By Adam Jones

In a case that will dramatically impact both the pharmaceutical and biotech industries, the U.S. Supreme Court recently expanded the ability of researchers to experiment with patented drugs without being held liable for patent infringement.#160 In a unanimous ruling, the Court held that the use of patented compounds in preclinical studies is protected under the current “safe harbor” law allowing experimental use of patented compounds, as long as there is a reasonable basis for believing that the experiments will produce information relevant to filing for FDA approval.#160 The case, Merck KGaA v. Integra LifeSciences, was a clear victory for pharmaceutical researchers and may have the effect of speeding the development and delivery to the market of new and generic drugs, however, some biotech companies worry that the case could put them out of business.

The dispute in the case began over Integra’s ownership of patents related to short amino acid sequences, called RGD peptides, which play an important role in many biological functions.#160 Merck had been funding anti-cancer research looking for drug candidates that would inhibit angiogenesis, the process by which new blood vessels sprout from existing blood vessels.#160 Angiogenesis plays a critical role in the development and nourishment of tumors.#160 When Merck proceeded to make use of Integra’s patented RGD peptides in its drug research without obtaining a license from Integra, Integra sued for infringement.#160

It is usually an act of patent infringement to make, use, offer to sell, or sell any patented invention, including pharmaceutical drugs and compounds.#160 However, in 1984 Congress created a “safe harbor” from patent infringement for certain activities related to drug research.#160 The purpose of this safe harbor, found in the Hatch Waxman Act of 1984, was to encourage the speedy delivery to market of generic drugs by allowing researchers to use whatever tools were available to them, without fear of liability for patent infringement.#160 Before enactment of the safe harbor, pharmaceutical companies owning a patent on a compound or drug could bar competitors from using the patented compound or drug for any purpose, including research, thus effectively stalling the development of potentially useful drugs by competitors until the term of the patent expired.

Merck claimed that its angiogenesis research was protected under the safe harbor.#160 Integra argued that the safe harbor did not apply to Merck because not all of Merck’s experiments using the patented compounds resulted in submission to the FDA of a product for regulatory approval.#160 The lower courts agreed with Integra, adopting a narrow view of the safe harbor protection, and essentially limiting the use of patented compounds to clinical trials, the final stages of drug research, rather than early-stage experiments that could determine which of several compounds would make a good drug candidate.#160 This interpretation of the safe harbor clause severely limited the research abilities of pharmaceutical companies.#160 Integra was awarded $15 million in damages based on patent infringement in a jury trial in the U.S. District Court in San Diego.#160 The Federal Circuit Court upheld Merck’s liability for patent infringement, and the Merck appealed to the Supreme Court.

After reviewing the case, the Supreme Court took a broad view of the safe harbor clause, finding that Congress intended to “leave adequate space for experimentation and failure on the road to regulatory approval.”#160 The Court interpreted the safe harbor to exempt from infringement “all uses of patented compounds ‘reasonably related’ to the process of developing for submission under any federal law regulating the manufacture, use, or distribution of drugs.”#160 The decision makes clear that the safe harbor for using patented compounds applies to a wide variety of medical and pharmaceutical research, not solely to research that will yield an FDA-approved drug.#160 Researchers must only have a reasonable basis for believing that a patented compound may be useful in creating a new drug for submission to the FDA for approval.#160

The decision allows researchers much greater freedom to experiment with patented compounds in an effort to create new and useful drugs.#160 One of the major benefits to patients that may come of the Court’s ruling, though, may be in the increased availability of generic drugs.#160 The expanded scope of the safe harbor clause, will now allow pharmaceutical companies to more quickly obtain FDA approval for generic counterparts to brand-name drugs, and introduce the generic drugs to the market as soon as possible after expiration of the brand-name drug’s patent.#160 Without a broad interpretation of the safe harbor clause, pharmaceutical companies would have to wait to perform research on patented drugs until the 20-year patent term had expired.#160 It typically takes many years to perform the experiments required to obtain FDA approval, and now pharmaceutical companies can begin the process of developing generic and competing drugs before the patents of the original drugs have expired.#160 The result is that companies are able to bring generic and competing drugs to market as soon as possible after the expiration of the relevant patents, rather than being delayed for up to a decade while maneuvering through the experimentation and FDA approval stages.

