Looks Can Be Deceiving (and Costly): The Legal Implications of Counterfeit Products to a Pharmaceutical Manufacturer

The World Health Organization has estimated that drug counterfeiting affects 5-8% of all drugs, representing approximately $10-$15 billion to the U.S. pharmaceutical market alone. The Food and Drug Administration has estimated that approximately 10% of the drugs in worldwide distribution are counterfeit, with most being sold in developing countries. Not surprisingly, the most commonly counterfeited drugs are those with the largest sales, as well as drugs with high profit margins and drugs that are easier to counterfeit.

The FDA has stated that, in recent years, counterfeiting has moved into the area of finished pharmaceuticals, more so than to the counterfeiting of bulk drug ingredients. Moreover, with the increase in sales of drugs over the Internet, the agency is becoming even more concerned about the prevalence of drug counterfeiting, and the increasing ease by which counterfeited drugs may be distributed into the marketplace.

The costs of counterfeit products to pharmaceutical companies can be enormous and the legal implications daunting. Negligence, product liability and breach of warranty are only some legal theories that a plaintiff's lawyer may use to challenge companies when counterfeited versions of their products surface. In addition, manufacturers doing business outside of the United States (particularly in developing countries) must be aware that sales of counterfeit drugs in those countries could lead to legal action being taken against them, where the legal system may be significantly different from that of the United States. Of course, sales of counterfeit drugs outside the United States can also expose a drug company to liability at home.

Risks That Counterfeiting Presents

Counterfeit products present a number of risks to drug manufacturers and distributors. First, there is the potential for loss of good will and negative economic consequences. Once a counterfeit drug enters the market and consumers unknowingly purchase the counterfeit product, the customers' perception of the product will likely be harmed (eg, the product is not as safe or effective as advertised).

If a counterfeit product damages the legitimate drug's reputation, demand for the legitimate drug could decrease. Doctors who formerly prescribed the drug will more than likely receive negative feedback from patients regarding the drug's quality (or lack thereof) and choose not to prescribe the drug as frequently, if at all. Distributors may also be influenced by the drug's negative reputation and may not be willing to purchase the drug for fear that its sales will decrease in the near future. Counterfeit products could also reduce the legitimate manufacturers' sales through direct competition, by forcing the legitimate manufacturer to lower the price for its drugs.

In addition to lost sales and good will, other costs of counterfeiting include potential legal costs (eg, responding to liability claims or regulatory challenges), the costs of resolving the counterfeit issues, and the cost of time spent responding to governmental and consumer inquiries.

Where Problems Can Arise

The following are some, but not all, areas where potential problems can arise ' problems that may make a drug more vulnerable to counterfeiting:

• Lack of internal quality controls within the drug company or in the supply chain;
• Lack of internal security measures;
• Use of third parties in the manufacturing and distribution process with less than vigilant oversight; and
• Failure to monitor the product's distribution channels adequately and possible diversion or counterfeiting trends.

Today, there are also an increasing number of players in the distribution and supply chain. In many states, becoming an authorized distributor of pharmaceuticals is as simple as completing a form and paying a small fee at the county clerk's office. Some drugs may change hands a number of times among small secondary distributors before reaching the hands of the dispensing pharmacist. In short, there may be too many chefs in the proverbial kitchen, which can lead to confusion and disarray, thereby resulting in loss of accountability, responsibility, and tracking.

Legal Theories of Liability

There are a number of common causes of action that could result from counterfeiting. For example, a negligence action might arise from drug counterfeiting. Here, an injured party could assert that a drug company breached its duty to ensure that counterfeit products did not reach the end consumer. Another potential theory of liability is breach of warranty, where a plaintiff might seek to establish that a purchased product was not fit for its intended purpose, based on its labeling. Under a strict liability legal theory, the manufacturer's care is not relevant; a plaintiff must only prove that the product contained a manufacturer defect when it was sold. The violation of the Federal Food, Drug, and Cosmetic Act (the “FDC Act”) or FDA regulation may be used to demonstrate that a company was negligent, although an injured party is not entitled to bring a private cause of action for recovery under the FDC Act.

A potential challenge for a company defending itself is to show that it did not know, or had no reason to know, that counterfeit drug products were being sold or, if it did know, it was doing everything it could to stop the sale of counterfeit products. Furthermore, if a counterfeit product's distribution were widespread, a company could face suits in several states, each with its own set of rules and laws. The laws of some states may be more favorable to consumers and the laws of others more favorable to a manufacturer. In any case, the more jurisdictions, the more difficult it conceivably will be to coordinate the cases and keep costs manageable. As costs increase, the company is faced with the prospect of diverting money from other projects in order to defend itself.

