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If it Takes History Seriously, the Supreme Court Will Strike Down the CFPB

WLF Legal Pulse - Thu, 10/31/2019 - 10:13am

Everyone knows where to find the most powerful person in Washington. He lives and works in an old neoclassical mansion known as the White House. Every day, swarms of tourists, cranks, and clowns gather at the fence beyond his front door, tacitly acknowledging his preeminence.

Where can one find Washington’s second most powerful person? Is he at the main executive building? Is she in an office next to the Capitol? Perhaps he’s at the Supreme Court? Plausible suggestions all. But no one in these places can get much done without the support of other—sometimes many other—equally mighty and ambitious people.

There’s a case to be made that the second most powerful person in the federal government sits a block from the West Wing, in a drab concrete structure the sightseers invariably pass without a glance. The building houses the Consumer Financial Protection Bureau, the director of which implements more than a dozen major statutes—and answers to no one. Not to voters. Not to other bureaucrats. Not even to the chief executive. Although a CFPB director can be fired for misconduct, she cannot be removed due to her policies. The protocols she imposes, the priorities she sets, and the tactics she uses are in her hands to make. Her choices are her own. The president is stuck with them.

What are we to make of this? What do the traditions of our nation and our law have to say about this regulatory lord and her fiefdom?

*

“Will no one rid me of this turbulent priest?” Four knights immortalized this howl of protest, indignantly emitted by Henry II while his blood was up, by taking it seriously. They took their leave, rode to the Norman coast, and crossed the Channel. They found the Archbishop of Canterbury, Thomas Becket, in his cathedral, and they hacked him to pieces.

Becket had once been the king’s friend and counsellor. When Henry had him appointed archbishop in 1162, however, he promptly went native. The Church of that day was a power apart—a body with its own lands and privileges, its own laws and courts—and Becket became its champion. He denied the Crown’s authority, undermined royal policy at every turn, and excommunicated clerics loyal to the king. Henry could do little about any of it except shout and sputter. When at last, in 1170, the knights mistook one of Henry’s many impotent tirades as a command and removed Becket by cutting him down, the scandal shook the kingdom to the core. Becket was hailed a martyr and a saint. Henry spent years atoning for the sacrilege he had set on foot.

Just as the King of England could not always remove a man, neither could he always retain one. Edward II’s favorite, Piers Gaveston, gave the high and mighty of the realm nicknames such as “burst belly” and “the cuckold’s bird.” The barons took him to the woods and executed him in 1312.

Parliament impeached Charles I’s first minister, the Earl of Strafford, in 1640. When Strafford proceeded to defend himself a little too ably at his trial, the Puritans dropped the impeachment, attainted him, forced the king to sign a death warrant, and had him beheaded before 100,000 spectators. Charles never forgave himself. When he in his turn stepped onto a scaffold in 1649, he declared that God was punishing him for the “unjust sentence” that he had “suffered to take effect.”

But these dramatic episodes are aberrations. They are exceptional. For centuries England’s high officials—its chancellors, its judges, and, once Henry VIII had his way, even its bishops—served at the king’s pleasure. A minister’s powers were the king’s powers. They were, as Maitland explained, “royal prerogatives” that “the king might lawfully exercise himself were he capable of discharging personally the vast business of government.” An untrammeled power of appointment and removal was itself such a prerogative.

Some of these prerogatives were stripped away just as the American colonies were becoming a going concern. After the Revolution of 1688, the Crown lost finally and for all time the power to suspend a law. No sovereign has vetoed a bill from the throne since Queen Anne did so in 1708. When Anne died in 1714, the monarchy’s power to remove a judge “during good behavior” died with her. Royal authority withered further under George I and George II, Hanoverians who cared little about England or its affairs. Although George III took some interest in governing, by his day the king no longer attended cabinet meetings.

Yet the king remained formidable, at least in theory. He retained his say in foreign affairs. And his power to appoint and remove officers was untouched. The king, Blackstone wrote in 1765, was still “the fountain of honour, of office, and of privilege.” It was for him alone, therefore, to decide “in what capacities, with what privileges, and under what distinctions his people [we]re best qualified to serve and to act under him.” He could even create new offices, albeit only with what money parliament might supply.

