The United States District Court for the District of Columbia recently upheld the Federal Trade Commission’s rulemaking regarding the Hart-Scott-Rodino reportability of certain patent licensing arrangements in the pharmaceutical industry. The decision is unsurprising.
Effective December 16, 2013, the United States Federal Trade Commission (“FTC”) requires that parties to certain pharmaceutical patent license arrangements in which “all commercially significant rights to a patent” are transferred report their arrangements to the FTC and the Department of Justice, Antitrust Division, under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (“HSR”). A transfer of “all commercially significant rights” occurs even where the patent owner retains limited manufacturing rights. Additionally, retaining “co-rights” to the development and commercialization of the art covered by the patent does not immunize the license from reporting requirements. These “co-rights” include co-marketing, co-development, co-promotion, and co-commercialization. The FTC does not believe the “co-rights” constitute the right to “commercially use” the patent nor are they kept by the patentee to support the commercial efforts of the licensee. Even if “all commercially significant rights” are transferred, the license still must meet the jurisdictional tests, including the size-of-transaction. If the value of the license does not exceed $75.9 million, the license is not reportable even if it is for “all commercially significant rights to a patent.”
The new rule replaces the “make, use and sell” test. Under that test, notification was required when the patent owner transferred all “make, use and sell” rights on an exclusive basis to the licensee, including as against the grantor. The FTC viewed these licenses as an effective sale and therefore an asset acquisition that was potentially reportable. Anything less than an exclusive license to “make, use or sell” was not viewed as an asset acquisition. So if a patent owner retained rights to manufacture, even if only for the licensee, the license was not viewed as truly exclusive and therefore the transaction was not reportable.
The FTC notes that in recent years, the pharmaceutical industry in particular has used these “non- exclusive” licenses to transfer competitively significant assets and avoid compliance with the HSR Act. The FTC has indicated that it may expand the new rule to cover other industries as its experience with those industries matures. At present, the FTC believes that the pharmaceutical industry is the proper place to start.
In effect, the “make, use or sell” rule offered the pharmaceutical industry an HSR exemption. Patents confer the right to exclude others from practicing the covered art. In addition, the patentee is free to charge whatever it wishes for its product. In the pharmaceutical industry in particular, patents can represent significant economic value. Under the “make, use or sell” rule, patentees could transfer significant economic value, and possibly confer market power, without having to observe the HSR Act and without allowing the government its “first look” at the transaction. The new “commercially significant rights” rule closes that loophole.
The new rule disrupts a well-established acquisition vehicle in the pharmaceutical industry. Because these transactions are now potentially reportable, business will not quickly and cleanly be able to rely on the license-with-some-retained-rights as a mechanism to transfer commercially significant intellectual property. The suspensory provisions of the HSR Act will delay closing of the transaction by at least 15 days and potentially much longer if there is a substantive review.
Perhaps reacting to this new unwanted scrutiny and lack of certainty, the pharmaceutical industry sued the FTC, demanding that the new rules be rescinded. Pharmaceutical Research and Manufacturers of America v. Federal Trade Commission, Civ. No. 13-1974 (BAH) (D.D.C.). The suit challenged the FTC’s “final rule” implementing the changes in approach. Premerger Notification; Reporting and Waiting Period Requirements, 78 Fed. Reg. 68,705 (Nov. 15, 2013). PhRMA alleged that the final rule violated the Administrative Procedures Act because the FTC: “(1) lacked statutory authority to issue an industry-specific rule rather than a rule of general application; (2) failed to establish a rational basis for such an industry-specific rule; and (3) failed to comply with legally required procedures.” Among other things, PhRMA alleged that the final rule “imposes ‘fundamental changes to the HSR Act pre-merger notification requirements that would, for the first time in the Act’s 37-year history, single out and burden one industry alone with additional notification requirements for patent license transactions previously not regarded by the antitrust agencies as potentially anticompetitive enough to warrant any pre-closing review whatsoever.’” Pharmaceutical Research and Manufacturers of America v. Federal Trade Commission, Civ. No. 13- 1974, mem. op. at 2 (BAH) (D.D.C. May 30, 2014).
In a lengthy decision steeped in administrative procedure law, the court denied PhRMA’s petition and found for the FTC. Among other things, the Court found that the FTC had broad discretion to exempt whole classes of transactions from the requirements of the HSR Act, including the very type of licenses at issue here, and that the procedures the FTC followed in implanting the final rule were reasonable. The decision is not controversial.
The purpose of the HSR Act is to give the government a first look at potentially anticompetitive transactions before they are consummated. Prior to HSR, courts were hesitant to unwind consummated mergers. As a consequence, the government had a difficult time stopping anticompetitive deals. The HSR Act was passed in 1976 to give the government a chance to stop these deals in their incipiency, before the parties could “scramble the eggs.” A purpose of the HSR Act was to facilitate the enforcement of the substantive provisions of the Clayton Act that prohibit anticompetitive mergers and acquisitions. Congress gave the FTC the ability to issue rules and regulations that facilitate that enforcement. Among others, Section (d)(2)(B) of the HSR Act specifically authorizes the FTC to “exempt, from the requirements of this Section, classes of persons, acquisitions, transfers, or transactions which are not likely to violate the antitrust laws[.]” 15 U.S.C. 18a(d)(2)(B). And it’s not true that the FTC is singling out a particular industry “for the first time.” The FTC has recognized many industries that do not merit meaningful antitrust scrutiny: goods and realty in the ordinary course (16 C.F.R. § 802.1); real property (§ 802.2); carbon- based minerals (§ 802.3); investment rental property assets (§ 802.5); acquisitions by employee trusts (§ 802.35); and certain foreign banking transactions (§ 802.53), among others. Some industries are simply unconcentrated such that deals in those industries will rarely if ever raise substantive problems. In any event, just because a transaction is not subject to the HSR Act does not mean that the FTC or the DOJ cannot challenge it. The agencies do, in fact, challenge unreportable transactions.
The loss was not unexpected, and it is not that significant a loss. Reporting and observing the waiting periods do add some time and expense to transactions, but the FTC will still have to seek an order from a court enjoining the deal if the FTC wants to halt a transaction. A court could very well conclude that the “holdback” provisions in such licenses do in fact immunize the licenses from substantive challenge. The real test will be if the license/hold-back structure will continue to be used aggressively in the industry, and, ultimately, whether the FTC will bring any challenges to such licenses.