Patent Baristas

A US Court of Appeals for the Federal Circuit (CAFC) upheld a ruling which blocked sales of Ranbaxy’s generic alternative to Pfizer Inc’s Accupril blood pressure drug (Quinapril HCl), a generic equivalent of Pfizer’s (Parke Davis) anti-hypertensive agent Accupril Tablets. [Pfizer, Inc. and Warner-Lambert Company, LLC, v. Teva Pharmaceuticals USA, Inc., Ranbaxy Pharmaceuticals, Inc., and Ranbaxy Laboratories Limited, Fed. Cir. (05-1331, November 22, 2005)]

Teva and Ranbaxy appealed from the District Court order granting a motion for a preliminary injunction filed by Pfizer and Warner-Lambert to prevent Teva and Ranbaxy from infringing United States Patent No. 4,743,450 (“the ’450 patent”). The ’450 patent relates to pharmaceutical compositions containing angiotensin converting enzyme (“ACE”) inhibitors such as quinapril and their methods of manufacture. The ’450 patent discloses minimizing cyclization, hydrolysis, and discoloration by using formulations containing a metal-containing stabilizer and a saccharide.

The appeal involves the ’450 patent’s independent claims 1 and 16. Claim 1 is a composition claim:

A pharmaceutical composition which contains: (a) a drug component which comprises a suitable amount of an ACE inhibitor which is susceptible to cyclization, hydrolysis, and discoloration, (b) a suitable amount of an alkali or alkaline earth metal carbonate to inhibit cyclization and discoloration, and (c) a suitable amount of a saccharide to inhibit hydrolysis.

Claim 16 is a process claim:

A process for stabilizing an ACE inhibitor drug against cyclization which comprises the step of contacting the drug with: (a) a suitable amount of an alkali or alkaline earth-metal carbonate and, (b) one or more saccharides.

Ranbaxy sought FDA approval to market its own generic version of Accupril® by filing its own ANDA and certifying that its product would not infringe the ’450 patent. Ranbaxy sent Warner-Lambert a paragraph IV certification letter on April 7, 2003, explaining why Ranbaxy believed its product would not infringe the ’450 patent. Ranbaxy’s letter indicated that it had adopted and relied upon the construction of “saccharide” Warner-Lambert had previously stipulated to in its case against Teva.

The district court eventually granted summary judgment against Teva, finding the ’450 patent not invalid for lack of enablement and infringed. In granting the motion for a preliminary injunction, the district court construed “saccharide,” as the term is used in claim 1, and “saccharides,” as the term is used in claim 16, to include “mono-, di-, tri-, and polysaccharides.” In doing so, the court simultaneously rejected both the stipulated construction previously entered in the separate case and Ranbaxy’s proposed construction of “sugars, including the lower molecular carbohydrates, specifically mono- and disaccharides.”

In upholding the preliminary injunction, the Fed. Circuit held that:

The claim language itself does not support Ranbaxy’s proposed construction.“[T]he claims themselves provide substantial guidance as to the meaning of particular claim terms.” Id. at 1314. Claim 1 includes “a suitable amount of a saccharide to inhibit hydrolysis,” and claim 16 includes “one or more saccharides.” It is important to note that the claims do not include the terms “sugar” or “sugars.” Neither do the claims distinguish between polysaccharides having ten or less monosaccharide units and polysaccharides having more than ten monosaccharide units.

…

This court has previously construed a disputed claim term by referencing use of “i.e.” in a patent specification. See Abbott Labs. v. Novopharm Ltd., 323 F.3d 1324, specification.” (emphasis added)). “[I]t is necessary to consider the specification as a whole, and to read all portions of the written description, if possible, in a manner that renders the 1327, 1330 (Fed. Cir. 2003). In that case, however, the court did not identify any support in the intrinsic evidence for a construction of the disputed claim term other than the construction linked to “i.e.” Id. at 1330. Indeed, the problem with Ranbaxy’s argument is that it ignores the fact that the person of ordinary skill in the art is deemed to have read the claim term in the context of the entire patent. Phillips, 415 F.3d at 1313. See also SanDisk Corp. v. Memorex Prods., Inc., 415 F.3d 1278, 1285 (Fed. Cir. 2005) (“The court must always read the claims in view of the full patent internally consistent.” Budde v. Harley-Davidson, Inc., 250 F.3d 1369, 1379–80 (Fed. Cir. 2001).

