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May 2013

For many companies conducting pre-clinical and clinical development programs it is often necessary, and usually cost-effective, to outsource manufacturing of the study drug to a Contract Manufacturing Organisation (CMO).

This outsourcing gives rise to a number of commercial and legal issues which need to be carefully managed to limit the risks to the company concerned. In this article we examine a number of the risks, the problems which can arise and the strategies which can be employed to minimise the potential exposure.

Contract manufacturing agreements

Many of the leading CMOs are major companies and they can often afford to be relatively inflexible, particularly with small to medium sized pharmaceutical or biotech companies, when negotiating the terms of their contracts.

Limits on liability

Understandably CMOs will normally seek to limit their obligations to their customers to producing a drug to comply with the specification and in accordance with cGMP (Good Manufacturing Practice). While CMOs will not (by law) be able to exclude their liability for death or personal injury as a result of their negligence, it is common for the CMO to exclude liability to their customers for indirect, special or consequential losses or for any loss of profits, revenue, business opportunity or goodwill.

Companies should be aware that this means they will be unable to recover damages for any delay to, or increased costs of, clinical trials, caused by a failure of the CMO to provide compliant product as these costs fall into the categories excluded. Unusually, the only remedies for a failure by the CMO to provide compliant product is for the CMO to replace the affected batch(es). Even then, CMOs may be reluctant to agree to obligations to remanufacture within a fixed timeframe, which would significantly impact on their timelines for the manufacture of other products. For a biotech company with limited cash horizons, delays of this kind can be extremely serious and obtaining at least some guarantees regarding the timing of remanufacture is a sensible precaution.

CMOs will also almost invariably seek to limit their overall liability to the value of the services they provide, the argument being that as service providers they are not benefitting from any share of the potential upside by way of milestones and royalties in the event of successful clinical development and approval of the drug. Whether a company can successfully increase this overall limit on liability is dependent on their negotiating strength but it may be the case that the limit can be raised for certain types of liability.

The limits on liability need to be particularly carefully considered and great care needs to be taken in a situation where one or more of the raw materials, which may be provided directly by the company, forms a large proportion of the cost of manufacturing a batch of the drug. If there is a failure by the CMO to manufacture the drug to specification or in accordance with cGMP, then although the CMO will cover its own costs of remanufacture the company will be left with the expense of providing replacement raw materials. Although often resisted by CMOs, it is not unreasonable for the CMO to have to take on the risk of replacing the raw materials if the remanufacture is required as a result of the CMO’s default, and they may well already have insurance which would cover such costs. If not, the CMO may well seek to increase the cost of the services to cover the cost of insurance or resist the replacement of raw materials altogether in relation to the first few development batches of drug before the manufacturing process has been tried and tested.

Particularly in the early stages of manufacturing, or where there is any development component to the manufacturing services, CMO will be very reluctant to agree to fixed delivery dates for finished product. This is likely to be in direct conflict with the need of the company to manage pre-clinical and clinical development timelines and related costs and there are limits to how this can be addressed. Nevertheless, it is usually possible to negotiate at least some provisions in relation to flexibility on timing of slots and forecasting which can mitigate the risks.

The impact of partnering

The limited availability of funding for biotech companies means that there is a necessity to partner programs earlier and earlier in development, and outsourcing risks can be accentuated where the biotech company has partnered the relevant program with a pharmaceutical company. An increasingly common occurrence in partnering agreements is for the pharmaceutical company to provide financial support to the biotech to enable it to take forward the pre-clinical and clinical development of a program to a point at which an option to commercialise the drug may be exercised and the program is then transferred. It is essential when determining the level of financial contribution from the partner that there is sufficient flexibility to deal with certain additional costs that can unfortunately arise given the risks inherent in the manufacturing process.

Where the drug involved is a small molecule the partner taking over the clinical development of the compound may wish to manufacture the drug itself or enter into a manufacturing and supply agreement with a third party manufacturer. Sometimes however, and particularly in the case of much more complex biological molecules where the licensor has particular expertise, there is often a desire or need for the biotech company to continue to be involved in the supply to the pharma partner of the drug for the purposes of clinical trials and even potentially for commercialisation. In some respects this can be attractive to biotech companies as they will potentially make a margin on the supply of the drug as well as benefitting from milestones and royalties.

There is a real risk however that the biotech company ends up negotiating a supply agreement with its pharma partner which has stretching supply obligations, but is unable to replicate these in its negotiations with its CMO. In the event of non-compliant batches, or delays in delivery by the CMO, considerable exposure can arise. The challenges of managing forecasting obligations as an intermediary in the supply chain should also not be underestimated. Pharmaceutical companies are often in a better position than earlier stage biotech companies to negotiate demanding terms of supply with CMOs. The potential downside to inserting itself into the supply chain in this way is the possible exposure of the biotech company as an intermediary if it is unable to “back-to-back” its supply agreement to its pharma partner with its agreement with its CMO.

From a legal perspective, additional problems can arise if adverse events occur in a trial or the trial drug is found to have a latent defect. It may be by no means immediately clear whether the fault lies in an innate property of the drug itself, a problem with raw materials supplied to the CMO, the manufacturing of the product, the storage or transportation of the drug or its administration. Where the biotech company is an intermediary there will always be a risk that it becomes embroiled in the process of determining the cause which can result in additional costs at the very least and potentially defence of any claims which are issued by or on behalf of the trial subjects or the sponsor of the trial.

It is important that any agreement with a CMO contains strong auditing provisions, a common formulation being a right to a minimum number of audits or inspections each year as well as unlimited additional rights in the event of a quality issue. Additional rights should also be sought to attend any audit or inspection by relevant regulatory authorities relating the drug covered by the agreement where this is permitted by the regulator. A notification of inspection provision will therefore be required and it is useful to provide that any licensee of the drug program should also be permitted to attend as this is likely to be a requirement of any partner.

