Product Liability: When Bad Things Happen to Good Companies

Guidant's problems with its ICD business, coming in the midst of its merger negotiations with Johnson & Johnson, highlighted the impact that product recalls and problems can have for companies. Generally speaking, product liability is becoming a bigger issue for medical device companies as consumers grow more skeptical that the government is protecting their interests where product safety is concerned.

The long, protracted battle between Johnson & Johnson and Boston Scientific Corp. over Guidant Corp. might never have become long or protracted or anything but routine—except for the price, of course—had it not been for the problem that Guidant's implantable defibrillator (ICD) business ran into just as J&J began to do its due diligence on the deal. [See Deal], [See Deal] BSC officials have insisted that the ICD problems aren't long-term concerns—and clearly backed up that opinion by the size of their bid for Guidant. But J&J officials clearly thought they were an issue, and Guidant's problems served to highlight an issue that many device executives ignore or take for granted—the risks of product liability claims and lawsuits.

More to the point, the fact that the players in the J&J/Guidant/BSC drama were all huge, multi-national companies reinforced a perception that product liability is primarily something that only large, well-established companies need to worry about—a belief that, say product liability experts, small companies in particular hold at their peril.

Until BSC's last-minute offer, it was clear that Guidant's ICD troubles would have a material and measurable impact—costing something in the neighborhood of $4 billion, as measured by J&J's follow-on bids. And though BSC's final winning bid has mitigated that cost, Kevin Quinley, CPCU, senior vice president at product liability specialist Medmarc Insurance Group, calls Guidant "the poster child for every device company's nightmare about the multiple negative consequences" of product liability claims, consequences that include everything from recall and compliance costs to legal costs associated with both individual plaintiffs and class action lawsuits to directors and officers liability claims.

Guidant's high-profile problems—and their implications for the J&J deal—may make the situation seem unique, says Quinley, but small start-ups, even those whose products may be years away from commercialization, aren't immune from product liability risk. Product liability problems are "equal opportunity headaches" for device companies, he says, discriminating surprisingly little between big and small players. "Big, established, public companies with many products in the pipeline have no monopoly on liability exposures," says Quinley. Small, less well-known companies, such as start-ups may have a lower profile, he concedes. "But that profile can quickly be elevated as enterprising attorneys find out that they have a product problem," he says.

Indeed, Quinley says that Medmarc is increasingly seeing companies at the clinical-trials stage of development facing product liability lawsuits when something goes wrong—and the early-stage, experimental nature of the technology mechanisms offers little protection from aggressive plaintiff counsel. "The fact that [the product is being used in a clinical trial] does not grant them immunity or insulation," he notes. Company exposure, obviously, differs case by case. But Quinley points out that personal injury attorneys are increasingly targeting the clinical trials process for a number of reasons. "There's a perception [by plaintiffs and their attorneys] that the informed consents are not valid, that the risks are not thoroughly and totally disclosed to patients, and that there are big concerns about the financial incentives inherent in the clinical trial," he says—specifically, that the financial incentives offered to physicians conducting or participating in the clinical trials are not always disclosed and may represent a questionable incentive to use a product that later proves to have been unsafe.

Such concerns are not, strictly speaking, product liability issues—lack of disclosure or inappropriate financial incentives, for example, are corollary to the product defects and malfunctions that are at the heart of product liability claims and lawsuits. But they become fair game for aggressive attorneys when products misfire. Notes Quinley, "To the extent that a plaintiff's attorney can show that the company conducting the clinical trial put their financial interests over the interests of the patient or that a manufacturer sponsor of the trial structured the incentives in a skewed manner, then that can very much infuriate a jury, and motivate them to award significant damages to an injured claimant."

Medmarc's primary role is to underwrite product liability insurance, providing financial protection to medical device companies for any claims or lawsuits that arise from product problems. (The company was launched in 1979 by 31 members of the predecessor to AdvaMed, the medical device industry trade association.) In addition, like most insurers, Medmarc also offers a range of client education and related services, through a loss prevention department that works with device companies to help them strengthen their internal systems and processes to reduce the odds that they'll ever face a product liability suit.

Large device companies usually do have full product liability protection. But Medmarc officials note that for many small companies, product liability is something they think they'll need later, not today. "I think there's sometimes the perception that because they're small, no one's going to come after them," says Tom Konopka, a Medmarc senior vice president. "They believe that big companies are more visible and they're more obvious targets. But when something goes wrong, you can be sure the plaintiff's bar is going to come calling."

On a related issue, says Konopka, small companies also often make the mistaken assumption that if they underfund product liability, they're safe from targeting by plaintiffs. "The feeling is that if they don't have insurance and the plaintiff knows that, they won't be named in the suit," he says. "But what actually happens is that the attorneys come after their assets, of which the insurance contract is only one."

Start-ups often don't pay much attention to product liability for another reason: in today's device world, many start-ups simply assume that they're going to sell out to a large company at or even before commercialization and so the product liability issues will fall to the big company to deal with. "But what often happens," he says, "is that the CEO thought that the company would be sold by year four or five but this pesky little product liability problem happened and no one wanted to look at the company because of the perception that it was damaged goods."

