E-Newsletter, May 2008

In this issue:

  • Maryland Employers Need to Review Their Leave Policies
  • Compliance with the 2008 Amendments to the FMLA Act of 1993
  • The Limited Liability Company: The Business Hybrid
  • The Crossroads of Pharmaceutical Pedigree and Product Liability Litigation
  • Congress Votes to Strengthen the Consumer Product Safety Commission
  • Product Recalls and Managing the Risks of a Defective Product

Maryland Employers Need To Review Their Leave Policies

By Thomas L. McCally and Tracy Stuger

A recent change in the “Maryland Guide to Wage Payment and Employment Standards” (“Maryland Guide”) of the Department of Labor, Licensing and Regulation (DLLR) has a major impact on how all Maryland employers can handle unused vacation pay at an employee’s termination. Regardless of information included in employers’ handbooks or provided to employees at the time of their hiring, employers are now required to pay out all of an employee’s accrued vacation time at the time of the employee’s termination.

Previously employers were allowed to include language in their policy manuals to establish whether a departing employee would be paid unused vacation pay. The main crux of DLLR’s previous position was that a denial of accrued vacation time could be permitted if the employer’s policy regarding forfeiture of vacation leave was communicated to the employee in advance. Therefore, by including provisions of forfeiture within their employee handbooks many employers were protected from subsequent claims of unpaid wages by former employees.

DLLR’s new ruling, however, is directly contrary to its previous position on this issue. The department’s recent change now provides that “when an employee has earned or accrued his or her leave in exchange for work, an employee has a right to be compensated for unused leave upon the termination of his or her employment regardless of the employer’s policy or language in the employee handbook.”

The DLLR is the primary regulatory authority for businesses in the state. Its modification undoubtedly comes as a result of the decision made by the Maryland Court of Special Appeals in Catapult Technology Ltd. v. Wolfe, No. 997 (August 20, 2007). In Catapult, the employer, Catapult Technology, Ltd., maintained a policy that required its employees to provide two weeks notice of resignation. Accordingly, Catapult’s employee handbook noted that failure of an employee to provide the required notice resulted in the forfeiture of accrued vacation leave. Although Catupult’s policy regarding leave was contained within its employee handbook, the Court of Special Appeals ruled that accrued, unused paid time off is a “wage” and must be paid to employees upon termination.

Although the Catapult decision drew concern, the Court’s decision in the case was not published and therefore was not binding upon other courts. However, the Court’s decision, combined with the recent change in DLLR’s guide, represent significant changes to longstanding policies that employers cannot ignore. Both the ruling in Catapult and the recent change to the “Maryland Guide” weigh heavily in favor of employees and provide tremendous support to employees who may challenge an employer’s decision to withhold payment of accrued vacation leave at termination. Maryland employers must take a proactive approach to ensure that they are adequately protected.

Advice to Employers

Employers must now consider revising their policy manuals to reflect the recent changes. Many employers currently have policies in place that are similar to the policy of Catapult. Common policies that many employers have established in their handbooks, for example, provide that if an employee were to quit his job without providing notice, or if an employee is terminated for cause, then that employee would be prohibited from being able to collect accrued vacation leave. Based on recent developments, policies such as these may be considered unlawful. Likewise, “use it or lose it policies” in which an employee’s leave is forfeited if not used by a specific date, may also be at risk.

From a fiscal standpoint, employers must also, at all times, be mindful about how accrued leave may be impacting their bottom line. For instance, if any accrued vacation time leave is carried over to a new fiscal period, the accrued leave might have to be treated as a liability on an employer’s balance sheet as it may potentially have to be paid out to an employee at termination.

Employers must also be aware of any universal leave policies that they may have in effect. Universal leave policies generally combine both sick time and vacation. In light of the recent change in the law, companies may want to revisit their use of universal leave policies. Grouping vacation leave that is payable to an employee upon separation, with sick leave, a benefit that is not payable upon termination, could result in the chaos for an employer in determining the apportionment of actual accrued vacation leave at an employee’s departure. Such a policy would expose an employer to unneeded risk and liability.

Please contact Thomas McCally or Tina Maiolo if you have any questions concerning the change in Maryland law.

Compliance With The 2008 Amendments To The Family And Medical Leave Act Of 1993

By Tina M. Maiolo and Nat P. Calamis

On January 28, 2008, President Bush signed into law the National Defense Authorization Act for Fiscal Year 2008, (“NDAA”) Pub. L. 110-181. As part of the NDAA, the Family and Medical Leave Act (“FMLA”) of 1993 was amended to expand its protections to cover eligible employees whose family members are serving in the United States military. The recent amendments to the FMLA went into effect the date that they were signed by the President; therefore it is important for employers subject to the FMLA1 to quickly take steps to ensure that they are acting in compliance with these new provisions.

The 2008 amendments to the FMLA expand coverage in two major areas. First, under amended Section 102(a)(1)(E) of the amended Act, employees are now entitled to a total of 12 weeks of unpaid leave during a 12 month period “[b]ecause of any qualifying exigency (as the Secretary shall, by regulation, determine) arising out of the fact that the spouse, or a son, daughter, or parent of the employee is on active duty (or has been notified of an impending call or order to active duty) in the Armed Forces in support of a contingency operation.” According to the Department of Labor’s website, “[b]y its express terms, this provision [Section 102(a)(1)(E)] of the NDAA is not effective until the Secretary of Labor issues final regulations defining ‘any qualifying exigency.’ DOL is expeditiously preparing such regulations. In the interim, DOL encourages employers to provide this type of leave to qualifying employees.” See Department of Labor website, at http://www.dol.gov/esa/minwage/printpage.asp?REF=/esa/whd/fmla/NDAA_fmla.htm

The second major change under the recent amendments to the FMLA is Section 102(a)(3), which provides that “an eligible employee who is the spouse, son, daughter, parent, or next of kin of a covered service member shall be entitled to a total of 26 work weeks of leave during a 12-month period to care for the service member.” The term “covered service member” is separately defined in Section 101(16) of the amended FMLA as “a member of the Armed Forces, including a member of the National Guard or Reserves, who is undergoing medical treatment, recuperation, or therapy, is otherwise in outpatient status, or is otherwise on the temporary disability retired list, for a serious injury or illness.”