Ranbaxy admits that mannitol is not a sugar. It nevertheless argues that the patentee labeled mannitol as a sugar, and that we should respect the patentees’ decision to do so. Thus, according to Ranbaxy, “Mannitol, lactose, and other sugars are preferred” is, for the purpose of the patent, a list of like ingredients, “sugars.” We are not convinced that one of ordinary skill in the art would understand the patentee to have classified mannitol as a sugar in this sentence. As the district court found and Ranbaxy does not dispute on appeal, mannitol is not actually a sugar. On the other hand, lactose is a sugar. The reference to “other sugars” therefore appears to relate to the disclosure of lactose only. In short, the reference to “other sugars” does not mean that mannitol is a sugar or should be considered to be a sugar for purposes of the ’450 patent.

…

Extrinsic evidence in the form of technical dictionaries, treatises, and expert testimony supports the conclusion drawn from the ’450 patent that one of skill in the art would understand “saccharides” to encompass more than sugars. The district court reviewed the extrinsic evidence presented by the parties and found that one of skill in the art would understand “saccharides” to include polysaccharides. Ranbaxy, however, points to specific examples of references and testimony that allegedly support its view that “saccharides” means sugars.

The CAFC then went on to affirm the grant of the preliminary injunction stating that the district court’s claim construction was not erroneous; the district court did not abuse its discretion when it determined that Ranbaxy likely infringes the ’450 patent either literally or under the doctrine of equivalents; and the district court did not abuse its discretion when it found that the harm and public interest favors enjoining Ranbaxy.

Get the opinion here.

The Baristas had a post from Patent Baristas featured in the newly launched BlawgWorld 2006: Capital of Big Ideas, an eBook sampler of 51 of the most influential law blogs (blawgs). BlawgWorld is published by TechnoLawyer, a publisher of various e-mail newsletters for the legal marketplace. The Barista article, “Misconduct (and Not Just Scientific) is a Problem for Everyone,” provided a discussion of recent allegations of misconduct by U.S. researchers in light of a survey showing one in three researchers admitted to some type of professional misbehavior.

See the Patent Baristas Sampler article here.

They’ve also launched a special BlawgWorld home page at http://www.blawgworld.com. Anyone who joins TechnoLawyer using the form on this home page will immediately receive a free copy of BlawgWorld. (Best of all, joining TechnoLawyer is free and so are the newsletters they publish!)

We recommend that you join TechnoLawyer using the BlawgWorld home page, and check out their legal newsletters. We especially like Fat Friday, a weekly newsletter that enables TechnoLawyer members to discuss any legal technology or practice management issue on their mind.

We reported earlier that the U.S. Patent and Trademark Office (USPTO) issued a ruling against one of several patents that Pfizer holds on Lipitor (atorvastatin), its top-selling cholesterol drug. In the reexamination proceeding initiated last year by the Public Patent Foundation (“PUBPAT”), the USPTO rejected all 44 of the claims of U.S. patent 5,969,156 when it ruled that Pfizer’s arguments for securing the patent in 1999 were invalid. PUBPAT’s Request for Re-examination alleged that the claims of the ‘156 patent are anticipated by U.S. patents 5,273,995 and 5,686,104 as having disclosed crystalline atorvastatin.

Now, the tide has turned. On Nov. 23, 2005, the Examiner issued a Notice of Intent to Issue Ex Parte Re-Examination Certificate. Included in the allowed claims are 21 of the original claims, 13 amended claims and 73 newly presented claims!

In the Statement of Reasons for Patentability and/or Confirmation, the Examiner stated that:

Claims 1-117 are allowed because they are directed to crystalline forms of atorvastatin which are not found in the prior art. More specifically, the prior art form of atorvastatin found in Mills et al (US 5,686,104) and Roth (US 5,273,995) are amorphous compared to the instant claims which are crystalline forms of the same compound.

In its response, Pfizer submitted declarations showing the x-ray powder diffraction analysis of the atorvastatin calcium compounds of the prior art as compared to the compounds claimed in the ‘156 patent. Claims 2, 4, 5, 9 and 31 were amended to correct a typographical error while claims 1, 28, 29, 36 and 38 were amended. In doing so, Pfizer admitted that “it has now been determined that it is possible, although unlikely, that certain lots of atorvastatin calcium used in early clinical trials might be argued to fall within the scope of some of the broad originally issued claims of the ‘156 patent.” The claims have now been amended to limit the claims to a crystalline Form I atorvastatin hydrate having an X-ray powder diffraction containing the following 2-theta value measured using CuK-alpha radiation: 22.0.

