For more than two decades, Jim Heslin has been a trusted advisor to the movers and shakers of the medical device field, yet he’s an innately modest man. His deep knowledge of patent law is matched by keen industry insight, making him a leader in Wilson Sonsini Goodrich & Rosati’s IP counseling practice. In short, Jim’s so unique, someone should patent him.
Two years after his 1978 graduation from the UC Berkeley School of Law, Jim began working as a patent attorney at Townsend and Townsend and Crew (now Kilpatrick and Townsend), where he built an impressive practice over the course of 30 years. For the first six of those, Jim worked for Bertram Rowland, author of the Cohen-Boyer recombinant DNA patent that laid the foundation for the multibillion-dollar biotech industry. In time, Jim chose to specialize in another burgeoning field: medical devices. His reputation grew along with his client base, and he eventually founded and led Townsend’s medical device technology patent group.
After a firm merger raised some client conflict issues, Jim joined Wilson Sonsini Goodrich & Rosati as a partner in May 2011. “Wilson has the world’s best corporate medical device practice,” he says. “About half my clients were already with the firm, so it made sense for me to follow suit.”
According to Jim, part of the attraction of the firm, both for him and for his clients, is its breadth of expertise. “WSGR offers the most comprehensive legal counsel for start-up and small medical device companies, including the corporate, licensing, and IP side of things.”
Over the course of his career, Jim has developed close ties with many of the major players in the medical device industry—which comes in handy at times. “Once when I was representing a client, the examiner rejected our patent application, claiming the technology was ‘so simple it could be done with a Fogarty catheter,’” Jim recalls. “Fortunately, I was able to prevail upon Dr. Tom Fogarty, and he was willing to sign a declaration saying in essence, ‘I’m Dr. Fogarty and no, this procedure cannot be done with a Fogarty catheter.’”
“It was sort of like the scene in Annie Hall where Woody Allen is stuck in a line listening to some guy going on about Marshall McLuhan—until McLuhan himself steps in to correct the man’s misinterpretation of his work,” Jim adds. “It wasn’t quite as dramatic as that moment in the movie, but in the patent context, it was every bit as good, especially for my client, who got the patent.”
Results like that have earned Jim great loyalty among his client base, including Robert Behl, the founder and chairman of PercSys, Inc. Bob’s relationship with Jim has spanned 20 years and three companies: first InnerDyne, which developed new surgical procedures; then RadioTherapeutics, which was focused on cancer treatment; and now PercSys, which develops new ways to treat kidney stones. “I’ve worked with a lot of patent attorneys, and Jim’s the best,” Bob says. “He asks provocative questions that can broaden the scope of your original idea. But what really differentiates him from other patent attorneys is that his thinking is very strategic. He’s always got your company’s long-term goals in mind.”
And in Bob’s view, long-term thinking about intellectual property is essential. “In Silicon Valley start-ups, IP is the key to success,” he says. “You can come out of the chute quickly, but eventually, someone will challenge you on IP. I’ve seen my share of that during my career, which is why I’m very happy to have Jim on my side.”
In contrast to some high-powered attorneys, Jim isn’t just focused on making clients money; he also likes to help them save it. “A lot of other lawyers don’t go before the Patent and Trademark Office unless there’s a crisis, and then the client has to pay for the whole trip,” Bob says. “Jim makes an effort to piece together a number of cases to build critical mass for his trips to Washington. That way, clients get the benefit of his face-to-face time in D.C., but the costs are shared.”
Innovation and Regulation
Jim has seen some major changes in the 20 years he’s been advising companies in the medical device industry. “There used to be maybe a dozen large companies in the U.S.; now there are probably just five or six,” he observes. “But that consolidation at the top hasn’t slowed innovation. There are still a number of doctors and other founders out there who are inventing devices and starting new enterprises, just as there were 20 years ago. In fact, there are more than ever.”
He also sees new challenges when it comes to launching technology. “I think most people in the field agree that the biggest issue is the way that increased regulation has significantly lengthened the time it takes to get FDA approval,” Jim says. “And on the patent side, there are more people trying to do similar things at the same time, which raises the bar so it takes more effort to get patents granted.”
