<PAGE>
                                                                   Exhibit 10.43
 
                      COLLABORATION AND LICENSE AGREEMENT




                                 By and Among



                              PHARMACOPEIA, INC.



                                      and



                             SCHERING-PLOUGH LTD.
<PAGE>
 
                                Table of Contents


 ARTICLE I - DEFINITIONS                                                       1
                                                                               
   1.1  ACCEPTANCE                                                             1
                                                                               
   1.2  ACTIVE COMPOUND                                                        1
                                                                               
   1.3  AFFILIATE                                                              1
                                                                               
   1.4  AGREEMENT COMPOUND                                                     2
                                                                               
   1.5  AGREEMENT PRODUCT                                                      2
                                                                               
   1.6  COLLABORATION                                                          2
                                                                               
   1.7  COLLABORATION COMMITTEE                                                2
                                                                               
   1.8  COLLABORATION RESEARCH PLAN                                            2
                                                                               
   1.9  COLLABORATION PLATFORM TECHNOLOGY                                      2
                                                                               
   1.10 COLLABORATION TARGET-SPECIFIC TECHNOLOGY                               2
                                                                               
   1.11 COLLABORATION TECHNOLOGY                                               2
                                                                               
      1.11.1 Collaboration Patent Rights                                       2
      1.11.2 Collaboration Know-How                                            3
                                                                               
   1.12 COLUMBIA LICENSE                                                       3
                                                                               
   1.13 COMBINATION PRODUCT                                                    3
                                                                               
   1.14 DERIVATIVE COMPOUND                                                    3
                                                                               
   1.15 DEVELOPMENT CANDIDATE                                                  3
                                                                               
   1.16 DISCOVERY LIBRARY                                                      3
                                                                               
      1.16.1 Collaboration Discovery Library                                   3
      1.16.2 SP Discovery Library                                              3
                                                                               

   1.17 EXCLUSIVITY PERIOD                                                     3
                                                                               
   1.18 FDA                                                                    4
                                                                               
   1.19 FIRST COMMERCIAL SALE                                                  4
                                                                               
   1.20 FTE                                                                    4
                                                                               
   1.21 HRD                                                                    4
                                                                               
   1.22 IND                                                                    4
                                                                               
   1.23 LEAD COMPOUND                                                          4
                                                                               
   1.24 LIBRARY                                                                4
                                                                               
   1.25 LIBRARY COMPOUND                                                       4
                                                                               
   1.26 MAJOR MARKET                                                           4

                                                                             -i-
<PAGE>
 
   1.27 NDA                                                                    4
                                                                              
   1.28 NET SALES                                                              4
                                                                              
   1.29 OPTIMIZATION LIBRARY                                                   5
                                                                              
   1.30 PHARMACOPEIA CHANGE IN CONTROL                                         5
                                                                              
   1.31 PHARMACOPEIA ENABLING TECHNOLOGY                                       5
                                                                              
   1.32 PHARMACOPEIA TECHNOLOGY                                                5
                                                                              
      1.32.1 Existing Pharmacopeia Patent Rights                               5
      1.32.2 Existing Pharmacopeia Know-How                                    6
      1.32.3 Pharmacopeia Improvements                                         6
                                                                              

   1.33 PHASE III                                                              6
                                                                              
   1.34 PRODUCT                                                                6
                                                                              
   1.35 REGULATORY APPROVAL                                                    6
                                                                              
   1.36 SCHERING COMPOUND                                                      6
                                                                              
   1.37 SCHERING TECHNOLOGY                                                    6
                                                                              
      1.37.1 Schering Patent Rights                                            6
      1.37.2 Schering Know-How                                                 7
      1.37.3 Schering Improvements                                             7
                                                                              
   1.38 SP PRODUCT                                                             7
                                                                              
   1.39 SUBLICENSEE                                                            7
                                                                              
   1.40 TARGET                                                                 7
                                                                              
   1.41 TERRITORY                                                              7
                                                                              
   1.42 THIRD PARTY                                                            7
                                                                              
   1.43 US AGREEMENT                                                           7
                                                                              
ARTICLE II - COLLABORATION                                                     8
                                                                              
   2.0 COLLABORATION EFFECTIVE DATE                                            8
                                                                              
   2.1 COLLABORATION RESEARCH PLAN                                             8
                                                                              
   2.2 COLLABORATION TERM                                                      8
                                                                              
      2.2.1 Extension of Collaboration Term                                    8
      2.2.2 Termination of Collaboration Upon Pharmacopeia                    
            Change in Control                                                  8
                                                                              
   2.3 PHARMACOPEIA RESPONSIBILITIES                                           8
                                                                              
   2.4 SPL RESPONSIBILITIES                                                    9
                                                                              
   2.5 COLLABORATION STAFFING                                                  9
                                                                              
      2.5.1 PHARMACOPEIA FTE COMMITMENTS                                       9
      2.5.2 SPL FTE COMMITMENTS                                               10
                                                                              
   2.6 ADDITIONAL COLLABORATION EXPENSES                                      10
                                                                              
      2.6.1 Capital Expenditures                                              10
      2.6.2 Third Party Licenses re Pharmacopeia Enabling Technology          11

                                                                            -ii-
<PAGE>
 
      2.6.3 Other Third Party Licenses                                        11
                                                                              
   2.7 RESERVED TARGETS                                                       11
                                                                              
   2.8 RECORD KEEPING AND INSPECTION OF RECORDS                               12
                                                                              
   2.9 LIBRARIES                                                              12
                                                                              
      2.9.0 Discovery Libraries                                               12
      2.9.1 Classification; Limit on SP Discovery Libraries                   12
      2.9.2 Identification of Targets                                         13
      2.9.3 Coded Targets                                                     13
      2.9.4 Targets for Optimization Libraries                                13
                                                                              
   2.10 COMPOUND IDENTIFICATION                                               13
                                                                              
   2.11 COPIES OF LIBRARIES                                                   13
                                                                              
   2.12 ACTIVE COMPOUNDS                                                      14
                                                                              
   2.13 RETAINED RIGHTS                                                       14
                                                                              
   2.14 PHARMACOPEIA INDEPENDENT RESEARCH ACTIVITIES                          14
                                                                              
      2.14.1 Activities Outside the Collaboration                             14
      2.14.2 Restrictions on Use of Collaboration Technology                  14
                                                                              
                                                                              
 ARTICLE III - COLLABORATION MANAGEMENT                                       14
                                                                              
   3.1 COLLABORATION COMMITTEE                                                14
                                                                              
   3.2 DESIGN OF LIBRARIES; FRESH LIBRARIES                                   15
                                                                              
   3.3 COLLABORATION COMMITTEE MEETINGS                                       15
                                                                              
   3.4 COLLABORATION COMMITTEE DECISIONS                                      15
                                                                              
   3.5 DEVELOPMENT STATUS; NOTICE OF SALE OF PRODUCTS                         16
                                                                              
   3.6 DILIGENCE                                                              16
                                                                              
                                                                              
 ARTICLE IV - LICENSES AND EXCLUSIVITY                                        16
                                                                              
   4.1 LICENSE TO SPL                                                         16
                                                                              
      4.1.1 Compounds and Products                                            16
      4.1.2 Collaboration Target-Specific Technology                          17
                                                                              
   4.2 SUBLICENSES                                                            17
                                                                              
   4.3 DIRECT AFFILIATE LICENSES                                              17
                                                                              
   4.4 COLLABORATION PLATFORM TECHNOLOGY                                      17
                                                                              
   4.5 THIRD PARTY RIGHTS                                                     17
                                                                              
      4.5.1 Pharmacopeia Third Party Activities                               17
      4.5.2 No Liability                                                      18
      4.5.3 Pharmacopeia Reports to SPL On Third Party Rights                 18
                                                                              
   4.6 COLUMBIA SUBLICENSE                                                    18
                                                                              
   4.7 COLLABORATION RESEARCH ACTIVITIES                                      18

                                                                           -iii-
<PAGE>
 
   4.8  PHARMACOPEIA'S USE OF LIBRARY COMPOUNDS FOR QUALITY CONTROL           19
                                                                              
   4.9  LIBRARY EXCLUSIVITY                                                   19
                                                                              
      4.9.1 Optimization Libraries                                            19
      4.9.2 SP Discovery Libraries                                            19
      4.9.3 Collaboration Discovery Libraries                                 19
      4.9.4 Extension of Exclusivity for Collaboration 
            Discovery Libraries                                               20
      4.9.5 Co-Exclusive Collaboration Discovery Libraries                    20
                                                                              

   4.10 NO OTHER PRODUCTS                                                     21
                                                                              
   4.11 LICENSE GRANT BACK FOR ABANDONED AGREEMENT COMPOUNDS                  21
                                                                              
                                                                              
   ARTICLE V - PAYMENTS                                                       21
   
   5.1  PAYMENTS BY SPL                                                       21
                                                                              
   5.2  COLLABORATION FUNDING                                                 21
                                                                              
      5.2.1 Funding During Year One                                           21
      5.2.2 Funding During Subsequent Years                                   21
      5.2.3 Increased FTE Requirements                                        21
      5.2.4 Wind-Down in Final Year                                           21
      5.2.5 Annual FTE Rate Adjustments                                       22
      5.2.6 Quarterly Adjustment                                              22
      5.2.7 Manner of Payment                                                 22
                                                                              
   5.3  MILESTONE PAYMENTS                                                    23
                                                                              
      5.3.1 Events and Amounts                                                23
         (a) Discovery Library Milestones                                     23
         (b) Optimization Library Milestones                                  23
      5.3.2 Lead Compound                                                     23
      5.3.3 Development Candidate                                             24
      5.3.4 Manner of Payment                                                 24
      5.3.5 Announcement of Milestones                                        24
                                                                              
   5.4  ROYALTIES                                                             24
                                                                              
      5.4.1 Base Royalty                                                      24
      5.4.2 Royalty Term for Agreement Products                               25
      5.4.3 Royalty Terms for SP Products                                     25
      5.4.4  Single Royalty; Non-Royalty Sales                                25
      5.4.5 Third Party Royalties                                             26
         (a) SPL Responsibilities                                             26
         (b) *                                                                26
      5.4.6 Compulsory Royalty Reductions                                     26
      5.4.7 Royalty Overpayment                                               26
                                                                              
   5.5  REPORTS; PAYMENT OF ROYALTY; PAYMENT EXCHANGE RATE                    
        AND CURRENCY CONVERSIONS                                              26
                                                                              
      5.5.1 Royalty Reports and Payments                                      26
      5.5.2 Payment Method                                                    27
      5.5.3 Place of Royalty Payment and Currency Conversions                 27
                                                                              
   5.6  MAINTENANCE OF RECORDS; AUDITS                                        27
                                                                              
      5.6.1 Records; Inspection                                               27

_________________

   *     CONFIDENTIAL TREATMENT REQUESTED

                                                                            -iv-
<PAGE>
 
   5.7 COORDINATION WITH PAYMENTS UNDER US AGREEMENT                          28
                                                                              
   5.8 TAX MATTERS                                                            28
                                                                              
      5.8.1 Withholding Taxes                                                 28
      5.8.2 Sales Taxes                                                       28
                                                                              
   5.9 PRODUCT DEVELOPMENT COSTS                                              28
                                                                              
                                                                              
 ARTICLE VI - PATENTS AND INVENTIONS                                          28
                                                                              
   6.1 OWNERSHIP OF SCHERING TECHNOLOGY AND PHARMACOPEIA TECHNOLOGY           28

   6.2 OWNERSHIP OF COLLABORATION TECHNOLOGY                                  29

   6.3 FILING, PROSECUTION AND MAINTENANCE OF PATENTS                         29

     6.3.1 Collaboration Technology                                           29
     6.3.2 Collaboration Platform Technology                                  29
     6.3.3 Schering Technology                                                29
     6.3.4 Pharmacopeia Technology                                            30
     6.3.5 Pharmacopeia's Rights Regarding Patents Relating 
           to Agreement Compounds                                             30

   6.4 COOPERATION                                                            30
                                                                              
      6.4.1 Cooperation                                                       30
                                                                              
   6.5 ENFORCEMENT                                                            31
                                                                              
      6.5.1 Notice                                                            31
      6.5.2 Collaboration Technology                                          31
      6.5.3 Collaboration Platform Technology                                 31
      6.5.4 Schering Technology and Pharmacopeia Technology                   31
      6.5.5 Cooperation; Costs and Recoveries                                 31
                                                                              
   6.6 INFRINGEMENT CLAIMS                                                    32
   
   6.7 CERTIFICATION UNDER DRUG PRICE COMPETITION AND 
       PATENT RESTORATION ACT                                                 32
   
   6.8 PATENT TERM RESTORATION                                                32
                                                                              
                                                                              
 ARTICLE VII - CONFIDENTIALITY                                                32
                                                                              
   7.1 CONFIDENTIAL INFORMATION                                               32
                                                                              
   7.2 PERMITTED USE AND DISCLOSURES                                          33
                                                                              
   7.3 RETURN OF CONFIDENTIAL INFORMATION                                     33
                                                                              
   7.4 NONDISCLOSURE OF TERMS                                                 33
                                                                              
   7.5 PUBLICATION                                                            33
                                                                              
   7.6 PHARMACOPEIA EMPLOYEES                                                 34


 ARTICLE VIII - REPRESENTATION, WARRANTIES AND COVENANTS                      34

   8.1 SPL                                                                    34

   8.2 PHARMACOPEIA                                                           34
                                                                              
   8.3 COMPLIANCE WITH AGREEMENT AND LAWS                                     35
                                                                              
                                                                             -v-
                                                                              
<PAGE>
 
   8.4  DISCLAIMER                                                            35
                                                                              
                                                                              
 ARTICLE IX - INDEMNIFICATION                                                 35

   9.1  INDEMNIFICATION BY SPL                                                35
                                                                              
   9.2  INDEMNIFICATION BY PHARMACOPEIA                                       36
                                                                              
   9.3  NO CONSEQUENTIAL DAMAGES                                              36
                                                                              
   9.4  PROCEDURE                                                             36
                                                                              
   9.5  INSURANCE                                                             36
                                                                              
                                                                              
 ARTICLE X - TERM AND TERMINATION                                             36

   10.1 TERM AND EXPIRATION                                                   36
                                                                            
   10.2 TERMINATION FOR CAUSE                                                 37
                                                                            
   10.3 TERMINATION UPON BANKRUPTCY OR INSOLVENCY                             37
                                                                            
   10.4 TERMINATION FOR PHARMACOPEIA CHANGE IN CONTROL                        38
                                                                            
   10.5 CONCURRENT TERMINATION WITH THE US AGREEMENT                          38
                                                                            
   10.6 EFFECT OF TERMINATION                                                 38
                                                                            
     10.6.1 Accrued Obligations                                               38
     10.6.2  Return of Materials                                              38
     10.6.3 Effect on Agreement Products                                      39
     10.6.4 Licenses                                                          39
        (a) Termination by Pharmacopeia Pursuant to Section 10.2              39
        (b) Termination by SPL Pursuant to Sections 10.2 or 10.3              39
        (c) Termination by Pharmacopeia Pursuant to Section 10.3              39
 

 (D) TERMINATION BY SCHERING PURSUANT TO SECTION 10.4                         39
 
     10.6.5 Surviving Provisions                                              39
                                                                              
 ARTICLE XI - MISCELLANEOUS                                                   40
                                                                              
   11.1 ASSIGNMENT                                                            40
                                                                              
   11.2 GOVERNING LAW                                                         40
                                                                              
   11.3  DISPUTE RESOLUTION                                                   40
                                                                              
   11.4 NO IMPLIED LICENSES                                                   40
                                                                              
   11.5 REPRESENTATION BY LEGAL COUNSEL                                       40
                                                                              
   11.6 WAIVER                                                                40
                                                                              
   11.7 INDEPENDENT CONTRACTORS                                               40
                                                                              
   11.8 SOLICITATION OF EMPLOYEES                                             41
                                                                              
   11.9 COMPLIANCE WITH LAWS                                                  41
                                                                              
                                                                            -vi-
<PAGE>
 
   11.10 EXPORT CONTROL                                                       41
                                                                              
   11.11 PATENT MARKING                                                       41
                                                                              
   11.12 NOTICES                                                              41
                                                                              
   11.13 FORCE MAJEURE                                                        42
                                                                              
   11.14 SEVERABILITY                                                         42
                                                                              
   11.15 COUNTERPARTS                                                         42
                                                                              
   11.16 CAPTIONS                                                             42
                                                                              
   11.17 COMPLETE AGREEMENT                                                   42
                                                                              
      11.17.1 Final Agreement and Amendments                                  43
      11.17.2 Relationship to US Agreement; Controlling Provisions            43
                                                                              
   11.18 RECORDING                                                            43
                                                                              
   11.19 FURTHER ACTIONS                                                      43


EXHIBIT A - CURRENCY CONVERSION

SCHEDULE 1.28 - Elements Of Fully Absorbed Manufacturing Costs

                                                                           -vii-
<PAGE>
 
                      COLLABORATION AND LICENSE AGREEMENT

     This COLLABORATION AND LICENSE AGREEMENT (the "Agreement"), effective as of
October 29, 1998 (the "Effective Date"), is made by and among: Pharmacopeia,
Inc., a Delaware corporation having its principal place of business at 3000 East
Park Boulevard, Cranbury, New Jersey 08512, (hereinafter referred to as
"Pharmacopeia"); and Schering-Plough Ltd., a Swiss corporation having its
principal place of business at Toepferstrasse 5, CH 6004, Lucerne, Switzerland,
(hereinafter referred to as "SPL").  Pharmacopeia and SPL are sometimes referred
to herein individually as a Party and collectively as the Parties.  References
to "SPL" and "Pharmacopeia" shall include their respective Affiliates (as
hereinafter defined).

     WHEREAS, Pharmacopeia has developed proprietary technologies relating to
the design and preparation of encoded compound libraries based upon
combinatorial chemistry; and

     WHEREAS, SPL and Pharmacopeia desire to collaborate to design, prepare and
screen compound libraries against SPL's biological targets; and

     WHEREAS, Pharmacopeia and SPL's Affiliate Schering Corporation have entered
into a collaboration and license agreement relating to the United States, its
territories, possessions and commonwealths, of even date herewith;

     NOW, THEREFORE, in consideration of the covenants, conditions, and
undertakings herein contained, SPL and Pharmacopeia hereby agree as follows:

                                   ARTICLE I
                                  DEFINITIONS

     As used in this Agreement, the following capitalized terms, whether used in
the singular or plural, shall have the respective meanings set forth below:

     1.1  "Acceptance" shall mean, with respect to an IND, NDA or HRD submitted
           ----------                                                
by or on behalf of SPL or its Affiliate or Sublicensee, notice by the FDA (or an
analogous regulatory authority in another country) that the IND, NDA or HRD has
been accepted for review by the FDA (or analogous regulatory authority). In the
event that the FDA (or analogous regulatory authority) is not required to
provide such a notice of acceptance of an IND, NDA or HRD, then "Acceptance"
shall be deemed to occur: (i) in the case of an IND, thirty (30) days following
the date of submission, or if previously rejected any resubmission, of such IND;
or (ii) in the case of an NDA or HRD, sixty (60) days following the date of
submission, or if previously rejected any resubmission, of such NDA or HRD,
unless in each case SPL or its Affiliates or Sublicensee receives notice from
the FDA (or analogous regulatory authority), during the applicable thirty (30)
or sixty (60) day period, that the NDA or HRD is not acceptable for review.

     1.2  "Active Compound" shall mean, except as otherwise provided in
           ---------------                                             
Section 2.12, a Library Compound that demonstrates activity against a specific
Target, which Library Compound (i) was found to have such activity at a
concentration set forth in the applicable Collaboration Research Plan during
screening of one or more Libraries by Pharmacopeia in the conduct of the
Collaboration or (ii) was found to have such activity during screening by or on
behalf of SPL.

     1.3  "Affiliate" shall mean any individual or entity directly or indirectly
           ---------
controlling, controlled by or under common control with, a Party to this
Agreement. For purposes of this Agreement, the direct or indirect ownership of
fifty percent (50%) or more of the outstanding voting

                                                                             -1-
<PAGE>
 
securities of an entity, or the right to receive fifty percent (50%) or more of
the profits or earnings of an entity shall be deemed to constitute control, or
if not meeting the preceding requirements, any company owned or controlled by or
owning or controlling Pharmacopeia or SPL at the maximum control or ownership
right permitted in a country where such company exists.  Such other relationship
as in fact results in actual control over the management, business and affairs
of an entity shall also be deemed to constitute control.

     1.4   "Agreement Compound" shall mean any Active Compound or Derivative
            ------------------
Compound as well as any compositions-of-matter claimed in patent applications
filed or patents issued under Article VI which claim an Active Compound or
Derivative Compound.

     1.5   "Agreement Product" shall mean any product containing an Agreement
            -----------------
Compound, including, without limitation, products for the therapeutic or
prophylactic treatment or prevention of diseases and conditions in human beings
or animals.

     1.6   "Collaboration" shall mean the research and drug discovery programs
            -------------                                            
to be performed at Pharmacopeia's facilities by SPL or Pharmacopeia under this
Agreement to discover Agreement Compounds for further development by SPL.

     1.7   "Collaboration Committee" shall have the meaning set forth in
            -----------------------
Section 3.1.

     1.8   "Collaboration Research Plan" shall have the meaning set forth in
            ---------------------------
Section 2.1.

