The Supreme Court is taking up two U.S. Court of Appeals for the Seventh Circuit cases where rulings shielded both food-and-pharmacy chains from FCA liability for alleged improper billing involving prescription drugs. If the high court sides with the Seventh Circuit, the impending result could mean an exponential loss of taxpayer money.
In the April 13, 2023 edition of The Legal Intelligencer, Edward T. Kang and Kandis Kovalsky wrote “When Is Knowing ‘Knowing’ in FCA Cases? High Court Examines Two Cases“
The knowledge of falsity element in False Claims Act (FCA) cases—i.e., whether fraudulent claims were submitted knowingly, not merely negligently, may soon become an objective standard regardless of the defendant’s actual knowledge. The Supreme Court is taking up two U.S. Court of Appeals for the Seventh Circuit cases where rulings shielded both food-and-pharmacy chains from FCA liability for alleged improper billing involving prescription drugs. If the high court sides with the Seventh Circuit, the impending result could mean an exponential loss of taxpayer money.
Under the FCA, “any person who knowingly submits a false claim to the government or causes another to submit a false claim to the government or knowingly make a false record or statement to get a false claim paid by the government” may be held liable. The term “knowingly” anticipates a knowledge requirement such that a person who simply submits a false claim to the government without the knowledge of falsity does not violate the act. Rather, they must have submitted such a claim with knowledge of the falsity or “scienter.” As laid out in Section 3729(b)(1), the FCA’s standard for scienter only allows liability when fraud occurs with actual knowledge; deliberate ignorance of the truth or falsity of the information, or; reckless disregard of the truth or falsity of the information. In recent years, courts have struggled with interpreting the scienter element, especially where FCA defendants assert an objectively reasonable alternative interpretation of an ambiguous statute to justify their conduct.
The two Seventh Circuit cases are Proctor v. Safeway, 30 F.4th 649 (7th Cir. 2022) and Schutte v. SuperValu, 9 F.4th 455 (7th Cir. 2021). In both cases, the circuit court’s rulings rejected liability because the purported misconduct allowed for reasonable views of compliance obligations. In these cases, the relators alleged that the pharmacy chains overcharged Medicare and Medicaid for generic drugs, despite charging customers paying for the drugs out of pocket much lower prices through discounts. In other words, the pharmacy chains were not offering discounted drug prices to the government while they offered such prices to those customers who paid out of pocket. The relators-plaintiffs contributed this overcharge to a deliberate failure by the retailers, citing that federal law required these pharmacies to bill Medicare and Medicaid based on “usual and customary” (U&C) pricing offered to customers. The relators further alleged that both Safeway and SuperValu knew of their defrauding scheme and took efforts to conceal these pricing practices. Despite the Seventh Circuit’s agreeing that the companies overcharged the government, it held that the retailers would avoid liability as they made “objectively reasonable” determinations of U&C pricing under an ambiguous regulation. The court further opined that this “objectively reasonable” standard withstood scrutiny even if Safeway and Supervalu did not actually believe their interpretation was correct and consciously intended to deceive the government.
The Seventh Circuit adopted the Supreme Court’s “Safeco standard for scienter” arising out of the 2007 decision in Safeco Insurance Co. of America v. Burr, 551 U.S. 47 (2007). The Safeco court held that an individual acting under an incorrect legislative interpretation could not possibly have acted with knowledge or reckless disregard if their interpretation was “objectively reasonable” and there was no “authoritative guidance” explicitly cautioning against their interpretation. Applying this two-step inquiry, the Seventh Circuit held that Safeway’s and SuperValu’s conduct was consistent with an objectively reasonable interpretation of “usual and customary” price since no statute or regulation precluded this interpretation.
Unlike the Seventh Circuit, the Third Circuit has long emphasized a distinction between falsity and scienter, rejecting the Seventh Circuit’s “objectively reasonable” standard. In United States v. Care Alternatives, 2020 WL 103808 at *4 (3d. Cir. 2020), relators alleged that Care Alternatives, a hospice facility, “admitted patients who were ineligible for hospice care and directed its employees to improperly alter those patients’ Medicare certifications to reflect eligibility.” This posed the question of whether a reasonable physician would determine that the patients were hospice eligible. The Third Circuit held that findings of falsity and scienter must be independent of one another for purposes of FCA liability, warning that by grouping the scienter element into an “objective” falsity test, a court would fail to fully consider evidence of scienter.
A circuit split has developed on this issue and where an objectively reasonable interpretation can shield an FCA defendant from liability. In Phalp v. Lincare Holdings, 857 F.3d 1148 (11th Cir. 2017), where relators alleged diabetic testing suppliers submitted claims to Medicare without adequate authorization from beneficiaries, the Eleventh Circuit held that scienter “can exist even if a defendant’s interpretation is reasonable.” The court relied upon the Eighth Circuit’s holding in Minnesota Association of Nurse Anesthetists v. Allina Health System, 276 F.3d 1032 (8th Cir. 2002), that “scienter is established if a defendant knowingly disregards the proper interpretation of an ambiguous regulation.” Both circuits recognize that those who do business with the government are obligated to ensure they are in conformity with compliance laws and cannot simply rely on their interpretation even if such interpretation is reasonable.