According to the above-cited U.S. Department of Labor website, “[t]he Department of Labor is working quickly to prepare more comprehensive guidance regarding rights and responsibilities under this new legislation. In the interim [the Wage and Hour Division] will require employers to act in good faith in providing leave under the new legislation.” On February 11, 2008, the Department of Labor published a Notice of Proposed Rulemaking stating its intent to revise the regulations relating to the FMLA as a result of the recent amendments. The Department of Labor is currently in the process of receiving public comments responsive to its Notice of Proposed Rulemaking. It is unclear when these final regulations dealing with the amendments to the FMLA will be released by the Department of Labor.

Without clear guidance from the Department of Labor as to their present obligations under the amended FMLA, it is important for employers to take a cautious approach to ensure that they are acting in compliance of these new provisions. First, it is clear under amended Section 102(a)(1)(E) of the Act that as of January 28, 2008, all employers subject to the FMLA must provide eligible employees with up to 26 weeks of leave to care for spouses, children, parents, or next of kin who are members of the armed services being treated for injury or illness. “Next of Kin” is defined in amended section 101(18) of the Act as “used with respect to an individual, means the nearest blood relative of that individual.”

As was stated above, amended Section 102(a)(1)(E) of the Act is not effective until the Secretary of Labor issues regulations defining “qualifying exigency”. Despite this, the Department of Labor is encouraging covered employers to provide leave to eligible employees subject to this provision, and the Department of Labor is also requiring employers to act in good faith in providing employees with leave under the amendments to the FMLA. Thus although employers may not yet be specifically bound by the provisions of amended Section 102(a)(1)(E), it would be prudent for employers to immediately provide up to 12 weeks of leave to employees who are forced to undertake family obligations, such as child care, as a result of the deployment to active duty of a spouse, child, or parent of that employee.

Finally, employers covered by the FMLA should make sure that they are still in compliance with the posting requirements set forth under the Department of Labor’s regulations. Specifically, 29 CFR 825.300(a), provides that “every employer covered by the FMLA is required to post and keep posted on its premises, in conspicuous places where employees are employed, whether or not it has any ‘eligible’ employees, a notice explaining the Act’s provisions and providing information concerning the procedures for filing complaints for violations of the Act with the Wage and Hour Division.” Thus, to fully protect themselves, employers subject to the FMLA should post notices which explain that pursuant to the recent amendments of the Act, employees who are family members of soldiers in active service in the military, and employees who are family members of soldiers who are receiving treatment for injuries or illness, are now entitled to leave pursuant to the amended Act. An example of a notice incorporating the recent amendments to the FMLA can be found on the Department of Labor’s website.

 

  1. Pursuant to 29 CFR 825.104(a) “an employer covered by the FMLA is any person engaged in commerce or in any industry or activity affecting commerce, who employs 50 or more employees for each working day during each of 20 or more calendar workweeks in the current or preceding calendar year.”

The Limited Liability Company: The Business Hybrid

By Tina M. Maiolo and Laelia U. Banks

Arguably the most important decision a business owner must make is what business structure to use in his/her company formation. The simplistic days of sole-proprietorships, partnerships and corporations are long gone and the advent of the Limited Liability Company (LLC) has brought on a whole new level to business structures in this country.

What is An LLC?

A creature of state law, the LLC is often described as a combination of a partnership and corporation because it gives the benefits of a partnership’s tax advantages and management flexibility while affording the liability protection of a corporation. To better understand what an LLC is meant to accomplish, it helps to first get the nuts and bolts of corporate and partnership structures.

Generally, corporations are formed by filing articles of incorporation with a state agency. Governed by by-laws and strictly managed, a corporation’s major appeal is the fact that it protects its shareholders (owners) from the corporation’s creditors and offers its shareholders limited liability. Unless a shareholder gives a personal guarantee, a creditor will not be able to attach a shareholder’s assets that are not invested in the business. With this benefit, however, comes every shareholder’s nightmare; double taxation. A regular corporation is taxed as if it is a separate person, thus diminishing the shareholders’ returns to the corporation’s earnings minus the taxes paid by the corporation.

Of course there are ways to avoid the corporate tax, but these alternatives also have their downside. For example, shareholders can choose to be taxed as an S Corporation, which provides that the shareholders pay all of the tax themselves on the net income earned by the corporation or claim all of the corporation’s losses as their own, thus allowing the corporation’s income and expenses to be ignored at the corporate level. The problem, however, is that to qualify as an S Corporation, the company cannot have more than 35 shareholders, other business entities cannot be shareholders, and shareholders may not receive preferred returns over other shareholders.

So, historically, if a business owner did not want his/her company to be subject to corporate tax but could not qualify or did not want to do business as an S Corporation, a partnership was almost the only other alternative for forming a business. At a very basic level, a partnership’s income and losses flow through directly to the partners and is not subject to double taxation, like its counterpart, the corporation. The partners are, however, jointly and severally liable for all debts and judgments of the partnership. Of course, those wishing to minimize liability can always enter into a limited partnership. This, however, also has its drawbacks as the limited partnership does require at least one general partner, leaving one person completely exposed to liability for the partnership debts and judgments.