     1.9   "Collaboration Platform Technology" shall mean Collaboration
            ---------------------------------                          
Technology relating to assays, compound screening methods and biological
research tools, in each case which are demonstrated to be broadly applicable
(i.e., can be readily applied and used in research directed to a variety of
pharmacologically distinct Targets); provided, however, that Collaboration
                                     --------  -------                    
Platform Technology shall not include any rights in or to (1) any of SPL's
Targets, (2) any Library Compounds, or (3) any Agreement Compounds.

     1.10  "Collaboration Target-Specific Technology" shall mean
            ----------------------------------------            
Collaboration Technology relating to assays, compound screening methods and
biological research tools, in each case which are discovered and developed
through Collaboration research directed to a specific Target, or a small number
of closely related Targets (e.g. a family of biological receptor subtypes), and
are not readily applicable to other types of Targets; provided, however, that
                                                      --------  -------      
Collaboration Target-Specific Technology shall not include any rights in or to
(1) any of SPL's Targets, (2) any Library Compounds,  or (3) any Agreement
Compounds.

     1.11  "Collaboration Technology" shall mean Collaboration Patent Rights and
            ------------------------
Collaboration Know-How.

           1.11.1  "Collaboration Patent Rights" shall mean: (i) all patents and
                    ---------------------------                                 
patent applications claiming any invention or discovery made by or on behalf of
Pharmacopeia in performance of the Collaboration (including, without limitation,
the synthesis and composition of matter of any Agreement Compound, or method of
use thereof); and (ii) any divisions, continuations, continuations-in-part,
reissues, reexaminations, extensions or other governmental actions which extend
any of the subject matter of the patent applications or patents in (i) above,
and any substitutions, confirmations, registrations, revalidations, or additions
of any of the foregoing, in each case, which is owned or controlled, in whole or
part, by license, assignment or otherwise by Pharmacopeia during the term of
this Agreement; provided, however, that Collaboration Patent Rights shall not
                --------  -------                                            
include any patents or patent applications which are Schering Technology,
Pharmacopeia Technology or Pharmacopeia Enabling Technology.

                                                                             -2-
<PAGE>
 
           1.11.2  "Collaboration Know-How" shall mean all proprietary ideas,
                    ----------------------                                   
inventions, data,  know-how, instructions, processes, formulas, materials,
expert opinion and information (including, without limitation, (i) biological,
chemical, physical and analytical data and information relating to Agreement
Compounds, and (ii) any structure-function data obtained from Library Compounds)
discovered and/or developed in performance of the Collaboration by or on behalf
of Pharmacopeia, in each case, to the extent Pharmacopeia has the right to
license or sublicense the same, and subject to any limitations and prohibitions
of such license or sublicense; provided, however, that Collaboration Know-How
                               --------  -------                             
shall not include Collaboration Patent Rights, Schering Technology, Pharmacopeia
Technology or Pharmacopeia Enabling Technology.

     1.12  "Columbia License" shall mean that certain License Agreement
            ----------------                                           
effective as of July 16, 1993, as amended and restated as of October 6, 1995,
entered by and between Pharmacopeia, Inc., the Trustees of Columbia University
in the City of New York and the Cold Spring Harbor Laboratory.

     1.13  "Combination Product" shall mean a Product which comprises two
            -------------------                                          
(2) or more active therapeutic ingredients at least one (1) of which is an
Agreement Compound or a Schering Compound.

     1.14  "Derivative Compound" shall mean any compound, other than a Library
            -------------------                                       
Compound, derived (a) by or on behalf of SPL, or (b) in the performance of the
Collaboration by Pharmacopeia, in each case from an Active Compound, and having
activity against the same Target as such Active Compound. As used herein, a
compound shall be deemed to have been "derived from" an Active Compound if it *.

     1.15  "Development Candidate" shall mean a Lead Compound or derivative
            ---------------------                                          
thereof which possesses the desirable properties of a therapeutic agent for the
prevention or treatment of a clinical condition, in the absence of required
safety trials necessary to begin human testing.

     1.16  "Discovery Library" shall mean a Library transferred to SPL pursuant
            -----------------                                         
to this Agreement for screening against one or more Targets and which is not an
Optimization Library.

           1.16.1  "Collaboration Discovery Library" shall mean a Discovery
                    -------------------------------
Library that is not an SP Discovery Library.

           1.16.2  "SP Discovery Library" shall mean a Discovery Library based
                    --------------------
on one or more specific SPL proprietary core structures which core structures
are (i) discovered, designed or developed by or on behalf of SPL without
assistance or information from Pharmacopeia or any Pharmacopeia employee, or
(ii) designed or developed by Pharmacopeia based on proprietary SPL structures
or structure-function data.

     1.17  "Exclusivity Period" shall mean, with respect to any Collaboration
            ------------------                                 
Discovery Library and for all Library Compounds contained in such Library, that
period commencing on the date Pharmacopeia first provides SPL notice that such
Collaboration Discovery Library is available to be shipped to SPL or Schering
Corporation. (the "Notice Date"), and continuing until *,
or such later date as may be established under Section 4.9.4 below.  In the
event that SPL is unable to accept delivery of any Collaboration Discovery
Library at the time of the applicable Notice Date, SPL may, upon written notice
to Pharmacopeia, delay delivery of such Collaboration Discovery Library, in
which case the Notice Date with respect to such Collaboration Discovery Library
shall be deemed to be the earlier of (i) the date that SPL notifies Pharmacopeia
that

__________________

*     CONFIDENTIAL TREATMENT REQUESTED

                                                                             -3-
<PAGE>
 
SPL is ready to accept delivery of the first plates from such Collaboration
Discovery Library or (ii) the date three (3) months after the original Notice
Date.

     1.18  "FDA" shall mean the United States Food and Drug Administration
            ---                                                           
or any corresponding foreign registration or regulatory authority.

     1.19  "First Commercial Sale" shall mean, with respect to any Product,
            ---------------------                                          
the first sale for end use of such Product in the Territory after receipt of the
requisite Regulatory Approval.

     1.20  "FTE" shall mean a full-time employee dedicated to the conduct
            ---                                                          
of the Collaboration or, in the case of less than full-time dedication, a full-
time equivalent person-year, based on a total of forty-six and one-fourth
(46.25) weeks or one thousand eight hundred fifty (1,850) hours per year, of
work on or directly related to the Collaboration.

     1.21  "HRD" shall mean a health registration dossier or its equivalent
            ---                                                            
covering an Agreement Product filed in any country outside the United States and
which is analogous to an NDA and including, where applicable, applications for
pricing, pricing reimbursement approval, labeling and Regulatory Approval.

     1.22  "IND" shall mean an Investigational New Drug application, as defined
            ---                                                        
U.S. Food, Drug and Cosmetic Act and the regulations promulgated thereunder for
initiating clinical trials in the United States, or any corresponding foreign
application, registration or certification.

     1.23  "Lead Compound" shall mean any Active Compound or Derivative
            -------------                                              
Compound with respect to which SPL or its Affiliates initiates a program of
medicinal chemistry to identify a Development Candidate based upon the structure
of such Active Compound or Derivative Compound.

     1.24  "Library" shall mean any chemical compound library prepared by
            -------                                                      
Pharmacopeia employees working on the Collaboration, and/or SPL employees
working at Pharmacopeia's facilities on the Collaboration,  under the terms of
this Agreement using (i) combinatorial chemistry techniques or (ii) such other
techniques as may, from time to time, be agreed by the Parties.

     1.25  "Library Compound" shall mean any compound which is contained in
            ----------------                                               
a Discovery Library or Optimization Library hereunder.

     1.26  "Major Market" shall mean Japan or any three (3) of the following
            ------------                                          
countries; France, Germany, Italy, Spain or the United Kingdom.

     1.27  "NDA" shall mean a New Drug Application, Product License
            ---                                                    
Application, or Biologic License Application, as defined in the U.S. Food Drug
and Cosmetics Act and regulations promulgated hereunder, or the equivalent filed
with the FDA seeking approval to market and sell a Product in the United States.

     1.28  "Net Sales" shall mean, with respect to each country in the
            ---------                                                 
Territory, the invoice price billed by SPL or its Affiliates, or their
respective Sublicensees, to Third Parties (whether an end-user, a distributor or
otherwise) for the sale of Products, and exclusive of intercompany transfers or
sales among SPL, its Affiliates and/or Sublicensees in the Territory, less the
reasonable and customary deductions from such gross amounts including: (i)
normal and customary trade, cash and quantity discounts, allowances and credits;
(ii) credits or allowances actually granted for damaged goods, returns or 
rejections of Product and retroactive price reductions; (iii) sales or similar
taxes (including duties or other governmental charges levied on, absorbed or
otherwise imposed on the sale of Product including, without limitation, value
added taxes or other governmental charges otherwise measured by the billing
amount, when included in billing); (iv) freight, postage, shipping, customs
duties and

                                                                             -4-
<PAGE>
 
insurance charges, when included in billing; (v) charge back payments and
rebates granted to managed health care organizations or their agencies, and
purchasers and reimbursers or to trade customers, including but not limited to,
wholesalers and chain and pharmacy buying groups;  (vi) commissions paid to
Third Parties other than sales personnel and sale representatives or sales
agents; and  (vii) rebates (or equivalents thereof) granted to or charged by
national, state or local governmental authorities in a country in the Territory.
In determining Net Sales of a Product any of the above discounts shall be
accounted for and apportioned based on the list price of each such Product.

     In the event that a Product is sold in the form of a Combination Product,
Net Sales for such Combination Product will be calculated by multiplying actual
Net Sales of such Combination Product by the fraction A/(A+B) where: A is the
invoice price of the Agreement Product and/or Schering Compound contained in the
Combination Product if sold separately by SPL, an Affiliate or Sublicensee; and
B is the invoice price of any other active therapeutic ingredients in the
Combination Product if sold separately by SPL, an Affiliate or Sublicensee.  In
the event that the Product is sold in the form of a Combination Product
containing one or more active therapeutic ingredients other than an Agreement
Product and/or Schering Compound and one or more such active therapeutic
ingredients of the Combination Product are not sold separately, then the above
formula shall be modified such that A shall be the fully allocated manufacturing
cost to SPL, its Affiliates or Sublicensee of the Agreement Product and/or
Schering Compound and B shall be the fully allocated manufacturing cost to SPL,
its Affiliate or Sublicensee of any other active therapeutic ingredients in the
combination, in each case, determined in accordance with the schedule of fully
allocated manufacturing costs set forth in Schedule 1.28.

     1.29  "Optimization Library" shall mean a Library based upon one or more
            --------------------                                        
Active Compound or Schering Compound structures, and which is designed to
optimize such structures with respect to activity against one or more specific
Targets.

     1.30  "Pharmacopeia Change in Control" shall mean any of the following:
            ------------------------------                       
(i) a reorganization, merger or consolidation of Pharmacopeia with a Major
Pharmaceutical Company if the shareholders of Pharmacopeia (determined
immediately prior to the reorganization, merger or consolidation taking effect)
hold, directly or indirectly, less than fifty percent (50%) of the surviving
corporation (determined immediately after such reorganization, merger or
consolidation takes effect); (ii) an acquisition by a Major Pharmaceutical
Company of direct or indirect beneficial ownership of voting stock of
Pharmacopeia representing more than fifty percent (50%) of the total current
voting power of Pharmacopeia then issued and outstanding; (iii) a sale of all or
substantially all the assets of Pharmacopeia to a Major Pharmaceutical Company;
or (iv) a liquidation or dissolution of Pharmacopeia. As used in this Section
1.30, the term "Major Pharmaceutical Company" shall mean any entity (including
any corporation, joint venture, partnership or unincorporated entity) having
annual sales of pharmaceutical products of at least five hundred million dollars
($500,000,000), as well as any Affiliates or division(s) of such entity, that is
engaged in the research, development, manufacturing, registration and/or
marketing of drug products that are approved under NDAs, HRDs, ANDAs or
Biologics License Applications.

     1.31  "Pharmacopeia Enabling Technology" shall mean the Columbia License
            --------------------------------                         
and any other proprietary technology owned or controlled by Pharmacopeia with
the right to grant sublicenses which is necessary or useful for the design,
preparation and use of Libraries.

     1.32  "Pharmacopeia Technology" shall mean Existing Pharmacopeia Patent
            -----------------------                                  
Rights, Existing Pharmacopeia Know-How, and Pharmacopeia Improvements (except
for Pharmacopeia Improvements which are Pharmacopeia Enabling Technology).

           1.32.1  "Existing Pharmacopeia Patent Rights" shall mean (i) all
                    -----------------------------------                    
patents and patent applications existing as of the Effective Date that claim the
synthesis or composition of matter of an

                                                                             -5-
<PAGE>
 
Active Compound, or the method of use thereof, and (ii) any divisions,
continuations, continuations-in-part, reissues, reexaminations, extensions or
other governmental actions which extend any of the subject matter of the patent
applications or patents in (i) above, and any substitutions, confirmations,
registrations, revalidations, or additions of any of the foregoing, in each
case, which is owned or controlled, in whole or part, by license, assignment or
otherwise by Pharmacopeia during the term of this Agreement, and subject to any
limitations and prohibitions of such license or sublicense; provided, however,
                                                            --------  ------- 
it is understood that Existing Pharmacopeia Technology shall not include any
Pharmacopeia Enabling Technology.

           1.32.2  "Existing Pharmacopeia Know-How" shall mean all ideas,
                    ------------------------------                       
inventions, data, know-how, instructions, processes, formulas, expert opinion
and information, including, without limitation, biological, chemical, physical
and analytical data and information, existing as of the Effective Date, owned or
controlled in whole or part by Pharmacopeia by license, assignment or otherwise,
which is necessary for the discovery, development, manufacture or use of
Agreement Compounds and/or the discovery, development, manufacture, use, sale or
commercialization of Agreement Products, in each case, to the extent
Pharmacopeia has the right to license or sublicense the same, and subject to any
limitations and prohibitions of such license or sublicense; provided, however,
                                                            --------  ------- 
that Existing Pharmacopeia Know-How shall not include Existing Pharmacopeia
Patent Rights or Pharmacopeia Enabling Technology.

           1.32.3  "Pharmacopeia Improvements" shall mean all patentable
                    -------------------------                           
inventions conceived and reduced to practice, solely or jointly, by Pharmacopeia
or SPL in the conduct of the Collaboration that are within the scope of a claim
of an issued patent within the Existing Pharmacopeia Patent Rights or
Pharmacopeia Enabling Technology (i) which patent issued prior to the Effective
Date or (ii) which claim has an effective filing date prior to the Effective
Date; provided, however, that Pharmacopeia Improvements shall not include
      --------  -------                                                  
Pharmacopeia Independent Technology (as defined in Section 2.14).

     1.33  "Phase III" shall mean Phase III clinical trials as prescribed
            ---------                                                    
by applicable FDA regulations, regardless of whether such trials are conducted
in the United States or elsewhere

     1.34  "Product" means any Agreement Product or SP Product.
            -------

     1.35  "Regulatory Approval" shall mean any applications or approvals,
            -------------------                                           
including any INDs, NDAs, supplements, amendments, pre- and post-approvals,
marketing authorizations based upon such approvals (including any prerequisite
manufacturing approvals or authorizations related thereto) and labeling
approval(s), technical, medical and scientific licenses, registrations or
authorizations of any national, supra-national (e.g. the European Commission,
the Council of the European Union, or the European Agency for the Evaluation of
Medicinal Products), regional, state or local regulatory agency, department,
bureau, commission, council or other governmental entity, necessary for the
manufacture, distribution, use, import, export or sale of Product(s) in the
Territory.

     1.36  "Schering Compound" shall mean a compound which is independently
            -----------------                                              
discovered by or on behalf of SPL, without the use of Collaboration Technology
or Pharmacopeia Technology as demonstrated by documented evidence created at the
time of such discovery, and which is active against a specific Target.

     1.37  "Schering Technology" shall mean Schering Patent Rights, Schering
            -------------------
Know-How and Schering Improvements.

           1.37.1  "Schering Patent Rights" shall mean (i) all existing patents
                    ----------------------                                     
and patent applications owned or controlled in whole or in part by SPL or its
Affiliates as of the Effective Date (including, without limitation, those which
claim the synthesis or composition of matter of an Active Compound, or the
method of use thereof, or which relate to any Target or any assay provided by
SPL

                                                                             -6-
<PAGE>
 
for use in the Collaboration or the corresponding Targets for such assays), (ii)
all patents and patent applications claiming any invention or discovery made by
or behalf of SPL or its Affiliates, other than in performance of the
Collaboration, in connection with the discovery and/or development of any
Agreement Compounds and/or Schering Compounds, and/or the development and
commercialization of any Product, and (iii) any divisions, continuations,
continuations-in-part, reissues, reexaminations, extensions or other
governmental actions which extend any of the subject matter of the patent
applications or patents in (i) or (ii) above, and any substitutions,
confirmations, registrations, revalidations, or additions of any of the
foregoing.

           1.37.2  "Schering Know-How" shall mean all ideas, inventions, data,
                    -----------------                                         
know-how, instructions, processes, formulas, materials, expert opinion and
information, including, without limitation, biological, chemical,
pharmacological, toxicological, pharmaceutical, physical and analytical,
clinical, safety, manufacturing and quality control data and information (except
for any of the above arising in performance of the Collaboration) owned or
controlled in whole or part by SPL by license, assignment or otherwise, which is
necessary for the discovery, development, manufacture, use, sale or
commercialization of Products, in each case, to the extent SPL has the right to
license or sublicense the same, and subject to any limitations and prohibitions
of such license or sublicense; provided, however, that Schering Know-How does
                               --------  -------                             
not include Schering Patent Rights.

           1.37.3  "Schering Improvements" shall mean all patentable inventions
                    ---------------------                                      
conceived and reduced to practice solely or jointly by SPL or Pharmacopeia in
the conduct of the Collaboration that are within the scope of the claims of any
issued patent within the Schering Patent Rights (i) which patent issued prior to
the Effective Date or (ii) which claim has an effective filing date prior to the
Effective Date.

     1.38  "SP Product" shall mean any product for the therapeutic or
            ----------                                               
prophylactic treatment or prevention of diseases and conditions in human beings
containing a Schering Compound, provided such SP Product  is not a Combination
Product containing both a Schering Compound and an Agreement Compound.

     1.39  "Sublicensee" shall mean with respect to a particular Product, a
            -----------                                                    
Third Party to whom SPL has granted a sublicense under the applicable
Pharmacopeia Technology, Schering Technology or Collaboration Technology to
make, use and/or sell such Product.  As used in this Agreement, it is understood
that "Sublicensee" shall also include a Third Party or Third Parties to whom SPL
has granted the right to distribute such Product, provided that such Third Party
or parties has (have) the primary responsibility for marketing and promotion at
its (their) expense of such Product within the field or territory for which such
distribution rights are granted, which marketing and promotional activities are
not subsidized directly or indirectly by SPL.

     1.40  "Target" shall mean a biomolecular entity (including, without
            ------                                                      
limitation, receptors, enzymes, nucleic acids and proteins, and/or fragments
thereof) that a small molecule is screened against in order to determine whether
the small molecule demonstrates a specific biochemical or pharmaceutical effect.

     1.41  "Territory" shall mean the shall mean all the countries and
            ---------                                                 
territories in the world except for the United States and its territories,
possessions and commonwealths.

     1.42  "Third Party" shall mean any Party other than Pharmacopeia and its
            -----------                                                   
Affiliates, Schering-Plough Ltd. and its Affiliates, Schering Corporation and
its Affiliates, and their permitted assigns.

     11.43 "US Agreement" shall mean that certain Collaboration and License
            ------------
Agreement entered into by and between Pharmacopeia and Schering Corporation of
even date herewith.

                                                                             -7-
<PAGE>
 
                                  ARTICLE II
                                 COLLABORATION

     2.0  Collaboration Effective Date.  The Parties wish Pharmacopeia to begin
     ---------------------------------                                         
performance of the Collaboration effective as of October 1, 1998 (the
"Collaboration Effective Date") and agree that upon execution of this Agreement
on the Effective Date the Parties' respective obligations relating to
performance of the Collaboration hereunder shall be deemed to be effective as of
the Collaboration Effective Date.  Notwithstanding the foregoing, the
effectiveness of this Agreement is expressly conditioned upon the Board of
Directors of Schering-Plough Corporation approving this Agreement and the
execution of this Agreement by the Parties on the Effective Date.

     2.1  Collaboration Research Plan.  Within thirty (30) days of the Effective
     --------------------------------                                           
Date, the Collaboration Committee shall agree upon a written overall plan for
the research and drug discovery activities to be conducted by the Parties (the
"Collaboration Research Plan").  The Collaboration Research Plan shall be
periodically revised and updated (at least annually) by the Collaboration
Committee during the term of the Collaboration.  The Collaboration Research Plan
shall set forth the responsibilities of each of the Parties with respect to
performance of the Collaboration.  The Collaboration Committee shall have
responsibility for monitoring the performance of Collaboration research
programs.  Notwithstanding the foregoing, the Parties acknowledge and agree
that, subject to Section 2.7 below, SPL, in its sole discretion, shall have
primary responsibility and decision making authority with respect to the
selection of the Targets and specific research programs to be conducted during
the Collaboration.

     2.2  Collaboration Term.  The term of the Collaboration shall be for a
     -----------------------                                               
period of five (5) years unless extended pursuant to Section 2.2.1, or earlier
terminated pursuant to Section 2.2.2 or Article X.

