On June 1, 2023, the Supreme Court of the United States (SCOTUS) issued its much-anticipated opinion in United States ex rel. Schutte v. SuperValu Inc. and United States ex rel. Proctor v. Safeway, Inc. (Schutte), holding that a defendant’s subjective understanding of an ambiguous law, even if objectively reasonable, is relevant in proving scienter under the False Claims Act (FCA). The opinion, which was unanimous and authored by Justice Thomas, is not surprising given the questions and comments from the justices during the oral argument. Although SCOTUS framed the issue under review in Schutte in narrow terms, the opinion is likely to have broad implications for future cases brought under the FCA, especially those based on alleged violations of ambiguous laws.
In Schutte, SCOTUS granted certiorari to review two rulings from the Seventh Circuit Court of Appeals affirming summary judgment for the defendants in two non-intervened cases brought under the FCA based on the theory that the defendant-pharmacies defrauded the federal government by underreporting their “usual and customary” (U&C) drug prices because they excluded lower pricing offered to customers through discount programs. See United States ex rel. Schutte v. Supervalu Inc., 9 F.4th 455 (7th Cir. 2021); United States ex rel. Proctor v. Safeway, Inc., 30 F.4th 649 (7th Cir. 2022). The fraud theory in Schutte and Proctor hinges on the interpretation of the regulatory definition of U&C pricing. The defendants won summary judgment in both cases by invoking the scienter standard articulated in Safeco. Counsel argued that the relators could not establish a triable issue of fact on the question of scienter because the defendants had an objectively reasonable interpretation of the U&C price definition that was not contradicted by authoritative guidance, and any evidence of a contrary subjective understanding of the definition was irrelevant. In split panel decisions, the Seventh Circuit affirmed the dismissal of both cases.
In reversing the Seventh Circuit’s rulings, SCOTUS rejected the application of the scienter standard reflected in Safeco Insurance Co. of America v. Burr, 551 U.S. 47 (2007), which was decided under the Fair Credit Reporting Act and applies a different mens rea standard than the FCA, and resolved a circuit split regarding whether a defendant can be liable under the FCA when it has an objectively reasonable interpretation of an ambiguous law, regardless of subjective intent. Without expressly doing so, Schutte would appear to overturn the approach adopted by the Fourth, Eighth, and D.C. Circuits imposing an objective standard of scienter, where a defendant’s reasonable interpretation does not satisfy the scienter element, even if that interpretation is wrong, unless authoritative guidance warns the defendant against that interpretation. See United States ex rel. Sheldon v. Allergan Sales, LLC, 24 F.4th 340, 343-44, 351 (4th Cir. 2022), vacated en banc by 49 F.4th 873 (4th Cir. 2023); United States ex rel. Miller v. Weston Educ., Inc., 840 F.3d 494, 503-03 (8th Cir. 2016); United States v. Sci. Applications Int’l Corp., 626 F.3d 1257, 1272 (D.C. Cir. 2010). Consistent with the holding of Schutte, the Sixth, Ninth, Tenth, and Eleventh Circuits always evaluate a defendant’s subjective understanding in proving scienter under the FCA. See, e.g., United States ex rel. Prather v. Brookdale Senior Living Communities, 892 F.3d 822, 838 (6th Cir. 2018); United States v. Chen, 402 F. App’x 185, 187-88 (9th Cir. 2010); United States v. Boeing Co., 825 F.3d 1138, 1145-50 (10th Cir. 2016); United States ex rel. Phalp v. Lincare Holdings Co., Inc., 857 F.3d 1148, 1155 (11th Cir. 2017).
The core holding of Schutte is that “[t]he FCA’s scienter element refers to [a defendant’s] knowledge and subjective beliefs – not to what an objectively reasonable person may have known or believed.” In reaching this holding, SCOTUS explicitly rejected an argument commonly raised by defendants in FCA cases that an objectively reasonable interpretation of an ambiguous law cannot result in the submission of false claims, reasoning that “such facial ambiguity alone is not sufficient to preclude a finding that [a defendant] knew their claims were false.” In other words, regardless of whether a defendant’s interpretation of the ambiguous law was objectively reasonable, what matters is what the defendant knew and subjectively believed about that law. In both cases decided under Schutte, there was evidence suggesting that the defendants believed that their interpretation of the ambiguous U&C price definition was incorrect. SCOTUS held that it was reversible error for the district courts to not consider such evidence in conducting the scienter analysis under the FCA.