The Declaration of Independence accuses George III of committing “every act which may define a Tyrant.” At times the document seems to rail against a despot whose writ ran no farther than Thomas Jefferson’s imagination. Accurate or no, however, Jefferson’s view of the king played on the minds of the men who assembled for the Constitutional Convention in 1787. The charter they crafted prises many royal prerogatives from the grasp of our chief executive. In line with the British practice by that time, he may not remove judges. But he also may not declare war or create offices; those powers belong to Congress. And he may not make treaties or appoint senior officers by himself; he needs the Senate’s approval.

But the British monarchy was not the Framers’ only point of reference. The Articles of Confederation had created a meagre executive power and assigned it to Congress. Forget George III; the absence of a separate executive was, Jefferson exclaimed, “the source of more evil than we have ever experienced from any other cause.” “Nothing is so embarrassing nor so mischievous in a great assembly as the details of execution,” he cried. Hamilton agreed. The lack of a “proper executive” led, he wrote, to a “want of method and energy.” “Responsibility” was too “diffused.” The Framers wanted to fix this problem.

So it is important to note how the Framers went about trimming the executive bough. First, they invested a chief executive with his panoply: they roundly vested “the executive Power” in a single “President.” Then, when they wanted to revoke some prerogative or other, they did so openly and in plain words. The president may not “provide and maintain a Navy”; he may not grant anyone a “Title of Nobility”; and so on. The Framers wanted to reduce the president’s authority to a point, and no further. “All the powers properly belonging to the executive department of the government are given,” as Fisher Ames put it to the First Congress, “and such only taken away as are expressly excepted.”

The Constitution requires the president to rely on Congress to erect and fund offices, and on the Senate to approve principal officers. Meanwhile, however, it commands the president, and the president alone, to “take Care that the Laws be faithfully executed.” And although it says that judges “shall hold their offices during good behavior,” it extends no like protection to executive officials. A balance has plainly been struck. The president answers to Congress, but the government answers to the president. An officer must, in Washington’s words, “assist the supreme Magistrate in discharging the duties of his trust.”

When Jefferson became president, he circulated among his heads of departments a letter setting Washington’s administration as his standard. Washington had required his officers to keep him “always in accurate possession of all facts and proceedings.” He had “formed a central point for the different [executive] branches, preserved a unity of object and action among them,” and “met himself the due responsibility for whatever was done.” Jefferson contrasted this approach with “Mr. Adams’s administration,” in which the president, during “his long and habitual absences,” let the government be “parceled out” among “four independent heads, drawing sometimes in opposite directions.” “That the former is preferable to the latter course,” declared Jefferson, “cannot be doubted.” Washington—and Jefferson—clearly believed that the president may guide, command, and, when necessary, remove government officials. Indeed, although no law granted the president a removal power, Washington, Adams, and Jefferson each dismissed many officers. Jefferson fired 124 of them.

The early presidents’ conduct was not challenged. To the contrary, the First Congress endorsed the notion that the president enjoys an unfettered removal power. When Madison moved to establish a Department of Foreign Affairs, “the head of which” was to be an officer “removable by the President,” a debate erupted about the nature of the removal power. A few representatives argued that removal required an impeachment trial in the Senate. Others argued that the Senate’s approval, at least, was necessary. Still others believed that, although the president should be allowed to remove people at will, his power to do so came not from the Constitution but from Congress. Madison, for his part, contended that “the lowest officers, the middle grade, and the highest” all “depend, as they ought, on the president.” And because he in turn depends on the “community,” the “chain of dependence” terminates in “the people.” An unqualified removal power ensures, in other words, that voters may hold the president to account for his officers’ actions.

In what is now known as the Decision of 1789, Congress passed several bills that contained no removal clause, but that discussed who would manage the papers of a removed officer. The traditional view holds that Congress thereby affirmed that the Constitution empowers the president to remove officers at will. Legislators on both sides of the debate placed that gloss on the affair in their private letters. The votes turned, one senator wrote, on “whether the President had a constitutional right to remove; not on the expediency of it.” Madison told Jefferson that his colleagues had taken the position “most consonant” to “the text of the Constitution” and “the requisite responsibility and harmony in the Executive Department.”

