On January 25, in a 2-1 decision in U.S. ex rel. Sheldon v. Allergan Sales, LLC, 2022 WL 211172, the Fourth Circuit became the most recent federal appellate court to hold that the objective scienter standard in the Supreme Court’s Safeco decision applies to the False Claims Act (FCA). Under the Fourth Circuit’s decision, the FCA’s scienter element cannot be met if the defendant’s interpretation of applicable statutory or regulatory requirements was objectively reasonable and no authoritative guidance from a circuit court or government agency warned the defendant away from its interpretation.

The Seventh Circuit’s similar holding last year in U.S. ex rel. Schutte v. SuperValu Inc. was one of the most important False Claims Act cases of 2021. Expect Sheldon to be a consequential decision as well.

Factual Background

The Fourth Circuit’s opinion in Sheldon follows from a declined complaint in which the relator alleged that a pharmaceutical manufacturer, Forest Laboratories, LLC (later merged into Allergan Sales, LLC), fraudulently reported its “Best Price” under the Medicaid Drug Rebate Statute, 42 U.S.C. § 1396r-8. The Rebate Statute requires manufacturers seeking to have their drugs covered by Medicaid to provide quarterly rebates to the government based on sales of their drugs. The rebate amount is the greater of a statutory minimum rebate or the difference between the manufacturer’s Average Manufacturer Price and its Best Price. The Rebate Statute and Centers for Medicare and Medicaid Services (CMS) regulations define Best Price as the “lowest price available” from the manufacturer during the rebate period.

The relator alleged that Forest provided separate discounts to different entities along the distribution chain—a 20% discount to a patient’s insurance company and a 10% discount to the patient’s pharmacy, for example—but failed to aggregate these discounts when reporting its Best Price—in this example, by reporting a Best Price of 80% reflecting only its discount to the insurance company, rather than an aggregated Best Price of 70%. Forest was allegedly required to aggregate its discounts, and the relator claimed its failure to do so caused the government to overpay by $680 million.

The district court granted Forest’s motion to dismiss, and the Fourth Circuit affirmed.

Fourth Circuit Opinion Adopting Safeco

The Fourth Circuit noted that courts are “tasked with ‘strict enforcement’ of the False Claims Act’s ‘rigorous’ scienter requirement.” With this in mind, the Fourth Circuit held that the objective scienter standard the Supreme Court articulated in Safeco Ins. Co. of Am. v. Burr, 551 U.S. 47 (2007), applies to the FCA.

The Fourth Circuit acknowledged that Safeco interpreted the term “willfully” with respect to the Fair Credit Reporting Act. But the Supreme Court interpreted “willfully” to include both knowledge and recklessness, and the FCA defines scienter to include “actual knowledge, deliberate ignorance, and reckless disregard.” Given this “parallel,” the Fourth Circuit held that Safeco’s reasoning applies with equal force to the FCA.

According to the Fourth Circuit, Safeco “set forth a two-step analysis,” “first asking whether defendant’s interpretation was objectively reasonable and then determining whether authoritative guidance might have warned defendant away from that reading.” This constitutes a “threshold requirement” shared by all three FCA scienter terms: actual knowledge, deliberate ignorance, and reckless disregard.

The Fourth Circuit rejected concerns that Safeco “writes defendants a blank check.” Safeco first requires “an objectively reasonable reading of the statute,” the court emphasized. And even then, “not every objectively reasonable reading will suffice.” If the defendant has been warned away from its interpretation by authoritative guidance—which the court held is limited to circuit court precedent or relevant agency guidance “with sufficient specificity to be able to function as a warning”—then Safeco does not apply.

The Fourth Circuit observed that the Safeco standard “duly ensures that defendants must be put on notice before facing liability for allegedly failing to comply with complex legal requirements.” Such notice is required under the FCA, the court reasoned, to provide defendants “due process” when faced with “damages that are essentially punitive in nature.” “It is profoundly troubling,” the Fourth Circuit said, “to impose such massive liability on individuals or companies without any proper notice as to what is required.” Safeco avoids these concerns by “putting the burden where it belongs. If the government wants to hold people liable for violating labyrinthine reporting requirements, it at least needs to indicate a way through the maze.”

Applying this analysis, the Fourth Circuit concluded that Forest was entitled to dismissal because its interpretation of the Rebate Statute and CMS regulations was at least objectively reasonable, and there was no authoritative guidance warning Forest that it was required to aggregate its rebates.

Takeaways

We have written about the Seventh Circuit’s Schutte decision from last year, which similarly adopted Safeco’s objective scienter standard in the context of the False Claims Act (and stay tuned for additional discussion about Schutte and other scienter cases in our upcoming Healthcare Fraud and Abuse Review 2021). Sheldon will also be a consequential decision as courts continue to grapple with the False Claims Act’s scienter requirement. Given the dissents in both Schutte and Sheldon, we expect this issue to be litigated vigorously in FCA cases in the years to come.