Contract development and manufacturing organizations (CDMOs) and their drug company clients see the world differently. For the drug company a new product—brand or generic—may represent the opportunity for substantial profits if the product is successful. CDMOs, on the other hand, are in the services business and therefore much more product agnostic. What matters to the CDMO is working on both blockbuster drugs and run-of-the-mill projects in a profitable manner without exposing itself to undue risk. So, in this “Men are from Mars, Women are from Venus” contracting world, how can CDMOs best communicate their contracting priorities to their drug company clients, so that each party can address its most important concerns and figure out a way to make money together and help patients? 

I caught up with Susan Fyan, senior counsel at Perrigo. Susan and her team provide comprehensive legal counsel and support to the OTC pharmaceutical and oral care divisions of Perrigo’s Consumer Self-Care Americas business unit. Prior to her legal career, Susan was a pharmaceutical scientist at Pfizer and Pfizer Animal Health, working in a number of scientific roles, including pharmaceutics and formulation development, pharmaceutical sciences project team leadership, and clinical supply chain project management. I thought Susan would be the perfect person to ask some of our hardest contracting questions.

Stephen Sayre: Okay Susan, let’s start with the “D” for development. When a CDMO is engaged to develop or formulate a drug product, the drug sponsor needs to understand the CDMO views this as a process-level commitment and not an outcome-level commitment. As drug products have become increasingly complex, developing that product (whether novel or generic) is no sure thing and the contractually savvy CDMO will be quite leery of promising that it will be able to achieve the desired result. And most likely it wants to avoid any compensation structure that is based on achieving that outcome. How can the CDMO convey this message without appearing to be “afraid of commitment”?

Susan Fyan: Assessing the probability of technical and regulatory success with a development project is a very fact/project specific analysis, and depends on a number of considerations, including the current state of the technology and the developmental stage of the project when it is brought to the CDMO partner (i.e., the working assumption is that the probability of technical success increases with each advancing project milestone, with some caveats). From a customer perspective, risk management and mitigation is key.

An option to address those risks is the inclusion of discrete go/no go milestones in the contract, with payment milestones tied to each, the idea being that the project can be terminated following completion of any individual milestone, with payment to be made for work up to that point. This also provides the customer with an “escape door” for a project that either is not going to plan technically, or that is no longer of interest to the business for some reason.

Similarly, we sometimes build in check points for the CDMO regarding technical feasibility at each step. The above requires more advance thought and work to incorporate a detailed project plan into the contract with logical go/no go decision points, but the upfront effort can definitely be worthwhile for both the CDMO and the customer in terms of managing project risks.

Sayre: It sounds like what you are saying is that for the CDMO some projects are less risky than others and that in those situations, the CDMO should be willing to accept more of an outcome-based fee model. That makes some sense though it seems like it might be a bridge too far to ask a CDMO to move from a time and materials structure in the development context.

Let’s turn to another aspect of development that often comes up in contract discussions between CDMOs and their drug company customers, which I refer to as the “CDMO Re-Use Model.” If a CDMO discovers a method or technique in developing a drug product for a specific customer, it needs to retain the right to re-use that method or technique for other customers. Customers often take issue with this position insisting that they should own and have complete control over work that they paid for. Susan, I’m sure you have encountered this issue before. Any pearls of wisdom on how to deal with it?

Fyan: I think it is important to differentiate and define in the agreement the specific “Product” under development versus the underlying CDMO know-how and capabilities—and improvements thereto gleaned by the CDMO in the course of the work for the customer. This requires a good and specific definition of the “Product” as well as clear definition upfront of the background IP each party to the agreement is bringing to the arrangement. Typically, we look for information specific to the Product (capital P) to be considered customer confidential information. However, the general know-how and capabilities typically remain available for the CDMO to utilize in supporting other customers in the same space, without reference to customer confidential information.

Another key goal from a customer perspective is “portability” of the developed product, i.e. perpetual FTO with respect to the “Product,” even after any commercial manufacturing arrangement with the CDMO ends under the terms of the agreement. Achieving such freedom to operate may require that the CDMO is willing grant a fully paid, non-exclusive license to any of its background IP incorporated into the “Product,” to the extent needed for the customer to manufacture and sell such “Product.”

Sayre: I have seen this general framework work and once agreed to use licenses to implement. It is certainly understandable why the customer would insist on Product portability one way or the other and in my experience CDMOs will try not to interfere with that goal.

Now that we have conquered development, let’s move on to issues that arise in manufacturing. When the drug company has provided the formulation and it was not created by the CDMO, some CDMOs will take the position that the only warranty provided is that the CDMO complied with the instructions and procedures provided it. The CDMO may even resist providing the warranty that the product actually complies with the technical specifications that the product claims to have. In addition, in this situation the CDMO will likely resist all other product-related warranties, including any warranty of IP non-infringement. How do you react to those positions?

Fyan: This is a challenging issue, and the solution with regard to a technical warranty is likely tied to the developmental stage of the product brought forward by the customer, i.e., a modified warranty may be acceptable at the development stage, with a “ramp up” in warranty as/if the project progresses successfully. At the appropriate development stage—and assuming technical success and that the CDMO becomes the commercial manufacturer—the manufacturing process and related specifications will need to be validated and made the subject of a warranty. A warranty of non-infringement with respect to third party IP rights would also still likely be needed by the customer for any CDMO IP incorporated into the “Product” in the course of the project.

