Pharmaceutical Patent Transfers Subject to the Hart Scott Rodino Act (HSR Act): Increased Review Raises Importance of Valuation
Proposed Amendments to the Rules under the Hart Scott Rodino Act ("HSR Act") would require compliance with the Act's reporting and waiting period requirements for certain acquisitions of exclusive pharmaceutical patent licenses that historically have not been reportable because the licensor retained manufacturing rights under the patent. Because these transactions will no longer be HSR exempt, determining the transaction value will now be critical in assessing whether the patent license will require an HSR filing.
On August 13, 2012, the Federal Trade Commission (FTC), in consultation with the U.S. Department of Justice, proposed Amendments to the premerger notification Rules regarding when a transfer of rights to a pharmaceutical patent is reportable under the HSR Act. The Commission received three submissions during the comment period. The Amendments would extend HSR Rules 801.1 and 801.2 to formalize and broaden unofficial guidance given by FTC staff regarding the circumstances under which transactions involving the transfer of exclusive rights to a pharmaceutical patent — generally by license — are potentially reportable under the HSR Act. Notably, the proposed Amendments would result in a significant change in the weight given by FTC staff to retained manufacturing rights by deeming a license to be exclusive even when the licensor retains the right to manufacture pharmaceuticals for the licensee.
Pharmaceutical Patent Rights Transfers Under the HSR Act
Under the HSR Act, parties involved in acquisitions of voting securities and assets that meet certain party and transaction size thresholds must file a notification with the federal antitrust agencies and observe a waiting period prior to closing their transaction so that the agencies have time to review the transaction before assets become commingled. The reportable transaction size threshold is currently $68.2 million, subject to annual adjustment.
At the present time, entering into an intellectual property license – irrespective of industry - is not reportable as an asset acquisition unless it includes the exclusive rights to "make, use and sell" under the patent. However, when the licensor retains some rights in the patent, either outright or over time, legal analysis and consultation with FTC staff are often necessary to determine whether the exclusivity of the license has been compromised for HSR Act reportability purposes.
In the pharmaceutical industry it is not uncommon for licensors to retain the right to manufacture, granting only the rights to "use and sell" under a patent, and over time the FTC staff has viewed the grant of such a license to be a non-reportable event similar to entering into a simple distribution agreement. Other types of licenses that have not been treated as asset transfers under the HSR Act include the grant of co-exclusive licenses where the licensor retains rights to use and/or grant additional licenses for the intellectual property, and the grant of marketing and distribution rights, even if those grants are exclusive.
Exclusive licenses that are asset transfers must be exclusive even against the grantor. Even where a licensor retains the right to terminate or "march-in" (assume the license under certain regulatory conditions), the license will still be viewed as exclusive, and potentially subject to HSR Act reporting as an asset transfer. Limited, or "field of use" exclusivity can still render a license exclusive under the HSR Act, for example when the license grants an exclusive geographic territory or exclusivity for specific uses.
Formalizing and Expanding the Types of Patent Transfers Subject to HSR Act Notification
The proposed Amendments would change this approach based on the Commission's current belief that the pharmaceutical industry "presents unique incentives for the use of exclusive licenses." According to the Commission, in the pharmaceutical industry an innovator may discover a compound, but not have the resources to support its approval and marketing, so it must license the rights to others (often to a much larger company). Accordingly, the Commission is limiting the proposed Amendments to pharmaceutical patent rights. Notably, the proposed Rules do not refer to "licenses," as the FTC does not want the form of the transaction to dictate the types of rights transfers that are subject to notification under the HSR Act.
According to one commentator, the FTC's focus on pharmaceutical patents is unwarranted because the types of pharmaceutical licensing transactions subject to the proposed Amendments are not unique to the pharmaceutical industry, and the actions and motivations of the parties to these licenses are similar to those found in other industries. It is argued that the FTC has not provided sufficient reasoning as to why the pharmaceutical industry warrants different treatment from other industries, and it is noted that the FTC has never before promulgated an HSR rule that increases the Act's requirements only with respect to one industry.
Valuing Patent Transfers under the HSR Act
If they are no longer exempt outright from the HSR Act, patent license valuation will take on a greater significance in determining HSR reportability. The HSR transaction value for an asset acquisition, including an exclusive license acquisition, is the fair market value or, if determined to be greater than the fair market value, the acquisition price. The acquisition price of an exclusive license is equal to the gross amount of future royalties due under the license agreement during the life of the license at face value, not discounted to present value or for risk. If, as is often the case when dealing with intellectual property rights, future royalties are too speculative to estimate reasonably (e.g., payment milestones are contingent on approvals or other events outside the parties' control), the acquisition price is "undetermined," and the value of the license is the current fair market value of a fully paid-up license.
Based on informal guidance from FTC staff, such fair market value is what a third party licensee would pay at present in cash, in an arm's length negotiation; thus the estimated future royalties and other payments should be discounted to present value. The value must be determined in good faith by the board of directors of the buyer or its designee, within 60 days of filing or consummation (if no filing is required).
Given all of these variables, calculating the HSR transaction value of a patent license can be difficult and time consuming. While companies may feel compelled to hire outside experts to determine the fair market value associated with particular license rights, the valuation does not need to be in accordance with GAAP (Generally Accepted Accounting Principles), and any commercially reasonable basis for making the valuation will be accepted, as long as it was done in good faith. It is important for parties' internal documents to be accurate and consistent with the value ultimately determined for the HSR analysis.
According to the Commission, the proposed Amendments are expected to require HSR notification of approximately 30 additional patent transfers each year. Clearly, this will require that many more patent transfers be analyzed for HSR Act reportability. Given the FTC's longstanding position on non-exclusive intellectual property licenses, it may come as a surprise to some parties that the HSR Act may apply to their transaction. Having been able to close transactions for years without complying with the HSR Act, some parties may believe a specific exemption applies to licenses or pharmaceuticals.
While the Amendments are now only proposals, companies considering granting exclusive rights to a pharmaceutical patent should at this time analyze the HSR Act reportability of the transfer under the proposed Amendments and, if necessary, provide for additional time to comply with the HSR Act's notification and waiting period requirements. Identifying potentially reportable license transactions will require analysis of the rights transferred and retained, as well as a calculation of the somewhat amorphous acquisition price and fair market value of the rights being transferred. The parties' documents may take on added significance. In certain competitively sensitive transfers the parties will need to consider the implications on costs, timing and closing of a formal or informal investigation. The proposed Amendments are consistent with the antitrust enforcement agencies' overall focus on the pharmaceutical industry.
 Proposed Amendments to the Premerger Notification Rules 801.1 and 801.2: HSR IP Rulemaking, Project No. P989316: http://www.ftc.gov/os/2012/08/120813hsr-ipnprm.pdf.
 Comments are available at: http://www.ftc.gov/os/comments/premergeriprights/index.shtm.
 ABA Premerger Notification Practice Manual, 4th Ed. ("PNPM") # 27.
 Id. An exclusive license for an area outside of the US would constitute an asset transfer, but transfers of assets located outside the US are often exempt from HSR reporting. Rule 802.50.
 Baker Botts Comments pp 8-13.
 Rule 801.10.
 PNPM #87.
 PNPM #86.
 PNPM #87.
 Proposed Rulemaking 77 Fed. Reg. 50,060.
 The initial waiting period under the HSR Act is usually 30 calendar days (15 calendar days in certain limited situations). See Rules 803.10, 801.30; 11 U.S.C. 363(b).