Not everyone is happy with the Supreme Court’s recent decision, though.#160 Many biotech companies produce patented compounds and products used in drug research.#160 The broad interpretation of the safe harbor clause could deprive them of valuable licensing revenue, and effectively put them out of business.#160 Also, universities that rely on licensing money from patents they hold for research techniques could be adversely affected.#160 The owners of existing drug patents that will now be freely available for use in research by their competitors argue that they spent substantial time and money to develop and market the patented drugs, and now their competitors will have an unfair head start in bringing competing drugs to market.#160

Patent law was established to provide a reward for innovation by granting its owner a limited monopoly on the patented invention, and some feel as though the expanded view of the safe harbor clause undercuts the reward function of patented drugs, and may in fact reduce the incentive to create new drugs based on compounds other than those already patented.#160 We continue to struggle to find a balance between rewarding innovation and making products freely available to the public.#160 Nowhere is this balance more difficult to achieve than in the pharmaceutical industry, where humanitarian concerns play an important role, and innovation is key to survival.

By Julie Garcia

Determining the choice of entity for a high technology company can be a daunting task. In general, careful consideration should be given to the choice of entity when forming any type of company; however, high technology companies have additional issues that may alter the decision regarding the choice of entity. Generally, raising capital to fund the research, development and manufacturing of the company’s products may determine the type of entity best suited to the needs of the new company. Typically, the type of entity will be either a corporation or a limited liability company. If a corporation is chosen, the decision as to whether the corporation will be a Subchapter S Corporation will also need to be made. Partnerships and sole proprietorships are not commonly chosen as the type of entity for high technology companies primarily due to liability concerns. Corporations and limited liability companies each have pros and cons that must be carefully considered for each situation when determining the type of entity.

Corporations have been in existence for a long time and generally have a well established base of both statutory and case law guidance. Although each jurisdiction may have different rules, regulations and cases that govern corporations and some jurisdictions may be more favorable to corporations than other jurisdictions, general corporate principles exist that can be examined when determining the type of entity to use for a new venture. If a corporation is chosen, the jurisdiction for formation should be carefully analyzed to determine the most advantageous jurisdiction. Many businesses prefer corporations because of the long standing history and general feeling of comfort regarding issues that are important to the founders of a business, such as liability protection and corporate governance. Financing a corporation is a path that has been well trodden and individual strategy based on the company’s circumstances and business plan becomes the focus of financial planning. If a high technology company plans on funding its operations through venture capital, formation of a corporation is generally preferable to other types of entities due to general familiarity with the corporate structure and a long history of investments into corporations by venture capitalists, angel investors and institutional investors.

A Subchapter S Corporation, generally referred to as an S Corporation, is a variation on the corporate entity. An S Corporation provides the same general protections as a corporation and is subject to the same corporate governance rules and regulations as a corporation; however, S Corporations generally provide a tax benefit to the company. An S Corporation is subject to limitations on the number and type of eligible shareholders. An S Corporation is limited to 75 shareholders (subject to specified counting considerations, for example, husband and wife) and, in general, only individuals and not entities are allowed to be shareholders of an S corporation. In addition, shareholders cannot be nonresident aliens. There are a few exceptions to the rule denying entities as shareholders, however, the exceptions generally relate to trusts formed for estate planning purposes controlled by a shareholder. Another corporation is generally not allowed to be a shareholder of an S Corporation which may create an issue if the funding of the company depends on institutional investors or venture capitalists. Most high technology companies obtain financing from venture capital funds, institutional investors or angel investors which are generally formed as entities that are not allowed to be shareholders of an S Corporation. Although an S Corporation is generally favored by high technology companies that will be funded by the founders, a high technology company that plans on obtaining significant funding from external sources will generally not be eligible to become an S Corporation.

A limited liability company is a newer type of entity, as compared to corporations, that has gained wide acceptance and is the preferred choice of entity in certain industries and/or transactions. A limited liability company provides a lot of the same general protections as a corporation, and although an analogy can generally be made to the rules, regulations and case law governing corporations, significant areas of limited liability company rules and regulations have not yet been tested in the courts. Although capital can be raised for a limited liability company, the general structure of a limited liability company may impose an administrative burden if a significant number of investors are projected. Although a limited liability company operating agreement may allow for different classes of membership interests and ultimately may allow for more creativity in structuring the investment transaction, the lack of court and statutory guidance on a number of issues deter many smaller high technology companies from choosing the limited liability company structure.

High technology companies face a number of issues that a traditional company may not face due to concerns with its intellectual property protection and concerns relating to financing of the company. The traditional model for a high technology company seeking funding from venture capitalists or institutional investors is generally to form as a corporation and sell stock to raise capital. Although corporations may have different classes of stock and become complicated, the general nature of corporate governance may be more structured than a limited liability company and provide a better framework to handle a large number of investors. Although an S Corporation may be preferable, particularly from a tax perspective, it may not be a viable option if the company intends to seek investments from venture capitalists or institutional investors formed as entities to fund its research, development and product launch. A limited liability company, although preferable in a number of industries, may impose limitations on a high technology company that become burdensome and outweigh the tax advantages as the choice of entity. Careful consideration to the business plan, future financing needs and general operating structure of a new business venture should be made prior to the formation of a high technology company.