Minimizing Risk

Third-Party Legal Action. A drug company may minimize its liability exposure if manufacturer X has reason to believe that distributor Y is participating in the sale of counterfeit drugs and the FDA (or other federal/state agency) has not taken action. The manufacturer may seek to stop the offending action by asking a court to issue an order restraining the distributor from taking the violative action (an analogy would be the enforcement of a trademark or patent). However, a petitioner may have difficulty providing sufficient evidence to convince a judge to issue the order, such as making a showing of the likelihood of success on the merits of the suit and that irreparable harm will occur if the court does not stop the action. If the counterfeiting is being assisted by any person under contract with manufacturer X, the company might be able to void the contract or if not, to seek relief from a court under its contract (depending on how the contract is drafted, an action based on the contract may form an easier basis to convince a court to intervene).

Relationship with the FDA. Another important step a company can take to minimize risk is to establish and maintain a good working relationship with the FDA. The FDA has wide and powerful abilities to demand documents, perform inspections, seize products, and conduct interviews if counterfeiting is detected.

A company must also demonstrate the ability to control and identify its products through the marketplace. A firm should consider implementing the FDA's Radiofrequency Identifica-tion (“RFID”) technologies either to authenticate or track and trace approved drugs. RFID is a state-of-the-art technology that uses electronic tags on product packaging to allow manufacturers and distributors to track drug products more precisely as they proceed through the supply chain. The technology is similar to that used for tollbooth and fuel purchasing passes. The FDA considers electronic pedigrees to be a type of “electronic safety net” that utilizes technology, which allows illicit drug transactions to be rapidly identified. The technology has the potential to improve the FDA's ability to conduct investigations of suspected counterfeiting or diversion of prescription drugs.

In November 2004, the FDA continued its efforts to combat drug counterfeiting by issuing a Compliance Policy Guide (“CPG”) concerning “Radiofrequency Identification Feasi-bility Studies and Pilot Programs for Drugs.” The CPG makes clear that the FDA considers the use of RFID technology critical to ensuring the long-term safety and integrity of the country's drug supply.

The CPG provides that the FDA will not pursue enforcement against a participant in an RFID study, so long as the study meets certain criteria. The drugs involved in an RFID study must be limited to prescription or over-the-counter finished products, and the RFID technology is only to be used for inventory control, tracking and tracing, verification of shipment and receipt, and authentication of finished products. The technology must not be used to replace current labeling control systems or otherwise substitute for compliance with existing FDA requirements (eg, fulfillment of Current Good Manufacturing Practices). RFID tags used in studies subject to the CPG are to contain a serial number that uniquely identifies the product, and may not contain or transmit information for health care practitioners or consumers. The tags may contain information such as handling or storage conditions, labeling information or expiration date, and lot number. They may not, however, contain or transmit advertisements or information about product indications or off-label usage. Studies involving RFID must also meet other requirements, such as tag placement requirements. The aforementioned are only some of the points described in the CPG. Authentication technologies assure that a drug is indeed the approved new drug and not a counterfeit.

While the FDA's recommendations are not legally binding, they may become industry standard and, at a minimum, demonstrate a good faith effort to minimize the risk of counterfeiting.

Internal Monitoring. In addition to the aforementioned recommendations, a company should review current standard operating procedures (“SOPs”) to ensure that the SOPs are addressing possible counterfeiting. There must also be written procedures for the possible triggering events for an investigation of counterfeiting. Once a triggering event occurs, the company must investigate and document the event to a conclusion. When preparing such procedures, a company may choose to review the National Association of Boards of Pharmacy Model Rules or the Drug Enforcement Administration requirements (eg, security, storage).

A manufacturer must work to ensure that contracts executed in the distribution of the drug require all downstream handlers of the drug to account for the product. Moreover, all contracts must contain indemnification language, where downstream distributors will indemnify and hold harmless the drug company for counterfeiting that occurs after the product has left the company's hands.

A drug manufacturer should keep detailed documentation on the tracing of the products through the marketplace and coordinate the control of expiration dating system ' and the destruction of drugs past these dates ' with the aforementioned anti-counterfeiting SOPs. Finally, a company must perform routine (and sometimes unannounced) audits of some distributors. This right should be explicit in contracts with distributors.

Conclusion

Drug companies must not take counterfeiting lightly. Proactive planning, implementation and training, establishing policies and guidelines (and internal monitoring to ensure there is compliance with these policies), careful construction of contracts, partnering with government agencies and the right companies, and expenditure of appropriate resources are all important steps to minimize the risk of counterfeiting. No one said it would be easy and inexpensive. However, companies cannot afford to wait and let the proverbial lawsuit hit the fan.

