False Claims Act Knowledge Element After Schutte: What Is Lost, What Remains, What Companies Should Do Next To Minimize Exposure To Liability

• Published date: 14 July 2023
• Subject Matter: Corporate/Commercial Law, Government, Public Sector, Litigation, Mediation & Arbitration, Food, Drugs, Healthcare, Life Sciences, Compliance, Corporate and Company Law, Government Contracts, Procurement & PPP, Trials & Appeals & Compensation
• Law Firm: Akin Gump Strauss Hauer & Feld LLP
• Author: Mr Robert S. Salcido

Key Points

• Supreme Court eliminates FCA scienter defense based solely upon an objectively reasonable interpretation of ambiguous law when defendant has subjective knowledge that claim is false.
• Supreme Court ruled that the FCA's scienter element applied to defendant's subjective beliefs at the time defendant submitted claims.
• Other related FCA defenses should remain in effect, such that defendants have valid FCA defenses if there is objective ambiguity and there is a genuine subjective belief in the validity of the claim; if defendant has an honest opinion as to the accuracy of the claim; or acts with mere negligence or inadvertence.
• In light of the Court's rejection of the reasonable interpretation of ambiguous law doctrine, companies can reduce potential exposure to liability by ensuring that they investigate employee complaints, develop processes to ensure that their practices conform to law, review relevant industry publications or billing practices to confirm entitlement, and making periodic inquiries of government officials when confronting ambiguous guidance because courts have found that those who engage in these practices do not act with substantial and unjustifiable risk that their claims are false in violation of the FCA.

Before the Supreme Court's ruling in U.S. ex rel. Schutte v. SuperValu Inc.,¹ seven circuit courts of appeal had ruled that the defendant was innocent under the False Claims Act (FCA) if the defendant could show that objectively: (i) the governing statute, regulation or contract that was allegedly breached was ambiguous in relevant part; (ii) under a reasonable interpretation of the governing provision, the defendant's representation could be accurate, not false; and (iii) there was no official governmental guidance to warn defendant away from that reasonable interpretation.² If defendant was able to satisfy these three elements, courts ruled that defendants' subjective intent did not matter³ and it did not matter whether defendant held this interpretation before it submitted its claims or whether it developed this construction of law after claims were submitted.⁴ Further, because the test was objective, courts could determine the issue as a matter of law.⁵

In Schutte, the Supreme Court considered whether the reasonable interpretation of ambiguous law doctrine is solely an objective test or whether defendant's subjective intent should be considered in determining whether defendant acted with scienter under the FCA. The Court ruled that the FCA's scienter element applied to defendant's subjective beliefs at the time defendant submitted claims.⁶

This article examines the Supreme Court's ruling in Schutte; assesses what defenses are left for those confronting ambiguous law; and proposes steps companies can take to minimize exposure to liability in light of the Court's ruling. As to defenses that remain, defendants, under existing case law, may still prevail if the law is ambiguous and defendants have a genuine belief that their practices conform with law or are able to show that, as most, their claims were based on an honest mistake or mere negligence, that is, acted without substantial and unjustifiable risk that their claims are false. As to steps to minimize risk of liability, companies should act to ensure that they investigate employee complaints, develop processes to ensure that their practices conform to law, review relevant industry publications or billing practices of others to confirm entitlement or make inquiries of the government because courts have found that those who engage in these practices do not act with substantial and unjustifiable risk that their claims are false.

The Court's Ruling in Schutte

In Schutte, Justice Thomas, writing for the Court, observed that, at times, a law is "open to interpretation" but a person might correctly understand what the law means in context and may submit claims that are inaccurate anyway.⁷ The Court noted that in Schutte it had to consider whether, under these circumstances, the defendant may knowingly submit false claims under the FCA.⁸

In Schutte, under the governing law, pharmacies were required to bill Medicare and Medicaid for their "usual and customary" drug prices.⁹ The Court noted that, at the trial court level, relators contended that the pharmacies reported "usual and customary" prices that were higher than the discounted prices that were the pharmacies actual usual and customary prices.¹⁰ For example, relators presented evidence that Safeway charged just $10 for 94% of its cash sales for a 90-day supply of a cholesterol drug between 2008 and 2012.¹¹ Yet Safeway apparently reported prices as high as $108 as "usual and customary" during that time.¹² Similarly, the Court noted that relators presented evidence that at least for some drugs for some time periods SuperValu made more than 80% of its case sales for prices less than what it disclosed as its "usual and customary" price.¹³

