Last November, the Federal Trade Commission (“FTC”) announced a rule requiring advance notice of proposed exclusive patent license agreements in the pharmaceutical industry that exceed $75.9 million in value. Upon receipt of such a notice, the FTC or the Justice Department may then oppose the transaction on antitrust grounds.
This was the first industry-specific rule that the FTC had issued under the Hart-Scott-Rodino Antitrust Improvements Act (the “HSR Act”). Sure enough, the Pharmaceutical Research and Manufacturers of America (“PhRMA”) filed suit, arguing that, although the HSR Act allows the FTC to exempt certain industries from the Act’s filing requirements, it does now allow the FTC to create a rule which specifically targets an industry.
PhRMA reasoned that an earlier version of the HSR Act included a provision allowing the FTC to “impose reporting burdens on certain classes or categories of persons” but this was removed from the final version of the Act. Congress’s removal of this language constituted a refusal to grant the FTC the power to target a specific industry, PhRMA contended.
On May 30, 2014, the judge presiding over PhRMA v. FTC granted the FTC’s motion for summary judgment and upheld both the FTC’s power to target a single industry and the new rule (the “Final Rule”) itself. The court turned PhRMA’s argument regarding the legislative history on its head: If the FTC can exempt industries under the HSR Act, it can exempt all industries except for the pharmaceutical industry. Rather than make the FTC pursue this roundabout path to the same result, the court upheld the FTC’s more direct route.
As of this publication, PhRMA has not appealed the court’s decision or announced on its website any intention to do so.
Now that the Final Rule has survived a court challenge, let’s review its scope: The rule requires prior notification to the FTC of exclusive patent licenses in the pharmaceutical industry. The FTC and the Justice Department then have 30 days to decide whether to object to the transaction on antitrust grounds.
The Final Rule applies to patent licenses that transfer “all commercially significant rights” to a patent. In elaborating on this standard, the rule goes on to say that if the licensor retains the right to manufacture for the licensee and/or to help the licensee commercialize the product but otherwise grants exclusive rights to the licensee, then all commercially significant rights will have been transferred and the transaction must, if it is large enough, be the subject of an HSR Act notice.
The HSR Act applies only to transactions and parties meeting certain size requirements. If the transaction exceeds $303.4 million, then the size of the parties is irrelevant and a notice is required. If the transaction is less than $75.9 million, then no notice is required. Between those two thresholds, a filing is required if one party to the transaction has annual net sales or total assets of $15.2 million or more and the other party has annual net sales or total assets of $151.7 million or more. These figures are indexed for inflation each year.
The transaction value of an exclusive license is, in turn, the greater of the acquisition price at the time of transaction or the fair market value of the assets being licensed. See HSR Act Rule §801.10.
There are two ways to determine the acquisition price of a license at the time of transaction. Informal FTC guidance indicates that the acquisition price is generally equal to the gross amount of future royalties due under the license agreement at face value. These royalties may not be discounted to determine present value or to account for risk.
However, similar guidance states that if these future royalties are too speculative to estimate reasonably, as may occur, for example, when milestone payments are contingent on events outside of 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.
Fair market value must be determined in good faith by the board of directors of the ultimate parent entity of the buyer within 60 days of filing (or consummation if no filing is required). See HSR Act Rule §801.10(c)(3). Failure to file can result in penalties of up to $16,000 per day, so there is a persuasive reason to take the valuation exercise seriously.
The FTC has explained its adoption of a rule that targets only the pharmaceutical industry by reporting that, in the experience of the office that reviews HSR filings, exclusive patent licenses arise only in the pharmaceutical industry, thus giving rise to the need for this specialized rulemaking.
PhRMA disputed this contention in court, but the FTC’s experience, based upon filings that it was allowed to keep confidential, was persuasive. Thus, the new rule is a potential hurdle in completing a major license transaction in the pharmaceutical industry even if the licensor retains manufacturing and other limited rights.