Our region, measured by the five hour train ride from Boston to Washington, D.C., with its center located here in New Jersey remains the largest, most effective life science cluster in the world. While New Jersey's "Garden State" moniker harkens back to when the State's economy was primarily agriculturally based, the nicknames "Invention State" and "Nation's Medicine Cabinet" more aptly define its role in today's life science industry. Within a two hour drive of Newark International Airport can be found over 130 "pure play" biotechnology companies occupying over 3 million square feet of space and employing over 8,000 scientists, management, marketing and regulatory staff. To measure the scope of our life science cluster, add to this the 65,000 employees from the major 28 pharmaceutical companies based in New Jersey (15 of the world's largest 20) and the over 300 medical device and related entities.
The industrial "cluster" concept pioneered by Harvard Professor Michael Porter was applied to our region in his landmark 2003 Life Science Cluster Study commissioned by Prosperity New Jersey, Inc. That study continues to be a valuable roadmap for the region's life science industry and it lays out an important role for our region's international lawyers. The focus of this article is the role of the international lawyer in advising foreign clients doing business in our region or abroad in successful collaboration where life science innovations in the laboratory can be refined, clinically tested, associated good manufacturing procedures ("GMP") developed and certified, and the innovation brought to market.
One region of the world that is actively seeking such collaboration within this industry is the life science cluster led by the White Rose University Consortium in the North of England. Although reliable statistics can be hard to come by, it appears that the United Kingdom is the largest biotech region in Europe, the second largest worldwide outside of the United States; and of that, approximately one-third is centered among the leading research Universities of Sheffield, York and Leeds that make up the White Rose University Consortium. The combined research power of the three institutions ranks alongside that of the Universities of Oxford and Cambridge and accounts for 86% of the North of England's research spending and five of the area's Research Centres of Excellence - oncology, structural biology, reproductive biology, genomic medicine and drug delivery - all directly relevant to drug discovery and development. In close cooperation with the New Jersey Life Science Coalition, leading elements of the White Rose University Consortium are in the early stages of planning to bring a technology showcase of the innovations of their members to our region in the first quarter of 2006.
In either advising life science companies in our region or an innovative enterprise from the North of England or elsewhere, we all recognize that there is no single working collaboration model involving elements of legal, licensing and funding structure that is the answer for all relationships but such a model and its variations can be a valuable starting point.
Legal Structure: Jurisdiction.
Creating a legal structure for life science collaboration must recognize the common client motivation to seek to avoid risk and that the life science collaboration typically is funded in a manner that recognizes the collaboration will often generate years of development costs (i.e., losses) before finally generating income. Foreign enterprises establishing themselves in our region typically will not directly have the parent entity conduct business here but rather will seek our advice in forming a domestic limited liability affiliate to seek to shield themselves from what they often perceive to be our overly litigious society. One frequent area of confusion for a foreign company which should be addressed arises from the fact that in their home country, there often is simply a single government authority for creating legal entities (in England, the national Company House) and that is not the case in the U.S. Here in the United States, that role is assumed by the 50 individual states. It is beyond the scope of this article to suggest any single jurisdiction is better than another to incorporate a life science collaboration entity, but an illustration to demonstrate the importance of this decision arises when a foreign enterprise may insist on incorporating its limited liability affiliate as a corporation in the state of New York where it established its initial office only to find that as one of the ten largest shareholders (in fact the only shareholder) of the affiliate, it is directly liable for the unpaid wages of its affiliates' employees under New York BCL § 630.
Another frequent area of confusion which should be addressed arises from the typical practice that in the company's home country the governmental authority for creating legal entities will not permit a second entity to have the same name adopted by an earlier filing entity. Foreign companies are often surprised to learn that any one of our 50 states can incorporate an entity of the same name. Solutions to this potential source of confusion are found in the application of our federal trademark laws discussed later in a later part of this article.
Finally, foreign enterprises need to adopt management procedures that later can withstand attempts to pierce the corporate veil.
Legal Structure: Opaque Or Transparent.
In recognition that a life science collaboration will generate losses in the development phase, legal counsel can advise clients to take advantage of the innovations in legal limited liability entities that today provide the prospective U.S. entity with a menu of both traditional corporations (both IRS Code Subchapter S and Subchapter C) and partnerships (limited and general) as well as now more well known recent entities such as limited liability companies ("LLCs") and limited liability limited partnerships ("LLPs"). With the exception of the Subchapter S corporation, all of these entities can incorporate the "blank-check" series preferred capital structures typically used by collaborative enterprises in implementing rounds of venture capital investment funding or in customizing equity investments into the innovative enterprise by their collaborative licensee.
A common first choice of entity on this available menu is often an LLC, an extremely flexible and fluid entity. Here in the United States, an LLC can be either an "opaque" or "transparent" entity for federal and many state tax purposes by simply "checking the box." This type of entity has management officers or managers and unit equity structure often familiar to foreign companies and avoids the restrictions imposed on Subchapter S corporations which are not available to non-resident shareholders. Here in the United States, if elected to be treated as a "transparent" entity, the losses by an LLC can be in excess of invested capital, are allocated to the LLC equity owners in proportion to their ownership and such losses may be available here in the United States to offset equity owner income derived from other sources. When the LLC is later able to generate income from its prior expensed developments, such income together with the federal and state tax liabilities on such income are passed through to the LLC owners even when there may not be cash available for distribution with which to pay such taxes. If the LLC owners desire at this stage to terminate the pass through "transparency" of the LLC, a possible technique to consider employing is the creation of a wholly-owned Subchapter C corporation subsidiary for the LLC enterprise, merge the two entities together with the subsidiary surviving and thereby transform a "transparent" LLC enterprise into an "opaque" Subchapter C corporation for federal and state tax purposes. The surviving Subchapter C corporation pays taxes on its own income, creating taxable income to its owners only when dividends are actually paid to the owners.
If an innovative enterprise is to be formed that is expected to rely upon venture capital sources or if liquidity for the enterprise owners is expected to be provided in the future by taking the entity public, a frequent choice off the available menu is simply beginning the enterprise as a Subchapter C corporation from inception. This is because it can preserve its net operating losses for up to 20 years going forward as an offset against future income. The "double taxation" nature of this structure, where the Subchapter C corporation pays taxes on its income and the owners pay taxes on their dividend distributions, may be offset by the common circumstance that for the next several years the enterprise is essentially investing all of its cash in innovation development. When cash is available for distribution, the mandatory 30% withholding on dividends to off-shore equity owners may be reduced as the U.S. often has bilateral tax treaties in effect which, in the case of the UK/U.S. treaty, would reduce withholdings on corporate dividends from the U.S. affiliate to the UK equity owners to 15% (5% for corporate owners, provided such owners own at least 10% of the enterprise).
Published October 1, 2005.