In its response, Pfizer stated that atorvastatin is an “unusual” molecule that exists in a large number of polymorphs with various “amorphous” forms and a greater number of different crystalline forms but that Form I crystalline atorvastatin calcium trihydrate is the active ingredient in Lipitor and the only form ever marketed by Pfizer. They also stated that the original atorvastatin calcium utilized by Pfizer in early development was an amorphous solid. Pfizer then points out the differences between the amorphous and crystalline atorvastatin, including chemical stability, impurities, particle size and dissolution profiles.

The ‘156 patent at issue with the current re-exam is set to expire in 2017, thus extending the useful patent protection of the drug (keep in mind that Lipitor is set to become the world’s first $10-billion-a-year drug so the stakes are extremely high).

Although the ‘156 patent is one of five patents listed by Pfizer with the U.S. Food and Drug Administration (FDA) for atorvastatin, it is the only one asserted by Pfizer in patent infringement lawsuits filed last year against web sites selling generic atorvastatin to Americans. Two are under review by a Delaware court and the remaining two have never been asserted by Pfizer against any competitor to Lipitor.

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Dowload the Notice of Intent to Issue Ex Parte Re-Examination Certificate here.

Download Applicant’s Amended Claims Set here.

Yes, Blawg Review #34(!) is up over at Phosita, hosted by Douglas Sorocco. This is an awesome round-up of blawgs with lots of great posts – obviously the turkey hangover wasn’t too bad this year. We loved the post (of course) over on Brand Autopsy musing about the Lowest Common Coffee Denominator. So, is your firm more like Starbucks or Dunkin’ Donuts (atmosphere v. consistency)?

We also learn that Sorocco and wife are expecting their first child in February (and reading up on things at the Mommy Blawg). Congrats!

We’re just happy to hear that Steve Nipper, over at rethink(ip), was able to get that useless “www” removed off the front end of the uspto.gov URL. Way to go, Steve!

The accused infringers, AWH Corp., et al., have petitioned for review of one part of the en banc ruling on claim construction in the Phillips case. (I hardly can write a sentence without using Latin). Now that all the fanfare over the Federal Circuit’s consideration of that case, and over the 33 amici that weighed in on it, has died down – we see a petition for certiorari devoted to the single issue that the en banc Court did not decide. So, we have case with no final judgment (just reversal of a non-infringement ruling based on a stipulation), that is taken up by an accused infringer (instead of a patentee whose rights were lessened by “interpretation”), on an issue that was not decided by the Circuit Court. I’m deeming this petition to have the chances of a one-hander from outside the three-point line.

Our Supreme Court tends to hear constitutional issues, or cases arising therefrom. Here, the petitioners argue, as have many before them, that their case “illustrates perfectly what has gone wrong in the Federal Circuit.” AWH makes no argument that the Federal Circuit mis-construed Phillips’ patent claims, only that the Circuit should be “deferential to” the claim construction rulings made in the District Courts. Deferential review is proper, AWH argues, because claim construction is a mixed question of fact and law, or is a legal conclusion based on disputed facts.

The petition, in my view, asks that the Markman case be reconsidered (which, in my view, is not likely to happen). The holding in Markman that claim interpretation is a legal issue forms the basis for the Federal Circuit to review those interpretations as a matter of law, using the de novo standard of review. It seems that AWH has asked the Supreme Court to revisit this necessary premise. If I recall correctly (which can be challenging as I age), the Markman cases considered the argument that claim interpretation can present a mix of fact and law – and they held, no matter, patent claims are interpreted as a matter of law. From that, I presume that the AWH petition prays for a change in settled law.

Also, the precedent that AWH relies upon are mostly non-patent cases, with differing interests at stake. Every cert. petitioner, who loses in the Federal Circuit, cites to Anderson v. Bessemer City. That was a civil rights, Title VII case, which tend to get a different level of scrutiny from the Court than nuances of patent law. AWH relies too on the Ornelas case, involving search and seizure, again, a constitutional claim. It cites Pierce v. Underwood, which asked if the same, or a lesser, standard of review applies to a district court’s interpretation of state law questions. The analysis in those cases starts from more compelling interests than the standard of “deference” that was passed on without any ruling in Phillips. Even Markman was a contest over the 7th Amendment right to a jury.

