The Medical Device Rodeo: Harnessing Innovation
The medical device industry is highly innovative. In this industry, a company's growth is dependent on innovation and the speed with which that company brings to market new ideas. No company has a monopoly on the ability to invent. However, the most successful companies do not rely solely on their own ability to innovate to drive growth. Rather, such companies build upon their own success by harnessing the best innovation of others.
There are many ways for a company to harness another company's innovation. For example, innovations can be acquired through a number of means, but frequently is through acquisition. Intellectual property (IP) is often the main driver and occasionally it is the exclusive driver behind these deals. After all, without IP a company can copy the ideas of another with impunity. Due to the importance of IP, proper due diligence must be performed on the target company's technology. The IP due diligence process can be divided into two general categories: reviewing the patent landscape for potential third party patents and reviewing the IP of the target company. Both categories are important to the overall success of a transaction, but depending on the goals of the acquiring company one category may be of greater relative importance than another area.
Freedom to Operate: There have been scores of deals that companies wish they could undo because of freedom to operate issues. Generally, these "problems" could have been avoided had a thorough due diligence been performed. It is understood that the scope of review needs to be commensurate with the size of the potential transaction. Thus, if a company is looking at a $100,000 in-license fee for a particular technology, that deal will not receive as much freedom to operate scrutiny as a deal involving the acquisition of a company for a billion dollars. Nonetheless, there are certain best practices that should be implemented irrespective of the size of a given deal.
First, it is important to understand what a patent does and does not provide the patent owner. It is a common misunderstanding that having a patent provides the patent owner with the right to practice the subject matter claimed in the patent. Patent laws simply do not work that way. What a patent gives the owner of the patent is the powerful right to exclude others from making, using, selling, offering to sell, or importing the patented technology. Thus, in the hands of a competitor, a patent can be used to prevent a company from bringing to market a good that it has been developing. Obviously, it is critically important to ferret out the existence of such third party patents before the deal is signed, or at least early enough that the risk can be mitigated. Otherwise, the company could have made a major investment only to find out later that it cannot market that product because of a blocking patent.
These blocking patents are identified only through a careful study of the subject technology and the appropriate patent databases. A key gating decision involves identifying the aspects of the underlying technology should actually be reviewed. By way of quick illustration, a new bone implant may comprise a particular design, a unique metal composition, and it may utilize what may be considered stock parts that have been on the market for many years. It is obvious to focus the freedom to operate study on those aspects that are new. However, it is well recognized that some patents are combinations of old parts. Therefore, there is some risk in overlooking a patent that claims the use of the older part in the context of a new application, i.e., the subject bone implant. Yet countless dollars can be wasted trying to clear such old parts. Therefore, an appropriate, informed, balance must be made in identifying the important aspects of the product that need to be cleared.
It is also necessary to understand where the product will be sold. A product sold globally versus only within the United States involves different search considerations. It is more economical to conduct a review for a global product in only one jurisdiction, such as the United States, and assume that that search would identify all relevant patents across the globe. Yet, not everybody files in the United States. So this strategy would miss a blocking third party patent in another country. But a global search for third party patents can be extraordinarily expensive. Again, appropriate balances must be made between the size of the overall deal and the amount of risk that the acquiring company is willing to assume.
Second, to the extent that potential blocking third party patents have been identified, the acquiring company needs to assess the severity of the threat. For example, does the target company already have a license to that patent? If so, the acquiring company may actually benefit from this transaction. Alternatively, does the underlying product actually infringe the third party patent? It is not uncommon that a potential third party patent that appears relevant upon first glance is not relevant after a detailed investigation of the scope of the patent. In patent law, the words of the claims define the scope of the patent and therefore a thorough understanding of the claims can resolve infringement questions in a favorable manner for the acquiring company.
If infringement risk cannot be resolved through such a study and the target company does not have a license, the deal may not be over, yet. For example, is a license obtainable? If so, the acquiring company should seek to shift the costs of the license back to the target company. Another option is to perform a detailed validity analysis. The patent office is not immune from making mistakes. In other words, invalid patents do issue from the patent office. As well intentioned as a patent examiner might be, an Examiner at the U.S Patent and trademark Office has only a few days to examine each patent application. Thus, it is common for an Examiner to miss the most relevant "prior art". This is why patents are only "presumed" to be valid. Therefore, the acquiring company may be able to move forward with a deal if it can reach a comfort that the potentially blocking patent is not valid.
