Claims for Interference With At-Will Contracts Now Require Independently Wrongful Act

Manatt, Phelps & Phillips, LLP

Manatt, Phelps & Phillips, LLP

On August 3, 2020, the California Supreme Court held in Ixchel Pharma, LLC v. Biogen, Inc. that tortious interference with at-will contracts requires establishing wrongful conduct independent of interference itself. 9 Cal. 5th 1130, 1137 (2020). The court reasoned that parties have no legal rights to future performance if the agreement can be freely terminated, so third parties should be free to compete for that business by all lawful and proper means. In contrast, claims for interference with contractual relationships that parties are not free to terminate do not impose this additional pleading requirement, because interference with a contractual obligation is a wrong in and of itself. This decision puts claims for interference with at-will contracts on par with claims for interference with prospective economic advantage, which have long required pleading independently wrongful conduct to state a claim. This decision also adopts the formulation of the Second Restatement of Torts and brings California in line with a number of other states, including New Jersey, Virginia and Colorado.

The case before the court involved Ixchel Pharma, LLC, a pharmaceutical company, which sued Biogen, Inc., as a result of a settlement agreement Biogen entered into with Ixchel’s partner Forward Pharma. The agreement required Forward to terminate its contract with Ixchel for the joint development of a drug containing dimethyl fumarate (DMF). The Biogen–Forward contract aimed to resolve the parties’ patent dispute regarding the use of DMF and required Forward to cease all development of drugs with DMF as an active ingredient. Forward had a right to terminate the Ixchel contract at any time with 60 days’ advance notice—and did so. Following the termination, Ixchel sued Biogen, alleging, among other claims, tortious interference with contractual relations and with prospective economic advantage. The court held that to state a claim for contractual interference with an at-will agreement, Ixchel must prove independently wrongful conduct.

Before Ixchel, California law recognized two torts involving disruptions of economic relationships—interference with contractual relations and interference with prospective economic advantage—though the claims required different tests.

To establish a claim for interference with contractual relations, a plaintiff must establish (1) the existence of a valid contract between plaintiff and a third party; (2) defendant’s knowledge of the contract; (3) intentional acts designed to induce a breach or disruption of the contractual relationship; and (4) actual breach or disruption of the contractual relationship. Ixchel, 9 Cal. 5th at 1140. Contracts warrant protections because they involve a cemented relationship on which parties rely to “structure their decisions, invest resources, and take risks.” Id. at 1146. In light of the parties’ firm rights, “[i]ntentionally inducing or causing a breach of an existing contract is . . . a wrong in and of itself.” Id. Pleading a claim for interference with contract does not require separately pleading wrongful conduct independent of the interference.

Prospective economic advantage stands on a different footing because the parties have no firm rights, but only an expectancy of future benefit. Id. at 1142. Expectancies receive no shelter from free competition. To the contrary, in “our . . . culture firmly wedded to the social rewards of commercial contests, the law usually takes care to draw lines of legal liability in a way that maximizes areas of competition free of legal penalties.” Della Penna v. Toyota Motor States, U.S.A., Inc., 11 Cal. 4th 376, 392 (1995). Therefore, to state a claim for interference with prospective economic advantage, interference itself is not enough. Plaintiff must prove that the interfering conduct is itself wrongful “by some legal measure other than the fact of interference itself.” Ixchel, 9 Cal. 5th at 1142.

In Ixchel, the court determined that contracts terminable at will are more analogous to the prospective economic advantage scenario because “[l]ike parties to a prospective economic relationship, parties to at-will contracts have no legal assurance” of the relationship continuing. Id. at 1147. To the contrary, a party to an at-will contract has a right to terminate the agreement at its prerogative, including if it finds a better offer from a competitor, decides not to continue business or for any other reason. Since at-will contractual relations are “not cemented in the way that a contract not terminable at will is[,] [t]he interest in protecting the contract from interference more closely resembles the interest in protecting prospective economic relationships than the interest in protecting a contractual relationship . . . .” Id. The court thus held that like a claim for interference with a prospective economic advantage, a claim for interference involving an at-will agreement requires alleging “that the defendant engaged in an independently wrongful act.” Id. at 1148. Anything else, the court explained, “risks chilling legitimate business competition.” Id. (“Without an independent wrongfulness requirement, a competitor’s good faith offer that causes a business to withdraw from an at-will contract could trigger liability or at least subject the competitor to costly litigation.”).

The rule announced in Ixchel regarding at-will contracts previously applied in the limited context of at-will employment relationships. In Reeves v. Hanlon, the Supreme Court held that “to recover for a defendant’s interference with an at-will employment relation, a plaintiff must plead and prove that the defendant engaged in an independently wrongful act.” See Reeves v. Hanlon, 33 Cal. 4th 1140, 1144–45 (2004). The rationale—that “[a] former employee has the right to engage in a competitive business for himself and to enter into competition with his former employer, even for the business of . . . his former employer, provided such competition is fairly and legally conducted”—applies outside the employment context. Id. at 1149. Now it has officially been extended there. Ixchel, 9 Cal. 5th at 1147.