It was not until the twentieth century that the Supreme Court turned its gaze squarely on removal. When at last it did so, it threw its weight behind what was by then the custom and understanding of more than 130 years. Although the president holds all “executive power,” the court said in Myers v. United States (1926), he “alone and unaided could not execute the laws.” He must “execute them by the assistance of subordinates,” and, to do so effectively, he must be able to remove “those for whom he cannot continue to be responsible.”

*

This has been a story about the American government as it was designed and built. The government described in grade-school textbooks. The government in which one branch makes the law, another administers it, and a third applies it to cases and controversies. The plan never worked perfectly. That was never a possibility. The lines between the powers are at times too obscure, the humans tasked with finding them often too fallible and corrupt. But the model endured. Its imprint was real.

That model is gone. Not long after Myers, the Supreme Court declared, in Humphrey’s Executor v. United States (1935), that some officers can be subject only to for-cause removal. The court permitted the creation of a new, fourth branch of government. The fourth branch exercises not only executive powers, but also “quasi-judicial” and “quasi-legislative” ones. This is the branch of the commissions and boards—the branch of the Federal Trade Commission, the Securities and Exchange Commission, and the National Labor Relations Board, to name but a few. These independent agencies have their own rules, their own judges, and their own domains. They are, like Becket’s Church, a power apart.

The court has approved, in particular, of agencies governed by panels. Spreading control among a number of board members or commissioners, we are told, makes the novel bodies’ autonomy and clout more tolerable. We are to rest easy because, in a committee of five, only a confederacy of at least three may ignore, foil, and defy the president and the public.

In recent years, however, in what seems almost like a deliberate effort to wreak constitutional havoc, Congress has taken to creating departments governed by individual directors. The most powerful of these is the head of the Consumer Financial Protection Bureau. She is tasked with administering a raft of consumer-protection laws. She decides what rules her agency will issue, against whom they will be enforced, and what the penalties for breaking them will be. She draws her budget—more than $600 million—from another independent body, which shields her appropriations from the threat of presidential veto. She serves a five-year term, which means she often will proceed under a president who did not even choose her. And still, she can be removed only for “inefficiency, neglect of duty, or malfeasance in office.”

Earlier this month the Supreme Court agreed to decide, in Seila Law LLC v. Consumer Financial Protection Bureau, whether the CFPB’s structure is constitutional. The case will be contentious. Many issues will be hotly debated. The question of when and how the court may overturn its own rulings will likely attract much attention. The supposed virtues of politically insulated experts, and the palpable vices of the current chief executive, will surely worm their way into the discussion. There can be no doubt, however, about what the constitutional text and history teach us. The president, they say, can remove officers at will.

Also published by Forbes.com on WLF’s contributor page.

The post If it Takes History Seriously, the Supreme Court Will Strike Down the CFPB appeared first on Washington Legal Foundation.

Categories: Latest News

Delaware Chancery Court Clarifies Review Standard for Challenges to Conflicted-Controller Transactions

WLF Legal Pulse - Wed, 10/30/2019 - 3:11pm

Stephen M. Bainbridge is William D. Warren Distinguished Professor of Law, UCLA School of Law and serves as the WLF Legal Pulse’s Featured Expert Contributor, Corporate Governance/Securities Law.

In an important recent decision, Tornetta v. Musk,1 the Delaware Chancery Court provided new guidance on how to structure conflict-of-interest transactions to which a corporation’s controlling shareholder is a party. The case involves a shareholder lawsuit challenging an incentive compensation plan granted to Tesla, Inc.’s CEO, Elon Musk. The plan laid out twelve tranches of stock options to be awarded over a ten-year period. In order for Musk to receive each tranche, Tesla had to achieve specified milestones in market capitalization and operating results. According to the Plaintiff, the fair present value of the award was either $2.6 or $3.7 billion, which allegedly dwarfed CEO compensation at Tesla’s peer companies by orders of magnitude.