When I first read the order specifying the issues for en banc consideration in the Phillips case, it seemed to augur that auspicious changes in patent claim interpretation would be forthcoming. Then, after the 33 amici and the litigants and many commentators spoke at length about those seven questions, the Federal Circuit’s decision was more a repackaging of precedent than anything remarkable. The present petition for certiorari by AWH also recasts arguments about the settled law of claim interpretation, which for the present is likely to remain unchanged.

Today’s post comes from Guest Barista C. Lee Thomason, a registered patent attorney and IP litigator at Frost Brown Todd’s Louisville office.

CincyTechUSA announced that Robert W. Coy, Jr. of St. Louis joined the organization as president. Coy was senior vice president for Entrepreneurial Development for the St. Louis Regional Chamber and Growth Association. He replaces Rich Kiley, who has served as interim executive director of CincyTechUSA since May of 2004.

CincyTechUSA focuses on assisting companies in life sciences and technology-related industries by leveraging the existing infrastructure. CincyTechUSA is expected to sharpen its strategies in the following areas:

• Connecting tech entrepreneurs to the critical resources they need for success: technology, money, customers, markets, management, partners and support services.

• Improving Cincinnati USA’s tech image with a focus on recruiting and retaining vital talent.

In addition, CincyTechUSA now offers a TechConnect program, designed to help technology-based companies grow and succeed. TechConnect is a one-stop approach that helps entrepreneurs identify resources and connect companies to them.

In Invitrogen Corporation v. Clontech Laboratories, Inc., Fed. Cir. 04-1039, -1040 (November 18, 2005), the CAFC vacated an invalidity judgment and the district court’s conception ruling based on anticipation by § 102(g)(2) prior art where the inventors could not appreciate the discovery they made.

Invitrogen appealed from a decision by the United States District Court for the District of Maryland, invalidating two hundred and twenty-one claims, in three related Invitrogen patents, as anticipated by § 102(g)(2) prior art. The invalidity was based on the district court’s underlying ruling that researchers at Columbia University conceived of a similar invention before, and were diligent in reducing it to practice after, Invitrogen’s first reduction to practice in 1987. On appeal, Invitrogen challenged the district court’s partial summary judgment dating conception by the Columbia researchers. On cross-appeal Clontech challenged three underlying partial summary judgments in favor of Invitrogen: (1) that the claims-in-suit are enabled; (2) that the claims-in-suit satisfy the § 112 written description requirement; and (3) that Clontech’s products literally infringe claims 3, 4, 12, and 13 of U.S. Patent No. 6,063,608.

The patents involved in the suit were owned by Invitrogen: U.S. Patent No. 5,244,797 (“the ‘797 patent”), U.S. Patent No. 5,688,005 (“the ‘005 patent”), and U.S. Patent No. 6,063,608 (“the ‘608 patent”). The appeal involved the ‘797 patent, claims 1-4; the ‘005 patent, claims 8-29; and the ‘608 patent, claims 1-196. All three patents issued from continuations of a common parent application, No. 07/143,396 (“the ‘396 application”), filed on January 13, 1988, and share a common written description.

The patents disclose a genetically modified enzyme, reverse transcriptase, involved in DNA replication. Reverse transcriptase (“RT”) is a naturally occurring enzyme produced by retroviruses, such as the Moloney-Murine Leukemia Virus (“MMLV”). Invitrogen’s genetic modifications affect how the modified RT participates in DNA replication. DNA replication involves a series of discrete steps. The original DNA, a molecule comprised of two strands of nucleotides forming a double helix, is opened to expose single strands. Messenger RNA (“mRNA”), comprising a single strand of nucleotides, forms opposite the exposed DNA strands. The mRNA detaches from the exposed DNA and serves as a template against which a first strand of complementary DNA (“cDNA”) forms. This is first strand synthesis. The mRNA detaches from the first cDNA strand, allowing a second, complementary DNA strand to form opposite the first strand, completing the process. This is second strand synthesis. The completed cDNA molecule is a copy of the original DNA transcribed by the mRNA. “Reverse transcription” describes building the cDNA from the mRNA template.

