09/10/2014 04:21 pm ET Updated Nov 10, 2014

Directors Could Be Personally Liable for Off-Label Drug Marketing Violations

A recent decision of the federal Court of Appeals for the Ninth Circuit indicates that corporate directors could face personal liability for off-label drug marketing penalties (Rosenbloom v. Pyott). The broader conclusion is that directors need to object on-the-record to corporate strategies that may potentially produce legal violations. The more reports that directors receive concerning corporate marketing and sales, the easier it may be to conclude that the directors knew and condoned unlawful activity that the reports revealed or suggested.

Allergan, Inc. shareholders sued the directors demanding that the directors reimburse the corporation for its loss (derivative suit). The current Ninth Circuit decision is one of a number of lawsuits in a tangled situation. Some $600 million had been paid by Allergan in settlements and fines for marketing Botox for off-label uses between 1997 and 2010. The Food and Drug Administration (FDA) had approved Botox for certain limited uses. Allergan had promoted Botox for a variety of off-label uses including spasticity, pain, headaches, and migraines. A physician may prescribe an approved drug for uses other than those listed on an FDA-approved label (hence off-label uses) since the FDA does not regulate the practice of medicine. However, drug manufacturers are prohibited from promoting these off-label uses.

Regulatory actions against drug manufacturers for promoting a drug for off-label uses are frequently brought under federal statutes that govern the introduction of new drugs or misbranded drugs into interstate commerce (21 U.S.C. Sec. 331). If this off-label promotion caused improper claims to be submitted under Medicare or Medicaid for payment, then a federal False Claims Act (FCA) action may be brought against the drug manufacturer. The FCA allows civil penalties, criminal cases, and whistleblower rewards (31 U.S.C. 3729). These federal cases may also give rise to legal actions by private insurance companies and patients. A potential domino chain of claims may follow the initial off-label proceeding. Given the potential for expensive protracted litigation and large judgments, there is a considerable incentive for the drug manufacturer to settle out-of-court. This leads to shareholders suing the directors for the corporation's loss.

The Ninth Circuit stated that if the Board of Directors knew or should have known of legal violations and did nothing, then the Directors violated their duty of loyalty. In brief summary, the plaintiffs in this case alleged that the Board of Directors monitored off-label promotions and sales and funded organizations that promoted these off-label uses. Additionally, the allegations stated that the Board received repeated warnings from the FDA concerning misbranding, although many did not involve Botox. The Court wrote that "the combination of widespread and enduring illegality in Allergan's corporate activity strongly supports an inference of Board knowledge and intentional disregard."

While acknowledging that "we really do not know what happened at Allergan from 1997 - 2010," the Ninth Circuit indicated that factual discovery should continue. The plaintiffs' allegations, if true, could mean that the Board was not protected by the business judgment rule. The business judgment rule protects directors from personal liability for corporate loses when the directors have made an informed and lawful decision with the exercise of due diligence.

A related issue not discussed by the Ninth Circuit's decision involves the First Amendment free-speech aspects of off-label promotions. May the drug manufacturer simply gather and distribute truthful information concerning off-label prescriptions by physicians? There is legal support for the proposition that truthful commercial speech cannot be prohibited. In 2012, the federal Court of Appeals for the Second Circuit in a divided 2:1 decision reversed the criminal conviction of a pharmaceutical sales representative who had been charged with conspiracy to introduce a misbranded drug into interstate commerce (U.S. v. Caronia). The Second Circuit majority indicated that the applicable statute did not expressly criminalize off-label promotion. Commentators may be found on all sides of this complex issue.

The entire issue of off-label activity requires review by Congress and ultimately the Supreme Court. Regardless of specific regulatory changes, directors need to be alert to and prohibit potential legal violations by corporate officers and employees. Otherwise, directors face significant personal liability when the corporation is penalized. Beyond the scope of this comment, but further emphasizing the need for affirmative action, is the observation that directors and officers liability insurance policies exclude coverage for illegal activities.