In an attempt to benefit from a corporation’s limited liability structure and a partnership’s pass through taxation, the first LLC legislation was passed in the late 1970s. By the 1990s it was clear the LLC was here to stay, and today, all 50 states and the District of Columbia have enacted LLC legislation.

Revealing its similarities to both corporations and partnerships, the LLC is formed by filing fairly informal articles of organization, which parallel a corporation’s articles of incorporation. It is the LLC’s Operating Agreement (analogous to a corporation’s articles of incorporation but more similar in form to a partnership agreement or a corporation’s by-laws and shareholder agreement) that sets forth the rules that govern the company as well as identifies the rights and responsibilities of the LLC’s members.

Within the Operating Agreement, it is the members who define how the LLC will be managed. Unlike the legal requirements of corporations or partnerships, there is a lot of flexibility in choosing how to manage an LLC. Sometimes, most or all of the control of the LLC will be vested in a few people, similar to a corporate structure, while other times the members might decide that everyone will have an active role in the day to day operations of the company.

Advantages of Forming an LLC

Given the flexible nature of the LLC, there are many advantages to forming this type of company, some of which were already discussed above.

  1. Limited Liability: LLC owners have limited liability, similar to a corporation. Unless they have signed a personal guarantee, members of an LLC cannot be held personally liable for any of the company’s debts. A member’s liability is limited to the amount he/she has invested in the company.
  2. Pass-through taxation: For tax purposes, generally, LLCs are treated as sole proprietorships or partnerships and no tax is assessed on the company itself. An LLC with a single owner is automatically taxed as a sole-proprietor while an LLC with several owners is automatically taxed as a partnership. It is possible, however, for an LLC to be treated as a corporation as well for tax purposes.
  3. No Citizenship Requirement: There is no requirement that LLC owners be citizens or residents of the United States
  4. Flexible Management Structure: An LLC can be managed directly by its owners or members or a manager who is hired to run the business. Also, unlike corporations, the LLC business structure does not require formal minutes or meetings and as a result is much easier to operate.

Disadvantages of Forming an LLC

Although the perks are many, the LLC can have its share of disadvantages.

  1. Transferability: It is often harder to transfer ownership of an LLC than with a corporation. In addition, corporations live forever, while the LLC is dissolved when a member dies or becomes bankrupt.
  2. Expenses: Many states require LLCs to pay ongoing fees, such as annual report and/or franchise tax fees. While it is not extremely expensive for small businesses, it is more expensive to form an LLC than it is to form a sole proprietorship or partnership, neither of which requires documents to be filed for formation with a state agency.
  3. New Structure: Finally, in relation to the corporation and partnership, the LLC is a fairly new business structure that is for all practical purposes still developing. As such, there is less case law and legal precedent for LLCs than there is for corporations.

Determining whether your business is best suited for an LLC structure and determining how your LLC should operate depends on a number of different factors, which are unique and specific to each business owner’s needs and visions for his/her company. Given the relative newness of the LLC along with the fact that each state has different, specific and possibly quite complicated laws governing LLCs, it is best to consult experienced and capable counsel to assist you in making the crucial decisions of whether and how to form your LLC.

The Crossroads Of Pharmaceutical Pedigree And Product Liability Litigation

By Paul J. Maloney

Pharmaceuticals are high value items that pass through numerous hands before reaching the consumer. This creates significant opportunity for counterfeiting, and associated profit on the part of those wrongdoers. Counterfeiters put innocent lives at risk, compromise product integrity, and undermine the faith in the pharmaceutical delivery system in this country. The FDA has been stymied in its efforts to implement a pedigree system for uniform delivery of drugs both by industry resistance and court intervention. As such, pedigree legislation rests, by default, with the individual states for enforcement of inconsistent pedigree laws.

The annual global market for pharmaceuticals is estimated at $500 billion. The World Health Organization (“WHO”) reported in 2006 that the counterfeit drug industry worldwide had revenues of over $40 billion. The same report also referenced that counterfeit drug sales will likely reach $75 billion globally by 2010.

Despite having a well developed—albeit complex—drug distribution program, the United States is not immune to counterfeit drugs. Best estimates are that 1% of all prescription drugs in this country are counterfeit. A recent PhARMA press release estimates that the scope of all counterfeit business—not just drugs—costs the US economy between $200 billion and $250 billion per year, and is responsible for the loss of more than 750,000 American jobs.

Not a day passes without there being some article in the news concerning counterfeits in general, and counterfeit and/or adulterated drugs in particular. www.safemedicines.org maintains a running list of reference articles. The Washington Post ran an article on February 7, 2008 captioned “Safety of Drug Imports Questioned: Some In Congress Want FDA to Expand Overseas Inspections.” The article referenced a letter written by Senator Grassley of Iowa to the FDA on February 1, 2008 concerning the number of inspections in China that dropped from 18 in 2004 to 11 in 2007. The article noted that China is believed to have hundreds, if not thousands, of plants that make ingredients for drugs headed to the United States. The FDA responded that it cost the agency $6.2 million in 2007 to pay for 300 foreign drug inspections. The Bush administration was pushing for a $5.7% increase.

Twelve days later, The Washington Post ran an article on page 1 captioned “FDA Says It Approved the Wrong Drug Plant: Heparin Probe Sends Inspectors to China.” The Chinese facility that produced the active ingredient for the blood-thinner Heparin was never inspected by the FDA because the agency confused its name with another. The article pointed out that there have been 350 adverse reactions to the Heparin reported to the FDA since the end of 2007, and four patients who took the drug died. As of April 8, 2008, the number of reported deaths is 62.