If the patent appears to be infringed and no invalidity position is apparent, again not all may be lost. For example, are easy design around solutions available? Similarly, when does the blocking patent expire in relation to product launch? If the patent will expire before the anticipated launch date of the product, even the most relevant of patents becomes irrelevant through the passage of time.
Communication is key when conducting a Freedom to Operate (FTO) analysis. This ensures that the FTO results are being regularly communicated to the business people, who can then act upon that information. Most deals are about getting the numbers to work and knowledge of the third party patent landscape can often be used to renegotiate a deal. At the very least, the business better understands what its potential return on investment may be because a good FTO allows the acquiring company to make appropriate risk-adjusted calculations. Good communication also ensures that counsel is spending time reviewing the aspects of the technology that are most important to the company.
Vetting the target company's IP: Third party IP is not the only IP that should be vetted during a diligence review. The IP of the target should also be reviewed. Indeed, it is easy to make a mistake during the patenting process, whereas it can be extremely difficult to engage in "error" free prosecution. For one, the patent is typically prosecuted years before the economic value of the patent is understood. Moreover, it is not uncommon that the product changes from the time the application is filed to when the patent issues. Therefore, decisions must be made years before the product may enter the commercial marketplace and the actual patent application may not even describe important features of the commercial product. Under these circumstances, the early decisions may impact whether a patent even covers the commercial product.
Thus, one of the tasks of this aspect of the review is to ensure that no mistakes were made or at least that those that were made were not fatal to the validity of the underlying patent. The second aspect is to ensure that the target company's IP either already covers the commercial product or that it likely will issue with claims that would cover that product.
As previously indicated, it is easy to make a mistake in prosecuting a patent application. Not every mistake is relevant to the deal. Others, however, are critically important to identify. Understanding these critical mistakes is important both for the acquiring company as well as the company to be acquired. In fact, it may be most important for the target company to understand these pitfalls as they are the ones best positioned to avoid these mistakes in the first instance. Without intending to provide an exhaustive list, a few clearly avoidable mistakes are worth mentioning:
Cross citation of prior art: Patent practitioners have complained for years that inequitable conduct, which is the fraudulent procurement of a patent, is a reprehensible "plague" on the patent system. Without passing judgment on this defense, it is clear that the most common form of inequitable conduct claim, i.e., the failure to cite relevant prior art, can be easily avoided by employing proper checks and balances to ensure that relevant art gets cited to the US Patent Office. The most simple of these checks and balances is to ensure that prior art cited in a foreign patent office is then brought to the attention of the US Patent Office. By doing this simple task, one can almost completely mitigate the risk that an inequitable conduct defense can be raised.
Ownership and inventorship: Typically, ownership is a non-issue for patents. However, whenever a joint venture exists and patents flow from that joint venture, one should investigate whether inventorship appears correct on the face of any issued patents. For example, it is not uncommon, especially in the setting of University-sponsored research, that persons are inadvertently omitted from the inventorship of a patent. So long as the omission was inadvertent and not purposeful, the patent remains enforceable. However, a third party could obtain a license from the unnamed inventor for a substantial discount to its intrinsic value. Another common problem comes from contractual obligations over improvement patents that flow from a joint venture. One therefore needs to carefully review these contracts to ensure that the acquiring company is securing the appropriate rights.
Proper payment of fees: We have seen several deals fall apart because the patentee failed to pay proper maintenance fees for the patent. Either they forgot to pay maintenance fees and the patent lapsed or they paid small entity fees at a time when they should have paid large entity fees. Again, these kinds of mistakes are readily avoidable so long as proper care is taken.
Proper claim scope: The final and maybe the most important consideration when vetting the IP of the target company is ensuring that the claims they have obtained are of adequate scope to protect your investment. At the very least the claims should cover the commercial product. Surprisingly, we have seen many portfolios where the target company's IP did not even cover their own products. But beyond a purely defensive posture, the target company's IP should be positioned to competitors outside of direct competition for the target company's products. If the IP can be readily designed around because of narrow claim scope, it is important to note that during the diligence review.
In conclusion, IP due diligence should be a part of every acquisition due diligence investigation in order to harness another company's innovation and maximize the opportunity. The pitfalls for not performing an IP due diligence or performing an inadequate due diligence are simply too great.