How to amicably terminate a pharmaceutical BD project

Macroeconomic hardships are challenging the prospects of business development projects in the pharmaceutical industry. In these uncertain times, sound preparation for exit or bankruptcy is the sign of a good sense of responsibility

In the pharmaceutical industry, business development (BD) projects typically involve acquiring products and technologies through licensing, investment, M&A, joint development/commercialisation, and other means. Three years into the pandemic, the industry worldwide has been greatly affected in terms of market environment and business expectations, posing various challenges to their BD projects.

In this context, contractual terms such as force majeure, change of circumstances and change of market conditions have become common issues voiced in both internal company meetings and between business partners when discussing how to proceed with BD projects. Should it stay or should it go? At some point, the tough question must be asked.

Plan exit at outset

BD projects are naturally based on contractual agreements. When a project faces termination for some reason, the exit mechanism becomes key. Termination or rescission clauses, if compromised by unclear procedures or ill-defined rights and obligations, can make the situation difficult and costly for parties, both timewise and economically.

Termination or rescission of agreements may be either by law or by will. Under Chinese law, termination is usually due to force majeure or a change of circumstances, which are both loosely defined. If opinions conflict, a court or arbitral tribunal will be counted on to ultimately decide their applicability. Hence, termination by will is relatively more predictable, as it is based on prior agreement of the parties.

Responsible project management tends to negotiate exit scenarios early on, clarifying expectations of both parties in the event of termination.

Termination by will is further divided into termination without cause and termination for cause. The former means that a party may terminate the agreement without cause, which is often adopted in business projects of an experimental nature, or those dominated by one party. However, it is rare to see such terms in co-operative development, commercialisation and licensing projects, where the parties have a relatively close or balanced relationship.

Termination for cause means the agreement can be terminated on the occurrence of an agreed upon condition. These terms can take many forms, such as termination for bankruptcy, or for breach of representations or warranties. They can also be “tailored” to fit specific business needs, for example, if triggered by an abrupt change in the competition landscape that leads to delays in research and development, or causes issues with product safety or effectiveness. Another example is termination on divestment in a strategic co-operation between investment partners.

The method of termination may affect the ultimate outcome of a BD project. In amicable projects, a flexible approach to termination is commonly adopted. For example, when a predefined condition occurs, the project may enter a wind-down phase during which the parties jointly decide whether to terminate. This method provides ample opportunity for the parties to consult and reassess the project while still potentially fulfilling their various business objectives.

Termination or rescission does not signal the absolute end of a BD project. The key to any exit mechanism is planning for what comes next.

A properly drafted exit mechanism should provide for the settlement of outstanding payments, liquidated damages, allocation of expenses, and other similar matters to avoid delay or disputes. In addition, it should stipulate post-termination ownership arrangements such as: for IP licensing and ownership distribution, if applicable; termination of a framework agreement; how to resolve unfinished orders; and, if ongoing clinical trials are involved, how to terminate or complete trials while ensuring the safety of subjects.

Navigating bankruptcy

Termination of a BD project can sometimes be dramatic, such as when a party enters bankruptcy. In such a scenario, the other parties may not necessarily acquire all the rights and interests derived from the project. In fact, acquiring those rights can be quite a struggle.

According to general bankruptcy practice in the PRC, when a debtor is declared bankrupt, its assets become part of the bankruptcy estate and are placed under the control of an administrator. Creditors are required to declare their claims within a specified period. When distributing the bankruptcy estate in satisfaction of the claims, the administrator must respect the order of priority, exemption rights and recall rights. However, debts owed as part of a BD project are usually considered unsecured debts, and unlikely to be fully satisfied in bankruptcy.

In any BD project, the arrangements in respect of ownership and use of IP rights tend to be of importance. Chinese bankruptcy law provides no special status to IP licence agreements. Once a party’s bankruptcy application is accepted, the administrator can decide whether to continue to perform such agreements. Ultimately, if the bankruptcy results in liquidation, the bankrupt party will be unable to perform them.

If licensed IP rights are part of a party’s bankruptcy estate, they will usually be sold at auction. The administrator may decide whether to set the assignment/succession of the BD project agreements as an auction condition, which can lead to highly uncertain outcomes. The licensee, as an unsecured creditor, holds little advantage.

Therefore, in practice, parties to a BD project should strive to prevent licensed IP from becoming part of a bankruptcy estate. This may be accomplished by assigning it to a bankruptcy-remote entity (such as the licensee) at an arm’s length price before the bankruptcy. This restricts exercise of the recall right, granting the licensee a markedly improved position to take the reins. As a precaution, both parties may also agree in advance that if the licensor suffers business difficulties, becomes insolvent or files for bankruptcy, the licensee is entitled to request a technology transfer.

Aaron Gu is a life sciences and medical health specialist at Han Kun Law Offices. He can be contacted at +86 21 6080 0505 or by email at aaron.gu@hankunlaw.com
Zhu Min is a partner at Han Kun Law Offices. He can be contacted at +86 21 6080 0955 or by email at min.zhu@hankunlaw.com