When he’s counseling clients, Jim often guides them back to the fundamentals. “The main point I try to drive home is that patents are good, but they always have to be secondary to the product,” he says. “No matter how good a patent you have, your product isn’t guaranteed success—and patents only exist to protect successful products. Some clients will ask, ‘How can I change my product to get a patent?’ But you know, there’s no value to that. The idea is for companies to focus on building the best product they can. Then it’s up to me to figure out how to get the best patent protection for that product.”
Jim says the medical device field is more recession-proof than other parts of the economy—but it’s not immune. “It’s certainly not protected from things like lack of government funding, and it’s more likely to be affected by policy changes in areas like health insurance,” he observes. “Because of that, the industry is currently focused on procedures and tools that will help reduce the expense of healthcare, rather than add to it. Yes, there always will be room for costly cutting-edge technology that saves lives, but unless a technology is dramatically better than other treatments, cost savings are increasingly important.”
Another factor that Jim sees changing the shape of the medical device industry is globalization. “Historically, innovation in medical devices has been driven by the U.S. economy and government, because R&D reimbursement has been significantly greater here than anywhere else in the world,” he points out. “Companies would focus on developing products for the U.S. market, where they’re going to get most of their revenue, and then they’d sell it elsewhere. There are those who would say that the rest of the world has been freeloading on the U.S. government, but that’s going to change. There’s probably going to be less U.S. government revenue available, and investors from outside the country will step in to fill that void.”
Couple that with the greater difficulty in getting devices approved in the U.S., and the global balance is starting to shift. “A lot of medical device companies will consider commercializing first in Europe—that’s happening now—and I think in the next decade they’ll consider commercializing first in Asia,” Jim says. “You’re already seeing that in places like Singapore, where the government is identifying medical devices as an area where it wants to be a leader. Long term, I think most of the multinationals will still be based in the U.S., but they’re going to focus on foreign markets much more than they did in the past.”
Jim also has some interesting observations on the technological direction medical devices are taking. “I’m seeing a global trend towards devices that exist in what used to be defined as a drug space,” he says. “The poster child for that is Ardian’s device that alleviates hypertension by ablating a portion of the renal artery. That treatment is very effective, and Medtronic just acquired Ardian for roughly a billion dollars. There are other companies operating in that space, as well as some of the other areas where devices might work as well or better than drugs, like obesity and diabetes. I also see a huge amount of interest in brain stimulation for treating conditions like Parkinson’s disease.”
When talking to Jim about the medical device field, one can sometimes forget that he’s a lawyer, not a scientist. “Patent attorneys are a unique combination of the two fields,” he says. “If they’re litigators, they probably fall more on the legal side, but if they’re patent prosecutors and counselors like I am, their knowledge of the industry and technology is as important as their knowledge of patent law.” Fortunately for Jim’s clients, he’s a master of both realms.
By Doug Portnow, Associate, Palo Alto
The America Invents Act
In 2004, a report published by the National Academy of Sciences recommended changes to the U.S. patent system in order to correct generally recognized weaknesses related to the quality of granted patents and the costs associated with filing and obtaining granted patents, as well as to help harmonize U.S. patent law with other international jurisdictions.1 The report sparked public debate on patent reform that has lasted for seven years and now has culminated in the America Invents Act. This bill appears likely to become law and, once signed by the President, will be the first major revision to the U.S. patent system in over 50 years.
Senate Bill S. 23
The Senate’s version of the America Invents Act, S. 23, originally was introduced in the Senate in 2009 and initially contained several provisions related to patent litigation. These provisions attempted to address issues such as forum shopping, the legal standard for determining willful infringement, and concerns about excessive damage awards. However, as debate continued over the years, many of these matters were addressed in the courts, and resulting case law resolved some of the issues. Thus, the bill eventually was streamlined. In a 95-5 vote, the Senate approved S. 23 on March 8, 2011, with overwhelming support from both Democrats and Republicans. Major provisions in S. 23 were directed at converting the current patent system from a first-to-invent standard to a first-to-file standard, creating a new post-grant opposition period, and giving the U.S. Patent and Trademark Office (PTO) the authority to keep the fees it collects and establish its own fee structure.
