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Anticipating Early Termination of a Strategic Partnership

Daniel S. Porper, Attorney, Wyrick Robbins Yates and Ponton LLP

When planning a strategic partnership, the parties spend considerable time focusing on what will happen during the development and commercial exploitation of the subject technology.

This is understandable, as this is the stage of the relationship where there is economic fruit to bear. The parties often fail to give the same type of attention to the winding-down of the relationship when things do not go as planned. Whatever the reason for the early termination, there can be significant economic consequences to the parties.

In order to mitigate the potential damages to the parties in connection with an early termination of the strategic partnership, the parties must take the time during the negotiation of the strategic partnership agreement to determine what will happen in the event of such a termination. The primary issues to address are as follows:
  • Who will own intellectual property developed in connection with the partnership? While the parties will have agreed to the allocation of intellectual property rights during the normal course of the relationship, the parties may intend a different result as a consequence of the early termination.
  • Will a party have a license to use the other party's technology? If so, what are the associated financial terms, if any?
  • Who will own tangible assets relating to the technology, such as manufacturing equipment?
  • Who will own regulatory approvals relating to the technology?
  • Are there any termination fees or reimbursable costs and expenses?
  • Will the parties provide transition services to each other?
  • Will the parties be subject to non-solicitation or non-competition covenants?
The resolution of each of these issues is primarily dependent upon (1) the event that is the cause of the early termination and (2) the desire of the parties to use termination as an incentive for performance or a disincentive to terminate.

The parties should predict the events that could adversely affect the partnership and then carefully define the termination rights to anticipate such events. Regardless of what the parties eventually agree, the termination rights can generally be classified into two categories:
  • For cause (e.g., breach of contract, change of control, contributed technology infringes a third party's intellectual property rights, insolvency, etc.)
  • Failure due to reasons with regard to which neither party is in control (e.g., technology does not perform as expected, market demand is less than expected, research committee deadlock, regulatory issues, etc.)
Upon a termination of the partnership for cause, the non-terminating party should bear the bigger burden and the terminating party should receive more favorable termination rights.

An extreme example of this would be a termination provision that: (1) provides the terminating party with all of the rights (whether via license or assignment of intellectual property) necessary to continue commercializing the subject technology on a royalty-free basis, (2) obligates the non-terminating party to reimburse the terminating party for any development costs paid by the terminating party and (3) prohibits the non-terminating party from creating a competing technology.

There are varying degrees of "for cause" terminations, and thus, the agreement can be drafted to provide less severe consequences to the non-terminating party for less severe "for cause" events.

Upon a termination of the partnership for reasons outside of the control of either party, the parties should share the burdens and benefits in an amount proportionate to their respective contributions. For example, if each party contributed equally to the partnership, the termination provision could provide each party with all of the rights (via cross-licenses of intellectual property) necessary to continue commercializing the subject technology in a specific field, with or without royalty obligations.

There is an obvious correlation between the severity of the consequences of termination and the amount of effort exerted by a party to avoid an action or inaction that will result in termination. The parties in a strategic partnership should keep in mind that their relationship is like a marriage and not one of service provider-client.

When there are problems, the parties should be motivated to work them out rather than terminate the relationship. The extreme termination for cause example above provides an incentive for a party to terminate the partnership rather than make the effort to resolve issues and continue on with the partnership-the parties set themselves up for failure. At the same time, the strategic partnership agreement cannot have effects of termination that are so weak that parties will not care about non-performance.

Accordingly, when determining the severity level of the consequences of termination the parties must carefully balance their use (1) as a threat that motivates performance or (2) to encourage the parties to work together in the event of a problem, rather than terminate.

Parties to a strategic partnership should not treat the termination provisions of an agreement like they are boilerplate. Such provisions provide a framework for a reasonable exit in the event the strategic partnership does not proceed as planned.

With such a framework, the parties understand whether or not their actions or inactions give rise to a termination right, as well as the consequences of such behavior.

© 2006 Daniel S. Porper. All rights reserved.

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