          2.2.1  Extension of Collaboration Term.  SPL shall have the right, in
          --------------------------------------                               
its sole discretion, to extend the Collaboration for an additional * period by
providing written notice to Pharmacopeia on or before the * of the Collaboration
Effective Date. If SPL does not provide such notice, the Collaboration shall
expire on the fifth anniversary of the Collaboration Effective Date.

          2.2.2  Termination of Collaboration Upon Pharmacopeia Change in
          ---------------------------------------------------------------
Control.  In the event of a Pharmacopeia Change in Control during the term of
-------                                                                      
the Collaboration, SPL shall have the right, in its discretion, (i) to terminate
the Agreement pursuant to Section 10.4, below, or (ii) to terminate the
Collaboration and not the Agreement upon ninety (90) days written notice to
Pharmacopeia after such Change in Control expressly stating its intention to
terminate the Collaboration.  In the event that SPL elects to terminate the
Collaboration and not the Agreement, then  (a) SPL will not be obligated to make
the payments set forth in Section 5.2 for the period after the effective date of
such termination, (b) subject to Sections 2.10 and 2.11, Pharmacopeia shall not
be obligated to conduct any Collaboration research activities after the
effective date of such termination, and (c) the remaining terms and conditions
of this Agreement, including without limitation the licenses and royalty
obligations set forth herein, shall remain in full force and effect until the
Agreement expires or is terminated as set forth in Article X, below.

     2.3  Pharmacopeia Responsibilities.  Pharmacopeia shall use commercially
     ----------------------------------                                      
reasonable efforts to provide:

          (i)  the number of scientist FTEs agreed to by the Parties, as set
forth in Section 2.5, and such additional scientists as may be mutually agreed
to in writing by the Parties and paid for by

__________________

*     CONFIDENTIAL TREATMENT REQUESTED

                                                                             -8-
<PAGE>
 
SPL, for performance of the Collaboration during each year of the Collaboration
(it being understood and agreed that FTEs provided by Pharmacopeia for the
Collaboration under the US Agreement shall also be deemed to be provided to this
Collaboration for purposes of determining the number of FTEs provided by
Pharmacopeia hereunder);

          (ii)   research facilities, laboratories and equipment sufficient to
enable the Collaboration scientists (including Pharmacopeia employees and one
(1) SPL employee to be provided pursuant to Section 2.4(i)) to perform the
Collaboration in a fashion similar to the operation of Pharmacopeia's own
operations, and which shall be located in dedicated laboratories at
Pharmacopeia's research facilities in Monmouth Junction, New Jersey;

          (iii)  access to Pharmacopeia Enabling Technology by the Pharmacopeia
scientists working on the Collaboration and by SPL scientists, if any, working
on the Collaboration at Pharmacopeia's facilities as set forth in Section 2.4,
as Pharmacopeia, in its discretion, deems is reasonably necessary and useful for
the optimal performance of the Collaboration;

          (iv)   administrative services necessary to conduct the business of
the Collaboration in a manner comparable to that of Pharmacopeia's own business
activities; and

          (v)    during the term of the Collaboration, on an as needed basis, up
to an additional * miscellaneous FTEs, at Pharmacopeia's expense, to assist with
SPL's requests for Library plate production and/or Library Compound decodes
pursuant to Sections 2.10 and 2.11, which additional FTEs shall not be dedicated
FTEs assigned to the Collaboration and shall not be included in the FTE
allocations set forth in Section 2.5.

It is understood and agreed that, except as may be mutually agreed by the
Parties, Pharmacopeia shall not be obligated hereunder to conduct research or
development activities in the Collaboration which are outside the scope of the
Collaboration Research Plan.

     2.4  SPL Responsibilities.  SPL shall provide research funding for the
     -------------------------                                             
Collaboration as set forth in Section 5.1 and shall use commercially reasonable
efforts to provide:

          (i)    one scientific director provided by Schering Corporation, in
combination with Schering-Plough, Ltd., to work full-time at Pharmacopeia during
the term of the Collaboration managing the day-to-day operations of the
Collaboration (the "Collaboration Director"); and

          (ii)   additional support for Collaboration research projects,
including, without limitation, scientists, facilities and materials to perform
biological research to identify Targets, assay development, Library screening,
medicinal chemical research and analytical support services.

     2.5  Collaboration Staffing.
     --------------------------- 

          2.5.1  Pharmacopeia FTE Commitments.  Pharmacopeia will provide *
          -----------------------------------                              
FTEs at the start of the first year of the Collaboration consisting of
* chemists and *   biologists (each of which shall be a *
and * miscellaneous FTEs to handle Library production, engineering,
decoding, quality control, etc. for the Collaboration (which
miscellaneous FTEs *.
During the first quarter of the 1999 calendar year, Pharmacopeia will
add an additional * FTEs to the Collaboration from personnel currently assigned
to work on research projects under the December 22, 1994 Collaboration Agreement
between Pharmacopeia, Schering Corporation and Schering-Plough Ltd. The total
number of Collaboration FTEs shall be increased to *, consisting of * chemists,
* biologists and * 
miscellaneous FTEs, by the start of the second year of the Collaboration.
Subject to the wind-down

__________________

*     CONFIDENTIAL TREATMENT REQUESTED

                                                                             -9-
<PAGE>
 
provisions set forth in Section 5.2.4, Pharmacopeia shall continue to provide *
FTEs to the Collaboration during each subsequent year of the Collaboration, or
such other number as the Parties shall agree upon in writing.  With the
exception of the * FTEs responsible for support activities for the Collaboration
(such as Library production, engineering,  decoding, quality control, etc.), all
of the Pharmacopeia FTEs assigned to work on the Collaboration *
In the event that SPL determines that it will be
unable to screen the number of Discovery Libraries anticipated to be delivered
in year *
of the Collaboration *,
SPL may, upon written notice to Pharmacopeia at least six (6) months prior to
the beginning of such year, reduce the number of chemistry FTEs to be provided
to the Collaboration by Pharmacopeia in such year; provided, however, that such
                                                   --------  -------           
reduction shall be in whole FTE increments, and SPL shall not so reduce the
number of chemistry FTEs to be provided by Pharmacopeia to less than eighty
percent (80%) of the number of Pharmacopeia chemistry FTEs assigned to the
Collaboration at the time of such notice.  On or before the Effective Date
Pharmacopeia will provide to SPL a list individually identifying those
Pharmacopeia FTEs assigned to the Collaboration, which list shall be updated
from time to time during the term of the Collaboration as FTEs assigned to work
exclusively for the Collaboration are added, removed and/or replaced.  It is
understood that, in the aggregate, the education, training and experience levels
of Pharmacopeia FTEs assigned to the Collaboration will be reasonably
representative of Pharmacopeia employees working on Pharmacopeia's internal
research programs.  Within fifteen (15) business days after the Effective Date,
Pharmacopeia will provide SPL with: (i) a copy of the * Collaboration; and (ii)
Pharmacopeia's written representation and warranty that *.

          2.5.2  SPL FTE Commitments.  During the term of the Collaboration SPL
          --------------------------                                           
shall, in combination with Schering Corporation under the US Agreement, provide
a single scientific director as set forth in Section 2.4(i).  Such director
shall be subject to Pharmacopeia's confidentiality restrictions such as limited
access to laboratories and access only to data that specifically relate to the
Collaboration.  It is understood that the scientific director shall remain an
employee of Schering Corporation, and that SPL shall remain responsible for, and
indemnify Pharmacopeia for any claims arising from or relating to, the conduct,
activities, salary and benefits of such director, except to the extent caused by
the gross negligence or willful misconduct of Pharmacopeia.  In addition, SPL
shall provide such additional FTEs located at SPL's research facilities as SPL
determines, in its sole discretion, are reasonably necessary to support the
ongoing research programs of the Collaboration, including, without limitation,
assay development, screening, medicinal chemistry, analytical services and
animal testing services.

     2.6  Additional Collaboration Expenses.
     -------------------------------------- 

          2.6.1  Capital Expenditures.  In the event that the Parties determine
          ---------------------------                                          
that one or more Collaboration research projects to be performed at
Pharmacopeia, as identified in the Collaboration Research Plan, will require
Pharmacopeia to incur unanticipated reasonable out-of-pocket expenses in
connection with such research project(s) for capital expenditures on specialized
equipment, the Parties shall agree on the additional monies to be paid by SPL to
Pharmacopeia therefor. It is understood and agreed that Pharmacopeia shall not
be obligated hereunder to pay any such unanticipated capital expenditures
without its express consent, and that the failure of Pharmacopeia to conduct
research activities that cannot be performed without such expenditures shall not
constitute a breach of this Agreement. It is further understood and agreed that
SPL may, by providing written notice, prohibit Pharmacopeia from using
specialized equipment acquired pursuant to this Section 2.6.1, and for which SPL
has paid and/or reimbursed Pharmacopeia for all of the acquisition costs and
major operating costs, for activities outside of the Collaboration. The Parties
acknowledge and agree that, at SPL's

__________________

*     CONFIDENTIAL TREATMENT REQUESTED

                                                                            -10-
<PAGE>
 
option, SPL may elect to provide on loan to Pharmacopeia any such specialized
equipment required for performance of the Collaboration, which equipment shall
be returned to SPL upon termination of the Collaboration.

          2.6.2  Third Party Licenses re Pharmacopeia Enabling Technology.  In
          --------------------------------------------------------------     
the event that the Parties agree that it is necessary for Pharmacopeia to obtain
any license from a Third Party to Pharmacopeia Enabling Technology (existing as
of the Effective Date) for the performance of Library encoding and/or decoding
in connection with one or more Collaboration research projects, SPL shall pay to
Pharmacopeia SPL's equitable share of any amounts paid by Pharmacopeia pursuant
to such license.  Pharmacopeia shall provide SPL notice of such payment
obligations and invoice SPL for such costs and SPL shall pay the invoice within
* days.  SPL's share, which may be subject to adjustment periodically, shall be
determined by ascertaining the independent value the licensed technology has to
Pharmacopeia and Third Parties collaborating with Pharmacopeia, as reasonably
determined by Pharmacopeia, and apportioning the license costs between
Pharmacopeia, SPL and such Third Parties in an equitable manner; provided,
                                                                 --------  
however, that SPL may reduce any royalty otherwise due Pharmacopeia hereunder to
-------
reimburse it for any royalties actually paid to Pharmacopeia pursuant to this
Section 2.6.2, as set forth below. The amount of the reduction shall be equal to
*    of the royalty paid to Pharmacopeia pursuant to this Section 2.6.2, but in
no event shall the royalty due Pharmacopeia for any calendar quarter, with
respect to any Product, be thereby reduced to less than * of the royalty due
Pharmacopeia under Section 5.4.1 with respect to Net Sales of such Product. In
the event that Pharmacopeia enters into a royalty-bearing license or agreement
during the term of this Agreement with respect to Pharmacopeia Enabling
Technology, and SPL does not approve and agree to pay for its equitable share of
such license or agreement within * days after a request by Pharmacopeia, the
subject matter covered by such license or agreement shall not be within this
Agreement for any purpose

          2.6.3  Other Third Party Licenses.  In the event that the Parties
          ---------------------------------                                
agree that it is necessary for Pharmacopeia to obtain a license (except for any
licenses relating to Pharmacopeia Enabling Technology obtained pursuant to
Section 2.6.2) from a Third Party in order to perform one or more Collaboration
research projects selected by SPL, the Parties shall agree on the respective
amounts to be paid by SPL and Pharmacopeia to obtain any such license.  Each
Party's share of such license costs shall be determined by ascertaining the
independent value the licensed technology has to SPL (as reasonably determined
by SPL), and to Pharmacopeia and any Third Parties collaborating with
Pharmacopeia (as reasonably determined by Pharmacopeia) and apportioning the
license costs between Pharmacopeia, SPL and such Third Parties in an equitable
manner.  It is understood and agreed that Pharmacopeia shall not be obligated
hereunder to pay for any such license without its express consent, and that the
failure of Pharmacopeia to conduct research activities that cannot be performed
without such license shall not constitute a breach of this Agreement.  It is
further understood and agreed that, in the event that no Third Parties have
shared in the costs and SPL has paid and/or reimbursed Pharmacopeia for all of
the costs of such licenses, SPL shall have the right, by providing written
notice, to prohibit Pharmacopeia from using licensed technology, or other
license rights, acquired pursuant to this Section 2.6.3 for activities outside
of the Collaboration.

     2.7  Reserved Targets.  The Parties acknowledge that , as of the Effective
     ---------------------                                                     
Date, there are certain Targets with respect to which Pharmacopeia may have
obligations under its existing agreements with Third Parties, and that
Pharmacopeia will not conduct certain research activities with respect to such
Targets in connection with the Collaboration (each such Target a "Reserved
Target").  SPL shall not knowingly request Pharmacopeia to develop assays with
respect to, or screen any Libraries against, such Reserved Targets.  *
          In the event that during the term of the Collaboration Pharmacopeia's
Third Party obligations with respect to a given Reserved Target expire, or such
Reserved Target otherwise becomes available for unrestricted use in the
Collaboration, Pharmacopeia shall promptly notify SPL and such Target shall
thereafter cease to be a Reserved Target. It is further

__________________

     *     CONFIDENTIAL TREATMENT REQUESTED

                                                                            -11-
<PAGE>
 
understood and agreed that, notwithstanding any other provision of this
Agreement, Pharmacopeia shall not be obligated to conduct any activities in
performance of the Collaboration that would constitute a breach of any of its
obligations to any Third Party.

     2.8  Record Keeping and Inspection of Records.  Each of SPL and
     ---------------------------------------------                  
Pharmacopeia, and their respective Affiliates, shall maintain records of its
Collaboration activities (or cause such records to be maintained) in sufficient
detail and in good scientific manner appropriate for patent and regulatory
purposes as will properly reflect all work performed and the results achieved in
performance of the Collaboration.  SPL shall also maintain analogous records of
its development activities with respect to Agreement Compounds and Agreement
Products.  Such records may include books, records, reports, research notes,
charts, graphs, comments, computations, analyses, recordings, photographs,
computer programs and documentation thereof, computer information storage media,
samples of materials and other graphic or written data generated in connection
with the Collaboration, including any data required to be maintained pursuant to
all requirements of applicable laws, rules and regulations, or as directed by
the Collaboration Committee.  Pharmacopeia's records shall also document by name
which individuals assigned to the Collaboration pursuant to Section 2.5.1 are
working on each specific Collaboration research project (identifying the
Target(s) involved, to the extent known by Pharmacopeia at the time of the
research).  During the Collaboration and for *  years thereafter, each of SPL
and Pharmacopeia shall have the right, upon at least five (5) business days'
prior notice, to inspect all such records of the other Party (or legible copies
thereof) during normal business hours. Each Party's rights under this Section
2.8 shall be limited to one (1) inspection in any calendar year. In each case,
the Party conducting the inspection shall maintain such records and the
information disclosed therein in confidence in accordance with Section 7.1, and
shall use such information solely for purposes of this Agreement. Upon request
and tender of payment for the actual cost in providing copies, Pharmacopeia
and/or SPL, as appropriate, shall provide to the requesting Party copies of such
records

     2.9  Libraries.
     -------------- 

          2.9.0  Discovery Libraries.  A Discovery Library is generally a large
          --------------------------                                           
collection of compound (typically containing anywhere from 10,000 to 100,000
compounds, but more typically around 30,000 to 50,000 compounds) prepared by
combinatorial chemistry techniques based on one or more core structures such
that the compounds in the library represent a number of structurally diverse
classes of compounds useful for screening against a variety of Targets.  The
selection of core structures and the design of Discovery Libraries based thereon
are generally handled such that the compounds contained in the Discovery Library
are novel compounds (i.e, are not generally known and have not been included in
compound libraries previously prepared by Pharmacopeia).  The Parties
acknowledge and agree (i) that the Discovery Library descriptions set forth in
this Section 2.9.0 represent general guidelines for the size and composition of
Discovery Libraries, (ii) that SPL and Pharmacopeia will generally be
cooperating in the design of Discovery Libraries, and that Discovery Libraries
prepared for the Collaboration may therefore vary from the general guidelines
set forth herein, and (iii) that nothing in the Section 2.9.0 shall be construed
as a commitment or representation by Pharmacopeia that any given Discovery
Library prepared for the Collaboration will conform to such guidelines.

          2.9.1  Classification; Limit on SP Discovery Libraries.  At the time
          ------------------------------------------------------              
SPL and Pharmacopeia agree that Pharmacopeia will prepare and provide to SPL any
given Library, SPL and Pharmacopeia shall agree upon the appropriate
classification of such Library as a Collaboration Discovery Library, SP
Discovery Library, or Optimization Library.  It is understood and agreed that
the number of SP Discovery Libraries provided to SPL in a given year during the
term of the Collaboration * in
such year without the prior written consent of Pharmacopeia. It is further
understood and agreed that if the *

__________________

*     CONFIDENTIAL TREATMENT REQUESTED

                                                                            -12-
<PAGE>
 
*, for all purposes of this Agreement, unless otherwise agreed in writing by the
Parties.  In determining the number of SP Discovery Libraries and total number
of all Discovery Libraries for purposes of this Section, *.

           2.9.2  Identification of Targets.  At the time that SPL notifies
           --------------------------------                                
Pharmacopeia of an Active Compound from any Library pursuant to Section 2.12,
SPL shall also notify Pharmacopeia of the applicable Target(s) (in coded form
only) and the general therapeutic area relevant to such Target.

           2.9.3  Coded Targets.  To the extent that SPL identifies Targets to
           --------------------                                               
Pharmacopeia in coded form pursuant to Section 2.9.2, SPL shall use a unique
code for each Target, and shall not use more than one code to identify the same
Target unless SPL tells Pharmacopeia that more than one code identifies the same
Target and specifies the applicable codes.  SPL shall have no obligation to
disclose to Pharmacopeia the identity of any Targets on a non-coded basis prior
to the publication of a patent application disclosing both (i) the structure of
an Active Compound having activity against the Target and (ii) the identity of
the Target.  If, at any time, SPL has identified a Target to Pharmacopeia on a
non-coded basis, SPL shall identify the codes, if any, that SPL had used to
identify such Target, and shall thereafter only identify such Target on a non-
coded basis.

           2.9.4  Targets for Optimization Libraries.  At the time that SPL and
           -----------------------------------------                           
Pharmacopeia initiate the design and preparation of an Optimization Library, SPL
shall identify the Target (in coded form only) and the relevant general
therapeutic area for which the Optimization Library is being prepared.

     2.10  Compound Identification.  Following SPL's screening of the Discovery
     -----------------------------                                             
Libraries and/or Optimization Libraries, at SPL's request, during the term of
this Agreement (for so long as Pharmacopeia's business operations include
preparing and providing libraries and related services), Pharmacopeia shall
decode and identify to SPL any Library Compound in such Libraries that
demonstrates activity in SPL's screening assays; provided, however, Pharmacopeia
                                                 --------  -------              
shall have no obligation (i) to decode more Library Compounds than can
reasonably be accomplished by * Pharmacopeia FTEs, in conjunction with their
other assigned tasks in the Collaboration.  *
If SPL requests the decoding of additional Library Compounds during the
Collaboration, or requests any decoding after the end of the Collaboration, then
Pharmacopeia shall decode such compounds and invoice SPL for the actual direct
labor and material costs associated with, and other allocated costs directly
required for, such decoding, and SPL shall pay such invoice within *days of
receipt.

     2.11  Copies of Libraries.  Until the exhaustion of all copies of a
     -------------------------                                          
particular Library, SPL may provide Pharmacopeia notice that SPL wishes to
obtain sets of plates from such Library containing sufficient quantities of
compounds to perform an agreed number of assays, and Pharmacopeia will deliver
such plates to SPL as soon as practicable; provided, however, that during the
                                           --------  -------                 
term of the Collaboration, Pharmacopeia shall have no obligation to prepare more
such Library plates than can reasonably be accomplished by * Pharmacopeia FTEs,
in conjunction with their other assigned tasks in the Collaboration. * If SPL
requests the preparation of additional Library plates during the Collaboration,
or requests any preparation of such Library plates after the end of the
Collaboration, then Pharmacopeia shall prepare such plates and invoice SPL for
the actual direct labor and material costs associated with, and other allocated
costs directly required for, such preparation, and SPL shall pay such invoice
within * days of receipt. Following the exhaustion of all copies of a

__________________

     *     CONFIDENTIAL TREATMENT REQUESTED

                                                                            -13-
<PAGE>
 
Library, SPL may request a further set of plates for any such Library, and the
Parties shall negotiate in good faith the terms on which such plates may be
provided.

     2.12  Active Compounds.  Any Library Compound identified as meeting the
     ----------------------                                                 
definition of an Active Compound through (i) screening of one or more Libraries
by Pharmacopeia and/or SPL in the conduct of the Collaboration, or (ii)
screening of one or more Libraries by SPL after the term of the Collaboration,
shall be an Active Compound.  It is understood that no grant of any licenses by
Pharmacopeia to SPL, its Affiliates or Sublicensees under Section 4.1 with
respect to any Library Compound shall become effective unless and until
Pharmacopeia has received notice that such Library Compound is an Active
Compound.  Pharmacopeia shall be deemed to have received such notice effective
upon receipt of a request by SPL to decode a Library Compound.  In the event
that SPL or its Affiliates or Sublicensees identifies, without decoding by
Pharmacopeia pursuant to Section 2.10, a particular Library Compound with
activity against a Target, SPL shall give Pharmacopeia notice identifying such
Library Compound as an Active Compound, which notice shall be effective upon
receipt by Pharmacopeia.  Notwithstanding the foregoing, any Active Compound
that is subject to a license by Pharmacopeia to a Third Party (as set forth in
Section 4.5 or 4.9.5) granted prior to the time the Library Compound is decoded
as set forth in Section 2.10 above or,  with respect to a Library Compound which
is not decoded, the time that Pharmacopeia receives actual notice from SPL as
set forth in this Section 2.12, shall not be deemed to be licensed to SPL under
Section 4.1.

