If an interpretation of a law is objectively reasonable, a defendant’s actual state of mind is irrelevant. This is what the majority of a US Court of Appeals for the Fourth Circuit panel held when affirming dismissal of a relator’s False Claims Act (FCA) qui tam suit alleging Medicaid fraud in United States ex rel. Sheldon v. Allergan Sales, LLC.[1] With this decision, the Fourth Circuit joined five other appeals courts in applying the Supreme Court of the United States’ decision in Safeco Insurance Co. of America v. Burr [2] to FCA cases and holding that a defendant cannot act with the requisite state of mind, or scienter (which can be satisfied through showing knowledge, deliberate ignorance or recklessness), when the defendant is acting under an “objectively reasonable” reading of a statute and was “not warned away from that interpretation by authoritative guidance.” [3]

The ruling, and the similar rulings that preceded it, are important for subjects of FCA investigations and defendants in qui tam litigation who have operated under objectively reasonable interpretations of statutes and regulations. It has broad implications across an array of healthcare topics governed by laws that are ambiguous or subject to multiple reasonable interpretations, including topics discussed later in this report. For example, statutes and regulations aimed at responding to the COVID-19 pandemic are sure to be the source of enforcement activity and qui tam litigation for years to come, but many of those laws were hastily drafted and contain unclear requirements. Allergan will prove to be an important check on COVID-19 enforcement overreach.

The Relator’s “Best Price” Theory in Allergan

In Allergan, the relator, a former employee of Forest Laboratories, LLC (subsequently merged with Allergan Sales, LLC), alleged that Forest participated in a fraudulent reporting scheme under the Medicaid Drug Rebate Statute by purportedly failing to aggregate discounts provided to separate customers for purposes of “best price” reporting obligations. [4] Under the Rebate Statute, drug manufacturers must provide quarterly rebates to states on Medicaid sales of covered drugs. The Centers for Medicare and Medicaid Services (CMS) calculates these rebates based on reporting from the manufacturer. [5]

The relator alleged that Forest improperly failed to aggregate discounts given to every customer in the distribution chain, thereby leading to false pricing reports to CMS and reducing the amount of the state rebates Forest had to pay. [6] In one example given by the relator, Forest gave a 20% discount to a patient’s insurance company and a 10% discount to the same patient’s pharmacy. Forest reported a best price as having a 20% discount (the highest single discount it offered), but the relator alleged that the best price should have been a 30% discount (a combination of the two discounts in the same supply chain for the same drug). [7] The relator alleged that this practice reduced the rebates that Forest paid to participating states and resulted in the federal government paying at least $680 million more than it would have if Forest had accurately reported its best price. [8]

In seeking dismissal, Forest argued that the Rebate Statute and CMS’s regulations interpreting the statute were ambiguous regarding how best price should be calculated. [9] Neither the statute, the associated regulations nor the rebate agreement into which manufacturers must enter with the Secretary of Health and Human Services specified that discounts must be aggregated. [10] Forest therefore argued that CMS guidance could be interpreted as being the discount applied to any single entity. In fact, both the rebate agreement and CMS acknowledge the complexity of the program and therefore encourage manufacturers to simply make “reasonable assumptions” in preparing their calculations of “best price.” [11] Forest also relied on written comments it had submitted during CMS’s rulemaking process laying out its interpretation of the statute and urging CMS to provide clarity. CMS declined to offer clarification. [12]

The District Court and the Fourth Circuit Side with the Defendant

In affirming the decision from the US District Court for the District of Maryland, the Fourth Circuit applied the Supreme Court’s two-step analysis in Safeco to determine whether Forest acted knowingly under the FCA. [13] In Safeco, the Supreme Court interpreted the Fair Credit Reporting Act’s state of mind requirement, holding that the requirement cannot be satisfied if the defendant’s interpretation of a law is objectively reasonable, irrespective of the defendant’s subjective intent. [14] The Fourth Circuit in Allergan held that application of this standard “duly ensures that defendants must be put on notice before facing liability for allegedly failing to comply with complex legal requirements.” [15] Importantly, the FCA “does not assess liability through ambush.” [16]

Applying Safeco’s test, the Court first analyzed whether Forest’s interpretation was objectively reasonable. The Court found that “Forest’s reading of the Rebate Statute was not only objectively reasonable but also the most natural,” given that the statute defined Best Price as the single lowest price available to any entity. [17] Second, the Court analyzed whether “authoritative guidance might have warned defendant away from that reading.” The Court found that “Forest was not warned away from its reading by authoritative guidance from CMS” because, despite being expressly asked to clarify the rule regarding discounts, CMS failed to do so and “thereby maintained strategic ambiguity.” [18] The Court further relied on the language of the rebate agreements, which provide that “in the absence of specific guidance,” manufacturers should “make reasonable assumptions in their calculations of . . . Best Price, consistent with the requirements and intent of [the Rebate Statute], Federal regulations and the terms of this agreement.” [19]

