On June 1, the U.S. Supreme Court unanimously refused to apply the Safeco objective knowledge standard to the False Claims Act (FCA), holding instead in U.S. ex rel. Schutte v. Supervalu Inc. that the FCA's scienter element turns on a defendant's "knowledge and subjective beliefs," not on "what an objectively reasonable person may have known or believed."
Although the Supreme Court's measured opinion avoided the heated debates that characterized lower court rulings on this issue, the Court's holding guts the Safeco defense defendants have relied on to secure dismissals at the motion to dismiss and summary judgment stages. The upshot is that defendants have lost an essential tool they have come to rely on in FCA actions.
Background
As we've covered in our False Claims Act Fundamental series, the FCA requires the government or a relator to prove that the defendant "knowingly present[ed] . . . a false or fraudulent claim for payment or approval." This is known as the scienter element. The FCA defines knowledge as any of the following:
- Actual knowledge that a claim is false.
- Deliberate ignorance that a claim is false.
- Reckless disregard that a claim is false.
Historically, the scienter element was treated as a factual question to be resolved by the factfinder. As a result, the scienter element was typically not seen as a basis for dismissal on a motion to dismiss or at summary judgment.
But that changed after the Supreme Court's 2007 opinion in Safeco Ins. Co. of America v. Burr, where the Supreme Court, interpreting the term "willfully" in the Fair Credit Reporting Act (FCRA), held that a defendant cannot act with "knowledge" or "recklessness" if there is an objectively reasonable interpretation of the statute the defendant is accused of violating that would permit the defendant's conduct, and the defendant has not been warned away from that interpretation.
After Safeco, defendants in FCA actions began to argue that the same objective knowledge standard should apply to the FCA's scienter element—and every appellate court to address the issue agreed. As a result, the Safeco defense began to serve as a key tool for FCA defendants, who secured dismissals on motions to dismiss and at summary judgment on that basis. The power of the Safeco defense was that it turned on the ambiguity of the law the defendant was accused of violating, and thus could be resolved as a matter of law in motion practice.
Schutte, typifying this trend, involved a pair of consolidated qui tam cases from the Seventh Circuit. In both cases, the defendant pharmacies were accused of violating the FCA by submitting false "usual and customary" drug prices to federal healthcare programs. The relators contended that the defendants knew the retail prices they submitted were not their actual usual and customary prices because the pharmacies sold a majority of drugs at discount prices for certain periods.
Applying Safeco, the Seventh Circuit affirmed grants of summary judgment to the pharmacies, reasoning that the pharmacies could not have possessed the requisite scienter because it was objectively reasonable to interpret usual and customary to mean retail price, and the pharmacies had not been warned away from that interpretation. The Seventh Circuit's rulings demonstrated the power of the Safeco defense. It did not matter whether the pharmacies actually believed their claims were false—an open question that remains unresolved—because the term "usual and customary" was ambiguous on its face and could have permitted the defendants' conduct.
Supreme Court Opinion
In a unanimous opinion, the Supreme Court held that Safeco's holding is "tied to the FCRA's particular text" and has no application to the FCA's definition of knowledge. Instead, the Supreme Court looked to the language of the FCA and its roots in common law fraud, and reasoned that all three scienter terms under the FCA—actual knowledge, deliberate ignorance, and reckless disregard—"focus primarily on what [defendants] thought and believed." That is, the key question is "what the defendant thought when submitting the false claim."
The Supreme Court allowed that a defendant might make a "forgivable mistake" by "honestly read[ing]" the applicable law to permit its conduct, in which case FCA liability would not lie. But if the defendant subjectively had actual knowledge, deliberate ignorance, or reckless disregard that its claims were false when it submitted them, then "it does not matter whether some other, objectively reasonable interpretation of" the statute would have permitted the defendant's conduct. Put differently, the facial ambiguity of a statute or regulation "alone is not sufficient to preclude a finding that" a defendant knew its claims were false.
Implications
The Supreme Court explained that it did not need to address "the parties' policy arguments," because the legal question before the Court was decided by the statutory text. But that does not mean the opinion will not have significant implications. Some lower court judges had argued Safeco's objective knowledge standard was necessary to curb the FCA's overreach and protect defendants navigating labyrinthine regulatory requirements from punitive liability under the FCA. Other lower court judges decried Safeco as permitting fraudsters to get away with fraud by crafting after-the-fact interpretations that supported their positions.
The upshot of Schutte is defendants can no longer rely on the Safeco defense, and it will be harder for defendants to argue failure to prove scienter as a basis for dismissal before trial. Given the essentially punitive liability the FCA imposes—treble damage plus per-claim civil penalties—Schutte will increase the number of settlements involving defendants who simply cannot risk proceeding to trial in the face of a potentially catastrophic adverse judgment.
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