Tesla’s board of directors and its disinterested shareholders approved the compensation plan. Seventy-three percent of the disinterested shares were represented in person or by proxy at the stockholder meeting during which the plan was approved voted. They represented 47% of the total number of outstanding disinterested shares.

In his opinion, Vice Chancellor Joseph Slights acknowledged that Delaware courts normally approach boards’ executive compensation decisions with a high degree of deference. Critically, however, Musk is not just Tesla’s CEO but also its controlling shareholder.2 A controlling shareholder has been analogized to the proverbial 800-pound gorilla,3 which gives rise to “an obvious fear that even putatively independent directors may owe or feel a more-than-wholesome allegiance to the interests of the controller, rather than to the corporation and its public stockholders.”4

In response to that risk, Delaware law imposes a more intrusive standard of review on conflicted-controller transactions than on ordinary business decisions. In the latter, the standard of review is the business judgment rule; in the former, however, the burden of proof shifts to the conflicted controller to show that the transaction was fair to the corporation and its minority shareholders. In Kahn v. Lynch Communications Systems, Inc.,5 for example, the Delaware Supreme Court reaffirmed that the “exclusive standard of judicial review in examining the propriety of an interested cash-out merger transaction by a controlling or dominating shareholder is entire fairness.” Having said that, however, the Kahn court further held that “approval of the transaction by an independent committee of directors or an informed majority of minority shareholders shifts the burden of proof on the issue of fairness from the controlling or dominating shareholder to the challenging shareholder-plaintiff.”

The Kahn court’s description of fairness as the “exclusive” standard of review seemed to preclude invoking the business judgment rule in conflicted-controller transactions. In its 2014 decision in Kahn v. M & F Worldwide Corp. (“MFW”),6 however, the Delaware Supreme Court held that “when a controlling stockholder merger has, from the time of the controller’s first overture, been subject to (i) negotiation and approval by a special committee of independent directors fully empowered to say no, and (ii) approval by an uncoerced, fully informed vote of a majority of the minority investors” the standard of review becomes the business judgment rule.7

In Tornetta, the Tesla defendants argued that MFW was irrelevant to the facts of this case:

They rely heavily on a ‘statutory rubric’ argument, claiming MFW’s dual protections, devised in the context of a squeeze-out merger, mimic the approvals required by 8 Del C. § 251 but have no practical application to transactions where our law does not mandate approval at both the board and stockholder levels. … I do agree with Defendants that nothing in MFW or its progeny would suggest the Supreme Court intended to extend the holding to other transactions involving controlling stockholders.8

Vice Chancellor Slights, however, observed that the risk of coercion is just as present when a conflicted controller enters into a compensation arrangement as when it proposes a freezeout merger:

Indeed, in the CEO compensation context, the minority knows full well the CEO is staying with the company whether vel non his compensation plan is approved. As our Supreme Court observed in Tremont II:

‘[I]n a transaction such as the one considered … the controlling shareholder will continue to dominate the company regardless of the outcome of the transaction. The risk is thus created that those who pass upon the propriety of the transaction might perceive that disapproval may result in retaliation by the controlling shareholder.’

These words apply with equal force to the compensation setting.9

Accordingly, in order for a conflicted-controller transaction to be reviewed under the business judgment rule rather than entire fairness, the transaction must receive both of MFW’s dual protections.

On the facts before it, the Vice Chancellor—for purposes of defendants’ motion to dismiss—concluded that:

I have determined on the pleadings that Defendants have satisfied the ‘majority of the minority’ condition but have not satisfied the ‘fully functioning, independent special committee’ condition. The burden of persuasion shifts to Plaintiff, therefore, to demonstrate the Award is not entirely fair. At this stage, the bar set for Plaintiff is to demonstrate from well-pled facts that it is reasonably conceivable the Award is unfair to Tesla. [H]e has cleared the bar, albeit just barely.10

The Vice Chancellor’s conclusion that the “majority of the minority” vote requirement was satisfied required him to distinguish then Chancellor (and now Chief Justice) Leo Strine’s decision in In re PNB Holding Co. Shareholders Litigation11 In that case, plaintiff shareholders had challenged a freezeout merger with a controlling shareholder. In that context, Strine held that approval of a conflicted interest transaction by a “majority of the minority” means approval by a majority of the outstanding disinterested shares not just a majority of those present and voting:

