Are you a parent corporation with a subsidiary that does business with a state or local government? Are you a manufacturer or supplier whose products end up down the distribution chain with a state or local government? If so, you could be the "beneficiary" of a false claim and could be liable for penalties and treble damages.
Since the 1986 amendments to the federal False Claims Act ("FCA"), 31 U.S.C. § 3729, et seq., added a qui tam provision, an increasing number of states have enacted similar FCA statutes. Currently, twenty-nine states and the District of Columbia have general and/or health care FCA statutes with qui tam provisions, and another six have FCA statutes without qui tam provisions. California led the way in 1987, and in doing so departed from the federal FCA to include a unique provision that makes liable a person who:
- is a beneficiary;
- of an inadvertent submission of a false claim;
- who subsequently discovers the falsity of the claim; and
- fails to disclose the false claim to the government within a reasonable time.
Cal. Gov't Code § 12651(a)(8). The following states have
followed California's lead to include similar provisions in
their general and/or health care FCA statutes: District of
Columbia; Hawaii; Kansas; Massachusetts; Montana; Nebraska; Nevada;
New Hampshire; New Mexico; Oregon; Tennessee; and
Wisconsin.1 These peculiar "beneficiary"
provisions are little understood, and therefore are increasingly
being used by clever relator's counsel to include a whole host
of "deep pocket" defendants who had nothing to do with
the submission of the false claim.
First, the term "beneficiary" is not defined in any of
the statutes. As a result, the term could be read broadly enough to
reach anyone who somehow benefitted from the false claim. For
example, could a prime contractor on a public works project be
liable as a beneficiary when a subcontractor mistakenly,
negligently, or intentionally inflates labor rates? Could a
manufacturer who mistakenly, negligently, or intentionally does not
state the true price or quality of a product supplied to a customer
be liable as a beneficiary if that customer in turn sells the
product to the government? Could a parent corporation or
shareholder be liable as beneficiaries when a subsidiary
mistakenly, negligently, or intentionally submits false claims
under its contracts with the government?
Second, these statutes extend liability to this amorphous
contingent of potential "beneficiaries" based merely on
later acquired knowledge that a false claim was made. By
definition, the "beneficiary" need not have had any role
in the submission of the false claim. Under federal law, however,
mere knowledge of a false claim has never been enough to impose
liability, regardless of whether the person with knowledge
benefitted from the false claim. See U.S. ex rel.
Piacentile v. Wolk, 1995 WL 20833 (E.D. Pa.); U.S. v.
President & Fellows of Harvard College, 323 F.Supp.2d 151
(D. Mass. 2004); U.S. v. Safe Environment Corp., 2002 WL
976033 (N.D. Ill.).2
Making matters worse, there are only two published decisions on
this provision—which differ wildly from each
other—one disregarding principles of statutory
interpretation to expand liability in an alarming manner, and the
other adhering to those principles to limit liability in a sensible
manner.3
City of Burbank ex rel. Armenta v. Mueller Co.
In 2006, the California Court of Appeal issued the first
reported decision interpreting the scope of a beneficiary
provision, City of Burbank ex rel. Armenta v. Mueller Co.,
142 Cal.App.4th 636, 645-49 [47 Cal.Rptr.3d 832] (2006) (reversing
summary judgment in favor of defendants).4
Mueller held, notwithstanding a scathing dissent, that the
parent and great-grandparent corporations of a subsidiary
corporation that allegedly intentionally submitted false claims
could be liable as beneficiaries. In reaching this holding, the
Court of Appeal made several pronouncements regarding statutory
interpretation: (1) "third persons who did not submit the
false claims themselves" can be liable, i.e.,
"the statute does not require that the beneficiary have
submitted the false claim"; and (2) the statute's
reference to the "'inadvertent submission of a false
claim' does not preclude the imposition of liability on the
beneficiary of a false claim where the claim has been submitted
intentionally." 142 Cal.App.4th at 647-48. The Court of Appeal
did not discuss the manner in which a beneficiary had to benefit
from a false claim, and apparently did not appreciate the
consequences of conferring beneficiary status solely based on the
parent-subsidiary relationship. By extending liability to a
beneficiary who did not submit the claims, the Mueller
majority set up the potential for an absurd result under the
statute where a beneficiary could be liable for an
"inadvertent" submission, but not an
"intentional" submission. The Mueller
majority's solution was to, in effect, define the word
"inadvertent" as including "intentional"!
Recognizing that the majority had flouted long-settled tenets of
corporate law, Justice Vogel wrote a scathing dissent:
I dissent because the majority opinion eviscerates corporate law and opens a supersize can of worms by attaching liability to parent, grandparent, and great-grandparent corporations for the acts of their direct and indirect subsidiaries based solely on status—the existence of the relationships.
142 Cal.App.4th at 655. Justice Vogel accused the majority of
"ignor[ing]" two "rule[s]": (1) "that the
only basis on which the parent and grandparent could be liable for
the subsidiary's wrongdoings is under an alter ego theory based
on evidence that would permit [relator] to pierce the corporate
veil"; and (2) that alter ego liability can never be based on
the mere fact of the parent-subsidiary relationship, or on the mere
existence of common directors and officers." Id. at
652 [citations omitted]. Justice Vogel then turned to what she
termed "the majority's whimsical interpretation of
'beneficiary' as that word is used in the [statute]."
