Fourth Circuit Adopts Objective Reasonableness Standard in Determining Scienter Element of the False Claims Act

The Fourth Circuit, in United States ex rel. Sheldon v. Allergan Sales, LLC, No. 20-2330, 2022 WL 211172 (4th Cir. Jan. 25, 2022) recently upheld the dismissal of False Claims Act (“FCA”) lawsuit brought by a quit tam relator (“Relator”) against his employer, Forest Laboratories, LLC (“Forest”) alleging that Forest engaged in a fraudulent price reporting scheme under the Medicaid Drug Rebate Statute (“Rebate Statute”).[1]

Notably, the Fourth Circuit adopted the US Supreme Court’s decision in Safeco Ins. Co. of Am. v. Burr, 551 U.S. 47 (2007) in holding that the scienter element of the FCA is subject to an “objective reasonableness” standard, where a defendant can defeat FCA liability by establishing that its interpretation of the applicable statute or regulation was objectively reasonable and that no authoritative guidance from a court or agency could have “warned defendant away” from that interpretation. Just last year, the Seventh Circuit adopted this standard in U.S. ex rel. Schutte v. SuperValu Inc., joining the Third, Eighth, Ninth, and DC Circuits in holding the same.  

At issue in Sheldon was the reasonableness of Forest’s interpretation of the Rebate Statute in determining how it calculated certain discounts given to separate customers for purpose of reporting its “best price” to the government. The District Court dismissed the complaint on the basis that Forest’s reading of the Rebate Statute was “objectively reasonable,” there was no authoritative guidance to the contrary, and thus Forest did not act “knowingly” under the FCA. The Fourth Circuit affirmed.[2]

The FCA

The FCA applies to those who knowingly submit false or fraudulent claims for payment to the federal government.^[3] To this end, the FCA creates liability for any person who, inter alia, “(A) knowingly presents, or causes to be presented, a false or fraudulent claim for payment or approval; [or] (B) knowingly makes, uses, or causes to be made or used, a false record or statement material to a false or fraudulent claim.”^[4] Thus, the party alleging an FCA violation must prove: (1) defendant made false statements or engaged in a fraudulent course of conduct; (2) with the requisite knowledge; (3) the statements or conduct were material; and (4) caused the government to pay out money or to forfeit monies due on a “claim.”^[5] The FCA defines several of its terms—“claim,”^[6] “knowingly,”^[7] and “material”^[8]—however, it does not define what is “false” or “fraudulent.”

The Medicaid Rebate Statute

Medicaid offers federal financial assistance to states that reimburse certain medical expenses for eligible individuals, a well-known component of which includes prescription drugs.[9] To ensure that Medicaid receives the “best price” from a manufacturer that it would otherwise sell its prescription drugs to a public or private purchaser, Congress enacted the Rebate Statute.[10] Participating manufacturers are required to execute Rebate Agreements with Secretary of Health and Human Services (“HHS”), provide quarterly rebates to states, and report its “Average Manufacturer Price” and its “Best Price” for covered drugs to the Centers for Medicare & Medicaid Services (“CMS”).[11] Thus, whatever rebate is provided to the state by the manufacturer, the payments by the Federal Government are reduced by the same amount.[12] Both the Rebate Statute and the CMS regulations define the “Best Price” to essentially include the lowest price the manufacturer sells its drugs to institutions and governmental entities. Due to Medicaid’s complexity, both the Rebate Agreement and the CMS regulations provided for the ability of manufacturers to make reasonable assumptions in calculating their Best Price in the absence of specific guidance.[13]

Relator’s Complaint

The Relator alleged that that Forest erred in calculating its “Best Price” under the Rebate Statute by giving discounts to separate customers along distribution chains and failing to account for those combined amounts in its Best Price calculation.[14] Relator’s false claim was premised on the net effect of Forest’s actions, in that Forest was paying reduced rebates to participating states, resulting in the government reimbursing at least $680 million more than it would have had Forest accurately reported its Best Price.[15]

The decision provides an example to illustrate this effect—Relator alleged that in FY 2013, Forest gave a 20% discount to a patient’s insurance company and a 10% discount to the same patient’s pharmacy—two different entities on the distribution chain, and that Forest was required to aggregate these two discounts.[16] Thus, Relator alleged that Forest’s Best Price that it should have reported to CMS was 70%. However, Forest only reported the higher of the two discounts (20%) and reported a Best Price of 80% (thereby giving Medicaid the statutory minimum rebate percentage of 23.1%).[17] Because Relator alleged that the rebate should have been 30%, Relator alleged that the Government thus paid 6.9% more for this particular drug than it should have.