The change from a first-to-invent standard to a first-to-file standard represents a major shift in the patent system. Under the current system, an inventor who files a patent application after another party may challenge the previously filed patent application using what is known as an interference proceeding. During the interference, the later inventor still may prove that he or she is the actual inventor by demonstrating an invention date earlier than the filing date of the first patent application. Changing to a first-to-file system eliminates this option and harmonizes the U.S. system with most other patent jurisdictions in the world. While the proposed new system provides a more clear-cut test for inventorship, critics say that it disadvantages independent inventors and small businesses that may lack the resources to file patent applications as early as organizations with better funding.
The Senate bill also introduces a post-grant opposition period that creates a nine-month window following patent issuance in which a third party may challenge the patent. The post-grant opposition procedure allows a petition to be filed requesting that one or more patent claims be cancelled due to lack of patentability. This procedure is broader than the existing reexamination system because a post-grant opposition petition may be filed if there is an issue with patentability or if the petition raises any novel or unsettled legal questions relevant to other patents or patent applications. Currently, reexamination petitions can only be filed when there is a question of novelty or obviousness.
The third major aspect covered in S. 23, and perhaps the most important, is a provision empowering the PTO to set its own funding, ending fee-diversion practices. Traditionally, the PTO has collected fees for accepting and examining new patent applications. However, the PTO is not permitted to keep the money it collects, and the fees are diverted to other government accounts where they may be used to pay for non-patent-related projects. The PTO, like other government agencies, has been required to fight to obtain its funding via the congressional budgeting and appropriations process, and in recent years a significant percentage of the fees collected by the PTO has been diverted. Money from these fees is critical to the PTO, as it allows funding for projects that help to improve the speed and quality of patent examination. With the backlog of patent applications awaiting examination amounting to just under 700,000, ending fee diversion would allow the PTO to hire more examiners, train them, and implement accelerated patent-examination programs.
House of Representatives Bill H.R. 1249
The House of Representatives soon followed the Senate, introducing its own version of patent reform legislation, H.R. 1249, on March 30, 2011. The House Judiciary Committee quickly advanced H.R. 1249, and on April 14, 2011, the bill was sent to the House floor for debate and voting. The House of Representatives passed the bill 304-117 after only two days of debate. Overall, 168 Republicans and 136 Democrats voted for the bill.2 A manager’s amendment also passed 283-140, resulting in changes to the bill that were related to PTO funding. H.R. 1249 is now similar to Senate Bill S. 23, but there are differences between the two versions.3 For example, H.R. 1249 is virtually identical to S. 23 with respect to the change from first-to-invent to first-to-file, but the House bill has a new derivation proceeding for determining whether the first-to-file applicant derived the invention, thereby providing a mechanism for determining whether the grant of a first-to-file patent was appropriate.4 The House bill also allows assignees (e.g., corporations) to file patent applications, eliminating the current requirement that an individual inventor be listed as the applicant.
In addition, H.R. 1249 is similar to the Senate version with respect to the post-grant opposition period, but the House version increases the length of time allowed for filing an opposition petition to 12 months after issuance. The bill also creates a new Patent Trial and Appeal Board (PTAB) to rule on post-grant oppositions. Under the bill, petitions for post-grant review will be granted if the evidence demonstrates that it is more likely than not that at least one of the claims challenged in the petition is unpatentable, or if the petition raises a novel or unsettled legal question that is important to other patents or patent applications. Thus, the post-grant opposition may be based on any ground of invalidity, unlike current reexamination proceedings, which are limited to prior art raising a substantial new question of patentability. The House bill also contains provisions that limit the use of the post-grant review procedure when there is associated litigation. For example, post-grant review is prohibited if the petitioner files a lawsuit challenging patent validity before filing a post-grant petition. Automatic stays in litigation may be granted under certain circumstances when the post-grant procedure is used.
