T.C. Mem o. 2 01 6- 16 3

UNITED STAT ES TAX COURT

SPIR IDON SPIREAS AND AMALIA KASSAPIDIS -SPI REAS, Pet it io ne rs v. COMM ISSI ONER OF INTERNAL REVENUE, Resp on de nt

Doc ke t No . 10 72 9- 13
. Fi le d Au gu st24 , 20 16
. W il li am F. Co lg in , Rob ertR. Mart in el li , andCh ris ti naK. Harpe r, fo r pe ti ti on ers . Geral d A. Tho rp e, fo r res po nd en t.

MEMORANDUM FINDINGS OF FACT AND OPINION LAUBER, Ju dg e: The In te rn al Rev enue Serv ic e (IR S o r res po nd en t) d et erm in ed , for

20 07 an d 2 00 8 re sp ect iv el y , def ic ie nc ie s i n p et it io ne rs ’ Fed eral in co m e ta x o f $4 ,08 3,2 64 an d $ 1,7 45 ,70 1. Th e d efi ci en ci es aro se fro m res po nd en t’s co ncl us io n tha t the royalt ie s Sp iri do n S pi reas (pe ti ti on er) re cei ve d u nd er a l ic en se- 2 -

[* 2] ag reem en t ar e ta xabl e as ord in ary in co m e rat he r th anas c ap it al ga in . The qu es ti on we m

us t d eci de is whet he r pe ti ti on er tran sf erre d “ al l s ub st an ti al rig ht s” to th e rel ev an t t ech no lo gy, suc h tha t the royalt ie s h e rec ei ve d a re el ig ib le forcap it al ga in tre atm en t u nd er s ect io n 1 23 5. Fin di ng as we do th atpe ti ti on er re ta in ed 1
va lu ab le rig ht s i n the tec hn ol og y th atwas the subjec t o f th e tr an sf er, we s us ta in
res po nd en t’s d et erm in at io n tha t s ect io n 1 23 5 d oe s n otap pl y an d tha t the royalt ie s co ns ti tu te d o rd in ary in co m e. FINDINGS OF FACT So m e o f th e fac ts ha ve be enst ip ul at edan d a re s o fo un d. Th e st ip ul at io ns of fact s an d the att ach edex hi bi ts are i nc or po rat edby thi s re fere nc e. Pet it io ne rs resi de d i n P en ns y lv an iawhen th ey fil edth e p et it io n. Pet it io ne r imm ig rat edto th e Uni te d S ta te s fr om Greece in19 85 an d c om pl et edm as te r’s an d d oc to ral stud ie s i n p ha rm aceu ti cal tec hn ol og y an d i ndus tri al ph arm acy. He ob ta in edhi s Ph .D. deg ree fr om St. J oh n’s Un iv ers ity

in19 93 . Dr. San fo rdM. Bo lt on , no w dec eas ed , was ch ai rm anof t he ph arm aceu ti cal sci en ces de pa rtment a t St . Jo hn ’s when pe ti ti on er was writ in g h is do ct or al th es is an d s erv ed
as hi s fa cu lty

advi se r. All st atut ory

refe ren ces are t o the Int ern al Rev enue Co de ineffe ctforth e 1 y ears inis su e, an d a ll Ru le refe ren ces are t o the Tax C ou rt Rul es of P ract ic e an d Pro cedur e. W e ro un d a ll do ll ar am ou nt s t o the ne ares t d ol lar.- 3 -

[* 3] A. The Liqui so li d Tec hn ol og y an d P at en ts Pet it io ne r’s di ss ert at io n a dd res se d t ech ni qu es de si gn edto im pr ov e, inlab or at ory -s cal e stud ie s, the so lubi li ty of drug s n oteas il y di ss ol ve d i n wat er. Pet it io ne r subs eque nt ly became a reno wne d e xp ertinth e sc ie nc e o f drug de li ve ry , in cl ud in g

“ li qu is ol id ” te ch no lo gi es , whi chin vo lv e n ov el m etho ds of dru g fo rm ul at io n. He is anin ve nt oran d h as sec ur ed , join tl y or i nd iv idua ll y , m or e th an80 U.S. andfor
ei gn pa te nt s an d/ orpate ntap pl ic at io ns . In19 97 pe ti ti on er an d Dr. Bo lt onorg an iz edHy gr os ol Ph arm aceu ti cal Co rpo rat io n (Hygro so l) f

orth e p ur po se of e xp lo it in g the li qu is ol idtec hn ol og ie s the y were d ev el op in g. Hy gr os ol is anele ct in g s m al l b us in es s o r “ S” co rp or at io n. At al l re le va ntti m es , pet it io ne r an d Dr. Bo lt on each own ed50 % of Hygro so l; th ey to oktu rn s s erv in g a s i ts pre si de ntan d v ic e p res id en t. Hy gr os ol rece iv edth e ro y al
ti es at i ss ue inth is cas e, an d tho se royalt ie s fl owe d thr ou gh to pe ti ti on er an d Dr. Bo lt on . Inlaypers on s’ term s, the li qu is ol idtec hn ol og y canbe th ou gh t o f as a to ol
. Thi s t oo l ca n b e u se d t o c reat e uni qu e fo rm ul at io ns forth e d el iv ery of a ch em ic al in tab le t fo rm , su chas anu tri ti on al supp le m en t o r a p ha rm aceu ti cal dru g. Th e li qu is ol idtec hn ol og y

de ve lo pe d b y

pe ti ti on er an d Dr. Bo lt on aim edto so lv e th e pr ob le m of l ow “bi oa va il ab il ity ” o f wat er-i ns ol ub le dru gs .- 4 -

[* 4] “ Bi oa va il ab il ity ” ref ers to th e ex te ntan d ra te at wh ic h adru g e nt ers th e bo dy’ s s y st em ic cir cu la ti on an d i s thu s ab le to have th e d es ire d the rap eu ti c eff ect . Dru gs de li ve redin tra ve no us ly hav e a 1 00 % bi oa va il ab il ity rat e. Drug s d el iv ered
or al ly hav e a l owe r bi oa va il ab il ity rat e b ecau se th ey

m us t fi rs t b e d is so lv edinth e ga st ro in te st in al flu id s an d p as s thr ou gh th e in te st in al wall be fo re re ach in g the bl oo ds tre am . So ft- ge la ti n c ap su le s ai d b io av ai labi li ty becau se th e dru g i s al read y ina li qu idso lu ti on , whi chfaci li ta te s qui ck er an d m or e co m pl et e ab so rp ti on of t he dru g whi le inth e g as tro in te st in al tra ck . The m anuf actur in g p ro ces s re qu ire d t o p ro du ce so ft- ge la ti n c ap su le s, h owe ve r, canbe co m pl ex an d e xp en si ve . Liqu is ol idtec hn olo gy inv ol ve s p ro du ct io n o f “ li qu is ol idsyste m s,” wh ic h are p owd eredform s o f drug s i n l iqui d s ol ut io ns th atcanbe co m pr es se d i nt o t ab le ts or p la cedinha rd
ge la ti n c ap su le s, wh ic h a re ty pi cal ly cheap er t o m anuf actur e. A m ajorgo al of li qu is ol idtec hn ol og y

is to en ha nc e th e b io av ai labi li ty of wat er-i ns ol ub le dru gs de li ve redinth es e fo rm at s. In19 98 pe ti ti on er b eg ande ve lo pi ng “ gr anul ar l iqui so li d s y st em s,” wh ic h are l iqui so li d s y st em s tha t i nc lu de a vo la ti le so lv en t. Gran ul ar l iqui so li d s y st em s are i de al for

dru gs th atde gr ad e und er h eat . The p ro ces s fo r m ak in g g ranul ar l iqui
so li d s y st em s g en eral ly inv ol ve s m ix in g the dru g wi th vo la ti le an d n on vo la ti le- 5 -

[* 5] so lv en ts witho utap pl y in g a ny heatto pro du ce the dru g s ol ut io n o r su sp en si on . Pet it io ne r an d Dr. Bo lt on were i ss ue d, jo in tl y or i nd iv idua ll y , fou r U.S. pa ten ts rel at edto li qu is ol idtec hn ol og y . In J un e 1 99 6 the y ap pl ie d fo r, an d i n S ep te m be r 19 98 th ey

were i ss ue d, Pa te ntNo. 5 ,80 0,8 34 for“ li qu is ol idsyste m s an d
m etho ds of p rep ari ng same” (83 4 p at en t). Th e 8 34 pa te ntcla im s a m etho d o f
us in g ano ve l m athe m at ic al alg or ithm to de te rm in e acc ep tabl e fo rm ul at io ns us in g th e li qu is ol idtec hn ol og y . InOcto be r 19 97 pe ti ti on er an d Dr. Bo lt onap pl ie d fo r, an d i n Oct ob er 1 99 9 th ey were i ss ue d, Pa te ntNo. 5 ,96 8,5 50 (55 0 p at en t). Th e 5 50 pa te nt , whi chals o co ve red“ li qu is ol idsyste m s an d m etho ds of p rep ari ng same,” was a “ di vi si on of” th e 8 34 pa te nt . The cl ai m s o f th e 5 50 pa te ntres em bl e th os e o f th e 8 34 pa te ntbu t di sc lo se ad di ti on al pro du ct s tha t ca n b e p rep aredus in g the li qu is ol idtec hn ol og y . InAug us t 1 99 8 p et it io ne r an d Dr. Bo lt on ap pl ie d fo r, an d i n Au gu st20 00 th ey were i ss ue d, Pa te ntNo. 6 ,09 6,3 37 (33 7 p at en t). In May 200 0 p et it io ne r in
di vi du al ly app li edfor , andinJu ly 200 2 h e was is su ed , Pat en t No . 6,4 23 ,33 9 (3 39 pa te nt ). The 3 37 an d 3 39 pa te nt s, wh ic h a ls o c ov ered“ li qu is ol idsyste m s an d
m etho ds of p rep ari ng same,” were “ co nt inua ti on s- in -p art ” o f th e 5 50 pa te nt . In
co nt ras t t o the pro ces se s d is cl os edinth e 8 34 an d 5 50 pa te nt s, the pro ces se s d is
-- 6 -

[* 6] cl os edinth e 3 37 an d 3 39 pa te nt s d o n otrequi re the us e o f el ev at edtem pe ratu res . W e wil l re fer t o the 83 4, 5 50 , 33 7, an d 3 39 pate nt s co ll ect iv el y as t he Pat en ts . W e wil l re fer t o the tec hn ol og y un de rlyin g e achof t he Pat en ts as t he li qu is ol idtec hn ol og y . B. Neg ot ia ti on s To wardLice ns in g Ag reem en t At the rel ev an t t im es , Mu tu al Ph arm aceu ti cal Co m pa ny, Inc. (M utua l), was
a co m pa ny whos e b us in es s fo cu se d o n d ev el op in g a ndm ark et in g g en eri c dru gs . Uni te d R es earc h Lab or at or ie s, In c. (URL), was anaffi li at e o f Mu tu al th atdi st ribu te d p ha rm aceu ti cal pro du ct s an d s om e h eal th an d n ut rit io na l s up pl em en ts . W e wil l re fer t o the se co m

pa ni es co ll ect iv el y

as M utua l. Pet it io ne r was in tro du cedto Mu tu al th ro ug h apro fes si on al co ll eag ue . In a Sep te m be r 19 97 m eet in g wi th Mu tu al , pet it io ne r ex pl ai ne d h ow the li qu is ol id te ch no lo gy cou ldbe us edto en ha nc e th e b io av ai labi li ty of va rio us dru gs an d
nu tri ti on al supp le m en ts , su chas C oQ1 0. He p ro vi de d e xa m pl es of p ha rm aceu ti cal pr oduc ts he was d ev el op in g, u si ng th is tec hn ol og y , inco ll ab or at io n wi th othe r drug co m pa ni es . On Se pt em

be r 17 , 19 97 , pet it io ne r an d M utua l s ig ne d aco nf id en ti al ity ag reem en t. Thi s i nc lu de d a n a dd en du m , pre pa redby pet it io ne r, th atex cl ud ed- 7 -

