A Pending Patent Problem –

In a bid to convince voters last year to support Proposition 71-the California Stem Cell Research and Cures Initiative-backers guaranteed that some of the money invested for research would be returned to Sacramento in the form of licensing fees and royalties. Some may call that wishful thinking, or just good politics.

Whatever it was, it worked as a tantalizing incentive, especially when voters considered how much would be invested on research. The measure authorizes the state to spend $295 million a year over the next 10 years to study stem cells. That amounts to more than 21 times what the federal government currently spends annually on stem cell research. Only California researchers are eligible for Prop 71 grants.

And the payoff is nothing to sneeze at. One pre-election study claimed that Prop 71 research contracts could return between $537 million and $1.1 billion in royalties, depending on how agreements are structured, once all components of the legislation are up and running.

But John Wetherell, a partner at Pillsbury Winthrop in San Diego, echoes a note of caution. He says that Independent Citizens’ Oversight Committee (ICOC), which is charged with setting up the research program, has come under increasing pressure to make sure the state recoups its investments once stem cell treatments become available in hospitals.

That’s where the problems lie. Wetherell says if the ICOC fails to come up with a way for investors, researchers and California citizens alike to share in the royalties and fees, then the lawsuits will fly.

“The state is already exerting a lot of political pressure on the ICOC to recoup the money invested,” Wetherell says. “Under Proposition 71, the ICOC must require-it’s not an option-that the state share in future revenues.”

The politicking has already begun. State Sen. Deborah Ortiz from Sacramento has introduced a bill that would require California to “reap the benefits of its funding.” And Controller Steve Westly, who serves as chair of the ICOC’s Financial Oversight Committee, is pressing fellow committee members to draft royalty agreements to “benefit from the best possible deals.”

Yet, those who’ve observed Prop 71 say that all the talk about the state getting its fair share is just that-talk. Stem cell research, though promising, is still very much in its infancy. And concerns about who owns the IP and who shares in it are a little premature, many argue. It could be years, if not decades, before treatments and cures are developed that can be transferred from the research bench to the hospital bed.

The VC Stake

No matter how long it takes, many are willing to wait for the payoff. Michael Powell, managing director at San Francisco-based Sofinnova Ventures, says that finding cures takes time, not just money. “Cash alone won’t do it,” he says.

To be sure, VCs such as Powell are remaining patient, given the potential for the rewards once the research can be commercialized. It’s that potential that motivated venture capitalists to contribute half of the Prop 71’s war chest, which totaled more than $21 million.

And it’s also why VCs are concerned about sharing fees and royalties-even long before the models have been established and the revenue sharing staked out. Stem cells, taken from human embryos, are undifferentiated, which means that they can be coaxed to grow into any number of specialized cells, such as those that can produce insulin or those that can replace damaged nerve cells. Those who drafted and supported Prop 71 hope that research done with state grants will lead to cures and treatments for such diseases as Alzheimer’s, diabetes and Parkinson’s.

Prop 71’s fine print says future agreements must balance the state’s opportunity “to benefit from the patents, royalties and licenses” with “the need to assure that essential medical research is not unreasonably hindered.”

Phillip Philbin, a patent attorney monitoring Prop 71 developments from his office at Haynes and Boone in Dallas, says that the balancing act will be a delicate one. “The public generally expects such publicly funded research to be made widely available,” he says.

But an increasing number of public research institutions, particularly state-supported universities, are retaining their patents and granting exclusive licenses for the use of those patents. Granting exclusive rather than less-lucrative non-exclusive licenses in return for royalties is having “a chilling effect” on research, he says.

“We’re seeing more and more of this across the country,” says Philbin, who thinks that if ICOC decides to grant exclusive licenses, especially on IP that covers basic areas of research, scientists would side-step ground-breaking research.

It will be up to the ICOC to balance the need for fair returns to those who commercialize the stem cell exploration, against the taxpayer who has paid for the research, he says.

“The devil is going to be in the details of what these agreements look like, and how they are structured,” says Philbin. “The voting public may not be getting what they thought they were getting when they voted for the proposition.”