On May 1, 2007, the FDA released an alert to consumers about counterfeit drugs from multiple internet sellers. Six weeks later, counterfeit drugs purchased over the internet were blamed for the death of a woman in Vancouver, Canada. It was widely reported that this was the first clear cut case of death from counterfeit drugs bought on the internet, but as the Regional Coroner for Vancouver Island stated, “It likely won’t be the last.” The pills taken by decedent had 15 times the amount of aluminum that would be considered fatal.

On January 31, 2008, The New York Times reported that nearly 200 Chinese cancer patients were paralyzed or otherwise harmed last summer by contaminated leukemia drugs. The same Chinese drug maker is the sole supplier to the United States for the abortion pill known as RU-486. Approximately one-half of those injected with the contaminated leukemia drug could not walk as a result of the injections. The same article referenced 18 Chinese who died in 2006 after taking an intravenous drug used to treat liver disease, which was laced with diethylene glycol, a toxic chemical used in some antifreeze. Also in 2006, at least fourteen Chinese died after taking a Chinese antibiotic that was not properly sterilized during production.

Counterfeit Crime Wave

The market for counterfeit drugs in this country has been compared to organized crime in its level of sophistication. Counterfeiters pocketed $28 million in a single transaction for diluted Epogen. As many as 25,000 cancer patients may have received sub-potent medicine that was one-twentieth (1/20th) the prescribed strength when Procrit was re-labeled by U.S. counterfeiters. The counterfeiters earned approximately $46 million. Criminal prosecutions are few and far between. One problem is that the evidence is destroyed by patient use. Another is that the effects of a counterfeit pharmaceutical are often attributed to an underlying disease. If a patient dies, the cause of death will typically be related to the underlying disease process, and not as a result of a counterfeit drug. The FDA and U.S. Attorney’s Office are generally understaffed and unwilling to tackle the complexities of the counterfeit drug business in this country. This results in a high profit, low risk trade off for the criminal element, which will likely continue.

Nevertheless, there have been some high profile prosecutions. Julio Cesar Cruz received a thirteen years six month sentence without the possibility of parole for masterminding the 2003 Lipitor scam. He had previously been convicted of distribution of cocaine. In addition to his sentence, he was ordered for forfeit more than $2 million in profits for selling counterfeit drugs and participating in a conspiracy to purchase and sell counterfeit, misbranded and illegally imported drugs. Numerous co-conspirators received sentences as well, to include one who supervised the importation of counterfeit prescription drugs into the United States who received a nine year and six month term without parole.

Another high profile case involved Marc Anthony Kolowich, who was sentenced to 51 months in jail in a case prosecuted by the San Diego United States Attorney. Kolowich operated an internet pharmacy website at www.worldExpressrx.com from which customers could order prescriptions without having a prior prescription. Customers were to fill out a health questionnaire and pay a $35 fee for a doctor’s consultation, but there was no doctor involved. Kolowich received a 51-month jail sentence and forfeited $3 million in assets. Many of his co-conspirators plead guilty, and received sentences, most of which amounted to a slap on the wrist.

The case of Michael Carlow has been well documented. He was the subject of a book by Catherine Eban, Dangerous Doses: How Counterfeiters are Contaminating America’s Drug Supply. Carlow’s scheme included Medicaid fraud, counterfeit re-labeling, and diversions through offshore companies. At his zenith, Carlow operated more than two dozen front companies in a half dozen states, and generated $3 million per month. He plead guilty in November 2006 to charges of selling $42 million in counterfeit drugs to one distributor.

Intersection of Pharmaceutical Pedigree and Product Liability Litigation

I have now touched upon the scope of the counterfeit drug problem in this country. Where does this leave manufacturers, distributors, and pharmacies when a product liability lawsuit is filed on the basis of counterfeit drugs? The leading case on this topic is Fagan v. AmerisourceBergen Corp., et al. (hereinafter “ABC”).

Facts: 18 year old Timothy Fagan filed suit in the Eastern District of New York alleging that following a liver transplant on February 15, 2002, he was provided—and used—two months worth of counterfeit Epogen. His lawsuit was filed against ABC, Amgen, CVS Corporation, and Procare Pharmacy (a subsidiary of CVS).

The facts are straightforward. CVS delivered three prescriptions to Mr. Fagan from two different lot numbers from March 20th to May 20, 2002. Six days after Amgen posted a warning on its website of the potential for counterfeit Epogen, CVS called plaintiff to advise him of the problem. The Epogen delivered was 1/20th the strength set forth on the label. Fagan claimed medical damages to include worsening anemia, excruciating pain from the below strength injections, and delayed recovery from the liver transplant. The lawsuit included the usual claims for negligence, breach of implied and express warranty, fraudulent misrepresentations, etc.

Each of the parties filed a Motion to Dismiss the Complaint at the outset of the litigation.

Amgen: The manufacturer moved to dismiss claiming that it had no duty to: (1) make its product tamper resistant; (2) continuously monitor its products from the time it left its control until the time purchased by the consumer; and (3) protect the public from criminal misuse, even if foreseeable. The court agreed with these arguments, and dismissed the claim. In finding that Amgen owed no duty to Fagan under the circumstances, the court established favorable precedent for manufacturers in similar counterfeit cases. As the court noted:

“Plaintiff cannot establish that it was feasible for Amgen to design the Epogen in a safer manner. Even if Amgen was aware of the diversion and counterfeiting of prescription drugs, and that its packaging could be violated by a counterfeiter, no packaging is completely tamper-proof.”

“…a manufacturer does not have a duty to anticipate and prevent criminal conduct by third parties, or to design its product in such a way as to anticipate and frustrate criminal tampering.”

