The Supreme Court Holds that the False Claims Act’s Scienter Element Turns on Defendant’s Subjective Beliefs, Rejecting Seventh Circuit’s Objective Standard

The Supreme Court recently issued a significant decision clarifying what it means to “knowingly” submit a false claim under the False Claims Act. At issue in United States ex rel. Schutte v. SuperValu Inc. were allegations that two retail pharmacies had a practice of asking Medicare and Medicaid to reimburse the full retail price of the drugs they dispensed, rather than the discounted prices they regularly charged customers. The Seventh Circuit granted summary judgment to Defendants SuperValu and Safeway, on the basis that they could not have “knowingly” submitted false claims because an objectively reasonable person might have thought regulations allowed the stores to seek reimbursement for the full retail price.
The Supreme Court disagreed in a unanimous decision. The FCA’s scienter element, the Court explained, refers to the defendant’s knowledge and subjective beliefs at the time the claim was submitted—not to what an objectively reasonable person would have known or believed.    

Post-Schutte, there is no question the FCA’s scienter standard is subjective, not objective. But the Court’s decision leaves much more unanswered—indeed, the Court specified in several places that it was not answering several key questions. For example, how should companies proceed when regulations are ambiguous, as is often the case?  And exactly what sort of subjective awareness will suffice to subject a company to liability under the FCA?

Relators’ Allegations

The Schutte decision arises out of two qui tam suits that separately accused retail pharmacy chains SuperValu and Safeway of not offering Medicare and Medicaid the same discounted drug prices they regularly charged their retail customers. According to the relators, these discount programs eventually accounted for a substantial portion of the chains’ drug sales.  

But SuperValu and Safeway allegedly never passed those same discounts on to Medicare and Medicaid. Medicare Part D and state Medicaid plans offer prescription drug coverage to qualifying individuals. By regulation, these programs “typically reimburse pharmacies for the lowest of different amounts, one of which is often the pharmacy’s ‘usual and customary charge’ to the public.” As a result, when SuperValu and Safeway submitted reimbursement claims to Medicare and Medicaid, “they often were required to charge and disclose their ‘usual and customary’ price for that drug.” According to the relators, though, the chains routinely reported their higher retail prices instead of the discounted prices “they usually and customarily charged to the public.”

The Seventh Circuit’s Decision

SuperValu and Safeway each prevailed on summary judgment on the basis that they could not have acted “knowingly” under the FCA’s scienter element, and the Seventh Circuit affirmed in both cases.  

The Seventh Circuit “relied heavily on Safeco Ins. Co. of America v. Burr, 551 U.S. 47 (2007)—a case that interpreted the term ‘willfully’ in the Fair Credit Reporting Act (FCRA).”  The court “read Safeco to dictate a two-step inquiry for ascertaining whether a defendant acted recklessly or knowingly.” “At step one,” the court was supposed “to ask whether [the] defendant’s actions were consistent with any objectively reasonable interpretation of the relevant law.” If so, that ended the inquiry, regardless of whether the defendant believed that interpretation when they submitted their claims. Only if the defendant’s actions were objectively unreasonable would the court move on to “step two” and “consider the defendant’s actual subjective thoughts.” In other words, under the Seventh Circuit’s approach, a claim had to be “objectively unreasonable, as a legal matter, before a defendant could be held liable for ‘knowingly’ submitting a false claim, no matter what the defendant thought.” Applying that standard, the Seventh Circuit held that SuperValu and Safeway could not have “knowingly” submitted false claims to Medicare and Medicaid—even if they had known their discounted prices were their “usual and customary” prices (which the district court in SuperValu found was enough to establish falsity)—because a reasonable person could have thought the phrase referred to the pharmacies’ “retail prices.”

The Supreme Court’s Decision

The Supreme Court granted the relators’ certiorari petition to decide a specific question about scienter: “Whether 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.”

In a unanimous opinion by Justice Thomas, the Supreme Court squarely rejected the Seventh Circuit’s two-part inquiry. In substance, the Court explained, the question was whether a defendant who submits a false claim while believing it is false, can nevertheless escape FCA liability by arguing that a “hypothetical, reasonable person” could have thought the claim was lawful. The answer to that question, the Court explained, was a “straightforward” no.

Starting with the text, the Court noted that the FCA prohibits parties from “knowingly” presenting false claims. By defining “knowingly” to include actual knowledge, deliberate ignorance, and reckless disregard, the Court noted, the FCA “largely tracks the traditional common-law scienter requirement for claims of fraud”: the FCA’s scienter element and the common law both “focus primarily on what respondents thought and believed.” Actual knowledge, for example, “refers to whether a person is ‘aware of’ information,” 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.” Just as importantly, the FCA’s text and the common law both “point to what the defendant thought when submitting the false claim—not what the defendant may have thought after submitting it.” Accordingly, the FCA focuses not on what an objective person might have thought, or on what “post hoc interpretations” might have made a defendant’s claims accurate. What matters is whether the defendant knew or believed that their claim was false when they submitted it.

