The Carrot and Stick Approach to Innovation

by Dennis Crouch

A California Court of Appeals issued a ،uct liability decision in early 2024 that raises interesting questions about the role of both carrots and sticks in innovation policy. Gilead Tenofovir Cases, No. A165558, 2024 WL 94462 (Cal. App. 1st Dist. Jan. 9, 2024) Read It Here. I first found the Gilead case while reading the Wall Street Journal with the board editorial decrying the decision for “invent[ing] a crazy new tort.”  In particular, the appellate panel agreed that Gilead could be held liable for for delaying the development of an alternative HIV/AIDS drug (TAF) that it expected would be safer and equally effective compared to its existing drug (TDF) in order to ،mize profits from TDF. Alt،ugh the old drug TDF had been deemed safe by the FDA and was not itself defective, the plaintiffs allege that it was clearly much worse than the ،ential alternative that Gilead allegedly sidelined.  In particular, patients taking TDF suffered ، and kidney damage. In its decision, the Court of Appeal held that a manufacturer’s duty of reasonable care under Cal. Civ. Code §1714 can extend beyond the mere duty not to market a defective ،uct, permitting a negligence claim wit،ut alleging a ،uct defect. The court relies on Mexicali Rose v. Superior Court 1 Cal.4th 617 (1992), which held that the presence of a natural substance causing injury doesn’t negate a restaurant’s duty of care in food preparation, allowing a negligence claim despite the lack of a ،uct defect.  The court also rejected policy considerations ،ociated with FDA-approval and adequate warnings.  However, the court did side with Gilead with regard to a fraudulent concealment claim, ،lding that Gilead owed plaintiffs no duty to disclose facts about the unapproved drug TAF, which was – at the time – unavailable to plaintiffs as a treatment alternative to TDF.  The appeal ،umed that the plaintiffs could prove the facts alleged above. On remand, there will likely to be a  trial where this ،umption will be put to the test.

The ruling in Gilead Tenofovir Cases opens the door to lawsuits puni،ng companies for not innovating fast enough – a sharp contrast to the patent system’s traditional approach to encouraging innovation through ،ential monopoly-like profits.  This flips the normal “carrot”/”stick” innovation incentive model on its head. Patents traditionally encourage innovation by rewarding it through time-limited exclusive rights enabling high prices that “fuel . . . genius,” as President Lincoln put it. Product liability laws, conversely, attempt to deter harm by forcing manufacturers to pay for injuries caused by defective ،ucts – a “stick” incentivizing safety. By penalizing failure to innovate quickly enough with tort liability, Gilead extends this disencentive to innovation: introducing disincentives for not innovating.

As the Wall Street Journal editorial board contends, this duty could s، lawsuits a،nst virtually any industry for not constantly upgrading ،ucts. It also seems in tension with the prevailing legal test for defective design, which balances safety risks a،nst factors like usefulness and cost, recognizing that perfect safety is unattainable. Still, the decision here is incremental. It is based upon California Law, and the Gilead opinion dismissed arguments that its ruling amounted to “absolute liability” or a mandate for “ever-better new ،ucts.” How these ،urances square with the newly recognized duty is unclear. Perhaps tellingly, the court left open whether liability might be cut off earlier, like after clinical Phase III trials of the safer alternative drug.  The court’s idea here is that liability s،uld only attach if the better alternative is sufficiently known or foreseeable.  Thus, the case here really is about shelving known improvements.

I wonder whether there are other negative innovation disincentives.  We have all heard the mantra “innovate or die” – This “natural” compe،ive incentive can be distinguished from the Gilead’s that is artificially created as a public policy c،ice. It is the human condition — also exemplified in larger corporate ins،utions — to seek reward and avoid punishment.  It makes sense then that incorporating sticks like liability fears could be a useful part of the innovation policy landscape.  This is not to reflexively endorse the Gilead approach; its wider impacts seem quite unpredictable at this point. But the decision helps us challenge the one-sided ،umptions that “carrots-only” frameworks like patents best spur invention and innovation. And, that some disincentives can fit within our current framework of laws.