ABC: Similar to Amgen, ABC argued that it owed no duty to plaintiff, and even if it owed a duty, the criminal conduct of others was the proximate cause of damage to Fagan. The court was not as receptive to ABC’s arguments as it was to those of Amgen. Specifically, the court found that there was a “special relationship” between the distributor and the plaintiff since the distributor was in the best position to protect Fagan from harm. In finding that ABC owed a duty, the court noted:

 

 

“…ABC was in the best position to prevent the harm alleged by modifying its practices so as to avoid purchasing its drugs from the ‘gray market.’ Accordingly, plaintiff’s allegations sufficiently raise factual questions as to whether ABC owed him a duty of care.”

 

The court also rejected ABC’s claim that an intervening criminal act by a third-party cut off its liability in noting that:

 

“…since plaintiff has alleged that ABC knew that its distribution practices helped to foster the “gray market,” it was reasonably foreseeable that by continuing to do so, a person would be able to counterfeit or misbrand prescription drugs and deliver such drugs to retailers, who would then pass them along to unwary consumers.”

 

Pharmacy: CVS also filed a Motion to Dismiss. It contended that: (1) it did not knowingly dispense a drug that was inferior or defective; and (2) it did not have a duty to warn customers of potential criminal misuse of a medication. The court again disagreed, and at least at the Motion to Dismiss stage of the litigation found that there were factual issues to include:

 

“…potentially negligent conduct on the part of CVS ProCare, including, inter alia, its failure to inspect the label of the medication purchased from ABC, which was purportedly defective on its face.”

 

It should be noted under New York law of this case a pharmacist has an obligation “to exercise the highest practicable degree of prudence, thoughtfulness, and vigilance, and the most exact and reliable safeguards consistent with the reasonable conduct of business.” In reaching its decision, the court also made reference to an allegation in the Complaint that CVS knew of the counterfeiting and diversion of prescription drugs since 1988, and the fact that some of its drugs may have been purchased on the “gray market” was sufficient to preclude dismissal of the negligence claim at the outset of the case.

As a result of the initial rulings, the entire claim was dismissed as to Amgen, negligence claims were allowed to go forward against ABC and CVS, and the implied warranty of merchantability claim allowed to go forward as to CVS. In applying New York law, the court in Fagan held the distributor and dispenser to a higher standard than that of the manufacturer. The court found it significant that the distributor had knowledge of the “gray market” and questionable practices related thereto. The distributor was also the first in the line of distribution to be able to pick up on the counterfeit drug, and failed to do so. The finding against the pharmacist appears harsh on its face, but New York has no equivalent statute to the “sealed container” defense available in many states. The court put both CVS and ABC in a position to, in essence, prove that they did not know of a “gray market” for Epogen—something difficult to do.

Lipitor Recall

The Lipitor scam from 2003 forms the factual backdrop for two additional counterfeit drug cases. The following facts are gleaned from Arons v. Rite Aid Corporation, 2005 WL 975462 (NJ Super. L.) (March 23, 2005) and Ashworth v. Albers Medical, Inc., et al., 395 F. Supp. 2d 395 (2005). Lipitor, the best selling prescription drug in the world, is used to lower cholesterol. It is exclusively manufactured by Pfizer Ireland Pharmaceuticals, and distributed by Pfizer, Inc. in the United States. In late-2002, Albers Medical Distributors, a national distributor for prescription and over-the-counter pharmaceutical products, purchased hundreds of bottles containing 5000 tablets each represented to be 10 mg of Lipitor. Albers also acquired smaller quantities of bottles containing tablets represented to be 20 mg of Lipitor. Albers obtained written pedigree information, which turned out to be counterfeit. Numerous individuals with experience in the wholesale drug industry reviewed the pedigree data during the time the tablets navigated through the supply chain. None picked up the counterfeit paperwork. The pedigree data showed that 774,180 of the 10 mg tablets had been bought and sold by six different entities in Puerto Rico, Tennessee, Maryland, Missouri, and Illinois within a nine-day period in early-2003.

When Albers bought the tablets, it contracted with MedPro, Inc., a pharmaceutical repackaging specialist in Nebraska to repackage the tablets from 5000 tablet bottles into 90-tablet packages. As the scam unfolded, Med-Pro declared bankruptcy. The aforementioned Mr. Cruz and Mr. Carlow were both involved in the scam. Mr. Albers was indicted as well.

In November 2002, Albers began to sell a substantial quantity of 90-tablet packages represented to be 10 mg Lipitor and 20 mg Lipitor to H.D. Smith Wholesale Drug Company. H.D. Smith, in turn, sold substantial quantities to Rite Aid Corporation in March and April 2003, and smaller quantities to Americare Pharmacy in February 2003. As of February 2003, Rite Aid operated 3,356 stores throughout 28 states and the District of Columbia. Between April 3, 2003 and June 1, 2003, Rite Aid pharmacies dispensed approximately 16,600 tablets represented to be Lipitor, a portion of which it had purchased from H.D. Smith.

Ashworth v. Albers

In April and May 2003, plaintiff, Tammy Ashworth, purchased 30 tablets purporting to be Lipitor from a pharmacy in Big Chimney, West Virginia operated by Rite Aid of West Virginia. On the day after Ms. Ashworth made her second purchase, the FDA announced that Albers had agreed to a voluntary recall of three lots of 90-tablet bottles of 10 mg Lipitor repackaged by Medpro. By mid-July, based on additional FDA testing, approximately 200,000 bottles had been recalled.

Rite Aid notified its customers, including Ms. Ashworth, of the potential problem on June 9, 2003. The notice indicated it was impossible to tell through inspection whether the Lipitor she received was safe for use, so it requested that the tablets be returned to Rite Aid for replacement. Only after receiving the notification from Rite Aid, Ms. Ashworth notified her physician that she had experienced dizziness, sluggishness, and chest pains from April 24th to June 9, 2003. Her treating physician confirmed “dangerously high” levels of triglycerides, and admitted her to the hospital for treatment.

