As our study into disputes involving AIM and Standard listed companies – TAKING AIM – shows, a conflict that escalates into a dispute can have a significant impact on a business. Alongside the immediate impact on a business and its operations, if the situation proves litigious, it can affect finances, reputation and the future success of the companies involved.

In the life sciences arena, deals and collaborations to advance new developments and growth frequently come with big numbers attached. And when it comes to risk areas for a dispute, the financial terms are a key area. So, planning for alternative scenarios and building in ways to aid dispute avoidance as part of your contractual arrangements is crucial. But what might that look like and what are the potential tools available at contract stage to try and avoid conflict down the line?

As ever, when agreeing contractual terms, the watchword is clarity. Parties who focus on tightly-defining the financial terms in their life sciences contracts stand a better chance of avoiding disputes in the future.

In this first article in our new 'Life sciences contract disputes toolkit', we outline key points to consider when drafting the terms of your agreements and highlight some mechanisms for dispute avoidance.

Typical financial terms

Life sciences deals typically deploy a mix of upfront payments, milestones and royalties in order to spread risk and reward over what are sometimes lengthy collaborations with uncertain outcomes. The large sums involved can mean that parties are incentivised to litigate over future disagreements about whether or not a particular payment is due.

What do parties need to cover in their contract to reduce the risk of disputes? Here we look at a number of considerations to help address some of the typical areas where conflict can arise.

Upfront payments

Sometimes seen as a reward to the licensor for previous investment in the product or area of technology, securing an upfront payment is valuable for licensors; particularly as in some cases it will be the only payment that will definitely be made under the contract.

From the point of view of the contract, the key considerations for upfront payments are usually practical ones. For example, the following points should be clearly set out:

  • The size of the upfront payment and whether it will be paid in full or in tranches.
  • Timing of payment – on signature or within a number of days or months?
  • Whether it is refundable in any circumstances.
  • Practical considerations such as bank details, invoicing or payment currency (and any currency conversion).

Milestones

Milestones are typically triggered by events in a product's journey to market, whether it be development, regulatory or sales. In particular, experience shows that appropriately defining the triggers for milestone payments can be an area where parties trip up and find themselves in dispute later on, so care is needed in this area.

Some common potential issues in setting out milestone triggers include:

  • Development milestones are frequently payable on achieving certain criteria. But in reality, many potential products will achieve some but not all of those criteria and may still be approved for progression to the next stage of development. Which party gets to decide whether the criteria (or enough of them) have been met for the milestone to be triggered? What if not all criteria are met but the product still progresses?
  • Linked to the previous point, because it has been known for patients and healthy volunteers to have bad reactions to a medicine in development and therefore volunteers/patients are now routinely dosed sequentially, milestone payments due on initiation of clinical trials are often paid on the third patient dosed, rather than the first.
  • What are the appropriate notification arrangements? Some milestone triggers, such as upon Food and Drug Administration (FDA) approval, will be public. But particularly for non-public triggers, such as research outcomes, licensors may want notification and reporting obligations to ensure they know when a milestone has been hit.
  • There may be more than one product coming out of a deal. How many times can a milestone be triggered? The first product, all products, or somewhere in between? And what is a new product – a new composition of matter or just a change in the formulation?
  • An additional indication may add significant value. Will milestones be paid for subsequent indications? And, in some cases, what is an "indication" for the relevant disease area? For example, are first and second line treatments in oncology separate indications for the payment of milestones? And do indications with a small patient population warrant the same milestone payments as "blockbuster" indications?
  • Missed or skipped milestones in product development may actually be a sign of success. What if a milestone is skipped but subsequent milestones are achieved? For example, if a product goes through an accelerated approvals process (meaning a later milestone is achieved but an earlier one is skipped), should the earlier milestone still be paid on the basis that achieving an accelerated approval is a success?
  • Some deals include the payment of sales milestones, triggered by a certain volume or value of sales. For sales milestones, which products (all licensed products or on a product-by-product basis) and territories are included in the calculation? Are triggers annual or aggregate? Will sales milestones be paid once (on first achievement) or every time a trigger is achieved?

Royalties

Royalties favour licensees because they are payable only when a product is generating sales. They are typically calculated as a percentage of net sales (i.e. sales of products, less certain agreed deductions). Royalties can often be an area for dispute because of the potential complexities around how they are calculated.

The following issues need to be set out clearly:

  • Rates and what they are payable on. Should a flat rate be applied across all products sold or should rates be tiered for different sales volumes? If they are tiered, once the threshold for a tier is reached does the new royalty rate apply to all sales, including those for the lower tiers or just that portion of sales in the new higher tier?
  • Which products and territories attract a royalty? Should there be step-downs for countries in which patent protection has lapsed?
  • Are royalties payable on sales by sub-licensees or only on sales of the head licensee?
  • How long should royalties be payable? In life sciences product deals it is fairly typical to see royalties tied to patent protection, subject to a minimum period of around ten years post launch in a particular territory. Should this typical royalty term be extended by reference to regulatory exclusivity?
  • Should the licensee be able to deduct any further costs from royalty payments (for example, in the event of generic or biosimilar competition, or taking licences to third party IP covering the licensed product (anti-royalty stacking))? If so, should the licensor have the protection of a floor on deductions (typically set at 50%)? In addition, where an offset for licences of third party IP is agreed, should the scope of the relevant third party licences be limited to the composition of matter of the licensed product or should it be any third party IP covering the licensed product?
  • Appropriate reporting and audit rights (including ensuring that such rights will be applied to the records of any sub-licensees) are an important practical protection to ensure visibility for the licensor, ideally to head off any issues in respect of incorrect payments before they become too significant. The length of time a licensee is required to keep records of sales can act as a de facto limitation period, because without access to such records a licensor may struggle to evidence any incorrect payments. It is not uncommon to see record retention periods of two or three years (i.e. significantly shorter than the statutory limitation period under English law, at least), meaning that a licensor would be well advised to carry out regular audits to keep track of any issues in practice and, hopefully, resolve them without the need for a formal dispute.

Looking for more insight into managing contractual disputes?

For more guidance, sign-up to our mailing list to receive the next article in this life sciences contract disputes series, as well as essential updates from our Life Sciences team. If you have any questions about this insight, please contact Mathilda Davidson or Felicity Wade-Palmer.