While the Seventh Circuit’s ruling in Schutte remained good case law, those doing business with the federal government were well-advised to analyze and document their reasonably objective interpretations of ambiguous regulations as a protective measure against potential FCA liability. The Seventh Circuit’s ruling in Schutte, along with the 2018 Brand Memo and SCOTUS’s opinion in Azar v. Allina Health Services, 139 S. Ct. 1804 (2019) (Allina), seemed to collectively signal a tide in favor of the defense when it came to the industry’s obligation to parse difficult regulatory language and agency statements regarding the same. The Brand Memo directed DOJ not to use agency guidance as a basis for proving violations of applicable law. In Allina, SCOTUS held that US Department of Health and Human Services (HHS) could not bring enforcement actions predicated on violations of payment policies it had not promulgated through notice-and-comment rulemaking. But with the Brand Memo retracted by the Garland Memo in July 2021, and Schutte now overruled, the question remains how those doing business with the government should react to this new landscape.
- First, as SCOTUS’s opinion makes clear, potential FCA defendants should not rely solely on any post hoc “objectively reasonable” interpretation of an ambiguous law as a defense to an FCA claim. Instead, the focus will be on the defendant’s subjective understanding of the truth or falsity of the legal requirements underlying claims at the time of submission. This will make defeating FCA cases at the motion to dismiss stage based on scienter all the more difficult.
- Second, SCOTUS’s opinion in Schutte adds new complexity to issues surrounding the attorney-client privilege, some of which predate the decision. When an entity or individual analyzes a law or regulation for purposes of determining compliance, the work may be attorney-client privileged. Under the now-overruled reasoning of the Seventh Circuit, an entity might have considered disclosure of that analysis for purposes of its defense, raising complicated issues of waiver. Now, given that the defendant’s subjective understanding of the law is the prevailing evidence for purposes of scienter under the FCA, defendants may want to consider how and when they memorialize their analysis and understanding of ambiguous regulatory requirements. If evidence of internal knowledge of a potential adverse interpretation of a legal requirement—even on the part of one employee—can be taken as scienter for purposes of an FCA claim, defendants should be cautious in creating documentation of discussions of legal requirements that could be interpreted, however wrongly, as showing bad intent. Correspondingly, potential waiver of privilege to disclose a reasonably objective interpretation of a relevant law or regulation at the time the defendant submitted the claim will be less enticing.
- Third, SCOTUS’s ruling in Schutte unfortunately suggests that now more than ever potential FCA defendants should be vigilant in tracking and understanding agency guidance and comments, which can be voluminous and unclear. While the SCOTUS opinion in Schutte does not consider the question of whether knowledge of agency commentary that contradicts an objectively reasonable interpretation of a statute or regulation (there was no such agency commentary discussed in the opinion), we can presume that if a defendant has knowledge of an agency statement that contradicts the defendants’ interpretation of the law, then that will be taken as evidence of scienter. And while Allina clarifies how HHS must use notice-and-comment rulemaking when it changes a substantive legal standard governing the payment for services, one can still imagine a variety of agency statements (from HHS or others) that do not require notice-and-comment rulemaking and may outwardly appear to contradict an objectively reasonable interpretation of a statute or regulation. Acting contrary to these agency statements, even if an entity believes its interpretation is correct, may be evidence of scienter.
Finally, following from the above, Schutte can be taken to suggest that potential FCA defendants may want to proactively seek agency clarification where rules or guidance are unclear. As Schutte acknowledges, a finding of scienter under the FCA only requires that the defendant have “reckless disregard” for the truth or falsity of their claims. In Schutte the defendants had received word from a pharmacy benefit manager and a state Medicaid program that their interpretation of the relevant rule might be incorrect and had internal discussions of the same. Schutte holds that scienter evidence exists where a defendant knows there is a risk that their interpretation is incorrect and acts anyways. Where rules and agency guidance are unclear, seeking agency clarification may be advisable.