     2.13  Retained Rights.  Subject to the rights and licenses granted to SPL
     ---------------------                                                    
hereunder, and the limitations expressly set forth in Section 4.6, Pharmacopeia
shall retain ownership of the tangible property embodied in the encoded
Discovery Libraries and Optimization Libraries.

     2.14  Pharmacopeia Independent Research Activities.
     -------------------------------------------------- 

           2.14.1  Activities Outside the Collaboration.  The Parties
           --------------------------------------------
acknowledge that during and after the term of the Collaboration Pharmacopeia may
(either alone or in collaboration with one or more Third Parties) perform
independent research and development activities with respect to Targets,
including, without limitation, to identify, develop and commercialize products,
which activities are not within the scope of this Agreement ("Pharmacopeia
Independent Technology"). The Parties further acknowledge that Pharmacopeia
Independent Technology may include technology independently acquired, discovered
or developed by Pharmacopeia (as demonstrated by documented evidence created at
the time of such acquisition, discovery or development) and which coincidentally
is substantially the same as technology within the scope of Collaboration
Technology and/or Schering Technology. SPL shall have no rights or licenses
whatsoever to any Pharmacopeia Independent Technology.

           2.14.2  Restrictions on Use of Collaboration Technology.  To the
           -------------------------------------------------------         
extent that Pharmacopeia is entitled to use Collaboration Technology under this
Agreement for purposes outside the Collaboration, Pharmacopeia will not
knowingly use such Collaboration Technology to jeopardize the commercial value
of Agreement Products.


                                  ARTICLE III
                           COLLABORATION MANAGEMENT


     3.1   Collaboration Committee.  The Parties shall establish a Collaboration
     -----------------------------                                              
Committee to oversee, review and coordinate the conduct of the Collaboration.
The Collaboration Committee shall be comprised of two (2) representatives from
each of SPL and Pharmacopeia, or such other equal number of representatives as
the Parties may agree, each Party's members selected by that Party.  Each of
Pharmacopeia and SPL may replace its Collaboration Committee representatives at
any time upon written notice to the other Party.  The Collaboration Committee
shall be chaired by the Collaboration Director appointed by SPL, unless
otherwise agreed by the Parties.  From time to time the

                                                                            -14-
<PAGE>
 
Collaboration Committee may establish various subcommittees, constituted as
agreed by the Collaboration Committee, to oversee particular projects or
activities within the Collaboration.

     3.2  Design of Libraries; Fresh Libraries.   At SPL's discretion, SPL's
     -----------------------------------------                              
representatives on the Collaboration Committee may contribute to the development
of the design of one or more Discovery Libraries or Optimization Libraries, or
contribute particular starting materials for use in synthesis of the Discovery
Libraries or Optimization Libraries.  Except as set forth in Section 4.9.5, or
as the Parties may otherwise agree in writing, the Libraries made available to
SPL under this Agreement shall not have been provided to Third Parties, or
screened by Pharmacopeia for itself or for Third Parties.  Notwithstanding any
other provision of this Agreement, Pharmacopeia shall not be obligated to
prepare or deliver to SPL any Library containing one or more compounds
previously delivered by Pharmacopeia to any Third Party.

     3.3  Collaboration Committee Meetings.  During the term of the
     -------------------------------------                         
Collaboration, as it may be extended, the Collaboration Committee shall meet six
(6) times per year, or more often as agreed by the Parties, at such locations as
the Parties shall agree.  At such meetings the Collaboration Committee will
formulate and review the Collaboration objectives with respect to each
Collaboration research project (including, without limitation, review and
approval of the design of Libraries), monitor the progress of the Collaboration
toward those objectives, and take such other actions as may be specified under
this Agreement or which the Parties deem appropriate.  The Collaboration
Committee may designate a patent committee comprised of employees or
representatives of the Parties to oversee the patent prosecution and/or
enforcement activities described in Article VI, and to facilitate communication
and agreement between the Parties regarding inventorship of inventions made in
the Collaboration and the classification of such inventions (e.g., as SPL
Improvements, Pharmacopeia Improvements, Collaboration Platform Technology,
Collaboration Target-Specific Technology, etc.).  Additional non-voting
representatives or consultants from either Party may from time to time be
invited by SPL or Pharmacopeia to attend and participate in Collaboration
Committee meetings (e.g., to evaluate and advise on business or scientific
issues) subject to compliance with the confidentiality provisions of Section
7.1.  Each Party shall be responsible for its own expenses in connection with
the Collaboration Committee.

     3.4  Collaboration Committee Decisions.  Decisions of the Collaboration
     --------------------------------------                                 
Committee shall be based upon the consensus of all the members.  In the event
that the Collaboration Committee cannot or does not, after good faith efforts,
reach agreement on an issue, such issue shall be referred to the respective
Presidents of SPL's Affiliate, the Schering-Plough Research Institute ("SPRI"),
and Pharmacopeia for resolution.  In the event that the Presidents of SPRI and
Pharmacopeia are unable to resolve the issue within fifteen (15) business days
after submission of the issue to them, then the unresolved issue may be
submitted by either Party to binding arbitration pursuant to Section 11.3 of
this Agreement, except that the decision shall be made by one (1) arbitrator
with expertise in pharmaceutical product development, and the decision of the
arbitrator shall be rendered within six (6)  months of initiation of the
arbitration.  During the pendency of any such arbitration proceedings, the
Parties shall proceed with performance of the Collaboration following the course
of conduct determined by SPL; provided, however, that notwithstanding the
                              --------  -------                          
foregoing, Pharmacopeia shall not be obligated to (i) take any action that would
violate its obligations to any Third Party, (ii) spend or forego receiving any
amounts of money (except as necessary in connection with the fulfillment of
Pharmacopeia's responsibilities under Section 2.3), (iii) conduct any of the
activities referred to in Section 2.7 with respect to Reserved Targets, or (iv)
knowingly prepare or deliver to SPL any Library containing one or more compounds
previously provided to any Third Party.  Notwithstanding the foregoing, SPL, in
its sole discretion, shall have complete and final control over SPL's research,
development and commercialization of Schering Compounds, Agreement Compounds
and/or Product(s) in accordance with the terms and conditions of this Agreement.

                                                                            -15-
<PAGE>
 
     3.5  Development Status; Notice of Sale of Products.  During the term of
     ---------------------------------------------------                     
this Agreement, SPL shall provide Pharmacopeia written semi-annual reports
within thirty (30) days after the end of each six (6) month period, providing:
(i) a brief report summarizing the development status of each Lead Compound
and/or Development Candidate under development at SPL; (ii) the status of all
patent applications claiming any Library Compounds or Derivative Compounds, and
(iii) copies of all such patent applications which have published during such
six (6) month period and were not previously provided to Pharmacopeia.  Such
reports shall contain information sufficient to allow Pharmacopeia to monitor
the status of SPL's efforts with respect to the accomplishment of the milestones
set forth in Section 5.3; provided, however, that nothing hereunder shall be
                          --------  -------                                 
construed as requiring SPL to provide Pharmacopeia with any specific research
data or results, including, without limitation, information relating to Targets
or data obtained from screening programs being conducted at SPL.  Until the
First Commercial Sale of each Agreement Product by or on behalf of SPL
hereunder, SPL shall keep Pharmacopeia reasonably informed as to the status of
the pre-clinical, clinical and commercial development of such Agreement Product
by providing Pharmacopeia with semi-annual written reports summarizing such
activities with respect to each potential Agreement Product under development
during the term of this Agreement.  Within thirty (30) days of the First
Commercial Sale of any Agreement Product, or any SP Product as to which
Pharmacopeia is entitled to receive royalty payments hereunder, SPL shall give
Pharmacopeia written notice thereof, which notice shall describe the relevant
Product, identify the active ingredients in such Product, and identify the
specific Target(s) which led to the development of such Product, it being
understood that SPL shall identify such Target(s) on a non-coded basis, and
shall identify the code(s), if any, used by SPL under this Agreement to identify
such Target; provided, however, that nothing herein shall require SPL to
             --------  -------                                          
disclose to Pharmacopeia any of SPL's proprietary information which has not been
previously publicly disclosed, beyond that which is necessary to satisfy SPL's
reporting requirements under this Section 3.5.

     3.6  Diligence.  The Parties acknowledge and agree that all business
     --------------                                                      
decisions regarding research, development and commercialization of Agreement
Products including, without limitation, decisions relating to the development
and manufacture of Agreement Compounds, or to the design, development,
manufacture, sale, price, distribution, marketing and promotion of Agreement
Products under this Agreement, and the decision whether to develop a particular
Agreement Compound, or to develop and commercialize a particular Agreement
Product, shall be within the sole discretion of SPL.  SPL shall use reasonable
good faith efforts to discover and develop Agreement Compounds, and to discover,
develop and commercialize Agreement Products; provided, however, that SPL shall
                                              --------  -------                
have no quotas or other minimum diligence obligations with regard to number of
Agreement Compounds and Agreement Products to be developed and commercialized
hereunder.  SPL's diligence obligations hereunder are expressly conditioned upon
the continuing absence of any adverse condition or event which warrants a delay
in commercialization of an Agreement Product including, but not limited to, an
adverse condition or event relating to the safety or efficacy of the Agreement
Product or unfavorable pricing, pricing reimbursement, labeling or lack of
Regulatory Approval, and SPL shall have no obligation to develop or market any
such Agreement Product so long as in SPL's opinion any such condition or event
exists.  SPL shall use commercially reasonable efforts to overcome any
unfavorable pricing or pricing reimbursement.  The Parties acknowledge and agree
that none of the diligence obligations in this Section 3.6 shall apply to any
Schering Compounds or SP Products, the discovery, development and
commercialization of which are the sole and exclusive responsibility of SPL.

                                  ARTICLE IV
                           LICENSES AND EXCLUSIVITY


     4.1  License to SPL.
     ------------------- 


          4.1.1  Compounds and Products.  Pharmacopeia agrees to grant, and
          -----------------------------                                    
hereby grants to SPL an exclusive license under the Pharmacopeia Technology and
Pharmacopeia's interest in the

                                                                            -16-
<PAGE>
 
Collaboration Technology (exclusive even as to Pharmacopeia and its Affiliates),
to make, have made, use, sell, offer to sell, import and export Agreement
Products in the Territory.  It is understood that such licenses shall include
the right to conduct drug research and development, and the exclusive right to
discover, develop, make, have made and use Agreement Compounds, during the term
of this Agreement.

          4.1.2  Collaboration Target-Specific Technology.  Pharmacopeia agrees
          -----------------------------------------------                      
to grant, and hereby grants, to SPL an exclusive license (exclusive even as to
Pharmacopeia and its Affiliates), under all of Pharmacopeia's interest in the
Collaboration Target-Specific Technology for any and all purposes in the
Territory, including the right to grant sublicenses.

     4.2  Sublicenses.  SPL shall have the right to sublicense the rights
     ----------------                                                    
granted in Section 4.1 above; provided, however, that SPL and its Affiliates
                              --------  -------                             
shall not provide any Discovery Library or Optimization Library to any Third
Party without the prior written consent of Pharmacopeia, except that such
consent shall not be required if the Third Party is a contractor or academic
collaborator conducting Library screening on behalf of SPL and is not granted,
and will not be granted or otherwise acquire, any rights to Agreement Compounds
or Agreement Products.  Each such sublicense shall be consistent with all the
terms and conditions of this Agreement.  It is further understood that SPL's
Sublicensees shall have no rights under the sublicense granted in Section 4.6
herein, but may make, have made, use, sell, offer to sell, import and export
Agreement Products.  SPL shall remain responsible to Pharmacopeia for all of
each such Sublicensee's applicable financial and other obligations due under
this Agreement.  Such Sublicensee shall not have the right to grant further
sublicenses, and such sublicenses may not be assigned or transferred to any
Third Party without the prior written consent of Pharmacopeia.  Each sublicense
shall provide for its continuation following early termination of the license
rights of SPL hereunder and its assignment to Pharmacopeia.  Promptly following
the execution of each sublicense requiring Pharmacopeia's consent hereunder, SPL
shall give Pharmacopeia written notice of the existence and identity of each
Sublicensee and identify the Agreement Product(s) sublicensed to such
Sublicensee.

     4.3  Direct Affiliate Licenses.  Whenever SPL shall reasonably demonstrate
     ------------------------------                                            
to Pharmacopeia that, in order to facilitate direct royalty payments by an
Affiliate, it is desirable that a separate license agreement be entered into
between Pharmacopeia and such Affiliate, Pharmacopeia will grant such licenses
directly to such Affiliate by means of an agreement which shall be consistent
with all of the provisions hereof and SPL shall guarantee the Affiliate's
obligations thereunder and otherwise provide to Pharmacopeia assurances of
performance satisfactory to Pharmacopeia.  SPL shall reimburse Pharmacopeia for
its reasonable attorneys' fees and costs incurred in connection with any such
separate license agreement.

     4.4  Collaboration Platform Technology.  Upon conclusion of the
     --------------------------------------                         
Collaboration Term, Pharmacopeia and SPL each agree to grant, and hereby grant,
to the other a co-exclusive license under their respective interests in the
Collaboration Platform Technology in the Territory, as follows:  (i) SPL and
Pharmacopeia may each use such Collaboration Platform Technology for any and all
internal uses, including without limitation, in collaboration with Third Parties
for drug discovery, and (ii) neither Pharmacopeia nor SPL may license,
sublicense or otherwise transfer the Collaboration Platform Technology to any
Third Party.

     4.5  Third Party Rights.
     ----------------------- 

          4.5.1  Pharmacopeia Third Party Activities.  It is understood that
          ------------------------------------------                        
Pharmacopeia is in the business of providing combinatorial libraries to Third
Parties, and that Pharmacopeia will grant such Third Parties rights after the
Effective Date to acquire licenses for compounds derived from such libraries
similar to SPL's rights under this Article IV.  Notwithstanding the licenses
granted to SPL under Section 4.1 above, it is possible that a Third Party may
acquire rights from Pharmacopeia with

                                                                            -17-
<PAGE>
 
respect to one or more compounds of which Pharmacopeia is a sole or joint owner,
which compounds were made and designed independently of Pharmacopeia's
activities in the Collaboration; accordingly, Pharmacopeia's grant of rights
under Section 4.1 is limited to the extent that (i) a Third Party (either alone
or jointly with Pharmacopeia) has filed a patent application with respect to
such a compound prior to the filing by SPL (either alone or jointly with
Pharmacopeia) of a patent application with respect to such a compound, or (ii)
Pharmacopeia has previously granted a Third Party a license, an option to
acquire a license, a right of first negotiation, field exclusivity, or a non-
competition covenant with respect to such a compound, and is subject to any such
grant of rights to a Third Party.

          4.5.2  No Liability.  It is understood and agreed that, even if
          -------------------                                            
Pharmacopeia complies with its obligations under this Agreement, compounds
provided to Third Parties in the course of Pharmacopeia's other business
activities may result in Third Party patent applications and patents, including
patent applications and patents owned by such Third Parties, or owned jointly by
Pharmacopeia and such Third Parties, which could conflict with patent
applications and patents owned by SPL, or jointly owned by SPL and Pharmacopeia
hereunder.  Pharmacopeia shall use reasonable efforts to avoid such conflict,
which efforts shall be comparable to those used by Pharmacopeia in performing
similar obligations under its agreements with Third Parties.  It is understood
that, unless SPL is damaged as a proximate result of a material breach by
Pharmacopeia of Section 4.9, or of any of the representations and warranties in
Article VIII, then Pharmacopeia shall have no liability under this Agreement
with respect to any such conflict

          4.5.3  Pharmacopeia Reports to SPL On Third Party Rights.  During the
          --------------------------------------------------------             
period from the Effective Date until the First Commercial Sale of an Agreement
Product, within thirty (30) days of a written demand by SPL concerning a
Pharmacopeia license to a Third Party of a patent application owned or co-owned
by Pharmacopeia, Pharmacopeia shall, to the extent it may do so without
breaching any contractual or other legal obligation, provide SPL with a
statement explaining why the invention(s) claimed in the patent application or
technology licensed to such Third Party is independent of Pharmacopeia's
activities in the Collaboration.  Such statement shall be supported by written
records kept in the ordinary course of business consistent with pharmaceutical
industry standards, provided that such records need not be provided to SPL at
the time of providing such statement, but may have to be provided pursuant to
Section 11.3.  Such information shall be deemed Confidential Information of
Pharmacopeia pursuant to this Agreement.

     4.6  Columbia Sublicense.  Pharmacopeia agrees to grant, and hereby grants,
     ------------------------                                                   
to SPL a non-exclusive sublicense, without the right to sublicense, under the
Columbia License, to make, have made, use, offer to sell, sell, import and
export Agreement Products in the Territory, (including, without limitation, the
right to decode Library Compounds).  It is understood and agreed that such
sublicenses do not include the right to create, make or have made encoded
combinatorial libraries or use methods or processes relating to the preceding,
except as expressly provided in this Agreement.  It is further understood and
agreed that SPL's right to decode Library Compounds, as granted hereunder, shall
only be exercisable in the event that Pharmacopeia is unable or unwilling to
provide decoding services to SPL, in which event Pharmacopeia shall promptly
provide to SPL the technology and know-how necessary to perform such decoding.

     4.7  Collaboration Research Activities.  SPL agrees to grant, and hereby
     --------------------------------------                                  
grants, to Pharmacopeia a royalty-free, non-exclusive license under (i) SPL's
interest in the Collaboration Technology, and (ii) any Schering Technology which
SPL, in its sole discretion, reasonably determines is necessary or useful for
Pharmacopeia's performance of the Collaboration, in each case to use during the
term of the Collaboration and solely in performance of the Collaboration such
intellectual property of SPL (including, without limitation, research materials
and reagents, as are reasonably necessary or useful to assay compounds in
certain Optimization Libraries, to be selected by SPL, for activity against the
applicable Target).  Pharmacopeia will not be required to pay any fees to use
such intellectual property, but will as a condition precedent to such use
execute any consents or 

                                                                            -18-
<PAGE>
 
sublicenses required by any SPL licensor. Pharmacopeia shall not be required to
execute any unreasonable consents or licenses and will not be in breach of this
Agreement for failure to do so.

     4.8  Pharmacopeia's Use of Library Compounds for Quality Control.
     ----------------------------------------------------------------  
Notwithstanding Section 4.1 above or Section 4.9 below, and subject to the other
applicable provisions of this Agreement, Pharmacopeia shall retain the right
under the Collaboration Technology to make, have made and use Library Compounds
solely for Pharmacopeia's internal quality control purposes, provided that such
rights shall not include the right to conduct any research other than quality
control research on any individual Library Compounds.  Pharmacopeia agrees to
use reasonable efforts not to conduct quality control research pursuant to this
Section 4.8 which would adversely affect SPL's ability to commercialize
Agreement Products or which would jeopardize the commercial or research value of
the Collaboration Technology.

     4.9  Library Exclusivity.
     ------------------------ 

          4.9.1  Optimization Libraries.  SPL shall have exclusivity with
          -----------------------------                                  
respect to all Optimization Libraries, as follows:  Pharmacopeia shall not *
for any purpose, * for any purpose.  Solely to ensure such exclusivity
Pharmacopeia agrees to *
This Section 4.9.1 shall
survive the termination or expiration of this Agreement.

          4.9.2  SP Discovery Libraries.  SPL shall have exclusivity with
          -----------------------------                                  
respect to all SP Discovery Libraries, as follows:  Pharmacopeia shall not *
for any purpose, *
for any purpose.  Solely to ensure such exclusivity, Pharmacopeia
agrees to *.  This Section 4.9.2 shall survive the
termination or expiration of this Agreement.

          4.9.3  Collaboration Discovery Libraries.  To provide SPL a period of
          ----------------------------------------                             
exclusivity for screening of the Collaboration Discovery Libraries provided to
SPL hereunder, Pharmacopeia agrees that until the termination of the Exclusivity
Period for a Collaboration Discovery Library, including as such period may be
extended, Pharmacopeia shall not * for any purpose,
* for any purpose.  The undertakings in this
Section 4.9.3 shall be in addition to and not in derogation of any
undertakings of Pharmacopeia expressly set forth in the other terms of this
Agreement with respect to Collaboration Discovery Libraries, Agreement Compounds
and Agreement Products.  Solely to ensure such exclusivity, Pharmacopeia agrees
to *.  Upon expiration of the applicable Exclusivity Period with respect to a
Collaboration Discovery Library, including as it may be extended pursuant to
Section 4.9.4, below, the *

__________________

*     CONFIDENTIAL TREATMENT REQUESTED

                                                                            -19-
<PAGE>
 
provided, however, that Pharmacopeia's rights shall be subject to SPL's rights
--------  -------                                                             
to Active Compounds and to the provisions of Section 4.9.5 below.

