Seventh Circuit Endorses Objective Reasonableness as a Defense under the FCA

In a much-awaited Seventh Circuit decision, the court joined four other circuits in endorsing the “objective reasonableness” defense under the federal False Claims Act (FCA). In a 2-1 panel decision, the court not only upheld the lower court’s summary judgment for the defendant, but did so on the basis of an objective—not subjective—assessment of the defendant’s state of mind. Moreover, in determining whether authoritative guidance from the government could negate that “reasonable” state of mind, the court imposed a high bar for what guidance from the government could be considered “authoritative.” In short, the Seventh Circuit’s decision provides significant protection for FCA defendants who struggle to maintain compliance in industries—like health care—where the regulatory environment is complex, constantly changing, and often contradictory.

In Schutte v. SuperValu, No. 11-cv-3290, 2021 WL 3560894 (7th Cir. Aug. 12, 2021), the defendant SuperValu pharmacies had offered price-matching discounts to compete with low cost competitors like WalMart. The discounts were only applied, however, if a patient asked for them, and then only to the lowest price of a local competitor. SuperValu was alleged to have instructed its pharmacists to process these discounted transactions as cash transactions so the claims would not go directly to insurers. Further, SuperValu allegedly did not report the price-matching to third-party insurers or the government. In 2011, the relators brought an FCA case against SuperValu, alleging SuperValu had caused the government to “subsidize its market competitiveness” by failing to give third-party insurers, including Medicare Part D and Medicaid, its usual and customary “cash” price, as it was allegedly obligated to do. The government did not intervene in this case.

After dispensing with a variety of regulatory sources summarily, the sole remaining issue for the Seventh Circuit on summary judgment was whether SuperValu’s conduct was consistent with the guidance in the Medicare Prescription Drug Benefit Manual, which requires pharmacies to charge government programs no more than the “usual and customary” drug price per law or contract. SuperValu argued its interpretation of the “usual and customary” provision allowed it to ignore those instances in which its pharmacies matched prices to meet local competition. In particular, SuperValu argued it was entitled to summary judgment because its interpretation of the provision, even if ultimately incorrect, was objectively reasonable under the circumstances.

The specific legal question for the court was whether defendants’ interpretation was: (1) reasonable at the time of the interpretation; and (2) whether “reasonableness” should be interpreted objectively (i.e., from a reasonable person standard) or subjectively (i.e., based on the actual beliefs of the participants at the time, regardless of how an objective observer might have interpreted the Medicare Prescription Drug Benefit Manual’s language). If the defendant’s interpretation was reasonable, it could not be found to have “knowingly” or “recklessly” violated the FCA. Notably, only “knowing” violations are actionable.

In a 2007 decision, the Supreme Court had held that under the Fair Credit Reporting Act (FCRA), the standard for “reasonable interpretation” was an objective one, and a defendant’s subjective intent was irrelevant in determining scienter. Safeco Insurance Co. of America v. Burr, 551 U.S. 47, 70 (2007). Other circuits had considered whether this same standard should be applied in the context of the FCA—which has similar scienter language to the FCRA—and four circuit courts had concluded that it should. The Seventh Circuit’s decision in Schutte continues this trend, and does so using particularly energetic language. 2021 WL 3560894, at *6. In particular, “[t]he FCA includes a scienter standard and limits liability to knowingly false claims. By its own terms, Safeco holds that a failure to establish its objective scienter standard precludes a finding that a defendant acted knowingly.” Id. at *8.

The Seventh Circuit also noted, consistent with Safeco, that “authoritative guidance” from the government can rebut an objectively reasonable interpretation of a regulation or rule. The court held, however, that such “authoritative guidance” can only derive from two governmental sources: “circuit court precedent,” or “guidance from the relevant agency.” Id. at *11 (emphasis added). And even where there is some form of agency guidance, the relevant provision “must have a high level of specificity to control an issue.” Id. at *12 (emphasis added).

Finally, the Seventh Circuit chose not to decide whether, as defendants argued, Centers for Medicare & Medicaid Services (CMS) manuals should never be considered “authoritative guidance” (because large portions of them do not go through notice and comment rulemaking). Rather, the court concluded the guidance in the manual at issue was not “highly specific” enough to rebut the defendant’s objective interpretation. Accordingly, because the relators could not show the defendant’s interpretation was objectively unreasonable, they could not satisfy the scienter prong of the FCA, and the court upheld summary judgment in the defendant’s favor.

Key Takeaways

This ruling continues a company-friendly trend, holding that FCA defendants can defeat relators’ claims at the motion to dismiss or summary judgment stage by demonstrating the legal interpretation being challenged was objectively reasonable. Foley attorneys are monitoring the ongoing developments to help advise clients regarding the potential impact of such precedent in their relevant jurisdictions.

Foley is here to help you address the short- and long-term impacts in the wake of regulatory changes. We have the resources to help you navigate these and other important legal considerations related to business operations and industry-specific issues. Please reach out to the authors, your Foley relationship partner, or to our Government Enforcement Defense and Investigations Group or Health Care Practice Group with any questions.