Vioxx settlement puts Merck back on track

The settlement with Vioxx plaintiffs should mean a bright future for Merck.

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(Fortune) -- During its heyday in the 1970s, Merck earned a reputation among scientists as "the Harvard of the pharmaceutical industry." It may no longer be, but at least today, the company's legal department is looking like Harvard Law.

Merck's agreement to settle the bulk of its Vioxx lawsuits for a fixed amount of $4.85 billion will unshackle a company that has made enormous strides in the three years since it pulled its notorious painkiller from the market. Merck drew quite a bit of skepticism back in late September of 2004, when the company was forced to withdraw Vioxx after studies suggested it caused heart attacks and strokes. Merck's then-general counsel Ken Frasier insisted that the drugmaker would vigorously defend itself in each and every product liability case.

More than 20 million Americans had taken Vioxx. And using previous drug liability lawsuits as a guide, legal observers believed Merck would ultimately pay over $20 billion to plaintiffs and their lawyers to settle the expected deluge of cases.

That massive flood never came to pass. Over the last three years, juries have decided in Merck's favor 12 times. Five Vioxx cases were decided in favor of plaintiffs. One case was dismissed, and two cases were unresolved mistrials.

Merck's legal team believes it prevailed by keeping the legal arguments grounded in science. Merck's current general counsel Bruce Kuhlik says the company had a change to show juries that "we acted responsibly and really were following the science throughout the development and distribution of the drug." In winning the bulk of its cases, Merck's legal team narrowed the field of plaintiffs by showing that the company could defend itself against broad personal injury claims that didn't involve heart attack or stroke, or use of the drug for a substantial period of time.

Now that the statute of limitations has expired in most states, Merck believes it is the right time to settle. As of early October, Merck announced this morning, the company has been named in 26,000 cases involving some 47,000 plaintiff groups. As part of the settlement, Merck will award plaintiffs only after they pass a series of checks in which patients need to prove, among other things, that their Vioxx use caused either a myocardial infarction or ischemic stroke. Merck will record a fourth quarter 2007 pre-tax charge of $4.85 billion for the cost of the settlement.

There will undoubtedly be small groups plaintiffs who continue to pursue cases against Merck. Merck CEO Richard Clark told investors that the company will fight those cases as needed. "Ultimately, the science is on our side," Clark says.

That science has been on Merck's side in the labs, too. In the last two years, Merck has introduced 8 new products, including potential blockbusters Gardasil, a preventative treatment for cervical cancer and Januvia, a diabetes medicine.

The success is the result of a deliberate strategy not to get bogged down by Vioxx. When CEO Clark took the helm at Merck in May 2005, he told company employees to "put a fence around" the Vioxx matter and execute as if it weren't there. That mantra seems to have paid off. The company's researchers abandoned a long-standing and somewhat haughty go-it-alone strategy, partnering with smaller companies on more collaborative deals than ever before. Since 2004, Merck has signed roughly 125 collaborative research deals. At the same time, lab workers have reduced the average time it takes to usher a drug through the final stages of research by roughly 11 months.

That improvement can pay enormous dividends. It gets medicines to patients sooner and adds nearly a year to the limited period in which Merck can sell its future medicines under patent protection. "Top engineers are lining up again to join the company," says Clark. "That wasn't happening a few years ago."

Investors are lining up, too. Even as the Vioxx litigation weighed on the company's shares, Merck's (Charts, Fortune 500) stock had more than doubled from it post-Vioxx low of around $26 (which occurred in October of 2005). As of this afternoon, shares have jumped another 4.5% to $57.

Perhaps Merck is on the way to recieving comparisons to hallowed institutions once again. If nothing else, Merck's execution in the midst of crisis will almost certainly merit study at the Harvard Business School.