The World Health Organization has estimated that drug counterfeiting affects 5-8% of all drugs, representing approximately $10-$15 billion to the U.S. pharmaceutical market alone. The Food and Drug Administration has estimated that approximately 10% of the drugs in worldwide distribution are counterfeit, with most being sold in developing countries. Not surprisingly, the most commonly counterfeited drugs are those with the largest sales, as well as drugs with high profit margins and drugs that are easier to counterfeit.

The FDA has stated that, in recent years, counterfeiting has moved into the area of finished pharmaceuticals, more so than to the counterfeiting of bulk drug ingredients. Moreover, with the increase in sales of drugs over the Internet, the agency is becoming even more concerned about the prevalence of drug counterfeiting, and the increasing ease by which counterfeited drugs may be distributed into the marketplace.

The costs of counterfeit products to pharmaceutical companies can be enormous and the legal implications daunting. Negligence, product liability and breach of warranty are only some legal theories that a plaintiff's lawyer may use to challenge companies when counterfeited versions of their products surface. In addition, manufacturers doing business outside of the United States (particularly in developing countries) must be aware that sales of counterfeit drugs in those countries could lead to legal action being taken against them, where the legal system may be significantly different from that of the United States. Of course, sales of counterfeit drugs outside the United States can also expose a drug company to liability at home.

Risks That Counterfeiting Presents

Counterfeit products present a number of risks to drug manufacturers and distributors. First, there is the potential for loss of good will and negative economic consequences. Once a counterfeit drug enters the market and consumers unknowingly purchase the counterfeit product, the customers' perception of the product will likely be harmed (eg, the product is not as safe or effective as advertised).

If a counterfeit product damages the legitimate drug's reputation, demand for the legitimate drug could decrease. Doctors who formerly prescribed the drug will more than likely receive negative feedback from patients regarding the drug's quality (or lack thereof) and choose not to prescribe the drug as frequently, if at all. Distributors may also be influenced by the drug's negative reputation and may not be willing to purchase the drug for fear that its sales will decrease in the near future. Counterfeit products could also reduce the legitimate manufacturers' sales through direct competition, by forcing the legitimate manufacturer to lower the price for its drugs.

In addition to lost sales and good will, other costs of counterfeiting include potential legal costs (eg, responding to liability claims or regulatory challenges), the costs of resolving the counterfeit issues, and the cost of time spent responding to governmental and consumer inquiries.

Where Problems Can Arise

The following are some, but not all, areas where potential problems can arise ' problems that may make a drug more vulnerable to counterfeiting:

• Lack of internal quality controls within the drug company or in the supply chain;
• Lack of internal security measures;
• Use of third parties in the manufacturing and distribution process with less than vigilant oversight; and
• Failure to monitor the product's distribution channels adequately and possible diversion or counterfeiting trends.

Today, there are also an increasing number of players in the distribution and supply chain. In many states, becoming an authorized distributor of pharmaceuticals is as simple as completing a form and paying a small fee at the county clerk's office. Some drugs may change hands a number of times among small secondary distributors before reaching the hands of the dispensing pharmacist. In short, there may be too many chefs in the proverbial kitchen, which can lead to confusion and disarray, thereby resulting in loss of accountability, responsibility, and tracking.

Legal Theories of Liability

There are a number of common causes of action that could result from counterfeiting. For example, a negligence action might arise from drug counterfeiting. Here, an injured party could assert that a drug company breached its duty to ensure that counterfeit products did not reach the end consumer. Another potential theory of liability is breach of warranty, where a plaintiff might seek to establish that a purchased product was not fit for its intended purpose, based on its labeling. Under a strict liability legal theory, the manufacturer's care is not relevant; a plaintiff must only prove that the product contained a manufacturer defect when it was sold. The violation of the Federal Food, Drug, and Cosmetic Act (the “FDC Act”) or FDA regulation may be used to demonstrate that a company was negligent, although an injured party is not entitled to bring a private cause of action for recovery under the FDC Act.

A potential challenge for a company defending itself is to show that it did not know, or had no reason to know, that counterfeit drug products were being sold or, if it did know, it was doing everything it could to stop the sale of counterfeit products. Furthermore, if a counterfeit product's distribution were widespread, a company could face suits in several states, each with its own set of rules and laws. The laws of some states may be more favorable to consumers and the laws of others more favorable to a manufacturer. In any case, the more jurisdictions, the more difficult it conceivably will be to coordinate the cases and keep costs manageable. As costs increase, the company is faced with the prospect of diverting money from other projects in order to defend itself.

