The Challenges Transactions in the Life Sciences Sector Face in Light of the New Medical Devices Regulation

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In highly regulated industries, regulatory compliance is of increased importance, as it determines the marketability of the products and therefore the future viability of the business. The already highly regulated market of medical devices now faces even stricter regulations due to the Medical Devices Regulation (EU) 2017/745 (MDR), which has been directly applicable in all EU member states since 26 May 2021. The new regulations affect almost every business in the sector of medical devices as well as the entire process of transactions in this market.

The Medical Devices Regulation (MDR)

The European Parliament and the Council passed the MDR on 5 April 2017, with effect from 25 May 2017. Since 26 May 2021 the MDR is directly applicable in all EU member states. As an EU regulation, the MDR does not need to be transposed into national law to be applicable in the respective member state. This especially serves businesses operating in different European countries, as it standardizes the legal framework that has to be complied with.

The MDR contains several new regulations and changes, of which the following have the greatest practical impact:

  • The scope of the MDR has been extended to include specific product groups without medical purpose
  • The classification rules were extended and modified, leading to a higher risk classification of many products
  • Stricter requirements are placed on notified bodies, which additionally have to be certified under the new regulations
  • A new obligation for manufacturers to label their products has been introduced and higher standards for quality and risk management, clinical evaluation as well as technical documentation are being set
  • Manufacturers are now additionally obliged to be able to provide sufficient financial coverage in respect of their potential liability.

The new regulations impact various aspects of transactions especially if a business operating in the medical devices sector is being acquired. Compliance with the MDR is not only subject to (legal) due diligence but must also be considered in the structure of a transaction and in the share or asset purchase agreement.

Impact on (legal) due diligence

To fully comprehend the opportunities and risks of a transaction in a highly regulated industry extensive due diligence is necessary, requiring sufficient expertise in the relevant sector. In addition, conducting due diligence is essential to successfully negotiate an allocation of the liability risks between the seller and the purchaser, which is in both their interest. Especially in the current buyer-friendly transaction market, thorough due diligence is important for the purchaser as extensive guarantees are very difficult to enforce. Specific risks immanent to the regulations on medical devices and relevant to the business in question must be identified in order to be reflected accordingly in the subsequent agreements.

The first question to identify potential risks is whether the target company is dealing with products classified as medical devices. The definition of a medical device has remained mostly unchanged under the MDR, so that the scope of application has hardly changed. The only reform is, that particular products without medical purpose are now subject to the regulation (e.g. colored lenses or lasers used for skin resurfacing). Therefore, it needs to be examined whether non-medical products are now considered medical devices (according to Art. 1 Par. 2 and Annex XVI MDR). Besides that, borderline cases can complicate the determination of the scope of application, especially regarding medical apps which, in individual cases, may be considered as medical devices.

The second question should be what type of economic operator the target company is. The MDR identifies manufacturers, importers and dealers as the main economic operators and sets different legal requirements for each of them. Additionally, the role of suppliers is of practical importance, although it is not explicitly defined by the MDR.

If the target company is a manufacturer of medical devices, as it is mostly the case, the following aspects are especially important for the (legal) due diligence:

  • Correct declarations of conformity based on a conformity assessment according to the regulation
  • Product-specific documentation meeting the regulatory requirements
  • CE marking of all manufactured products
  • Correct labelling of the products
  • Sufficient financial coverage in respect of potential liability risks

The aspects of conformity and CE marking carry the major risk, as a failure of the target company to comply with the regulatory requirements, e.g. due to increased obligations under the MDR, results in a loss of company value. Most importantly, the manufacturer must be able to provide valid certification and CE marking for the respective product, otherwise the product is not marketable. As the rules of classification have changed and are now stricter under the MDR, it also has to be reviewed, if products must be placed in a higher risk category than before. This also determines the requirements for the conformity assessment and whether a notified body has to be consulted in the process. With the EU declaration of conformity, the manufacturer then has to issue, he assumes responsibility for compliance with the requirements of the MDR and all other EU legislation applicable to the device.

Furthermore, manufacturers are now obliged to implement a Unique Device Identification system (UDI) according to the requirements of the MDR and separately label each device accordingly. This is meant to allow the identification and facilitate the traceability of devices to allow future safety precautions relating to a specific product more efficient.

Another obligation established by the MDR is, that “manufacturers shall, in a manner that is proportionate to the risk class, type of device and the size of the enterprise, have measures in place to provide sufficient financial coverage in respect of their potential liability”. The specifics of this obligation are not clear as the regulation fails to provide further details or a definition of what is meant by “sufficient financial coverage”. Whether the manufacturer’s financial coverage is sufficient or not can therefore not be evaluated in a legally secure way. The remaining risk resulting from this uncertainty can reduce the purchase price or lead to a warranty or indemnity.

In addition to the product and internal processes, the stricter regulations of the MDR can also impact existing agreements of the manufacturer with suppliers and dealers as well as joint venture agreements. In terms of the MDR, it is crucial to what extent detailed product specifications and licenses are determined in the respective contract. It is a major financial risk for the manufacturer if the products do not meet the requirements of the MDR and are therefore no longer compliant with the respective agreement. This could not only result in a loss of income but also in claims for damages by the contracting party.