Post-issuance review of patents under existing inter-parties reexamination procedures will remain in effect, but H.R. 1249 modifies the reexamination system by placing limitations on its use when there is associated litigation. It also modifies the standard for review. The PTAB that will be formed under the House bill will be responsible for conducting inter-parties reviews instead of the Reexamination Unit. The post-grant opposition and revised reexamination procedures are expected to provide welcome alternative dispute resolution mechanisms that will help avoid costly and complex litigation.
The House bill creates a new supplemental examination procedure that gives patentees a second chance to submit references or information inadvertently omitted during prosecution. This procedure may only be used under certain conditions, and it will not cure a deficiency if the patentee committed or attempted to commit fraud against the PTO. Thus, supplemental examination will end a patent infringer’s use of an inequitable-conduct defense in many situations. Similarly, the bill expands the timeframe in which third parties may submit protests to patent applications.
The major difference between the House and Senate bills relates to PTO funding. The two versions of the bill were very similar until a manager’s amendment modified the House bill as a compromise for opponents who argued that allowing the PTO to set its own funding gave the agency too much authority. The House bill now requires that collected PTO fees be held in a Patent and Trademark Fee Reserve Fund for exclusive PTO use. The PTO can only access this money with congressional approval. Even with this change, however, critics have continued to express concern that the House bill will result in higher fees by the PTO. The PTO maintains that such fees are essential to provide resources that will help improve the speed and quality of patent examination.
The House bill also expands the prior-use defense to patent infringement. Under current patent law,5 prior users of a method are provided with a defense to infringement when someone else obtains a patent for the method that is being practiced. This currently only applies to methods, but H.R. 1249 proposes extending the prior-use defense to all patents. Critics of this provision argue that this weakens patent rights and therefore harms innovation because inventors would be dissuaded from disclosing their inventions to the public.
Finally, the House bill eliminates the failure-to-disclose best mode as a basis for invalidity of a patent, establishes that failure to obtain or disclose patent opinions may not be used to prove that an accused infringer willfully infringed the patent, and states that such failure cannot be used to prove that an accused infringer intended to induce infringement of the patent. The bill also provides limitations on the current widespread use of qui tam suits for patent false marking.6 Other provisions in H.R. 1249 mandate a post-grant validity review of some business method patents related to financial products or services, and the bill specifically defines certain tax strategy patents as being unpatentable subject matter7 without precluding the patentability of all business method patents. Additionally, the House version creates a patent ombudsman to address complaints from the public, as well as a pro bono program for applicants who cannot afford PTO fees or legal services. The bill also authorizes the PTO to grant priority examinations to certain technologies that are determined to be critical to the U.S. economy.
In order to reconcile the Senate and House versions, the Senate agreed to vote on House version H.R. 1249 after reconvening from summer recess.8 On September 6, 2011, the Senate voted 93-5 to close debate on the bill,9 and with encouragement from Senate leaders in both parties, the Senate voted the following day. Several last-minute amendments, including one preventing fee diversion, were rejected, and the House version of the bill was approved in an 89-9 vote without adding any amendments.10 While some critics of the America Invents Act feel that it will disadvantage small inventors and undermine Congress’s ability to oversee the PTO, it now seems certain that H.R. 1249 will be adopted and signed by the President in a matter of days, as the Obama administration has already indicated its support for the bill. Letters from U.S. Commerce Secretary Gary Locke to House Judiciary Committee leaders state that the bill promises to strengthen patent rights and empowers the PTO with authority to set its own fees.11 As a result, it seems likely that the America Invents Act will become law.
Many patent practitioners support the bill, and when combined with recent administrative efforts by PTO officials, this legislative effort appears to be full of promising changes. PTO leaders such as Under Secretary of Commerce David Kappos and U.S. Patent Commissioner Robert L. Stoll have been working with industry12 on improving relations and streamlining procedures between the patent community and the PTO. The new law, combined with changes in PTO administrative procedures, should help reduce patent pendency, improve patent quality, and update the appeals process. Giving the PTO more freedom with its own budget also will help hire and train new examiners, as well as maintain the agency’s information technology systems.