[* 7] m ark et in g s tra te gi es he was a lre ady us in g fo r th e li qu is ol idtec hn ol og y . Pet it io ne r in cl ud edth is ad de ndum be cau se he di d n otwantto be for ecl os edfro m us in g s uc h m ark et in g s tra te gi es inco ll ab or at io n wi th co m pa ni es othe r th an Mu tu al
. Dur in g fa ll 19 97 pe ti ti on er ex pe ct edMu tu al to pro po se a co ll ab or at io n t o de ve lo p asupe r-b io av ai labl e Co Q10 pro du ct . Ins te ad , Mu tu al inDecem be r 19 97
se nthi m anun so li ci te d l et te r as ki ng forhi s h el p i n d ev el op in g acap su le form of et op os id e. Eto po si de is us edinch em ot he rap y to tre atcert ai n ty

pe s o f can cer. Pe
ti ti on er re jecte d thi s p ro po sa l b ecau se (am on g o th er thi ng s) he was a lre ady co ll abo rat in g wi th BarrLabo rat or ie s, a l arg e dru g c om pa ny, on u si ng th e li qu is ol id te ch no lo gy to fo rm

ul at e et op os id e. On Dec em

be r 23 , 19 97 , Mu tu al sen t p et it io ne r an d Dr. Bo lt on a la rg er s cal e pr op os al th atin cl ud eda dr aftli cen se ag reem en t. Thi s ag reem en t, i f im pl em en te d,
wou ldha ve gra nt edMu tu al anex cl us iv e li cen se to us e, th ro ug ho utth e p ha rm aceu ti cal in du st ry , th e li qu is ol idtec hn ol og y rep res en te d b y

th e 8 34 pate nt . Peti
ti on er re jecte d thi s p ro po sa l b ecau se he ha d n o i nt en ti onof g iv in g M utua l the
ex cl us iv e ri gh t t o u se th is tec hn ol og y . At th atti m e, he was a tt em pt in g t o e xp lo it th e li qu is ol idtec hn ol og y with o th er p harm aceu ti cal co m pani es an d was work in g with a t l eas t two co m

pa ni es inaneffo rt t o c reat e supe r-b io av ai labl e dru gs .- 8 -

[* 8] InJan uary

19 98 pe ti ti on er ag reedto pro vi de co ns ul ti ng servi ces to Mu tu al in co nn ect io n wi th it s re se arch an d d ev el op m en t (R &D) ac ti vi ti es . Thes e se rv ic es were n otdi rect ly relat edto th e li qu is ol idtec hn ol og y . Howev er, wh il e p et it io ne r was pro vi di ng th es e se rv ic es , Mu tu al su ccee de d i n o bt ai ni ng FDA app ro va l fo r two dru g p ro du ct s. Th is bo os te d p et it io ne r’s co nf id en ce tha t i t wo ul d b e ab le to se cu re FDA ap pr ov al if dru gs were d ev el op edus in g the li qu is ol idtec hn ol og y . Inlat e Feb ru ary 19 98 pe ti ti on er s en t M utua l a l et te r pr op os in g s ig ni fic an t ch an ge s t o the Decem

be r 19 97 dra ft l ic en se ag reem en t. In st eadof g ran ti ng Mu tu al anex cl us iv e li cen se to us e th e li qu is ol idtec hn ol og y , pet it io ne r pr op os edth atit
wou ldrece iv e a l ic en se to us e th attec hn ol og y on ly in co nn ect io n wi thsp eci fic pr oduc ts th atth e p art ie s ag reedto de ve lo p. Aft er s ev eral m on th s o f ad di ti on al
ne go ti at io ns th e p art ie s ex ecu te d ali cen se ag reem en t b as edon th is pri nc ip le
. C. The Lice ns e Agr eem en t On J un e 1 2, 1 99 8, Hy gr os ol , Dr. Bol to n, an d p et it io ne r (co ll ect iv el y , li cen so rs ) en te redin to a li cen se ag reem en t wi th Mu tu al (19 98 li cen se ag reem en t o r ag reem en t). Th e ag reem en t g ran te d t o M utua l the rig htto us e th e li qu is ol idtec hno lo gy, on apro du ct -b y -p ro du ctba si s, t o d ev el op , pro du ce, an d s el l wi th in th e Uni te d S tate s n ew an d g en eri c p ha rm aceu ti cal dru gs , as d et erm in edby the pa rti es- 9 -

[* 9] on th e b as is of u na ni m ou s co ns en t. The ag reem en t b eg anwith the fol lo win g reci ta ls : W HEREAS, th e fo un de rs of Hygro so l, Sp ire as an d B ol to n, h av e ob ta in eda no ti ce o f al lo wan ce o f th ei r pa te ntcla im s i n the ir app li cati onfor Uni te d S ta te s Let te rs Pat en t en ti tl edLIQUISOLID SYSTEMS AND METHODS OF PREPARING SAME * * * (th e “ Pat en t” ) * * * ; an d W HEREAS, Spi reas an d B ol to n d ev el op edan d a re the in ve nt or s o f al l the tec hn ol og y

whi chis th e subjec t o f th e Pat en t (t he “ Tech
no lo gy”); an d * * * W HEREAS, Hy gr os ol , Spi reas an d B ol to n d es ire to gra ntto Mu tu al an d Un it edth e ex cl us iv e ri gh t t o u ti li ze the Tech no lo gy on ly fo r th e d ev el op m en t o f ne w gen eri c dru g fo rm s an d n ew dr ug pro du ct s (th e “ Pro du ct s” ), un an im ou sl y sel ect edby H y gr os ol , Uni te d a nd Mu tu al an d, af

te r so sel ect ed , to be de ve lo pe d, p ro du cedan d s ol d i n th e Uni te d S ta te s. Sect io n 2 of t he ag reem en t, capt io ne d “ Gran t o f Exc lu si ve Rig ht s,” p ro vi de d tha t the li cen so rs gra nt edto Mu tu al “ [t]he ex cl us iv e ri gh ts to ut il iz e th e Tech no lo gy on ly to d ev el op Pro du ct s tha t M utua l, Un it ed , andHy gr os ol , act in g i n go odfai th wil l u na ni m ou sl y sel ect .” Mu tu al was a ls o g ran te d the ex cl us iv e ri gh t, withi n the Uni te d S ta te s, “ to pro du ce, m ark et , sel l, p ro m ot e an d d is tri bu te * * *
sa idPro du ct s co nt ai ni ng th e Tech no lo gy.” The “ Tech no lo gy” was d efi ne d a s “ th e te ch no lo gy whic h i s the subjec t o f th e Pat en t,” wh ic h d en ot edth e o rig in al 83 4 pa te nt .- 10 -

[* 10 ] Sect io n 7 .4 o f th e ag reem en t ad dr es se d a fte r-ac qu ire d t ech no lo gy. It p ro vi de d tha t “ [i]f, du rin g d ev el op m en t o f a Pro du ct , a ne w pat en t o f sp eci fic ap pl ic ati oncla im s i s s ecu redba se d o n the ori gi na l Pa te nt , th e n ew pa te ntsh al l b e th e p ro pe rty of Hy gr os ol , Spi reas an d B ol to n.” Howev er, Mu tu al inth atev en t wo ul d ha ve th e ri gh t, wi th ou t p ay in g a dd it io na l co m pe ns at io n, “ to ut il iz e su chpa te ntas if d es cri be d i n the de fin it io n o f ‘Paten t’ setforth ab ov e.” Thu s, the “ Tech no lo gy” th atMu tu al rece iv edth e ri gh t t o u se ul ti m at el y in cl ud edno t o nl y

th e 8 34 pa te nt bu t al so th e 5 50 pa te nt , whi chwas a“ di vi si on of” th e 8 34 pa te nt , andth e 3 37 an d 33 9 p at en ts , whi chwere “ co nt in ua ti on s o f” the 55 0 p at en t. The term “ Pro du ct s” was d efi ne d t o m ean“ ne w gen eri c dru g fo rm s an d n ew drug pro du ct s” de ve lo pe d u si ng th e Tech no lo gy. “ Pro du ct s” co ul d a ls o i nc lu de
nu tri ti on al supp le m en ts th atwere ei th er co m bi ne d wi thph arm aceu ti cal dru gs or requi redFDA app ro va l t o b e m ark et edas dru gs . The t erm “ Pro du ct s” thus ex cl ude d n ut rit io na l s up pl em en ts un co nn ect edto an y FDA-ap pr ov eddru g a ndno t re qu iri ng FDA app ro va l. Sec ti on 5.5 furth er p ro vi de d tha t “ [t]he gro up of p ot en ti al Pro du ct s t o b e se le ct edby the pa rti es to th is Agre em en t s ha ll ex cl ud e, atall ti m es du rin g the li fe o f th is Agre em en t, p ro du ct s tha t Hy gr os ol , Spi reas , andBo lt on are de ve lo pi ng or a re i n n eg ot ia ti on s t o d ev el op foran ot he r pa rty.”- 11 -

[* 11 ] Mu tu al ’s rig ht s t o u se th e Tech no lo gy with res pe ctto a pa rti cu lar Pro du ct be ga n o nc e th e p art ie s ag reedinwrit in g t o d ev el op th atPro du ctan d M utua l p ai d pe ti ti on er $ 10 ,00 0 t o c on du cta feas ib il ity stud y . Duri ng th e ag reem en t’s fi rs t y ear, the li cen so rs pl ed ge d t o m ak e a g oo d- fai theffo rt t o p ro po se th ree P ro du ct s fo r de ve lo pm en t. If M utua l d et erm in ed , aft er p et it io ne r pr es en te d the res ul ts of h is study , to di sp en se with fu rth er fe as ib il ity stud ie s an d d is co nt in ue de ve lo pi ng th at Pro du ct , th e li cen so rs were the n fr ee “ to off er the Pro du ctto an y

othe r en ti ty.” If the pa rti es ag reed , fol lo win g c om pl et io n o f fea si bi li ty stu di es , to de ve lo p a p art ic ul ar Pro du ct , form ul at io n s tu di es wou ldbe gi n u nd er p et it io ne r’s supe rvi si on with avi ew to pro du ci ng a cl in ic al ba tc h o f th e Pro du ctm eet in g M utua l’s sp eci fic at io ns fordi ss ol ut io n a ndst ab il ity . Thatst ag e wou ldbe fol lo wedby clin ical stud ie s an d (i f th ey

were s uc ces sf

ul ) de ve lo pm en t o f a m ark et in g s tra te gy for th e Pro du ct . If Mu tu al so lda Pro du ct , 20 % of t he gro ss pro fit(as de fin ed ) was to be pa idto Hy gr os ol qu art erl y . If Mu tu al di d n otact iv el y de ve lo p, p ro du ce, o r se ll a pa rti cu lar Pro du ct , th e li cen so rs co ul d t erm in at e it s ex cl us iv e ri gh ts with re sp ectth eret o. Mu tu al wou ld al so for fei t i ts ex cl us iv e ri gh ts with re sp ectto a Pro du ct , andsu chrig ht s wo ul d
rev ertto th e li cen so rs , if M utua l n ot ifi edth em th atitwas d is co nt in ui ng de ve lo pm en t o r m ark et in g o f th atPro du ct . On th e o th er h an d, the ag reem en t p erm it te d- 12 -