SuperValu and Safeway offered three counterarguments, but none persuaded the Court. 

First, the pharmacy chains argued that “they could not have ‘known’ that their claims were inaccurate” because the phrase “usual and customary” was ambiguous.  

The Court acknowledged that the phrase was “less than perfectly clear,” but noted that SuperValu and Safeway both allegedly knew that it referred to their discounted prices. As the Court explained, “it might have been a forgivable mistake if [defendants] had honestly read the phrase as referring to retail prices,” but that is not what relators say happened.  Rather, the relators pointed to evidence that SuperValu and Safeway both understood that their retail prices were not their “usual and customary charge.” According to the relators, the chains received notices from pharmacy benefit managers and regulators explaining that the phrase refers to discounted prices, and executives at both companies allegedly raised concerns about letting state agencies or pharmacy benefit managers “find out about their discounted prices.” If that evidence is to be believed, the Court explained, then SuperValu and Safeway might have known, or at least been aware of an unjustifiably high risk, that their claims were false.  And if that were the case, then the fact that others might have reasonably misinterpreted “usual and customary charge” would not preclude a finding that SuperValu and Safeway had the requisite scienter under the FCA.  

Second, SuperValu and Safeway, like the Seventh Circuit, pointed to Safeco. The chains argued that “Safeco [had] already interpreted the common-law definitions of ‘knowing’ and ‘reckless’ and that it did so by looking first at whether the defendant’s ‘reading of the statute’ was ‘objectively unreasonable.’” “[B]ecause the FCA has the same common-law terms,” defendants reasoned, “it should be read with the same, objective common-law focus.”

The Supreme Court rejected this argument “twice over.”  First, the Court noted that Safeco interpreted a different statute, the FCRA, which had a different mens rea standard, “willfully.”  Second, Safeco did not create a “purely objective safe harbor” to fraud claims. In Safeco, the Court had acknowledged that “the common law of recklessness contained an objective standard because it encompassed actions involving ‘an unjustifiably high risk of harm that is either known or so obvious that it should be known.’” Whether that same “objective form of ‘recklessness’” might suffice to establish scienter under the FCA was not at issue, the Court explained. And the mere fact Safeco had referenced it was not meant to suggest there is some “general rule” that a defendant whose actions are objectively reasonable can never “knowingly” or “recklessly” commit fraud.  

Third and finally, SuperValu and Safeway argued that their alleged misrepresentations were not actionable under the FCA. The pharmacies offered a three-step argument:  (1) The FCA incorporates the common law of fraud; (2) at common law, only misrepresentations of fact (not law) are actionable as fraud; and (3) the alleged falsity of their claims turns solely on a legal interpretation of the phrase “usual and customary,” not on any misrepresentation of fact.

The Court rejected this argument as well, finding that “those premises do not support that conclusion.” The Court acknowledged that many courts appear to have stated that misrepresentations of law are not actionable at common law, but explained that the defendants’ alleged misrepresentations were not purely legal: “Rather than saying, ‘this is what “usual and customary” means,’” SuperValu and Safeway “essentially said, ‘this is what our “usual and customary” prices are.’” In doing so, the chains “plainly implied facts about their prices that were not known to the plan sponsors, pharmacy benefit managers, and state Medicaid agencies that received their claims.” So, even assuming the FCA incorporated the common-law rule that defendants championed, that rule would not have barred relators’ claims.  

The Court thus vacated the judgments in favor of SuperValu and Safeway and remanded for further proceedings. 

What’s Next? 

In reversing the Seventh Circuit, the Court answered one question: post-Schutte, there is no doubt that “objective reasonableness” will no longer defeat FCA claims, and in particular, will no longer be a basis for disposing of allegations of knowing falsity early in the litigation process.  Companies can therefore expect invasive discovery regarding their subjective interpretations of governing regulations.

But the Court’s decision leaves open far more questions than it answered.  The Court wrote that “reckless disregard” “captures defendants who are conscious of a substantial and unjustifiable risk that their claims are false, but submit the claims anyway”—but just what is a substantial and unjustifiable risk? If a defendant’s liability under the FCA turns solely on what it knew (or should have known) about the lawfulness of its conduct, how should companies proceed in the face of ambiguous regulations—a situation they regularly confront? And although objective reasonableness might not be a defense to FCA liability, what if a defendant acts in an objectively unreasonable manner, ignoring “an unjustifiably high risk of illegality that was so obvious that it should have been known”—could the government and relators argue that is enough to open a defendant up to liability, “even if the defendant was not actually conscious of that risk”? Expect these questions to be at the forefront of FCA litigation in the years to come.

In the meantime, because potential FCA liability will turn on subjective intent at the time claims are submitted, companies might want to consider working with their counsel to: (1) reasonably interpret the meaning of the relevant standards, which are often not clear in the context of health care and other industries; and (2) contemporaneously document the company’s interpretation of the relevant standards and how the company applied that interpretation to the claims it submitted.

For more information on the issues in this Client Alert, please contact Goodwin’s Healthcare Government Enforcement and False Claims Act Defense practice group.