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Court says that fraudsters who violate rules they later claim are unclear may not violate the False Claims Act

Posted  August 19, 2021

Last week, the Seventh Circuit Court of Appeals, the federal appellate court for Illinois, Indiana, and Wisconsin decided U.S. ex rel. Yarberry v. Supervalu, an important decision that may lead more unscrupulous government contractors to help themselves to public funds to which they are not entitled.  Unless the Supreme Court or Congress steps in to correct the Seventh Circuit’s errors, the government may have considerably less power to go after contractors who cheat.

In Supervalu, two whistleblowers alleged that Supervalu pharmacies submitted claims for payment to government healthcare programs, including Medicare and Medicaid, that was false because Supervalu did not report its true “usual and customary” drug prices to these payers for millions of sales.  “Usual and customary” prices are the amounts at which pharmacies sell prescription drugs to “cash” customers who do not have insurance coverage for the drugs.  Government payers use the “usual and customary” drug prices pharmacies like Supervalu charge as a limit on what the government will pay for the drugs.

The whistleblowers alleged that when Supervalu reported to the government its “usual and customary” prices, it failed to include drugs it sold under a widely advertised and publicly available price-matching discount program.  The result was that Supervalu told the government its “usual and customary” prices were much higher than they actually were—and that the government paid tens of millions of dollars more each year for the drugs than it would have if Supervalu’s reports were accurate.

The whistleblowers sued Supervalu on behalf of the federal government under the federal False Claims Act (FCA).  To prevail, they had to show that Supervalu knowingly submitted false claims to the government.  Congress gave the whistleblowers three ways to prove that Supervalu submitted false claims “knowingly.”  They could present to a jury evidence that Supervalu had “actual knowledge” that the claims were false because Supervalu excluded discount sales from the “usual and customary” prices it told the government it charged cash customers.  Or they could show that Supervalu acted in “deliberate ignorance” of falsity of its price reports to the government.  Or the whistleblowers could demonstrate that Supervalu “recklessly disregarded” the falsity of the information in the reports.

In the district court, Supervalu argued that a defendant in an FCA case cannot “knowingly” violate a legal requirement that has more than one reasonable interpretation.  The district court agreed with Supervalu.  The court concluded that Supervalu could have reasonably understood that “usual and customary” price reporting does not include the discount programs it offered—even if its understanding was wrong and even if Supervalu did not actually understand the price-reporting requirement that way.  As a result, the district court granted summary judgment to Supervalu on the issue of knowledge, which doomed the whistleblowers’ case.

The Seventh Circuit affirmed the lower court’s ruling, announcing two major holdings, over a vigorous dissent.  First, the court held that the standard for proving intent that the Supreme Court articulated in Safeco Insurance Company of America v. Burr, 551 U.S. 47 (2007), a case that interpreted the intent provision of the Fair Credit Reporting Act (FCRA), applied to the FCA.  Safeco interpreted the FCRA’s common-law scienter requirement, under which plaintiffs must show that defendants acted “willfully,” a term the Supreme Court said includes both “knowing” and “reckless disregard.”  “Reckless disregard,” as noted above, is included in the FCA’s definition of “knowingly.”

Safeco described a two-step inquiry to determine “reckless disregard.”  A defendant who has an incorrect interpretation of a statute or regulation does not act with reckless disregard if (1) the defendant’s interpretation is objectively reasonable and (2) no “authoritative guidance” cautioned the defendant against its interpretation.  Critically, a defendant’s subjective intent is irrelevant. In other words, it doesn’t matter what a defendant actually believed.  And it doesn’t matter if a defendant actually thought it was violating the law.

Second, the majority held that the Safeco standard reaches all three scienter terms that define “knowingly” under the FCA.  Even though Safeco’s analysis was limited to defining “reckless disregard,” the majority held that “reckless disregard” was the “baseline” intent standard that a whistleblower must necessarily establish before proving the more demanding standards for “deliberate ignorance” or “actual knowledge.”

Judge Hamilton’s dissent pulled no punches: “The issue is whether the [FCA] can reach businesses that submit false claims for government payment but claim there is some legal ambiguity that kept them from ‘knowing’ for certain that their claims were false.  Under the text and history of the [FCA], the answer should be yes. [But] [t]he majority answers no.  It thus creates a safe harbor for deliberate or reckless fraudsters whose lawyers can concoct a post hoc legal rationale that can pass a laugh test.”  The dissent faulted the majority’s interpretation for conflicting with the FCA’s text, its common-law foundations, and the law’s history and purposes.  And while the dissent acknowledged that two other circuit courts have applied Safeco to the FCA in binding decisions, the majority’s holding deepens a circuit split concerning the FCA’s knowledge standard.

The most troubling aspect of Supervalu is its holding that bad faith and a defendant’s subjective understanding of legal requirements are irrelevant.  That’s the exact opposite of the way in which courts assess intent under the common law of fraud, and how they should continue to assess it under the FCA.  If Supervalu were extended, it could mean that intent could become a question of law.  A defendant may seek to use that theory to argue for dismissal, by urging a court that it had a reasonable interpretation of a legal requirement, even where a mountain of evidence may show the defendant did not actually have that interpretation or was warned away from it by advisors and experts.

Supervalu may create potential hurdles for whistleblowers and the government in FCA cases.  Until the full Seventh Circuit reconsiders the panel majority’s opinion, the Supreme Court clarifies the knowledge standard under the FCA, or Congress rewrites the law, fraudsters may enjoy a freer hand, at least in some parts of the Midwest.

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Tagged in: Contract Non-Compliance, Court Decision, Drug and DME Pricing, FCA Federal, Government Procurement Fraud, Healthcare Fraud, Medicaid, Medicare, Pharma Fraud, Pricing Fraud, Whistleblower Case,