American Journal of Law & Medicine

Groping for the reins: ERISA, HMO malpractice, and enterprise liability.


As Canada approaches the end of its first decade of government-run health care with universal coverage and controlled costs, the majority in the United States Congress has proposed repealing the federal guarantee of health coverage to poor and disabled persons embodied in Medicaid.(1) This somber turn in the history of American health care comes only a few years after an optimistic President Clinton resurrected the efforts of Presidents Truman and Nixon to establish universal coverage. Clinton's own party quashed his Health Security Act prior to any formal debate. Characterizing the plan as Byzantine government that would limit choice, health insurance companies, the very industry President Clinton tried to accommodate by rejecting the Canadian model, opposed the plan.(2) Ironically, the possibility of such legislation accelerated the movement by health care insurers and other large-scale payers to assume control of health care delivery through the establishment of "managed care" systems.(3) While this movement has initially reduced costs, it has also restricted consumers' choice and imposed new administrative procedures.(4)

Physicians, meanwhile, scramble as business managers invade the previously exclusive domain of medical decision-making.(5) A survey of office-based physicians shows that sixteen percent of the respondents had merged their practices, sold them to a hospital or health-care company, or joined a group practice in 1994. The total jumped to twenty-one percent the following year.(6) Those still in unaffiliated solo or group private practice must often justify to third-party payors the need for procedures which were once routinely reimbursed.(7) Many others affiliated themselves with health maintenance organizations (HMOs) where they must adhere to new guidelines prior to ordering tests and making referrals.(8) While the aim of such guidelines has been to reduce unnecessary procedures, this fails to explain additional covenants that the "physician shall agree not to take any action or make any communication which undermines or could undermine the confidence of enrollees or the public in [the HMO] or the quality of [its] coverage."(9) Because the physician's independent duty of care remains unchanged, traditional malpractice law would find him or her liable should these economic pressures result in treatment shortcuts. Gradually, however, courts have begun expanding liability to the managed care organization.(10)

Expansion of liability is now becoming problematic. The Clinton plan attempted to surpass the private sector by establishing national spending targets, reforming malpractice procedures, and expanding the rights of patients as consumers. Most importantly, it would have brought coverage to thirty-nine million uninsured Americans, a number climbing as managed care's market share grows.(11) Unable to afford insurance, these uninsured patients struggle to find treatment as financially strapped hospitals are cutting back on charity services.(12)

The collapse of health care legislation left two forms of federal involvement. First, the government remains a major buyer of health care in the private market through Medicare and Medicaid.(13) Second, it serves as the protector of the private sector's efforts to expand the scope of coverage through the Employee Retirement Income Security Act of 1974 (ERISA).(14) ERISA encourages employers to fund their own health care plans, which may be operated by a managed care organization, such as an insurance company.(15)

ERISA-governed plans now cover more than one-half of all American workers. The Act's preemption of a broad range of state laws, including actions for injuries and wrongful death resulting from negligence by the plan's physicians or administrators, provides inducement to employers and to managed care providers to establish such plans.(16) This preemption interferes with judicial efforts to establish corporate liability and, without physician negligence, may leave the injured patient without relief.

These developments are no accident. ERISA succeeds after the Clinton plan failed by cajoling the private sector to provide what other countries have long considered public responsibilities. Through ERISA the federal government sacrificed fundamental patient protection to encourage the private sector provision of health care and pension benefits.(17) Further, ERISA's remedies inadequately replace traditional tort relief. As states begin reformulating traditional concepts of medical malpractice to reach HMOs and other payor-as-provider organizations, ERISA undermines these changes.

This Article argues that the individual physician and the HMO which dictates the parameters of medical practice are locked in a single enterprise affecting patient care. Therefore, enterprise liability should be an essential component of any form of managed care liability. Part II describes the genesis of enterprise liability amid economic modernization and highlights its compelling principle of risk distribution. Part III reviews the parallel modernization of the health sector with the introduction of the third-party payor into medical decision-making between physician and patient. Part IV examines the current movement for third-party liability under traditional negligence when the third-party's acts affect medical decisions. Part V examines ERISA's vitiation of liability for payers when they operate under self-funded employer health care plans. Parts VI and VII conclude with a proposal to incorporate enterprise liability into ERISA to fairly reflect a true private sector approach to health care reform.