Sayre: I have seen different warranties during development versus production, but do not recall ever seeing the warranty change during commercial production. Your answer seems to imply that the warranty in a commercial production agreement could change once the CDMO has repeatedly manufactured spec-compliant product, relying on the instructions provided by the drug company customer. That would be an interesting approach. Food for thought.

I’d like to get your thoughts on another issue related to commercial manufacturing. Oftentimes the customer is dictating which suppliers the CDMO must use. And sometimes the customer is responsible for supplying the API or another key ingredient. This lack of supply chain control has two contractual impacts: (1) the CDMO may be unwilling to accept firm delivery date commitments; and (2) the CDMO may be unwilling to accept responsibility for defects in material it is not supplying itself, because it will not have sufficient access to the supplier. Have you encountered these issues when Perrigo is supplying raw materials?

Fyan: In our experience, choice of raw material suppliers generally works out best if it is a collaborative decision-making process between the customer and the CDMO. From a customer perspective, it is generally preferred that the CDMO have a direct, contractual relationship with the raw material suppliers (absent unique circumstances). If not, it is reasonable to incorporate a carveout to OTIF delivery requirements imposed on the CDMO for delays due to receipt of a customer-supplied raw material. 

Sayre: I agree that from a contractual perspective, customer-supplied material raises a number of issues. In my experience the trickiest ones involve allocating responsibility for defects in raw material when the CDMO only does limited testing of incoming material and has no visibility to the supplier’s quality control systems, having never conducted an audit. 

The next issue I would like to address with you is contractual indemnities and damage limitations. Many CDMOs will insist on a broad indemnity protecting it from all third-party claims that could arise from its involvement in the project, including claims that are not the fault of the Company. Drug companies should expect to see a bullet-proof cap on damages for the CDMO with very few carve-outs.

Conversely, many CDMOs will resist any attempt by the company commercializing the product to impose caps on its damages from the broad indemnities described above. This is in recognition of the fact that the CDMO is not making any profit if the drug turns out to be the next Lipitor and thus should be protected from any significant downside risk. Where do you try and land on these issues?

Fyan: Absent a profit-sharing arrangement, it’s definitely increasingly common for our CDMOs to insist on a firm damages cap with very few carveout; typically based on potential exposure for the Product v. the total value of the contract to the CDMO. From a customer perspective, we can typically entertain a cap that is reasonable to the totality of the circumstances, but in that case, it would be essential at a minimum to have a carveout from the liability cap for personal injury or death due to CDMO negligence or misconduct.

Sayre: These are always tough issues and it seems are among the last issues to be resolved because they involve dollars and cents. The other factor that sometimes comes into play in my experience is that resolving the issue may require internal escalation, which can create its own complications.

Alright, let’s move out of the theoretical and into the practical. Each party to a contract typically wants to work from its own contract form. In the past, CDMOs were more likely to acquiesce to at least starting with the customer’s form. CDMOs have learned that working on a familiar form both saves review time and usually results in reduced contractual risk. Armed with this knowledge and with more leverage, CDMOs are now increasingly likely to insist on working with their own R&D, Manufacturing and Quality Agreement Forms. How do you typically react to use of CDMO forms?

Fyan: Our experience is that often, the CDMO templates tend to be quite “one size fits all,” which requires a lot of redlining and discussion. It can require several months for multiple redline exchanges and discussion, which from the customer vantage point is a negative trade-off timewise and can still lead to significant work for the CDMO legal and business/quality teams and thus, little (if any) time savings. Likewise, it can be quite burdensome on the customer workload side to undertake the legal, business and customer quality assurance review of CDMO paper.

Sayre: I certainly agree that trying to put a round peg into a square hole wastes everyone’s time. And I think this is another area that benefits with a discussion up front—involving counsel—to see which side has a better starting point. That said, I do wish that drug companies would be a little more willing to use quality agreement forms from the CDMOs since they often reflect how the CDMO complies with cGMP. 

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Stephen D. Sayre is a Member of the Corporate Finance Group and Co-Leader of the Mergers & Acquisitions sub-practice group at Dykema. Steve’s practice focuses on companies in the pharmaceutical industry, including drafting and negotiating development agreements, manufacturing and supply agreements and joint venture agreements. Steve also acts as outside general counsel for companies that do not have inside counsel, managing commercial litigation, employment and tax matters.

Susan Fyan is Senior Legal Counsel at Perrigo, a leading global provider of over-the-counter health and wellness products for consumers. Susan and her team provide comprehensive legal counsel and support to the OTC pharmaceutical and oral care divisions of Perrigo’s Consumer Self-Care Americas business unit. She is admitted to practice in Michigan and Florida and is a registered U.S. patent attorney. Prior to her legal career, Susan was a pharmaceutical scientist at Pfizer and Pfizer Animal Health, working in a number of scientific roles, including pharmaceutics and formulation development, pharmaceutical sciences project team leadership, and clinical supply chain project management.