[* 12 ] Mu tu al to subl ic en se to a th irdpa rty its rig ht s wi th res pe ctto a pa rti cu lar Pro du ct ; i n tha t ev en t, the li cen so rs were en ti tl edto 50 % of t he “ne t p ro ceed s” as de fin ed
. Apa rt f ro m royalt ie s t o b e p ai d o n u lt im at e sa le of P ro du ct s, p et it io ne r was pa idinothe r way s fo r work p erfo rm edat v ari ou s s ta ge s o f th e d ev el op m en t pr oc es s. Th e $ 10 ,00 0 up- fro ntfee was ba se d o n a n e st im at e th atth e fea si bi li ty study fora gi ve n P ro du ctwou ldtak e ap pr ox im at el y 15 da y s t o c om

pl et e. Fo r ad di ti on al ti m e d ev ot edto feas ib il ity stud ie s, p et it io ne r wou ldbe pa idas an i nd epe nd en t co nt ract orat ada il y rat e o f $6 00 . In M arch19 99 pe ti ti on er en te redin to anem pl oym en t ag reem en t t o s erv e as vi ce p res id en t o f res earc h a ndde ve lo pm en t fo r Mu tu al . His dut ie s as anem pl oyee in cl ud edlab or at ory an d re se archact iv it ie s rel at edto ob ta in in g F DA app ro va ls forth e co m pa ny’ s p ro du ct s. The 19 98 li cen se ag reem en t g ran te d M utua l ri gh ts to us e th e Tech no lo gy on ly in the ph arm aceu ti cal fie ld . Peti ti on er re ta in edrig ht s t o u se hi s l iqui so li d te ch no lo gy to d ev el op vi ta m in s, nut rit io na l s up pl em en ts , andothe r he al th -rel at ed pr oduc ts no t re qu iri ng FDA app ro va l. InFeb ru ary 19 98 pe ti ti on er en ga ge d o ne or m or e p ro fes si on al s t o m ark etth e li qu is ol idtec hn ol og y to va rio us co m

pa ni es inth e he al th an d n ut rit io n fi el ds . As of Ju ne 19 98 th e ri gh t t o e xp lo itth e li qu is ol idtec hno lo gy in the he al th an d n ut rit io n fi el ds ha d s ub st an ti al va lu e.- 13 -

[* 13 ] The 19 98 li cen se ag reem en t was no t p et it io ne r’s on ly effort t o c omm erci al
iz e th e li qu is ol idtec hn ol og y withi n the ph arm aceu ti cal fie ld . Duri ng 19 97 an d th ro ug h the da te of tha t ag reem en t, p et it io ne r worke d wi th othe r drug co m pa ni es to de ve lo p a t l eas t o ne ph arm aceu ti cal pro du ctus in g the Tech no lo gy. The Tech
no lo gy hadpo te nt ia l ap pl ic at io n t o tho us an ds of p ha rm aceu ti cal pro du ct s, an d Mu tu al ob ta in edrig ht s t o u se th atTech no lo gy on ly w ith re sp ectto Pro du ct s tha t th e li cen so rs pre se nt edto itforde ve lo pm en t. By withh ol di ng hi s as se ntas t o a pa rti cu lar drug , pet it io ne r co ul d re se rv e to hi m se lf a ndhi s co -li cen so rs th e ex cl usi ve rig ht s t o d ev el op ne w form ul at io ns of t ha t dru g u si ng th e li qu is ol idtec hn olo gy. The li cen so rs co ul d a ls o re acqui re ri gh ts to us e th e Tech no lo gy withres pe ct to Pro du ct s tha t M utua l d ecl in edto pu rs ue or aba nd on edaft er d ev el op m en t h ad be gu n. Th e ri gh t t o u se th e Tech no lo gy to d ev el op dru gs th atwere n otpro po se d by the li cen so rs to , or s el ect edforde ve lo pm en t b y , Mutu al ha d s ub st an ti al va lu e at th e ti m e th e 1 99 8 l ic en se ag reem en t was si gn ed
. D. Sel ect io n o f Pro du ct s fo r Dev el op m en t As o f th e d at e th e ag reem en t was si gn ed , pet it io ne r ha d n oty etde ve lo pe d a
co m m erci al ly viabl e dru g o r othe r pr oduc t u si ng th e Tech no lo gy. Whi le th e Tech
no lo gy inc lu de d p at en te d c on cep ts forad dr es si ng th e “ lo w bi oa va il ab il ity ” p ro ble m , th e p art ie s re co gn iz edth atth es e co nc ep ts wou ldne edto be ad ap te d t o the- 14 -

[* 14 ] pe cu li ar p ro pe rti es of e ach sp eci fic ch em ic al or m ol ecu le inord er t o c reat e a ne w, comm erci al ly suc ces sf ul , form ul at io n o f th atdru g. Whenth ey ex ecu te d the 19 98 li cen se ag reem en t, the li cen so rs ha d n otid en ti fie d a ny Produc ts th atwou ld be pre se nt edto Mu tu al forde ve lo pm en t. St art in g i n m id -1 99 8, p et it io ne r sc reen edup to 10 0 dru gs , th ro ug h p rel im ina ry tes ts , to de te rm in e th ei r su it ab il ity forde ve lo pm en t u nd er the 19 98 li cen se ag reem en t. Of th es e, th e p art ie s s el ect edm or e th an20 Pro du ct s fo r fu rth er d ev el
op m en t. The ag reem en t s pe ci fie d tha t the se sel ect io ns ha d t o b e m em or ia li zed“ in writ in g,” an d the pa rti es di d thi s b y ex ecu ti ng sh ort en ga ge m en t l et te rs . Betwe en Ju ne 24 , 19 98 , andDecem be r 30 , 20 02 , th e p art ie s ex ecu te d e ng ag em en t l et te rs co m m it ti ng th em se lv es to pu rs ui ng “ hi gh ly to m ax im al ly bio av ai labl e fo rm ul ati on s” of v ari ou s dru gs , in cl ud in g Ib up ro fen , Lov as ta ti n, an d Vi ag ra; an d t o pu rs ui ng “bi oe qu iv al en t fo rm ul at io ns ” o f va rio us dru gs , in cl ud in g Lo va st at in , Pax il , andZol of

t. A typic al en ga ge m en t l et te r was two pa rag rap hs lo ng an d was si gn edby a repr es en ta ti ve of M utua l an d b y pe ti ti on er as th e rep res en ta ti ve of Hy gr os ol
. By earl y 20 00 th e U.S. m ol ecu le pate ntha d e xp ire d fo r a dru g c al le d fe lo
di pi ne , whi chis us edto tre athi gh bl oo d p res su re. Itwas m anuf actur edby a larg e, un rel at edph arm aceu ti cal co m pa ny andm ark et edun de r th e b ran d n am e Pl en di l.- 15 -

[* 15 ] Any ph arm aceu ti cal co m pa ny cou ldpu rch as e th e fel od ip in e m ol ecu le ; ho wev er, the re re m ai ne d ano ne xp ire d fo rm ul at io n p at en t o n the Ple nd il pro du ct . Bec au se of i ts ch em ic al stru ctur e, fel od ip in e h as lo w waterso lubi li ty and de gr ad es if i t i s ex po se d t o e le va te d t em pe ratur es or l ig ht . Peti ti on er p erfo rm ed pr el im in ary te st s o n fe lo di pi ne inearl y 20 00 . After d oi ng so , he was ho pe fu l tha t th e Tech no lo gy cou ldbe us edto de ve lo p ane w form ul at io n o f fel od ip in e th at wou ldov erco m e th e ch al le ng es po se d b y th is dru g, an d a ch ie ve bi oe qu iv al an ce with the Ple nd il pro du ct , witho utin fri ng in g o n the ex is ti ng form ul at io n p at en t. On M arch 7, 2 00 0, M utua l s en t p et it io ne r anen ga ge m en t l et te r ad dr es si ng th e d ev el op m en t o f th ree P ro du ct s, i nc lu di ng fel od ip in e. Thi s l et te r rea d i n fu ll as fo ll ows : Thi s l ette r is th e fo rm al en ga ge m en t o f Hy gr os ol an d M utua l fo r ge ne ric bi oe qu iv al en t v ers io ns of Ryth m ol an d P le nd il Ext en de dRel eas e, as well as m ax im al ly bio av ai labl e fo rm ul at io ns of P ro pa feno ne , inacco rd an ce wi th th e Lic en se Agre em en t b etweenHy gr os ol an d M utua l d at edJu ne 12 , 19 98
. Att ach edwith thi s l et te r is a ch eckforThi rty Thou sa ndDol lars ($ 30 ,00 0) foren ga ge m en t o f th es e th ree p ro du ct s, i n a cco rd an ce wi th th e Lic en se Agre em en t. Pl eas e si gnbe lo w if thi s i s ac cep tabl e to Hy gr os ol Ph arm aceu ti cal Co rp .- 16 -

[* 16 ] Pet it io ne r co un te rs ig ne d thi s l et te r (Ma rch 20 00 en ga ge m en t l et te r) i n h is cap aci ty as vi ce p res id en t o f Hy gr os ol . Felo di pi ne was the 11 thdru g tha t the pa rti es ha d s el ect edforpo ss ib le de ve lo pm en t und er the 19 98 li cen se ag reem en t. 2 Whe n h e si gn edth e March20 00 en ga ge m en t l et te r, pe ti ti on er h adco m pl ete d ro ug hl y

