Diligence and active marketing: interpretation in the Acolyte Biomedica case

Judgment in the case of Porton Capital Technology Funds and others v 3M UK Holdings Limited and another [2011] EWHC 2895 (Comm) was handed down earlier this week.  This case is of importance to IP licensing practitioners, as it considers the interpretation of obligations:

  • diligently to seek regulatory approval for BacLite, a diagnostic assay for detecting MRSA; and
  • actively to market BacLite.

The case also considers whether a contracting party acted unreasonably in withholding consent, and this is relevant to licence agreements as such agreements often include provisions about consent.

In fact, this case was not about a licence agreement at all.  It concerned terms in a share purchase agreement.  Part of the price for the shares was a so-called earn-out provision, under which the purchaser agreed to pay a royalty on net sales of BacLite and agreed to comply with certain diligence and marketing obligations.  Unusually, therefore, we are considering typical licensing terms that have been transported into the alien world of a share purchase agreement.

To add to the sense of unreality, the case was heard in the Commercial Court, part of the Queen’s Bench Division of the High Court, and not in its natural home of the Chancery Division, where it might well have been decided by a specialist intellectual property judge.  IP Draughts has not encountered the judge in this case, Mr Justice Hamblen.  It seems that he is a high quality commercial judge, whose experience has been mainly in areas such as shipping and insurance.

But what takes this case right out of the dry, sheltered world of IP transactions and into the political spotlight is its alleged connection with Dr Liam Fox and Mr Andrew Werritty – remember them?  According to the BBC website earlier this week:

The dispute came to public attention after it emerged it was discussed by Mr Boulter and Mr Fox at a meeting in June in Dubai, arranged by Mr Werritty.

Mr Boulter said he had believed Mr Werritty to be a government official and had openly spoken to him about details of the dispute with 3M.

That discussion later became the subject of a blackmail case in the US, during which it became known no Ministry of Defence officials had been present.

Why does it concern the Ministry of Defence?  Because the share purchase agreement relates to the purchase of shares in Acolyte Biomedica Limited, a company formed to exploit technology developed in the MOD’s Defence and Evaluation Research Agency at Porton Down.

Coming back to the technical drafting issues that concern IP lawyers (sorry!), Hamblen J concluded that 3M had breached the terms of the agreement and was liable to pay damages of US$1,299,808.

The judge’s description of the facts is interesting as it shows how a large company, that has paid a substantial sum of money for rights to a product that apparently works, has a market and makes annual sales exceeding US$1M, concludes that it is not making enough money and decides to drop the product.

Interpretation of obligation to “diligently” seek regulatory approval

The claimants in this case represented over 60% of the vendors under the share purchase agreement.  Their counsel argued  that an obligation to act diligently required 3M to act (a) with reasonable expedition, and (b) with reasonable care.  3M argued that diligently in this context meant “with reasonable application, industry and perseverance”, without any distinct requirement of reasonable care.  The judge agreed with 3M on this point.

After examining the detailed factual history of 3M’s attempts to prepare for and seek regulatory approval for the product, the judge found that 3M had acted diligently in some instances and had not acted diligently in others.

Interpretation of obligation to “actively market”

3M contended that “actively” was used in contrast to “passively” and that as long as some steps were geing taken to go out and sell BacLite then the obligation was satisfied.  The claimants contended that this interpretation woujld deprive “actively” of meaningful content and that it required, in accordance with the dictionary and ordinary meaning of the word, that marketing was carried out diligently, energetically and briskly.

The judge decided that actively meant more than simply the taking of some active marketing steps.  He favoured the expression “characterised by action” which had been put forward by the claimants, but he also accepted 3M’s case that this involved a reasonable margin of appreciation being accorded to 3M so long as it acted in good faith with a view to marketing BacLite successfully in pursuit of the common commercial interest of both parties.

The judge considered the detailed factual history of 3M’s marketing efforts.  He concluded that by various dates between June 2008 and February 2009, 3M was no longer actively marketing BacLite in the territories that it was required to do so.

Obligations not to act without consent

Under the share purchase agreement , 3M was required to ensure that Acolyte Biomedica did not cease to carry on its business of developing and marketing BacLite “without the reasonable consent of the vendors, which shall not be unreasonably withheld”.

At various times between June and October 2008, 3M sought the vendors’ consent to discontinue the BacLite business on the grounds of changing market conditions and the disproportionate cost of continuing the business.  3M offered the vendors US$1.07M to settle the matter, but the vendors declined and through their US attorneys, McDermott Will & Emery indicated that they were seeking the maximum potential earn out of £41M.

Hamblen J was asked to decide whether the vendors had acted unreasonably in withholding their consent.  He was referred to several cases, some of them from landlord and tenant law, on how “such consent not to be unreasonably withheld” should be interpreted.

The judge felt that the landlord and tenant cases were of assistance in interpreting this phrase and he set out in his judgment some extracts from the judgments in the important cases in this field.  The judgment in the present case is worth looking at to see the general approach taken in that field – see paragraphs 219 to 222 in particular.

On the facts, he found that the vendors had been reasonable in refusing to give consent.

The judge also considered the likely amount of net sales that would have been achieved if 3M had performed its contractual obligations.  After a detailed analysis of the position each territory, including predictions as to how many new customers would have been obtained, he concluded that net sales of US$2,152,000 would have been achieved.  Under the share purchase agreement, 3M was required to pay the vendors 100% of these net sales.  The claimants, representing 60.4% of the vendors, were therefore entitled to US$ 1,299,808.

According to the BBC report mentioned above, attention may now focus on parallel US proceedings brought by 3M, in which there is some suggestion that Liam Fox and Andrew Werritty may be called as witnesses.  However, it is not immediately clear to IP Draughts from looking at the interweb whether those proceedings are still live.

2 Comments

Filed under Contract drafting, Legal Updates, Licensing

2 responses to “Diligence and active marketing: interpretation in the Acolyte Biomedica case

  1. Norman, the case report doesn’t address the question of costs, so I don’t know whether that is to be the subject of a separate hearing. Usually, in the English system, the court orders the loser to pay the winner’s legal costs (which, after detailed assessment by a costs judge, may amount to about 70% of actual costs). If an offer has been made that is greater than the amount awarded, the court may make a costs order that favours the defendant.

    [Additional comment added by author:] My guess is that the investors’ mind-set may have been:
    1. We’ve covered our investment costs in the upfront payment we received, so the earn-out is pure profit.
    2. Our maximum earn-out is £40M. We think it is clear that 3M have been in breach of contract, and the fact that they are prepared to offer $1.7M confirms that view.
    3. If we take it to court and beat $1.7M we may get a costs order in our favour. The downside risk of being liable for the other party’s costs is probably fairly low.
    4. It is worth a punt on the costs of litigation in the hope of getting a windfall of many times our costs.

  2. Norman

    If I understand correctly, the plaintiffs wanted £41m, were offered US$1.07m, declined, sued and were awarded US$1.3m, for a gross return from litigation of US$230,000, of which a substantial part (all, more than all?) would have been eaten up in attorney fees and indirect costs. If that is right, the plaintiffs made a very serious error (60-fold) in estimating the damages. There might be an interesting lesson in how that calculation went awry.

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