Reverse transcriptase affects at least two steps in this process. First, it facilitates the formation of cDNA opposite the mRNA template, a step called DNA polymerase activity. Second, it degrades the mRNA strand of the mRNA / cDNA hybrid molecule so that the first strand cDNA nucleotides are free to form a second strand and complete the DNA replication. Degrading or destroying the mRNA template is called RNase H activity. Until the mRNA template is removed from the first strand cDNA, the second strand cDNA synthesis cannot occur.

If RNase H activity destroys the mRNA template, as happens with naturally occurring RT, then it cannot serve as a template for additional cDNA. But if the RNase H activity of RT is inhibited, and the mRNA is detached from the hybrid mRNA / cDNA first strand without being destroyed, then scientists can reuse the mRNA to form additional cDNA. An RT with inhibited RNase H behavior is useful for efficiently cloning DNA. As described and claimed in the patents, Invitrogen developed mutant RT with DNA polymerase, but no RNase H, activity (“RNase H minus”). More particularly, Invitrogen altered a gene that originally encoded wild or natural RT, resulting in a mutant enzyme with the desired properties. Invitrogen reduced this invention to practice on January 27, 1987.

Beginning in the early 1980s two scientists at Columbia University, Dr. Stephen P. Goff and his post-doctoral researcher, Dr. Naoko Tanese, studied the effects of random mutations in the MMLV gene for RT – an approach called “random mutagenesis.” In 1984, Tanese prepared a panel of roughly 100 mutants. Without sequencing the mutants, Goff did not know where the MMLV gene had been altered in each mutation. Two mutant genes created in 1984 were H7 and H8, each encoding enzymes that later proved to lack RNase H activity. After creating the mutant MMLV genes, Tanese tested the mutant RT they encoded for DNA polymerase activity. Roth tested the mutant RT for a different function called integrase. In late 1984, Tanese also tested the mutant RT for RNase H activity. But the tests using 1984 assay technology yielded inconclusive results. The mutant RT under investigation was produced in E. coli bacteria, which naturally produces an enzyme with RNase H activity. The RNase H activity of the bacterial enzyme introduced too much background noise to measure, with existing methods, the RNase H behavior of the mutant RT.

The 1984 assay technology could have been used to measure the mutant RT RNase H activity if Goff and Tanese first purified the mutant RT for each mutant MMLV gene – that is, if they had they isolated the mutant RT from the background E. coli enzymes. Goff concluded that approach was too time consuming for the large number of mutant MMLV at issue, so he and Tanese developed a new in situ assay. That new assay was designed to measure the RNase H activity of the mutant RT without first isolating it from the bacterial enzymes. Not until March 1987, however, did Goff and Tanese complete the new assay and apply it to their panel of mutants. Nonetheless, in 1986, before finishing the new assay, Goff sequenced various mutant RT genes. Among those he sequenced were H7 and H8. When Goff and Tanese completed the new in situ assay in March 1987, they rapidly determined which parts of the MMLV RT gene affected which enzyme properties. By March 7, 1987, they established that H7 and H8 encoded mutant RT with DNA polymerase activity but no RNase H activity.

Goff and Tanese started publishing their work after March 1987. On January 29, 1988, Goff filed a patent application pertaining to this research. In 1993 the U.S. Patent and Trademark Office (“PTO”) declared an interference between Goff’s application and the ‘260 application that eventually issued as Invitrogen’s ‘005 patent. (October 18, 1993 notice of interference from PTO). The sole count described a method for producing a genetically modified RT with DNA polymerase but “having substantially no RNase H activity.” Goff’s assignee, Columbia University, defaulted and the PTO ruled in Invitrogen’s favor. As a result, the PTO never reviewed Goff’s research records to determine priority of invention between Goff and Invitrogen.

The district court determined that Goff et al. invented a mutant [RT] enzyme that did not have RNase H activity. The enzyme was prepared in December 1984, and its reduction to practice was confirmed in March 1987. The Court has also found that Goff was diligent and that he did not abandon, suppress or conceal his invention. Goff’s work is available as prior art as of December 1984. On October 17, 2003, the district court entered final judgment in both actions, invalidating several claims under § 102(g)(2) in view of Goff: (a) ‘797 patent, claims 1-4; (b) ‘005 patent, claims 8-29; and (c) ‘608 patent, claims 1-196.