30 % of t he workth atul ti m at el y res ul te d i n asu cces sf

ul ne w form

ula ti on of f el od ip in e. The p rin ci pa l ch al le ng es th is m ol ecu le po se d wer e it s l ow so lubi li ty in wat er an d i ts hi gh sen si ti vi ty to h eatan d l ig ht . In s ol vi ng th es e p ro ble m s, p et it io ne r em

pl oyed the Tech no lo gy and(inpa rti cu lar) the cla im s g ov ern in g

“ gr anul ar l iqui so li d s y st em s” co ve redby the 33 9 p at en t. Bu t co ns id erab le work
was requi redto ad ap t the Tech no lo gy to fe lo di pi ne ’s id io syncra si es , reg ul at in g the rel eas e o f th e dru g fr om

th e g en eri c tabl etan d m ak in g the act iv e in gr ed ie ntst ab le in tab le t fo rm . Peti ti on er an d M utua l re frai ne d fr om see ki ng a pa te nton th is for
m ul at io n i n o rd er t o p rev en t co m pe ti to rs fro m

see in g the di sc lo su res th ata pa te nt

The Marc h 2 00 0 e ng ag em en t l et te r al so co m m it te d the parti es to purs ui ng 2 ne w form ul at io ns of p ro pa fen on e an d Ryth m ol . Prop afen on e is th e g en eri c n am e fo r a dru g u se d t o treathe artarrythm ia ; i t was m ark et edby an unr el at eddru g c om pa ny un de r th e b ran d n am e Rythm ol . Mutua l ev en tu al ly obt ai ne d F DA app ro va l fo r a p ro pa fen on e fo rm

ul at io n a ndpa idroyalt ie s the refo r to Hy gr os ol un de r th e 19 98 li cen se ag reem en t. Inth e te xtwe fo cu s m ai nl y on fel od ip in e b ecau se it ge ne rat ed99 .64 % of the royalty in co m e atis su e in th is cas e. Howev er, the an al y si s fo r th e p ro pa fen on e fo rm ul at io n i s i de nt ic al inall m at eri al asp ect s t o the an al y si s fo r th e fel od ip in e fo rm ul at io n.- 17 -

[* 17 ] ap pl ic at io n wo ul d re qu ire . Howev er, the fel od ip in e fo rm ul at io n was no ve l,
us efu l, an d n on ob vi ou s, an d i t qua li fie d a s p at en tabl e. Und er the 19 98 li cen se ag reem en t, Mu tu al ob ta in edth e ex cl us iv e ri gh t t o pr oduc e an d s el l wi th in th e Uni te d S ta te s an y “ Pro du ct [] con ta in in g the Tech no lo
gy,” whic h i nc lu de d the fel od ip in e fo rm ul at io n. Itob ta in edFDA app ro va l fo r th at fo rm ul at io n, an d i t h as su cces sf ul ly m ark et eda ne w gen eri c fo rm of f el od ip in e th atres ul te d fr om

pe ti ti on er’s ap pl ic at io n o f th e Tech no lo gy. Fel od ip in e an d p ro pa fen on e were the on ly Produc ts de ve lo pe d u nd er the 19 98 li cen se ag reem en t tha t res ul te d i n c omm erci al su cces s. E. Exp ertTest im on y 1. Dr. Davi d En sc or e Pet it io ne r of

fere d, an d the Co urt re co gn iz ed , Dr. Davi d En sc or e as anex pe rt in dru g fo rm

ul at io n, d ev el op m en t, an d m anuf actur in g. Dr. Ens co re h as a Ph .D. in ch em ic al en gi ne eri ng an d h as work edas aco ns ul tantinth e fi el d o f ph arm aceu ti cal pro du ctform

ul at io n fo r m or e th an30 y ears . He is li st edas the in ve nt oror co in ve nt oron 25 U.S. pat en ts rel at in g t o dru g d el iv ery an d m ed ic al de vi ces . Dr. Ens co re cr ed ib ly test ifi edth atpe ti ti on er u se d the Tech no lo gy to i nv en t a fo rm ul at io n a ndm anuf

actur in g p ro ces s fo r a o nc e-d ai ly felo di pi ne ex te nd ed
rel eas e tabl etth atco ul d b e m anuf actur edwitho utcau si ng de gr ad at io n o f th e dru g- 18 -

[* 18 ] an d was bi oe qu iv al en t t o the Ple nd il ex te nd ed -rel eas e p ro du ct . Dr. Ensc or e te st ifi edth atth e fel od ip in e fo rm ul at io n was anad ap ta ti on of t he “ gr anul ar l iqui
so li d” tec hn ol og y

di sc lo se d b y

th e 3 39 pa te nt . His t es ti m on y , inco nju nc ti on with pe ti ti on er’s t es ti m on y , in di cat es th atpe ti ti on er’s i nv en ti onof t he fel od ip in e fo rm ul at io n o ccu rredso m et im e b etweenMay 10, 2 00 0 (wh enpe ti ti on er ap pl ie d fo r th e 3 39 pa te nt ), an d M ay 20 01
. 2. Geo rg e M. Go ul d Pet it io ne r of

fere d, an d the Co urt re co gn iz ed , Geor ge M. Gou ldas a n e xp ert in th e fi el ds of p at en ts an d l ic en si ng . Mr. Gou ldha s p ract ic edpa te ntlaw fo r m or e th an50 y ears . He sp en t m uc h o f hi s ca reeras c hi ef p at en t co un se l fo r Hof fm an nLa Ro ch e, a m ajorph arm aceu ti cal co m pa ny. He ha s fr eque nt ly test ifi edas a n ex pe rt o n p at en t an d i nt el le ctua l p ro pe rty law. Mr. Go ul d t es ti fie d tha t a s ci en ti stoc cupyin g p et it io ne r’s po si ti on in19 98
m ig htha ve co ns id ereden te rin g i nt o a n R &D ag reem en t wi th a ph arm aceu ti cal pa rtn er, the n e xe cu ti ng li cen si ng arrang em en ts forpa rti cu lar pr oduc ts to whi ch ap pl ic at io n o f th e Tech no lo gy seem edpro m is in g. Mr . Gou ldexpr es se d the vi ew th atth e 1 99 8 l ic en se ag reem en t was , insubs tanc e, anR&D ag reem en t, an d tha t th e March 20 00 en ga ge m en t l et te r was , insubs tanc e, a li cen se ag reem en t. Viewi ng th e March 20 00 en ga ge m en t l et te r as a li cen se ag reem en t b y whi ch- 19 -

[* 19 ] Hy gr os ol tra ns ferr edth e fel od ip in e fo rm ul at io n t o M utua l, Mr . Gou ld op in edth at“ al l s ub st an ti al rig ht s” were the reb y tra ns ferr ed . Thatwas s o, h e te st ifi ed , bec au se fel od ip in e was us efu l o nl y as adru g a ndwou ldha ve no va lu e as a nut rit io na l s up pl em en t. F. IRS Ex am in at io n Pet it io ne rs ti m el y

fil edjoi ntFed eral in co m e ta x re tu rn s fo r 20 07 an d 2 00 8
on Fo rm s 1 04 0, U.S. In di vi du al Inc om e Tax Return, o n wh ic h the y rep orte d ro y al
ti es rece iv edun de r th e 1 99 8 l ic en se ag reem en t as lo ng -te rm cap it al ga in . The IR S
ex am in edth os e returns an d i ss ue d p et it io ne rs a ti m el y a no ti ce o f de fic ie nc y . That
no ti ce d et erm in edth atth e ro y al ti es rece iv edwere n otsubjec t t o s ect io n 1 23 5 a nd sh ou ldha ve be enrep orte d a s o rd in ary in co m e. OPINION The Co m m is si on er’s d et erm in at io ns ina no ti ce o f de fic ie nc y are g en eral ly pr es um edco rrec t, an d the tax pa y er b ears th e b ur de n o f pr ov in g tho se de te rm in ati on s erro ne ou s. Ru le 14 2( a); W el chv. Hel ve rin g, 2 90 U.S. 11 1, 1 15 (19 33 ). At tri al pe ti ti on ers m ov edto sh iftth e b ur de n o f pr oo f to res po nd en t u nd er s ect io n 74 91 (a)( 1) . Sev eral of t he is su es on whi chpe ti ti on ers see k t o s hi ft t he bu rd enof pr oo f in vo lv e le ga l co nc lu si on s, n otfactua l m at te rs ; s ect io n 7 49 1( a)(1 ) do es no t ap pl y to sh iftth e b ur de n o f pr oo f as to th em . In an y ev en t, b ecau se we de ci de th is- 20 -

[* 20 ] cas e o n apre po nd eran ce o f th e ev id en ce, i t d oe s n otm at te r who ha s the bu rd enof p ro of

. See s ec. 7 49 1( a); Est at e o f Turne r v. C omm is si on er, 1 38 T.C. 30 6, 3 09 (20 12 ). 3 Abs en t s ti pu la ti on to th e co nt rary, thi s ca se is ap pe al ab le to th e U.S. Co urt of App eal s fo r th e Thi rdCir cu it . On le ga l que st io ns , we acco rd in gl y fol lo w th e pr eced en t o f th atco urt. See Gol se n v . Comm is si on er, 5 4 T.C. 7 42 , 75 7 (1 97 0) , aff’d, 4 45 F.2d98 5 (1 0t h C ir. 1 97 1)
. A. Gov ern in g S ta tu to ry Fram ewo rk Ro y al ty paym en ts rece iv edun de r a l ic en se ag reem en t ar e g en eral ly tax edas or di na ry in co m e. Howev er, s ect io n 1 23 5( a) p ro vi de s tha t a t ran sf er o f pr op erty

“ co ns is ti ng of a ll subs tant ia l ri gh ts to a pa te nt* * * b y an y ho ld er s ha ll be co nsi de redth e sa le or e xc hang e o f a cap it al ass ethe ldform or e th an1 year.” Thi s tre atm en t ap pl ie s re ga rd le ss of wh ethe r th e co ns id erat io n re cei ve d i n e xc ha ng e is

Whe th er the bu rd enha s s hi fte d m at te rs on ly in the cas e o f anev id en ti ary 3 ti e. See Po la ckv. Co m

m is si on er, 3 66 F.3d60 8, 6 13 (8t h C ir. 2 00 4) , aff’g T.C. Mem o. 2 00 2- 14 5. Inth is cas e we d is cern edno ev id en ti ary ti e o n a ny m at eri al is su e o f fac t. See Payne v. Co m m is si on er, T.C. Mem o. 2 00 3- 90 , 85 T.C.M. (CCH) 10 73 , 10 77 (20 03 ) (“ Altho ug h a ss ig nm en t o f th e b ur de n o f pr oo f is po te nti al ly relev an t atth e o ut se t o f an y cas e, whe re * * * th e Co urt fi nd s tha t the un di spu te d fa ct s fa vo r on e o f th e p art ie s, the cas e is no t d et erm in edon th e b as is of whi chpa rty bo re the bu rd enof p ro of , andth e as si gn m en t o f bu rd enof p ro of be
co m es irr el ev an t.”)
.- 21 -

[* 21 ] pa y ab le pe rio di cal ly or is co nt in ge nton pro du ct iv ity or u se of t he pro pe rty. Sec. 1 23 5( a)(1 ) an d (2 ). 4 Fo r pa y m en ts to qu al ify for capi ta l g ai n treat m en t u nd er s ect io n 1 23 5, i t i s no t n eces sa ry

th atth e p ro pe rty tran sf

erre d b e p at en te d o r be subjec t t o apate nt ap pl ic at io n a t the ti m e o f tr an sf er. See sec . 1.1 23 5- 2( a), In co m e Tax Reg s. Itis
su ffi ci en t tha t the tax pa y er tran sf er al l s ub st an ti al rig ht s t o apa te nt ab le pro du ct th atis he ldas atra de sec ret , whet he r orno t a p at en t ap pl ic at io n i s u lt im at el y fil ed
. See B ur de v. Co m

m is si on er, 3 52 F.2d99 5, 9 98 n.4 (2dCir . 19 65 ), aff’g 4 3 T.C. 25 2 (1 96 4) ; Gi ls on v. Co m m is si on er, T.C. Mem o. 1 98 4- 44 7, 4 8 T.C.M . (CCH) 92 2. As th e Thi rdCir cu itex pl ai ne d i n M ag nu s v . Comm is si on er, 2 59 F.2d89 3, 89 8- 89 9 (3 d C ir. 1 95 8) , rev ’g 28 T.C. 89 8 (1 95 7) : “ [O]ur in qu iry is a im edat as cert ai ni ng * * * wh ethe r ri gh ts am ou nt in g t o fu ll an d c om pl et e co ntro l wer e rel in qu is he d. A tr an sf

er o f so m ethi ng les s co ns ti tu te s a m ere l ic en se with the
ro y al ti es * * * re cei ve d the reu nd er t ax ab le as o rd in ary in co m e.” (Fn . ref.
om itte d.)