Enterprise liability has been described as the tort law equivalent to Brown v. Board of Education.(18) A modern declaration of society's duty toward injured members, enterprise liability required years of scholarly chiseling at the constraints of common law before taking form. Traditional tort and contract law, based on the principles of individual fault and bargaining parity, were well-suited to the atomized world of pre-industrial economic activity, "dominated by small enterprises, individual merchants and independent craftsmen."(19) The development of large-scale industry, which included mass-production and adhesion contracts,(20) shifted the balance of power away from the individual long before courts and legislatures had the theoretical tools with which to respond.

Laying the foundation for a new approach proceeded brick-by-brick, beginning with Francis Bohlen, who was among a number of political and social theorists seeking a more economic basis for tort principle. He proposed the benefit theory, which treats liability as an internal cost borne by the party benefited by the behavior which put the victim at risk.(21) Thus, manufacturers should internalize the cost of producing safe products or pay damages to victims of unsafe products by incorporating them into the products, cost. A major force in the establishment of workers' compensation legislation, where the economically advantaged employer assumed liability, Bohlen maintained that the employee's recovery from work-related injuries should be automatic.(22) Fleming James believed that the issue centered on which party could best absorb the risk. He looked at the very need for society to examine its own interest in the distribution of loss apart from the individuals affected, both under the traditional fault system and within modem economic conditions. Fault-based liability treated parties as economic equals, thereby permitting moral judgment of one party's conduct to deter injurious actions. New economic relations called for a revised approach:

Human failures in a machine age cause a large and fairly regular - though probably reducible - toll of life, limb, and property.... The problem of decreasing this toll can best be solved through the pressure of safety regulations with penal and licensing sanctions, and of self-interest in avoiding the host of non-legal disadvantages that flow from accidents. But when this is all done, human losses remain.... If a certain type of loss is the more or less inevitable by-product of a desirable but dangerous form of activity it may well be just to distribute such losses among all the beneficiaries of the activity though it may be unjust to visit them severally upon those individuals who had happened to be the faultless instruments causing them.(23)

Assuming the same economic basis exists, consumers of health care are no less justified in seeking relief from the burden of proving fault than consumers of products, especially because health care providers claim a nobler motivation than profiting from the provided service.(24)

James noted that this new principle of "social insurance" was already the model for industrial accidents.(25) The statutory workers' compensation system had operated for decades as an industry-sponsored, no-fault system for awarding recovery for injuries. Mandatory employer contributions to a workers' compensation fund stems from the need of large-scale manufacturers to predict these losses in order to internalize them as a part of the cost of the product.(26)

James described how insurance accomplishes this, even in the face of a court's application of fault:

[T]ort liability no longer merely shifts a loss from one individual to another but it tends to distribute the loss according to the principles of insurance, and the person nominally liable is often only a conduit through whom this process of distribution starts to flow. This does not at all mean that the loss disappears and does not have to be paid for. But it does mean that you ought to know who is paying for it, and in what proportions, before you can really see and evaluate what is going on even in terms of the fault principle. And it does mean that when the courts talk and reason about a rule of law as though the judgment were to come out of the defendant's pocket, they are often thinking in terms of complete unreality.(27)

At the same time, no diminution in motivation to avoid injurious conduct occurs. instead, the insurer shares this concern with the manufacturer:

Insurance has made direct contributions to the work of accident prevention. The wide combination of risks has brought together large aggregations of capital. This has put the insurance companies in a strategic position effectively to carry out programs to promote safety.(28)

The evolution of modem society also called for a re-examination of contract law. Friedrich Kessler argued that a standardized contract embodied the accumulation of vast economic power in the hands of large enterprises and its implications for the capacity of traditional contract law to protect those less powerful. Originally, they served to provide uniformity and predictability to the multitude of similar transactions in which a large company typically engages. However, a large company's economic power to dictate terms in order to reduce "judicial risk" the danger that a court or jury may be swayed by `irrational factors' to decide against a powerful defendant" lead to standard clauses limiting liability under a host of circumstances.(29) While it was the main avenue out of feudalism into the modem age, the freedom to contract now served to enforce "powerful industrial and commercial overlords enabling them to impose a new feudal order of their own making upon a vast host of vassals."(30)

