Supreme Court Grants Cert to Tackle False Claims Act Scienter Standard
The U.S. Supreme Court will soon clarify the knowledge requirement for False Claims Act (“FCA”) cases. On January 13, 2023, the Supreme Court granted certiorari in a pair of consolidated cases from the Seventh Circuit to consider “whether and when a defendant’s contemporaneous subjective understanding or beliefs about the lawfulness of its conduct are relevant to whether the defendant acted ‘knowingly’ when it presented false or fraudulent claims” in violation of the FCA. Essentially, the Court will decide whether a defendant “knowingly” violates the FCA when the defendant relies on an objectively reasonable interpretation of the law. The Supreme Court granted petitions in two Seventh Circuit cases – United States ex rel. Schutte v. Super Valu Inc. and United States ex rel. Proctor v. Safeway, Inc. – which has been consolidated and set for oral argument on April 18, 2023.
FCA “Knowingly” Standard
Enacted in 1863 during the Civil War to seek reparations for defense contractor fraud, the FCA is a federal civil and criminal statute that imposes liability on individuals and entities who submit a claim for reimbursement to the U.S. federal government that he or she knows or should know is false. The FCA has become an expansive and powerful tool the government relies upon to seek substantial damages and penalties – the filing of a false claim can lead to fines of up to three times the federal program’s loss, in addition to an $11,000 fine per claim. Indeed, the Solicitor General has stated that the FCA is the primary tool by which the federal government combats fraud in federal contracts and programs. Under the FCA, every instance of a service or item billed to a federal program is considered a separate claim. Criminal penalties for submitting false claims include imprisonment and criminal fines.
The FCA imposes liability on any person who “knowingly presents, or causes to be presented, a false or fraudulent claim for payment” to the government, or who “knowingly makes, uses, or causes to be made or used” a “false statement” material to such a claim. Thus, to be liable under the FCA a defendant must act “knowingly” – defined under the FCA to mean that a person, with respect to the information: (1) has actual knowledge of the information; (2) acts in deliberate ignorance of the truth of the falsity of the information; or (3) acts in reckless disregard of the truth or falsity of the information. Importantly, specific intent to defraud is not required. As a result, whether a defendant has acted with the necessary scienter is often a hotly litigated issue. This is particularly true in cases where the alleged FCA violation stems from a violation of another statute or regulation that is open to multiple interpretations.
Notably, the civil FCA includes a whistleblower provision that permits private individuals to file lawsuits on behalf of the federal government and entitles qui tam relators to a percentage of any recoveries.
The Cases
As background, Medicare Part D and Medicaid laws and regulations require pharmacies seeking reimbursement for drugs to charge more than the “usual and customary” price they charge to the “general public” (the “U&C price”).
The qui tam relators in Schutte alleged that SuperValu charged customers of its in-store pharmacies a discounted price for prescription drugs, but fraudulently reported the non-discounted price as its U&C price to Medicare and Medicaid, thereby knowingly submitting false claims to the federal health care programs.
Similarly, in the Safeway case, the qui tam relator, Thomas Proctor (“Proctor”) filed a complaint against national grocery chain Safeway, Inc. (“Safeway”) alleging that the grocer knowingly submitted false claims to Medicare and Medicaid and overcharged federal health care programs for prescription drugs. Specifically, Proctor alleged that Safeway violated the FCA by knowingly misreporting its retail price for certain drugs as its U&C price even though the public paid much less than the retail price.
“Objective Reasonableness” Standard
The two consolidated cases are a follow-up to the Supreme Court’s 2007 decision in Safeco Insurance Co. v. Burr, which did not involve the FCA. Rather, Safeco interpreted the Fair Credit Reporting Act (“FCRA”) to establish the “reckless disregard” scienter standard. In Safeco, the Supreme Court held that an FCRA defendant interpreting an ambiguous statute or regulation does not act with “reckless disregard” if the law has “more than one reasonable interpretation,” the defendant acted consistently with one of those interpretations, and no authoritative guidance “warned the defendant away” from that interpretation. Critically, the Safeco standard is objective.
The Seventh Circuit extended the Safeco standard to the FCA in Schutte and Safeway. In each case, the Seventh Circuit issued 2-1 panel decisions shielding SuperValu and Safeway, respectively, from FCA liability for the alleged fraudulent billing practices.
The Seventh Circuit first decided Schutte, holding that Safeco controlled the interpretation of the FCA “knowingly” scienter requirement. On that understanding, the court held that an FCA “defendant who acted under an incorrect interpretation” of governing law does not act knowingly “if (1) the interpretation was objectively reasonable and (2) no authoritative guidance cautioned defendants against it.” Applying the Safeco standard to the FCA, the Seventh Circuit found that “a defendant’s subjective intent does not matter” and that “it is not enough that a defendant suspect[s] or believe[s] that its claim was false” because the standard is “objective.” Rather, the issue turns on whether the defendant “know[s] that its claims are false.” Therefore, the court found that it is “irrelevant” to the inquiry whether the defendant actually “held [an objectively reasonable interpretation] at the time that it submitted its false claim.” Moreover, the majority explained that a defendant “might suspect, believe, or intend to file a false claim, but it cannot know that its claim is false if the requirements for that claim are unknown.”
