DOJ to Join Oral Argument in En Banc Rehearing of Fourth Circuit Case on ‘Objectively Reasonable’ Defense

Next week, the full Fourth Circuit will hear oral argument in US ex rel. Sheldon v. Allergan Sales, LLC to determine whether a defendant’s “objectively reasonable interpretation” of an ambiguous statute or regulation is sufficient to preclude a finding of intent under the FCA. Defendants and the entire FCA bar will be watching the case closely.

The Fourth Circuit will consider a critical issue for False Claims Act (FCA) defendants—whether an objectively reasonable interpretation of a statute or regulation, even if erroneous, is a defense under the FCA. In United States ex rel. Sheldon v. Allergan Sales, LLC,[1]  a split panel aligned with “every other circuit to consider the issue”[2] and held that the defendant drug manufacturer “did not act ‘knowingly’” because its reading of the relevant statute was “objectively reasonable” and no U.S. circuit court case or other “authoritative guidance” warned it otherwise.[3] In May, the Fourth Circuit granted rehearing en banc, and next week, it will hear oral argument with the Department of Justice (DOJ) participating.[4] The FCA bar will be watching the argument closely for signs of whether the full Fourth Circuit will follow other circuits in applying an objective test for intent.

Background and District Court Dismissal

The relator (or qui tam plaintiff) alleged the defendant violated the Medicaid Drug Rebate Statute by improper price reporting and sought single damages of over $680 million.[5] The statute requires manufacturers to report pricing data to the Centers for Medicare and Medicaid Services (CMS) for each prescription drug they make.[6] That includes reporting the “Best Price” at which the manufacturer sells the product “to any purchaser in the United States,” including “prices to wholesalers, retailers, [nonprofits], or governmental entities” and net of rebates and other discounts.[7] The defendant read “Best Price” to mean the lowest price charged for a drug to any one customer, net of discounts to that customer;[8] the relator contended that the calculation must aggregate all discounts given to different customers—and that not doing so made the manufacturer’s invoices to Medicaid false claims under the FCA.[9]

The district court focused its analysis mainly on scienter—the FCA’s knowledge element,[10] which can be satisfied by (i) actual knowledge, (ii) deliberate ignorance, or (iii) reckless disregard.[11] The court found the Rebate Statute ambiguous,[12] and then applied a two-step test.[13] In the first step, the court found defendant’s interpretation of the statute “not . . . objectively unreasonable,”[14] and in the second step found defendant was not “warn[ed] . . . away” from that interpretation by CMS.[15] Accordingly, the court found falsity and scienter defeated, and granted the motion to dismiss.[16]

Fourth Circuit Decision

A divided Fourth Circuit panel affirmed, relying largely on Safeco Ins. Co. of Am. v. Burr, 551 U.S. 47 (2007), a case in which the Supreme Court endorsed an “objectively reasonable interpretation” test for intent under the Fair Credit Reporting Act (FCRA).[17] In particular, the majority drew on Safeco’s treatment of the FCRA’s “willfulness” requirement, which the Supreme Court interpreted to include not just “knowing” misconduct but also “reckless disregard.”[18] Therefore, under both the FCA and the FCRA, “reckless disregard” is the lowest level of culpability that is actionable.[19] Defendant’s interpretation of the statute, the majority found, was reasonable at the very least,[20] thus satisfying the first Safeco prong. The second prong was met by the lack of any contrary “authoritative guidance” from CMS, despite defendant’s requests for clarification from the agency.[21] The majority pointed to the punitive nature of the FCA, with its treble damages regime, as making clear notice particularly vital: “If the government wants to hold people liable for violating labyrinthine reporting requirements,” it must “indicate a way through the maze.”[22]

A strongly worded dissent charged the majority with “effectively neuter[ing] the False Claims Act” by “eliminating” the knowledge and deliberate ignorance scienter standards and so distorting the remaining standard that “fraudsters [can] escape any liability so long as they can come up with a post hoc legal rationale that passes the smell test.”[23] However, it is not apparent that Safeco actually gives FCA defendants such an all-purpose liability escape hatch. Safeco, as the majority cautioned, is not a “blank check” but instead requires a defendant’s reading of a statute to be both “objectively reasonable”[24] and not contrary to circuit court precedent or agency guidance.[25]

In addition, the dissent questioned the majority’s assertion of unanimity across the circuits that have considered Safeco’s applicability to FCA scienter.[26] In particular, the dissent cited the Eleventh Circuit in Phalp as “declin[ing] to import” into the FCA “the recklessness standard recognized in Safeco.” [27] Phalp, however, does not reject or even mention Safeco; what it declines to adopt is a rule permitting reasonable interpretation of an ambiguous statute, without more, to defeat scienter.[28] The dissent therefore cited no circuit court opinion expressly rejecting Safeco‘s applicability to FCA scienter.

Government Arguments

Despite declining intervention, the government has taken an active role as amicus in the appeal, and will participate in oral argument before the en banc court.[29] The government asserted that “the district court erred in holding that defendant could defeat plausible allegations of both falsity and knowledge simply by identifying an ambiguity in the relevant requirement.”[30] Not unlike the Allergan dissent, this characterization overlooks both relevant prongs of the Safeco test: the defendant’s interpretation of the ambiguity must be objectively reasonable, and there must be no authoritative judicial or administrative guidance warning the defendant that its interpretation, though reasonable, is incorrect.[31] Those prongs give effect to the meaning of “reckless disregard” by providing a clear test to determine whether the defendant’s action entailed “'an unjustifiably high risk of harm that is either known or so obvious that it should be known.”[32]

The government also suggested narrower grounds for reversal, arguing that the relator had adequately pleaded that the defendant was warned away from its interpretation by CMS guidance and that other sources (like lawyers) could also provide sufficient basis to warn a defendant away from an interpretation.[33] The majority’s approach, however, does not disregard these concerns.  Requiring the government to provide clear and authoritative guidance is necessary to address due process, and other considerations—like warnings from attorneys or industry practice—are relevant to the first prong of the Safeco test (objective reasonableness).[34]

Overview and Outlook

With the majority’s now-vacated holding in Allergan, the roster of circuit courts recognizing Safeco “objectively reasonable interpretation” as a defense to FCA scienter stood at four published and two unpublished. If the en banc Fourth Circuit winds up affirming, like the panel majority did, that emerging consensus will be solidified to the benefit of defendants operating in ambiguous statutory or regulatory frameworks. Reversal, on the other hand, and depending on the court’s precise holding, could yield a more uncertain picture—even the possibility of an outright circuit split.