Hart-Scott-Rodino Filings For Exclusive License Agreements
Although Hart-Scott-Rodino filings are usually the province of M&A attorneys, IP attorneys involved in transactions including grants of exclusive licenses may also need to be alert to the possible need for them. The U.S. Federal Trade Commission (FTC) has taken the position that the grant of an exclusive license is the transfer of an asset to the licensee and may trigger the requirement to report the transaction to the FTC and the U.S. Department of Justice under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (15 U.S.C. § 18a or § 7A of the Clayton Act (or the Act)) assuming jurisdictional thresholds are met. In order for the transaction to be treated as an acquisition under the Act, the license must be exclusive – even against the grantor. Moreover, the FTC has taken the position that partial or limited exclusivity, such as license grants for exclusive geographic territories or for specific exclusive uses, may be considered an acquisition of an asset for purposes of the Act. See ABA Section of Antitrust Law, Premerger Notification Practice Manual at page 29 (3rd ed. 2003).
Antitrust clearance filings under the Act are required and the associated waiting period (which in these types of cases is 30 days after both parties file, unless earlier terminated or extended as a result of a request by the regulatory authorities for additional information) applies in connection with acquisitions which meet certain jurisdictional thresholds set out in the Act. The three applicable thresholds which determine if filings are required (absent an available exemption), are generally termed the “Commerce Test,” the “Size-of-the-Parties Test” and the “Size-of-the-Transaction Test.” The Commerce Test is easily satisfied as it simply looks to whether either party is engaged in commerce or an activity affecting U.S. commerce. 16 C.F.R. § 801.4. The Size-of-the-Parties Test generally requires that one party to the transaction has annual sales or total assets of at least $100 million and that the other party has annual sales or total assets of at least $10 million. See 15 U.S.C. § 18a(a)(2). The size of each party is measured with respect to its ultimate parent entity and also includes any other entities such ultimate parent entity controls either directly or indirectly. 15 C.F.R. § 801.1(a)(1). The Size-of-the-Transaction Test is met if the fair market value, or, if determined and greater than the fair market value, the purchase price, of the assets being sold (i.e. the rights being exclusively licensed) is greater than $50 million. 15 C.F.R. § 801.1(h). In arms-length transactions, the fair market value and the purchase price are generally the same unless there are unusual circumstances to the contrary.
The applicable regulations state that the acquiring party or its designee has the responsibility to determine the value of the rights being licensed. See 15 C.F.R. § 801.10(c). However, the acquired party should also independently analyze the valuation because of the potentially severe consequences of not filing under the Act if such a filing is required.
The valuation of rights under an exclusive license is not ultimately based upon the actual value of the assets as determined many years from now but, rather, is to be based upon the acquiring party’s “good faith” determination of the value at the present time. See Id. As stated in a leading treatise on this subject:
“‘Good Faith’ should not mandate that the acquiring company select a value at the high end of the spectrum, but should allow the company to choose a value which it believes is reasonable and appropriate in the circumstances.”
Axinn, Fogg, Stoll & Prager, Acquisitions Under the Hart-Scott-Rodino Antitrust Improvements Act, Law Journal Seminars-Press at § 5.04[vii].
To the extent payments are contingent on conditions outside the control of the parties and too speculative to estimate reasonably (as is often the case for license agreements), a good faith determination needs to be made of the current fair market value of all assets being received. The FTC has provided little guidance on how the valuation is to be performed, but has stated that the goal is to determine what a licensee would pay at present in cash for the assets being acquired, in an arm’s-length negotiation. See Premerger Notification Practice Manual, 92 (3rd ed. 2003). When future payments, such as future royalties, are determined, valuation is the gross amount of future royalties at face value, not discounted to present value. If the amount of such future payments is too speculative to estimate reasonably, the value of the license is the current fair market value of a fully paid-up license. See Id. at 91.
With respect to licenses covering both the U.S. and other countries, the valuation should be based on the U.S. rights being exclusively licensed, not non-U.S. rights or non-exclusive rights, pursuant to certain exemptions under the applicable regulations for acquisitions of foreign assets and the inapplicability of the Act to the purchase of non-exclusive licenses. Therefore, when an exclusive grant of intellectual property rights includes both U.S. and non-U.S. territories, the amounts being paid would need to be split in U.S. and non-U.S. components for valuation.
Accordingly, the following steps should be taken when doing a valuation of an exclusive license of intellectual property rights involving contingent payments:
1. Each of the possible payments should be listed. This is straightforward for upfront or milestone payments but a good faith estimate is required for royalty payments.
2. The amounts (other than the upfront payment) should each be discounted to reflect the likelihood that the payments would not each be made (e.g. if the royalties would be $200 million if the product were successful but the estimated likelihood of successful commercialization is 50 percent, then the valuation would be $100 million, subject to the following steps).
3. The sum of these amounts should then be tabulated.
4. The amount determined in the foregoing manner should then be multiplied by the percentage of the overall value of the license for the licensed territory represented solely by the United States, i.e. excluding Europe, the rest of North America and the rest of the world (e.g. utilizing the foregoing example, if 40 percent of the value of a worldwide license grant is with respect to revenues generated from sales in or into the United States, then the $100 million figure would be multiplied by 40 percent, producing a figure of $40 million).
5. If the result of the foregoing analysis is a valuation of $50 million or more (and the other jurisdictional tests are met without there being any available exemptions), then Hart-Scott-Rodino filings would be needed.
The parties involved in the grant of an exclusive license of intellectual property rights should have a strong interest in making a proper “good faith” valuation because the FTC and the Department of Justice have the authority to seek civil penalties for persons not complying with the Hart-Scott-Rodino submittal requirements (or incompletely complying with such requirements). These civil penalties can be up to $11,000 per day of noncompliance (measured from the date when a submittal should have been made to the date of actual submittal) and may be assessed on any officer or director of the party failing to make the required submittal as well as upon the party itself. See 15 U.S.C. § 18a. Additionally, the waiting period for completion of a transaction can be extended until there is full compliance with the requirements of the Act and courts can grant other equitable relief, including injunctive relief, as appropriate in particular circumstances. There are no criminal penalties nor is there a right of private action for parties other than the federal government agencies to seek penalties.
The substantial nature of possible penalties which could be applied if a Hart-Scott-Rodino filing were required but not done certainly militates a careful determination of whether a filing is necessary under the Act. However, a filing should not be done needlessly since, in the event a filing is required:
- There is a $45,000 filing fee when the value of the assets is greater than $50 million but less than $100 million. When the value of the assets is greater than $100 million but less than $500 million, the filing fee is $125,000, and when greater than $500 million, the filing fee is $280,000. The filing fee is payable by the “acquiring person”, (i.e., the licensee) unless otherwise agreed by the parties. 15 C.F.R. § 803.9.
- Completion of the report form is a moderately substantial task.
- The parties must await completion of the 30-day initial waiting period (or obtain early termination of such review period) before the transaction may become effective. 15 C.F.R. § 803.11.
Accordingly, transactions including grants of exclusive licenses should always be analyzed carefully for potential Hart-Scott-Rodino reporting requirements.