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Due diligence in the biotech industry
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Due diligence in the biotech industry

In brief: Senior Associate Matt Ireland and Law Graduate Pat Crisp examine due diligence as it relates to the biotech industry.

Introduction
When is due diligence required?
Practical considerations
The due diligence process – general principles
Conclusion

Introduction

The purpose of due diligence is to gather information and identify any risks or problems associated with a business or an asset. Due diligence can take many forms, and the legal due diligence undertaken by lawyers should be distinguished from any financial, accounting or commercial review conducted by the client and its other advisers. As intellectual property (IP) will generally be the most valuable asset of a biotech company, a thorough legal due diligence exercise will necessarily focus on its IP rights. The purpose of due diligence relating to IP assets is to confirm the existence and validity of IP rights and to identify material shortcomings and risks.

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When is due diligence required?

Many commercial transactions involving biotech companies may require some form of due diligence to be conducted. The form of the transaction influences the relevant issues. For example, if the transaction involves a share sale it is necessary to consider the impact of a change of control on IP rights. Furthermore, if the transaction takes the form of a sale of assets (including IP) the relevant issue will be the transferability of those assets.

Mergers and acquisitions

Generally, the purpose of legal due diligence in the context of an acquisition is to assist the purchaser in assessing the level and nature of legal risk in the business to be acquired. This information may have a large impact on the eventual sale price and other terms of the sale agreement. Significant due diligence often precedes merger and acquisition (M&A) transactions and extensive data rooms may need to be established to provide potential purchasers and their advisers with access to the relevant documents.

In recent years, with the rise in the number of private equity acquisitions, vendor due diligence has become increasingly common in the context of a competitive bid process where bidders are reluctant to undertake their own due diligence until they have some exclusivity. A vendor due diligence process can speed up the entire transaction and reduce total costs and disruption, and can also give a vendor the chance to identify and resolve any legal issues identified before potential purchasers commence their own due diligence. However, vendors should be aware that due diligence reports are subject to the misleading and deceptive conduct provisions of the Trade Practices Act 1974 (Cth).

Public offerings

A company wishing to offer its shares to the public by way of initial public offering will need to ensure that it meets the disclosure requirements in the Corporations Act 2001 (Cth). The process by which this is achieved is called 'verification'. Verification involves checking all statements of fact and opinion made in the relevant offer document and keeping a full record of the evidence on which they are based. Verification also ensures that statements have been appropriately qualified and that all assumptions have been articulated. Appropriate due diligence is, of course, the cornerstone of this exercise.

Commercial collaboration

Commercial collaborations may take many forms, ranging from joint ventures to licensing arrangements. A party to such an arrangement will often want to conduct a due diligence exercise to ensure that the other party has the resources, including the necessary IP rights, to carry out its obligations and to check the relevant facts before offering their future commercial partner any warranties.

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Practical considerations

Materiality threshold

It is important that lawyers and their clients, before commencing a due diligence exercise, establish a financial benchmark - or 'materiality threshold' - below which matters are considered not to be significant enough to the transaction as a whole to warrant individual review. A matter may be considered to be material if it could reasonably be expected to have a balance sheet effect of more than a specified dollar value or a profit-and-loss effect of more than a specified dollar value in one year. Materiality thresholds ensure that the due diligence has the proper focus. It is important to note, however, that the commercial drivers of the parties may shift as the transaction progresses and the focus of due diligence investigations may require modification accordingly.

Access and confidentiality

In some cases, the party conducting the due diligence may send out an information request, which indicates what information they are expecting to see. In other cases, the party in respect of which due diligence is being conducted may form its own view on what information is relevant.

In either case, there are a range of ways of providing access to the relevant materials. A physical data room may be established, or an online (or virtual) data room may be set up so that parties and their advisers can access information from their desktops. Alternatively, specific documents may be delivered directly as required. Whichever way information is provided, it is important to be aware of confidentiality issues and to establish appropriate protocols for the handling of confidential information.