The Fourth Circuit’s Adoption of Safeco

The Fourth Circuit focused on the scienter element of the FCA, which the Supreme Court noted in Universal Health Servs., Inc. v. United States, 579 U.S. 176, 136 S. Ct. 1989, 2001, 195 L. Ed. 2d 348 (2016) (“Escobar”) as a “rigorous” requirement.[18] Noting that, although the FCA defines “knowingly” to include actual knowledge, deliberate ignorance, and reckless disregard, the FCA does not provide guidance as to how these terms apply in situations where a Defendant has the subjective belief that it complied with a statute or regulation.[19]

To compensate for this gap in the statute, the Fourth Court turned to the US Supreme Court’s scienter analysis in Safeco, which, in interpreting the scienter requirement under the Fair Credit Reporting Act (“FCRA”), requires a finding that a defendant acted “willfully” to support a violation of the statute.[20] The Supreme Court then determined that “willfully” under the FCRA included both (1) knowing and (2) reckless violations of the statute.[21] The Supreme Court defined “recklessness” as “conduct violating an objective standard: action entailing ‘an unjustifiably high risk of harm that is either known or so obvious that it should be known,’” and notably determined that a defendant’s subjective intent was irrelevant—in essence, subjective bad faith could not defeat a defendant’s objectively reasonable reading of a statute.[22]

Thus, Safeco established a two-step analysis to determine reckless disregard: The first step examines whether defendant's interpretation of the relevant statute was objectively reasonable. The second step examines whether authoritative guidance, i.e. guidance issued by the government to clarify a law, might have warned defendant away from that reading.[23]

In applying the Safeco framework to the FCA—as has been done by numerous other circuits—the Fourth Circuit concluded that, “a defendant cannot act ‘knowingly’ if it bases its actions on an objectively reasonable interpretation of the relevant statute when it has not been warned away from that interpretation by authoritative guidance.”[24] Furthermore, the court held “[t]his objective standard precludes inquiry into a defendant’s subjective intent.”[25] Thus, what was critical in the court’s analysis was whether defendant’s interpretation of the relevant statute was reasonable and grounded in statutory text—even if that interpretation was incorrect.[26] Important to this analysis was whether the defendant had any guidance from the courts or the agency “that might had warned it away from the view it took.”[27]

In affirming the use of the Safeco framework, the Fourth Circuit placed certain limitations on the application of the precedent to FCA cases. For instance, the court held that Safeco does not apply to “factually false” claims, i.e. the “paradigmatic FCA action” in which a payee makes a factually false claim by either (1) submitting an incorrect description of the goods or services provided; or (2) requesting reimbursement for goods or services never provided.[28] Rather, Safeco is applicable only to “legally false” claims—as was the case in Sheldon—where a defendant has provided the goods or services to the government, directly or indirectly, for the agreed upon price, but failed to comply with an ancillary requirement in a statute, regulation, or contract.[29]

In further caveating its application to FCA cases, the court also confirmed that Safeco requires an objectively reasonable reading of a statute, and thus defendants who begin with an unreasonable reading of a statute will face increased risk of FCA prosecution.[30] In that vein, the court noted that “not every objectively reasonable reading will suffice,” as the government has the ability to issue clarifying authoritative guidance, and thus defendants who “turn a blind eye” to such guidance will not be shielded from liability.[31]

Perhaps most critically, the court expounded upon the importance of notice and due process in the context of legal falsity cases to ensure that defendants are afforded due process “before facing liability for allegedly failing to comply with complex legal requirements.”[32] The court stated that “[i]t is profoundly troubling to impose such massive liability on individuals or companies without any proper notice as to what is required” and that “Safeco avoids this trouble by making the government “provide a reasonably clear standard of culpability to circumscribe the discretion of the enforcing authority and its agents.”[33]

The Fourth Circuit’s Application of Safeco to Relator’s Allegations

Here, the Fourth Circuit applied the Safeco two-part test.

First, the Fourth Circuit found Forest’s reading of the Rebate Statute to be objectively reasonable, as the plain language of the statute indicated that the Best Price is “one offered to a single entity” rather than aggregate discounts given to separate customers as alleged by Relator.[34] However, this simple fact did “not give Forest a free ride”—the court also considered the fact that the statute includes aggregating discounts to a single entity even if given at different points in time—but noting that that is as far as the statute can be stretched.[35] The court confirmed that other provisions in the Rebate Statute confirmed this reading, and even beyond the statutory text, this reading confirmed with “practical realities” in that the “Medicaid statutes and regulations are among the most completely impenetrable texts within human experience.”[36] The court also examined the CMS regulations and determined that they simply mirror the statutory language.[37] In sum, the court concluded that Forest’s reading “has a foundation in the statutory text.”[38]

Second, the court found that CMS did not warn Forest away from its objectively reasonable reading, as none of its guidance dealt with aggregating discounts to different entities.[39] Rather, the court found that CMS knew as early as 2006 that manufacturers were not aggregating discounts given to different entities along supply chains.[40] In comments on its proposed Medicaid drug pricing rule, CMS stated that Best Price “has always been interpreted to mean the single lowest price to a particular customer.”[41] Moreover, the final rule, which adopted all material aspects of the proposed rule’s Best Price definition, merely reflected the Rebate Statute, which supports Forest’s interpretation.[42]

