The contract loophole that cost a drug company hundreds of millions

This is my true, firsthand story of how a drug company lost hundreds of millions of dollars because of a lawyer’s blunder. Many identifying details have been altered or simplified.

Once upon a time, there was a Small Drug Lab developing a promising new drug. As is typical nowadays, this was a single-purpose drug lab, founded to research this exact drug, and funded by a small group of investors hoping to get big returns.

The goal of any such venture is FDA approval. And this particular Small Drug Lab was seeking FDA approval for a drug that treated an extremely common type of irritation, for which there was currently no adequate treatment - in short, a potential absolute blockbuster that would make early investors unimaginably wealthy. And with the drug having already passed Phase I / Phase II human clinical trials, investors were lining up to get involved and help fund the most expensive part: Phase III clinical trials.

To pass Phase III clinical trials and get FDA approval, your drug has to meet two¹ criteria: sign and symptom.

• Meeting sign means you do better than placebo on treating the objective indicia of the disease.
  • In the case of irritation, it means your patients are objectively less red and dry.
• Meeting symptom means you do better than placebo on treating the subjective indicia of the disease.
  • In the case of irritation, it means your patients report feeling better and less itchy.

Obviously both sign and symptom are equally important. But equally obviously, symptom is a bajillion times more important, especially for irritation. “Your Irritation Will Look Better But Will Still Feel Awful” doesn’t make for great copy.

This was, disappointingly, the result of Small Drug Lab’s Phase III clinical trial. It beat placebo on sign, but it did not beat placebo on symptom. However, it came reallllly close on symptom, and symptom is usually harder to meet, so Small Drug Lab decided to begin a second Phase III clinical trial to try again.

Small Drug Lab’s investors, however, had only really planned on one Phase III clinical trial, and were now somewhat reluctant to shell out more. Many other once-promising treatments for this condition had also failed at symptom, after all. At the same time, these results had caught the attention of Drug MegaConglomerate. They saw enough in the study that they were willing to bankroll the second round of trials, and offered to buy Small Drug Lab (more specifically, its patent on the drug under development, which was its only meaningful asset). Small Drug Lab’s investors accepted.

There was just one problem. How much was Small Drug Lab worth? After all, the second round of trials wouldn’t be done for another year. If that study also failed, then the FDA would probably never approve the drug, and Small Drug Lab was essentially worthless. But if that study was successful and Small Drug Lab got FDA approval, Small Drug Lab would be extremely valuable.

If you’ve ever been a BigLaw or Wall St type (or even if you haven’t), the answer is probably obvious - the purchase contract would simply account for these future contingent events.² So each side’s fancy BigLaw lawyers sat down and worked out that most of the money would be paid after the second Phase III clinical trial, as follows:

• If the second trial met sign AND symptom, then Drug MegaConglomerate makes a gigantic payment on the order of hundreds of millions of dollars.
  • In this scenario, this is a promising drug that is almost certainly getting FDA approval to treat a very common disease. This is the jackpot.
• If the second trial again met sign but NOT symptom, then Drug MegaConglomerate makes a medium payment, on the order of tens of millions of dollars.
  • In this scenario, this is a drug with a pretty limited future. It might still get approval for a more limited indication, but it’s hard to envision it being a true blockbuster.
• If the second trial meets neither sign NOR symptom, then Drug MegaConglomerate makes a pittance payment to Small Drug Lab’s investors, less than a million dollars.
  • This is basically the “thanks for trying” payment. We all did our best, but things didn’t work out, sorry old chap, here’s a little something for the chairs and monitors in your office, better luck next time.

A sharp-eyed reader will note that this purchase agreement between the two parties did not exactly cover all possibilities. Specifically, no provision was made for what would happen if the second Phase III trial met symptom, but not sign.

There is no clear answer as to why. In speaking to those involved, my understanding is that it was just a genuine oversight. Literally no one on either side, nor any of the lawyers drafting the agreement, thought this was a possibility. The treatment had already met sign, after all, and sign is a lot easier to meet than symptom. So it simply never occurred to anyone that this could happen.

That is, of course, what happened.

When the second round of trials came in, everyone was stunned to find that it just barely missed sign, but blew symptom away.

From a regulatory perspective, this was fantastic news. Doing so well on symptom, coupled with only barely missing sign while having met it previously, was a near-guarantee this would get FDA approval and head to market.

After the celebration, the investors went back to the agreement to figure out how much money they’d be getting. What they expected to see was a contract that basically said this:

1. Sign and symptom? Hundreds of millions of dollars.
2. Sign only? Tens of millions of dollars.
3. Neither sign nor symptom? Less than a million dollars.

In other words, the contract is silent as to what would happen if symptom is met but not sign. Legally, when a contract is silent, a judge will hear from both sides as to what the parties must have intended. In this scenario, everyone would probably have a good chuckle about how silly they were, and Drug MegaConglomerate would just pay the hundreds of millions of dollars without going to a judge. That’s because 99/100 judges would have found that to be the fair result. Hundreds of millions of dollars was the intended reward for FDA approval, and though they might not have gotten that approval the way they expected, they got it in the end.

But to the investors’ horror, what the contract actually said was this:

1. Sign and symptom? Hundreds of millions of dollars
2. Sign only? Tens of millions of dollars.
3. Otherwise? Less than a million dollars.

Now the contract does explicitly say what should happen if symptom is met but not sign - that falls under #3, and the investors will receive less than a million dollars, as if the drug was a total bust.

But wait – that’s totally unfair! Yes it is. And 99/100 judges would agree it’s unfair. But that no longer matters. Because 100/100 judges will never override the explicit terms of such a contract to achieve a “fair” result. Court opinions along the lines of “Regrettably, I have no choice but to uphold the unambiguous terms of the contract as written…” are practically a cliché.

Now, maybe once in a while, an especially soft-hearted judge might bend the rules, and strain to find an ambiguity when none exists, for a particularly sympathetic plaintiff.³

But this is a contract for hundreds of millions of dollars. Even the most soft-hearted judge in the world isn’t going to mess with that kind of contract, because the assumption is that everyone involved hired fancy expensive BigLaw lawyers and got exactly what they wanted - especially when it comes to the amount of money being paid in a purchase agreement, arguably the single most important provision in the whole agreement.

Not only that, but as is typical in commercial contracts, the two parties had explicitly agreed that any dispute would be heard in front of the least soft-hearted judges in the country: the esteemed members of the Delaware Court of Chancery. This is a business court that only hears business cases and is respected by businesses everywhere for their very business-focused approach. A court where wearing a light blue shirt instead of a white shirt under your suit is considered a major faux pas. In short, the court least interested in your sob stories and most interested in exactly what the contract says.

And so the rest of the story basically writes itself. The investors wrote Drug MegaConglomerate a letter asking when they would get their hundreds of millions. Drug MegaConglomerate sent back a letter that politely told them to pound sand. The investors sued in Delaware Chancery, in an attempt even they surely knew was fruitless, and got exactly nowhere.

In total, the investors were paid just under a million dollars for the drug. The drug received FDA approval and went on to generate half a billion annually for Drug MegaConglomerate. Earlier this year, the drug was sold to some other MegaConglomerate, this time for over five billion dollars. This sale also had a few contingent payments built in, and I think it will surprise no one that the lawyers were instructed to pay a bit of extra attention to that section this time.