By Robert Rhoad, Andy Liu, and Haaleh Katouzian

On May 10, 2022, the Fourth Circuit granted a rehearing en banc for a case decided earlier this year, United States ex rel. Sheldon v. Allergan Sales, LLC.

In 2014, a relator brought a qui tam action against his employer, Forest Laboratories, LLC (Forest), alleging that Forest “engaged in a fraudulent price reporting scheme under the Medicaid Drug Rebate Statute[.]”  The Medicaid Drug Rebate Statute (Rebate Statute) requires a drug manufacturer to report its “Best Price” to the Centers for Medicare & Medicaid Services (CMS) so that CMS can calculate rebates it is owed based on that price.  The relator argued that Forest gave different discounts to different customers on the distribution chain but failed to aggregate those discounts when calculating its Best Price, resulting in the government paying $680 million more than if the discounts were aggregated.

The majority, in a 2-1 decision, included the following as an example of the allegation: “on one covered drug, [the relator] alleged that in FY2013 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 . . . [The relator] alleged that Forest was required to aggregate these discounts, report a Best Price of 70%, and give Medicaid a 30% rebate. Instead, Forest did not aggregate these discounts because they were given to different entities, reported a Best Price of 80% (based on the highest discount given to a single entity), and gave Medicaid a 23.1% rebate . . . [The relator] allege[d] that this led to the federal government paying 6.9% more for this drug than it would have if Forest had accurately reported Best Price.”

Forest moved to dismiss the action, arguing, among other things, that there could be no “knowing violation” of the False Claims Act (FCA) because its interpretation of the Rebate Statute was plausible and objectively reasonable.  The Fourth Circuit agreed.  Because “[t]he FCA defines ‘knowingly’ as including actual knowledge, deliberate ignorance, and reckless disregard” and “Safeco interpreted ‘willfully’ to include both knowledge and recklessness[,]” the Fourth Circuit, reasoned that the Supreme Court’s scienter standard set forth in Safeco Insurance Co. of America v. Burr, 551 U.S. 47 (2007) (“Safeco”) (addressing willfulness/scienter under Fair Credit Reporting Act), applied to the FCA.[1]

The Court concluded that the relator “failed to plead scienter as required by the FCA” because “Forest’s reading of the Rebate Statute was not only objectively reasonable but also the most natural. And Forest was not warned away from its reading by authoritative guidance from CMS.”[2]  The Court held that the defendant’s reading of the statutory text was “the best reading of that text” and that “CMS knew as early as 2006 that manufacturers were not aggregating discounts given to different entities along supply chains” but “never clearly stated that discount aggregation to different entities was required, [so] it did not act with the specificity necessary to warn Forest away from its interpretation.”

The majority made clear that Safeco only applied to legally false claims, such as those in the case before it.  Additionally, the majority stated that Safeco does not “write defendants a blank check.”  The Safeco test still “requires an objectively reasonable reading of the statute”—“and not every objectively reasonable reading will suffice.”  The test also “allows the government to issue authoritative guidance that clarifies its interpretation of the law and so warns defendants away from otherwise reasonable interpretations.”  Thus, “Safeco’s standard duly ensures that defendants must be put on notice before facing liability for allegedly failing to comply with complex legal requirements.”

“If the government wants to hold people liable for violating labyrinthine reporting requirements, it at least needs to indicate a way through the maze.”  The relator’s position, the majority stated, “instead makes sinister actors out of parties who have followed the law in every respect and sought administrative guidance where none was ever provided” and ultimately “takes the FCA a very long step toward a strict liability statute.”  It went on to hold that “[t]he False Claims Act does not assess liability through ambush. Companies must instead knowingly submit a false claim to be liable. And Forest simply did not do so here.”

The dissent strongly disagreed.  The Safeco decision, the dissent reasoned, instead “concerned a narrow issue: the proper interpretation of the Fair Credit Reporting Act’s scienter requirement.”  The dissent stated that the majority’s opinion “effectively neuter[ed] the False Claims Act—the Government’s primary tool for fighting fraud—by eliminating two of its three scienter standards (actual knowledge and deliberate ignorance) and replacing the remaining standard with a test (objective recklessness) that only the dimmest of fraudsters could fail to take advantage of.”

The rehearing of Allergan en banc will be closely watched given the importance of the applicability of Safeco to FCA claims, especially with similar cases moving up toward the Supreme Court.[3]

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[1] The Fourth Circuit, “[i]n adopting this standard, . . . join[ed] each and every circuit that has considered Safeco’s applicability to the FCA.”

[2] This reasoning follows the “two-step analysis as to reckless disregard” identified by Safeco.

[3] See e.g., United States ex rel. Schutte v. SuperValu Inc., 9 F.4th 455 (7th Cir. 2021).  A petition for a writ of certiorari was filed on April 1, 2022.  The question presented is “[w]hether and when a defendant’s contemporaneous subjective understanding or beliefs about the lawfulness of its conduct are relevant to whether it ‘knowingly’ violated the False Claims Act.”  For the petition, see here.