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The Importance of Intellectual Property Rights in Business Deals

China IP News
October 2010

Racine, Richard B.


Authored by Richard B. Racine

As Chinese companies look beyond their own borders to do business, these companies often look to enter into business arrangements with companies already in the foreign market to give it a head start in that market. These deals can include acquiring a foreign company or entering into a joint venture with a foreign company, all in the hope of increasing business. Intellectual property rights (IPR) often form a key part of these deals.

For example, if a Chinese pharmaceutical company has spent significant time and money developing a new drug, the Chinese company may want to partner with a company to assist with the commercialization of the drug in the United States. Or, the Chinese company may want to acquire or partner with a U.S. company that has also done research in this area. Instead, the Chinese and U.S. companies may want to set up a joint venture in which they together conduct research and development to identify new drugs.

Before entering into any of these deals, the Chinese pharmaceutical company should understand completely the IPR involved in the deal. Not doing so can doom the deal to failure.

So, what should the Chinese company do?

1. Freedom to Operate

A freedom to operate (FTO) analysis should be performed. If the deal involves making, using, or selling a product in the United States, it is critical to analyze whether such a manufacture, use, or sale might infringe a U.S. patent. This FTO analysis should be done before the U.S. activity occurs. Why? Because if a product imported into the United States is found to infringe a U.S. patent, the product could be barred from entry into the U.S. by an exclusion order from the U.S. International Trade Commission (ITC). So, to minimize the risk from such an ITC exclusion order, a FTO analysis should be performed. This involves a review of active U.S. patents to determine if any apply to the product or its manufacture or use in the United States.

For example, if a Chinese pharmaceutical company has developed a new active pharmaceutical ingredient (API) that it plans to sell in the United States to treat cancer, it is important to determine whether any U.S. patents would be infringed by that API or its use to treat cancer. This infringement analysis should focus not only on the API but also the entire pharmaceutical formulation. If, for example, the formulation includes components to extend the release of the drug in the body after the patient swallows the pill, then patents should also be reviewed to make sure that these extended release components would not infringe a U.S. patent.

Once the FTO has been performed, an informed decision can be made of the potential business risks of exporting the product to the United States. If the FTO shows minimal patent problems, then the Chinese company can decide to enter the U.S. market knowing it is in a strong position. If, on the other hand, the FTO identifies some problem patents, the potential impact of those patents on the deal can be analyzed before importation starts. It might be possible, for example, to acquire a license to the patents or make some changes in the product to avoid infringement problems.

2. Patent Coverage

In sports, it is often said that the best defense is a good offense. That saying often applies to business deals as well. One way to minimize the business impact of patents of another company is for the company to invest in developing its own patent portfolio. The Chinese company planning to enter the U.S. market should make sure it is filing for U.S. patents so that it develops its own portfolio of patents. These patents could be used to make sure that no one can copy the invention. A strong patent portfolio can also be used as a bargaining chip if another company asserts patents against the Chinese company.

To have value, however, the patents must be good and strong. It is important that they be well written and of appropriate breadth. A patent with claims that are too narrow and could be easily avoided does not have the same leverage as one that is sufficiently broad to protect the invention.

For example, if a pharmaceutical company has developed a new active pharmaceutical ingredient (API) that is administered daily to a patient orally in an extended release formulation, it is preferable that the patent protection for this invention be not limited to just this specific formulation and mode of administration. Rather, it is better, if possible, if the patent portfolio would include patents to (i) the API itself, (ii) the API in the extended release formulation, (iii) the API administered to the patient by other methods (e.g., intravenously as well as orally), (iv) dosage regimes other than daily, and (v) the use of the API in combination with other drugs. In other words, as big a fence as possible should be erected around the invention to protect it.

The key is that in any deal involving selling a product in the United States, valuable IPR should be obtained if at all possible. Without good IPR, the potential market value of the deal could be less as competitors believe they are free to copy the product without fear of an infringement suit.

3. Due Diligence

What if the deal between the Chinese company and the U.S. company involves the Chinese company acquiring rights to a product already developed by the U.S. company? For example, what if a Chinese pharmaceutical company decides to license or acquire rights in an API developed in the U.S. in the hope of eventually selling the API in the U.S? What should be done before the deal is signed? Very simply, it is important to understand the IPR involved in the deal. The best way to do so is by conducting a due diligence analysis.

Such a due diligence analyzes: (1) whether third parties have U.S. patents that might affect the deal; (2) whether the U.S. patents being acquired by the Chinese company are strong and good patents; and (3) whether the U.S. company has ownership of the patents that it is offering to sell or license to the Chinese company. It is important that this due diligence be done before the deal is completed.

The analysis of third party patents that might affect the deal is similar to the FTO described above. The analysis of the patents being acquired by the Chinese company studies the strengths and weaknesses of the U.S. patents to see if they are worth the money. This is not much different than inspecting a house before buying it to make sure that there are no hidden defects. Just as one would not buy a house without such an inspection, a Chinese company should not acquire U.S. patents without such a due diligence investigation.

In such an investigation, the U.S. patents and their prosecution histories are reviewed in light of the relevant prior art to reach an opinion as to strengths and weaknesses of the patent. For example, are the patent claims too broad in view of the prior art so that their validity is doubtful? Or, are the claims too narrow and can be easily avoided because unnecessary limitations were added to the claims during their prosecution? Other issues are also often investigatedinventorship, ownership, enablement, etc. The extent of the due diligence often depends on the value of the deal. The more money that is being invested, the more important it is that the due diligence be as comprehensive as possible to make sure that any IPR being purchased by the Chinese company has value and provides the desired protection. 

In conclusion, when Chinese companies enter into business deals in the United States, the IPR should be reviewed. Making sure that there are no infringement issues and that the IPR being obtained is strong and valid can often increase the value of the deal.