*Special thanks to Susan Pennypacker for her assistance with research.
1James J. Mullen III and Collette R. Verkuil, “Parsing the Senate’s Patent Reform Bill,” March 15, 2011, Law360.
By Scott Murano, Associate (Palo Alto Office)
The table below includes data from 2010 and 2011 life science transactions in which Wilson Sonsini Goodrich & Rosati clients participated. Specifically, the table compares—by industry segment—the number of closings, the total amount raised, and the average amount raised per closing across the second half of 2010 and the first half of 2011.
The data demonstrates that venture financing activity has increased significantly during the first half of 2011 compared to the second half of 2010. While the total number of financings completed across all industry segments during the first half of 2011 decreased by approximately 7 percent compared to the second half of 2010, from 83 closings to 77 closings, the total amount of money raised across all industry segments during the first half of 2011 increased by more than 51 percent compared to the second half of 2010, from $431.3 million to $653.51 million. This represents a resurgence of capital into life sciences companies—an amount of activity not seen since the second half of 2009. The medical devices and equipment industry segment was the largest beneficiary among all life sciences industry segments of this increased financing activity in terms of total amount raised, securing approximately 153 percent more capital in the first half of 2011 ($495.03 million) than in the second half of 2010 ($195.1 million).
Other data from our recent transactions suggests that of all financings completed for our life sciences clients in 2010 and the first half of 2011, including equity financings at all stages as well as bridge financings, the relative percentage of Series A equity financings increased from 22.2 percent in 2010 to 31.4 percent in the first half of 2011; the relative percentage of Series B and Series C (and later) equity financings remained roughly the same, representing approximately 14 percent and 24 percent, respectively; and the relative percentage of bridge financings decreased from 40.3 percent in 2010 to 31.4 percent in the first half of 2011. The surge in Series A equity financing activity relative to later-stage equity investment is a positive sign for early-stage companies that have experienced difficulty accessing capital. Similarly, to the extent that a bridge financing investment is used to mitigate investment risk, the decrease in bridge financing activity relative to equity financing activity may suggest that investors are becoming less risk-averse, potentially at the early stages, which may be explained by the relative increase in Series A financing activity.
In addition to the increased financing activity, the number of “up” rounds, or equity financings conducted at pre-money valuations greater than their post-money valuations from prior rounds, in the first half of 2011 has improved since 2010, with such rounds increasing from 46.9 percent to 60.9 percent. Over the same period, “flat” rounds have decreased from 18.8 percent to 13.0 percent and “down” rounds have decreased from 34.4 percent to 26.1 percent. More specifically, median pre-money valuations increased with respect to Series A equity financings from $4.5 million in 2010 to $6.06 million in the first half of 2011, decreased with respect to Series B equity financings from $16.48 million in 2010 to $5.5 million in the first half of 2011, and increased with respect to Series C (and later) equity financings from $64.39 million in 2010 to $72.28 million in the first half of 2011. This is again good news for early-stage companies, which the data suggests are not only conducting equity financing with greater frequency, but also at improved valuations.
Overall, the data indicates that access to venture capital for life science companies improved in the first half of 2011 compared to 2010. Similarly encouraging is the attractiveness of the life sciences industry as a place to invest relative to other industries.
Our data suggests that of the total amount of money raised in the first half of 2011 from transactions in which Wilson Sonsini Goodrich & Rosati clients participated, 28 percent was raised by the life sciences industry segment—the highest percentage among all industry segments. The next highest industry segments were clean technology and renewable energy at 22 percent, software at 18 percent, and communications and networking at 12 percent; no other industry segment exceeded 8 percent. The fact that the life sciences industry ranked first by this measure represents a change from 2010, when the clean technology and renewable energy industry segment claimed 30 percent of total money raised, with the life sciences industry following at 20 percent. The latest data suggests that the fundraising environment has improved significantly for life science companies in recent months—which hopefully means that more good news is yet to come.