Sect io n 1 23 5( b) (1 ) de fin es th e te rm “ ho ld er” t o i nc lu de “ an y in di vi du al 4 who se effo rts crea te d s uc h p ro pe rty.” Resp on de ntag rees th at , forpu rp os es of t hi s cas e, pe ti ti on er i s the rel ev an t tran sf ero r an d tha t h e qua li fie s as a “ ho ld er” wi th in th e m ean in g o f th is sec ti on .- 22 -

[* 22 ] Inde te rm in in g wh ethe r “ al l s ub st an ti al rig ht s” ha ve be entra ns ferr ed , th e

“ ci rcu m st an ces of t he who le tra ns act io n, ra th er tha n the parti cu lar te rm in ol og y us edinth e in st ru m en t o f tr an sf er, s ha ll be co ns id ered .” Sec. 1 .12 35 -2 (b )(1 ), In co m e Tax Reg s. See Ju dav. Co m m is si on er, 8 77 F.2d10 75 , 10 78 (1s t Ci r. 19 89 ), aff’g 9 0 T.C. 1 26 3 (1 98 8) ; M erck& Co . v. Sm ith, 2 61 F.2d16 2, 1 64 (3d Ci r. 19 58 ). W e co ns id er the pra ct ic al effec t o f th e te rm s t o wh ic h the pa rti es ha ve ag reed , bu t we wi ll no t re fo rm th e p art ie s’ agr eem en t t o a lt er i ts term s ab se ntun us ua l ci rcu m st an ces . See Co m m is si on er v . Dani el so n, 3 78 F.2d77 1, 7 75 (3dCir
. 19 67 ) (“ [A] party

canch al le ng e th e ta x c on se qu en ces of h is ag reem en t as co nst ru edby the Co m

m is si on er o nl y

by adduc in g p ro of

whi chinanact io n b etween th e p art ie s t o the ag reem en t wo ul d b e adm is si bl e to alt er tha t co ns tru ct io n o r to sh ow i ts un en fo rceabi li ty becau se of m is ta ke , un du e in flu en ce, fraud , [or ] du res s.”) , vac at in g a ndrem an di ng 44 T.C. 54 9 (1 96 5) ; M y lan, In c. & Subs . v. Co m m is si on er, T.C. Mem o. 2 01 6- 45 , at * 14 -* 15 (di sc us si ng th e Dan ie ls on rul e in th e co nt ex t o f tr an sf

ers of i nt el le ctua l p ro pe rty). Cap it al ga in tre atm en t i s n otav ai labl e whe re the in st ru m en t o f tr an sf er

“ gr an ts rig ht s t o the gra nt ee, i n fi el ds of u se withi n trad es or i ndus tri es , whi chare le ss th anall th e ri gh ts co ve redby the pa te nt , whi chex is t an d h av e v al ue at t he ti m e o f th e g ran t.” Se c. 1.1 23 5- 2( b) (1 )(i ii ), In co m e Tax Reg s. To asc ert ai n- 23 -

[* 23 ] whet he r a t ax pa y er h as tra ns ferr ed“ al l s ub st an ti al rig ht s,” we co ns id er whe th er h e h as ret ai ne d ri gh ts th at , inth e ag gr eg at e, ha ve subs tant ia l v al ue . See E.I. duPo ntde Nem ou rs & Co . v. Un it edSta te s, 4 32 F.2d10 52 , 10 55 (3dCir
. 19 70 ). The cen tra l d is pu te be twee n the pa rti es m ay be en cap su la te d i n the qu es ti on :

“ All subs tant ia l ri gh ts to what ? ” Res po nd en t s ub m it s tha t the in st ru m en t o f tr an sfer i s the 19 98 li cen se ag reem en t an d tha t the cru ci al qu es ti on is whet he r pe ti ti on er th ereb y tra ns ferr edall subs tant ia l ri gh ts to th e Tech no lo gy. Res po nd en t co nt en ds th atth e an swe r to th is qu es ti on is “ no ,” ur gi ng th atpe ti ti on er re ta in edva lu ab le rig ht s t o u se th e Pat en ts an d l iqui so li d t ech no lo gy bo thou ts id e th e p ha rm aceu ti cal fie ld(e.g ., inde ve lo pi ng vi ta m in s an d n ut rit io na l s up pl em en ts ) an d i ns id e th e ph arm aceu ti cal fie ld(e.g ., inde ve lo pi ng dru gs on whi chhe was the n c ol labo rat in g with o th er co m

pa ni es or m ig htinfutur e d ecl in e to pro po se to Mu tu al forde ve lo pm en t). Pe ti ti on ers subm itth atth e k ey do cu m en t i s the Marc h 2 00 0 e ng ag em en t le tt er; th atth is let te r was insubs tanc e a l ic en se ag reem en t; an d tha t the cen tra l qu es ti on is whet he r pe ti ti on er the reb y tra ns ferr edall subs tant ia l ri gh ts to th e fel od ip in e an d p ro fafe no ne form ul at io ns . Peti ti on er co nt en ds th atth e an swe r to th is qu es ti on is “ y es ,” ur gi ng th atfel od ip in e an d p ro pa fen on e h av e n o v al ue- 24 -

[* 24 ] ou ts id e th e p ha rm aceu ti cal fie ldbu t ar e u se fu l o nl y as dru gs . W e co nc lu de th atres po nd en t h as th e st ro ng er s id e o f th is arg um en t. B. Natu re o f th e Ri gh ts Tran sf erre d Pen ns y lv an ialaw g ui de s o urco ns tru ct io n o f th e rel ev an t d oc um en ts an d
su gg es ts th e fo ll owi ng pri nc ip le s ap pl ic ab le to co nt ractin te rp ret at io n. Th e fu nd am en ta l g oa l o f co nt ractin te rp ret at io n i n P en ns y lv an iais to asc ert ai n the in te ntof th e co nt ract in g p art ie s. Ro be rt F . Fel te , Inc . v. Whit e, 30 2 A.2 d 3 47 , 35 1 (P a. 19 73 ). Whe n the term s o f a wri tt enco nt ractare cl ear a ndun am bi gu ou s, the in te nt of th e p art ie s i s t o b e as cert ai ne d fr om th e d oc um en t i ts el f. Hut ch is on v. Su nb eam Co al Co rp ., 51 9 A.2 d 3 85 , 39 0 (P a. 19 86 ); P in es Pla za Bo wli ng , Inc . v. Ro ss vi ew, In c., 14 5 A.2 d 6 72 (Pa. 1 95 8)
. If am bi gu ity ex is ts ina co nt ract , par ol ev id en ce i s ad m is si bl e to ex pl ai n o r res ol ve th e am

bi gu ity . This is so reg ard le ss of wh ethe r th e am bi gu ity is lat en t (i.e ., creat edby extrin si c o r co ll at eral cir cu m st an ces ) orpa te nt(i.e ., creat edby the te rm s o f th e in st ru m en t i ts el f). See S te uart v . McCh es ne y , 44 4 A.2 d 6 59 , 66 3 (P a. 19 82 ); I n re Est at e o f Herr, 1 61 A.2d32 , 34 (Pa. 1 96 0) . A con tra ctis am bi gu ou s if i t i s re as on ab ly sus cep ti bl e o f di ffer en t co ns tru ct io ns an d c ap ab le of b ei ng un de rs to odinm or e th anon e se ns e. Krip p v . Krip p, 8 49 A.2d11 59 , 11 63 (Pa. 2 00 4)
.- 25 -

[* 25 ] Whi le un am

bi gu ou s co nt ract s ar e in te rp ret edby the co urt as a m at te r of law,
am bi gu ou s wri ti ng s re qu ire factua l d et erm in at io ns by the fin de r of fact . Ibi d. 1. The 19 98 Lice ns e Agr eem en t W e d is cern li tt le if any am bi gu ity inth e 1 99 8 l ic en se ag reem en t. Tha t ag reem en t i s the “ in st ru m en t o f tr an sf er.” Se c. 1.1 23 5- 2( b) (1 ), In co m e Tax Reg s. Sect io n 2 of t he ag reem en t, capt io ne d “ Gran t o f Exc lu si ve Rig ht s,” p ro vi de s tha t th e li cen so rs gra nt edto Mu tu al “ [t]he ex cl us iv e ri gh ts to ut il iz e th e Tech no lo gy” to de ve lo p n ew fo rm

ul at io ns of s el ect edPro du ct s. Th e ri gh ts tra ns ferr edwere th us th e ri gh ts to us e th e li qu is ol idtec hn ol og y em bo di edinth e Pat en ts an d t o m ak e an d s el l an y

“ Pro du ct s co nt ai ni ng th e Tech no lo gy,” th atis , any Produc ts su cces sf ul ly gen erat edby exp lo it at io n o f th e Tech no lo gy. Co nv ers el y , th e 1 99 8 l ic en se ag reem en t d idno t tran sf er ri gh ts to th e fo rm ul at io n o f an y

sp eci fic dru g. Itco ul d n otpo ss ib ly hav e d on e so , bec au se no su ch fo rm ul at io ns ex is te d i n J un e 1 99 8. In de ed , th e p art ie s atth atti m e h adno t s el ect ed
an y dru gs forde ve lo pm en t u si ng th e Tech no lo gy, andth ey di d n otkn ow wh at drug s wo ul d i n the futur e b e p ro po se d o r se le ct edforde ve lo pm en t. Fel od ip in e an d p ro pa fen on e in parti cu lar, th e 1 1t h a nd12 th dru gs pro po se d b y th e li cen so rs , were n otsel ect edforde ve lo pm en t u nt il Marc h 2 00 0.- 26 -

