thirty days is an unreasonably short time frame within which to expect the company to file a complaint (note the 45-day period under Hatch-Waxman). This is especially true when one considers that innovator companies face a unique problem that rarely arises during litigation involving small molecule drugs. In the biotech world, due in part to the Bayh-Dole Act, many universities and academic institutions hold the underlying patents for the innovator biologic drug and must participate in litigation involving the patents due to jurisdictional standing requirements. Typically, these institutions license the patents to emerging biotech companies who fund the clinical stages of research and development and eventually launch the product. An emerging biotech company simply cannot communicate with universities and other third-party patent holders to coordinate litigation on all relevant patents in 30 days. The process involves too many people to move that quickly, particularly if more than one patent is designated for litigation. Yet, if the innovator start-up does not bring suit within the designated 30 days, its damages are limited to a reasonable royalty. For venture capitalists (VCs), this represents a decrease in the value of the emerging company's patent and therefore lost return on investment. If this time frame is not corrected, it will weaken economic incentives to invest in emerging biotech companies.

Limitations On Patent Enforcement. Finally, under the BPCIA, innovator companies are prohibited from enforcing any patents that are not identified in the original exchange of lists between the innovator company and the FOB applicant. Although the same holds true under Hatch-Waxman, given the prevalence of third-party patent holders in the biotech industry, it is critical that legislative proposals provide an effective mechanism for the FOB applicant to notify these third-party patent holders in order to identify potentially infringed patents. Unfortunately, several of the current legislative proposals do not adequately address notification of third-party patent holders. Although the latest version of the BPCIA does provide for third-party access to the FOB application for patent identification purposes, the notification provision is woefully inadequate. For example, none of the current proposals requires that the FOB applicant provide a sample of its product to the patent holder, which likely will be needed in order to evaluate the issue of infringement. For VCs, this discourages investment in innovative biotech companies.

Although the patent provisions of the BPCIA are an improvement over prior draft versions of the bill, problems still exist that must be addressed. Strong patent protection is essential to incentivizing VC funding of emerging biotech companies, the foundation of innovative biologic product research and development. The Hatch-Waxman Act has succeeded because it effectively balances patient access to affordable generic drugs with incentives for innovator companies to continue to invest in research and development of new drugs. To be equally beneficial, follow-on-biologics legislation must appropriately protect the intellectually property and market exclusivity of emerging companies to foster continued VC investment in the biotech industry.

To put this in context, according to a recent Health Affairs article, of the 8,259 generic applications filed between 1984 and 2000, only 6 percent (478) raised patent challenges. The absence of intellectual property conflicts between brand and generic drug companies signals that the Hatch-Waxman regime efficiently balances price competition with stimulation of innovation. There are no data to predict the number of patent conflicts that will arise between branded biologics and biosimilar companies; however, we can surmise that if Congress does not achieve the optimal balance between competition and innovation through appropriate market exclusivity and intellectual property protection, VC investment in emerging biotech companies will become higher risk.

Patent Reform: Potential Weakening Of IP Protection And Discouragement Of VC Investment

The BPCIA and other legislative proposals for abbreviated approval of follow-on biologics do not adequately protect the intellectual property of innovator biologic companies, potentially discouraging VC investment in emerging biotechs. Intellectual property protection for the biotech industry may be further weakened by pending patent reform legislation, creating additional disincentives for VC investment in the life sciences sector.

The House and Senate are both considering legislation, the Patent Reform Act of 2007, that would significantly alter the current patent system. The House passed its measure in early September and is waiting for the Senate to vote on the companion bill. Venture capitalists should keep a close eye on the progress of these bills as passage of the legislation would have important implications for VC investment in all sectors. Patent reform is of particular importance to the biotech industry, however, because the industry relies heavily on intellectual property to support returns on investment. In particular, currently proposed provisions governing apportionment of damages, postgrant review, and inequitable conduct could seriously weaken intellectual property protection for emerging biotechnology companies and discourage VC investment in the industry.