For example, he described a boilerplate clause used by insurance companies to escape liability for losses suffered by individuals who had submitted applications through an agent not formally accepted by the insurer.(31) Those courts unwilling to enforce the strict terms of the contract sought a solution by the back door. With the help of tort law, they nullified the parts of contract law which were contrary to the pubic interest.(32) Tort principles regularly allow courts to restrict the principle of contractual freedom to address egregious inequities.(33)

Finally, the privity of contract requirement, applied to injured parties suing either in negligence or on breach of warranty, hindered both tort and contract law reform. Mass production for mass consumption required a far-reaching distribution system. Thus, new businesses emerged devoted strictly to the purchase, transport, and resale of goods to increasingly far-flung markets, because this intermediate link shielded the maker from the buyer under traditional liability theories. The "assault on the citadel" began with Judge Cardozo in MacPherson v. Buick Motor Co., when he focused on whether "the nature of a thing is such as to place life and limb in peril when negligently made,"(34) a decision which began a national trend.(35) His decision rested on the cost internalization work of Bohlen.(36) Because the manufacturer benefits from the consumer's purchase, privity becomes meaningless.

Kessler's analysis of the modem contract, however, stated that the problem stemmed not simply from privity or any other feature, but from the underlying balance of power of the parties:

Society, when granting freedom of contract, does not guarantee that all members of the community will be able to make use of it to the same extent. On the contrary, the law, by protecting the unequal distribution of property, does nothing to prevent freedom of contract from becoming a one-sided privilege.(37)

While decrying the courts, resort to tort law to redress inequities which fall within the terms of the contract, he states that the society in which the courts might remain neutral had long passed:

The prevailing dogma ... insisting that contract is only a set of operative facts, helps to preserve the illusion that the "law" will protect the public against any abuse of freedom of contract. This will not be the case so long as we fail to realize that freedom of contract must mean different things for different types of contracts. Its meaning must change with the social importance of the type of contract and with the degree of monopoly enjoyed by the author of the standardized contract.(38)

Strict liability for injuries caused by defective products became the vehicle for James to address the inadequacies of traditional law to overcome faultless injury, adhesion contracts, and a lack of privity.(39) In a paper delivered to the 1956 meeting at the Torts Round Table of the Association of American Law Schools in Chicago, he stated that defective products were an especially apt subject for the establishment of strict enterprise liability.

Here the commercial law has developed the implied warranties of quality which are frequently imposed by law for reasons of social policy and not because of any express or implied-in-fact understanding of the parties.(40)

James added that such imposed warranties should extend beyond quality to product safety to include:

strict liability on the part of the manufacturer, upon an implied warranty, for unreasonable dangers lurking in any kind of product.... Liability should extend to anyone who is hurt by a foreseeable use of the product. The forseeability here involved is different from that required in negligence cases. It is not the foreseeability of unreasonable risks, but rather the foreseeability of the kinds of risks which the enterprise is likely to create.(41)

The first judicial ratification of enterprise liability appeared in Henningsen v. Bloomfield Motors, Inc.,(42) where the New Jersey Supreme Court held both Chrysler and a car dealership liable for the injuries suffered by a car buyer's spouse when the steering on their new Plymouth suddenly pulled right, causing her to crash into a building.(43) Modernizing consumer law, the court viewed the parties as unequal in power:

Under modern conditions the ordinary laymen, on responding to the importuning of colorful advertising, has neither the opportunity nor the capacity to inspect or to determine the fitness of an automobile for use, he must rely on the manufacturer who has control of its construction, and to some degree on the dealer who, to the limited extent called for by the manufacturer's instructions, inspects and services before delivery. In such a marketing milieu his remedies and those of persons who properly claim through him should not depend "upon the intricacies of the law of sales. The obligation of the manufacturer should not be based alone on privity of contract. It should rest, as was once said, upon `the demands of social justice.'"(44)

Ultimately, the court held that an implied warranty imposed by operation of law exists for defective products which injure the ultimate consumer.(45) Moreover, the "[a]bsence of agency between the manufacturer and the dealer who makes the ultimate sale is immaterial."(46)

The Supreme Court of California provided a better articulation of the economic underpinning for shifting the burden to the manufacturer in Greenman v. Yuba Power Products, Inc.(47) There, the plaintiff had been injured by a piece of wood which flew off a lathe manufactured by the defendant.(48) The court concluded that the purpose of imposing liability "is to insure that the costs of injuries resulting from defective products are borne by the manufacturers that put such products on the market rather than by the injured persons who are powerless to protect themselves.'"(49) Accordingly, the court held that:

[t]o establish the manufacturer's liability it was sufficient that plaintiff proved that he was injured while using the [product] in a way it was intended to be used as a result of a defect in design and manufacture of which plaintiff was not aware that made the [product] unsafe for its intended use.(50)

Casting this theory in modem economic terms,(51) three principles illustrate the judicial(52) and legislative(53) affirmation of enterprise liability and incorporation of the work of Kessler,(54) James,(55) and Bohlen.(56) First, manufacturers exert power over all aspects of product design and marketing.(57) Investment and advertising renders obsolete the traditional burden of caveat emptor.(58) Second, insurance available to manufacturers for product defects easily spreads the risk, especially when the cost of the premium can be paid by the actual consumer as a part of the product's price.(59) Finally, strong social policy requires internalization of the costs of safety to the manufacturers.(60) Because the profits accrue to the manufacturer and the injuries to the consumer, liability becomes an economic incentive to invest in design of safety features, quality control of production, and truth in marketing.(61)

Enterprise liability can address similar problems posed by medical care. Medical treatment is the product of a network of trained individuals, many of whom have no contact with the patient. Thus, the individuals may not have a traditional duty of care toward the patient, yet their negligence can have devastating consequences. In addition, patients lack the bargaining power to negotiate all aspects of treatment, where, for example, they may consent to procedure without full comprehension of the procedure and its risks.(62) Consequently, the medical enterprise is superiorly placed to manage both the risk and to distribute its costs in compensating anyone injured from its well-intended efforts.


A. Insurance and the Rise of the Modern Health Industry

Up until the 1920s, health care was largely a private matter between the solo practitioner and the self-paying patient.(63) Expenses which a family could not meet were often absorbed by the provider or defrayed by the early third-party payors, such as local communities that provided for the medical treatment of the poor.(64) Rising costs of health care created a need for new mechanisms.(65)

Commercial health insurance did not become widespread until the 1930s.(66) Difficulty monitoring abuse and the problem of "adverse selection," that those who purchase insurance are those most likely to need medical treatment, contributed to the slow growth.(67) Insuring against illness is premised on conditions, which run counter to general principles of the insurance industry, that the insured event: (1) be susceptible to unambiguous description; (2) be something the insured person has no control over; and (3) be a relatively uncommon occurrence for individuals but have a predictable incidence for a group.(68) In health care, once it was understood that the existence of insurance actually increases the utilization of services, the setting of premiums became inherently problematic.

The Depression appeared to push aside these doubts. The New Deal left out health care, leaving hospitals with empty beds and patients too poor to pay for services.(69) Following an example in Baylor, Texas, where a hospital provided school teachers with up to twenty-one days of care for a premium of fifty cents per month, hospitals began the non-profit Blue Cross plans. With pressure from physicians, Blue Cross coverage became multi-hospital, and private insurance companies soon entered the market with cash indemnity plans.(70) Physicians organized in California to provide coverage for their own services under Blue Shield.(71) Expansion of employee coverage received a major boost during World War II, when the War Labor Board ruled that health coverage to workers did not violate wage controls.(72) The rise in organized labor spurred increased coverage of health insurance to compensate for the New Deal's shortcomings(73) and the total enrollment in Blue Cross soared from seven to twenty-six million subscribers.(74)

The federal government both responded to and stimulated the expansion of health services through key legislation:the Hill-Burton Act, subsidizing the construction of hospitals, the GI bill, which did the same for physician training; and the creation of the National Institute of Health, which expanded the role of the government in all aspects of research and the development of medical specialties.(57) Commercial indemnity insurance jumped to twenty-eight million subscribers after the war, and between 1945 and 1949 Blue Cross membership soared to thirty-one million.(76) By 1953, sixty-three percent of all Americans were insured.(77)

It became apparent by 1964 that an exclusively private sector-driven approach failed to reach large segments of society.(78) The growth in employee-based health insurance meant that much coverage ended upon retirement. Moreover, no mechanism existed for coverage of low-income families, except piecemeal programs at the state level. On his election in 1964, Lyndon Johnson declared that health care would be part of his Great Society.(79) The creation of Medicare and Medicaid eventually added fifty million consumers to the health care market. …

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