[* 26 ] The reci ta ls to th e 1 99 8 l ic en se ag reem en t co nf irm th e p art ie s’ in te nt . The fif th “ whe reas ” cl au se st at es th at“ Hy gr os ol , Spi reas an d B ol to n d es ire to gra ntto Mu tu al an d Un it edth e ex cl us iv e ri gh t t o u ti li ze the Tech no lo gy on ly for the de ve lop m en t o f ne w gen eri c dru g fo rm s an d n ew drug pro du ct s * * * un an im ou sl ysele ct edby” th e p art ie s. Th is sen te nc e le av es li tt le do ub t tha t wh atth e li cen so rs in te nd edto tra ns fer t o M utua l was a li m it edrig htto us e th e Tech no lo gy, coupl ed with the rig htto m ak e an d s el l an y dru g fo rm

ul at io ns su cces sf

ul ly dev el op edus in g th e Tech no lo gy. Sect io n 4 of t he ag reem en t, capt io ne d “ Co m pe ns at io n,” supp orts res po nde nt ’s vi ew th atMu tu al was p ay in g ro y al ti es forrig ht s t o u se th e Tech no lo gy gen eral ly, no t fo r th e fel od ip in e fo rm ul at io n s pe ci fic al ly. Pet it io ne rs subm itth atDr. Sp ire as was “ th e so le in ve nt or ” o f th e fel od ip in e fo rm ul at io n andth athe “ in ve nt ed th e fel od ip in e te ch no lo gy in h is in di vi du al cap aci ty as anin ve nt or .” Dr. Ens co re si mil arl y tes ti fie d tha t p et it io ne r in ve nt edth e fel od ip in e fo rm ul at io n s om et im e aft er Ma y 20 00 an d tha t i t was anad ap ta ti on of t he “ gr anul ar l iqui so li d” tec hn ol ogy cov eredby the 33 9 p at en t. Tha t p at en t, u nl ik e th e o th er Pa te nt s, was is su edto pe ti ti on er i nd iv idua ll y , no t t o p et it io ne r an d Dr. Bo lt on joi nt ly. Thu s, i f Mu tu al were p ay in g o nl y

forth e fel od ip in e fo rm

ul at io n, o ne wou ldha ve expe ct edth at pe ti ti on er wo ul d re cei ve m os t, i f no t al l, o f th e res ul ti ng royalt ie s.- 27 -

[* 27 ] Bu t tha t i s n otwhatth e 1 99 8 l ic en se ag reem en t p ro vi de d. Se ct io n 4 pro vi de d tha t, i f Mu tu al rece iv edFDA app ro va l fo r an d s ol d aPro du ct , th en20 % of th e g ro ss pro fitwou ld“be pa idto Hy gr os ol qu art erl y .” Hy gr os ol was o wne d 5 0- 50 by pet it io ne r an d Dr. Bo lt on , andDr. Bol to n wo ul d thu s re cei ve 50 % of a ll
ro y al ti es pa idun de r th e ag reem en t. Thi s d iv is io n m ak es pe rfec t s en se if the
ro y al ti es were p ai d fo r us e o f “ th e Tech no lo gy,” whic h a t tha t t im e co ns is te d o f th e 8 34 Pat en t, wh ic h was joi nt ly owne d b y pe ti ti on er an d Dr. Bo lt on . This di vi si onis ha rdto reco nc il e wit h p et it io ne r’s th eo ry th atth e ro y al ti es were p ai d
ex cl us iv el y

fora pr oduc t o f whi chhe , inhi s i nd iv idua l capa ci ty, was th e so le in ve nt or . The co nc lu si on th atMu tu al was p ay in g ro y al ti es for us e o f “ th e Tech no lo
gy” is supp orte d, n oton ly by th e te rm s o f th e 1 99 8 l ic en se ag reem en t, b utals o b y th e “ ci rcu m st an ces of t he who le tra ns act io n.” Sec. 1 .12 35 -2 (b )(1 ), In co m e Tax Reg s.; see Merc k & Co ., 26 1 F .2dat 1 64 . See g en eral ly In re Es ta te of He rr, 1 61 A.2dat 3 4 (“ [T]he Co urt i n i nt erp ret in g awil l o r a co nt ractcanalwa y s co ns id er th e su rro un di ng cir cum st an ces inord er t o a sc ert ai n the in te nt io n a ndm ean in g o f th e p art ie s.”) . Duri ng th e n eg ot ia ti on s t owa rdth e ag reem en t p et it io ne r cl earl y ha d, as a pr im ary go al , m ai nt ai ni ng co nt ro l o ve r th e li qu is ol idtec hn ol og y . He te st ifi edth athe was h es it an t t o l ic en se th is tec hn ol og y to Mu tu al be cau se he was- 28 -

[* 28 ] alr eady

co ll ab or at in g wi th othe r co m pani es to de ve lo p dru g fo rm ul at io ns us in g i t. He was als o i nt eres te d i n e xp lo rin g u se of the Tech no lo gy in the fie ldof
nu tri ti on al supp le m en ts , su chas C oQ1 0. Whe n M utua l i n Dec em

be r 19 97 pro po se d tha t i t re cei ve anex cl us iv e li
cen se to us e th e Tech no lo gy for al l p ur po se s, p et it io ne r fi rm ly rejectedth atid ea. Und er the ag reem en t u lt im at el y si gn ed , Mu tu al was g ran te d ri gh ts to us e th e Tech no lo gy on ly w ith re sp ectto Pro du ct s “ un an im ou sl y sel ect ed ” b y

th e p art ie s. Mu tu al was e xp li ci tl y

de ni edth e ri gh t t o u se th e Tech no lo gy with res pe ctto

“pr oduc ts th atHy gr os ol , Spi reas , andBo lt on are d ev el op in g o r are inne go ti at io ns to de ve lo p fo r an ot he r pa rty.” Rig ht s t o u se th e Tech no lo gy woul d a ls o re ve rt t o th e li cen so rs as t o agi ve n P ro du ctif M utua l d idno t fo ll ow thr ou gh on it s co m mit
m en ts . In s ho rt, the ne go ti at in g h is to ry co nf irms th e p art ie s’ un de rs tand in g tha t wha t was be in g l ic en se d was a ri gh t t o u se th e Tech no lo gy, alb ei t a c aref ul ly circu m sc rib edrig htto do so . Inass ert in g tha t p et it io ne r “ tra ns ferr edhi s fe lo di pi ne tec hn ol og y to URL [an d] Mu tu al ,” pe ti ti on ers ig no re the di sp os it iv e p ro vi si on s o f th e 1 99 8 l ic en se ag reem en t. Insec ti on 7.2 , Mu tu al ex pl ic it ly agree d “ th atall form ul at io ns rel at in g to th e Pro du ct s co nt ai ni ng th e Tech no lo gy andde ve lo pe d i n M utua l’s * * * faci li
ti es be lo ng to Hy gr os ol , Spi reas an d B ol to n,” subjec t t o M utua l’s ri gh ts un de r th e- 29 -

[* 29 ] Agre em en t. Sec ti on 7.4 si m il arl y pro vi de d: “ If dur in g d ev el op m en t o f a Pro du ct , a ne w pat en t o f sp eci fic ap pl ic at io n c la im s i s s ecu redba se d o n the ori gi
na l p at en t, the ne w pat en t s ha ll be th e p ro pe rty of Hy gr os ol , Spi reas , andBo lt on .” Mu tu al was n oten ti tl edto ou tri gh t o wne rs hi p o f subs eque nt ly dev el op ed te ch no lo gy, buton ly “ th e ri gh t t o u ti li ze s uc h p at en t as if d es cri be d i n the de fin it io n o f ‘Paten t’” se t fo rth inth e 1 99 8 l ic en se ag reem en t. Thi s m ak es itcle ar th atall rig ht s M utua l o bt ai ne d wer e g ov ern edby, an d l im it edby, th e 1 99 8 l ic en se ag reem en t. 5 2. The Marc h 2 00 0 En ga ge m en t Let te r Inco nt en di ng th atpe ti ti on er tran sf erre d a ll subs tant ia l ri gh ts to th e fel odi pi ne form

ul at io n, p et it io ne rs lar ge ly ign or e th e 1 99 8 l ic en se ag reem en t, wh ic h Mr. Go ul d o pi ne d was insubs tanc e anR&D ag reem en t s et ti ng forth “ a fra m ework” forpro du ctde ve lo pm en t. In st eadth ey rel y on th e March20 00 en ga ge m en t le tt er, wh ic h M r. Gou ldop in edwas i n s ub st an ce a l ic en se ag reem en t. Mr . Gou ld ’s

On b rie f pe ti ti on ers arg ue th atth e “ li qu is ol idpa te nt s d idno t co ve r Dr. 5 Sp ire as ’ ne w, un ique an d p at en tabl e fel od ip in e * * * tec hn ol og [y ]. ” If tha t wer e so , itis ha rdto see ho w Mu tu al wou ldha ve th e ri gh ts to m ak e an d s el l tha t Pr odu ct . Mutua l was gra nt edit s m ak e-an d- se ll rig ht s b y th e 1 99 8 Li cen se Agre em en t, wh ic h d efi ne s tho se rig ht s as th e ri gh ts to pro du ce, m ark et , andsel l “ Pro
du ct s co nt ai ni ng th e Tech no lo gy.”- 30 -

[* 30 ] tes ti m on y

on th es e p oi nt s was unpe rs ua si ve be cau se itig no redth e te rm s, pu rp os e, an d e ffec t o f bo th do cu m en ts . 6 The M arch 20 00 en ga ge m en t l ette r was jus t tha t-- anen ga ge m en t l et te r. It st at edrathe r pl ai nl y

th atth e p art ie s h adsel ect edth ree dru gs forde ve lo pm en t an d tra ns mit te d a$3 0,0 00 ch eck“ fo r en ga ge m en t o f th es e th ree p ro du ct s.” Itwas s ub
st an ti al ly sim il ar t o 2 0 o th er en ga ge m en t l et te rs th e p art ie s s ig ne d t o m em or ia li ze th ei r se le ct io n o f certa in dru gs forfurth er i nv es ti ga ti on . Thes e en ga ge m en t l et te rs gr an t n o ri gh ts an d h av e n o ro y al ty paym en t t erm s. Farfro m co ns ti tu ti ng free
st an di ng li cen se ag reem en ts , th ey si m pl y ren de redth e 1 99 8 l ic en se ag reem en t op erat iv e wit h re sp ectto th e Pro du ct s tha t the y id en ti fie d. The 19 98 li cen se ag reem en t s pe ci fie d tha t M utua l was gra nt edrig ht s “ to ut il iz e th e Tech no lo gy on ly to d ev el op Pro du ct s tha t M utua l, Un it edan d Hygro so l * * * una ni m ou sl y

sel ect .” Sect io n 2 .2 o f th e ag reem en t p ro vi de d tha t the pe rio d Exp ertwitne ss tes ti m on y m ay he lp th e Co urt und ers tandanarearequi rin g 6 sp eci al iz edtra in in g o r kn owl ed ge . See Fed . R. Evi d. 7 02 ; Sn y de r v. C omm is
si on er, 9 3 T.C. 5 29 , 53 4 (1 98 9) . Butwe are n otbo un d b y anex pe rt’s o pi ni on , es pe ci al ly whe n the tes ti m on y ve rg es on leg al or qua si -le ga l s ub jects su chas c on tra ctin te rp ret at io n. We weig h a n e xp ert ’s tes ti m on y inli gh t o f hi s o r he r qu al ifi
cat io ns an d wi th res pe ctto all cred ib le ev id en ce i n the reco rd . Depen di ng on ou r ov eral l ev al ua ti on of t he ev id en ce, we m ay rejectanex pe rt’s o pi ni on init s en ti rety , acce ptitinit s en ti rety , or a ccep t s el ect edpo rti on s o f it . See Hel ve rin g v . Nat’l Gro cery Co., 30 4 U.S. 2 82 , 29 4- 29 5 (1 93 8) ; Se ag at e Tech ., Inc . & Co ns ol
. Subs . v. Co m

m is si on er, 1 02 T.C. 14 9, 1 86 (19 94 ).- 31 -

[* 31 ] du rin g wh ic h M utua l s ha ll ha ve ex cl us iv e ri gh ts with re sp ectto a Pro du ct