Minimizing Risk

Third-Party Legal Action. A drug company may minimize its liability exposure if manufacturer X has reason to believe that distributor Y is participating in the sale of counterfeit drugs and the FDA (or other federal/state agency) has not taken action. The manufacturer may seek to stop the offending action by asking a court to issue an order restraining the distributor from taking the violative action (an analogy would be the enforcement of a trademark or patent). However, a petitioner may have difficulty providing sufficient evidence to convince a judge to issue the order, such as making a showing of the likelihood of success on the merits of the suit and that irreparable harm will occur if the court does not stop the action. If the counterfeiting is being assisted by any person under contract with manufacturer X, the company might be able to void the contract or if not, to seek relief from a court under its contract (depending on how the contract is drafted, an action based on the contract may form an easier basis to convince a court to intervene).

Relationship with the FDA. Another important step a company can take to minimize risk is to establish and maintain a good working relationship with the FDA. The FDA has wide and powerful abilities to demand documents, perform inspections, seize products, and conduct interviews if counterfeiting is detected.

A company must also demonstrate the ability to control and identify its products through the marketplace. A firm should consider implementing the FDA's Radiofrequency Identifica-tion (“RFID”) technologies either to authenticate or track and trace approved drugs. RFID is a state-of-the-art technology that uses electronic tags on product packaging to allow manufacturers and distributors to track drug products more precisely as they proceed through the supply chain. The technology is similar to that used for tollbooth and fuel purchasing passes. The FDA considers electronic pedigrees to be a type of “electronic safety net” that utilizes technology, which allows illicit drug transactions to be rapidly identified. The technology has the potential to improve the FDA's ability to conduct investigations of suspected counterfeiting or diversion of prescription drugs.

In November 2004, the FDA continued its efforts to combat drug counterfeiting by issuing a Compliance Policy Guide (“CPG”) concerning “Radiofrequency Identification Feasi-bility Studies and Pilot Programs for Drugs.” The CPG makes clear that the FDA considers the use of RFID technology critical to ensuring the long-term safety and integrity of the country's drug supply.

The CPG provides that the FDA will not pursue enforcement against a participant in an RFID study, so long as the study meets certain criteria. The drugs involved in an RFID study must be limited to prescription or over-the-counter finished products, and the RFID technology is only to be used for inventory control, tracking and tracing, verification of shipment and receipt, and authentication of finished products. The technology must not be used to replace current labeling control systems or otherwise substitute for compliance with existing FDA requirements (eg, fulfillment of Current Good Manufacturing Practices). RFID tags used in studies subject to the CPG are to contain a serial number that uniquely identifies the product, and may not contain or transmit information for health care practitioners or consumers. The tags may contain information such as handling or storage conditions, labeling information or expiration date, and lot number. They may not, however, contain or transmit advertisements or information about product indications or off-label usage. Studies involving RFID must also meet other requirements, such as tag placement requirements. The aforementioned are only some of the points described in the CPG. Authentication technologies assure that a drug is indeed the approved new drug and not a counterfeit.

While the FDA's recommendations are not legally binding, they may become industry standard and, at a minimum, demonstrate a good faith effort to minimize the risk of counterfeiting.

Internal Monitoring. In addition to the aforementioned recommendations, a company should review current standard operating procedures (“SOPs”) to ensure that the SOPs are addressing possible counterfeiting. There must also be written procedures for the possible triggering events for an investigation of counterfeiting. Once a triggering event occurs, the company must investigate and document the event to a conclusion. When preparing such procedures, a company may choose to review the National Association of Boards of Pharmacy Model Rules or the Drug Enforcement Administration requirements (eg, security, storage).

A manufacturer must work to ensure that contracts executed in the distribution of the drug require all downstream handlers of the drug to account for the product. Moreover, all contracts must contain indemnification language, where downstream distributors will indemnify and hold harmless the drug company for counterfeiting that occurs after the product has left the company's hands.

A drug manufacturer should keep detailed documentation on the tracing of the products through the marketplace and coordinate the control of expiration dating system ' and the destruction of drugs past these dates ' with the aforementioned anti-counterfeiting SOPs. Finally, a company must perform routine (and sometimes unannounced) audits of some distributors. This right should be explicit in contracts with distributors.

Conclusion

Drug companies must not take counterfeiting lightly. Proactive planning, implementation and training, establishing policies and guidelines (and internal monitoring to ensure there is compliance with these policies), careful construction of contracts, partnering with government agencies and the right companies, and expenditure of appropriate resources are all important steps to minimize the risk of counterfeiting. No one said it would be easy and inexpensive. However, companies cannot afford to wait and let the proverbial lawsuit hit the fan.