A right royal(ty) mess: interpreting royalty obligations for second medical use patents
Download PDFHow were the relevant clauses drafted?
The key terms and definitions in the patent sub-licences that the Court of Appeal had to consider were drafted as follows:
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Reading these through, both the High Court and the Court of Appeal found that they all lead, one way or another, to the definition of “Compound” – with the key dispute between the parties relating to the meaning of the italicised words in that definition and, in particular, the meaning of the words “may be”.
Tesaro submitted that the italicised words had the effect of limiting the scope of its payment obligation to sales of niraparib for uses or treatments falling within the scope of the licensed patents. It argued that those words simply indicate a point of time in the future, on the basis that certain of the licensed patents had not yet been granted at the date of the sub-licences and any commercialisation activity was some way off. AstraZeneca, however, disagreed and claimed that “may be” indicated some probability that the niraparib sold by Tesaro would be used in a manner that was covered by a claim of a licensed patent.
At first instance, the High Court found in favour of AstraZeneca and held that Tesaro had to pay royalties on all sales of niraparib in each country where at least one licensed patent subsists, regardless of whether those sales fell within the scope of the claims of the licensed patents.
THE COURT OF APPEAL’S DECISION
The Court of Appeal overturned the first instance decision, finding that royalties were only payable for sales of niraparib for uses covered or claimed by the licensed patents. Lord Justice Arnold, who gave the leading judgment, gave seven grounds for reaching this conclusion:
Meaning of “Compound”
1. Both the licence granted to Tesaro by AstraZeneca, and Tesaro’s obligation to pay a royalty, use the term “Licensed Product” and, accordingly, depend on the definition of “Compound”. In the context of scoping the licence, Lord Justice Arnold was satisfied that the italicised words used in the definition of “Compound” were intended to align the licence scope to the claims of the licensed patents. Accordingly, if given that meaning in the context of the licence scope, Lord Justice Arnold concluded that they must have the same function when used in the context of the royalty obligation.
2. The italicised words in the definition of “Compound” must be given some meaning and effect as they were obviously included for a purpose. As mentioned in ground 1 above, the apparent purpose was to align the scope of the royalty obligation with the scope of the patent claims and it is unclear “what other purpose they could be intended to serve”.
3. The words “may be” in the definition of “Compound” should be interpreted as implying “futurity” rather than a probability for two reasons. Firstly, at the date of the agreements, some of the licensed patents had not been granted and it was uncertain whether they ever would be. Secondly, it was not clear at the date of the agreements whether Tesaro would ever receive regulatory authorisation to market niraparib. (However, not all of the judges agreed with this analysis. Whilst not determinative of his conclusion on the overall outcome, Lord Justice Birss’s view was that the words “may be” referred to the existence of a possibility that the use could or might be claimed – as long as the possibility of that use being claimed wasn’t wholly fanciful (e.g. use as a hair loss treatment), then it was covered. Such a construction would simplify the determination of the amount of royalty due, which Lord Justice Birss viewed as a non-trivial advantage.)
Royalty term
4. The royalty term covers the period for which there is a valid claim for the exploitation of the licensed product under a granted patent. This suggests that royalties were intended to be linked to the scope of licensed patent claims.
Lack of mechanism to determine which sales caught not unusual
5. It was not unusual that the licence agreements did not contain a mechanism to determine whether sales of niraparib were for uses or treatments that fell within the scope of the licensed patent claims. If that was expected to cause serious problems, the parties could have agreed a royalty obligation that was independent of the scope of the licensed patents, but they didn’t do so.
Illegality
6. Many of the patents licensed to Tesaro were US patents and the US was a major market for both parties. There was a serious risk that AstraZeneca’s interpretation based on total sales of niraparib, rather than only those sales that fell within the scope of the licensed patents, could amount to “patent misuse” under US patent law and therefore be unlawful. When interpreting a clause with two possible meanings, one of which is lawful and the other unlawful, the former should be preferred. This was regarded by all three Court of Appeal judges as a particularly important factor that favoured Tesaro’s interpretation.
Alignment with head-licences
7. Finally, the recitals to the sub-licences that had been granted by AstraZeneca to Tesaro cross-referred to AstraZeneca’s head-licences (which Tesaro had seen before signing the sub-licences). Those head-licences, in turn, required AstraZeneca to pay royalties to the head-licensors only on sales covered by the licensed patents (with no contractual mechanism for determining when sales were for uses falling within the scope of those patents). Tesaro argued that this supported its interpretation and the Court of Appeal agreed. Whilst the wording in the two sets of agreements was slightly different, the Court of Appeal found that a reasonable reader would conclude that they intended to express the same idea. This was supported by evidence of an email sent by AstraZeneca to Tesaro during the negotiations for the sub-licence agreements which indicated that the downstream royalties (from Tesaro to AstraZeneca) matched the upstream royalties (from AstraZeneca to the head-licensors), which would only be the case if the head- and sub- licences had royalty obligations of the same scope.
COMMENT AND PRACTICAL TAKEAWAYS
This is an interesting decision that highlights some of the potential pitfalls and challenges when drafting royalty provisions in second medical use patent licences. Whilst cases like this will always ultimately depend on their specific facts, there are several broader points we can take away:
- Clear and consistent drafting is key: as with all complex commercial agreements, clear and consistent drafting is key to avoiding unforeseen consequences. This is particularly important for royalty clauses and other payment obligations in IP licences which, if poorly drafted, can significantly alter the intended commercial deal.
- Scope of licence and royalty obligation may be different: don’t assume that the scope of the royalty obligation will be treated as aligned with the scope of the licensed patents. What matters is the wording of the royalty obligation itself. In some circumstances, it may be appropriate for parties to a patent licence to agree a royalty obligation which extends beyond the scope of the licensed patents.
- Extra care is required where second medical use patents are being licensed: while conceptually it may seem logical to agree that royalties will be calculated based on sales that would infringe the claims of the licensed patents absent the licence agreement, it may be hard in practice to determine when infringement of a second medical use claim occurs. Consideration should be given to whether a commercial model that calculates royalties by reference to more easily determined criteria (e.g., all sales, all sales for use as a treatment for a particular disease or all sales for indications covered by a relevant marketing authorisation) may be more appropriate (subject to the next bullet point below). Whatever is agreed commercially, the parties should be clear on how any royalties will be calculated in practice and make sure that the drafting clearly reflects that approach.
- Drafting of head-licences could influence interpretation of sub-licences: if a sublicence cross-refers to a head-licence under which it was granted, the English courts may look to the drafting and intention behind provisions in the head-licence when seeking to interpret ambiguous provisions in the sublicence. This should be borne in mind when considering how to draft a sub-licence to achieve the parties’ commercial intention.
- Consider whether to get local law advice: this case highlights the impact that foreign law can have on the interpretation of an English law governed agreement. Given the English courts’ clear preference for a lawful interpretation of an ambiguous clause over an unlawful one, parties should carefully consider whether to seek local law advice when drafting patent licences covering countries other than the UK. The US “patent misuse” doctrine was relevant in this case given US patents were being licensed and the US was a major market for both parties. And so this is certainly something for those operating in the US to be mindful of. However, this principle appears to be one of broader application and could therefore arise with respect to other jurisdictions or in different contexts. As a result, depending on the profile of the patent portfolio being licensed, it may be prudent to seek a local law review by local counsel in material jurisdictions outside the UK, particularly where total sales royalties are being considered.
