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The FCA Does Not Assess Liability Through Ambush: Fourth Circuit Joins the List of Circuits Applying Safeco Inquiry to Legally False Claims

March 10, 2022

In U.S. ex rel. Sheldon v. Allergan Sales, LLC, No. 20-2330 (4th Cir. Jan. 25, 2022), the U.S. Court of Appeals for the Fourth Circuit applied the scienter analysis for “reckless” conduct articulated by the Supreme Court in Safeco Insurance Co. of America v. Burr, 551 U.S. 47 (2007) to the False Claims Act (“FCA”) in affirming the dismissal of a qui tam complaint for failure to plead scienter.  In a 2-1 decision, the Fourth Circuit joined the Third, Seventh, Eighth, Ninth, and D.C. Circuits, holding that an objectively reasonable interpretation of an ambiguous statute or regulation cannot serve as the basis for liability unless authoritative guidance warns the defendant against such an interpretation.  Sheldon adds increased support to defendants facing FCA allegations where the governing provisions are vague or ambiguous and is particularly notable as a pleading rather than merits stage ruling.

In Sheldon, a former employee alleged that Forest Laboratories, LLC (“Forest,” now part of Allergan Sales, LLC) had engaged in a fraudulent price reporting scheme by failing to aggregate discounts given to different customers for the purposes of reporting best price, and accordingly violated the Medicaid Drug Rebate Statute, 42 U.S.C. § 1396r-8 (“Rebate Statute”).  The Rebate Statute requires manufacturers seeking to have their drugs covered by Medicaid to submit quarterly rebates to the Government, including both their average prices and their best prices.  Manufacturers are then reimbursed based on the greater of the statutory minimum rebate or the difference between the manufacturer’s average price and best price.  Medicaid guidance on the matter states that manufacturers should “make reasonable assumptions” when calculating best price.  The relator claimed that the defendant violated the FCA by failing to account for all combined discounts given to certain customers when calculating best price, resulting in the Government overpaying in rebates by $680 million.  The United States District Court for the District of Maryland, however, disagreed and dismissed the complaint for failure to plead falsity or scienter.  In particular, the District Court found that: (1) the “plain and natural reading” of the Rebate Statute did not explicitly require aggregating such discounts, (2) Forest offered “a plausible and objectively reasonable interpretation” of the Rebate Statute, and (3) CMS guidance did not warn Forest away from that interpretation.  Therefore, the defendant did not act knowingly in submitting false or fraudulent claims and could not be held liable under the FCA.

A divided Fourth Circuit panel sided with the district court.  Relying on Safeco, the Fourth Circuit determined that the FCA’s scienter requirement involves a two-step inquiry in the face of a vague or ambiguous regulation or provision: (1) whether the defendant’s interpretation was objectively reasonable; and (2) whether any relevant authoritative guidance might have warned the defendant away from that interpretation.  In Safeco, the Supreme Court stated, “[w]here, as here, the statutory text and relevant court and agency guidance allow for more than one reasonable interpretation, it would defy history and current thinking to treat a defendant who merely adopts one such interpretation as a knowing or reckless violator.”  The Fourth Circuit determined that this same standard should apply to the FCA’s rigorous scienter requirement because it “duly ensures that defendants must be put on notice before facing liability for allegedly failing to comply with complex legal requirements,” underscoring that the FCA “does not assess liability through ambush.” 

The Fourth Circuit was careful to note the limits of this decision, however.  First, the Safeco standard can apply only to claims which are legally false under the FCA, as they involve contested statutory and regulatory requirements.  In the case of factually false claims where the law is clear, defendants will not be afforded the discretion to interpret the law differently.  Second, the standard of objective reasonableness does not write a blank check to defendants.  The second prong of the Fourth Circuit’s analysis—authoritative Government guidance to the contrary—still limits the extent to which a defendant may permissibly rely on its otherwise reasonable interpretation.  In practice, then, the Fourth Circuit reasoned that its analysis “does not shield bad faith defendants that turn a blind eye to guidance indicating that their practices are likely wrong.”

Applying the Safeco standard here, the Fourth Circuit determined that Forest did not act knowingly under the FCA because its reading of the Rebate Statute was both objectively reasonable and not deterred by any authoritative guidance.  The Fourth Circuit noted that Forest’s reading of the Rebate Statute was the “most natural,” plain English reading of the text.  In addition, the Government was on notice that manufacturers such as Forest were not aggregating discounts given to different entities along supply chains when reporting rebates because of comments offered to the Government as early as 2006.  In light of this, the lack of authoritative guidance from the Government to the contrary, the Fourth Circuit reasoned, indicated that aggregating discounts is not required under the Rebate Statute.

Disagreeing with the majority, Judge Wynn offered a lengthy, vigorous dissent expressing concern that the majority opinion would “effectively neuter” the FCA by eliminating the actual knowledge and deliberate ignorance scienter standards in favor of objective recklessness, which “only the dimmest of fraudsters could fail to take advantage of.”  Applying the concerns to the instant facts, the dissent argued that, even if the Safeco standard did apply, this case clearly indicated that Forest’s failure to aggregate discounts was not the product of “honest mistakes,” and therefore Forest’s interpretation could not be considered objectively reasonable.  The dissent concluded that “[i]n this swelling sea of fraud,” the majority decision relegates the Government to “bailing out with an ever-shrinking teaspoon.”

Sheldon will likely feature prominently in future FCA litigation both at the pleading and merits stages.  This decision adds the Fourth Circuit to a growing list of circuits to apply Safeco to the FCA and provides a potential defense to companies facing compliance with ambiguous statutory, regulatory, or contractual requirements.

For more information, please contact the professional(s) listed below, or your regular Crowell & Moring contact.

Brian Tully McLaughlin
Partner – Washington, D.C.
Phone: +1.202.624.2628
Lyndsay A. Gorton
Counsel – Washington, D.C.
Phone: +1.202.654.6713
Amanda H. McDowell
Associate – Washington, D.C.
Phone: +1.202.624.2602