The cleansing effect of ratification depends on the intuition that when most of the affected minority affirmatively approves the transaction, their self-interested decision to approve is sufficient proof of fairness to obviate a judicial examination of that question. I do not believe that the same confidence flows when the transaction simply garners more votes in favor than votes against, or abstentions from, the merger from the minority who actually vote. That position requires an untenable assumption that those who did not return a proxy were members of a ‘silent affirmative majority of the minority.’ That is especially so in the merger context when a refusal to return a proxy (if informedly made) is more likely a passive dissent. Why? Because under 8 Del. C. § 251, a vote of a ‘majority of the outstanding stock of the corporation entitled to vote’ is required for merger approval, and a failure to cast a ballot is a de facto no vote. Therefore, giving ratification effect only if a majority of the disinterested shares outstanding were cast in favor of the transaction also coheres with § 251. [FN74]

FN74. I need not, and do not, hold that a qualifying ratification vote always needs to track the percentage approval required for the underlying transaction. One can posit a situation when a particular type of transaction requires, by charter, a 66.67% supermajority vote, and a conflicted stockholder holds 40% of the total vote, with the rest of the votes held by disinterested stockholders. To promote fair treatment, the board makes approval subject to a majority of the minority vote condition. Nothing in this opinion suggests that ratification effect would not be given if an informed majority of the minority of the remaining 60% of the electorate voted in favor of the transaction.12

As Vice Chancellor Slights observed, however, DGCL § 251 required that the freezeout merger at issue in PNB—like all mergers—be approved by a majority of the outstanding shares. In contrast, under DGCL § 216(2) ordinary matters only require the affirmative vote of a majority of the shareholders present at the meeting. Accordingly, the court limited PNB’s definition of the majority of the minority to cases in which the statute requires approval by a majority of the outstanding shares.

This aspect of the Vice Chancellor’s decision is less well supported than the remainder of his analysis. First, neither § 216 nor § 251 expressly applies to conflicted-controller transactions. Those statutes speak to the basic vote required to authorize corporate action, not to the vote required to insulate a conflict-of-interest transaction from judicial review for fairness. Second, a close reading of Strine’s decision shows that he saw § 251 as strengthening the underlying argument for requiring approval by a majority of the disinterested shares rather than just a majority of the disinterested shares present at the meeting.

Overall, however, Vice Chancellor Slight’s opinion is a well-reasoned and persuasive extension of the trend in Delaware law towards judicial deference to corporate actions that benefited from procedural safeguards designed to ensure that the pertinent decision makers are free from coercion by a conflicted controller. It strengthens the argument that MFW is not limited to freezeout mergers, but rather now provides a roadmap by which all conflicted-controller transactions can receive the protections of the business judgment rule.

Notes:

  1. 2019 WL 4566943 (Del. Ch. Sept. 20, 2019).
  2. In an earlier decision involving Tesla, Vice Chancellor Slights had determined that Musk was Tesla’s controlling shareholder despite owning only 22% of Tesla’s voting stock. See In re Tesla Motors, Inc. Stockholder Litig., 2018 WL 1560293 (Del. Ch. Mar. 28, 2018), appeal refused sub nom. Musk v. Arkansas Teacher Ret. System, 184 A.3d 1292 (Del. 2018).
  3. In re Pure Resources, Inc. Shareholders Litig., 808 A.2d 421, 436 (Del. Ch. 2002).
  4. Leo E. Strine, Jr., The Delaware Way: How We Do Corporate Law and Some of the New Challenges We (and Europe) Face, 30 Del. J. Corp. L. 673, 678 (2005).
  5. 638 A.2d 1110, 1117 (Del. 1994).
  6. 88 A.3d 635 (Del. 2014).
  7. As the Supreme Court summarized its holding:

[T]he business judgment standard of review will be applied if and only if: (i) the controller conditions the procession of the transaction on the approval of both a Special Committee and a majority of the minority stockholders; (ii) the Special Committee is independent; (iii) the Special Committee is empowered to freely select its own advisors and to say no definitively; (iv) the Special Committee meets its duty of care in negotiating a fair price; (v) the vote of the minority is informed; and (vi) there is no coercion of the minority.