By Philip Oettinger, Partner, and Elizabeth Hill, Associate, Palo Alto
Companies that engage in discussions with corporate strategic partners encounter unique issues along the path to securing equity or debt financing from such investors. Below are some of the issues that a company should be prepared to navigate when negotiating an investment from a strategic partner.
1. Rights of First Refusal, Negotiation, Exclusivity, and/or Notice. Strategic partners often request rights of first refusal, negotiation, exclusivity, and/or notice as a condition to their investment in a company. Such rights typically will be requested in the form of (i) notice to the strategic partner in the event that the company receives an indication of interest from a third party with respect to a potential acquisition, distribution, licensing, or other arrangement, followed by (ii) a period of time in which the strategic partner has the exclusive right to negotiate with the company regarding a similar type of transaction. These rights should be strongly resisted or limited, as they present challenges to a company’s ability to negotiate the best deal with multiple parties, and generally could make the company less attractive to third parties. What third party is going to spend the time, energy, and cost to conduct due diligence and negotiate a definitive agreement if another party can match and enter into the transaction on the same terms ahead of them? To the extent that these rights are crucial to getting the deal done, notice of a firm offer without triggering other rights should be negotiated if possible. In addition, companies should bear in mind that although a strategic investment can lead to an exit strategy with that particular strategic partner, it also could limit a company’s exit opportunities depending on how competitors of that strategic partner perceive the relationship created by that investment, with or without any formal rights of first refusal, negotiation, exclusivity, or notice.
2. Distribution Rights. Product distribution rights are often a part of the investment package. However, such relationships should be valued appropriately outside of the investment and constructed so that they can stand on their own. While in some instances it may be acceptable to grant limited distribution rights in territories that are not of material interest to the company, it is important to resist or limit these rights in order to be an attractive acquisition candidate for multiple suitors. Companies should negotiate non-exclusive rights, if possible, and consider limiting rights to territories that they are unlikely to enter into, at least in the near term. Companies also should insist on the right to make a payment at any time to terminate the relationship (i.e., include a buyout clause) and/or the right to terminate the relationship without penalty in the event of the company’s acquisition by a competitor that distributes in the same territories.
3. Licensing Rights. Licensing of intellectual property also may be requested by a strategic partner in connection with an investment. This may be to allow the strategic partner to commercialize specific implementations of the intellectual property (for example, a company may have two related products exploiting overlapping intellectual property, but only have the funding for one of the products) or to determine how the company’s product(s) may work with the strategic partner’s products. Care should be taken to limit the scope of such licenses, ensure that such licenses are economically reasonable (without taking into account the investment), ensure that any ongoing obligations on the company are feasible, and determine how improvements to the company’s intellectual property should be addressed. Licenses also should terminate or contain buyout clauses that are triggered in the event of the company’s acquisition by a competitor of the strategic partner.
4. Protection of Intellectual Property, Confidential Information, and Strategy. Particularly in those instances where distribution, licensing, or other arrangements beyond the investment relationship (such as co-development or joint venture agreements) are being implemented, it is very important to understand the scope of the overlap between the rights and interests of the company and those of the strategic partner. In cases where intellectual property is disclosed, shared, or mutually developed, it is critical to understand and agree in advance on ownership of resulting improvements and inventions. Much more so than when traditional venture or angel partners are involved, companies should ensure that appropriate protections are put in place to protect their confidential information. Although most strategic partners will adhere to the same business ethics and provide reassurances that confidential information will not be shared internally with other business units or used except as required in managing their investment, as a matter of caution, companies should carefully identify core intellectual property and/or strategy and consider the timing of disclosing that information to strategic partners, if at all. Deals do get completed from time to time without the need for full disclosure, particularly where the intellectual property is sensitive. It is also important to ensure that a company’s strategic direction is not overly aligned with the strategic partner’s own interests, since other market participants may not share the same beliefs, concerns, or strategy.