Key Takeaways

As the Fourth Circuit now joins several other circuits in applying the Safeco framework to FCA cases, this case illustrates the ever evolving jurisprudence around interpretation of the various FCA elements, particularly in their application to legal falsity cases. For instance, the Supreme Court’s Escobar decision has sparked much debate over the “materiality” provision of the FCA. Meanwhile, the notion that an “objective falsehood” be established to prove the “falsity” element of the FCA (an undefined term in the statute) has been called into question in the context of “medical necessity” cases, which involve examination of whether and when a physician’s medical opinions regarding the condition of a patient can be established as false.[43]

A common thread across these legal falsity cases, i.e. a claim premised on failure to comply with an applicable statute or regulation, is, as was at issue in Sheldon, a defendant’s interpretation of a statute. This becomes increasingly difficult given the recent issuance of what is known as the Garland Memorandum, which grants permission to agencies to use “sub-regulatory guidance”—guidance that typically circumvents the notice and comment rulemaking process—in FCA prosecution for pursing false certification violations. Such permission naturally affords those agencies deference to their interpretation of their own self-promulgated guidance. Thus, in the context of Sheldon and its predecessors, it will be interesting to see how courts continue to measure a defendant’s interpretation of a statute, regulation, or even sub-regulatory guidance for purposes of compliance in determining FCA liability.

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 [1] 42 U.S.C. § 1396r-8.

[2] United States ex rel. Sheldon v. Allergan Sales, LLC, No. 20-2330, 2022 WL 211172 (4th Cir. Jan. 25, 2022)

[3] 31 U.S.C. §§ 3729 – 3733.

[4] 31 U.S.C. § 3729(a)(1)

[5] United States ex rel. Rostholder v. Omnicare, Inc., 745 F.3d 694, 700 (4th Cir. 2014).

[6] “Claim” means any request or demand for money or property (regardless of whether or not the United States has title to the money or property) that: (i) “is presented to an officer, employee, or agent of the United States”; (ii) or “is made to a contractor, grantee, or other recipient, if the money or property is to be spent or used on the Government’s behalf or to advance a Government program or interest,” and if the United States government either “provides or has provided any portion of the money or property requested or demanded”; (iii) or “will reimburse such contractor, grantee, or other recipient for any portion of the money or property which is requested or demanded.” § 3729(b)(2)(A)

[7] “Knowingly” means that person: (i) has actual knowledge about the falsity of a claim, (ii) “acts in deliberate ignorance of the truth or falsity” of the claim, or (iii) acts with “reckless disregard of the truth or falsity” of the claim. The FCA does not require proof that the person specifically intended to defraud the government. 31 U.S.C. § 3729(b)(1).

[8] “Material” is defined as “having a natural tendency to influence, or be capable of influencing, the payment or receipt of money or property.” § 3729(b)(4).

[9] United States ex rel. Sheldon v. Allergan Sales, LLC, No. 20-2330, 2022 WL 211172, at *2 (4th Cir. Jan. 25, 2022); 42 U.S.C. § 1396d(a)(12).

[10] 42 U.S.C. § 1396r-8.

[11] United States ex rel. Sheldon v. Allergan Sales, LLC, No. 20-2330, 2022 WL 211172, at *2 (4th Cir. Jan. 25, 2022)

[12] Id.

[13] Id. at *2 

[14] Id. at *3

[15] Id.

[16] Id.

[17] Id.

[18] Id. at *4 

[19] Id.

[20] Id.

[21] Id.

[22] Id.

[23] Id.

[24] Id. at *5 

[25] Id.

[26] Id.

[27] Id. at *4 

[28] Id. at *6.

[29] Id.

[30] Id.

[31] Id.

[32] Id. Citing FCC v. Fox Television Stations, Inc., 567 U.S. 239, 253, 132 S.Ct. 2307, 183 L.Ed.2d 234 (2012) (“A fundamental principle in our legal system is that laws which regulate persons or entities must give fair notice of conduct that is forbidden or required.”)

[33] Id.

[34] Id. at *8

[35] Id.

[36] Id.

[37] Id.

[38] Id.

[39] Id.

[40] Id.

[41] Id.

[42] Id.

[43] See United States v. Care Alternatives, 952 F.3d 89, 96 (3d Cir. 2020), cert. denied, 141 S. Ct. 1371, 209 L. Ed. 2d 119 (2021); United States v. AseraCare, Inc., 938 F.3d 1278, 1282 (11th Cir. 2019); United States ex rel. Winter v. Gardens Regional Hospital & Medical Center, Inc., 953 F.3d 1108, 1113 (9th Cir. 2020), cert. denied sub nom. RollinsNelson LTC Corp. v. United States ex rel. Winter, 141 S. Ct. 1380, 209 L. Ed. 2d 124 (2021)