'Commercially reasonable efforts' in licensing agreements: what needs to be considered?

Drafting and using purchase and licensing agreements in English has been standard practice for decades, even for European companies located in non-English-speaking regions. This is particularly true for internationally operating pharmaceutical companies. That typically leads to the adoption of classic contractual clauses from Anglo-American law, without necessarily understanding the specific legal consequences of using these clauses. A prominent example of this are clauses that require the licensee to make "commercially reasonable efforts" in the development of a pharmaceutical substance/product.

But what efforts are actually "commercially reasonable"? What may seem reasonable to one party may be insufficient to another. This was recently demonstrated in a case decided by the Delaware Court of Chancery in the USA. The decision provides great insights into the interpretation of the construct of "commercially reasonable efforts" and offers guidance on what parties should consider when including such clauses to best protect their interests.

Background – The Decision of the Delaware Court of Chancery

In November 2018, Alexion Pharmaceuticals, Inc. ("Alexion") acquired Syntimmune, Inc. ("Syntimmune") for a total purchase price of $1.2 billion. Of this, $400 million was paid upfront, while the remaining $800 million was to be paid in instalments upon reaching certain milestones related to the development of Syntimmune's monoclonal antibody ALXN1830. Alexion committed to making "commercially reasonable efforts" over a seven-year period to achieve these milestones. According to the agreement, the extent of these efforts was to be determined by what a company comparable to Alexion in a similar industry would do.

However, due to various circumstances, the development of ALXN1830 did not progress as expected. Initially, the trial programmes were interrupted due to the COVID-19 pandemic. Then, other development programmes were internally prioritised, leading to a reallocation of resources. When Alexion was eventually acquired by AstraZeneca in July 2021, a review of ongoing programmes was conducted. Potential, but not definitively confirmed, safety risks regarding ALXN1830 were identified, leading to the programme being completely terminated in December 2021.

The Shareholder Representative Services LLC ("SRS") subsequently filed a lawsuit on behalf of the former shareholders of Syntimmune. They claimed that Alexion had not made sufficient "commercially reasonable efforts" to achieve the remaining milestones.

Decision

The core issue in the Delaware Court of Chancery's decision was the extent of efforts Alexion was required to make under the "commercially reasonable efforts" clause to achieve the milestones.

The court interpreted the relevant contractual provision and found that an objective standard was derived from the contract, which required determining the "commercially reasonable efforts" by asking what a hypothetical company comparable to Alexion would do in a similar situation. The key question was therefore how such a comparable company would have acted in the specific circumstances and whether it would have also decided to terminate the ALXN1830 programme early due to the described circumstances.

The court concluded that Alexion had not made the required "commercially reasonable efforts" in the development of ALXN1830. It described the internal prioritisation of other programmes as ‘idiosyncratic’. Additionally, it noted that a hypothetical comparable company would have further investigated the data suggesting safety risks related to the programme. Finally, it identified AstraZeneca's pursuit of synergies following its acquisition of Alexion as another idiosyncratic reason for terminating the programme. Acting on such motives and failing to take obvious actions however would not have been expected from a hypothetical comparable company.

Takeaways

The decision underlines the importance and significance of "commercially reasonable efforts" clauses, especially their impact in the event of missed milestone events.

Upon closer examination, it becomes apparent that an objective formulation of a "commercially reasonable efforts" clause, as in the present case, is generally favourable to the seller or licensor. It results in idiosyncratic decisions by the buyer or licensee (e.g., regarding agreed development obligations) usually being classified as breaches of contract, provided they do not correspond to the objective reasonable behaviour of a hypothetical comparable company.

Conversely, it shows that a subjective formulation of such clauses is generally favourable to the buyer or licensee, as it can make even relatively atypical behaviour or anomalies in the licensee's behaviour appear contractually compliant, provided this behaviour is typically maintained in their own affairs. The parties could have, for example, agreed that the "commercially reasonable efforts" should be based on Alexion's typical behaviour in its own affairs. In this case, Alexion's decisions would likely not have been classified as a breach of contract, assuming that an early termination of the programme due to safety concerns or an idiosyncratic prioritisation of other programmes was typical for Alexion at the time.

Ultimately, it will depend on the individual case which party benefits from the specific formulation of the clause. If, e.g. the licensor is significantly ahead of all competing companies in its usual development efforts, a subjective comparison standard based on this company may be beneficial for the licensor.

Handling in Germany

"Commercially reasonable efforts" clauses have also been found in contracts governed by German law for some time. The question is whether and how the results of the decision can be transferred to German law.

The starting point is always the question of the relevant contract type. Contracts with "commercially reasonable efforts" clauses typically do not require the achievement of a specific result. Because the development of a pharmaceutical product is a risky endeavour, only efforts in that direction are usually required or promised. Therefore, contracts with "commercially reasonable efforts" clauses are generally to be categorized as so called ‘service contracts’ (Dienstverträge) rather than ‘work contracts’ (Werkverträge).

Service contracts initially require mere action. The specification of the service obligation is up to the parties, outside of existing standards such as those for doctors, lawyers, or tax advisors. This is where "commercially reasonable efforts" clauses come into play, defining the specific efforts to be made in fulfilling the service obligation. The insights from the Delaware Court of Chancery's decision are not only helpful but can be directly applied to German law.

Those who wish for a seller- or licensor-friendly formulation or want to exclude atypical (development) behaviour from being considered contractually compliant are generally well-advised with an objective formulation. Conversely, if a specific comparison standard is to be applied (e.g., higher development standards or particularly risky development efforts), a subjective formulation is advisable. Ultimately, the formulation will depend on the specific interests of the parties. In any case, the clause should include specific provisions that facilitate interpretation, as otherwise, the need for interpretation of the term "commercially reasonable efforts" poses risks for both parties. Such specification can be achieved by referring to a certain group of comparable companies or by otherwise specifying the standard of development efforts (e.g., by involving third parties in case of dispute). It should be noted that the necessary specification depending on the individual case increases the need for negotiation of the relevant clause(s). Therefore, a detailed examination of the advantages and disadvantages of the different formulations is essential.