“ co m m en ces as s oo n a s * * * sai d P ro du ctis id en ti fie d b y eit he r pa rty andag reed up on inwrit in g b y

Hy gr os ol , Mu tu al , andUni te d.” The M arch 20 00 en ga ge m en t le tt er s im pl y m em or ia li zedth atfel od ip in e an d p ro pa fen on e h adbe en“ id en ti fie d * * * an d a gr eedup on inwrit in g” by the pa rti es . The ex ecu ti on of t hi s l et te r di d n o m or e th anful fil l a c on di ti on st at edinth e 1 99 8 l ic en se ag reem en t: It s erv edto tri gg er, with re sp ectto th os e two Pro du ct s, the “ ex cl us iv e ri gh ts to ut il iz e th e Tech no lo gy” grant edto Mu tu al by sect io n 2 .1 o f th e ag reem en t. The 19 98 li cen se ag reem en t i s cl earl y th e rel ev an t “ in st ru m en t o f tr an sf er,”
se e se c. 1.1 23 5- 2( b) (1 ), In co m e Tax Reg s., b ecau se itis th e ag reem en t tha t g ran tedth e ri gh ts forwhi chMu tu al pa id . Ind eed , inass ert in g tha t M utua l re cei ve d “ al l
subs tant ia l ri gh ts ” to th e fel od ip in e fo rm ul at io n, p et it io ne rs ne ces sa ril y rel y on pr ov is io ns of t he 19 98 li cen se ag reem en t s ta ti ng th atMu tu al rece iv edrig ht s th ro ug ho utth e Uni te d S ta te s fo r a p erp etua l t erm . Peti ti on ers can no t l og ic al ly
co nt en d tha t the Marc h 2 00 0 e ng ag em en t l et te r se rv edto li cen se th e fel od ip in e fo rm ul at io n, wh il e rel y in g o n the 19 98 li cen se ag reem en t t o e st ab li sh th atMu tu -- 32 -

[* 32 ] al’s ri gh ts inth atform ul at io n wer e unl im it edtem po ral ly andex cl us iv e ge og rap hi cal ly. 7 Pet it io ne rs ass ertth atth ei r vi ew of th e si tu at io n i s s up po rte d b y whatth ey cal l the st atut e’s “ ‘in co ns id erat io n o f’ requ ire m en t.” Se ct io n 1 23 5 p ro vi de s tha t a tr an sf er o f pr op erty

co ns is ti ng of a ll subs tant ia l ri gh ts to a pa te ntsh al l b e tr eat ed
as th e sa le of acap it al ass et“ reg ard le ss of wh ethe r orno t p aym en ts inco ns id erat io n o f su chtrans fer” are p ay ab le pe rio di cal ly or co nt in ge nton pro du ct iv ity or us e. Pet it io ne rs no te th at , am on g the 20 -p lu s p ro du ct s the pa rti es sel ect edforde
ve lo pm en t, fe lo di pi ne an d p ro pa fen on e were t he on ly two tha t re su lt edinco m m erci al su cces s. Itth eref

or e m ak es sen se , th ey

urg e, to reg ardth e ro y al ti es as h av in g be enpa id“ in co ns id erat io n o f” tho se two Pro du ct s. 8 Mr. Go ul d’s t es ti m on y

was b as edon th e p rem is e th atex cl us iv e ri gh ts to 7 th e fel od ip in e fo rm

ul at io n c ou ldno t h av e b eengra nt edinJu ne 19 98 be cau se th e fel od ip in e fo rm

ul at io n d idno t yet ex is t. Inso tes ti fy in g h e as su m edwhathe was tryin g t o p ro ve , nam el y , th atth e subjec t o f th e li cen se was the fel od ip in e fo rm ul ati on . If th e subjec t o f th e li cen se was “ th e Tech no lo gy,” as the 19 98 li cen se ag reem en t u na m

bi gu ou sl y pro vi de d, the ti min g p ro bl em Mr. Go ul d i m ag in edgo es away be cau se “ th e Tech no lo gy” pl ai nl y ex is te d i n J un e 1 99 8. Equa ll y pro bl em at ic al ly, Mr. Go ul d d idno t co nv in ci ng ly exp la in ho w th e March20 00 en ga ge m en t l et te r co ul d h av e se rv edto li cen se th e fel od ip in e fo rm ul at io n, s in ce the fel od ip in e fo rm ul at io n d idno t ex is t i n M arch 20 00 eit he r. Pet it io ne r an d Dr. En sc or e te st ifie d tha t thi s fo rm

ul at io n was no t i nv en te d u nt il so m et im e aft er May 20 00
. W e d o n otth in k i t i s ac cu rat e to de sc rib e th e p hr as e “ in co ns id erat io n o f” 8 as set ti ng fortha “ requi rem en t.” Th e requi rem en t i m po se d b y sec ti on 12 35 is th at (co nt in ue d...)- 33 -

[* 33 ] In a dv an ci ng th is arg um en t, p et it io ne rs see k t o re dr aftth e 1 99 8 l ic en se ag reem en t, u si ng hi nd si gh t, t o a ch ie ve a m or e adva nt ag eo us tax res ul t. The li qu iso li d t ech no lo gy hadpo te nt ia l ap pl ic at io n t o tho us an ds of dru gs ; i n J un e 1 99 8 the pa rti es ha d n o i de a to whi chdru gs itm ig htus efu ll y be ap pl ie d. As a res ul t, the y ne ces sa ril y

craf te d tha t ag reem en t as a li cen se to us e th e Tech no lo gy to fi gu re o ut whi chdru gs mig htbe de ve lo pe d s uc ces sf ul ly. To em pl oy an an al og y

fro m a di ffer en t i ndus try, an o il co m pa ny tha t l ic en se s dril li ng tec hn ol og y

in ev it ab ly use s tha t t ech no lo gy no les s i n dril li ng dry ho le s th anindri ll in g s uc ces sf

ul well s. Th e sa m e was tru e h ere. Mu tu al ne ces sa ril y

“ut il iz e[d ] th e Tech no lo gy” eve ry ti m e p et it io ne r pe rfo rm edfeas ib il ity stud ie s o n a Pro du ctinit s l ab or at or ie s. Pet it io ne r pe rfo rm edfeas ib il ity stud ie s fo r Mu tu al ’s be ne fiton m or e th an20 Pro du ct s o ve r fo ury ears ; thi s amoun te d t o asi gn ifi can t

“ut il iz at io n” of t he Tech no lo gy by Mu tu al
. Whe n e nt eri ng in to th e 1 99 8 l ic en se ag reem en t, Mu tu al co ul d l og ic al ly
ex pe ctto de riv e v al ue fro m all su chus es of the Tech no lo gy. Eve n i f fea si bi li ty stud ie s o n apa rti cu lar drug di d n otpre di cta ho m e ru n, tho se stud ie s m ig hty ie ld (...co nt inue d) 8 a “ ho ld er” m

us t tran sf er “ al l s ub st an ti al rig ht s” inord er t o g etlo ng -te rm cap it al ga in tre atm en t; th e p hr as e “ in co ns id erat io n o f” ap pe ars to be no th in g m or e th ana ro ut in e p rep os it io na l p hr as e. Inan y ev en t, p et it io ne rs ’ arg um en t i s u nc on vi nc in g fo r th e rea so ns di sc us se d i n the tex t.- 34 -

[* 34 ] va lu ab le kn ow- ho w th atwou ldass is t d ev el op m en t o f si m il ar (o r red ire ct de ve lo pm en t t owa rddi ss im il ar) Pr oduc ts . Mutua l m ig htals o d eri ve va lu e b y us in g the Tech no lo gy to c ro ss unpr om is in g dru gs , or u np ro m is in g ty pe s o f drug s, of f of it s l is t. As i s tru e in m an y li cen si ng arrang em en ts , Mu tu al co nt ract edto pa y ro y al ti es no t o n the ba si s o f actua l u sa ge of t he Tech no lo gy, buton th e b as is of
sa le s o f Pro du ct s co nt ai ni ng th e Tech no lo gy. The paym en t s tru ctur e ch os enby the pa rti es do es no t al te r th e fac t tha t M utua l p ai d ro y al ti es to “ut il iz e th e Tech no lo gy.” Thos e ro y al ti es were p ai d “ in co ns id erat io n o f” i ts us e o f th at Tech no lo gy bo th when it s u se of the Tech no lo gy was su cces sf ul an d wh enitwas no t. Insu m , th e ri gh ts trans ferr edto Mu tu al are tho se gra nt edto itby the 19 98 li cen se ag reem en t an d o nl y th os e ri gh ts . Whi le res is ti ng th e co nc lu si on th atth is ag reem en t was th e rel ev an t “ in st ru m en t o f tr an sf er,” p et it io ne rs ha ve no t i de nt ifi ed
an y othe r do cu m en t tha t co ul d h av e g ran te d t o M utua l, an d d efi ne d, the sp eci fic rig ht s tha t M utua l i n fa ctpo ss es se d. We con cl ud e th atth e te rm s o f th e 1 99 8 li cen se ag reem en t an d the ex tri ns ic cir cu m st an ces bo th supp ort wh atwe be li ev e to be it s cl ear m ean in g. Th e ri gh ts gra nt edto Mu tu al un de r th e ag reem en t wer e th e li mit edrig ht s “ to ut il iz e th e Tech no lo gy * * * to de ve lo p P ro du ct s” an d t o m ak e- 35 -

[* 35 ] an d s el l “ Pro du ct s co nt ai ni ng th e Tech no lo gy.” This res ol ve s the fir stpa rt of ou r in qu iry, whic h re qu ire d u s t o i de nt ify the na tu re o f th e ri gh ts tra ns ferr ed
. 9 C. Subs tant ia li ty of th e Ri gh ts Ret ai ne d The rem ai ni ng qu es ti on is whet he r pe ti ti on er i n the 19 98 li cen se ag reem en t tra ns ferr ed“ al l s ub st an ti al rig ht s” to th e Tech no lo gy. W e co nc lu de th athe di d
no t. The rig ht s g ran te d t o M utua l wer e le ss th anall th e ri gh ts inth e Tech no lo gy be cau se th e li cen se was l im it edto th e p ha rm aceu ti cal in du st ry an d was res tri ct ed to sp eci fic Pro du ct s s el ect edby the pa rti es . W e fi ndth atth e li cen so rs ’ ret ai ne d rig ht s h adsubs tant ia l v al ue . A tax pa y er d oe s n ottra ns fer “ al l s ub st an ti al rig ht s” to a pa te ntif the in st ru m en t o f tr an sf

er “ gr an ts rig ht s t o the gra nt ee, i n fi el ds of u se withi n trad es or i ndu st rie s, wh ic h a re l es s tha n a ll th e ri gh ts co ve redby the pa te nt , whi chex is t an d
As an alt ern at iv e to th e th eo ry th atth e March20 00 en ga ge m en t l et te r was 9 in subs tanc e a l ic en se ag reem en t tran sf erri ng th e fel od ip in e fo rm ul at io n t o M utua l, pe ti ti on ers ass ertinth ei r an swe rin g b rie f th atth e p art ie s b eh av ed“ as if the 19 98 Lice ns e Agr eem en t g ran t an d ro y al ty pro vi si on s ap pl ie d t o the se tec hn ol og ie s af te r th ei r res pe ct iv e in ve nt io ns .” As l eg al supp ort fo r th is alt ern at iv e th eo ry , pet it io ners su gg es t the co ntractdo ctrin e o f “ subs ti tu te pe rfo rm an ce.” We are g en eral ly relu ct an t t o c on si de r arg um en ts adva nc edforth e fi rs t t im e in a pa rty’ s an swe rin g br ie f, an d we wi ll de cl in e to do so he re. See DiLeo v. Co m m is si on er, 9 6 T.C. 8 58 , 89 1, 8 92 (19 91 ), aff’d, 9 59 F.2d16 (2dCir . 19 92 ); S he lb y U.S. Dist rib s., In c. v. Co m m is si on er, 7 1 T.C. 8 74 , 88 5 (1 97 9) . In an y ev en t, we fi ndno factua l s up po rt in th e rec or d fo r th e n ot io n tha t the parti es co nduc te d the m se lv es “ as if” th e 1 99 8 li cen se ag reem en t ap pl ie d, ra th er tha n i n the be li ef tha t i t ac tu al ly app li ed
.- 36 -

