Three years ago, Salix Pharmaceuticals (Nasdaq: SLXP) licensed a promising compound with the goal of developing a new treatment for chronic diarrhea in HIV patients.

Morrisville, North Carolina-based Salix paid Napo Pharmaceuticals $5 million up front and pledged up to $300 million in milestone payments. But now Napo Pharmaceuticals wants to get out of the deal and it is suing Salix for breaching commitments under the collaboration agreement, raising questions about whether Salix will be the company to take to market what could become a blockbuster drug.

Salix disclosed the lawsuit Monday morning. The company said in a prepared statement that the lawsuit is baseless and Napo's claims are without merit. Salix added that it plans to continue with the development and commercialization of the drug under the terms of the collaboration agreement. Reached by phone, Napo CEO Lisa Conte referred questions to company attorney Dan Becko, who said that the company is asking the court for the right to terminate its contract based on breaches in the agreement. He referred additional questions to the complaint, which was filed on May 5 in the Supreme Court for the State of New York, New York County.

The HIV-associated diarrhea drug candidate being developed under the partnership is called crofelemer. Salix in November reported positive results in a phase 3 trial studying crofelemer for the HIV-associated diarrhea indication. The trial was conducted under fast-track status and has been part of a special protocol assessment, an agreement between the drug company and regulators that allows for an expedited U.S. Food and Drug Administration evaluation of manufacturing, toxicology and clinical trial protocols. Napo said that Salix had assured the company it was taking the necessary steps to develop the drug and Napo had been expecting a June filing of a new drug application for the compound. But Napo said that despite fast-track status from the FDA, Salix has failed to use "commercially reasonable efforts" to develop and commercialize the drug in a timely manner.

"Although Napo continued to reasonably rely on Salix's assurances, Salix kept Napo in the dark about the true facts until April 15, 2011, when Napo finally discovered the full truth and shocking state of Salix's inactivity and its intentional decision not to fulfill its obligations under the collaboration agreement, or to conduct itself in accordance with its own prior statements to Napo," the company said in the complaint.

In 2008, Salix paid Napo a $4.5 million license fee and made a $500,000 equity investment in privately held, San Francisco-based Napo. The agreement with Napo called for Salix to be responsible for development costs of crofelemer, but "costs exceeding $12.0 million for development of crofelemer for the HIV-associated diarrhea indication will be credited toward regulatory milestones and thereafter against sales milestones," Salix said in a regulatory filing. Salix has well exceeded that $12 million benchmark. Through Dec. 31, 2010, Salix has spent a total of $22.5 million on crofelemer R&D, including $10.9 million in 2010, according to Salix's annual report.

Napo said that Salix's breach of the agreement will cause Napo to suffer damages in excess of $150 million and delay the availability of crofelemer to hundreds of thousands of HIV patients who could benefit from a drug to treat an unmet medical need. Diarrhea is common among HIV patients. Napo says that an estimated 40 percent of patients living with HIV in the United States manage chronic diarrhea, which affects their ability to maintain their drug regimen. Napo calls crofelemer its lead drug candidate. In addition to HIV-associated diarrhea, Napo is also developing the compound to treat diarrhea-predominant irritable bowel syndrome, acute infectious diarrhea and pediatric diarrhea.

In its announcement of first-quarter financial results, Salix said that work continued for an "anticipated 2011″ submission to the FDA of a new drug application for crofelemer. But if, as Napo claims, Salix has been unable to devote attention to crofelemer, it could be because Salix has been preoccupied by another drug. Salix has been trying to get its drug Xifaxan approved for the additional indication of irritable bowel syndrome. The FDA in March sent Salix a complete response letter notifying the company it could not approve the drug without additional information. A meeting with the FDA on that drug is scheduled for June 20. In addition to preparing for that meeting, the company must now also prepare to respond to and possibly litigate a lawsuit regarding crofelemer.

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