If the Supreme Court were to adopt the Seventh Circuit’s decision—i.e., an FCA defendant could escape liability even if it subjectively believed its claims for payment to the government were false as long as it could come up with a reasonable explanation after the fact—it will likely change the landscape of FCA drastically. A potential defendant could knowingly submit false claims to the government as long as it has a creative legal team that could come up with a reasonable explanation that could justify its conduct after the fact. Circuit Court Judge David Hamilton wrote the dissenting opinion for both of the Seventh Circuit decisions. In his Safeway dissent, Hamilton pointed to the contemporaneous evidence of Safeway’s choices in hiding its U&C price-matching, and its after-the-fact reasons for doing so, which easily permits the interference that Safeway knew it was perpetrating a fraud that required concealing. Similarly, in his SuperValu dissent, Hamilton believed relators provided substantial evidence of actual knowledge of fraud or at the very least, deliberate ignorance, given that SuperValu’s usual and customary prices were eight to fifteen times greater than prices it was charging the public. He opined that the majority’s interpretation creates “a safe harbor for deliberate or reckless fraudsters whose lawyers can concoct a post hoc legal rationale that can pass a laugh test.”
Recognizing the magnitude of the appeal, the Supreme Court will allow the federal government to participate in oral argument, allocating 10 minutes to argue alongside the relators. This concession comes after a motion by the U.S. Solicitor General to participate in the proceeding, arguing that the government had substantial interest in the resolution. The Supreme Court’s hearing of this case in and of itself is significant. Although there is no rule regarding how many FCA cases the court hears per term, it typically hears no more than one such case per term. And, the court has already heard Polanksy v. Executive Health Resources, Inc. on Dec. 6, 2022, an FCA case from the Third Circuit.
Many practitioners on the relator’s bar are concerned about what the Supreme Court would do with the Seventh Circuit rulings. It is no secret that the court’s partisan balance has shifted, and FCA defendants have found support among right-leaning justices. These justices have shown contempt for Chevron deference, a doctrine upholding a government agency’s interpretation of a statute that the agency administers. If the court were to side with the Seventh Circuit, FCA litigation could be completely reshaped by new scienter standards. The Seventh Circuit’s interpretation could allow creative lawyers to run wild with any conceivable argument and also allow defendants to escape liability for conduct the defendants subjectively believed could be fraudulent. This new standard would run contrary to basic tort principles. The Supervalu majority ignored the Restatement’s discussion of common law fraud, which relies heavily on subjective belief. For instance, Restatement (Second) of Torts § 550 governs liability for fraudulent concealment and sets forth an “intent” requirement, in that a defendant is liable for a material representation that is false and known by the defendant to be false. The Seventh Circuit’s standard contains no such subjective element.
Recently, a district court in Pennsylvania has recognized the implications of evaluating FCA claims based on the “objectively reasonable” interpretation of Medicare compliance laws by denying a motion to dismiss where CVS is accused of colluding with drugmakers to keep Medicare beneficiaries from accessing certain generic drugs. See Ellsworth Associates v. CVS Health Corporation, Civil No. 19-2553 (E.D. Pa. March 10, 2023). In that case, relators have accused CVS of a scheme in which the pharmacy took rebates from 11 drugmakers to ensure that as many as 15 brand-name drugs were a part of its formulary, rather than less expensive and less profitable generic alternatives. Defendants argue they made a reasonable interpretation of Medicare law and eventually, no longer stocked generic versions of drugs in accordance with their rebate agreements. This conduct resulted in consumers being unable to obtain cheaper generic equivalents. Ultimately, the court addresses the Safeco standard by saying, “Safeco is not the blank check Defendants appear to think it is … it does not give an all-purpose liability escape hatch.”
The Supreme Court should join in the dissenting view of Hamilton, that evidence of actual knowledge is determinative of whether a fraudster is knowingly presenting false claims. That is, a defendant should be liable under the FCA if scienter is met based on an either subjective or objective standard. “Scienter” means knowingly or willingly. That means, if a defendant submits a false claim to the government for payment believing that the claim is false and that the claim was in fact false, it should be held liable for its conduct. It should not matter whether the defendant could conceive objectively reasonable explanations after the fact. This approach is consistent with the FCA goal of policing those who do business with the government to be honest and transparent. If the Seventh Circuit rulings stand, the court will be providing a “safe harbor” for unscrupulous defendants that offer “objectively reasonable” explanations after the fact. The EDPA ruling showcases the need for a scienter standard that goes beyond such a bare-bones explanation, and the Supreme Court should cognizably follow suit and seal this liability escape hatch.
Edward T. Kang is the managing member of Kang Haggerty. He devotes the majority of his practice to business litigation and other litigation involving business entities. Contact him at email@example.com.
Kandis L. Kovalsky, a member at the firm, focuses her practice on representing both corporate and individual clients in a broad range of complex commercial litigation matters in Pennsylvania and New Jersey state, federal and bankruptcy courts. Contact her at firstname.lastname@example.org.
Reprinted with permission from the April 13, 2023 edition of “The Legal Intelligencer” © 2022 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-257-3382 or email@example.com.