Princeton Drug Royalties Spark Suit Over Tax Exemption

Edward C. Taylor’s fascination as a Princeton University chemistry professor with butterfly wing pigmentation led him to invent a compound that Eli Lilly & Co. (LLY) turned into the $2.5 billion-a-year cancer drug Alimta.

Princeton, the fifth-richest U.S. university, patented Taylor’s invention, and the school reaped $524 million from 2005 to 2012 in license income, mostly from Lilly. The school used part of the money to build a new chemistry building and pay $118 million to faculty through 2011 beyond their salaries.

As with many discoveries, Taylor’s had unintended consequences.

Residents in Princeton, New Jersey, have sued the municipality and the university, saying the school should lose its tax-exempt status because it shares royalties with faculty. A state Tax Court judge refused to dismiss the case this summer and said it may have wide implications beyond Princeton.

“We don’t give tax exemptions to universities so they can take profits and pay selected faculty,” Bruce Afran, an attorney for the residents, said in an interview. “Some faculty are becoming fabulously wealthy, while taxpayers are paying more than they should. That is fundamentally unfair.”

At a June 27 hearing, Judge Vito Bianco refused the school’s request to dismiss the case, ordering the pretrial collection of evidence to proceed. He limited the case to the 2011 tax year, dismissing claims for 2010.

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Pedestrians walk past a statue of former Princeton University president John Witherspoon near the East Pyne building on the school's campus in Princeton, New Jersey. Close

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Pedestrians walk past a statue of former Princeton University president John Witherspoon near the East Pyne building on the school's campus in Princeton, New Jersey.

“There’s a lot riding on this,” Bianco said at the hearing. “It’s not just for this university or for every university in the country, but for nonprofits as a whole. I think this case is going to have very, very deep” impact.

$17 Billion Endowment

Princeton’s $17 billion endowment as of June 2012 ranked fifth behind Harvard University’s $30.4 billion, according to the National Association of College and University Business Officers and Commonfund Institute. As universities increasingly rely on royalties to help fund research, the potential effect of the Princeton dispute concerns Sean Flanigan, president of the Association of University Technology Managers.

“Any time you impose new costs, something has to give,” Flanigan said. His organization represents managers of intellectual property at universities, research institutes and teaching hospitals.

“Even at a small tax rate, that dollar is not going into research,” said Flanigan, whose members collected $2.6 billion in license income in 2012. Most royalties, he said, “are being plowed back into research or scholarships or general upkeep.”

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Bruce Afran, an attorney representing Princeton residents, stands in front of the Frick Chemistry Laboratory near campus on Aug. 30, 2013. Close

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Bruce Afran, an attorney representing Princeton residents, stands in front of the Frick Chemistry Laboratory near campus on Aug. 30, 2013.

The university denies operating for profit and has tax-exempt status under the federal tax code, as well as for various taxes in New Jersey.

‘Every Confidence’

Princeton “welcomes the opportunity to develop the facts and address the issues,” said Martin Mbugua, a spokesman. It seeks “to serve the public good through programs of teaching and research, and the purpose of tax exemption is to allow the university to devote its resources to this mission,” he said. “We have every confidence that the court will uphold our tax exemption.”

Afran said the school, which owns some taxable properties and has long been the top taxpayer in town, should pay far more than it does. It will pay about $10.2 million for municipal, school district, county and sewer taxes this year, as well as $2.48 million in voluntary payments, according to Kathryn Monzo, the municipality’s assistant administrator.

The municipality will collect a total of $150 million in local, school, county, sewer and open-space taxes, she said.

Residents sued under state tax law. A 33-year-old federal statute, the Bayh-Dole Act, encourages patent-royalty payments to faculty. It allocates patent rights among the government, inventors and institutions that get federal money.

Schools’ Stance

Universities are watching with concern, said Flanigan.

“Do we want, by virtue of the courts, universities being treated as businesses when this is not a core mandate of any university?” Flanigan said. “We would not want any type of result that could have a chilling effect on innovation.”

Companies look more to universities to help with specialized research, and the schools in turn can become incubators for businesses. One profitable relationship has come through Stanford University, which owns the page-ranking patent invented by former students Sergey Brin and Larry Page.

Google Inc. has paid the school $337 million in royalties on that patented algorithm, which formed the basis for the creation of the world’s biggest search engine.

Columbia University researchers came up with a gene-splicing technology that revolutionized the biotechnology industry and received more than $600 million in royalties before the patent expired a decade ago.

Advanced Cancer

Alimta is approved to treat advanced-stage lung tumors after previous treatments fail, and is used to fight mesothelioma, a rare cancer caused by exposure to asbestos. The Princeton patent ensures that Lilly won’t face competition for Alimta from generic-drug makers until January 2017.

A separate patent, developed by Lilly, is the subject of a case before a judge in Lilly’s hometown of Indianapolis. The case may extend that protection until 2021.

The school ranked fourth in royalties in 2012, reaping $130.1 million, behind New York University ($184.6 million), Columbia University ($161.7 million), and the Massachusetts Institute of Technology ($137.1 million).

Afran, who represents four residents and the estate of a fifth, filed his suit in 2011 to challenge Princeton’s tax-exempt status because of the royalties. He also challenged the status of 19 of the school’s 230 buildings on campus, saying they engage in commercial activities including catering, computer sales and travel agency services.

