Managing Litigation Risk in Medical Device M&A

The costs of litigating an intellectual property case, and the amount of potential damages arising from losing the case, are high. Therefore, it is important for medical device company executives to understand that steps can be taken both to lower litigation risk resulting from conducting intellectual property due diligence and to understand the key sources of such risk.

A medical device company looking to acquire medical technology typically has two main goals while conducting IP due diligence before the acquisition. The first aim is to identify and minimize the risk associated with the IP rights of the technology under consideration. The second one is to identify and minimize risk associated with possible third-party IP rights. There is a third often overlooked but equally important goal. That is to lower the risk of litigation related to IP issues that could arise if the deal fails or after the deal closes. Because of its importance, we will examine this third possibility first.
If The Deal Fails
In the potential merger of medical device companies or the acquisition of a medical device company, the parties will generally execute a nondisclosure agreement (NDA) at an early stage of the negotiation process to allow the parties to exchange information freely. The information exchanged almost always includes confidential aspects regarding products and processes in development. If the deal fails, this confidential information provides significant fodder for various causes of action, including an alleged trade secret misappropriation claim.
The typical scenario is as follows: A start-up, small company, or individual attempts to sell technology to a larger medical device company. It so happens that the larger medical device company already was working in the area of the offered technology and already independently developed the core aspects of technology being offered. The parties cannot reach an agreement on a deal. The larger medical device company later markets its own product. The jilted start-up, small company, or individual believes its non-patented technology was misappropriated and sues.
To protect against such causes of action, the NDA should include a provision similar to the one offered below. The provision asserts that a patent infringement or copyright infringement claim is the only course of action (arising out of due diligence) that the parties can bring against one another if the deal fails: Each Party releases the other Party, its subsidiaries, and affiliated companies from any liability for any non-public reproduction of the Confidential Information, except for liability for claims of patent or copyright infringement.
Lessening Post-Closing Risk
The parties need to resolve post-litigation risk prior to closing the deal. The significant sources of post-closing litigation risk stem from third-party patents and third-party agreements.
Third-Party Patents. A recent economic survey from the American Intellectual Property Law Association estimated that the total litigation costs for patent infringement action range from $3 million to more than $10 million when the total at stake exceeds $25 million. Similarly, a study released by PricewaterhouseCoopers in 2008 on patent litigation damages reported that the median damages award from 1995 to 2007 in medical device patent infringement cases exceeded $6 million. Thus, one of the most significant sources of post-closing litigation risk is third-party patent infringement lawsuits. In addition to monetary damages, a chief concern is whether or not a third-party patent will block a buyer from commercializing the product that the company is seeking to acquire.
Relevant third-party patents can surface during IP due diligence through a number of processes—the target's patent screening process, opinions issued by the target's IP counsel, third-party notice letters, and the seller's independent freedom-to-practice analysis. It is important to understand how each of these processes identifies third-party patents and the advantages and shortcomings of each to lower post-closing litigation risk.
First, it is likely that the seller has incorporated some form of screening process for third-party patents into its product development process. Typically, the patent screening process for third-party patents precedes the commercial launch of a medical device. Its goal is to identify third-party patents that could pose a risk to a product under commercial development. The buyer needs to identify in its due diligence of the seller any third-party patents uncovered during the buyer's patent screening process.
It is essential that the buyer understand the format and structure of the seller's patent screening process in order to weigh fully the risks of any third-party patents flagged by the seller. For example, some companies use their engineers to conduct an initial search for relevant third-party patents. Any relevant third-party patents requiring further review are then forwarded to outside intellectual property counsel for a more complete evaluation. Other companies may forego the use of their engineers and outsource the entire process to outside IP counsel. In some situations, whether outside IP counsel performed the entire process or was only brought in at a certain point could inform the scope of any additional third-party patent analysis conducted by the buyer.
Haunted E-mails
Not only is the identification of third-party patents important, it is also essential to gain an understanding of any positions developed by the buyer with respect to any identified third-party patents and whether the buyer has memorialized any of those positions. Any characterizations of third-party patents not protected by the attorney-client privilege or work product immunity could pose problems in any subsequent lawsuits involving the identified third-party patents. For example, e-mails exchanged between two engineers of the seller discussing a third-party patent and whether the seller's product falls within the scope of the third-party's patent claim might come back to haunt the parties.
Second, any opinions rendered by the seller's attorneys regarding any third-party patents should be reviewed and analyzed. The review and analysis of these opinions should focus on two key areas. The first involves the identified third-party patents and the strength of the positions set forth in the opinions by the seller's attorneys. The second area concerns whether the positions set forth with respect to any third-party patents differ from any positions taken by the seller in its own opinions of counsel. The latter could become an issue in a later patent infringement action when determining whether to waive opinions of counsel in a response to a charge of willful infringement.