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The due diligence process – general principles

Typically, a legal due diligence will occur in the three stages outlined below. However, it is important to note that no two due diligence exercises are the same and lawyers will endeavour to tailor the process to the needs of the client. Before commencing, the legal team will want to discuss the client's expectations for the due diligence, the proposed time frame and any limitations on the exercise.

To this end, lawyers and their advisers may benefit from receiving certain general information. For example, an information memorandum summarising the relevant business or asset and the proposed transaction can prove very useful. Contact lists that assist in establishing effective communication channels with the parties and their advisers are also valuable.

Identification of relevant documents

Whether it is the party conducting due diligence, or the party in respect of which due diligence is being conducted, who decides what information the due diligence will be based on, at some point consideration must be given to which documents are relevant to the due diligence investigation. Relevance of documents will depend on the nature of the transaction and the commercial drivers of the parties.

In the context of a transaction involving the IP rights of a biotech company, the following documents will likely be relevant:

any certificates relating to registered IP and any registers maintained by the company; and
any filed or pending applications for registration, or oppositions to registration.

Searches of publicly available registers for any relevant registered trade marks, patents and designs (IP Australia), business names (state government Fair Trading or Consumer Affairs Departments), and domain names (various) should be undertaken and all publicly available information reconciled against company records.

In relation to unregistered IP, which will include copyright such as operating manuals and website text, trade secrets, know-how and confidential information, the following documents will be relevant:

agreements relating to the generation or licensing of that IP;
the company's methods for protecting IP; and
any documents relating to potential infringement.

Review of documentation

The party conducting due diligence, or its legal advisers, will be provided with access to relevant documentation for review. Confidentiality undertakings by the parties may be required during this process.

A review of IP may range from just confirming IP application and registration details to full patentability and freedom to operate reviews. Such a full review may include the need for opinions on patent protection being sought or obtained and cover third-party IP in the area of commercial activity. Depending on the review, the time and costs involved can vary greatly.

Reporting

The final step in the due diligence process is the preparation of a due diligence report summarising the material reviewed and identifying any material legal issues and risks. In some cases it may be more appropriate for the report to be prepared on an 'exceptions' basis where, instead of providing a summary of all materials reviewed, only material legal issues are reported on. Reference may be had to the due diligence report when it comes to negotiating warranties in the transaction documents.

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Conclusion

Biotech companies should be aware of the scenarios where an IP due diligence exercise is required, the process used, and the issues likely to be thrown up. As IP rights can form the very backbone of biotech companies, it is in their interest to confirm what IP is actually owned and ensure that they possess the relevant documents to establish rights of use. Good record-keeping practices and ensuring chain of IP ownership is accurately recorded can make any due diligence process less of a burden to a company.

For further information, contact Philip Kerr ph +61 2 9230 4937

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Company news

In brief: Regular news from the biotech industry.

Acrux's menopause spray approved by FDA
Asia Pacific leads race to become pharmaceutical industry powerhouse
EvoGenix shareholders approve Peptech merger
Genentech buys Tanox
IBM announce system to combat drug counterfeiting
Neuren Pharmaceuticals buy Hamilton and obtain late-stage compound
Pfizer HIV drug approved by FDA
Pfizer on track to triple Phase III portfolio by 2009

Acrux's menopause spray approved by FDA

July 31 – Melbourne biotech Acrux announced that the United States Food and Drug Administration (FDA) has granted marketing approval for its unique spray Estradiol MDTS, which is branded as EvaMist in the US. Estradiol MDTS utilises Acrux's patented delivery device to deliver the natural hormone estradiol through the skin. KV Pharmaceutical Company will distribute EvaMist in the US, with market launch expected in early 2008, while Acrux will retain the marketing rights to all territories outside the US. Acrux is due to receive a milestone payment of US$3 million within 30 days of market approval and will receive royalties from KV on sales of EvaMist in the US. In 2006, sales of all prescription estrogen products in the US were approximately US$1.4 billion. Acrux expects to submit a marketing application to the Therapeutic Goods Administration in Australia in the third quarter of 2007.