Contractual relationships in the life sciences sector
As an increasingly complex sector in which numerous stakeholders and parties may be involved in any given project, contractual arrangements that evolve throughout the life cycle of a particular product play a key role in the life sciences industry. On one project alone, a pharmaceutical or biotech business could be party to a variety of different contracts. These may include, for example, licensing agreements governing the use of certain intellectual property, service agreements relating to the development and manufacture of drugs, or contracts for the hire or purchase of pharmaceutical processing or manufacturing equipment. Each of these contracts is crucial to enable the companies involved to achieve commercial success and to progress drug research and development.
Expansion and consolidation through asset purchases
In order to streamline and develop project workstreams, it is very common for businesses in the life sciences sector to add new assets to, and sell assets from, their portfolios. Such acquisitions can enable a company to consolidate its position in a specific market, reduce research and development costs by bringing certain functions in-house, or expand into a new market altogether. Meanwhile, the disposal of certain assets may take place following a decision to conclude research in a certain area, or in order to raise capital by selling an asset that is deemed valuable in the wider market.
To ensure that a company benefits fully from any asset it purchases, it is important that all contracts relating to that asset continue to be performed following an acquisition. In particular, a buyer will wish to ensure that the relevant obligations and benefits under a contract are passed onto them and that they can continue to enforce that contract going forward.
How are the benefit and burden of a contract passed on to a buyer of an asset?
Novation is a mechanism of transferring one party’s rights and obligations under a contract to a third party. Novation is used to effectively “extinguish” one contract and replace it with a different one, allowing a third party (i.e. the incoming party) to agree to perform the outstanding obligations of an outgoing party. Novation is a particularly useful mechanism where the transfer of contractual obligations, such as to provide a service or to make payment, is required. Such obligations cannot be transferred by simply assigning a contract, and can only be transferred by novation.
As novation extinguishes one contract and replaces it with another, it is important that the new contract satisfies the legal requirements for formation of a valid contract. One of these requirements is consideration, based on the notion of reciprocity and the idea that a promisee cannot enforce a promise unless he has given or promised something in exchange for that promise. Generally, the promises agreed between each of the parties in a novation agreement will be deemed adequate consideration but, for the avoidance of doubt, novation agreements are often entered into in the form of deeds.
In order for a novation to be valid, all parties to the original agreement (i.e. the outgoing and the continuing parties) as well as the incoming party must consent to the novation. This is generally not an issue for the incoming and outgoing parties, however, obtaining the consent of the continuing party may be problematic in certain circumstances. For example, the continuing party may not consent to a novation where it deems the incoming party to be inferior to the outgoing party in some respect, for instance where it perceives a greater risk that the incoming party will breach key terms of the agreement. These risks are usually considered by the continuing party against the benefits of maintaining the commercial relationship before a decision is made regarding whether or not to agree to the novation.
A novation agreement generally releases the outgoing party from any future liabilities under the original contract, however it should also address the status of the pre-novation liabilities. Unless the novation agreement specifically states that these liabilities shall transfer over to the incoming party, they will generally stay with the outgoing party.
Invalid novation agreements
If the requirements for an effective novation are not fulfilled then the novation may be considered invalid and the transfer ineffective. Instead, it may be inferred that an assignment of the benefit of the contract has taken place instead (assuming this is it not prohibited in the original agreement), meaning that the outgoing party remains liable for the incoming party’s defaults under the contract.
Considering the above, in the event of an asset sale between businesses in the life sciences sector, it is important that the parties carefully consider whether there are any existing contracts that require novation, to ensure that performance of those contracts can continue and to minimise disruption to any related projects.