Background. One item on the negotiation checklist for patent licenses in the pharmaceutical sector is compliance with the U.S. Hart-Scott-Rodino (“HSR”) Premerger Notification Rules. The HSR rules require that certain patent licenses be reported to the Federal Trade Commission (“FTC”) before implementation. Up until now, the majority of such licenses were not subject to reporting requirements. Changes made by the FTC, taking effect in December, will require greater reporting of pharmaceutical patent licenses.

The changes made by the FTC expand the types of pharmaceutical patent licenses subject to early antitrust scrutiny and will impose additional costs (including in time and filing fees) on companies engaging in these transactions. Failure to report these transactions may result in civil penalties. Here is what business development and law department managers in the pharmaceutical industry need to know about the new rules.

The most significant change concerns patent licenses in which the licensor retains substantial rights (for example, the right to manufacture). These licenses may be reportable under HSR, regardless of whether the parties label them as “exclusive.” Under the amendment, the test will be whether the license transfers to the licensee “all commercially significant rights” in a patent.

What Stays the Same: Patents Are Assets and Licenses Can Be Subject to Premerger Notification

1. Patents Are Assets for HSR Purposes. The HSR Act requires reporting of large acquisitions of voting securities and assets. The amendment does not change the well-established principle that patents are assets for HSR purposes. As a form of property, a patent is an asset and thus the acquisition or assignment of a patent from another party is subject to the HSR Act.
2. Exclusive Patent Licenses Are Acquisitions of Assets for HSR Purposes. The amendment also does not change the principle that a traditional exclusive license is an asset acquisition for HSR purposes. The FTC views an exclusive license the same as a patent acquisition or assignment and thus insists on pre-closing reporting and antitrust review of covered exclusive patent licenses. This principle applies to exclusive patent licenses even if they are limited in scope, for example to specific indications or therapeutic areas.
3. Other HSR Tests Remain the Same. The amendment also does not change the size-of-the-transaction test, the size-of-the-parties test, and the exemptions used to determine when an exclusive patent license must be reported. Early stage licenses are likely to continue to be exempt from reporting under these tests.

The Key Change Is that Patent Licenses with “Co-Rights” Are Now Clearly Subject to HSR Reporting

The FTC initiated the rule-making based on its observation that pharmaceutical patent licensors often retain some rights. The licensor may retain the right to manufacture for the licensee, or the rights to co-develop, co-promote, or co-market. Questions arose over how to treat these types of patent licenses for HSR purposes.

The new rule establishes that the retention of co-rights does not render a license non-exclusive and, therefore, outside of the scope of the HSR reporting requirements. The FTC introduced, but did not clearly explain, a new “all commercially significant rights” test as the standard. Under this new test, if the licensee receives “all commercially significant rights” to the patent, the license is subject to HSR, regardless of whether it is labeled as an “exclusive” license by the parties.

The illustrations below, which correspond in part to several illustrations provided by the FTC, explain the application of the new FTC rule. These illustrations assume that all other elements of the HSR test, such as the size-of-the-transaction and size-of-the-parties tests, are met, and that no HSR exemptions apply.

• Illustration 1. The patent license grants the right to use the patented technology and sell the patented product to the exclusion of all others, except that the licensor will perform all manufacturing for the licensee. This will be reportable as a transaction transferring all commercially significant rights.

• Illustration 2. The same facts as Illustration 1 except that the license is limited to a particular therapeutic area or indication. This will be reportable as a transaction transferring all commercially significant rights.

• Illustration 3. The patent license grants the right to make, use, and sell the patented product to the exclusion of all others except that the licensor retains rights to promote and market. The licensee will book the sales and the licensor will benefit from sharing in greater royalties or other revenue sharing. This will be reportable as a transaction transferring all commercially significant rights.

• Illustration 4. The patent license grants the right to make, use, and sell the patented product except that the licensor retains rights to manufacture and sell. The licensor will book the sales and retain revenues from its sales. The licensee has not obtained all commercially significant rights.

Early Antitrust Assessment Is More Important Than Ever. The amendment increases the need to include an antitrust review early on in the negotiation process for a pharmaceutical license agreement. A screening should be performed to identify potential substantive antitrust risks arising from licensing transactions, such as consolidation or entrenchment of the licensee’s leadership position in a relevant market, which could be limited to a particular therapy or indication. As a result of this rule change, more licenses will be subject to FTC review prior to closing, and it will be more important than ever to assess the potential competitive effects of the license, particularly where the parties are actual or potential competitors.