Dealing with the Early Settlers

If figuring out how to handle future patent claims is not enough, Prop 71 backers will also have find a way to deal with early researchers of human stem cells technology, such as Geron Corp. and the University of Wisconsin (see sidebar, page 42).

Jean-Francois Formela, senior partner and life sciences industry specialist at Atlas Venture in Boston, believes that existing researchers who have applied for or hold valuable patents in stem cell technology will be cooperative not combative.

Formela says that if he was thinking of investing in a company that might intrude on Geron’s patents, for instance, he’d asked Tom Okarma, the CEO of the biotech company, if the two of them “could sit down and talk,” a strategy that could bypass all the messy and costly lawsuits.

“I would talk to Tom to see what can be done and what cannot be done,” says Formela. “I don’t think people block good stuff because they simply hold patents. I think they want to know how they can get their fair share and how they can cooperate.”

Formela says that he is more concerned about rumors that Sacramento wants to take as much as half of the royalties, fees and other sales that might eventually be generated when Prop 71 research is commercialized. He says that the ICOC will have to establish a clear legal structure for utilizing research after it is taken from the lab. If not, then he and other venture investors will shy away from investing in companies that seek to capitalize on such discoveries.

“If I had a company considering taking Proposition 71 funds, I would make sure we know the legal structure and have an understanding around the deal,” Formela says.

Sofinnova’s Powell also says that he will follow the same approach if and when it comes time to commercialize IP derived from Prop 71 research.

“If a company doesn’t have the freedom to operate, we won’t fund them,” says Powell, who adds that Sofinnova’s patent attorneys look long and hard at IP issues, and will continue to do so, including a close examination of sharing royalties.

The Price of Exclusivity

Most likely, observers say, the ICOC will issue exclusive licenses to companies seeking to commercialize stem cell research. But exclusive licenses can discourage researchers from pursuing their own work based on the inventions of others. And exclusive licenses, generally speaking, will increase the costs.

Strictly enforcing patent rights could deter new companies-especially startups funded by VCs-from entering the field, say many IP attorneys. Others say it’s premature to make such claims, and that models exist for cooperation, not courtroom battles.

Bob Taylor, a partner in the Silicon Valley office of Howey Simon Arnold and White, says lawsuits are unlikely, especially over IP developed in the early stages of research and development.

“Even if one party sues another over intellectual property, and wins, it’s a Pyrrhic victory, since it’s fairly costly to initiate litigation with respect to products … that may never work at all,” Taylor says.

Margaret Dunbar, an intellectual property attorney for Sonnenschein Nath and Rosenthal in Los Angeles, notes that in the early days of DNA research, Stanford University made a key patent widely available to researchers on a non-exclusive basis. Stanford, which charges $50,000 for non-exclusive rights to the Cohen-Boyer gene cloning technique developed on campus, has generated more than $300 million since the early 1980s from its patents. So there’s money to be made, even if licenses are non-exclusive. She also notes that the University of California system follows a similar philosophy of making its IP widely available.

“The stake is small, but it can still makes tens of millions of dollars,” she says.

William Gaede, a partner in the Silicon Valley office of McDermott Will and Emery, notes that fears about who will own the IP that would flow from Prop 71 grants is nothing new. It’s inherent in the industry.

“There is an inordinate amount of conflict over IP and biotech,” Gaede says. “It’s not only focused on the product, but the techniques used to develop the product, which gives rise to conflicting intellectual property rights.”

Some note that the debate over eventual IP rights misses the overall importance of the money flowing into new research.

“Any funding in this field is a good thing,” says Brenda Gavin, managing partner at Philadelphia-based Quaker BioVentures, which restricts its investments to the mid-Atlantic. “Make no mistake, this research will be done by someone, and if it is not done in the U.S., it will be done elsewhere.”

Gavin says it’s too early to worry about fights over the intellectual property that will come out of the laboratory.

“I doubt that this [Prop 71] will cause venture funds to run out and start companies in the stem cell area,” she says. “But, if the technology proves out, it may represent an opportunity for some venture funds. That is, it will be technology proven first, then funding of companies-not the other way around.”