Conception requires the “definite and permanent idea of the complete and operative invention” for conception, require more than unrecognized accidental creation. “[A]n accidental and unappreciated duplication of an invention does not defeat the patent right of one who, though later in time, was the first to recognize that which constitutes the inventive subject matter.” Silvestri v. Grant, 496 F.2d 593, 597 (CCPA 1974). Thus, “[t]he date of conception of a prior inventor’s invention is the date the inventor first appreciated the fact of what he made.” In other words, conception requires that the inventor appreciate that which he has invented.

The invalidity judgment depends on when Goff appreciated that H7 and H8 were RNase H minus, but retained DNA polymerase activity.7 Invitrogen contends that the district court misread the facts and misapplied the law to award Goff priority of invention. Under a correct application of law, Invitrogen argues, Goff did not conceive of the invention until March 1987, when he perfected his in situ assay and established that the H7 and H8 mutants were RNase H minus. Invitrogen contended that until that moment, Goff never recognized that his accidental creations, the H7 and H8 mutants, had the inventive features at issue. Clontech disagrees, and asked the court to affirm the district court’s ruling.

With unrecognized accidental duplication, the invention exists but remains unrecognized. The priority determination requires evidence that the inventor actually first made the invention, and that he understood his creation to have the features that, comprise the inventive subject matter at bar. Thus, the court must identify when, during an emerging recognition that a particular invention includes something new, the inventor’s understanding reaches the level needed for appreciation.

The court held that:

As a matter of law, the court’s conclusion is unsustainable. Langer and Silvestri require some connection between the physical result (the invention) and the belief (by the inventor). Here, the district court never identified corroborating evidence of Goff’s purported belief, nor identified how it could determine that Goff had reviewed such evidence and understood its import. There is no evidence that merely sequencing the mutant RT gene could, in 1986, establish the corresponding enzyme’s properties.

More fundamentally, the record is inconsistent with the district court’s notion that Goff set out to create RNase H minus RT, or that he recognized his invention in 1984. It shows, instead, that this action fits squarely within the unrecognized, accidental duplication cases. First, Goff’s research was general in nature. The random mutagenesis involved a panel of 100 randomly mutated MMLV RT genes. At his deposition, Goff testified that Tanese’s 1984 experiments “[were] focused on understanding what the consequences of those mutations were for the virus.” He explained that his “main grant and the main focus of [his] whole lab was to look at the [MMLV] mutants . . . and to look at the [effects] of those mutations on the virus.” Second, it was unknown at the time whether it was even possible to make an RNase H minus RT with DNA polymerase activity. Not until his March 1987 assay, Goff explained, had anyone shown that RNase H activity involved a separate area of the RT gene from the sequence responsible for DNA polymerase. The publications at the time were conflicting, and it was unclear “whether it would be possible to express [the two functions] separately because there are many multi function enzymes, but frequently [their] multiple activities are interconnected so intimately, that [it is] very hard to separate them.” Finally, asked to identify the time when he “decided” to create an RNase H minus mutant RT, Goff testified that “the belief was that we had them, but I didn’t know how to characterize them. I mean, it wasn’t that we wanted one. There was no reason to have one in our minds.” (emphasis added) Even assuming the district court had assessed an objective basis for appreciation – which it did not – on these facts the partial summary judgment of conception for Clontech is unsustainable.

* * *

In sum, the district court erred in granting judgment of invalidity under § 102(g)(2). Clontech’s challenges to the court’s partial summary judgments on written description and enablement are misplaced and fail to support the invalidity judgment. Accordingly, the court vacates the judgment of invalidity and the conception ruling on partial summary judgment, and remands for further proceedings.

On remand, we remind the district court that the material factual dispute we perceive regarding appreciation affects not only the proper date of conception, but also the date of reduction to practice. “It is now well settled that in [an accidental creation] there is no conception or reduction to practice where there has been no recognition or appreciation of the existence of the new form.” Silvestri, 496 F.2d at 597. Because we reserve the question of appreciation for the jury, its determination on this issue will decide the date of conception (as well as reduction to practice). IV. Finally, Clontech cross-appeals the district court’s partial summary judgment that the PowerScript RT infringes claims 3, 4, 12, and 13 of the ‘608 patent.

Among the most frequently asked questions I get from start-up companies is: How much should I pay for licensing in a technology? Answer: As little as possible. Kidding aside, this is really a very complicated question that cannot be answered without a lot of homework. While most companies seem to use a valuation method I like to call “pulling a number out of the air,” there are three primary methods used by licensing professionals to assess the value of IP assets. These are the Cost Method, Market Method and Income Method. With all of these methods, good data and data projection are critical in determining the appropriate numbers.