Id. at 645.

  1. Tornetta, 2019 WL 4566943 at *13. The defendants’ argument is supported by some commentators, as Ann Lipton has pointed out:

Itai Fiegenbaum argued that entire fairness should be the rule – even with MFW procedures in place – for less than transformative transactions.  See Fiegenbaum, The Controlling Shareholder Enforcement Gap, Am. Bus. L.J. (forthcoming).  Fiegenbaum claims that in a squeeze out kind of transaction, all eyes are on the controller, there’s a real likelihood of litigation, and that scrutiny coupled with MFW procedures may protect minority stockholders.  But in more ordinary transactions, that frequently will need to be brought derivatively and thus satisfy the demand requirement, controllers know that the chance of litigation is slight.

Vice Chancellor Slights did not address that concern.

  1. Id. at *11-12.
  2. Id. at *14.
  3. 2006 WL 2403999 (Del. Ch. 2006).
  4. Id. at *15.

The post Delaware Chancery Court Clarifies Review Standard for Challenges to Conflicted-Controller Transactions appeared first on Washington Legal Foundation.

Categories: Latest News

Force of Nature: The Power of Small Businesses in America’s Recreational Infrastructure

House Small Business Committee News - Wed, 10/30/2019 - 11:30am

The Committee on Small Business will meet for a hearing titled, “Force of Nature: The Power of Small Businesses in America’s Recreational Infrastructure.” The hearing is scheduled to begin at 11:30 A.M. on Wednesday, October 30, 2019 in Room 2360 of the Rayburn House Office Building.

The economic prosperity of the nation is impacted by the growing recreational and tourism sector, which is served by many small businesses. As Congress contemplates an infrastructure package, it is important to consider the outdoor recreational infrastructure, which produced $427.2 billion in gross economic output and supported over 5.1 million jobs nationwide in 2017. The hearing will examine the economic impact of the outdoor recreational infrastructure, how small businesses contribute to this industry, and how the federal government can ensure the industry continues to positively impact the economy through a comprehensive infrastructure package.

To view a livestream of the hearing, please click here. 


Hearing Notice 

Hearing Memo 

Witness List 

Witnesses 

Mr. Ray Rasker, Ph.D.
Executive Director
Headwaters Economics
Bozeman, MT
Testimony 

Mr. Frank-Paul Anthony King
President and CEO
Temple Fork Outfitters (“TFO”)
Dallas, TX
Testimony 

Ms. Lindsey Davis
Co-Founder and CEO
WYLDER
Salt Lake City, UT
Testimony 

Mr. John Wooden
Owner
River Valley Power & Sport
Rochester, MN
*Testifying on behalf of the National Marine Manufacturers Association
Testimony 

 

*Witness testimony will be posted within 24 hours after the hearing’s occurrence

 
 
 

Creating the Clean Energy Workforce

House Small Business Committee News - Tue, 10/29/2019 - 10:00am

The Committee on Small Business Subcommittee on Innovation and Workforce Development will hold a hearing titled, “Creating the Clean Energy Workforce.” The hearing is scheduled to begin at 10:00 A.M. on Tuesday, October 29, 2019 in Room 2360 of the Rayburn House Office Building.

The clean energy workforce has skyrocketed to over 4 million jobs due to dropping technology costs, more demand for clean and efficient energy technology, and supportive policies and investment at the local and state levels. With solar and wind increasing by 24.5% and 16 percent respectively from 2016 to 2017, solar and wind jobs are now outnumbering coal and gas jobs in 30 states and the District of Columbia. Further, energy efficiency jobs make up most of the clean energy workforce, supporting at least 2.2 million jobs across the country. As the country continues to develop and utilize this workforce, it is critical the voices of small businesses are heard as they employ many of these workers and need a steady pipeline of skilled workers. The hearing will delve into the various facets of the renewable energy workforce and the needs of small employers.