Ms. Ashworth proceeded to file a ten-count complaint alleging the usual misdeeds by the corporate defendants. She chose to sue Pfizer, Albers, Medpro, H.D. Smith and Rite Aid. The reported decision from the United States District Court in West Virginia only dealt with Rite Aid’s Motion to Dismiss and several other procedural issues. Rite Aid presented three arguments to the court: (1) it was entitled to a statutory sealed container defense; (2) it was entitled to a learned intermediary defense; and (3) there was no indication that Rite Aid had any knowledge that the Lipitor was counterfeit or had knowledge of a counterfeit operation.

The court agreed, and dismissed Rite Aid. The court found that there were:

 

“No allegations that Rite Aid knew or should have known that the Lipitor sold to plaintiff was counterfeit, whether by observing the tablets or the bottles in which the tablets came.”

 

The court in Ashworth distinguished the Fagan case noting that New York had no statutory scheme for the sealed container defense. It also pointed out that Rite Aid had no knowledge of prior counterfeiting practices as had been alleged in the Fagan case.

Typically, products liability cases trace back to the manufacturer in an upward stream from the seller. The Fagan court effectively eliminates the manufacturer, at least under New York law, for counterfeit schemes first undertaken by distributors. The Ashworth court, in construing West Virginia law, eliminates the ultimate drug dispenser from liability so long as there is not prior knowledge of counterfeit activity. Both cases tend to focus the inquiry on the distributor closest to the party that engineered the counterfeit scheme in the first instance.

Arons v. Rite Aid Corporation

The Arons case involved the same Lipitor scheme as the Ashworth case. Here, three plaintiffs in New Jersey filed a lawsuit against a host of defendants alleged to have been involved in the distribution of the counterfeit Lipitor. In this case, none of the three plaintiffs were alleged to have had adverse health effects, and one of the plaintiff’s cholesterol levels had even improved during the time he had taken potentially counterfeit Lipitor. In a well-reasoned opinion, the trial court refused to certify a class action suit as requested by plaintiffs. This was a resounding win for defendants in counterfeit drug cases, and will serve as a road map for future efforts to defeat similar class certification requests. In particular, the court found that:

 

“It is entirely unclear whether plaintiffs may have been among the unlucky ones who acquired tablets that are actually bogus. To extrapolate from the voluntary recall episode that plaintiffs likely were so unlucky creates impermissible speculation and conjecture.”

 

In part, the court justified the denial of the class certification as follows:

 

“…it is impossible to know with any certainty exactly what each purchaser took home in the tablets acquired from the pharmacies. The individual contents of the bottles sold at retail remain unknown. Many purchasers consumed their tablets. Some returned the leftovers to Rite Aid and Americare. Some retained their tablets. Just because the universe of tablets sold in the Spring of 2003 was the subject of a voluntary recall does not circumstantially demonstrate a breach of warranty.”

 

In addition to denying class certification, the court dismissed consumer fraud claims, but did allow certain warranty claims to go forward.

The Fagan, Ashworth, and Arons cases are the leading cases involving the intersection of counterfeit drugs and product liability claims. These cases point out the problems that plaintiffs will have in prevailing in a counterfeit drug case. Problems include: (1) preservation of the evidence; (2) proof that a counterfeit drug actually caused injury; (3) proof that any of the defendants had actual knowledge of the counterfeit activity; and (4) to the extent that class certification is denied, such cases may be prohibitively expensive for an individual plaintiff absent severe personal injury. These cases bode well for the defense of product liability claims arising out of counterfeit drug sales.

Congress Votes To Strengthen The Consumer Product Safety Commission

By Jan E. Simonsen and Ali A. Beydoun

We need to continually improve our import safeguards to meet the changing demands of a global economy. We must ensure that our food supply and imported products remain among the safest in the world. Our purpose is not just to look at today, but to anticipate tomorrow.
— Secretary Michael O. Leavitt
Chair, Interagency Working Group on Import Safety
August 6, 2007

Although the Consumer Product Safety Commission has not officially christened 2007 as the “Year of the Recalls”, it has been publically acknowledged by the Commission’s Acting Chairman Nancy Nord, the media, and a variety of consumer protection groups and safety advocates. The integrity and safety of products, especially imports, is being questioned and has shaken the long standing confidence regarding items which consumers have long taken for granted. In 2007, tires, dog food and toothpaste from China have all been recalled. Most troubling were toy recalls, including one that involved millions of dangerous toys distributed by Mattel. Many of the toys contained dangerous amounts of lead, while others were made with hazardous magnets that could seriously injure children if they were swallowed. Approximately $2 trillion of imported products entered the United States in 2006. Experts expect that number to triple in the next seven years. Compounding this situation is the threat of a wrong, or insufficient, reaction by government and business leaders to undersatnding the issues and implications of the potential solutions. The challanges of ensuring the safety of consumer products, regardless of whether they are produced domestically or abroad, include the ever present demand for new products, faster inventory turnover and greater consumer spending. In anticipation, U.S. importers, distributors and retailers should be looking to adopt proactive and pre-emptive approaches to influence and mange the impact of these legislative and regulatory changes, and to ensure compliance with stepped up standards and expectations while not compromising the risks inherent to their business and commerce.

The current Congress will almost certainly approve product safety legislation that will significantly impact the recall process and the process for ensuring product safety. In an effort to demonstrate their willingness to act, President Bush established the Interagency Working Group on Import Safety by Executive Order on July 18, 2007. The group is chaired by Health and Human Services Secretary Michael Leavitt, and includes officials from many other agencies such as the Department of Agriculture and the Consumer Product Safety Commission (CPSC). The IWGIS is commissioned to review and assess current procedures directed at ensuring the safety of products exported to the U.S.; identify the methods by which U.S. importers may enhance the safety of imported products; and, survey practices of federal, state and local governmental agencies concerning import safety to highlight best practices and improve coordination among agencies.