Judge Wynn wrote a strongly worded dissent expressing concern about the implications of the Court’s decision. [20] According to Judge Wynn, the Court’s decision would “effectively neuter” the FCA by eliminating the scienter standard altogether. [21] Even if application of Safeco here were wise, Judge Wynn concluded that Forest’s failure to aggregate the discounts could not have been the product of “honest mistakes” and therefore its interpretation could not be considered objectively reasonable. [22]

Allergan Represents a Decisive Trend, with Important Implications

With its Allergan decision, the Fourth Circuit joined the five other circuits that have addressed this issue and applied the Safeco two-step scienter test to FCA cases. [23] The Fourth Circuit’s Allergan decision has important implications for FCA cases moving forward:

• The decision provides defendants with an additional tool with which to defend FCA investigations and qui tam suits. In the first instance, it is an argument defendants should raise with DOJ in seeking declination. If a case proceeds to litigation, Allergan provides a framework through which FCA defendants can seek early dismissal on the grounds that the defendant’s conduct comported with an objectively reasonable interpretation of a law that did not conflict with any authoritative guidance.

• While important to all FCA defendants, the Allergan decision is especially significant to healthcare companies that are governed by complex regulations that can be subject to multiple interpretations. In the past two years in particular, healthcare institutions have navigated a barrage of evolving regulations and guidance in response to the COVID-19 pandemic. In the wake of Allergan, healthcare organizations should thoughtfully consider and document the bases for their interpretations of ambiguous statutes and regulations, in order to help demonstrate the objective reasonableness of those interpretations if enforcement activity should arise.

• In appropriate circumstances, it may be prudent for a company to seek clarification from the relevant payor or regulator, as Forest did in Allergan. Depending on the outcome of such a request, the fact that this request was made may be useful if the reasonableness of the defendant’s interpretation is later questioned. However, the benefits and risks of engaging with the regulator should be carefully evaluated in each situation.

• What constitutes “authoritative guidance” as used in Allergan and other cases likely will continue to be hotly contested in FCA cases. Courts will have to determine whether the guidance relied on by the government or a relator in an FCA case directly addresses the point of ambiguity in the statute or regulation, and whether sub-regulatory guidance such as manuals, opinions and policy statements that do not have the force of law should be considered in the Safeco analysis. The outcome of these future battles will determine just how much Allergan’s decision will impose a check on future FCA claims.

• While Allergan was decided based on the scienter element of an FCA claim, aspects of its reasoning are, as a logical matter, applicable to the “falsity” element of such a claim. If a statutory interpretation is objectively reasonable, a claim cannot be objectively “false” within the meaning of the FCA. In Allergan, the defendant advanced a falsity argument in addition to the scienter argument, contending that the relator failed to plausibly plead that the pricing submissions were objectively false. [24] The district court found its argument persuasive. [25] Indeed, if an interpretation of a law is objectively reasonable, it is difficult to see how a claim submitted in accordance with that interpretation could be “false,” much less knowingly so.

The relator in Allergan has filed a petition for rehearing en banc, which is pending as of the date of this publication.

1. 24 F.4th 340 (4th Cir. 2022).

2. 551 U.S. 47 (2007).

3. Allergan, 24 F.4th at 348; see United States ex rel. Schutte v. SuperValu Inc., 9 F.4th 455, 459 (7th Cir. 2021); United States ex rel. Streck v. Allergan, Inc., 746 F. App’x 101, 106 (3d Cir. 2018); United States ex rel. McGrath v. Microsemi Corp., 690 F. App’x 551, 552 (9th Cir. 2017); United States ex rel. Donegan v. Anesthesia Assocs. of Kansas City, PC, 833 F.3d 874, 879–80 (8th Cir. 2016); United States ex rel. Purcell v. MWI Corp., 807 F.3d 281, 290–91 (D.C. Cir. 2015).

4. 24 F.4th at 345–46.

5. Id. at 345 (discussing 42 U.S.C. § 1396r-8).

6. Id. at 346.

7. Id.

8. Id.

9. See id. at 346–47.

10. See id. at 345 (discussing 42 U.S.C. § 1396r-8(c)(1)(C)(i), (ii) and 42 C.F.R. § 447.505(a) (2007)).

11. Id. at 355.

12. See id. at 354.

13. Id. at 348.

14. 551 U.S. at 70.

15. 24 F.4th at 348–50.

16. Id. at 356.

17. Id. at 351–53.

18. Id. at 353–56.

19. Id. at 355 (internal quotations omitted).

20. Id. at 357 (Wynn, J., dissenting).

21. Id.

22. Id. at 358.

23. See Schutte, 9 F.4th at 459; Allergan, 746 F. App’x at 106; Microsemi, 690 F. App’x at 552; Anesthesia Assocs., 833 F.3d at 879–80; MWI Corp., 807 F.3d at 290–91.

24. United States ex rel. Sheldon v. Forest Laboratories, LLC, 499 F. Supp. 3d 184, 209 (D. Md. 2020).

25. Id. at 212 (holding that the defendant’s interpretation “cannot quality as objective falsehoods or constitute false statements under the FCA” when it was not objectively unreasonable).