In the Cost Method, the value is the cost incurred in developing or purchasing the relevant technology or intellectual property. But what if, as a result of changing markets or new information, you determine that the present value of the total revenues/return expected from this technology is less that the cost?

In the Market Method, the method for determining value is to learn what comparable technologies have licensed for recently. Of course, to do this you’ll need to (a) determine what transactions are comparable and (b) obtain current, reliable data. Usually, this is through compiled data reports.

In the Income Method, value is the estimated revenues the technology is likely to produce (and savings it is likely to generate) and comparing this to the estimated cost to generate the same revenues or savings from other sources, that is, total annual returns. Basically, it’s a method of determining what you can afford (or not afford) to pay in the end.

This issue came up while I was on a panel discussion at the BioOhio conference last week (although I was in pain from my broken shoulder). It did provide some interesting insights in the need for obtaining information relating to royalty rates.

One audience member stated that he felt universities or research institutions collaborate and share licensing information, essentially leaving a potential licensee at a disadvantage with little or no information as to what the “proper” royalty rate should be for a given technology. The audience member thus posed the question: Are there sources of royalty data available to a licensee to figure out the “appropriate” royalty amount to pay (i.e., the Market Method)?

The short answer is “Yes” but I find such royalty rate sources particularly unhelpful. We didn’t have time to get into details at the time but I think that finding out the range of average royalty rates for particular products is interesting in the sense of providing a general “ballpark” range — but not really helpful for your particular product and agreement.

Organizations like the Association of University Technology Managers (AUTM) and the Licensing Executives Society (LES) publish lists and statistical analyses of royalty rates (many industries use about 5% of the selling price as a typical rate) but rates can vary from 0.1 to 25% or more and depend on the industry.

Often, such royalty guides provide some range of royalty rates for certain technologies, e.g., a rate of 4%-12% for technologies related to therapeutic products. I would argue: So, what? What does that tell you about your therapeutic? Should it be 12%? Or only 4%? Or do you split the baby and call it 8%?

Granted, using an established royalty rate shown in certain guides sounds good since these are derived from prior actual licenses for comparable products. The rates in the guides come from negotiation and paid by a sufficient number of licenses. As with reasonable royalty, an established royalty rate derives from the outcomes of willing parties licensing without the threat of a suit, or resultant from litigation. These rates are reflective of the profitability of industry segments. Correspondingly, what might pass muster for an established royalty depends upon the definition of a market segment. Commodity items tend to garner a relatively low royalty rate, just shy of 3%, consumer goods 5%, while software garners around 7-8%. But generalities don’t tell you anything about your particular deal.

Very often, universities rely on the 25% Rule. It’s often accepted (as a rule of thumb) that a royalty rate equalling about one-quarter of the licensee’s anticipated pre-tax profits derived from the technology is a fair rate. Of course, one needs to then determine net profits. Thus, the rates depend on the market forces of each particular product. For example, if the licensee will have profit margins of 80%, the royalty paid to the licensor should be about 20% of pre-tax, net revenues. Conversely, if profits of 4% are expected, the royalty should be within the range of 1-1.5% of net revenues earned.

Note, however, that this rule-of-thumb doesn’t take into account specific circumstances determining the value of your particular technology. Therefore, the 25% Rule is only a starting number before looking at many other factors that should be taken into account in the final determination of value/rate. One needs to consider: Is the technology a breakthrough or core product? Is it merely an ancillary product or minor improvement? Is the intellectual property (patents, copyrights, etc.) strong enough to make the final product unique and valuable? Is the technology ready to be used immediately or will it require substantial R&D or regulatory clearance to be commercialized? Is there a high risk of failure? Can you maintain a high profit margin or will others eat your lunch? Therefore, royalties for pharmaceuticals in the pre-clinical stage may be from 0-5%, while royalties in Phase I may be 5-10% and royalties for launched products may top 20%. Again, guidebooks and rules-of-thumb will only get you so far.