Judge Hamilton dissented in Schutte arguing that this standard creates a “safe harbor for deliberate or reckless fraudsters whose lawyers can concoct a post hoc legal rationale that can pass a laugh test.” Because a defendant’s subjective intent is “irrelevant,” the rulings precluded the need for defendants to demonstrate that they actually and contemporaneously held the belief that their position was supported by an objectively reasonable interpretation of the law and that it was not “cautioned against” that interpretation at the time the defendant engaged in the alleged wrongful conduct. In Judge Hamilton’s view, the Schutte majority ignored the FCA text, history, and common-law background which established that “subjective bad faith” can establish the necessary “knowingly” scienter. Judge Hamilton concluded that the grant of summary judgment in favor of SuperValu should be reversed because the evidence would allow “[a] reasonable jury [to] find that SuperValu either actually knew or deliberately chose to keep itself in ignorance that it was submitting false claims.”
The Seventh Circuit affirmed the district court’s grant of summary judgment in Safeway “[f]or the same reasons” it had identified in Schutte. Again, Judge Hamilton dissented.
Petitions to Supreme Court
To date, there is no true circuit split on the application of the Safeco objective standard to the FCA’s knowledge requirement, because no circuit court to have considered the issue has expressly held that Safeco does not apply in the FCA context. Nonetheless, for those circuit courts who have considered the issue, there has been considerable debate as to whether the scienter standard is appropriate in the context of the FCA. By way of example, the Fourth Circuit’s adoption of the Safeco standard likewise came from a panel split 2-1. Thereafter the Fourth Circuit agreed to rehear the issue en banc in United States ex rel. Sheldon v. Allergan Sales, LLC, ultimately vacating the panel opinions in a 4-4 split while affirming the district court’s decision. Since the Seventh’s Circuit original decision in Schutte, five other circuit courts of appeal have issued similar rulings.
As a result, critics have urged the Supreme Court to grant cert and overturn the decisions. In an amicus brief filed at the invitation of the Supreme Court, the Solicitor General and the Department of Justice argued in favor of certiorari, pointing to a large number of ambiguities in federal law.
The Stakes
The FCA bar, government contractors, Medicare and Medicaid providers, pharmacies, prescription drug and medical device manufacturers, Congress, and others will be closely watching the Supreme Court’s forthcoming decision on this issue. The Supreme Court’s ruling will significantly affect FCA cases going forward.
Subjective Intent
In its amicus brief in support of petitioners, the Solicitor General argued on behalf of the federal government that the Seventh Circuit had erred in extending the Safeco standard to the FCA. The Solicitor General’s position is that the FCA’s three-prong definition of “knowingly” makes clear that the scienter standard “encompasses circumstances in which persons subjectively believe they are submitting false claims or statements to the government; are subjectively aware of a substantial risk that their claims or statements are false but deliberately avoid taking readily available steps to obtain clarification; or act in reckless disregard of known or objectively obvious facts indicating a high likelihood of falsity.” According to the Solicitor General, the Seventh Circuit’s narrower scienter standard disregards Congresses’ three-pronged statutory definition which focuses on the defendant’s state of mind, pointing to the “acknowledge knowledge” and “deliberate ignorance” prongs of the definition. Pointedly, the Solicitor General stresses that the Seventh Circuit’s interpretation of the Safeco standard would permit defendants who intentionally submit false claims for payment to the federal government to escape FCA liability based on “concededly incorrect post hoc justifications.”
In addition, the Solicitor General argues that the Supreme Court’s decision in Safeco does not support the Seventh Circuit’s holding. Per the federal government, Safeco is inapplicable because there the Court interpreted the FCRA’s penalties for “willfully” violating the statute’s requirements that, unlike the FCA, do not address a three-pronged statutory definition that “expressly focuses on a defendant’s subjective state of mind.” Moreover, the FCRA concerns a “general regulatory requirement” as opposed to “conditions specifically imposed on those who choose to do business with the government.”
Authoritative Guidance
The Seventh Circuit held that in order to be “authoritative,” guidance must issue from “either circuit court precedent or guidance from the relevant agency.” The court also stated that the guidance must be “specific enough to put a defendant on notice that its conduct is unlawful.” Notably, the Seventh Circuit did not address the question of whether agency guidance must be “binding” – rather, the court looked to the “totality of the circumstances” to determine that a footnote in the Medicare Prescription Drug Benefit Manual was not authoritative.
The Solicitor General has also taken issue with the Seventh Circuit’s position on the requisite criteria for authoritative guidance. Specifically, the court erred in holding that only circuit-court precedents or relevant agency guidance are “sufficiently authoritative” to give notice of a claim’s falsity for a defendant to act with the necessary knowledge. According to the Solicitor General, this standard would be “particularly inappropriate under the FCA” as it applies to claims submitted under contracts with non-federal intermediaries who help administer federal spending programs such as Medicare and Medicaid. The Solicitor General argues that there is consequently “no sound basis” to allow participants of such programs to disregard guidance from or contracts with those non-federal intermediaries when Congress has designated the same to administer the federal claims.
If the Supreme Court does affirm the Seventh Circuit’s holdings extending the Safe standard to the FCA, it will be important to see whether the Court also refines what constitutes “authoritative guidance” necessary to “warn away” defendant conduct.
Establishing FCA Violations
If the Supreme Court accepts the Seventh Circuit’s Schutte standard for FCA scienter, FCA cases involving interpretations of authoritative guidance will likely be decided at the pleading stage as a question of law without discovery. Doing so may also discourage qui tam relators and others from alleging FCA liability in matters involving a defendant’s interpretation of ambiguous and complex statutory and regulatory schemes. On the other hand, if the Supreme Court agrees with the Solicitor General and reverses the Seventh Circuit’s decisions, ambiguous statutory and regulatory schemes may potentially present additional FCA risk.
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