5. Financial Statements, Information, and Inspection Rights. Strategic partners typically will demand the same level of information and inspection rights that companies provide to their venture partners. Information rights (including the right to financial statements) often are provided to major holders of a company’s stock as defined by a minimum ownership threshold. If a strategic partner will hold a significant number of shares and thereby be entitled to certain rights as a major holder, a company should consider whether there is any information that it wants or needs to exclude for its own commercial interests. For example, disclosure should be managed appropriately to minimize the risk of sensitive information affecting the future valuation placed on a company by the strategic partner in an acquisition proposal. Similarly, information and inspection rights should be limited to avoid access to attorney-client privileged, highly confidential, and/or strategic information.
6. Voting Blocks over Fundamental Transactions. Care must be taken to resist any attempts by a strategic partner to obtain approval or veto rights of any sort. Particular care must be taken to avoid a voting block that would prevent (i) the sale of the company or its assets, (ii) a recapitalization of the company, or (iii) the company’s next round of financing. These blocking rights are of enhanced concern when the strategic partner acquires more than a majority of a given class or series of stock, because in certain instances the rights can arise under Delaware law (or other such laws under which a company is incorporated) without the need for an express provision. Companies should bear in mind that the interests of a strategic partner may not be aligned with other stockholders, even those of the same class or series of stock. Even where there are no blocking rights, it is wise to put in place a drag-along agreement that requires the strategic partner to approve transactions of the type described in (i)-(iii), subject to certain reasonable qualifications (e.g., approval by the board and holders of a majority of the preferred stock).
7. Board Membership or Observer Rights. With large investments strategic partners often will seek to be more involved in the management of the company, typically through board membership or board observer roles. Care should be taken to establish the limits of disclosures that will be made in this regard, with particular attention paid to any disclosures that may be required to allow the director to comply with his or her fiduciary obligations. With respect to observer rights, companies should note that observers may be monitoring their portfolio companies from both a financial and strategic perspective. Ideally, the board should have the right to exclude observers from board discussion and materials, to protect the company’s attorney-client privileged, highly confidential, and/or strategic information. For example, when discussing (i) freedom-to-operate matters in areas where the strategic partner holds significant intellectual property, or (ii) acquisition interest by entities other than the strategic partner, an understanding should be reached with the strategic partner that their board member or observer will not be included in those discussions.
8. Pre-negotiated Acquisitions. On occasion, investments will be made with a right to purchase the company at a pre-negotiated price. This type of transaction usually is structured as an up-front investment coupled with the strategic partner’s option to purchase the company at the pre-negotiated price. The difficulty here is that the dynamic is usually one-sided—if the company underperforms, the pre-negotiated price can be reduced, but if the company exceeds expectations, there is typically no adjustment to the pre-negotiated price. Also, as mentioned above, these rights will act to limit a company’s exit opportunities with other parties that may look to use the pre-negotiated price as an indicator of the company’s valuation and as leverage.
9. Obligations to Deliver without Funding. In certain circumstances, a company’s relationship with a strategic partner obligates the company to deliver certain clinical results or reports or meet product development milestones that are important to the strategic partner, but there is no obligation on the strategic partner to provide additional capital. In these situations, companies that fail to properly budget or plan for contingencies can find themselves in a difficult position where they must produce deliverables without the requisite funding to do so. Strategic partners may at that point take advantage of the situation to negotiate better terms and, if all else fails, look to acquire the company at a fire-sale price. Venture partners may not find such a situation to be an attractive investment, because their funds may be used to complete the work owed to the strategic partner rather than to further create value in the company’s principal business.
10. Publicity/Confidentiality. Strategic partners often will seek a measure of control over how their investment in a company is presented to the market and therefore may require a company to (i) keep confidential the fact that the strategic partner has invested in the company, and (ii) obtain approval before publicizing details of the investment. Companies often want to publicize information, in part to lend credibility to the organization for purposes of dealing with suppliers and customers, but also for the purpose of attracting additional investment. Companies should socialize this issue with the strategic partner and ensure that there is an understanding with respect to how the information may be shared with outsiders.