Third, the buyer needs to receive and study any correspondence with any third party regarding potential infringement by the seller of the third-party's patent rights. The buyer should review the correspondence in order to determine, one, the third-party's claims; two, the seller's responses to those claims; and three, any potential damaging statements made by the seller in that correspondence.
We advise that the buyer almost always independently analyze the risks associated with third-party patents through a product clearance or freedom-to-practice analysis. This involves identifying the products to be cleared, searching issued patents and published applications, and assessing the risk of infringement of any relevant patents. If the technology at issue is in a field new to the buyer, it is especially important for the buyer to download fully the seller's knowledge of competitors, competitive products, and third-party patent rights.
A Product Redesign Shield
While various provisions in the deal agreement—such as patent holdbacks, freedom-to-practice holdbacks and special indemnifying clauses—can provide certain monetary protections with respect to third-party patent infringement claims, they do not substantively affect the risk of a third-party patent infringement suit. One often overlooked method for lowering or eliminating such risk is to redesign the product or process at issue prior to the closing. In addition to eliminating or significantly lowering the risk of post-closing patent litigation, a redesign could result in a more competitive product.
Another way to lower or eliminate post-closing litigation risk with respect to third-party patents is to require that the seller enter into a license with the identified third party regarding third-party patents before closing. Generally, the deal agreement will provide that obtaining such a license is a condition of closing. While the pros of such an approach—specifically removal of the litigation risk—are apparent, this licensing idea also carries with it several cons.
First, the seller may not be able to obtain such a license, thus placing the deal in jeopardy, and this has ramifications for both parties. Second, the third party may not be aware that there is alleged infringement of its patent rights, and contacting the third party may awaken a sleeping giant. This has clear ramifications for the seller if the deal does not close, and for the buyer if the parties agree to close the deal in the absence of obtaining a license from the third party. Therefore, both parties should weigh the likelihood of obtaining a license from the third party, and how to approach it, against the risk of virtually guaranteeing legal action against the seller or buyer if the third party refuses to license the technology.
Third-Party Agreements. It is likely that the seller has entered into a number of agreements (e.g., consulting agreements, collaboration agreements, or licensing agreements) over time with third parties that implicate the intellectual property involved in the contemplated transaction. A thorough review of these third-party agreements is a must. That review may identify certain agreements that may pose potential post-closing litigation risk because of ambiguity or other reasons.
For example, the seller's consulting or collaboration agreements with third parties may fail to address adequately who owns any IP rights that result from the activities identified in the consulting agreements or collaboration agreements. In particular, a physician or consultant may have participated in the development or collaboration of a certain product, but the ownership rights of the parties regarding any IP claim resulting from the consultancy or collaboration is murky because of poor drafting. Or the seller's licensing agreements might fail to identify adequately the licensed rights or licensed products.
The easiest way to lessen or eliminate the risk of litigation associated with these agreements before closing is to rewrite them with clarity and with more acceptable terms. It should also be made a closing condition that the seller terminate the existing agreement and sign the rewritten agreement before completing the sale. When the agreement at issue involves an unhappy collaborating physician or consultant, the buyer can offer ongoing consulting arrangements or provide naming rights as part of any new agreement. Further, to ensure that the agreement is acceptable to all parties, the buyer, target, and third party can participate in negotiating the new agreement. To address any confidentiality concerns regarding a disclosure of the contemplated transaction, the buyer, seller and third party can enter into a tripartite NDA that governs their negotiations.
Mitigate Risk through Good Faith
Finally, once the deal has closed, post-closing litigation risk generally is lessened through mechanisms that focus on mitigating that risk as opposed to eliminating it. In one common scenario, the acquisition of a product in development is the impetus for a deal, but IP due diligence might have uncovered the potential infringement of a third-party patent. If the risk cannot be eliminated through a redesign, or if circumstances prevent the licensing of the patent rights that potentially cover the product, the buyer can give advance notice to competitors before commercial release. This serves to establish good faith, which could lower the amount of damages for any potential patent infringement claim stemming from that product.
In another common scenario, the buyer purchases a problem. Specifically, the seller may have had communications with a third party regarding a potential claim relating to the seller's IP rights or third- party's IP rights, but the parties have not resolved the issues.
Because the roles of the parties in the dispute have changed after the sale, the possibility of alternative dispute resolution (ADR) may exist. The simple fact that the buyer has slipped into the shoes of the seller may be enough to revive a stagnant resolution process. Generally, the cost of ADR is lower than litigation.
The existence of post-closing litigation risk relating to IP issues—including potentially high litigation costs and damages—is a reality in most transactions involving medical device technology. To deal successfully with this risk, a medical device company should first understand the common sources of such risk, and then employ various available mechanisms either before or after closing to eliminate or lessen the risk.
Gregory J. Vogler is a cofounder and shareholder, and Robert A. Surrette is a shareholder, in the law firm of McAndrews, Held & Malloy Ltd. (Chicago). Vogler can be reached at [email protected], and Surrette can be reached at [email protected].

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