If you want to strike a deal in which the licensor thinks the price is too low, you need to provide a basis for your numbers. I recommend to clients that, if necessary, they show their business plan to the licensor under a nondisclosure agreement. That often helps the other side understand that the offer is dictated by the business model and not just an offer to get the lowest royalty rate in order to keep more of the profits for itself. For example, substantiate an expected profit percentage by preparing a manufacturing cost estimate and then apply percentages customary in the specific industry for overhead items like R&D, engineering, marketing and sales, etc. Then the total cost per unit is deducted from the expected selling price per unit to establish a gross profit.

What is more difficult is deciding how much, if any, the royalty rate should be discounted based on risk factors. It is not impossible for discount factors to be in the 25-35%/year range. To determine the ultimate reasonable royalty rate, you need to consider extraneous factors (e.g., how soon until you will be ready to sell a product and gain revenue, the exclusionary position of the patents, the competitive products, market share, etc.).

I say that the “correct” royalty rate is the maximum royalty rate that the licensee is willing to pay that meets the minimum royalty rate the licensor is willing to accept. If you are only willing to pay 3% and the university will only accept 6%, then you’ll have no deal (and I’d argue you shouldn’t!). Why front your capital on a business venture that you can’t afford to pursue?

A reasonable royalty rate is often based on economic sense by utilizing a financial model which relates the investment required to develop a therapeutic technology to the income generated by such technology. What does that mean? It means you have to have a good business plan in place before you can talk turkey on royalty rates. And I don’t mean those wildly inflated fluffy business plans that companies create showing revenue in colorful logarithmic growth charts to impress potential investors. No, I mean a real, down-to-earth, cold shower type of business plan that takes into account all of the pain and suffering that could be encountered along the way.

For example, with a novel early-stage therapeutic technology that is licensed by a university to a commercial company, one has to look at the development of such technology. Entrepreneurs who intend to market a new drug must go through a very complex and expensive process. Bringing a new drug to market can take a company 10-15 years at a cost of over $800 million.

The first step in obtaining FDA approval for a new drug is to submit an Investigational New Drug (IND) application to the FDA that contains preclinical information including animal pharmacology and toxicology data. When the FDA has cleared the IND application, the drug manufacturer can conduct clinical trials in three phases:

Phase I: Study of the drug in 20 to 80 healthy human volunteers for up to one year to provide information on the drug’s toxicity and potential side effects.

Phase II: This type of study is conducted on patients with the targeted disease that the drug is intended to treat over two years to test the drug’s safety and efficacy.

Phase III: This is the most comprehensive of the investigational studies focusing on a large number of patients for approximately two to four years, depending on the drug and the patient population.

Once you have successfully completed three phases of clinical studies on an investigational drug, you submit the information as part of a New Drug Application (NDA). The submission is reviewed by the FDA. If the drug is granted NDA approval, the FDA may require that the company engage in a Phase IV clinical study.

At each step in the path, there is a substantial risk that the drug will fail. Even drugs that complete Phase III clinical trials will go on to gain FDA approval about half the time. And, after clearing all of these hurdles, sales may increase gradually and not reach full scale until many years after marketing approval. The total cost of production, marketing, selling, etc., (excluding royalty payments) may be 80-90% of sales value. Keep in mind, depending upon when patents were filed, a licensee may have only 10-12 years of patent-protected sales in which to recoup investment expenses.

Drug development (or other high-tech product development) is a high-risk venture and such risk should be reflected in the company’s required rate of return. In any event, the rates of returns will depend to a large extent on the maximum royalty rate, payable to the university, which will enable the company to achieve its desired rate of return.

A university will often push for a higher royalty rate based on the appeal of the technology (cutting-edge technologies deserve higher royalty rate), its proximity to human trials and the extent of the patent coverage, etc. The company usually bases its royalty rate by considering the amount of investment required for the development and the extent of patent coverage.

The expected sales volume is often a key determinant of the economically reasonable royalty rates. Thus, the factors that determine the expected sales volume such as the potential market, possible competition, the expected product price and the geographical coverage of the patents should be seriously considered while determining such rates.

Considering that the total investment required for the development can be hundreds of millions of dollars, in many cases only a small royalty rate is economically reasonable depending upon the expected sales volume. If the expected sales volume doubles, the reasonable royalty rate payable will likewise increase. However, as the amount of investment capital increases, the maximum royalty rate payable to the university will decrease. In that case, the range of reasonable royalty rates can easily vary from 1%-12% (or even well outside this range) depending upon the expected sales.

In light of this, guide books of reasonable royalty rates don’t seem all that helpful.