It is therefore recommended to adjust the agreements with suppliers and dealers to the increased regulatory duties of both parties. This should especially be observed in agreements with original equipment manufacturers. These are manufacturers that take over the actual manufacturing but label the product with the name and brand of another company, the agent and legal manufacturer. According to the MDR, the manufacturer has to be able to provide all necessary documentation in case of audits by the relevant authorities. Provided that by manufacturer the MDR means the legal manufacturer, the agreement with the original equipment manufacturer has to secure direct access to the relevant documentation. Otherwise, there is a risk, that the declaration of conformity, and with it the CE marking of the affected products, are no longer valid.

If the target company is an importer, the (legal) due diligence now also has to take compliance with the MDR into account as it for the first time explicitly specifies regulatory duties for importers. Importers are in particular required to only place products on the European market that are compliant with the MDR. They are obliged to verify the necessary CE marking and declaration of conformity for all products they deal with. Additionally, importers have to label the products with their contact information in order to trace them.

As a dealer, the target company has to ensure that the products are transported and stored according to the manufacturer’s guidelines. Furthermore, the dealer has to implement a complaint management system and communicate any complaints to the manufacturer to ensure conformity of the product or eliminate a risk caused by it.

Suppliers and original equipment manufacturers are only mentioned in the context of audits as access to technical documentation is essential for not only MDR compliance, but also for the protection of intellectual property rights.

Impact on the transaction structure

Considering the structure of a transaction, it has to be decided, whether a share deal or an asset deal is more favorable. Besides tax law arguments, the structure has a major impact on the risks resulting from MDR compliance or rather a lack thereof.

Taking the regulatory consequences into account, a share deal is more straightforward than an asset deal. In the case of a share deal, the target company maintains its legal identity and remains a regulatory market participant. Therefore, also the target company’s declarations of conformity and CE markings for its products remain valid as well as the contracts with notified bodies. Furthermore, all other contractual relations, e.g. with suppliers and dealers, are maintained except for contracts with change of control clauses, that are especially common in joint venture agreements. In this case the continuance of the contractual relationship depends on the other party’s decision to exercise its right to disengage from the contract.

Nevertheless, it should be noted that, if in addition to the change of shareholders the target company’s structure is being affected, especially in the areas of production and quality management, it is possible that the products may be required to undergo a new certification process. A loss of the CE marking might also be caused by a change in contracting parties due to the exercise of change of control clauses. Regulatory consequences can also follow from a change of the company name, which has to be notified to the supervisory authority and the notified body.

It is therefore recommended to ensure that in the event of internal restructuring prior to the transaction the target company, which is subject to the transaction, has effectively obtained all relevant CE markings.

In the case of an asset deal, the regulatory consequences are very different, resulting in a higher risk regarding the target company’s value and the marketability of its products. First, the target company is not the object of purpose, its assets are. Therefore, it does not remain the regulatory target after the transaction. Second, as the legal entity, contrary to a share deal, is not being transferred, the CE markings cannot be transferred to the new manufacturer. The CE markings are strictly bound to the manufacturer who issued the corresponding declaration of conformity in accordance with the MDR. Consequently, an initial proposal has to be made to the notified body (“Change Audit”). Such a new certification process in order to be granted the respective CE markings is always necessary, if changes are being made to the manufacturer’s company and/or its structural or procedural organization. If, however, the purchaser only takes over single operating sites without any changes, in individual cases a report to the supervisory authority and the notified body might be sufficient.

Overall, an asset deal is far more complicated and, as it has a larger regulatory impact, requires auditing of numerous processes as well as new labelling of products due to the change of the manufacturer. Consequently, it makes the (legal) due diligence regarding regulatory compliance more difficult, especially considering the strict regulations the MDR states.

Impact on SPA or APA

It may be useful to consider MDR compliance in the closing conditions, e.g. the adjustment of contracts or the renewal of the certification and CE marking of highly relevant products. In case of a longer period between signing and closing, it is recommended to agree on certain additional duties regarding the implementation of and/or the compliance with the MDR. Furthermore, a material adverse change clause connected to severe regulatory changes might also be considered.

All the risks mentioned above, especially those resulting from products losing their CE marking due to new regulations or the transaction structure as well as insufficient implementation of the MDR impact the revenues and the value of the target company. Therefore, they have to be taken into account in the purchase pricing. It can also be considered to reduce the purchase price, if the target company does not meet the requirements set by the MDR regarding sufficient financial coverage for potential liability. With regard to adjustments of the purchase price it should also be considered to allocate the risk of delayed MDR compliance caused by third parties. As the MDR also places stricter requirements on notified bodies, there currently might not be enough notified bodies already certified under the new regulation that are able to conduct the conformity assessment necessary to obtain the respective CE marking.

Implementation of and compliance with the MDR can also be ensured by a warranty issued by the seller, assuring the purchaser that he is not going to suffer any disadvantages due to the new regulations. Another option to deal with potential claims of third parties as well as known risks in conjunction with the MDR are indemnities in favor of the purchaser.

Conclusion

In transactions in industries as highly regulated as the medical device sector, it is particularly important to navigate the transaction process carefully and thoroughly. In doing so, special attention should be paid to the (legal) due diligence in order to adequately reflect the identified risks in the SPA or APA. The major risks regarding the MDR occur in connection with the declaration of conformity and the CE marking of devices which are essential for the marketability of the product and therefore the value of the target company. Finally, the challenges faced by businesses in the medical devices sector in connection with the certification process of their devices and compliance with the new regulations should guide the decision of whether to structure the transaction as a share or asset deal.

heiner.feldhaus@gof-partner.com

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