In September 2007, the IWGIS submitted its initial report to President Bush, Protecting American Consumers Every Step of the Way:  A strategic framework for continual improvement in import safety.  The report outlines an approach that can build upon existing efforts to improve the safety of imported products, while facilitating trade. On November 6, 2007 the Working Group released an Action Plan for Import Safety that provides specific short- and long-term recommendations to better protect consumers and enhance the safety of the increasing volume of imports entering the United States. The Action Plan promotes a program of improvements in product safety that is largely government “hands off” and business driven. For example, to encourage good importer practices, the IWGIS proposes creating a public list of certified foreign firms and businesses and giving products made by those firms expedited processing at US ports of entry. The IWGIS also suggests increasing civil penalties for non-compliance up to $10 million.

The Administrative initiative contemplates some legislative changes, but the Congress is working to create a product safety bill to send to the President by the end of the year that is likely to be far more expansive, with more mandatory testing standards, particularly for products intended for children. Among the import safety-related measures moving through the Congress are bills that would create a single agency to oversee food safety; increase the number of inspections and create a fee to defray food inspection costs; name an import “czar” to coordinate and oversee import safety; and to simplify the Food and Drug Administration’s and Consumer Product Safety Commission’s recall process.

Pending Bills in Congress

The two primary CPSC-related bills under consideration are S. 2045 (“The CPSC Reform Act”) in the Senate and H.R. 4040 (“Consumer Product Safety Modernization Act”) which has already passed both chambers of Congress.

The committee-passed bill, known as S. 2045 “the CPSC Reform Act”, is designed to reform the CPSC to provide greater protection for children’s products, to improve the screening of noncompliant consumer products, to improve the effectiveness of consumer product recall programs, and for other purposes. Under the bill, the CPSC would increase civil penalties for violations of the laws administered by the CPSC to a maximum of $250,000 per incident, with a $100 million cap (in place of its current $1.8 million cap). The Senate bill would also permit state attorney generals to pursue civil penalties for violations of the federal acts and provide for whistleblower protection for employees of manufacturers, private labelers, distributors, and retailers. Finally, the bill would require manufacturers or distributors to post a bond to cover recall costs or, for imported products or substances, holding costs. Furthermore, and with respect to children’s products, S. 2045 would require independent third party safety certifications for products designed for children, require the manufacturers to label their products with tracking information to facilitate recalls, and would completely ban the use of lead.

This bill is in the first stage of the legislative process where the bill is considered in committee and may undergo significant changes in markup sessions. The bill has been referred to the Senate Commerce, Science, and Transportation, Subcommittee on Consumer Affairs, Insurance, and Automotive Safety. This bill was considered in committee which has recommended it be considered by the Senate as a whole. Although it has been placed on a calendar of business, the order in which bills are considered and voted on is determined by the majority party leadership. Sometimes the text of one bill is incorporated into another bill, and in those cases the original bill, as it would appear here, would seem to be abandoned. It is likely that the bill will come to a vote at the end of the year.

The advancing H.R. 4040, the Consumer Product Safety Modernization Act, which has already passed both chambers of Congress, would make any children’s consumer product containing more than specified amounts of lead a banned hazardous substance under the Federal Hazardous Substances Act. Moreover, the Act would modify requirements regarding action plans of manufacturers, distributors, or retailers to deal with products that present a substantial hazard. It would also require manufacturers, distributors, or retailers to give public notice of a substantial product hazard on their Internet website and to third party Internet websites on which the product was for sale. The Act would authorize increases the maximum civil penalties under the Consumer Product Safety Act, the Federal Hazardous Substances Act, and the Flammable Fabrics Act, including forfeiture of assets associated with the violation of any Act enforced by the CPSC.

In December 2007 the House of Representatives voted 407-0 in favor pf the bill with 25 not voting. In March 2008, the Senate voted 79-13 in favor of the bill with 8 not voting. The bill may now proceed to a conference committee of senators and representatives to work out differences in the versions of the bill each chamber approved. The bill then goes to the President before becoming law.

At the heart of any debate over the strict measures being authorized in these bills is public concern about the importation of unsafe products from abroad; namely China. In response to this concern, as these bills indicate, the Senate Commerce Committee has drafted legislation (the forthcoming substitute for the CPSC Reform Act, S. 2045) that boost criminal penalties for distributing products in violation of consumer-products laws and regulations, dramatically raise fines for such violations, and give state attorneys general the power to sue firms on behalf of their citizens. Some may say this is a “gift” for trial lawyers. What remains to be seen is the effect, and even unintended consequences, these bills will have on commerce and the business sectors. At a time when economic growth is slowing, a balanced approach is vital. Congress should take care to avoid policies such as these that raise the cost of doing business, increase legal uncertainty and risk, and threaten jobs, while also managing to uphold its duty to care for the general welfare.

Product Recalls And Managing The Risks Of A Defective Product

By Jan E. Simonsen and Kelly M. Lippincott

A company’s brand name is often its most valuable asset. A brand name takes years to develop, but can be irreparably harmed in an instant if a trusted brand causes harm to the consumers that have grown to rely on it. When a company learns that one of its products has caused harm to one or more of its customers, it needs to take swift action to prevent future harm to its consumers and salvage its brand name.

A company may learn of problems with its products through a number of sources, including customer complaints, claims, news coverage, and regulatory agencies such as the U.S. Consumer Product Safety Commission or the U.S. Food and Drug Administration. The problem may be the result of a design defect, manufacturing defect, malicious tampering, accidental contamination, misbranding, or mislabeling. Whatever the reason for the defect, the company must decide what it will do to address the problem. Immediate action is necessary to protect customers, protect the brand name, and apply with the requirements of the regulatory agencies that have jurisdiction over the specific product.