Konopka recalls one manufacturer of gynecology devices that didn't ignore its product liability exposure, but significantly underfunded it. "They brought in a CFO from outside the device industry whose philosophy was one of low-exposure," he says. Sure enough, the company had two claims against it when it began discussions with a major device company about a possible acquisition. "Things were moving along swimmingly when the two claims came up," says Konopka. In the end, the claims didn't squash the deal, but it did cause "a lot of angst and a lot of back-and-forth negotiations at the eleventh-hour," he says.

Konopka notes that many VCs understand the importance of product liability insurance not just for portfolio companies—but for themselves as well. Those that don't "are playing Russian roulette with their investments, putting them at risk of uncovered claims and lawsuits, which can be asserted even against development-stage companies," he says.

Device companies most at risk are those that make implantable devices, if only because patients have the device for a long time and problems can have long-term and dramatic consequences—that's why some of the most notorious product liability cases in devices have involved implants: breast implants, the Dalkon Shield IUD, and Sulzer's hip implant problems of a few years ago.

But, says Konopka, manufacturers of devices that are used as instruments in individual, episodic procedures are also clearly at risk. Nor is product liability only an issue for high-tech products. Kevin Quinley jokingly says that Medmarc covers everything from "bedpans to pacemakers," though he adds, "I confess we haven't ever seen any bedpan claims." Still, he says, 510(k) devices run the same risks that PMA devices do. "There may be some subtleties and nuances in terms of certain types of legal defenses that a PMA product might have that a 510(k) product would not have," he says, but lawsuits, particularly groundless ones, can be brought against any company and can be "financially devastating," says Quinley. "Whether you're PMA or 510(k) isn't highly material to the question of whether or not one needs financial protection for product liability suits and claims."

The high-profile product liability cases and recalls such as those involving breast implants or total hip replacements, highlight both how rare major device problems are—and also how traumatic they can be when they do occur. More recently, the headline-grabbing problems that drug maker Merck & Co. Inc. faced with its Vioxx recall—and the multi-billion-dollar litigation exposure Vioxx has brought—have also resonated in the device world, heightening concerns among both device companies and the public about the safety of products.

The fact that devices, unlike drugs, are often simply tools in the hands of physicians and surgeons, rather than intrinsic therapeutic agents, offers little protection to medical technology companies. Kevin Quinley notes that most of Medmarc's litigated claims are, in fact, some blend of medical malpractice and product liability allegations. But patients and their attorneys are, if anything, more likely to target companies than physicians when something goes wrong. "What we find more frequently is that they're loathe to sue the doctor," he says, "and more likely to sue the device company because they often have a personal relationship with the doctor that they don't with the device company." Moreover, he notes, doctors sometimes help patients to target device companies, "because it's much easier to tell a patient the device malfunctioned than to say, ‘I screwed up,' or to say, ‘You know, you just had a bad outcome and it's one of those things,'" he says.

Device companies often become an especial target for a couple of other reasons, note Medmarc officials, and the trend toward targeting device companies has only gotten worsened in recent years. For one thing, medical malpractice reforms in many states have capped the amount of money that patients can recover from physicians, which has led many patients and their attorneys to focus on device companies who don't have such caps. Indeed, for many patients who've been wronged, device companies represent what Quinley calls "a more lucrative, deep-pocket defendant." And, he adds, "We've seen case after case that started out as a blend of medical malpractice and product liability but eventually morphed into a product liability case because, as Willie Sutton said about robbing banks, ‘that's where the money is.'"

As state tort reform has spread, Quinley goes on, "enterprising personal injury attorneys are going after the device company." High-profile product recalls such as Vioxx, and the implicit public indictment of the FDA have also helped to raise the risk of product liability claims, because they've increased the concern among consumers that the government is no longer performing adequate watch-dog services in ensuring that all products are safe and that product risks are now much greater. "The fact that a product is FDA approved might at one time have been very compelling to jurors," he says. "Today, it's less compelling because of the constant drum beat around products where it appears that the FDA might not have acted as quickly as it should have."

Finally, says Quinley, the recent scandals at the highest levels of corporate America like Enron and WorldCom are also contributing factors because they've conditioned many lay people, from whom jury pools are drawn, to believe that where there is smoke [in the form of a product defect acquisition], there's fire and that these big companies need to be brought to heel."

All of these trends, taken together, says Quinley, "have materially and adversely changed the legal environment that CEOs today are operating in." Tom Konopka argues that companies "need to pay attention to product liability because, as a good corporate citizen, it's the right thing to do. But you also want to pay attention because if you don't, the consequences can be enormous." And while the instances of really enormous device-related product liability claims, such as the one Guidant faces, are "blessedly few and far between," adds Kevin Quinley, "it would be a mistake for CEOs to think that's just Guidant, it'll never happen to me. Because I'm sure that's what Guidant's management thought."