          4.9.4  Extension of Exclusivity for Collaboration Discovery Libraries.
          --------------------------------------------------------------------- 
SPL shall have the right, in its sole discretion, to extend the Exclusivity
Period with respect to any particular Collaboration Discovery Library for
successive * periods by notifying Pharmacopeia no later than sixty (60) days
prior to the date on which such Exclusivity Period will expire, and concurrently
paying to Pharmacopeia a maintenance fee of*
for each such Collaboration Discovery Library.  In the event that SPL
has paid to Pharmacopeia milestone payments totaling * with respect to Library
Compounds contained in any given Collaboration Discovery Library and/or
Derivative Compounds derived from such Library Compounds, SPL's exclusivity with
respect to such Collaboration Discovery Library shall become perpetual and
irrevocable; provided, however, that if the Exclusivity Period for such
Collaboration Discovery Library has lapsed prior to the payment of such
milestone payments totaling *, then such exclusivity shall be subject to and
limited by (i) applicable rights, if any, granted to Third Parties during any
period of co-exclusive rights as set forth in Section 4.9.5, and (ii)
Pharmacopeia's rights regarding the Library Compounds identified before such
time in an "Outlicensing Notice" as set forth in Section 4.9.5.

          4.9.5  Co-Exclusive Collaboration Discovery Libraries.  Following the
          -----------------------------------------------------                
expiration of the Exclusivity Period (including any extensions thereof) for any
given Collaboration Discovery Library, Pharmacopeia shall have the right to *
provided, however, that Pharmacopeia shall not *
--------  -------                               
If after the expiration of the applicable Exclusivity Period, Pharmacopeia *

__________________

*     CONFIDENTIAL TREATMENT REQUESTED


                                                                            -20-
<PAGE>
 
*

     4.10  No Other Products.  With the exception of (i) any Schering Compounds
     -----------------------                                                   
which are the same as a Library Compound and with respect to which Schering
notifies Pharmacopeia in writing prior to finalization by the Collaboration
Committee of the design the relevant Library, or (ii) as otherwise agreed or
specifically provided in the terms of this Agreement, neither SPL nor its
Affiliates or Sublicensees shall commercialize any Library Compound, Active
Compound, Derivative Compound, or other composition-of-matter claimed in patent
applications filed, or patents issued, under Article VI which claim an Active
Compound or Derivative Compound, other than as an Agreement Product in
accordance with this Agreement.

     4.11  License Grant Back for Abandoned Agreement Compounds.  In the event
     ----------------------------------------------------------               
that Pharmacopeia acquires rights to patent applications and/or patents claiming
any Agreement Compounds pursuant to Section 6.3.5, SPL agrees to grant and
hereby grants to Pharmacopeia an exclusive license to make, have made, use,
sell, offer for sale, import and export products containing such Agreement
Compounds, in the Territory; provided, however, that such license shall be
                             --------  -------                            
limited to the general therapeutic area identified for the relevant Optimization
Library in accordance with Section 2.9.4.  SPL will retain the rights to such
Agreement Compounds for all other therapeutic uses.


                                   ARTICLE V
                                   PAYMENTS

                                        
     5.1  Payments By SPL.  In partial consideration for Pharmacopeia's
     --------------------                                              
conducting research activities in the Collaboration and the rights and licenses
granted SPL herein, SPL agrees to pay to Pharmacopeia the amounts set forth in
Sections 5.2, 5.3 and 5.4.

     5.2  Collaboration Funding.
     -------------------------- 

          5.2.1  Funding During Year One.  SPL shall pay to Pharmacopeia
          ------------------------------                                
research funding for the Collaboration at a rate of * per FTE
during the first year of the Collaboration based upon the actual
number of Pharmacopeia FTEs assigned to the Collaboration as set forth in
Section 2.5.1, plus any additional FTEs agreed upon by the Parties under Section
5.2.3.

          5.2.2  Funding During Subsequent Years.  SPL shall pay to Pharmacopeia
          --------------------------------------                                
research funding for the Collaboration at a rate of *,
plus any adjustment pursuant to Section 5.2.5, per FTE during each subsequent
year of the Collaboration, other than the final year of the Collaboration, based
upon the actual number of Pharmacopeia FTEs assigned to the Collaboration as set
forth in Section 2.5.1, plus any additional FTEs agreed upon by the Parties
under Section 5.2.3.

          5.2.3  Increased FTE Requirements.  In the event that the Parties
          ---------------------------------                                
agree that additional FTEs are necessary to meet unanticipated increases in
workload under the Collaboration, the Parties may agree to add additional
Pharmacopeia FTEs, which shall be provided at the then current FTE rate.

          5.2.4  Wind-Down in Final Year.  In the final year of the
          ------------------------------                           
Collaboration (i.e., year five if the Collaboration is not extended),
Pharmacopeia shall have the right, starting at the end of the

__________________

*     CONFIDENTIAL TREATMENT REQUESTED

                                                                            -21-
<PAGE>
 
second quarter of the final year, to remove FTEs from the Collaboration during
the remainder of the term of the Collaboration.  The foregoing notwithstanding,
the Parties agree that the minimum number of Pharmacopeia FTEs assigned to the
Collaboration at the end of the third and fourth quarters of the fifth year of
the Collaboration shall be *  and * , respectively.  It is understood and agreed
that, except as the Parties may otherwise agree, SPL shall pay Pharmacopeia 
for*
FTEs (at the then-current FTE rate, as adjusted) for the first three quarters of
the final year, and for * FTEs during the fourth quarter of the final year. In
the event that SPL requests additional Pharmacopeia manpower be available to the
Collaboration during the final year of the Collaboration (i.e., in excess of the
numbers set forth in the second sentence of this Section 5.2.4), SPL shall, in
addition to payment for such FTEs (at the then-current rate) during the
Collaboration, pay an additional wind-down fee per additional FTE at * of the
then-current FTE rate, which shall be payable in two equal payments due on the
first day of each of the first and second quarter of the year following the end
of the Collaboration.

          5.2.5  Annual FTE Rate Adjustments.  Starting on January 1, 2000, and
          -----------------------------------                                   
annually thereafter during the term of the Collaboration, the FTE rate to be
paid by SPL shall be adjusted to account for increases in salaries and other
costs.  The annual FTE rate adjustment shall be determined based upon: * of the
percentage increase in the SIRS Salary Survey (Biotech Sector) over the previous
one (1) year period; and * of the percentage increase in the Consumer Price
Index over the previous one (1) year period; provided, however, that the first
                                             --------  -------                
adjustment shall account for such increases over a two (2) year period.

          5.2.6  Quarterly Adjustment.  At the conclusion of each quarter,
          ---------------------------                                     
Pharmacopeia will calculate the actual number of FTEs provided by Pharmacopeia
during that quarter and calculate any difference between the actual number of
FTEs provided by Pharmacopeia and the number prepaid by SPL.  Any overpayment or
underpayment shall be reflected as a credit or additional charge, as the case
may be, in the next quarterly invoice as per Section 5.2.7 below, and in the
event that no further quarterly payments are due under this Section 5.2, then
(i) any underpayment shall be paid by SPL to Pharmacopeia within * business days
of receiving notice and invoice therefor, or (ii) Pharmacopeia shall within *
days reimburse SPL for any overpayment.

          5.2.7  Manner of Payment.  Funding for the Collaboration under this
          ------------------------                                           
Section 5.2 shall be payable quarterly in advance on the first day of each
calendar quarter, except that payment for the calendar quarter beginning on the
Collaboration Effective Date shall be due within * business days of the
Effective Date. Pharmacopeia shall send an invoice therefor to SPL * business
days prior to the end of the preceding quarter, and SPL shall pay such invoiced
amounts. The invoice will indicate the number of Pharmacopeia FTEs to be
assigned to the Collaboration for such quarter and any adjustment from the prior
quarter as determined in accordance with Section 5.2.6. The Collaboration
funding payment for the first quarter of 1999 shall be due within * business
days of January 1, 1999. SPL will use commercially reasonable efforts during
each calendar year during the term of the Collaboration to pay its first
calendar quarter Collaboration funding payments to Pharmacopeia on or before the
* day of January; provided, however, that in the event SPL is unable to complete
                  --------  -------
such payment, payment by SPL on or before the * day of January in such calendar
year shall not constitute a breach or default by SPL.

__________________

*     CONFIDENTIAL TREATMENT REQUESTED

                                                                            -22-
<PAGE>
 
5.3  Milestone Payments.
----------------------- 

          5.3.1  Events and Amounts.
          ------------------------- 

                 (a)   Discovery Library Milestones.  SPL agrees to pay to
                       ----------------------------
Pharmacopeia the following amounts upon attainment, by or on behalf of SPL, its
Affiliates or Sublicensees, of the indicated milestones with respect to
Agreement Products arising from a Discovery Library where no Optimization
Library was prepared:

          (i)    identification of a Lead Compound *;

          (ii)   * upon nomination of a Development Candidate;

          (iii)  * upon the filing and Acceptance of an
                   IND or its equivalent;

          (iv)   *upon initiation of treatment of the first patient in
                 a Phase III clinical study;

          (v)    * upon filing and Acceptance of an HRD with the
                 applicable regulatory authority in a Major Market; and

          (vi)   * upon Regulatory Approval in a Major Market.

                 (b)   Optimization Library Milestones.  SPL agrees to pay to
                 -------------------------------------                       
Pharmacopeia the following amounts upon attainment, by or on behalf of SPL, its
Affiliates or Sublicensees, of the indicated milestones with respect to
Agreement Products arising from an Optimization Library or from a Discovery
Library where an Optimization Library was prepared:

          (i)    identification of a Lead Compound *;

          (ii)   * upon nomination of a Development
                 Candidate;

          (iii)  *upon the filing and Acceptance of an
                 IND or its equivalent;

          (iv)   *upon initiation of treatment of the first patient in a
                 Phase III clinical study;

          (v)    *upon filing and Acceptance of an HRD with the
                 applicable regulatory authority in a Major Market; and

          (vi)   * upon Regulatory Approval in a Major Market.

It is understood and agreed that all amounts payable under this Section 5.3.1
are in addition to any milestone payments that may be due to Pharmacopeia under
the terms of the US Agreement.

          5.3.2  Lead Compound.  A "Lead Compound" shall be deemed to have been
          --------------------                                                 
identified at such time as SPL, its Affiliates or Sublicensees initiates a
program of medicinal chemistry optimization with respect to an Agreement
Compound.  Within thirty (30) days after the initiation of such a program, SPL
shall notify Pharmacopeia thereof, which notification will include
identification

__________________

*     CONFIDENTIAL TREATMENT REQUESTED

                                                                            -23-
<PAGE>
 
of the applicable Target(s) (in coded form only) and the general therapeutic
area relevant to such Target.

          5.3.3  Development Candidate.  A Development Candidate shall have been
          ----------------------------                                          
deemed to have been nominated upon the earlier of the date (i) the Schering-
Plough Research Institute Project Assessment Committee or its successor approves
proceeding with full development of such compound, or (ii) SPL (or its
Affiliate) initiates in vivo toxicology trials necessary, and meeting U.S. FDA
(or corresponding European or Japanese) standards, for obtaining approval for
use of such Agreement Compound in human clinical trials.  Within thirty (30)
days after the nomination of a Development Candidate, SPL shall notify
Pharmacopeia thereof, which notification will include identification of the
applicable Target(s) (in coded form only) and the general therapeutic area
relevant to such Target

          5.3.4  Manner of Payment.  All payments made to Pharmacopeia by SPL
          ------------------------                                           
pursuant to Section 5.3.1(a) or (b) shall be due within * days after the
achievement of the corresponding milestone and shall be nonrefundable and not
creditable against other amounts due to Pharmacopeia. The payments provided for
under this Section 5.3 shall only be payable once upon the first achievement of
the indicated milestone with respect to an Agreement Compound and/or Agreement
Product developed against a particular Target and no additional payments shall
be due on subsequent or repeated achievement of the same milestone for another
Agreement Compound and/or Agreement Product developed against the same Target.
No milestones shall be payable under this Section 5.3 with respect to any
compounds or products other than Agreement Compounds and Agreement Products.

          5.3.5  Announcement of Milestones.  The Parties acknowledge and agree
          ---------------------------------                                    
that the achievement of a milestone under Section 5.3.1(a) or 5.3.1(b) may, at
Pharmacopeia's discretion, be the subject of a press announcement, in accordance
with the terms of Section 7.4 of this Agreement, and irrespective of the
payment, if any, associated therewith.

     5.4  Royalties. In partial consideration for the Library exclusivity, know-
     --------------                                                            
how licenses, patent licenses and other rights granted to SPL hereunder, SPL
shall pay royalties to Pharmacopeia based upon the sales of Products in the
Territory.  The parties acknowledge and agree that, except as expressly set
forth herein, SPL's obligation to pay such royalties is not conditioned upon the
existence of patent protection for the Products.

          5.4.1  Base Royalty.  SPL shall pay to Pharmacopeia running royalties
          -------------------                                                  
on Net Sales of Products by SPL, its Affiliates and Sublicensees, as follows:

          (i)   * of Net Sales of Agreement Products where the Agreement
                Compound in such Agreement Product (A) was contained in an
                Optimization Library based upon an Active Compound that was
                contained in a Discovery Library or (B) is a Derivative Compound
                derived from an Active Compound in such Optimization Library.

          (ii)  * of Net Sales of Agreement Products where the Agreement
                Compound in such Agreement Product (A) was contained in an
                Optimization Library based on a compound, other than a Library
                Compound, identified by SPL in an internal SPL research program
                or obtained from a Third Party source or (B) is a Derivative
                Compound derived from an Active Compound in such Optimization
                Library.

          (iii) * of Net Sales of Agreement Products where the Agreement
                Compound in such Agreement Product (A) was contained in a

__________________

*     CONFIDENTIAL TREATMENT REQUESTED

                                                                            -24-
<PAGE>
 
                Discovery Library; (B) is a Derivative Compound, made by SPL,
                derived from an Active Compound in a Discovery Library, and no
                Optimization Library was made based on such Active Compound; (C)
                was contained in an Optimization Library and identified through
                SPL's screening of such Optimization Library against a Target
                other than the specific Target(s) for which the Optimization
                Library was prepared; or (D) is a Derivative Compound derived
                from an Active Compound identified through SPL's screening of an
                Optimization Library against a Target other than the specific
                Target(s) for which the Optimization Library was prepared.

          (iv)  * of Net Sales of SP Products containing a Schering Compound
                active against any Target for which the Collaboration prepared
                an Optimization Library leading to the discovery of an Agreement
                Compound claimed in a Patent or patent application owned or
                controlled by SPL

          5.4.2  Royalty Term for Agreement Products.  SPL's obligation to pay
          ------------------------------------------                          
royalties to Pharmacopeia under Section 5.4.1(i), 5.4.1(ii) and 5.4.1(iii) shall
continue for each Agreement Product, on a country-by-country basis, until the
date which is the later of (i) * years after the first commercial sale of such
Agreement Product in such country by SPL, its Affiliates or Sublicensees or (ii)
the expiration of the last to expire issued patent within the Pharmacopeia
Technology or Collaboration Technology containing any claim which would be
infringed by making, using or selling the applicable Agreement Product in the
applicable country in the absence of the license grants in this Agreement and
provided that the claims of such patent which would be so infringed are not
declared invalid or unenforceable in a final decision by a court of competent
jurisdiction from which no appeal can be or is taken.

          5.4.3  Royalty Terms for SP Products.  SPL's obligation to pay
          ------------------------------------                          
royalties to Pharmacopeia under Section 5.4.1(iv) shall continue for each SP
Product, on a country-by-country basis, until the expiration of the last to
expire issued patent in the applicable country within the Pharmacopeia
Technology, Schering Technology or Collaboration Technology containing a
composition-of-matter claim which would be infringed by making, using or selling
one or more Agreement Compounds active against the same Target as such SP
Product and which were discovered based upon an Optimization Library prepared
against such Target, and provided that the claims of such patent are not
declared invalid or unenforceable in a final decision by a court of competent
jurisdiction from which no appeal can be or is taken.  Notwithstanding the
foregoing, in the event that SPL abandons or ceases to maintain such patent (or
the relevant patent application) on or after the date on which Phase III
clinical trials with the SP Product are initiated by or on behalf of SPL, its
Affiliates of Sublicensees, then SPL shall be obligated to pay royalties to
Pharmacopeia under Section 5.4.1(iv) with respect to such SP Product at a * rate
of *, which obligation
shall continue, on a country-by-country basis, until the date which is
* years after the first commercial sale of such SP Product in the applicable
country by SPL, its Affiliates or Sublicensees; provided, however that SPL shall
                                                --------  -------
have no such royalty payment obligation with respect to any such patent which
was declared invalid or unenforceable in a final decision by a court of
competent jurisdiction from which no appeal can be or is taken, or in the case
of a patent application which was the subject of a final and unappealable
determination of unpatentability by the relevant governmental authority in the
applicable country.

          5.4.4  Single Royalty; Non-Royalty Sales.  No royalty shall be
          ----------------------------------------                      
payable under Section 5.4.1 above with respect to sales of Products among SPL,
its Affiliates and Sublicensees for resale; however, a royalty shall be payable
upon such resale by SPL's Affiliates and Sublicensees.  In no event shall more
than one royalty be due hereunder with respect to any Product unit even if
covered by more than one patent included in the Pharmacopeia Technology or
Collaboration Technology.  It is understood and agreed that if a Product is
manufactured outside the Territory and sold in the Territory,

__________________

*     CONFIDENTIAL TREATMENT REQUESTED

                                                                            -25-
<PAGE>
 
a royalty shall be due hereunder on Net Sales of such Product in the Territory.
No royalties shall accrue on the disposition of any Product in reasonable
quantities by SPL, its Affiliates or its Sublicenses as samples (promotional or
otherwise) or as donations (for example, to non-profit institutions or
government agencies for a non-commercial purpose) or for clinical studies.

          5.4.5  Third Party Royalties.
          -------------------------- 

                 (a) SPL Responsibilities. SPL shall be responsible for the
                 ------------------------
payment of any royalties due to licenses obtained from Third Parties relating to
the manufacture, use, marketing, sale or distribution of Products by SPL, its
Affiliates or Sublicensees under the Collaboration Technology, Pharmacopeia
Technology or Schering Technology (except for any payments due to Columbia
University pursuant to the Columbia License, which shall be the responsibility
of Pharmacopeia).

                 (b) * . Notwithstanding Section 5.4.5(a) above, if a Third
                 -------
Party alleges that the manufacture, use or sale of a Product infringes its
patents, based solely on the practice of the Pharmacopeia Enabling Technology
used by Pharmacopeia in connection with the encoding or decoding by Pharmacopeia
of Libraries pursuant to the performance of this Agreement, *
Any settlement of any infringement claim or action that would
require the payment of any royalty to a Third Party shall require the
mutual agreement of SPL and Pharmacopeia, except that if the Parties cannot
promptly reach agreement they shall appoint an independent patent counsel
reasonably acceptable to each of them to give an opinion, which will be binding
as between the Parties, as to whether the Third Party patent is valid and if so
whether it is infringed, and the parties shall have no further recourse to
dispute such opinion (including , without limitation, the provisions of Section
11.3, which shall not apply).  If it is the independent patent counsel's opinion
that the patent is valid and infringed by the sale of such Agreement Product,
solely due to Pharmacopeia's practice of the Pharmacopeia Enabling Technology in
connection with the encoding or decoding of Libraries pursuant to the
performance of this Agreement, SPL may settle the matter in its sole discretion
on such terms as it deems appropriate, provided that such settlement does not
contain an admission or acknowledgment of infringement or invalidity.

          5.4.6  Compulsory Royalty Reductions.  If the royalties set forth
          ------------------------------------                             
herein are higher than the maximum royalties permitted by the law or regulation
in any country or territory or possession thereof in the world, the royalty
payable for sales in such country, territory or possession shall be equal to the
maximum permitted royalty under such law or regulations.

          5.4.7  Royalty Overpayment.  In the event SPL pays Pharmacopeia
          --------------------------                                     
royalties in excess of the amounts due under Section 5.4.1 herein, SPL shall
promptly notify Pharmacopeia providing a written explanation of the amount of
overpayment.  Any such overpayment shall be fully creditable against royalties
subsequently due hereunder.

     5.5  Reports; Payment of Royalty; Payment Exchange Rate and Currency
     --------------------------------------------------------------------
Conversions.
-----------

          5.5.1  Royalty Reports and Payments.  After the First Commercial Sale
          -----------------------------------                                  
of an Agreement Product or SP Product on which royalties are payable by SPL, its
Affiliate or Sublicensees

__________________

*     CONFIDENTIAL TREATMENT REQUESTED

                                                                            -26-
<PAGE>
 
hereunder, SPL shall make quarterly written reports to Pharmacopeia within *
days after the end of each calendar quarter, stating in each such report
separately for SPL and each of its Affiliates and Sublicensees the number,
description, and aggregate Net Sales by country of each Product sold during the
calendar quarter upon which a royalty is payable under Section 5.4 above.
Subject to any reductions permitted pursuant to the express terms of this
Agreement, concurrently with the making of such reports, SPL shall pay to
Pharmacopeia royalties at the rates specified in Section 5.4.1.

          5.5.2  Payment Method.  All payments due under this Agreement shall be
          ---------------------                                                 
made by bank wire transfer in immediately available funds to an account
designated by Pharmacopeia.  All payments hereunder shall be made in U.S.
dollars.  Any payments that are not paid on the date such payments are due under
this Agreement shall bear interest, calculated on the number of days such
payment is delinquent, at the lesser of: (i) the prime rate as reported by the
Chase Manhattan Bank, New York, New York, on the date such payment is due, plus
an additional *, or (ii) the maximum rate permitted by applicable law.

