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An MD&DI December 1998 Column

HELP DESK

Larry R. Pilot, an attorney with McKenna & Cuneo, LLP (Washington, DC), discusses how companies should establish supply agreements.

Could you give me any assistance regarding forms or precedents for medical device supply agreements?

The two companies should first establish their goals for the agreement. The contracting parties should determine whether they merely want one company to supply a specific quantity of finished, marketable medical devices for the other to distribute or whether they want to create a more involved agreement that establishes licensing rights to develop additional technology associated with the devices.

The terms of the agreement will vary depending upon the parties' needs. For example, company A may enter into a strategic marketing agreement with company B that requires company B to complete clinical trials and regulatory applications for marketing a product in a foreign country, and requires company A to provide all of the devices at an agreed-upon price in return for royalties (see, for example, Neoprobe Corp., Securities and Exchange Commission (SEC) 10-k filing, Commission File 0-26520, March 31, 1998). A manufacturing agreement, on the other hand, may only require company B to manufacture and supply one or more of its devices to company A.

The agreement should define all terms and clearly state the rights and duties of each party. Although some terms may be common in the industry, such as good manufacturing practices, they should be defined within the confines of the agreement. The agreement should also clarify which products are included within the terms of the agreement—even products not yet in existence. Companies entering into the agreement with existing technology should anticipate that the other party may develop complementary devices and should ensure that marketing and licensing rights for such new devices are stated within the agreement. For example, if company A develops a catheter and partners with company B to market it, their agreement should state who may market an updated catheter—for example, if company B developed a specialized coating for the product—and who would receive the profits or royalties from the sales. Also, the parties should determine who is required to seek regulatory approval and ensure regulatory compliance for the device or devices.

A company seeking to expand worldwide might consider entering into a marketing agreement with others who have experience selling and distributing medical devices internationally. Negotiations should specify which company would seek regulatory approval for the device (for example, securing the European CE mark). Obtaining regulatory approval means submitting applications, performing any required clinical trials, paying appropriate initial and maintenance fees, and ensuring continued regulatory compliance. Regulatory compliance may also require compiling and reporting information (e.g., adverse events) about the medical device or devices or handling a device recall.

All of these and other possible situations should be clearly addressed in the agreement to avoid disputes later. It can be costly for either party to assume that its partner has taken the steps necessary for regulatory compliance, and doing so risks punitive action against the companies by a government authority. Of course, there's always the threat of putting themselves at a competitive disadvantage by entering the market too late. It is particularly important, then, for companies to agree before any work begins as to who is responsible for ensuring full legal and regulatory compliance for clinical studies, manufacturing and facility regulations, and commercial distribution after the agreement goes into effect.

Other items to consider include the duties and benefits of any intellectual property rights associated with the device, whether the agreement is exclusive, and its financial terms. If one party wants intellectual property rights, such as patents or trademarks, then the parties should discuss who will apply for, pay for, and maintain those rights, including enforcement through litigation or arbitration. Parties should clearly state what information exchanged between them should remain confidential, which may mean that only specified employees may access confidential information after signing covenants not to compete. Covenants not to compete, however, may only limit information use for a specific time period (generally less than five years) and within a limited geographic area (i.e., not worldwide).

The degree of exclusivity in the agreement will affect some of its terms. For example, if company B receives exclusive worldwide rights to market a device, it might agree to pay company A higher royalties or invest more money in additional research and development. The financial terms also will be affected by obligations to pay for research or regulatory compliance and should address new devices that are developed after the agreement goes into affect.

Finally, conditions should be specified that provide liquidated damages in the event that a party breaches the agreement. The agreement also should state what would happen if a dispute arises between the contracting companies. It is particularly important in the global market that the parties make prior arrangement as to what laws will govern in the event of a dispute and whether arbitration can be pursued before litigation.

The parties should also stipulate when the agreement will end. An agreement may end on a particular date, but the parties should consider what to do when confronted with changing market conditions or product viability. For example, if two companies executed an agreement granting company B exclusive worldwide sales and marketing rights to one of company A's products, they could construct their agreement to enable them to terminate the partnership if changing market conditions significantly alter the basis for their agreement. The termination clause in most agreements allows one party to terminate the agreement upon written notice to the other, either within a specified time period or on the occurrence of a material breach of contract. For example, if company B fails to provide an agreed number of medical devices within 45 days after company A notifies company B, then company A could write to company B and terminate the agreement (see, for example, Faulding, Inc., SEC 10-k filing, Commission File 0-13588, exhibit 10, June 30, 1996). When the parties decide what law governs, however, they should determine whether the termination clause they have constructed is legal within that jurisdiction.

Although on-line information about supply agreements appears scarce, companies may be able to obtain samples from industry groups. They can also obtain information from the Securities and Exchange Commission under the Freedom of Information Act. The SEC retains copies of company filings, including some 10-k and 8-k filings that disclose agreement terms.

"Help Desk" solicits questions about the design, manufacture, regulation, and sale of medical products and refers them to appropriate experts in the field. A list of topics previously covered can be found in our Help Desk Archives. Send questions to Help Desk, MD&DI, 11444 W. Olympic Blvd., Ste. 900, Los Angeles, CA 90064, fax 310/445-4299, e-mail [email protected]. You can also use our on-line query form.

Although every effort is made to ensure the accuracy of this column, neither the experts nor the editors can guarantee the accuracy of the solutions offered. They also cannot ensure that the proposed answers will work in every situation.

Readers are also encouraged to send comments on the published questions and answers.

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