To view a livestream of the hearing, please click here. 


Hearing Notice 

Hearing Memo 

Witness List 

Witnesses 

Mr. Mark Farrar Jackson
Vice President
Community Housing Partners dba CHP Energy Solutions
Christiansburg, VA
Testimony 

Mr. Jason L. Wardrip
Business Manager
Colorado Building and Construction Trades Council
Denver, CO
Testimony 

Mr. Ed Gilliland, CEcD, AICP, PMP
Senior Director
The Solar Foundation
Washington, DC
Testimony 

 

*Witness testimony will be posted within 24 hours after the hearing’s occurrence

 
 

Idaho Court Refuses to Peel Away Liability Protections from Brand-Name Drug Makers

WLF Legal Pulse - Tue, 10/29/2019 - 8:10am

Recently, an Idaho state court declined to adopt the novel, plaintiff-friendly theory of “innovator liability.” This theory, where adopted, imposes tort liability on brand-name drug manufacturers for injuries caused by generic versions of their drug. In Stirling v. Novartis Pharmaceuticals Corp., et al., No. CV01-18-4880 (Idaho Dist. Ct. Sept. 25, 2019), the court ruled that the plaintiffs could not sue Novartis for injuries caused by a generic drug. Faced with an issue of first impression in Idaho, Judge Greenwood declined to follow outlier decisions from state courts in California and Massachusetts. If upheld on appeal, Stirling will remove Idaho from plaintiffs’ lawyers’ litigation-tourism itinerary, at least for the purpose of some pharmaceutical litigation.

The Food, Drug, and Cosmetic Act, 21 U.S.C. § 301 et seq., prohibits the marketing of a new drug unless the manufacturer has submitted a New Drug Application (NDA) and the Food and Drug Administration (FDA) has approved the drug as safe and effective for its intended use. Under the Hatch-Waxman Amendments, enacted in 1984, “generic drugs” “can gain FDA approval simply by showing equivalence to a drug that has already been approved by the FDA.” PLIVA, Inc. v. Mensing, 564 U.S. 604, 612-13 (2011) (citing 21 U.S.C. § 255(j)(2)(A)). And under the current regulatory scheme, only brand-name manufacturers can make changes to a drug’s approved labeling (FDA can also require labeling changes to update warnings, describe adverse reactions, etc.). Generic manufacturers are only responsible for ensuring its label is identical to the brand-name drug’s label.

In Stirling, plaintiff Michelle Stirling alleged that a drug she took to suppress premature labor in women caused her and her child harm. Stirling and her husband brought six causes of action against Novartis including negligent failure to warn and negligence per se. Novartis moved to dismiss for lack of personal jurisdiction and for failure to state a claim.

Novartis owned the NDA for the brand-name drug Brethine. As the owner of this NDA, Novartis developed, manufactured, packaged, labeled, marketed, and distributed Brethine until around December 2001 when it sold the NDA rights. The plaintiffs alleged that the generic equivalent to Brethine, terbutaline sulfate, caused the injury, though the complaint does not mention who manufactured that specific product.

The court first addressed the concept of innovator liability. The plaintiffs’ memorandum defined innovator liability as “a theory under which a brand-name drug manufacturer may be held liable for injuries caused by an individual’s ingestion of the generic version of its drug” because the generic manufacturer has no control over the contents of the label. Stirling, No. CV01-18-4880, slip op. at 6. The court analyzed each count in the complaint to determine whether Idaho would recognize innovator liability. But even before beginning its legal analysis, the court made clear that one “crucial fact” prevailed throughout the complaint: “Novartis did not manufacture the drug that caused the injuries.” Id. at 7.

In dismissing the negligent failure-to-warn claim, the court discussed general negligence principles as well as the theory of innovator liability. The court noted that Novartis essentially challenged whether a manufacturer has a legal duty to warn the consumer of a similar product on the market. The court found that Idaho law generally holds that a company is not liable for injuries caused by other companies. Id.at 8 (citing Garrett v. Nobles, 102 Idaho 369, 372 (1981)).