          5.5.3  Place of Royalty Payment and Currency Conversions.  Royalties
          --------------------------------------------------------            
shall be deemed payable by the entity making the Net Sales from the country in
which earned in local currency and subject to foreign exchange regulations then
prevailing.  Royalty payments shall be made in United States dollars to the
extent that free conversion to United States dollars is permitted.  The rate of
exchange to be used in any such conversion from the currency in the country
where such Net Sales occurs shall be in accordance with the policy set forth in
Exhibit A hereto.  If, due to restrictions or prohibitions imposed by national
or international authority, payments cannot be made as aforesaid, the Parties
shall consult with a view to finding a prompt and acceptable solution, and SPL
or its designated Affiliates will, from time to time, deal with such monies as
Pharmacopeia may lawfully direct at no additional out-of-pocket expense to SPL.
Notwithstanding the foregoing, if royalties in any country cannot be remitted to
Pharmacopeia for any reason within six (6) months after the end of the calendar
quarter during which they are earned, then SPL shall be obligated to deposit the
royalties in a bank account in such country in the name of Pharmacopeia.

     5.6  Maintenance of Records; Audits.
     ----------------------------------- 

          5.6.1  Records; Inspection.  SPL and its Affiliates shall keep
          --------------------------                                    
complete, true and accurate books of account and records for the purpose of
determining the royalty amounts payable under this Agreement, which books and
records shall be maintained in accordance with SPL's records retention policies.
Upon prior written notice from Pharmacopeia, SPL shall, within a period not to
exceed forty-five (45) days, permit an independent certified public accounting
firm of nationally recognized standing selected by Pharmacopeia and reasonably
acceptable to SPL, at Pharmacopeia's expense, to have access during normal
business hours to examine pertinent books and records of SPL and/or its
Affiliates as may be reasonably necessary to verify the accuracy of the royalty
reports hereunder.  The examination shall be limited to pertinent books and
records for any calendar year ending not more than * months prior to the date of
such request. Such inspections may be made no more than once each calendar year.
In the event that the accounting firm correctly concludes that a variation or
error has occurred resulting in an underpayment of royalties by SPL of * or more
of the amount actually due for the period covered by the inspection, SPL shall
pay to Pharmacopeia such additional amounts, as well as the costs relating to
the inspection, within * days of receipt of an invoice for such amounts. Any
overpayment of royalties by SPL discovered through such audit shall be
fully creditable against royalties subsequently due hereunder. SPL may
designate competitively sensitive information which such auditor may not
disclose to Pharmacopeia; provided, however, that such designation shall not
                          --------  -------
encompass the auditor's conclusions. The accounting firm shall disclose to
Pharmacopeia only whether the royalty reports are correct or incorrect and the
specific details concerning any discrepancies. No other information shall be
provided to Pharmacopeia. The accounting firm employees shall sign
confidentiality agreements acceptable to SPL as a condition precedent to their
inspection. SPL shall include in each sublicense granted by it

__________________

*     CONFIDENTIAL TREATMENT REQUESTED

                                                                            -27-
<PAGE>
 
pursuant to this Agreement a provision requiring the Sublicensee to make reports
to SPL, to keep and maintain records of sales made pursuant to such sublicense
and to grant access to such records by Pharmacopeia's independent accountant to
the same extent required of SPL under this Agreement.  Upon expiration of the *
month period immediately following the receipt by Pharmacopeia of SPL's fourth
quarter royalty report for a given calendar year in accordance with Section
5.5.1, the calculation of royalties payable with respect to such year shall be
binding and conclusive upon Pharmacopeia, and SPL, its Affiliates and its
Sublicensees shall be released from any liability or accountability with respect
to royalties for such year, except for instances of fraud or other intentional
misconduct by Schering.

     5.7  Coordination With Payments under US Agreement.  The milestones and
     --------------------------------------------------                     
royalties payable by SPL under Sections 5.3 and 5.4 are in consideration for the
rights and licenses granted to SPL under this Agreement and are in addition to
any amounts payable to Pharmacopeia under the US Agreement.  It is understood
and agreed that, with respect to the specific milestones payable under Sections
5.3.1(a)(ii)-(iv) and 5.3.1(b)(ii)-(iv), the occurrence of the same milestone
event will result in milestone payment obligations under both this Agreement and
the corresponding provisions of the US Agreement.

     5.8  Tax Matters.
     -----------------

          5.8.1  Withholding Taxes.  All royalty amounts required to be paid to
          ------------------------                                             
Pharmacopeia pursuant to this Agreement shall be paid with deduction for
withholding for or on account of any taxes  (other than taxes imposed on or
measured by net income) or similar governmental charge imposed by a jurisdiction
other than the United States ("Withholding Taxes") to the extent Pharmacopeia
and/or its Affiliates or their successors has the lawful rights to utilize the
Withholding Taxes paid by SPL as a credit against Pharmacopeia's and/or its
Affiliates regular U.S. tax liability.  SPL shall provide Pharmacopeia
documentation evidencing payment of any Withholding Taxes hereunder in a manner
that is satisfactory for purposes of the U.S. Internal Revenue Service.  Any
Withholding Taxes paid when due hereunder shall be for the account of
Pharmacopeia and shall not be included in the calculation of Net Sales.
Payments of Withholding Taxes made by SPL pursuant to this Section 5.8.1 shall
be made based upon financial information provided to SPL by Pharmacopeia, and to
the extent that such information is incorrect Pharmacopeia shall be liable for
any deficiency, and any fine, assessment or penalty imposed by any taxing
authority in the Territory for any deficiency in the amount of any such
Withholding Taxes, or the failure to make payment of Withholding Taxes, based
upon such incorrect information.  If SPL is required to pay any such deficiency,
or any fine, assessment or penalty for any such deficiency based upon such
incorrect information (except to the extent caused by SPL's gross negligence or
willful misconduct), Pharmacopeia shall promptly reimburse SPL for such
payments, which shall not be included in the calculation of Net Sales.

          5.8.2  Sales Taxes.  Any sales taxes, use taxes, transfer taxes or
          ------------------                                                
similar governmental charges required to be paid in connection with the transfer
of the Discovery Libraries and Optimization Libraries shall be the sole
responsibility of SPL.  In the event that Pharmacopeia is required to pay any
such amounts, SPL shall promptly remit payment to Pharmacopeia of such amounts.

     5.9  Product Development Costs.  SPL shall, at SPL's expense, be
     ------------------------------                                  
responsible for conducting all development of Agreement Compounds, Agreement
Products, Schering Compounds and SP Products, and all commercialization of
Products.


                                  ARTICLE VI
                            PATENTS AND INVENTIONS


     6.1  Ownership of Schering Technology and Pharmacopeia Technology.  It is
     -----------------------------------------------------------------        
understood and agreed that (i) SPL shall own all Schering Technology including,
without limitation, SPL

__________________

*     CONFIDENTIAL TREATMENT REQUESTED

                                                                            -28-
<PAGE>
 
Improvements, and (ii) Pharmacopeia shall own all Pharmacopeia Technology
including, without limitation, Pharmacopeia Improvements, and all Pharmacopeia
Enabling Technology.

     6.2  Ownership of Collaboration Technology.  The Parties anticipate that
     ------------------------------------------                              
the Collaboration may result in new inventions, discoveries and innovations, as
well as improvements to existing technologies, whether patentable or not, within
the Collaboration Technology.  Ownership of Collaboration Technology shall be
determined based upon U.S. Patent Laws and the following guidelines; provided,
                                                                     -------- 
however, that ownership rights to all Collaboration Technology shall be subject
-------                                                                        
to the applicable licenses and other rights granted under Article IV of this
Agreement.

          (a)  Inventions by SPL Employees. Title to all Collaboration
          --------------------------------
Technology invented solely by employees of SPL working on the Collaboration at
Pharmacopeia shall be deemed to be owned by SPL

          (b)  Inventions by Pharmacopeia Employees. Title to all Collaboration
          -----------------------------------------                            
Technology invented solely by employees of Pharmacopeia shall be deemed to be
owned by Pharmacopeia.

          (c)  Joint Inventions. Title to all Collaboration Technology invented
          ---------------------                                                
jointly by one or more employees of SPL working on the Collaboration at
Pharmacopeia, and one or more employees of Pharmacopeia shall be deemed to be
jointly owned by SPL and Pharmacopeia.

     6.3  Filing, Prosecution and Maintenance of Patents.
     --------------------------------------------------- 

          6.3.1  Collaboration Technology.  SPL shall have the right to prepare,
          -------------------------------                                       
file, prosecute and maintain in such countries as it deems appropriate in its
discretion, at its own expense and upon appropriate consultation with
Pharmacopeia, patent applications and patents, and to conduct any interferences,
re-examinations, reissues, oppositions or requests for patent term extension or
governmental equivalents thereto within the Collaboration Technology (excluding
Collaboration Platform Technology), and Pharmacopeia shall give reasonable
cooperation in connection therewith, at SPL's request and expense.  In the event
that SPL does not file a patent or patent application claiming an invention
within such Collaboration Technology, or if it ceases to so prosecute, maintain,
conduct any interferences, re-examinations, reissues, oppositions or requests
for patent term extension or governmental equivalents thereto relating to such
an invention, Pharmacopeia shall have the right, in its sole discretion, to
undertake such activities at its own expense, and SPL shall give reasonable
cooperation in connection therewith, at Pharmacopeia's expense.

          6.3.2  Collaboration Platform Technology.  Before filing any patent
          ----------------------------------------                           
application claiming any invention within the Collaboration Platform Technology,
the Parties shall discuss whether and how to proceed with the filing,
prosecution, and maintenance of such patent, as well as the conduct of any
interferences, re-examinations, reissues, oppositions or requests for patent
term extension or governmental equivalents thereto.  The Parties shall share
equally the costs of such activities, unless one Party notifies the other in
writing that is does not wish to pay for its share of such activities, in which
event the other Party shall have the right to proceed at its own expense, and
the Party declining to pay for such costs shall have no further license, on a
patent-by-patent and country-by-country basis, to practice the Collaboration
Platform Technology claimed in any issued, valid and enforceable patent for
which the Party did not pay such costs.

          6.3.3  Schering Technology.  SPL shall have the right to prepare,
          --------------------------                                       
file, prosecute and maintain in such countries as it deems appropriate in its
discretion, at its own expense, patent applications and patents, and to conduct
any interferences, re-examinations, reissues, oppositions or requests for patent
term extension or governmental equivalents thereto within the Schering
Technology

                                                                            -29-
<PAGE>
 
and Pharmacopeia shall give reasonable cooperation in connection therewith, at
SPL's request and expense.

          6.3.4  Pharmacopeia Technology.  Pharmacopeia shall have the right to
          ------------------------------                                       
prepare, file, prosecute and maintain in such countries as it deems appropriate
in its discretion, at its own expense, patent applications and patents, and to
conduct any interferences, re-examinations, reissues, oppositions or requests
for patent term extension or governmental equivalents thereto within the
Pharmacopeia Technology, as well as any Pharmacopeia Enabling Technology, and
SPL shall give reasonable cooperation in connection therewith, at Pharmacopeia's
request and expense.

          6.3.5  Pharmacopeia's Rights Regarding Patents Relating to Agreement
          --------------------------------------------------------------------
Compounds.  In the event that SPL does not file a patent application in Europe
---------                                                                     
claiming an Agreement Compound (arising from an Optimization Library) as a
composition-of-matter, within two (2) years after the later of (1) the decoding
of the Active Compounds in such Optimization Library (after the entire
Optimization Library has been screened), or (2) the filing of a patent
application claiming one or more Schering Compounds, where such Agreement
Compounds, Active Compounds and Schering Compounds are all active against the
Target for which the relevant Optimization Library was prepared, it shall
promptly notify Pharmacopeia to that effect in writing, and Pharmacopeia shall
thereafter have the right to prepare, file, prosecute, maintain and defend such
patent applications, and any patents arising therefrom, in the Territory, all at
Pharmacopeia's expense.  Schering shall use diligent efforts (i) to provide such
notice to Pharmacopeia in a timely manner, and (ii) not to take any actions
(including publication) with respect to such Agreement Compounds, that would
prejudice the patentability of such Agreement Compounds.  Schering shall have no
rights or licenses under such patent applications and/or patents, which shall be
deemed to be Pharmacopeia Independent Technology.  Schering shall grant back to
Pharmacopeia the licenses set forth in Section 4.11, with respect to any such
Agreement Compounds, and shall have no royalty obligations under Section
5.4.1(iv) with respect to sales of any SP Products in the Territory active
against the relevant Target.  Notwithstanding the foregoing, the provisions of
this Section 6.3.5 shall not apply with respect to Agreement Compounds which the
parties agree are unpatentable under European Patent Laws.

     6.4  Cooperation.
     ---------------- 

          6.4.1  Cooperation.  Upon request, and at the requesting Party's
          ------------------                                              
expense, each of Pharmacopeia and SPL shall provide the other Party reasonable
assistance to prepare, file, prosecute and maintain patents and patent
applications covering any Collaboration Technology, SPL Improvements or
Pharmacopeia Improvements which the requesting Party has the right to file.
Reasonable assistance shall include, without limitation, providing the
requesting Party with necessary or useful data and information relating to the
Collaboration Technology, SPL Improvements or Pharmacopeia Improvements, as the
case may be, and reasonable access to the inventors of said inventions, as well
as causing the execution of required patent assignments and/or other documents.
With respect to all patent applications claiming Collaboration Technology or any
Active Compound or Derivative Compound, the filing Party shall give the non-
filing Party an opportunity to review the text of such patent applications
before filing, shall consult with the non-filing Party with respect thereto, and
shall supply the non-filing Party with a copy of the applications as filed,
together with notice of its filing date and serial number.  SPL will identify to
Pharmacopeia any of SPL's proprietary information contained in such documents to
be provided to Pharmacopeia to ensure that Pharmacopeia will protect SPL's
proprietary information, including without limitation, information relating to
Targets.  In addition, with respect to applications which do not include
Pharmacopeia inventors, SPL may redact or provide in coded form any information
contained in such documents to be provided to Pharmacopeia to the extent
necessary (in SPL's opinion) to protect SPL's proprietary information, including
without limitation, information relating to Targets.  Pharmacopeia and SPL shall
each keep the other Party advised of the status of the actual and prospective
patents and patent applications within the Collaboration Patent Rights for which
it is responsible, and upon the written request of the other Party,

                                                                            -30-
<PAGE>
 
will provide advance copies of any substantive papers related to the filing,
prosecution and maintenance of such Collaboration Patent Rights.

     6.5  Enforcement.
     ---------------- 

          6.5.1  Notice.  Each Party shall promptly notify the other of its
          -------------                                                    
knowledge of any actual or potential infringement of the Collaboration
Technology by a Third Party.

          6.5.2  Collaboration Technology.  SPL shall have the initial right,
          -------------------------------                                    
but not the obligation, to take reasonable legal action to enforce against
infringements by Third Parties or defend any declaratory judgment action
relating to any patent within the Collaboration Technology (excluding any
Collaboration Platform Technology) at its sole cost and expense.  If, within six
(6) months following receipt of notice of such infringement from Pharmacopeia
(or written notice of a declaratory judgment action alleging invalidity or
unenforceability of such Collaboration Technology), SPL does not take such
action against a commercially significant infringement, Pharmacopeia shall, in
its sole discretion, have the right, but not the obligation to take such action
at its sole expense.

          6.5.3  Collaboration Platform Technology.  In the event of an actual
          ----------------------------------------                            
or potential infringement of Collaboration Platform Technology by a Third Party,
SPL and Pharmacopeia shall discuss how to proceed in connection with such
infringement.  Unless otherwise agreed by the Parties,  the terms of Section
6.5.5 shall apply; provided, however, that the Parties may decide to jointly
                   --------  -------                                        
proceed in enforcement against any such patent infringement by Third Parties, in
which case the Parties shall also agree on allocation of costs and damages.

          6.5.4  Schering Technology and Pharmacopeia Technology.  It is
          ------------------------------------------------------        
understood and agreed that Pharmacopeia shall have the sole right, but not the
obligation, to initiate and conduct legal proceedings to enforce the
Pharmacopeia Technology and Pharmacopeia Enabling Technology against any actual
or threatened infringement or misappropriation or defend any declaratory
judgment action relating thereto, at its sole expense, and that SPL shall have
the sole right, but not the obligation, to initiate and conduct legal
proceedings to enforce the Schering Technology against any actual or threatened
infringement or misappropriation or defend any declaratory judgment action
relating thereto, at its sole expense.

          6.5.5  Cooperation; Costs and Recoveries.  Each Party agrees to render
          ----------------------------------------                              
such reasonable assistance as the enforcing Party may request, and at the
enforcing Party's expense.  Costs of maintaining any such action shall be paid
by the Party bringing the action and any damages or settlements recovered
therefrom shall belong to such Party.  To the extent that SPL recovers any lost
profits or other recovery based upon Third Party sales of infringing products,
Pharmacopeia shall receive an equitable share of such recovery, as determined
based upon the royalties Pharmacopeia would have been entitled to under this
Agreement on Net Sales by SPL, its Affiliates or Sublicensees of the relevant
Agreement Products and/or SP Products, as applicable, corresponding to such lost
profits.  If SPL, in its sole discretion, agrees to settle any such infringement
action by granting a sublicense to the Third Party infringer, and such Third
Party, but for the grant of such sublicense, would be infringing a claim of an
issued patent in the Collaboration Technology, or a composition-of-matter claim
of an issued patent in the Schering Technology, SPL shall *
provided, however, that net
--------  -------          
sales of such Third Party products in the Territory on which *
for purposes of this Agreement, and further provided that, notwithstanding
anything herein to the contrary, SPL's *
in any calendar quarter shall not exceed * from such Third
Party for the same quarter.

__________________

*    CONFIDENTIAL TREATMENT REQUESTED

                                                                            -31-
<PAGE>
 
     6.6  Infringement Claims. If the manufacture, sale or use of any Agreement
     ------------------------                                                
Product pursuant to this Agreement because of the practice of the Pharmacopeia
Technology, Collaboration Technology, Pharmacopeia Enabling Technology or
Schering Technology, results in any claim, suit or proceeding alleging patent
infringement against Pharmacopeia or SPL (or their respective Affiliates or
Sublicensees), such Party shall promptly notify the other Party hereto in
writing setting forth the facts of such claim in reasonable detail.  The Party
subject to such claim shall have the exclusive right and obligation to defend
and control the defense of any such claim, suit or proceeding, at its own
expense, using counsel of its own choice; provided, however, it shall not enter
into any settlement which admits or concedes that any aspect of (i) the Schering
Technology or Collaboration Technology in the case of Pharmacopeia, and (ii) the
Pharmacopeia Technology, Collaboration Technology, or Pharmacopeia Enabling
Technology in the case of SPL, is invalid or unenforceable without the prior
written consent of such other Party.  The Party subject to the claim shall keep
the other Party hereto reasonably informed of all material developments in
connection with any such claim, suit or proceeding.  Any claim, suit or
proceeding arising based upon SPL's manufacture, sale or use of any SP Product
shall be the sole responsibility of SPL.

     6.7  Certification under Drug Price Competition and Patent Restoration Act.
     -------------------------------------------------------------------------- 
Pharmacopeia and SPL each shall immediately give written notice to the other of
any certification of which they become aware filed pursuant to 21
U.S.C.(S)(S)355(b)(2)(A)(iv) and 355(j)(2)(A)(vii) claiming that Collaboration
Patent Rights do not cover the use or sale of any product(s) equivalent to an
existing Agreement Product(s) by a Third Party.  SPL shall have the right to
bring an infringement action, in its sole discretion and at its own expense, in
its own name and/or in the name of Pharmacopeia, subject to Section 6.5 above.
The provisions of Section 6.5.5 shall apply to any such infringement action.

     6.8  Patent Term Restoration.  The Parties hereto shall give reasonable
     ----------------------------                                           
cooperation to each other in obtaining patent term restoration or supplemental
protection certificates or their equivalents in any country in the Territory
where applicable to the Collaboration Technology.

                                  ARTICLE VII
                                CONFIDENTIALITY

     7.1  Confidential Information.  Except as expressly provided herein, the
     -----------------------------                                           
Parties agree that, for the term of this Agreement and for five (5) years
thereafter, the receiving Party shall not disclose and except as expressly
provided in this Article 7, shall not use for any purpose any confidential
information ("Confidential Information") furnished to it by the disclosing Party
hereto pursuant to this Agreement except to the extent that it can be
established by the receiving Party by competent proof that such information:

          (i)    was already known to the receiving Party, other than under an
obligation of confidentiality, at the time of disclosure;

          (ii)   was generally available to the public or otherwise part of the
public domain at the time of its disclosure to the receiving Party;

          (iii)  became generally available to the public or otherwise part of
the public domain after its disclosure and other than through any act or
omission of the receiving Party in breach of this Agreement;

          (iv)   was independently developed by the receiving Party as
demonstrated by documented evidence prepared contemporaneously with such
independent development; or

          (v)    was subsequently lawfully disclosed to the receiving Party,
other than under a duty of confidentiality, by a Third Party that had the right
to make such disclosure.