Application to Health Care Law

Ixchel will have ramifications for a variety of health care disputes alleging tortious interference with at-will agreements. Most evidently, in the health care employment context, it affirms that competitors are free to hire away contracted employees without a set contractual term as long as they do not engage in independently wrongful acts. For example, recently, in Coast Hematology-Oncology Associates Medical Group, Inc. v. Long Beach Memorial Medical Center, the California Court of Appeal, applying Ixchel, affirmed a grant of summary judgment on Coast’s cause of action for interference with contract resulting from Memorial’s hiring of two physicians from Coast. 58 Cal. App. 5th 715, 728–29 (2020). The Coast court held that allegations of trade secret theft, which often accompany employment disputes, did not constitute the requisite wrongful conduct necessary to state a claim because “[t]he trade secret dispute here was not why [physicians] decided to opt out of Coast.” Id. at 731. The Coast court held that to satisfy Ixchel, the wrongful conduct has to relate directly to the employment decision, rather than merely involve the same incident.

Another area to watch will be the application of Ixchel in areas that do not directly involve business competitors. For example, health plans and health insurers have alleged claims for interference with contractual relations against out-of-network providers that have enticed patients to obtain their services in lieu of more cost-effective network care by offering financial incentives, such as paying premiums or waiving contractual patient financial obligations (like coinsurance or copayments). Those types of inducements, when made in advance of treatment without consideration of individual hardship, undermine the managed care model. The managed care model creates cost savings by steering members (through lower cost shares) to network providers that have negotiated discounts with the plan. See, e.g., Kennedy v. Connecticut Gen. Life Ins. Co., 924 F.2d 698, 699 (7th Cir. 1991) (patient cost shares “sensitize [insureds] to the costs of health care, leading them not only to use less but also to seek out providers with lower fees,” which in turn “makes medical insurance less expensive and enables [insurers] to furnish broader coverage”).

Before Ixchel, courts had found that financially incentivizing members to go out of network by waiving required coinsurance or copayments was sufficient to state a claim for tortious interference with contract. See, e.g., Almont Ambulatory Surg. Ctr., LLC v. UnitedHealth Grp., Inc., 121 F. Supp. 3d 950, 981-82 (C.D. Cal. 2015) (allegations that a provider waived patient cost-share responsibility as an inducement to obtain out-of-network services adequately alleged an interference claim because the provider’s acts caused the payer “to pay more than it would otherwise have”). Ixchel is unlikely to affect the viability of these types of claims in the future for several reasons.

First, Ixchel’s added requirement to plead independently wrongful conduct applies only in the case of agreements terminable at will. Ixchel, 9 Cal. 5th at 1137. Insurance and health plan contracts are not terminable at will; they can be terminated only for limited reasons, such as fraud or non-payment of premiums. See, e.g., Cal. Ins. Code § 10384.17 (precluding insurers from rescinding or limiting policies except in cases of fraud or intentional misrepresentation of material fact). So Ixchel should not apply to causes of action for interference with insurance or health plan contracts.

Second, the rationale underlying Ixchel’s independently wrongful pleading requirement is predicated on the tenuous nature of the expectancy in an at-will contract: Just as a party to an at-will contract has no right to continued performance, a competitor has every right to appropriate business to itself by all proper means. See Ixchel, 9 Cal. 5th at 1146 (“In circumstances where parties have no legal assurance of future relations, the rewards and risks of competition are dominant.”). A claim for interference with an insurance contract is not predicated on interference with a future expectancy, but on performance under an existing contract. The plan designs a reimbursement structure to incentivize members to choose lower-cost care, and providers that waive those cost-shares “annul the benefits of the co-payment system” and increase expenses to the plan. See Kennedy, 924 F.2d at 699. The interference is thus with a “formally cemented economic relationship” that “is deemed worthy of protection from interference by a stranger to the agreement.” Ixchel, 9 Cal. 5th at 1142. Interference with these existing expectations by a third party is “a wrong in and of itself,” and therefore no further pleading should be required. Id.

Finally, the interference conduct alleged by health plans and insurers tends to be independently wrongful. For example, waiver of patient cost share obligations may amount to fraud because it misrepresents a provider’s actual charges and causes the plan to pay reimbursement based on an inflated amount. As the Department of Health and Human Services, Office of Inspector General explained in the Medicare context:

A provider, practitioner or supplier who routinely waives Medicare copayments or deductibles is misstating its actual charge. For example, if a supplier claims that its charge for a piece of equipment is $100, but routinely waives the copayment, the actual charge is $80. Medicare should be paying 80 percent of $80 (or $64), rather than 80 percent of $100 (or $80). As a result of the supplier’s misrepresentation, the Medicare program is paying $16 more than it should for this item.

Publication of OIG Special Fraud Alerts, 59 Fed. Reg. 65372-01, 65374-75 (Dec. 19, 1994). Courts have held that waiver amounts to fraud with respect to commercial policies. See, e.g., Almont, 121 F. Supp. 3d at 972 (providers’ charges to health plans and insurers are meant to reflect fees actually charged to the patient for claims; “reporting charges to an insurer that allegedly fail to account for co-pay waivers” “constitutes misrepresentation” of the actual charge for service).

Furthermore, financial incentives provided to patients may violate antikickback statutes. See, e.g., Cal. Ins. Code § 750 (“any person . . . who engages in the practice of . . . presenting . . . claims under policies of insurance, and who offers . . . any . . . consideration . . . as compensation or inducement to or from any person for the referral or procurement of . . . patients . . . is guilty of a crime”). So even if the independently wrongful requirement were to apply, there are grounds to allege that the conduct is independently wrongful.

For these reasons and others, we do not expect the holding of Ixchel to limit insurers’ ability to bring contractual interference claims when providers improperly divert patients out of network by offering financial incentives.

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Manatt, Phelps & Phillips, LLP

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