IP Due Diligence in Biotech Business Transactions


Intellectual property due diligence is generally conducted coincident with an investment or acquisition. Often the intellectual property is the most important asset of the target, particularly in the case of a start-up. Certain characteristics typify the due diligence process, regardless of the nature of the transaction, the underlying technology, or the size of the portfolio. Those characteristics include a short timeline, budget constraints, reliance upon representations made by counsel and the principals of the target, and the necessity of drawing conclusions.

At the outset the reviewer must clearly understand the nature and purpose of the transaction. This may be accomplished by a review of the business plan or, at the least, by an in-depth discussion with the investor prior to initiation of the portfolio review. Agreement as to the scope, timing and cost of the project should be reached before undertaking the review. If the budget permits, the review should involve several professionals: experienced patent and licensing attorneys and scientific advisors skilled in the relevant technology. The services of the latter are invaluable in comprehending the arcana of biotechnology.

Since it is seldom practical to thoroughly review the intellectual property portfolio of a target company, decisions must be made early in the process regarding the scope of the review. Under certain circumstances, it will be necessary to rely upon the officers and counsel for the Company to identify the critical IP issues, both positive and negative. This usually results in the production of the "sui generic" opinion letter with which we are all familiar. In most cases only sophisticated investors should rely upon such opinions as they lack independent foundation. At the other extreme, given sufficient resources, counsel may conduct an ab initio review of the patent portfolio, including the complete file histories and independent prior art searches.

A due diligence review addresses two fundamentally distinct inquiries: freedom to operate and prospective exclusivity. The former is often the critical inquiry in evaluating the attractiveness of the investment, although this area presents particular difficulties in biotechnology. Counsel must be sufficiently knowledgeable about the projected business plans of the target to adequately evaluate potential impediments to implementation of those plans. The long horizon to commercialization of a biotechnology product presents distinct challenges in evaluating existing and pending patent claims. Following the passage of 35 U.SC. 154(d)(2), the practitioner can no longer confine the freedom-to-operate review to issued U.S. patents (and PCT publications). The existence of potentially problematic claims in even such inchoate documents as published applications should be addressed with patent counsel for the Company. It is rare for the target to have commissioned a formal opinion on an application, but the bases for a conclusion of unpatentability or non-infringement may well have been established.

If potentially blocking patent claims have been identified, either by disclosure from the target or by an independent review of the art, the situation should be discussed with patent counsel for the target. Although the general practice is not to share formal opinions of counsel, their existence and the bases for their conclusions are open to discussion. The reviewer should bear in mind and advise his client that the existence of an opinion of invalidity or non-infringement is not a cure, but merely a palliative. The patentee may well have a different view and have no qualms about suing for infringement. If the situation is such that the target has elected to enter into license negotiations with the patentee, it behooves the reviewer to become familiar with the status of the negotiations.

Once freedom-to-operate issues have been addressed, the question of exclusivity may be considered. This is often done in parallel with the freedom to operate inquiry in view of the usually urgent nature of the review. In practice, the challenge is considerably simpler since the investor has already become sufficiently intrigued by the opportunity to initiate the review. Whether the target company has multiple patents or merely a single pending application simply defines the time involved in conducting the assessment. In complex scenarios, the reviewer must rely upon the target to identify the key intellectual property, whether it is in the form of patents, licenses or trade secrets.

The basic exclusivity review has three components: confirmation of ownership, compliance with procedural formalities, and substantive evaluation. Defects in any one may lead to a catastrophic result. Generally the third area has received considerable scrutiny by the investor so that, unless there is a fundamental claim scope issue, the evaluation may focus upon the first two subjects. It is often the case that the simplest matters are those that are overlooked, particularly when the target has had multiple patent counsel involved in the evolution of its portfolio.

Clear title to the intellectual property is the single most significant problem in establishing exclusivity. All too often there are defects in the chain of title that cast serious doubt upon the exclusive rights of the target. This is particularly troublesome in the case of successive transfers of the patent properties. The reviewer must confirm that all inventors and any intervening assignees have assigned their rights to the target Company in assignment documents recorded with the USPTO. It is not enough that the inventors have agreed to such an assignment. It is also critical to establish that there are no unresolved inventorship disputes. The prospect of litigation to establish ownership does not make investors comfortable. The reviewer should also be cognizant of the existence of liens on the patent properties that provide executory rights to the lienholder.

The attainment of exclusivity via licensing relationships also requires close scrutiny. Most patent licenses are structured similarly . For the purposes of a due diligence review, the critical aspects are exclusivity, field of use, milestones, and reversionary rights. If the license grant is non-exclusive or is limited to certain therapeutic or diagnostic applications, the reviewer must consider the potential competitive ramifications. The ability of a competitor to enter the market with the same product, even if approved for different indications, may be a threat to the income stream. During the usually lengthy development phase for a biotech product, it is common for licensors to insist upon the attainment of certain milestones. Typically these milestones are expressed by reference to regulatory endpoints, e.g. completion of toxicity testing or the filing of an IND. Additionally, the milestones are often accompanied by financial obligations, requiring the licensee to make significant payments to the licensor upon reaching the milestone. The reviewer must satisfy himself and his client that the milestones are reasonable in time and scope and within the capability of the Company. The consequences of failure to reach a milestone must be clearly understood. Loss of exclusivity or even loss of all rights under the license are frequently used reversionary clauses in patent licenses. The opportunity to cure the defect must be present and not unduly onerous.

The second and third components of the IP review, procedural and substantive analyses, may usually be conducted simultaneously and are focused upon review of the file histories of the patent properties. Issues such as compliance with filing formalities, small entity status, copendency and priority claims, terminal disclaimers, term adjustments and extensions, and maintenance fee payments should be closely monitored. Timely filing of PCT applications with appropriate designations and conversion to national phase applications presents another opportunity for oversight. It is beyond the scope of most due diligence reviews to thoroughly investigate the foreign counterpart applications and patents and their interplay with foreign product approvals. Such a review is best conducted by an experienced foreign practitioner.

In considering the substantive content of the patent portfolio, the reviewer must call upon his experience to evaluate whether the claim scope is reasonable in view of the prosecution history and the prior art and whether there is congruence with stated business objectives. Arguments made during prosecution should be examined for consistency and legtimacy. In the biotech area, enablement is often more a serious barrier to allowance than obviousness and is somewhat more subjective in nature. The reviewer must guard against overzealous standards of patentability, bearing in mind that an issued patent is presumed valid. The single greatest challenge is understanding that the criteria for patentability have been evolving over time.

Upon completion of the review, it is customary to address any outstanding issues with counsel for the Company, both to provide an opportunity to rebut any negative conclusions and to agree upon remedial actions. This can be a somewhat sensitive area, since the reviewer may find himself advising a non-client with respect to its patent strategy. In addition, while certain reviews are not committed to writing, the usual review is generally summarized for the benefit of the investors. It is unlikely that privilege would attach to such a document because it is generally not held in confidence and is frequently circulated for the benefit of co-investors. Care should be taken then in addressing any problems, many of which may be resolved by appropriate future action.

In sum, a due diligence review focuses upon two distinct topics: freedom to operate and exclusivity. Both are necessary to establish the intellectual property foundation required to make the technology attractive to investors. The revisions to the U.S. patent code under the AIPA have further complicated the due diligence process. Potential investors now need to be as wary of an infringement issue arising from published applications as from issued patents. The scope of allowable claims and the requirements for an enabling disclosure have evolved considerably since the days of Cohen and Boyer. The only constant we can rely upon is the creativity of our inventors and clients.