                                                                            -32-
<PAGE>
 
     7.2  Permitted Use and Disclosures. Each Party hereto may use or disclose
     ----------------------------------                               
Confidential Information disclosed to it by the other Party to the extent such
information is included in the Pharmacopeia Technology, Schering Technology or
Collaboration Technology, as the case may be, and to the extent (i) such use or
disclosure is reasonably necessary and permitted in the exercise of the rights
granted hereunder in filing or prosecuting patent applications, prosecuting or
defending litigation, (ii) such disclosure is reasonably required to be made to
any institutional review board of any entity conducting clinical trials with
Agreement Compound(s) and/or Agreement Product(s), or to any governmental or
other regulatory agency, in order to gain approval to conduct clinical trials or
to market Agreement Compound(s) and/or Agreement Products, (iii) such disclosure
is required by law, regulation, rule, act or order of any governmental
authority, court, or agency, or is made in connection with submitting required
information to tax or other governmental authorities, or (iv) such disclosure or
use is reasonably required in conducting clinical trials, or making a permitted
sublicense or otherwise exercising license rights expressly granted to it by the
other Party pursuant to the terms of this Agreement; in each case, provided that
if a Party is required to make any such disclosure of another Party's
Confidential Information, other than pursuant to a confidentiality agreement, it
will give reasonable advance notice to the other Party of such disclosure and,
save to the extent inappropriate in the case of patent applications, will use
its reasonable diligent efforts to secure confidential treatment of such
Confidential Information in consultation with the other Party prior to its
disclosure (whether through protective orders or otherwise) and disclose only
the minimum necessary to comply with such requirements.

     7.3  Return of Confidential Information.  Following termination of this
     ---------------------------------------                                
Agreement, at any time upon request of the disclosing Party, the receiving Party
will return all documents, and copies thereof, containing the disclosing Party's
Confidential Information that are still in the receiving Party's possession or
control; however, the receiving Party may retain one copy of such documents in a
secure location solely for the purpose of determining its obligations hereunder,
to comply with any applicable regulatory requirements, or to defend against any
product liability claims.

     7.4  Nondisclosure of Terms.  Each of the Parties hereto agrees not to
     ---------------------------                                           
disclose to any Third Party the existence or the terms of this Agreement without
the prior written consent of each other Party hereto, except to such Party's
attorneys, advisors, investors and others on a need to know basis under
circumstances that reasonably ensure the confidentiality thereof, or to the
extent required by law.  Notwithstanding the foregoing, the Parties shall agree
upon a press release to announce the execution of this Agreement, together with
a corresponding Q&A outline for use in responding to inquiries about the
Agreement; thereafter, Pharmacopeia and SPL may each disclose to Third Parties
the information contained in such press release and Q&A without the need for
further approval by the other.  In addition, Pharmacopeia may make public
statements regarding progress with respect to the development and
commercialization of Agreement Compounds and/or Agreement Products, including
announcement of the achievement of milestones, following consultation with SPL
and with the written consent of SPL.  Nothing in this Section 7.4 shall prohibit
a Party from making such disclosures to the extent reasonably required under
applicable federal or state securities laws or any rule or regulation of any
nationally recognized securities exchange.  In such event, however, the
disclosing Party shall use good faith efforts to notify and consult with the
other Party prior to such disclosure and, where applicable, shall diligently
seek confidential treatment to the extent available.

     7.5  Publication.  Any manuscript by SPL or Pharmacopeia or their
     ----------------                                                 
Affiliates describing Agreement Products shall be subject to the prior review of
the other Party at least ninety (90) days prior to submission.  Further, to
avoid loss of patent rights as a result of premature public disclosure of
patentable information, the receiving Party shall notify the disclosing Party in
writing within thirty (30) days after receipt of a disclosure whether receiving
Party desires to file a patent application on any invention disclosed in such
scientific results.  In the event that the receiving Party desires to file such
a patent application, the disclosing Party shall withhold publication or
disclosure of such scientific results until the earlier of (i) a patent
application is filed thereon, or (ii) the Parties determine after

                                                                            -33-
<PAGE>
 
consultation that no patentable invention exists, or (iii) one hundred and
eighty (180) days after receipt by the disclosing Party of the receiving Party's
written notice of the receiving Party's desire to file such patent application,
or such other period as is reasonable for seeking patent protection.  Further,
if such scientific results contain the information of the receiving Party that
is subject to use and nondisclosure restrictions under this Article 7, the
disclosing Party agrees to remove such information from the proposed publication
or disclosure.

     7.6  Pharmacopeia Employees.  All Pharmacopeia employees assigned to work
     ---------------------------                                              
exclusively on Collaboration research projects pursuant to Section 2.5, shall *.
Any Pharmacopeia employees assigned to work exclusively on Collaboration
research projects shall also be subject to non-compete obligations, as set forth
below, with respect to any Target with respect to which Collaboration research
efforts directed to such Target are performed at Pharmacopeia (including,
without limitation, the design and preparation of Optimization Libraries for
such Target and/or the synthesis of Derivative Compounds based on Active
Compounds contained in such Libraries). None of the individual Pharmacopeia
employees participating in Target specific Collaboration research, and who at
any time during or after the term of the Collaboration have actual knowledge of
the identity of such Target, shall perform or otherwise contribute to any
research or development work relating to such Target for or on behalf of
Pharmacopeia and/or its Third Party collaborators for a period of * after the
date on which the Collaboration ceases all such Target specific research
activities at Pharmacopeia with respect to such Target. Pharmacopeia shall be
liable for any breach of *
and/or these non-compete obligations by its employees. In the event that, in the
course of Pharmacopeia's work on a Collaboration research program or in
connection with a patent application relating thereto, SPL has disclosed the
identity of a Target (other than in coded form) which is the subject of such a
research program to Pharmacopeia's Chief Science and Technology Officer
responsible for performance of the Collaboration (or his successor), all
Pharmacopeia employees working on such research program will be deemed to have
actual knowledge of the identity of such Target. The further disclosure of the
identity of a Target within Pharmacopeia shall be limited to only those
Pharmacopeia employees necessary to ensure that Pharmacopeia and its employees
does not breach the provisions of this Section 7.6. In addition, during and
after the term of the Collaboration, Pharmacopeia shall use reasonably diligent
efforts to ensure that such individuals do not disclose or provide access to any
Collaboration Target-Specific Technology, Schering Technology, or the results of
any screening or other Target specific research performed at Pharmacopeia in the
Collaboration, to any Pharmacopeia employees not working on the Collaboration
(except to the extent reasonably necessary for Pharmacopeia to ensure its
compliance with its exclusivity obligations hereunder) or to any Third Parties.

                                 ARTICLE VIII
                   REPRESENTATION, WARRANTIES AND COVENANTS

     8.1  SPL.  Schering-Plough Ltd. warrants, represents and covenants on
     --------                                                             
behalf of itself and its Affiliates that: (i) it has the legal right and power
to extend the rights granted in this Agreement;  (ii) it has the legal power,
authority and right to enter into this Agreement, and to perform all its
obligations hereunder, and (iii) it has not previously granted, and during the
term of this Agreement will not knowingly make any commitment or grant any
rights which in any material way conflict with the rights and licenses granted
herein.

     8.2  Pharmacopeia.  Pharmacopeia represents, warrants and covenants on
     -----------------                                                     
behalf of itself and its Affiliates that:  (i) it has the legal right and power
to extend the rights granted in this Agreement; (ii) it has the legal power,
authority and right to enter into this Agreement, and to perform all its
obligations hereunder; (iii) it has not previously granted, and during the term
of this Agreement will not knowingly make any commitment or grant any rights
which in any material way conflict with the rights and licenses granted herein;
(iv) to the best of its knowledge as of the Effective Date, there are

__________________

*     CONFIDENTIAL TREATMENT REQUESTED

                                                                            -34-
<PAGE>
 
no existing or threatened actions, suits or claims pending against it with
respect to the Pharmacopeia Technology or the Pharmacopeia Enabling Technology;
(v) to the best of its knowledge as of the Effective Date, it is not aware of
any Existing Pharmacopeia Know-How which is not available for use for all
purposes contemplated by this Agreement; (vi) as of the Effective Date, the
Columbia License is in full force and effect, and to the best of its knowledge
there does not exist any event of default with respect to Pharmacopeia under the
Columbia License which would constitute a breach of the Columbia License; (vii)
during the term of this Agreement, Pharmacopeia will use its best efforts not to
materially breach the Columbia License and will not modify or amend the Columbia
License in any way which would materially adversely effect the rights of SPL
under this Agreement; (viii) to the best of its knowledge and as of the
Effective Date, it owns or controls all of the Pharmacopeia Technology and
Pharmacopeia Enabling Technology, and has the rights to grant the licenses or
sublicenses granted to SPL hereunder with respect thereto; and (ix) to the best
of Pharmacopeia's knowledge as of the Effective Date, the creation or synthesis
of encoded combinatorial libraries by Pharmacopeia does not infringe any valid
Third Party patent rights

     8.3  Compliance with Agreement and Laws. Each Party shall comply in all
     ---------------------------------------                                
material respects with the terms of this Agreement and with all laws, rules and
regulations applicable to the discovery, development, manufacture, distribution,
import and export and sale of pharmaceutical products pursuant to this
Agreement.

     8.4  Disclaimer.  SPL and Pharmacopeia expressly disclaim any
     ---------------                                              
representation, warranty or guaranty that the Collaboration will be successful.
EXCEPT AS OTHERWISE EXPRESSLY SET FORTH IN THIS AGREEMENT, PHARMACOPEIA AND SPL
AND THEIR RESPECTIVE AFFILIATES MAKE NO REPRESENTATIONS AND EXTEND NO WARRANTIES
OR CONDITIONS OF ANY KIND, EITHER EXPRESS OR IMPLIED, WITH RESPECT TO THE
PHARMACOPEIA TECHNOLOGY, THE PHARMACOPEIA ENABLING TECHNOLOGY, THE SCHERING
TECHNOLOGY, THE COLLABORATION TECHNOLOGY, DISCOVERY LIBRARIES, OPTIMIZATION
LIBRARIES, LIBRARY COMPOUNDS, ACTIVE COMPOUNDS, DERIVATIVE COMPOUNDS, AGREEMENT
COMPOUNDS OR AGREEMENT PRODUCTS, OR INFORMATION DISCLOSED PURSUANT TO ARTICLE
VII, AND EXPRESSLY DISCLAIMS ALL WARRANTIES OF MERCHANTABILITY, FITNESS FOR A
PARTICULAR PURPOSE, VALIDITY OF THE PHARMACOPEIA TECHNOLOGY, PHARMACOPEIA
ENABLING TECHNOLOGY, COLLABORATION TECHNOLOGY OR SCHERING TECHNOLOGY (IN EACH
CASE, WHETHER PATENTED OR UNPATENTED), OR NONINFRINGEMENT OF THE INTELLECTUAL
PROPERTY RIGHTS OF THIRD PARTIES.

                                  ARTICLE IX
                                INDEMNIFICATION

     9.1  Indemnification by SPL.  SPL shall indemnify, defend and hold harmless
     ---------------------------                                                
Pharmacopeia and its Affiliates, and each of its and their respective employees,
officers, directors and agents (the "Pharmacopeia Indemnitees") from and against
any and all liability, loss, claims, damage, cost, and expense (including
reasonable attorneys' and professionals' fees and other expenses of litigation)
(collectively, a "Liability") arising out of or in connection with Third Party
claims relating to (i) the discovery, development, manufacture, use, testing,
marketing, sale or other disposition of Products by on behalf of SPL or its
Affiliates or Sublicensees, (ii) performance of the Collaboration by SPL, (iii)
any injury, illness or disease suffered by any SPL employees in connection with
the performance of the Collaboration, (iv) the use of any and all Targets with
respect to which research activities are conducted in the Collaboration,
including without limitation claims in connection with materials relating to
such Target, or (v) any breach by SPL of its representations and warranties made
under this Agreement, except, in each case, to the extent such Liabilities
result from the gross negligence or willful misconduct of Pharmacopeia, its
Affiliates, or any of their respective employees, officers, directors or agents.

                                                                            -35-
<PAGE>
 
     9.2   Indemnification by Pharmacopeia.  Pharmacopeia shall indemnify,
     -------------------------------------
defend and hold harmless SPL and its Affiliates, and each of its and their
respective employees, officers, directors and agents (the "SPL Indemnitees")
from and against any Liability (as defined above) arising out of or in
connection with Third Party claims relating to (i) Pharmacopeia's encoding or
decoding of Libraries, pursuant to this Agreement, (ii) the performance of the
Collaboration by Pharmacopeia, except to the extent directly related to the use
of Targets, (iii) any injury, illness or disease suffered by any Pharmacopeia
employees in connection with the performance of the Collaboration, (iv) any
product based upon a Library Compound developed, manufactured, used, sold or
otherwise distributed by or on behalf of Pharmacopeia, its Affiliates or
Licensees, as permitted under this Agreement (including, without limitation,
product liability and patent infringement claims), (v) any breach of
Pharmacopeia's contractual obligations to Third Parties (including, without
limitation, those relating to Reserved Targets), or (vi) any breach by
Pharmacopeia of its representations and warranties made under this Agreement,
except, in each case, to the extent such Liabilities result from the gross
negligence or willful misconduct of SPL, its Affiliates, or any of their
respective employees, officers, directors or agents.

     9.3   No Consequential Damages.  Except with respect to Third Party claims
     ------------------------------                                            
as provided for under Section 9.1 and 9.2, in no event shall any Party to this
Agreement have any claims against or liability to the other Party for any
special, consequential or incidental damages arising under this Agreement under
any theory of liability.

     9.4   Procedure.  In the event that any Indemnitee intends to claim
     ---------------                                                    
indemnification under this Article IX, it shall promptly notify the other Party
in writing of any such alleged Liability.  The indemnifying Party shall have the
right to control the defense thereof with counsel of its choice; provided,
                                                                 -------- 
however, that any Indemnitee shall have the right to retain its own counsel,
-------                                                                     
with the fees and expenses to be paid by the indemnifying Party, if
representation of such Indemnitee by the counsel retained by the indemnifying
Party would be inappropriate due to actual or potential differing interests
between such Indemnitee and any other Party represented by such counsel in such
proceeding.  The affected Indemnitees shall cooperate reasonably with the
indemnifying Party and its legal representatives in the investigation and
defense of any action, claim or liability covered by this Article IX.  Neither
Party may settle a claim or action related to a Liability for which it or the
other Party seeks indemnification hereunder without the consent of the other
Party, if such settlement would impose any monetary obligation on the other
Party or require the other Party to submit to an injunction or otherwise limit
the other Party's rights under this Agreement.  Any payment made by a Party to
settle any such claim or action shall be at its own cost and expense.

     9.5   Insurance.  Each Party shall obtain and maintain throughout the term
     ---------------                                                           
of this Agreement statutory Workers' Compensation and Employer's Liability
insurance covering all employees engaged in the performance of work under this
Agreement.  Each Party shall provide the other Party with evidence of such
insurance and/or self-insurance program, upon request.

                                   ARTICLE X
                             TERM AND TERMINATION

     10.1  Term and Expiration.  This Agreement shall be effective as of the
     -------------------------                                              
Effective Date and unless terminated earlier as provided in this Article X or by
mutual written agreement of the Parties, the term of this Agreement shall
continue in full force and effect, on a country-by-country and Product-by-
Product basis, until SPL and its Affiliates and Sublicensees have no further
obligation to pay royalties under Article V hereof in a country, at which time
the Agreement shall expire in its entirety in such country and the Parties shall
have no further payment obligations or other financial obligations to each other
with respect to the continuing use in such country of Pharmacopeia Technology,
Schering Technology and/or Collaboration Technology, as the case may be, in the
manner licensed herein.  As royalty payment obligations for a Product expire in
a country, even if the Agreement thereafter remains


                                                                            -36-
<PAGE>
 
in effect in such country, SPL, its Affiliates and Sublicensees, shall no longer
have any remaining payment obligations hereunder with respect to such a Product
in that country.

     10.2  Termination for Cause.  This Agreement may be terminated by written
     ---------------------------                                              
notice by either Party at any time during the term of this Agreement if the
other Party (the "Breaching Party") is in material breach or default of any of
its material obligations hereunder (including, without limitation, any payment
obligations), as follows:  (i) the terminating Party shall send written notice
of the breach or default to the Breaching Party; and (ii) if such default or
breach thereafter continues for sixty (60) days after written notice thereof was
provided to the Breaching Party, then the termination shall become effective at
the end of such sixty (60) day period, unless the Breaching Party  (or any other
party on its behalf) has cured any such breach or default prior to the
expiration of the sixty (60) day period or has commenced activities reasonably
expected to cure such breach within such sixty (60) day period and thereafter
uses diligent efforts to complete the cure as soon as practicable.

     10.3  Termination Upon Bankruptcy or Insolvency.  This Agreement may be
     -----------------------------------------------                        
terminated by Pharmacopeia giving written notice of termination to SPL upon the
filing of bankruptcy or insolvency of SPL or the appointment of a receiver for
the assets of SPL, or the making by SPL of an assignment for the benefit of
creditors, or the institution of any proceedings against Schering under any
bankruptcy law.  Termination shall be effective upon the date specified in such
notice.  The rights of SPL under this Agreement shall not terminate in the event
of a bankruptcy of Pharmacopeia, unless SPL elects to terminate this Agreement
in accordance with the following provisions of this Section 10.3.  In the event
that (i) Pharmacopeia shall make an assignment for the benefit of creditors,
file a petition in bankruptcy, petition or apply to any tribunal for the
appointment of custodian, receiver or any trustee for it or a substantial part
of its assets, or shall commence any case or proceeding under any bankruptcy,
reorganization, arrangement, readjustment of debt, dissolution or liquidation
law or statute of any jurisdiction, whether now or hereafter in effect; or (ii)
if there shall have been filed any such bona fide petition or application, or
any such proceeding shall have been commenced against it, in which an order for
relief is entered or which remains undismissed for a period of sixty (60) days
or more; or (iii) if Pharmacopeia by any act or omission of act shall indicate
its consent to, approval of or acquiescence in any such bona fide petition,
application, or proceeding or order for relief or the appointment of a
custodian, receiver or trustee for it or any substantial part of its property,
or shall suffer any such custodianship, receivership or trusteeship to continue
undischarged for a period of sixty (60) days or more; (each such event a
"Pharmacopeia Bankruptcy Event"), then SPL shall have the following rights.  SPL
shall have the right, in its sole discretion, to elect to terminate this
Agreement by giving written notice of such termination to Pharmacopeia.  In the
event that SPL does not elect to terminate this Agreement, then notwithstanding
any rejection of this Agreement by Pharmacopeia (which, for purposes of this
Section 10.3, includes any debtor in possession, trustee or other entity that
may succeed Pharmacopeia) pursuant to 11 U.S.C. (S)365 (together with its
foreign equivalents, the "Insolvency Statute"), SPL shall retain all of its
rights, benefits, licenses, protections and privileges under this Agreement and
shall be entitled to all of the rights, benefits and protections of a licensee
under the Insolvency Statute (including, without limitation, 11 U.S.C. 365(n)).*
provided
that SPL's obligations to make payments to Pharmacopeia under this
Agreement shall automatically be reduced by the amount of all out-of-pocket
costs and expenses incurred by SPL in exercising such rights.  In the event of
any Pharmacopeia Bankruptcy Event, Pharmacopeia shall, upon written request of
SPL, *

__________________

*     CONFIDENTIAL TREATMENT REQUESTED

                                                                            -37-
<PAGE>
 
* solely to
the extent necessary for SPL to *
hereunder prior to the applicable
Pharmacopeia Bankruptcy Event, and for purposes of the Insolvency Statute;
provided, however, that * shall only be exercisable if Pharmacopeia fails to
--------  ------- 
perform its obligations under this Agreement substantially as contemplated
herein, and further provided that * shall be limited to * of this sentence. The
Parties acknowledge and agree that all information, data and other intellectual
property referred to in this Section 10.3 (including, without limitation,
Pharmacopeia Technology, Pharmacopeia Enabling Technology, and Libraries) and
all Agreement Compounds, Agreement Products, Collaboration Technology and any
other intellectual property that is licensed, or is the subject of any other
right, benefit, protection or privilege that is granted, transferred or
otherwise afforded, to SPL hereunder is "intellectual property" within the
meaning of the Insolvency Statute. In the event of any Pharmacopeia Bankruptcy
Event and if any statute and/or regulation in any country in the Territory
requires that there be a specific grant or specific clause(s) in order for SPL
to obtain the rights and benefits as licenses under this Agreement which are
analogous to those rights under 11 U.S.C. (S)365(n), then this Agreement shall
be deemed to include any and all such required grant(s), clause(s) and/or
requirements. Notwithstanding the foregoing, the Parties acknowledge and agree
that to the extent Pharmacopeia is a U.S. based company, United States
bankruptcy laws will govern and all references to the Insolvency Statute shall
mean only 11 U.S.C (S)365.

     10.4  Termination for Pharmacopeia Change in Control.  In the event of any
     ----------------------------------------------------                      
Pharmacopeia Change in Control during the term of this Agreement, SPL shall have
the right to terminate the Agreement upon ninety (90) days written notice after
such Pharmacopeia Change in Control.  In the event that such Pharmacopeia Change
in Control occurs during the term of the Collaboration, SPL may, in its
discretion, elect to terminate the Collaboration and not the Agreement as set
forth in Section 2.2.

     10.5  Concurrent Termination with the US Agreement.  In the event of any
     --------------------------------------------------                      
termination of the US Agreement by Pharmacopeia or Schering Corporation under
the provisions of Sections 10.2, 10.3 or 10.4 thereof, as applicable, this
Agreement shall automatically terminate concurrently under the corresponding
Section 10.2, 10.3 or 10.4 of this Agreement.

     10.6  Effect of Termination.
     --------------------------- 

           10.6.1  Accrued Obligations.  Termination of this Agreement for any
           ---------------------------                                        
reason shall not relieve the Parties from any liability which at the time of
such termination has already accrued to the other Party, or which is
attributable to a period prior to such termination, nor preclude either Party
from pursuing all rights and remedies it may have hereunder or at law or in
equity with respect to any breach of this Agreement.

