Scenario 1: A pharmacy chain hires a value consultant to review its Medicare and Medicaid billing practices for ways to optimize the coding of drug reimbursements to maximize profits. Drugs that had historically been charged for government reimbursement at $1/pill as the “usual and customary price” are now getting coded for reimbursement at $3/pill—a 200% markup that represents a pure profit windfall to the pharmacy chain. Is this a violation of the False Claims Act (FCA)?

Scenario 2: A construction company that has years of experience in federal procurement contracting had never charged the government for reimbursement of several cost items, because the company’s previous CFO did not feel such reimbursement would meet the “reasonableness” requirements of FAR Part 31 (e.g., FAR 31.201-2(a)(1) and 31.201-3). But the company’s new CFO, holding a different interpretation of the reasonableness standards and Cost Accounting Standards (CAS), instructs his program leads to start charging those items for reimbursement in all new and existing contracts. Is this a violation of the FCA?

As with most questions involving the law, the right answer in both cases is: “It depends.” What it depends on is whether a relator or the Department of Justice is able to allege and then prove four essential elements: (1) the defendant presented a claim to the government, (2) the claim was false, (3) the defendant knew the claim was false, and (4) the false representation that the defendant made was material. (For a more detailed explanation of the FCA and recent enforcement trends, please read our September 2022 article published in Briefing Papers here.)

In both of the scenarios above, assume the potential defendants actually thought that the drug coding or reimbursement requests were risky (even excessive) when they submitted their claims for payment. But also, each thought that the claims they were submitting could be justified under the plain language and a reasonable interpretation of relevant regulations or standards. So the question becomes, which matters more when evaluating the “knowledge” element in an FCA case: the defendant’s subjective belief or apprehension that a payment request may be wrong, or an objective textual reading of a rule that suggests it is right?

On January 13, 2023, the U.S. Supreme Court granted certiorari and consolidated two FCA cases to more closely evaluate and answer this thorny question. There is a growing circuit split as well as tension in FCA jurisprudence over the third element—knowledge (also referred to in the case law as scienter, or a culpable state of mind/intent). The first case (No. 21-1326 (U.S.)) involves allegations by former pharmacist employees that SuperValu, a chain operating more than 800 retail pharmacies, submitted fraudulent claims for reimbursement under the Medicare and Medicaid programs. In the second case (No. 22-0111 (U.S.)), whistleblowers similarly alleged that Safeway pharmacies submitted false claims for reimbursement under Medicare and Medicaid.

In each of these cases, SuperValu and Safeway won at both the trial court level and the appellate court level (albeit in split decisions in the Seventh Circuit). In each case, the Seventh Circuit agreed with the defendants’ argument that the FCA claims brought by the whistleblowers must fail because the drug pricing was the result of an “objectively reasonable” regulatory interpretation of the Medicaid and Medicare reimbursement rules. The trial courts and the Seventh Circuit rejected the whistleblower plaintiffs’ contention that the supermarket pharmacies should be held liable for violating the FCA if they subjectively knew or had reason to believe that their conduct was improper or illegal.

The specific question presented in the petition on which the Supreme Court granted review in SuperValu is:

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.

As most government contractors can attest, it can be challenging to navigate the often ambiguous or conflicting mandates or regulations that defy easy interpretation or clearly crafted agency guidance. When faced with that level of confusion or ambiguity, the defense bar and its industry clients generally favor an interpretation of that knowledge element holding that a defendant cannot be liable if a legal obligation allows for more than one reasonable interpretation, the defendants followed one such interpretation, and no authoritative guidance warned it away from that interpretation. This is the standard the Supreme Court previously articulated in Safeco Ins. Co. v. Burr, 551 U.S. 47 (2007).

By contrast, relator plaintiffs argue that if a contractor thought what they were doing was wrong when they did it, that itself is adequate to show a culpable state of mind that the contractor is committing a fraud and should be held to account. They argue that clever lawyering or strained interpretations of the law should not provide an excuse for fraudulent conduct.

On one hand, the knowledge requirement has ordinarily been met if one can prove a defendant actually knew that they were demanding payment of money to which they were not fairly entitled. On the other hand, how can a demand for payment be fraud against the government if that same defendant can point to a reasonable textual interpretation of a rule or regulation that supports the reimbursement demand—even if that interpretation seems hyper-technical?

Which hand is right? We should know which way the Supreme Court decides this important question later this year. We expect that the objective standard articulated previously in Safeco will prevail. In the final analysis, a contractor should not be exposed to liability for treble damages, penalties, and attorney’s fees under the FCA for following a reasonable interpretation of a government rule. If the government doesn’t like that outcome, it can always write a clearer, fairer rule.