Apportionment Of Damages. Damages for patent infringement are critical to patent enforcement. The threat of significant monetary liability is often a deterrent to keep a potential infringer from engaging in infringing behavior. If the patent is infringed, damages should adequately compensate the patent holder for the infringer's unlawful use of the invention. In the context of biotechnology, damages protect the patent holder as well as the VC investor who has funded the emerging biotech company. Under current patent law, damages are awarded to a patent owner in a successful infringement suit either equal to the lost profits incurred by the patent owner or, more frequently, in the amount of a "reasonable royalty." A landmark case directs courts to consider a multitude of factors when calculating "reasonable royalty" to ensure that the patent holder is fairly, but not excessively, compensated in light of relevant economic factors. The factors are broadly designed to estimate the financial terms of a reasonable license for the patent if both licensee and licensor negotiated an agreement based on the assumption that the patent was valid and infringed.

The pending patent reform legislation significantly alters the calculation of reasonable royalty by giving the court only three options for determining the figure. In general, courts are directed to determine reasonable royalty based upon "the economic value properly attributable to the patentee's specific contribution over the prior art." Courts are specifically instructed to subtract the value of all prior art when calculating reasonable royalty. This ignores the fact that for most inventions, including biologic drugs, the value of the product (and its patent) is generally greater than the sum of its parts and is based upon market conditions at the time of infringement. The proposed new method of calculating damages would compensate the patent holder only for a part of the value of the patent, making infringement cheaper and more attractive and therefore discouraging VC investment in the biotech sector.

Post-Grant Review. A second worrisome provision in the Senate Patent Reform Act allows virtually anyone to administratively challenge the validity of a patent during a "second window" for post-grant opposition proceedings after the patent is granted (the House version has no such "second window"). Under the proposed new law, a potential infringer who can reasonably show that the patent would cause him "significant economic harm" may, through a petition to the Patent and Trademark Office (PTO), challenge the validity of the patent at any time during the life of the patent, provided certain conditions are met. Such a challenger can raise the full panoply of invalidity defenses, not just an objective presentation of prior art patents and printed publications. Even worse, this "second window" would remain open indefinitely, even if other challenges have been rejected.

Allowing limitless challenges to the validity of biotechnology patents throughout the life of the patent creates uncertainty about the validity of the patent, diminishes the value of the patent, and discourages VC investment in emerging biotechnology companies, to the detriment of the public and at the expense of innovation.

Inequitable Conduct. Finally, the proposed patent legislation worsens a difficult situation arising from judge-made doctrine that can deem valid patents unenforceable based on allegations of "inequitable conduct" in prosecuting the patent. At present, if a defendant alleges that the patentee misrepresented or failed to disclose material information to the patent examiner, a costly and time-consuming inquiry into the patent application process and the applicant's intentions is required. If this subjective inquiry turns up culpable conduct relating to even one claim, the entire patent can be declared unenforceable.

The present legislation would codify the current intent standard for inequitable conduct but set the standard of materiality to merely a prima facie case of unpatentability. In addition, the Senate version of the Patent Reform Act allows a determination of unenforceability for conduct that bears no relevance to the merits of the patent being considered. These changes would encourage timeconsuming and expensive litigation, further discouraging VC investment in emerging biotechnology companies.

Conclusion

Together, the pending follow-on biologics and patent reform legislation could weaken intellectual property protection for biotechnology companies, creating disincentives for VC investment in biotechnology. This would be particularly harmful to small, start-up biotechs who depend most heavily on VC funding. VCs should take immediate steps to communicate with their representatives in Congress to make sure that these proposals are revised to adequately protect VC investment in emerging biotech companies to foster continued life-saving biotechnology innovation.

Don Ware, Partner and Chair of the Intellectual Property Practice, represents biopharma companies and universities in patent and inventorship disputes, technology transfer issues, and intellectual property strategy. Most recently, he has worked on behalf of these clients to help shape proposed federal legislation affecting their intellectual property rights. Nick Littlefield, Partner and Chair of the firm's Government Strategies Group, uses his significant public policy background to provide clients with legal, legislative, regulatory and strategic planning advice in the areas of health care, biosciences and technology, education, venture capital and other industries. The authors would like to recognize Kalah Auchincloss, Associate, for her contributions to the article.

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