           10.6.2   Return of Materials.  Upon any termination of this
           ----------------------------
Agreement, SPL and Pharmacopeia shall promptly return to the other Party all
Confidential Information (including without limitation all Existing Schering
Know-How or Existing Pharmacopeia Know-How, as the case may be) as set forth in
Section 7.3

_________________

*     CONFIDENTIAL TREATMENT REQUESTED

                                                                            -38-
<PAGE>
 
           10.6.3  Effect on Agreement Products.  In the event that * or more
           ------------------------------------                              
Agreement Compounds and/or Agreement Products are being developed and/or
commercially exploited by SPL, its Affiliates or Sublicensees under this
Agreement and a breach entitling Pharmacopeia to terminate this Agreement occurs
which relates solely to a single Agreement Compound or Agreement Product, then
Pharmacopeia shall have the option to terminate this Agreement only with respect
to the applicable Agreement Compound or Agreement Product, and in which case all
of the terms of this Agreement shall remain in full force and effect with regard
to the other Agreement Compounds and/or Agreement Products being developed and
commercialized.  In the event this Agreement is terminated with respect to a
given Agreement Product, SPL shall have the right to continue to sell its
remaining inventory of such Agreement Product for a period of up to * after the
date of termination, provided that SPL continues to pay royalties to
Pharmacopeia with respect to such sales.

           10.6.4  Licenses.
           ---------------- 

                   (a) Termination by Pharmacopeia Pursuant to Section 10.2. In
                   -------------------------------------------------------- 
the event of termination by Pharmacopeia under Section 10.2, the licenses
granted hereunder relating to any Agreement Product, Discovery Library or
Optimization Library with respect to which there has been a material breach,
shall terminate, and the licenses granted to Pharmacopeia hereunder shall remain
in effect, subject to the terms and conditions of this Agreement; provided,
                                                                  --------
however, a breach shall have no effect on SPL's licenses hereunder other than
-------
with respect to the Library or Agreement Product to which the breach
specifically relates, and the remaining licenses granted hereunder shall remain
in effect, subject to the terms and conditions of this Agreement. In the event
that Pharmacopeia terminates the Agreement for a breach of SPL's payment
obligations regarding any SP Product as to which Pharmacopeia is entitled to
receive royalty payments hereunder, then the licenses granted to SPL hereunder
relating to Agreement Compounds active against the same Target as such SP
product shall terminate concurrently.

                   (b) Termination by SPL Pursuant to Sections 10.2 or 10.3. In
                   --------------------------------------------------------
the event of any termination by SPL pursuant to Section 10.2 or 10.3 above, any
licenses granted by SPL hereunder shall terminate concurrently, and any licenses
granted by Pharmacopeia shall remain in effect, subject to the terms and
conditions of this Agreement; provided, however, a breach shall have no effect
                              --------  -------
on the licenses granted to Pharmacopeia hereunder other than with respect to the
Agreement Product to which the breach specifically relates, and the remaining
licenses granted hereunder shall remain in effect, subject to the terms and
conditions of this Agreement.

                   (c) Termination by Pharmacopeia Pursuant to Section 10.3. In
                   --------------------------------------------------------
the event of any termination by Pharmacopeia pursuant to Section 10.3 above, any
licenses granted by Pharmacopeia hereunder shall terminate concurrently, and any
licenses granted by SPL shall remain in effect, subject to the terms and
conditions of this Agreement.

                   (d) Termination by SPL Pursuant to Section 10.4. In the event
                   -----------------------------------------------
of any termination by SPL pursuant to Section 10.4 above, any licenses granted
by Pharmacopeia to SPL, and by SPL to Pharmacopeia, shall remain in effect,
except for the licenses under Section 4.7, which shall terminate concurrently.

          10.6.5   Surviving Provisions.  Articles VI, VII, VIII, IX and XI of
          -----------------------------                                       
this Agreement, as well as Sections 2.9.2, 2.9.3, 2.12, 2.13, the last sentence
of 3.5, 4.1.2, 4.4, 4.5, 4.8, 4.9, 4.10, 5.3, 5.4, 5.5, 5.6, 5.7, 5.8, 5.9 and
10.6 shall survive the expiration or termination of this Agreement for any
reason.

__________________

*     CONFIDENTIAL TREATMENT REQUESTED

                                                                            -39-
<PAGE>
 
                                  ARTICLE XI
                                 MISCELLANEOUS

     11.1  Assignment.  This Agreement shall not be assigned, or assignable, by
     ----------------                                                          
either Party hereto to any Third Party without the prior written consent of the
other Party, and any such attempted assignment shall be void and without force
or effect; provided, however, that notwithstanding the foregoing, either Party
           --------  -------                                                  
may, without such consent, assign this Agreement and its rights and obligations
hereunder to an Affiliate or in connection with the transfer or sale of all or
substantially all of its business or assets related to the subject matter to
which this Agreement pertains, or in the event of its merger, reorganization,
acquisition, sale, consolidation or change in control or similar transaction.
This Agreement shall be binding upon, and inure to the benefit of, each Party,
its Affiliates, and its permitted successors and assigns.  Each Party shall be
responsible for the compliance by its Affiliates with the terms and conditions
of this Agreement

     11.2  Governing Law.  This Agreement and any dispute arising from the
     -------------------                                                  
performance or breach hereof, shall be governed, interpreted and construed in
accordance with the laws of the State of New Jersey, without giving effect to
conflict of law principles.  The Parties expressly exclude application of the
United Nations Convention for the International Sale of Goods.

     11.3  Dispute Resolution.  Except as set forth in Section 5.4.5(b), any
     ------------------------                                               
dispute under this Agreement which is not settled by mutual consent shall be
finally settled by binding arbitration, conducted in accordance with the
Commercial Arbitration Rules of the American Arbitration Association by three
arbitrators appointed in accordance with said rules.  The arbitration shall be
held in New York, New York and at least one of the arbitrators shall be an
independent expert in pharmaceutical product development (including clinical
development and regulatory affairs).  Any written evidence originally in a
language other than English shall be submitted in English translation
accompanied by the original or a true copy thereof.  The costs of the
arbitration, including administrative and arbitrators' fees, shall be shared
equally by the Parties.  Each Party shall bear its own costs and attorneys' and
witness' fees.  A disputed performance or suspended performances pending the
resolution of the arbitration must be completed within thirty (30) days
following the final decision of the arbitrators or such other reasonable period
as the arbitrators determine in a written opinion.  Any arbitration subject to
this Section 11.3 shall be completed within one (1) year from the filing of
notice of a request for such arbitration.

     11.4  No Implied Licenses.  Only the licenses granted pursuant to the
     -------------------------                                            
express terms of this Agreement shall be of any legal force or effect.  No
license rights shall be created by implication, estoppel or otherwise.

     11.5  Representation by Legal Counsel.  Each Party hereto represents that
     -------------------------------------                                    
it has been represented by legal counsel in connection with this Agreement and
acknowledges that it has participated in the drafting hereof.  In interpreting
and applying the terms and provisions of this Agreement, the Parties agree that
no presumption shall exist or be implied against the Party which drafted such
terms and provisions.

     11.6  Waiver.  Any delay or failure in enforcing a Party's rights under
     ------------                                                           
this Agreement or any waiver as to a particular default or other matter shall
not constitute a waiver of such Party's rights to the future enforcement of its
rights under this Agreement, nor operate to bar the exercise or enforcement
thereof at any time or times thereafter, excepting only as to an express written
and signed waiver as to a particular matter for a stated duration.

     11.7  Independent Contractors.  The relationship of the Parties hereto is
     -----------------------------                                            
that of independent contractors.  Nothing herein contained shall be deemed to
create an employment, agency, joint venture or partnership relationship between
the Parties hereto or any of their agents or employees.  Neither

                                                                            -40-
<PAGE>
 
Party shall have any power to enter into any contracts or commitments or to
incur any liabilities in the name of, or on behalf of, the other Party, or to
bind the other Party in any respect whatsoever.

     11.8   Solicitation of Employees.  SPL and Pharmacopeia both agree that,
     --------------------------------                                        
during the Collaboration Term and for one (1) year thereafter, without the
express prior written consent of the other Party, they will not knowingly induce
or attempt to induce, directly or indirectly, any scientific or technical
personnel then employed by the other Party to accept employment or affiliation
with the inducing Party or its Affiliates.

     11.9   Compliance with Laws.  In exercising their rights under this
     ---------------------------
license, the Parties shall fully comply with the requirements of any and all
applicable laws, regulations, rules and orders of any governmental body having
jurisdiction over the exercise of rights under this license.

     11.10  Export Control.  This Agreement and the obligations of both Parties
     ---------------------                                                     
hereunder are made subject to, and limited by, all applicable restrictions
concerning the export of products or technical information from the United
States of America which may be imposed upon or related to Pharmacopeia or SPL
from time to time by the government of the United States of America.
Furthermore, SPL agrees that it will not export, directly or indirectly, any
technical information acquired from Pharmacopeia under this Agreement or any
products using such technical information to any country for which the United
States government or any agency thereof at the time of export requires an export
license or other governmental approval, without first obtaining the written
consent to do so from the Department of Commerce or other agency of the United
States government when required by an applicable statute or regulation.

     11.11  Patent Marking.  SPL agrees to mark and have its Affiliates and
     ---------------------                                                 
Sublicensees mark all Agreement Products sold pursuant to this Agreement in
accordance with the applicable statute or regulations relating to patent marking
in the country or countries of manufacture and sale thereof.

     11.12  Notices.  Any notice required or permitted to be given or sent under
     --------------                                                             
this Agreement shall be in writing and shall be hand delivered or sent by
express delivery service or certified or registered mail, postage prepaid, or by
facsimile transmission (with written confirmation copy by registered first-class
mail) to the Parties at the addresses and facsimile numbers indicated below.

     If to Pharmacopeia, to:

          Pharmacopeia, Inc.
          3000 East Park Boulevard
          Cranbury, New Jersey  08512
          Attn: Chief Executive Officer
          Fax No.: (609) 452-3672

     If to SPL, to:

          Schering-Plough Ltd.
          Toepferstrasse 5
          CH 6004 Lucerne, Switzerland
          Attention:  President
          Facsimile No.: (011) 41 41 418 1630

                                                                            -41-
<PAGE>
 
          with copies to:

               Schering Corporation
               2000 Galloping Hill Road
               Kenilworth, New Jersey  07033
               Attention: Vice President, Business Development
               Facsimile No.: (908) 298-5379

               Schering Corporation
               2000 Galloping Hill Road
               Kenilworth, New Jersey  07033
               Attention: Law Department, Staff Vice President  Licensing
               Facsimile No.: (908) 298-2739

     Any such notice shall be deemed to have been given when received. Either
Party may change its address or its facsimile number by giving the other Party
written notice, delivered in accordance with this Section.

     11.13  Force Majeure.  Failure of any Party to perform its obligations
     --------------------                                                  
under this Agreement (except the obligation to make payments when properly due)
shall not subject such Party to any liability or place them in breach of any
term or condition of this Agreement to the other Party to the extent (and only
to the extent) that such failure is due to fire, explosion, flood, drought, war,
riot, sabotage, embargo, strikes or other labor trouble, failure of suppliers, a
national health emergency, compliance with any order or regulation of any
government entity acting with color of right, or any other cause beyond the
reasonable control of such non-performing Party and not caused by the
negligence, intentional conduct or misconduct of the non-performing Party (such
event or cause referred to as "force majeure").  The Party affected shall
promptly notify the other Party of the condition constituting force majeure as
defined herein and shall exert reasonable efforts to eliminate, cure or overcome
any such event of force majeure and to resume performance of its obligations
with all possible speed.  If a condition constituting force majeure as defined
herein exists for more than ninety (90) consecutive days, the Parties shall meet
to negotiate a mutually satisfactory resolution to the problem, if practicable.
The foregoing notwithstanding, nothing herein shall require any Party to settle
on terms unsatisfactory to such Party any strike, lock-out or other labor
difficulty, any investigation or proceeding by any public authority or any
litigation by any Third Party.

     11.14  Severability.  If any provision of this Agreement becomes or is
     -------------------                                                   
declared by a court of competent jurisdiction to be illegal, invalid or
unenforceable or void, it is mutually agreed that this Agreement shall remain in
full force and effect without such provision, and the Parties will, in good
faith, renegotiate the terms and conditions of this Agreement so as to lawfully
include the substance of such provision (to the extent possible) in order to as
fully as possible realize the intent of the Parties and their commercial
bargain.

     11.15  Counterparts.  This Agreement shall become binding when any one or
     -------------------                                                      
more counterparts hereof, individually or taken together, shall bear the
signatures of each of the Parties hereto.  This Agreement may be executed in any
number of counterparts, each of which shall be an original as against either
Party whose signature appears thereon, but all of which taken together shall
constitute but one and the same instrument.

     11.16  Captions.  The captions of this Agreement are solely for the
     ---------------                                                    
convenience of reference and shall not affect its meaning or interpretation.

     11.17  Complete Agreement.
     ------------------------- 

                                                                            -42-
<PAGE>
 
            11.17.1  Final Agreement and Amendments.  This Agreement with its
            ---------------------------------------                          
Exhibits, together with the US Agreement entered by the Parties of even date
herewith, constitutes the entire agreement, both written and oral, between the
Parties with respect to the subject matter hereof, and all prior agreements
respecting the subject matter hereof, either written or oral, expressed or
implied, shall be abrogated, canceled, and are null and void and of no effect;
provided, however that nothing herein shall effect the rights and obligations of
--------  -------                                                               
the Parties under the certain Collaboration Agreement and the certain Random
Library Agreement between Pharmacopeia, Schering Corporation and Schering-Plough
Ltd. effective as of December 22, 1994, as amended.  No amendment or change
hereof or addition hereto shall be effective or binding on either of the Parties
hereto unless reduced to writing and executed by the respective duly authorized
representatives of Pharmacopeia and SPL.

            11.17.2  Relationship to US Agreement; Controlling Provisions.  The
            -------------------------------------------------------------      
parties acknowledge and agree that this Agreement together with the US Agreement
are intended to operate together as a single worldwide agreement governing the
rights and obligations of Pharmacopeia, SPL and Schering Corporation.  For
purposes of clarity and avoidance of doubt, the parties agree that Article II,
Article III and Section 4.9 of this Agreement shall be subject to and governed
by the corresponding provisions of the US Agreement.  The parties further agree
that SPL's rights and obligations with respect to the filing, prosecution,
maintenance and enforcement of patents and patent applications under Article VI
of this Agreement shall be exercised and performed by the employees and/or
agents of Schering Corporation having responsibility for Schering Corporation's
rights and obligations under Article VI of the US Agreement, and that all such
activities will be performed in a coordinated manner.

     11.18  Recording.  Each Party shall have the right, at any time, to record,
     ----------------                                                           
register, or otherwise notify this Agreement in appropriate governmental or
regulatory offices anywhere in the world, and each Party shall provide
reasonable assistance to the other in effecting such recording, registering or
notifying.  The Parties acknowledge that this Agreement may be notified by
either Party to the European Community for compliance with applicable laws.

     11.19  Further Actions.  Each Party agrees to execute, acknowledge and
     ----------------------                                                
deliver such further instruments, and to do all other acts, as may be necessary
or appropriate in order to carry out the purposes and intent of this Agreement
including, without limitation, any filings with any antitrust agency which may
be required.


     IN WITNESS WHEREOF, this Agreement has been executed by the duly authorized
representatives of the Parties as of the date set forth below.
                                                                    ------------
                                                                    LEGAL REVIEW
                                                                    /s/
                                                                    ------------


PHARMACOPEIA, INC.                      SCHERING-PLOUGH LTD.

 
By: /s/ Richard Walsh                   By: /s/ David Poorvin
   -------------------------------         -------------------------------- 
Title: Sr. Vice President               Title:   Prokvrist
      ----------------------------            -----------------------------
Date:  October 29, 1998                  Date:   29 October 1998
     -----------------------------            -----------------------------

                                                                            -43-
<PAGE>
 
                                   EXHIBIT A


                                        

                              CURRENCY CONVERSION

                                        
*


__________________

*     CONFIDENTIAL TREATMENT REQUESTED
<PAGE>
 
                                 Schedule 1.28
                                 -------------


                Elements of Fully Absorbed Manufacturing Costs
                ----------------------------------------------

     The following expenses are included in manufacturing costs:


     1.   Direct Materials
          ----------------

     Materials used in the manufacturing process that are traced directly to the
completed product, such as:

     .    Inert raw materials or excipients

     .    Active substances/ingredients

     .    Packaging components such as bottles, caps, labels,
          etc.

     2.   Direct Labor
          ------------

     The cost of employees engaged in production activities that are directly
identifiable with product costs. Excludes supervision, which is included in
indirect labor, and production support activities such as inspection, plant and
equipment maintenance labor, and material handling personnel. Direct Labor cost
includes:

 .         Base pay, overtime, vacation and holidays, illness, personal time with
          pay, and shift differential.

 .         Cost of employee fringe benefits such as health and life insurance,
          payroll taxes, welfare, pension, profit sharing and bonuses.

     3.   Indirect Manufacturing Costs
          ----------------------------

     Costs which are ultimately allocated to product based on an appropriate
method such as standard direct labor hours, tank hours, grams, vials, etc., of
the operating departments. These costs include:

                                                                     i
<PAGE>
 
 .    Indirect Production Labor - salaries of employees engaged in production
     -------------------------
     activities who are not classified as direct labor, including supervision,
     clerical, etc.

 .    Costs of Direct Labor - employees not utilized for the manufacturing of
     ---------------------
     product such as training, downtime and general duties.

 .    Indirect Materials - supplies and chemicals which are used in the
     ------------------
     manufacturing process and are not assigned to specific products but are
     included in manufacturing overhead costs. Includes supplies for which
     direct assignment to products is not practical.

 .    Utilities - expenses incurred for fuel, electricity and water in providing
     ---------
     power for production and other plant equipment.

 .    Maintenance and Repairs - amount of expense incurred in-house or purchased
     -----------------------
     to provide services for plant maintenance and repairs of facilities
     and equipment.

 .    Other Services - purchased outside services and rentals such as the cost of
     --------------
     security, ground maintenance, etc.

 .    Depreciation - of plant and equipment utilizing the straight-line method of
     ------------
     calculation.

 .    Insurance - cost of inventory insurance, comprehensive insurance and other
     ---------
     insurance necessary for the safeguard of manufacturing plant and
     equipment.

 .    Taxes - expense incurred for taxes on real and personal property
     -----
     (manufacturing site, buildings and the fixed assets of equipment, furniture
     and fixtures, etc.). If manufacturing site includes other operations
     (marketing, R&D, etc.), taxes are allocated to manufacturing on the basis
     of total real and personal property.

 .    Cost of manufacturing, service departments - such as:
     ------------------------------------------
     (where applicable)

                                                                              ii
<PAGE>
 
     .         Packaging Engineering

     .         Manufacturing Maintenance

     .         Industrial Engineering

     .         Receiving and Warehousing

     .         Purchasing and Accounting

     .         Production Scheduling

     .         Inventory Management

     .         Plant Materials Management

     .         Central Weigh

     .         Manufacturing Administration

     .         Regulatory Affairs direct support to manufacturing (not to exceed
               $80,000 per year for a three(3) year period)


 .         Allocated costs of services provided to manufacturing including:
          (where applicable)

     .         Cafeteria

     .         Personnel Operations

     .         Health and Safety Services

     .         Division Engineering and Operations Services

     .         Plant Services (housekeeping)

     .         Manufacturing Information Systems

     .         Plant Power

     .         Office of V.P. Manufacturing


               Various bases are used for allocating these costs to
          manufacturing operating departments including headcount, square feet,
          metered utilities use, estimated services rendered, EDP computer
          hours, etc.


     4.   Quality Assurance Costs
          -----------------------

     Direct labor and indirect costs for Quality Assurance departments by
testing and approving materials used in manufacturing and completed
manufacturing batches and finished products.  This includes all manufacturing
in-process testing and testing of finished

                                                                             iii
<PAGE>
 
materials.  Excluded from product costs are QA costs related to research and
development, stability testing, etc.

     The following expenses are not included in manufacturing costs:

     a)   Inventory Carrying Costs

     b)   Regulatory Affairs Costs (except as set forth above)

     c)   Pilot plant costs, research batches and other similar costs prior to
          turnover to manufacturing.  These are handled as development costs and
          expensed to R&D.  This excludes commercial goods produced by a
          research facility.

     d)   Costs incurred by Manufacturing for special projects, or for Schering-
          Plough Research Institute requests, to establish and certify new
          production processes, batch sizes and product line improvements, and
          new vendor certification of equipment and primary materials
          components.  These costs are expensed to R&D.

     e)   Manufacturing start-up costs and initial one-time extraordinary
          manufacturing costs incurred prior to plant operation and achievement
          of a normal production activity level.  Includes costs of training,
          testing, qualification/validation of new equipment and facilities and
          initial trial batches.  These costs are deferred and then amortized to
          Other   Production Costs over five years.

     f)   Significant idle capacity is eliminated from factory overhead and
          product cost.  Idle or   excess capacity costs are culled out of the
          Manufacturing Budget and expensed as a period cost to Other Production
          Costs.

     g)   Finished goods warehousing, shipping and other distribution costs.
          These are included in distribution costs which are part of marketing
          expenses.

     h)   Product liability and/or business interruption insurance expenses.

                                                                              iv