Id. Justice Vogel cogently explained, based on the words
of the statute, legislative history, and a comparison with the
federal FCA, what conduct and persons beneficiary provisions are
meant to address:
[B]y its plain language, subdivision (a)(8) of section 12651 does not apply to third persons who do not themselves submit claims. To the contrary, it applies to a person who inadvertently submits a false claim to a government entity, receives a benefit (hence the use of the word "beneficiary"), then discovers the falsity of the claim and fails to disclose it. The only difference between the California and federal acts is that, for liability to attach under the federal act, the person submitting the claim must know at the time of submission that the claim is false, whereas liability can attach under the California False Claims Act if the submission is inadvertently false and the beneficiary later learns of the falsity and fails to report it to the victim.
142 Cal.App.4th at 654 [citations omitted]. In other words, as
stated by Justice Vogel, a beneficiary provision is meant "to
apply only to the 'negligent claimant,' and not to a third
party." Id.
In re Pharmaceutical Industry Average Wholesale Price Litigation
The Mueller decision focused on whether a third-party who did not submit claims could be a beneficiary and whether a third-party beneficiary could be liable where the person submitting claims did so intentionally, as opposed to inadvertently, and answered both questions yes. The only other reported case addressing the same provision, In re Pharmaceutical Industry Average Wholesale Price Litigation, 478 F.Supp.2d 164 (D. Mass. 2007) (granting motion to dismiss), did not even cite Mueller, and it is not apparent from the decision whether the district court agreed with Mueller's statutory interpretation. In fact, the district court was faced with a much different factual scenario—defendants (pharmaceutical manufacturers) alleged to have intentionally caused non-parties (pharmacies and physicians) to submit false claims. This conduct fits the classic definition of a violation of the substantive provisions under federal and state FCA statutes making liable a person who "knowingly presents or causes to be presented, a false or fraudulent claim" and "knowingly makes, uses, or causes to be made or used, a false record or statement." See 31 U.S.C. § 3729(a)(1)(A) & (B); Cal. Gov't Code § 12651(a)(1) & (2). The district court dismissed the beneficiary count and essentially gave meaning to the term "inadvertent," holding that a defendant who is alleged to have "intentionally induced" a false claim cannot have "subsequently discovered" that the claim was false:
While the FCA should be liberally read, plaintiff's claim is a round peg in a square hole. The alleged fraud is that the manufacturers intentionally induced doctors and other providers to submit false claims to get inflated reimbursements. Thus, even if drug manufacturers are considered beneficiaries in a broad sense because they profit from increased market share, these manufacturers cannot be said to be beneficiaries of an inadvertent submission of a false claim they "subsequently discovered." The count is dismissed.
In other words, a person involved in the misconduct from the
beginning cannot "subsequently discover" it. In contrast
to Mueller, In re Pharmaceutical Industry focused
on the mens rea of the beneficiary, and a beneficiary
intentionally causing a false claim to be made would not escape
liability – the person would just be liable under a
different provision. Although the holding of In re
Pharmaceutical Industry is favorable to defendants, as a
practical matter, it does not ameliorate the negative aspects of
the Mueller decision.
Conclusion
Given the current economic climate and budget deficits, state
and local governments have a compelling incentive to devise
inventive ways to generate revenue. Members of the qui tam
bar are ready to assist them in any way they can, and have taken to
heart the oft-repeated platitude that "[t]he False Claims Act
must be construed broadly so as to give the widest possible
coverage and effect to its prohibitions and remedies."
LeVine v. Weis, 90 Cal.App.4th 201, 210 (2001), citing
Southern Cal. Rapid Transit Dist. v. Superior
Court (1994) 30 Cal.App.4th 713, 724. Consequently, we foresee
that beneficiary provisions will be invoked more often, and
additional states may amend their FCAs to include them, in an
effort to cast a wider net over potentially liable parties.
If you find yourself sued under a beneficiary provision, it is
important to aggressively address the proper statutory
interpretation at the earliest stage, since the opportunity to
shape how this little understood provision will be construed in the
future is still available.
Footnotes
1. Oregon's statute uses different language: "Fail to disclose a false claim that benefits the person within a reasonable time after discovering that the false claim has been presented or submitted for payment or approval." (Or. Stat. § 180.755(1)(i).) Wisconsin's statute does not use the term "inadvertent." (Wisc. Stat. § 20.931(2)(h).)
2. At the time of the 1986 amendments, a beneficiary provision was proposed by the proponent of the California False Claims Act, but ultimately rejected. Thus, even though federal jurisprudence can be relied on as persuasive authority when there is a lacunae in state FCA case law regarding a particular statutory provision, the absence of a beneficiary provision in the federal FCA can make federal cases inapposite.
3. Partners Bryan Daly and Charles Kreindler presently represent J-M Manufacturing Company, Inc. ("JM Eagle") in an FCA case, U.S. ex rel. Hendrix v. J-M Manufacturing Company, Inc., Case No. EDCV 06-55-GW (C.D. Cal.) ("Hendrix"), brought under the federal FCA and twelve state FCA statutes, five of which include beneficiary provisions. In that case, JM Eagle and co-defendant Formosa Plastics Corp. U.S.A. (JM Eagle's former parent) successfully challenged the application of beneficiary provisions on a motion to dismiss under Fed.R.Civ.P. 12(b)(6). In an unreported ruling filed December 1, 2010, albeit with leave to amend granted, Judge Wu held that the relator had failed to plead the elements of claims under the beneficiary provisions. How Judge Wu will ultimately handle beneficiary claims is unclear at this time.
4. Partners Bryan Daly and Charles Kreindler represented three of the defendants in this case.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.