Further, relators claimed that the pharmacies were informed that their lower, discounted prices were their "usual and customary" prices, believed that their discounted prices were "usual and customary" prices and tried to hide their discounted prices from regulators and contractors.¹⁴ According to relators, evidence of this included that both SuperValu and Safeway received a notice in 2006 from a pharmacy benefit manager stating that the phrase "usual and customary" refers to discounted prices.¹⁵ Further, relators contended that executives at both companies raised concerns about letting state agencies or pharmacy benefit managers learn about their discounted prices.¹⁶

At the trial court level, the district court ruled against SuperValu on the falsity element, concluding that SuperValu's discounted prices were it "usual and customary" price and that, by not reporting them, SuperValu submitted false claims, but granted SuperValu summary judgment on the scienter element, ruling that SuperValu could not have acted "knowingly."¹⁷ Soon after, it granted Safeway summary judgment on the same basis.¹⁸ The Seventh Circuit affirmed.¹⁹ It found that the pharmacies' actions were consistent with an objectively reasonable interpretation of the phrase "usual and customary" because "the phrase could have been understood as referring to [the pharmacies'] retail prices, not their discounted prices."²⁰ Thus, the court reasoned that it did not matter whether the pharmacies thought that their discounted prices were actually their "usual and customary" prices.²¹ But what mattered was that "someone else" may have reasonably thought that the retail prices were what counted.²²

In light of this factual and procedural background, the Court sought to resolve the following legal question:

"If [pharmacies'] claims were false and they actually thought that their claims were false'because they believed that their reported prices were not actually their 'usual and customary' prices'then would they have 'knowingly' submitted a false claim within the FCA's meaning? Or is the Seventh Circuit correct'that respondents could not have 'knowingly' submitted a false claim unless no hypothetical, reasonable person could have thought that their reported prices were their 'usual and customary' prices?²³"

In addressing this legal question, the Court concluded that based on "the FCA's statutory text and its common-law roots, the answer to the question presented is straightforward: The FCA's scienter element refers to respondents' knowledge and subjective beliefs'not to what an objectively reasonable person may have known or believed."²⁴ The Court further concluded that facial ambiguity alone is not sufficient to preclude a finding that the pharmacies knew their claims were false.²⁵

As to the FCA's text, the Court noted that the FCA's actual knowledge, reckless disregard and deliberate ignorance standards largely track the traditional common-law scienter requirements for claims of fraud.²⁶ The court noted that on their face and at common law, the FCA's standards "focus primarily on what respondents thought and believed."²⁷ For example, "the term 'deliberate ignorance' encompasses defendants who are aware of a substantial risk that their statements are false, but intentionally avoid taking steps to confirm the statement's truth or falsity."²⁸ And the term reckless disregard, "captures defendants who are conscious of a substantial and unjustifiable risk that their claims are false, but submit the claims anyway."²⁹ Under these facts, the Court concluded that defendants could have acted with sufficient scienter to breach the FCA. The Court observed that what "typically matters at common law is whether the defendant made the false statement 'without belief in its truth or recklessly, careless of whether it is true or false'."³⁰ "If a defendant knows that he 'lack[s an] honest belief' in the statement's truth, that is often enough to establish scienter for fraud."³¹

The Court also concluded that "the text and the common law also point to what the defendant thought when submitting the false claim'not what the defendant may have thought after submitting it."³² Thus, defendants cannot rely upon "post hoc interpretations that might have rendered their claims accurate."³³ The focus instead is "on what the defendant knew when presenting the claim."³⁴

What Defenses Were Lost and What Remains After Schutte

To navigate in the post-Schutte world and to reduce the likelihood of FCA liability, it is important to understand what FCA knowledge-based defenses remain, what knowledge-based defenses specifically were lost and what precedent remains indicating when a company is not acting with "substantial and unjustifiable risk" regarding the presentation of a false claim. Specifically, under the case law, defendants have valid FCA defenses if there is objective ambiguity and there is a genuine subjective belief in the validity of the claim; if defendant has an honest opinion as to the accuracy of the claim; or acts...