If you are contemplating discussions with a strategic partner, you should do your due diligence on how successful that strategic partner has been in the past in setting up relationships with other companies, as well as the level and nature of their involvement after an investment. This will ensure that they are aligned with your expectations. If you would like to discuss any of the above issues further, please feel free to contact a member of Wilson Sonsini Goodrich & Rosati’s life sciences practice.
By Jon Nygaard, Attorney, and David Hoffmeister, Partner, Palo Alto
While many of the provisions of the Patient Protection and Affordable Care Act of 2009 (the healthcare reform statute signed into law in March 2010) already have taken effect, others become operative at various times in the future. One of these is the section entitled “Transparency Reports and Reporting of Physician Ownership and Investment Interests,” otherwise known as the Physician Payment Sunshine Act. Although the first legal deadline for action mandated by the Sunshine Act is not until March 31, 2013, it covers transactions from the previous calendar year, the one beginning January 1, 2012, less than four months away. Companies need to start implementing systems and procedures now to enable them to track and record transactions in compliance with the Sunshine Act’s mandates.
What exactly is the Physician Payment Sunshine Act? It is a “transparency reporting law” that requires United States manufacturers of marketed drugs, devices, biological products, or medical supplies covered under Medicare, Medicaid, or SCHIP to report to the Department of Health and Human Services (HHS) most “payments or other transfers of value” to physicians and teaching hospitals that are greater than $10 in value. Covered recipients include only physicians and teaching hospitals; pharmacists and other health professionals are not covered. HHS will post the reported information on a public website.
It is worth keeping in mind what the Sunshine Act is not. It does not regulate the conduct of manufacturers in their dealings with healthcare professionals. Other laws, and the codes of conduct that companies adopt, may regulate marketing practices, but the Sunshine Act does not. It is merely a reporting law.
Starting with transactions with physicians and teaching hospitals that take place on January 1, 2012, and thereafter, manufacturers must report in electronic form on an annual basis the following specifics about every payment or transfer of value:
The Sunshine Act does exempt several categories of payments or transfers. Educational materials provided to patients or that directly benefit patients, rebates and discounts, loans of covered devices, items provided under warranty, investment interests in a publicly traded security or mutual fund, and payments to a physician who is an employee of the reporting company need not be reported. In addition, the law exempts payments of less than $10 until the annual aggregate for a covered recipient exceeds $100, at which point all payments must be disclosed retroactively. Prescription drug and device samples also are exempted from the Sunshine Act’s reporting requirements, although they are covered by other laws. Payments related to clinical trials or product development agreements for new products are allowed a publication delay of four years or until product approval, whichever comes first. The Sunshine Act preempts individual state laws to the extent that they require the reporting of the same information, but state laws requiring the reporting of additional information are not preempted.
The Sunshine Act contains significant penalties for non-compliance. Failure to report a single payment or transfer can lead to imposition of a fine of between $1,000 and $10,000 with a $100,000 annual limitation. A knowing failure to report is subject to a fine of between $10,000 and $100,000 with a $1 million annual maximum.
While further guidance from HHS on the meaning of the statute, its definitions, and plans to enforce it has been promised, no guidance has been issued as of September 1, 2011. However, companies would be well advised to begin implementing systems, practices, and procedures that will allow them to begin tracking all transactions beginning January 1, 2012, and reporting them by March 31, 2013.
Please contact David Hoffmeister, Farah Gerdes, Kristen Harrer, or Jon Nygaard in Wilson Sonsini Goodrich & Rosati’s life sciences/FDA and healthcare practice with any questions about the Physician Payment Sunshine Act.
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Phoenix 2011 will mark the 18th annual conference for chief executive officers and senior leadership of medical device and diagnostic companies. The event will provide an opportunity for top-level executives from large healthcare and small venture-backed companies to discuss financing, strategic alliances, and other industry issues.
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Wilson Sonsini Goodrich & Rosati’s 20th Annual Medical Device Conference, aimed at professionals in the medical device industry, will feature a series of panels and discussions addressing the critical business issues facing the industry today.
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