Tax Form

He said Princeton misled the municipal tax assessor on a form called the “Initial Statement of Organization Claiming Property Tax Exemption.” It directs an organization to name individuals receiving profit or, if none, to “state none.”

Over several years, Princeton never stated “none.” It replied, “Only the officers & employees of the corporation receive normal compensation for their services. The trustees do not receive any compensation.”

“They’ve deliberately avoided acknowledging that they give profits to faculty,” he said. “They simply omitted the information and came up with an answer that avoids the question. It’s not only bad faith but it’s a form of deception.”

At the June 27 hearing, Keith Lynott, a university attorney, argued that the school “is not operated as a business, and it is not operated for the purpose of generating a profit. Research is an essential core element of the educational mission.”

The test under the law, he said, is “whether the institution seeks to generate profits from its activities, not merely whether it makes payments to individuals,” he said.

Property Rights

Payments to inventors, he said, are not profits. Rather, he said they are recognition that faculty members have property rights to inventions that they lose because, under the Bayh-Dole Act, they must assign them to the university.

“The royalty-sharing program is not a sharing of profits; it’s simply recognition in the form of just compensation for ownership interests that the faculty inventor would otherwise have,” said Lynott, of McCarter & English LLP.

Princeton Mayor Liz Lempert said residents have a complicated relationship with the university. The town, with a population of about 30,000, hasn’t made a public statement on the litigation.

“One of the fundamental underlying tensions is that they are an internationally recognized research university, and they have a need to grow and expand to stay competitive and continue to attract the greatest minds,” Lempert said.

Tax Increase

Residents want the university to pay more, particularly after a 2009 revaluation raised taxes for many, she said.

“There’s a broad feeling that they should be paying more than they’re paying,” Lempert said. “The impact of the revaluation was it shifted the tax burden from the wealthier properties onto more modest homes.”

While residents understand Princeton’s “tremendous benefit,” she said, “they also want to feel the university is being a good community partner and paying its fair share.”

The university’s treasurer, Carolyn Ainslie, said in an October court filing that all of the school’s “fundraising, investments, and other activities” support its educational mission. In the 2010-11 fiscal year, the cost of education was 150 percent to 200 percent of tuition, and 60 percent of undergraduates got financial aid to offset that amount.

Afran, an adjunct professor at Rutgers University School of Law in Newark, New Jersey, argued in court that Princeton doesn’t have to commercialize its patents. Instead, he said, the school could put them in the public domain.

Universities’ Choice

“They’re not forced against their will to give royalties to inventors,” Afran said. “Bayh-Dole says if the university chooses to commercialize its patents, it must give royalties to faculty.”

Patent lawyer William Atkins said it can cost drugmakers $100 million or more to develop a compound and conduct tests needed for regulatory approval to market a medicine.

“They wouldn’t have invested that money because the rights wouldn’t have been exclusive” if the invention were placed in the public domain and not patented, said Atkins of the Pillsbury law firm. He isn’t involved in the case.

A former patent lawyer at drugmaker Pfizer Inc. (PFE), Jason Rutt, said pharmaceutical firms increasingly form partnerships with universities and small companies to handle drug research, while large companies develop medicines for market.

“A lot of universities are trying to do this,” said Rutt, now with the Rouse law firm in London. “They come up with ideas at a very early stage, and someone else makes it happen. They get recompense for it. I see it as a win-win.”

Taylor, now an emeritus chemistry professor, declined to comment for this article.

Butterfly Wings

Taylor’s research into the molecular composition of the butterfly wings led him to study a field of chemistry that in turn led to investigating ways to retard the growth of cancer cells. In a 2011 article in Chemistry International, he wrote about his discovery.

“I have often been asked how an interest in the lovely white, yellow, and red pigments in the wings of butterflies could have led to the discovery of Alimta,” Taylor wrote.

It began in 1946, when he was a graduate student at Cornell University, he said. He found an article about how researchers isolated a compound from the human liver that had a core observed only as pigments in the wings of butterflies and the skin of tropical fish.

FDA Approval

After getting his doctorate from Cornell, he held different jobs before joining Princeton in 1954. He worked in several areas of research, not turning to cancer chemotherapy until the 1970s, he wrote. He had been a consultant to Lilly, and developed the compound that became Alimta.

In 2004, the U.S. Food and Drug Administration approved the drug for the treatment of malignant pleural mesothelioma when surgery isn’t an option. The FDA later approved it for the treatment of non-small cell lung cancer.

Sales went from $142.6 million in 2004 to $1.15 billion in 2008 to $2.59 billion last year, or 11 percent of Lilly’s total sales. Total sales since 2004 have been $12 billion.

The case is Estate of Eleanor J. Lewis v. Trustees of Princeton University, 010656-2011, Tax Court of New Jersey (Morristown).

To contact the reporters on this story: David Voreacos in Newark at dvoreacos@bloomberg.net; Susan Decker in Washington at sdecker1@bloomberg.net

To contact the editors responsible for this story: Michael Hytha at mhytha@bloomberg.net; Bernard Kohn at bkohn2@bloomberg.net

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