These are all points to be borne in mind when considering whether it would be desirable to act as the manufacturer or as the intermediary in a supply chain for the drug.

Transfer to a new manufacturer

As development progresses from pre-clinical studies through clinical trials to commercialisation there is often a need to scale up the manufacturing process and frequently a need to change manufacturers as a result. When a new CMO is selected, particularly in relation to biologicals, the standard form agreements of many CMOs often contain provisions which have the effect of potentially limiting the ability of the customer to transfer manufacturing to a new manufacturer. Such a need to transfer may arise for any number of reasons including a failure of the original CMO to produce drug product to specification, delays in supply, an inability of the original CMO to supply greater volumes, insolvency, a need to be able to dual source or quite frequently the desire of a partner to bring the manufacture of the product in house.

CMOs have an understandable commercial imperative to retain a manufacturing and supply mandate and will frequently argue that they need to be protected against the transfer of their proprietary process to another manufacturer. This may well be reasonable if they have a patented manufacturing process or some confidential process know-how which is essential to the manufacture of the drug. Frequently however it is the company who is providing the process having developed it itself or transferring it from the previous manufacturer, and in fact it is merely that the new manufacturer does not want to share its confidential background know-how with its competitors. The consequence of this is that a barrier to transfer is potentially created and it is worth examining in some detail how such a barrier can be overcome.

Who developed the manufacturing process?

Clearly, if the company is transferring the process to the CMO there can be no technology proprietary to the CMO which is essential to the manufacture of the drug and it should be possible as a condition of transfer to them that they will facilitate the subsequent transfer to another manufacturer if necessary or required. Of course, if the new manufacturer is intended to contribute considerably to the scale up of the manufacturing process or has otherwise substantially contributed to the development of the process they may seek to negotiate financial compensation in the event of their loss of the manufacturing mandate, at least in circumstances where they are not in default.

In practice the prospective manufacturer may be relatively relaxed about a subsequent transfer of the manufacturing process to a customer’s pharma partner compared with the potential transfer of its process to a rival CMO.

What intellectual property is needed by the new manufacturer?

Although CMOs will generally readily assign rights in all foreground intellectual property relating to the product, or exclusively relating to the manufacture of the product, they may well wish to retain rights to other more general foreground intellectual property in relation to the manufacturing, including the manufacturing documentation, to the extent that they are applicable to the manufacture of other products, as this will also be some compensation for the potential loss of the manufacturing mandate.

From the company’s perspective the ideal position would be to own all foreground intellectual property, which it has arguably paid for through the service fees. In practice, if this is resisted it may be sufficient for the customer’s ability to transfer manufacturing to another manufacturer to be granted an exclusive or even just a non-exclusive freedom to operate licence in relation to the product, or closely related class of products, which it can sub-license on to the new manufacturer along with a copy of the manufacturing documentation.

For security however, it would also be desirable to obtain a freedom to operate licence under the manufacturer’s background process intellectual property solely to the extent necessary for the exploitation of the foreground intellectual property. While this may well not be strictly necessary, on the basis that any subsequent manufacturer is likely to have its own existing proprietary process which it would adapt for the purposes of manufacturing the product, rather than seeking to copy the basic process and equipment of the preceding manufacturer, a freedom to operate licence in the absence of an obligation to provide details of any proprietary process know-how is nevertheless valuable as it removes the risk of a later allegation of infringement.

It may also be essential for the licensee to obtain copies of the manufacturing documentation. Although actual copies of this documentation may not need to be passed to a subsequent manufacturer, a full understanding of the contents may be essential to an effective transfer.

How will the transfer practically take place?

It is one thing to have a licence of proprietary know how and a right to a copy of documentation but in the event that the relationship breaks down or the manufacturing agreement is terminated as a result of breach by the manufacturer or the manufacturers insolvency, it will be essential for the customer to be able to transfer the process as quickly as possible to another manufacturer in order to minimise the impact on development and commercialisation. This will be much more easily achieved if any necessary proprietary know-how and documentation is placed in escrow for automatic release in the event of breach or insolvency.

Clear and enforceable obligations should also be included to provide assistance and co-operation in connection with the transfer of any know-how or technology required for the manufacture or for the validation of manufacturing processes or methods by a third party, as well as training of the customer’s or its licensee’s technical personnel involved in the subsequent manufacture.

Conclusions

Outsourcing manufacture of drugs is often an essential part of pre-clinical and clinical development programmes but should not be entered into lightly and it is always worthwhile to conduct a full investigation into, and understanding of, the capabilities, reputation and resources of a potential CMO. The performance of the CMO is likely to be a key element in the success of commercialisation of a drug and companies should consider avoiding CMOs whose conditions are advantageous in the short term, but have the effect of practically preventing the company from moving manufacturing to another manufacturer in the future.

As the development of a drug moves from pre-clinical development towards approval however, the financial risks arising from problems in respect of manufacturing increase substantially and it is essential to put in place agreements even at the stage of pre-clinical stage of manufacturing which minimise the potential exposure. This applies both when the company is contracting with a CMO and when it is acting as an intermediary in the supply chain.

Even where a CMO insists on imposing its own terms and conditions, a company who fully understands these terms and the potential areas of risk may be able to negotiate better terms or otherwise seek to lessen those risks.

This article only touches on some of the issues which should be considered and the negotiation and drafting of appropriate provisions can be critical in protecting the value of the drug program.

If you have any questions on this article or would like to propose a subject to be addressed by Synapse please contact us.

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