The Fourth Circuit Enforces Safeco's Rigorous, Objective Scienter Requirement for Civil False Claims in Sheldon

5 min

On January 25, in United States ex rel. Sheldon v. Allergan, No. 20-2330 (4th Cir., Jan. 25, 2022), the United States Court of Appeals for the Fourth Circuit upheld a lower-court dismissal of a False Claims Act (FCA) case brought against drug manufacturer Forest Laboratories, LLC and held that the test for scienter in issues involving a legal falsity is objective and is not met where the defendant applies an objectively reasonable interpretation to complicated or ambiguous laws or regulations without clear administrative or legal guidance. Significantly, the Fourth Circuit refused to consider evidence of subjective bad faith and held "this objective standard precludes inquiry into a defendant's subjective intent."

With this decision, the Fourth Circuit joined its sister Circuit Courts of Appeal in extending the Supreme Court's holding in Safeco Insurance Co. of America v. Burr, 551 U.S. 47 (2007), "interpreting the Fair Credit Reporting Act's analogous scienter provision" to the FCA.1 The Fourth Circuit held that "[u]nder the FCA, a defendant cannot act 'knowingly' if it based its actions on an objectively reasonable interpretation of the relevant statute when it has not been warned away from that interpretation by authoritative guidance." (Sheldon at *12). The court emphasized that "the Supreme Court has instructed that this 'rigorous' [scienter] requirement ought to find 'strict enforcement' in the courts." Id. (citing United States ex rel. Escobar, 136 S. Ct. 1989, 2002 (2016)).

In Sheldon, the relator brought a claim alleging that his employer was violating the Medicaid Drug Rebate Statute, 42 U.S.C. § 1396r-8, by failing to aggregate discounts given to separate customers along distribution chains when calculating the "Best Price" for its covered drugs to the Centers for Medicare & Medicaid Services (CMS). Under the Rebate Statute, "Best Price" is used to calculate the rebate the manufacturer must pay to states for each drug. The Court noted that the "FCA unquestionably has a punitive aspect" and that holding a company liable for its reasonable interpretation of a statute would "take the FCA a very long step toward a strict liability statute." (Sheldon at *3).

Analyzing Safeco, the Fourth Circuit applied the Supreme Court's interpretation of the scienter requirement of the Fair Credit Reporting Act that defendants have acted "willfully" and the finding that "willfully" includes both knowledge and recklessness. The Court observed that the "FCA defines 'knowingly' as including actual knowledge, deliberate ignorance, and reckless disregard. 31 U.S.C. § 3729(b)(1)(A)." (Sheldon at *12). Safeco lays out a two-step analysis for reckless disregard, first asking whether the defendant's interpretation was "objectively reasonable" and second by asking whether "authoritative guidance may have warned defendant away from that reading." (Sheldon at 11). The court made it clear that it was applying Safeco only to "legally false claims" which "involve contested statutory and regulatory requirements," not "factually false claims" in which someone has submitted incorrect descriptions of goods or services. (Sheldon at *14-15).

In Sheldon, the court found both that Forest's interpretation of the statute was objectively reasonable and that it had not been warned away from its interpretation. Indeed, CMS knew as early as 2006 that manufacturers were not aggregating discounts. After CMS submitted its proposed rule on drug pricing, several manufacturers offered comments and asked CMS to confirm that their interpretation would be accepted. CMS failed to do so and "thereby maintained strategic ambiguity." (Sheldon at *23). CMS's Rebate Agreement and its own rulemaking instructed manufacturers to "make reasonable assumptions" in the absence of specific guidance and even specifically instructed manufacturers not to submit these assumptions to CMS and that CMS would not respond if they did. The Fourth Circuit took note of the particular injustice that would ensue if entities were given a set of instructions, the government declined to provide clarification, and then the entities were subject to "potentially ruinous liability for following those instructions." (Sheldon at 27). As the court held, "[t]he False Claims Act does not assess liability through ambush. Companies must instead knowingly submit a false claim to be liable." (Sheldon at *28).

In extending Safeco to the FCA, the Fourth Circuit provided a roadmap to government contractors, including subcontractors, that are tasked with following a complex or ambiguous statute, law, or regulation and a lack of guidance. Provided that their interpretation is reasonable and there is no guidance warning them away from that interpretation, it is unlikely that the scienter requirement would be found to be met. This case highlights the importance for government contractors that are faced with ambiguous contract provisions or regulations to proactively seek guidance from the agencies with which they contract or by which they are regulated. Even if the agency fails to respond, such inquiry protects against a subsequent FCA finding, because proactively seeking administrative guidance and failing to receive any would further demonstrate the reasonableness of a course of action and the injustice of imposing liability for their interpretation.

[1] Id. at 4 (citing United States ex rel. Schutte v. SuperValu Inc., 9 F.4th 455, 459 (7th Cir. 2021); United States ex rel. Streck v. Allergan, Inc., 746 F. App'x 101, 106 (3d Cir. 2018); United States ex rel. McGrath v. Microsemi Corp., 690 F. App'x 551, 552 (9th Cir. 2017); United States ex rel. Donegan v. Anesthesia Assocs. of Kansas City, PC, 833 F.3d 874, 879–80 (8th Cir. 2016); United States ex rel. Purcell v. MWI Corp., 807 F.3d 281, 290–91 (D.C. Cir. 2015).