It then turned to the Iowa Supreme Court for guidance in the generic-drug context. In Huck v. Wyeth, Inc., 850 N.W.2d 353, 380-81 (Iowa 2014), the Iowa court bluntly called out this theory of liability for what it is—“deep-pocket jurisprudence [which] is law without principle.” Plaintiffs in such cases conflate the “foreseeability” of an injury with the existence of a legal duty in the first place. Id. But in order for foreseeability to play a role, a legal duty of care must first exist. Anything can conceivably be foreseeable, but without a legal duty, there is no tort liability. The Stirling court found Iowa’s reasoning persuasive and held that it would not expand tort liability to cover brand manufacturers for injuries caused by generic equivalents.

Similarly, the court dismissed the negligence per se claim by following the “traditional notion that the manufacturer of a product cannot be held liable where its product did not cause the alleged harm.” Stirling, No. CV01-18-4880, slip op. at 9. The other causes of action failed for the same reason.

Stirling echoes recent decisions in West Virginia and the U.S. Court of Appeals for the Seventh Circuit that rejected innovator liability. In McNair v. Johnson & Johnson, 241 W. Va. 26 (2018), the West Virginia Supreme Court held that a plaintiff may not recover damages in a strict-liability action unless it can show “that the defendant either manufactured or sold the product that allegedly injured the plaintiff.” Id. at 34. In reaching this holding, the court stated that the defendant is only liable if it breaks its duty of care to the plaintiff, and foreseeability of risk, while important, does not go so far as to create such a duty. Id. at 35-37. WLF filed an amicus curiae brief in McNair, criticizing plaintiffs’ lawyers’ attempts to conflate foreseeability with a duty of care and arguing that adopting innovator liability would mark a sharp and unwarranted break from longstanding principles of tort law.

In another case involving the theory of innovator liability, the Seventh Circuit held that federal law preempted state-law claims demanding that GSK add a different warning to its label. Dolin v. GlaxoSmithKline, LLC, 901 F.3d 803 (7th Cir. 2018). WLF also filed an amicus curiae brief in Dolin.

While those courts have properly limited the scope of tort liability to a company that actually owes a legal duty, other courts have usurped the federal government’s authority to regulate drug labeling. The California Supreme Court decided that brand-name drug manufacturers have a duty “to warn of the risks about which it knew or reasonably should have known, regardless of whether the consumer is prescribed the brand-name drug or its generic ‘bioequivalent.’” T.H. v. Novartis Pharm. Corp., 4 Cal. 5th 145, 165 (2017). In reaching its decision, the court focused primarily on the foreseeability of harm, and held that duty stems from foreseeability. Id. at 166-68. Then, looking at public-policy concerns, it held that the brand-name manufacturer was in the best position to bear the costs. Id. at 168-74. This decision is a clear example of the type of “deep-pocket jurisprudence” that Stirling, McNair, and Dolin avoided.

Massachusetts also adopted a form of innovator liability, but to a lesser extent than California. See Rafferty v. Merck & Co., Inc., 479 Mass. 141 (2018). There, the court held that manufacturers could be found “reckless” but not “negligent” in failing to update labels resulting in “an unreasonable risk of death or grave bodily injury.” Id. at 157.  

In order for a brand-name manufacturer to be liable for a plaintiff’s harms, the manufacturer must owe a duty of care to that plaintiff. Foreseeability of harm determines the scope of a duty; it does not determine whether one actually exists. The majority of courts around the country recognize this, and the Idaho trial court should be lauded for doing so in Stirling. As the plaintiffs’ bar works its way across America testing out this legal theory, courts will be asked to embrace the radical notion that manufacturers should be liable for products they did not make.

Decisions such as Stirling remind those courts to stay in their lane, and leave the expansion of drug-labeling requirements to federal legislators and, where appropriate, federal regulators. They should also bear in mind that any departure from longstanding principles of tort law will be the proverbial inch that plaintiffs’ lawyers will take and use to expand the law a mile or more.

Also published by Forbes.com on WLF’s contributor page.

The post Idaho Court Refuses to Peel Away Liability Protections from Brand-Name Drug Makers appeared first on Washington Legal Foundation.

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