False Claims Act’s Scienter Requirement is Based on Defendant’s Subjective Beliefs

What Happened

On June 1, 2023, the US Supreme Court unanimously held in United States ex rel. Schutte v. SuperValu, Inc. (the “Schutte decision”) the False Claims Act’s (“FCA”) scienter requirement turns on whether a defendant subjectively believed its claim was false, not whether a hypothetical, “objectively reasonable” person would have concluded the claim was false.

Analysis

The FCA

The FCA imposes liability on those who “knowingly present . . . a false or fraudulent claim [to the government] for payment or approval.” 31 U.S.C. § 3729(a)(1)(A). To establish a claim under the FCA, a plaintiff must show (i) the claim presented was false, and (ii) the defendant knew that the claim was false. To facilitate enforcement of the statute, the FCA permits private entities to bring qui tam lawsuits—sometimes called “whistleblower suits”—on behalf of the United States against defendants believed to have violated the FCA. The United States will then decide whether to intervene and prosecute the FCA claims as a plaintiff or decline to intervene and leave the whistleblower to continue prosecuting the action on the United States’ behalf.

United States ex rel. Schutte v. SuperValu, Inc.

The Schutte decision stems from a qui tam lawsuit alleging that Defendants SuperValu and Safeway defrauded the federal government by submitting false claims for reimbursement under Medicare and Medicaid. SuperValu and Safeway operated hundreds of retail pharmacies nationwide. Under Medicare and Medicaid, the Defendants could seek reimbursement for prescription drugs that they provided to qualifying individuals. Reimbursement under these programs was limited to the “usual and customary” price that the pharmacy charged for the drug. Thus, when submitting claims for reimbursement, the Defendants often had to disclose the “usual and customary” price that they charged for the drugs subject to reimbursement.

The Plaintiffs alleged that Walmart, a competitor of the Defendants in the retail pharmacy business, began providing many drugs at $4 for a 30-day supply. In response, the Defendants adopted a price-match program where they would match a competitor’s lower price if a customer requested. However, when presenting claims for reimbursement by Medicare and Medicaid, the Defendants allegedly reported their “usual and customary” prices as higher than the discounted amount they often charged customers. Further, the Plaintiffs provided evidence that the Defendants had reason to believe that the discounted prices constituted the “usual and customary” prices but took steps to conceal their practice of reporting higher prices.

The trial court ruled against the Defendants on the first element of the FCA claim: falsity. The court concluded that the discounted prices were the “usual and customary” prices, and that by not reporting them, the Defendants submitted claims that were false. But the court ruled in favor of the Defendants on the second element, finding that the Defendants did not act knowingly in submitting the false claims. On appeal, the Seventh Circuit affirmed. The court found that because the Defendants’ actions were consistent with an objectively reasonable interpretation of the phrase “usual and customary,” the Defendants did not submit false claims “knowingly,” despite evidence indicating that the Defendants subjectively thought that “usual and customary” meant the discounted prices. In other words, the Seventh Circuit applied an objective standard to the FCA’s scienter element, disregarding the Defendants’ subjective knowledge or beliefs.

The Supreme Court reversed, holding instead that the FCA’s scienter element refers to a defendant’s knowledge and subjective beliefs. The Court acknowledged that the phrase “usual and customary” might be ambiguous but concluded that courts could still find a defendant knew its claims were false. This is because “knowledge” under the FCA does not just encompass actual knowledge of a claim’s falsity; rather, a defendant can know its claim is false if the defendant acts in deliberate ignorance of the claim’s falsity or in reckless disregard of a substantial risk that the claim is false. The latter includes defendants who are aware of a substantial and unjustifiable risk that their claims are false but submit the claims anyway. And in determining whether a defendant is aware of such a risk, the Court emphasized that the answer ordinarily depends on the defendant’s subjective, culpable state of mind.

So, even if the phrase “usual and customary” was ambiguous and prevented the Defendants from having actual knowledge of the falsity of their claims, the Court found liability under the FCA was warranted because the Defendants were subjectively aware of the substantial risk their claims were false—primarily demonstrated by their steps to conceal the discounted prices—yet submitted their claims anyway. In concluding this way, the Court determined it did not matter how an objectively reasonable person would have interpreted the phrase “usual and customary.” What mattered was the Defendants believed their claims were not accurate.

Summary

Although the Schutte defendants were on the losing end of the Court’s scienter analysis, the decision may ultimately turn out to be better for future FCA defendants than it seems. For instance, the Court reasoned that the term “reckless disregard”—the lowest bar for FCA plaintiffs to clear when pleading violations of the FCA’s three scienter standards—requires defendants to be “conscious of a substantial and unjustifiable risk that their claims are false, but submit them anyway.” Slip op. 10.

The Court’s reasoning would appear to require FCA plaintiffs to allege that FCA defendants demonstrated “conscious” disregard of a risk that is both “substantial and unjustifiable.” Such a pleading standard could prove difficult to meet for plaintiffs who are unable to demonstrate knowledge of a defendant’s internal, subjective evaluation and decision-making related to claim risk and validity. The Court made clear it would leave analysis of the “reckless disregard” standard for another case. Id. at 10 & n.5 (“We need not decide how (or whether) that objective form of ‘recklessness’ relates to the FCA today[.]”).

At the end of the day, Schutte makes clear federal courts will address the FCA’s scienter requirement under a subjective standard, that is, what a defendant thought and believed about the claims it submitted. Therefore, companies that submit claims to the federal government should, after consulting with counsel, develop policies and standards that uniformly define the company’s interpretation of applicable billing requirements, such as potentially ambiguous terms like “usual and customary.” Further, when made aware of practices that could potentially result in FCA violations, companies should investigate these concerns and, if they determine that their practices are compliant, keep records explaining why they interpret the practices as compliant. All of this will help a company demonstrate—should FCA litigation arise—a subjective belief that their claims complied with regulatory requirements and the FCA.