How to be clear about royalty payments in a pharmaceutical licensing transaction

The owner of a valuable patent portfolio may wish to license it for a number of reasons, and will normally want to maximise revenue. From the other perspective, a licensee will not want to pay for more than it receives. Given the legal uncertainty over both patent validity and patent scope, nailing this down in clear terms can be difficult. This task gets harder when the licence is granted well in advance of commercialisation, as is often the case with pharmaceuticals.

The Court of Appeal has reviewed these issues in a dispute over a pair of patent sub-licences granted by AstraZeneca to Tesaro. These related to the use of a PARP inhibitor compound, niraparib, in the treatment of cancer.

What did the sub-licences say?

The patents being sub-licensed were not concerned with the compound itself, but related to the use of PARP inhibitors in particular treatment regimes. These “second medical use”-type patents are difficult to assess, with complex legal questions around both validity and claim scope. What’s more, their legal status and interpretation varies from country to country. When you have a worldwide licence of treatment regime patents, you face a complex set of legal questions about the scope of cover and how certain that is in any particular country.

The dispute here related to whether the licensee was required to pay royalties in relation to all of its sales of niraparib, or whether the royalties should apply only where there was patent cover for the particular use.

The sub-licences were subject to English law. The interpretation of contracts under English law principles follows well-rehearsed approach. The court aims to identify the intention of the parties by reference to what a reasonable person having all the background knowledge which would have been available to the parties would have understood them to be using the language in the contract to mean. This begins with the natural and ordinary meaning of the wording, together with:

• any other relevant provisions of the contract,

• the overall purpose of the clause and the contract,

• the facts and circumstances known or assumed by the parties at the time that the document was executed, and

• commercial common sense,

• but disregarding subjective evidence of any party's intentions

Key to understanding the scope of the sub-licences was wording of the “Compounds” definition:

“TESARO's PARP inhibitor compounds niraparib and Mk-2512 the use of which may be claimed or covered by, or the Exploitation of which may be claimed or covered by, one or more of the Licensed Patents”

The “may be claimed or covered by” wording is unusual. The trial judge concluded that it meant that all of the licensee’s sales were to be included in the royalty calculation, in each country where there were licensed patents, from the first commercial sale in that country. There was no need to assess whether or not the product sales fell within the scope of the patents in calculating royalties.

Scope of claims or all sales?

On appeal, a different conclusion was reached.

The appeal court pointed out that that a licence is only ever needed for acts that would otherwise infringe the patents. It also noted the difficulties in determining those boundaries, and so -

“In some circumstances it may be perfectly rational for the parties to agree to a royalty obligation which extends beyond the scope of the claims of the licensed patent. For example, in some circumstances the parties may agree that it would be too burdensome to try to determine which sales of a product fall within the claims and which do not, and that it would be simpler for both parties if a royalty was paid on all sales of the product, with the royalty rate being set at a level which reflects the fact that some sales do not fall within the claims.”

Here, though, the drafting indicated that the intention was for royalties to be paid only on usage that would be covered by the licensed patents, whether now or in the future.

The patent misuse doctrine

Tesaro had raised the US patent misuse doctrine, which acts to prohibit licensing that would require payments on activity that does not make use of the teaching of the patent. The Court of Appeal saw this as a strong reason to interpret the licence agreements as covering patented activity only.

What does this mean for licence agreements?

This case shows how difficult it can be to draft royalty clauses when patent scope is uncertain and the product at an early stage of development. However, licensors and licensees would do well to consider whether they are choosing an approach where royalty payments will be due on a whole class of activities that the licensee will undertake, with the royalty set accordingly, or only on activities that fall within the patents. Drafting can then be tailored to reflect this more accurately.