Rise in Number of Recalls

Product recalls are an extreme and expensive remedy, but they happen frequently and, in recent years, with increasing regularity. The U.S. Consumer Product Safety Commission’s website lists over 30 recalls in January 2008 of a variety of products from air compressors to toy train sets. The U.S. Food & Drug Administration’s (“FDA”) website lists over 20 recalls, market withdrawals and safety alerts in January 2008. The number of recalls has increased dramatically over the years. In 2000, the FDA reported approximately 80 recalls, market withdrawals and safety alerts. In 2007, that number rose to 375. The reason for the increase is unclear. The cynical view is that product quality is in a steep decline. Alternatively, it might be that companies are taking a more proactive approach to warning their customers of known defects. Product recalls help companies to protect their customers, reduce their litigation costs, and preserve their reputation and brand name.

Deciding Whether to Recall

The decision of whether a company should initiate a product recall depends on a number of factors, including whether the defect affects safety, the risk of physical harm to customers, the involvement of regulatory agencies, and the cost of the recall. While a product recall can be a costly endeavor for a company, often much higher than production costs, the cost of not doing a recall can be even greater. The longer a dangerous and defective product remains in the market, the greater the risk of product liability lawsuits, and the potential for both civil and criminal action by regulatory agencies. If a product is monitored by federal agencies, there may be mandatory notification requirements. There are many federal agencies that regulate products, including Consumer Product Safety Commission, Food and Drug Administration, National Highway Traffic Safety, Bureau of Alcohol, Tobacco and Firearms, Food Safety and Inspection Service of the U.S. Department of Agriculture, U.S. Department of Housing and Urban Development, Environmental Protection Agency, and Federal Aviation Administration. Each agency has rules and regulations that producers of certain products must follow in the manufacturing of their products, and sometimes, guidelines regarding product recalls.

The Costs of a Recall

There are many costs associated with a product recall. Besides the actual costs of conducting a recall, there is the cost of losing customer goodwill, damage to the brand name, and liability to third parties. Third parties include customers who are harmed by the product, as well as, other parties, such as distributors and other manufacturers, who incorporate the subject product into their own product. These other third parties may suffer loss of income or damage to their own reputation or brand as a result of the recall.

First Party Costs

In August 2007, Castleberry’s Food Company faced a product recall following a botulism scare. Castleberry’s parent company, Connors Bros., estimated that the recall of 90 different brands of the company would cost approximately $40 million. The cost of a recall can be very high depending on the size of the company, the number of products affected, and the number of its consumers. The cost of not taking a proactive approach to guarding the health and safety of your consumers from a known danger, however, can be much higher.

Liability to Third Parties

When a product is the subject of a recall, the first concern might be liability to the consumers of that product. In addition to the purchasers and users of its products, a company might be liable to its distributors and other third parties. There may be other companies that incorporate the component or ingredient into their own product. A recall of that component or ingredient may cause the other manufacturer to suffer an interruption to their business, loss of profits, and damage to their reputation due to the recall of their product.

Third party liability might not be a concern if the company only sells its products under its own label or sells its product directly to consumers. If the product is incorporated into other products, however, then the recall could also affect other manufacturers. This of course will increase the expense associated with any recall. Not only does the original producer need to recall the product, but any other manufacturer that uses the component will need to recall all of its products that incorporate the subject component. As the network of other manufacturers and distributors branches out, the cost and the effect of a product recall has a growing impact, thus increasing the potential liability to third parties.

Protection through Insurance Coverage

Some of the steep costs associated with product recalls can be defrayed by insurance coverage. General product-liability coverage does not usually cover the costs associated with a product recall. While general product-liability coverage is still essential for claims brought by consumers, there are many other risks associated with a product recall that a company must mitigate.

A growing number of carriers offer Product Recall Coverage. Product recall insurance can provide coverage for the costs of removing the product from the market, radio and television announcements, newspaper advertising, overtime for employees involved in the recall process, hiring additional employees to assist with the recall, inspection, destruction, repair, or replacement of the defective product, shipping costs, disposal costs, redistribution costs, lost profits, and business interruption.

Some policies go a step further and provide coverage for claims by third parties for when a company’s ingredient or component has made another product less useful. This type of coverage is particularly important for manufacturers of components and ingredients.

There are other coverages that are designed for specific industries. For instance, contaminated products insurance is designed for the food and beverage industry. This insurance covers losses associated with malicious product tampering and accidental product contamination. Often, general products liability insurance does not protect against such losses.

An Ounce of Prevention…

Developing a protocol through which to handle product recalls is essential for any manufacturer. A company should be diligent in looking for triggers that might indicate the need for a recall. Triggers include product liability claims, customer complaints, and test and inspection results. A system for identifying when a product recall may be necessary, assessing the need for a recall, and implementing the recall must be in place before a company is faced with the decision of whether to recall a product. Responsive action is necessary for a recall to be effective and to preserve the brand. A company that waits until it is faced with a recall to figure how it will handle a recall will cost itself valuable time.

A company should have a corporate team organized in advance that will be responsible for identifying triggers, such as product liability claims, customer complaints, and test and inspection results, to determine when a recall might be necessary. The team should also be organized to, if it determines a recall is needed, to swiftly implement the recall process. Having a crisis management plan in place before a company is confronted with the decision of whether to conduct a recall can minimize the costs of a recall, reduce litigation, and prevent adverse publicity which can scar a brand name. A company’s quick response to a defective product is the key to reducing the risk of others being harmed by the product, thus reducing the company’s exposure to liability.