[* 36 ] ha ve va lu e atth e ti m e o f th e g ran t.” Se c. 1.1 23 5- 2( b) (ii i), In co m e Tax Reg s. Inde te rm in in g wh ethe r a t ax pa y er h as tra ns ferr ed“ al l s ub st an ti al rig ht s,” t he Thi rdCir cu itha s ev al ua te d wh ethe r th e ta xp ay er h as ret ai ne d ri gh ts th at , inth e ag gr eg at e, ha ve subs tant ia l v al ue . See E.I. du Po ntde Nem ou rs & Co ., 43 2 F .2dat 10 55 . Inat l eas t two re sp ect s, the 19 98 li cen se ag reem en t d idno t tran sf er al l s ub
st an ti al rig ht s t o the Tech no lo gy. Fi rs t, the ag reem en t d idno t tran sf er t o M utua l al l ri gh ts to us e th e Tech no lo gy with in th e p ha rm aceu ti cal fie ld . Sect io n 5 .5 o f th e ag reem en t ex pl ic it ly den ie d M utua l an y rig ht s wi thres pe ctto dru g p ro du ct s p et iti on er was alr eady

in ve st ig at in g. Itpro vi de d: “ The gro up of p ot en ti al Pro du ct s t o be sel ect edby the pa rti es to th is Agre em en t s ha ll ex cl ud e, atall ti m es durin g the li fe o f th is Agre em en t, p ro du ct s tha t Hy gr os ol , Spi reas , andBo lt on are d ev el op in g orare i n n eg ot ia ti on s t o d ev el op foran ot he r pa rty.” The ag reem en t al so ga ve pe ti ti on er an d h is co -li cen so rs effe ct iv e v et o p ower o ve r th e dru gs as t o wh ic h M utua l co ul d e xe rci se it s ri gh ts inth e fu tu re. The Tech no lo gy hadpo te nt ia l ap pl ic at io n t o tho us an ds of dru gs , bu t s ect io n 2 .1 g ran tedMu tu al rig ht s t o u se th e Tech no lo gy “ on ly to d ev el op Pro du ct s tha t M utua l, Uni te d, an d Hygro so l * * * wil l u na ni m ou sl y sel ect .” The a gr eem en t re qu ire d the li cen so rs to act“ in go odfai th ” whe n p ro po si ng (orde cl in in g t o p ro po se ) Pro du ct s- 37 -

[* 37 ] forde ve lo pm en t. Bu t s itua ti on s ca n e as il y be im ag in edinwhi chth e li cen so rs m ig htha ve co nc lu de d, ac ti ng ingo odfai th , th atCo m pa ny X wou ldbe a m or e lo gi cal de ve lo pm en t p artne r fo r a p art ic ul ar Pro du ctth anMu tu al
. 1 0 The p art ie s u nd ers to odth atad di ti on al workwou ldbe requi redto ad ap t the li qu is ol idtec hn ol og y

to th e v ari ab le s o f in di vi du al dru gs . Butth is do es no t d im in
is h the va lu e o f th e Tech no lo gy gen eral ly or of pe ti ti on er’s ret ai ne d ri gh ts to us e it . Peti ti on er n eg ot ia te d a ss iduo us ly to m ai nt ai n c on tro l o ve r hi s p at en te d l iqui
so li d t ech ni qu es ; thi s s tro ng ly im pl ie s a b el ie f th atth e ri gh ts he ret ai ne d h adva lu e. Altho ug h fe lo di pi ne an d p ro pa fen on e tu rn edou t t o b e th e o nl y dru gs su cces sf

ul ly de ve lo pe d b etween19 98 an d 2 00 4, wh enpe ti ti on er l eftMu tu al ’s em pl oy, th is 1 1
ou tc om e was no t fo res eeab le whenth e p art ie s n eg ot ia te d the ag reem en t. We acco rd in gl y fin d a ndho ldth atth e li cen so rs ’ ret ai ne d ri gh ts to us e th e Tech no lo gy withi n the ph arm aceu ti cal in du st ry , as o f Ju ne 19 98 , hadsubs tant ia l v al ue . Seco nd , pet it io ne r ret ai ne d u nd er the 19 98 li cen se ag reem en t al l ri gh ts to us e th e Tech no lo gy ou ts id e th e p ha rm aceu ti cal fie ld , e.g., i n d ev el op in g n ut rit io nOne ex am

pl e m ig htbe wher e Co m

pa ny X ho ld s the pa te nton a parti cu lar 1 0 m ol ecu le bu t ca nn otbri ng itto m ark etforlac k o f a v iabl e fo rm ul at io n. Pe ti ti on er te st ifi edat t ria l tha t thi s was no t u nc omm on . The reco rddo es no t d is cl os e wha t dru gs or o th er p ro du ct s p et it io ne r m ay 1 1 ha ve de ve lo pe d u si ng th e li qu is ol idtec hn ol og y aft er 2 00 4.- 38 -

[* 38 ] al s up pl em en ts , vi ta m in s, an d o th er p ro du ct s n otrequi rin g F DA app ro va l. The res tri ct io n o f a l ic en se to on e fi el d o f us e, whe re a re se rv edfie ldof u se ha s va lu e atth e ti m e o f th e g ran t, fa il s t o c on ve y “ al l s ub st an ti al rig ht s.” Se e Mro s v . Co m m is si on er, 4 93 F.2d81 3, 8 17 (9t h C ir. 1 97 4) , rev ’g T.C. Mem o. 1 97 1- 12 3; Fawi ckv. Co m

m is si on er, 4 36 F.2d65 5, 6 63 (6t h C ir. 1 97 1) , rev ’g 52 T.C. 10 4 (1 96 9) ; s ec. 1 .12 35 -2 (b )(1 )(i ii ), In co m e Tax Reg s. Whe n h e ex ecu te d the 19 98 li cen se ag reem en t, p et it io ne r was ex tre m el y in
te res te d i n e xp lo rin g u se of t he Tech no lo gy to d ev el op “ supe r-b io av ai labl e” o r ot he r ne w form

ul at io ns of n ut rit io na l s up pl em en ts li ke Co Q10 . Ind eed , inFeb ru ary 19 98 he en ga ge d o ne or m or e p ro fes si on al s t o m ark etth e li qu is ol idtec hn ol og y to va rio us co m

pa ni es inth e h eal th an d n ut rit io n fi el ds . At tri al , pet it io ne r su gge st edth atth es e ret ai ne d ri gh ts ha d l it tl e co m m erci al va lu e b ecau se (fo r ex am pl e)
co ns um ers m ig htrefu se to pay ex trafora supp le m en t co nt ai ni ng a sm al le r do se of th e act iv e in gr ed ie nt . Buthi s t es ti m on y on th is po in t was an ecd ot al an d c on cl uso ry , anditwas a t o dd s wi th othe r po rti on s o f hi s t es ti m on y . Onc e ag ai n, i t i s i m

pl au si bl e th atpe ti ti on er wo ul d h av e n eg ot ia te d s o i ns is
te nt ly to re ta in rig ht s t o u se th e Tech no lo gy in the nu tri ti onfie ldif h e was co nvi nc edth atth es e ri gh ts ha d n o v al ue . W e acc or di ng ly findan d h ol d tha t the rig ht s- 39 -

[* 39 ] pe ti ti on er an d h is co -li cen so rs ret ai ne d t o u se th e Tech no lo gy, bot h wi th in th e p ha rm aceu ti cal fie ldan d i n o th er fi el ds , inth e ag gr eg at e h adsubs tant ia l v al ue . D. Co nc lu si on Pet it io ne r in Ju ne 19 98 ne go ti at eda de al to li cen se us e o f th e Tech no lo gy to Mu tu al on a li m it ed , pro du ct -b y -p ro du ct , bas is . It i s p os si bl e th athe m ig htha ve st ru cka di ffer en t d eal : He m ig htin it ia ll y have pro po se d a n R &D arra ng em en t (a s Mr. Go ul d wo ul d p ro babl y have advi se d) , th enwait edsev eral y ears to see what de ve lo pe d. Th e rec or d d oe s n otest ab li sh whatm ot iv at edhi s d eci si on . Tim e m ay ha ve be enof t he ess en ce, o r th e “bi rdinhand ” m an tram ay ha ve carr ie d the da y .

“ Whi le a ta xp ay er i s fr ee t o o rg an iz e h is affa irs as h e ch oo se s, n ev erthe le ss , on ce h av in g d on e so , he m us t ac cep t the tax co ns eque nc es of h is ch oi ce * * * an d
m ay no t en joy th e b en efi t o f so m e o th er ro ut e h e m ig htha ve ch os ento fol lo w bu t di d n ot .” Co m

m is si on er v . Nat’l Alf

al fa Deh y dr at in g & Mi ll in g C o., 4 17 U.S. 13 4, 1 49 (19 74 ). Pet it io ne r wis he s t o re vi se th e ag reem en t h e n eg ot ia te d i n 1 99 8, whi chby its term s g ran te d ali mit edrig htto us e “ th e Tech no lo gy,” andrep la ce i t with adi ffer en t arran ge m en t tha t, i n h in ds ig ht , mig htap pe ar t o g en erat e a m or e de si rab le tax ou tc om e. Pet it io ne r is no t atli be rty to u nd o the de al he m ad e o r th e do cu m en ts he si gn ed . See Co m m is si on er v . Dani el so n, 3 78 F.2dat 7 75 . Becau se pe ti ti on er i n the 19 98 li cen se ag reem en t d idno t tran sf er “pr op erty

co ns is ti ng of a ll- 40 -

[* 40 ] subs tant ia l ri gh ts to a pa te nt ,” se ct io n 1 23 5( a) d oe s n otap pl y . W e th us su st ai n re sp on de nt ’s det erm in at io n tha t the royalt ie s p et it io ne rs rece iv edare ta xabl e as ord in ary in co m e. To re fle ctth e fo reg oi ng , Deci si on wil l b e en te redfor
res po nd en t.