Introduction

In a decision last week, the Sixth Circuit announced a much-needed common sense approach to the application of the civil False Claims Act (“FCA”) in a complex regulatory environment. The decision rejected the government’s suggestion, where regulations are ambiguous or unclear, that a business should face FCA liability for seeking to increase its profits under the Medicare program. See United States ex rel. Williams v. Renal Care Group, Inc., No. 11-5779, 2012 WL 4748104 (6th Cir. Oct. 5, 2012). The Sixth Circuit’s decision is important and refreshing for a number of reasons. First, in analyzing three separate elements of FCA liability—falsity, materiality, and knowledge/intent—the court made clear that substantial proof is necessary to establish each element. Second, in casting aside the government’s attempt to use the FCA to punish a health care provider that lawfully formed a subsidiary corporation in order to increase its profits from Medicare billings, the court expressed sheer wonderment:

Why a business ought to be punished solely for seeking to maximize profits escapes us.

Slip op. at 9. Rather than accept at face value the notion that profit maximization is a fraud indicator, the court analyzed the underlying conduct and concluded that setting up a corporate structure in order to increase Medicare payments did not amount to recklessness under the FCA. In taking this approach, the Sixth Circuit joined other appellate courts that strictly enforce the FCA’s knowledge standard. Third, the Sixth Circuit also joined forces with the majority rule that violating the “conditions of participation” in a federal program does not render claims “false” under the FCA.

Importantly, however, the court also emphasized that, in dealing with a complex regulatory scheme, the best defense is exercising good faith in attempting to comply with those regulations. In this case, that meant seeking legal counsel as to the validity of their actions, following industry guidelines, and seeking advice from government officials. The ability to demonstrate such good faith was critical to the rejection of FCA liability in this case.

Background

To appreciate the full import of this decision, some background is needed on the complex scheme the government has set up regarding Medicare’s coverage of dialysis equipment and services provided to patients with end-stage renal disease. Initially, Medicare reimbursed providers who supplied dialysis equipment and services to dialysis facilities and to home dialysis patients using a uniform weighted payment (“Method I”). A fee-for-service form of reimbursement (“Method II”) was introduced, but Medicare limited this method to independent companies that only supplied home dialysis patients. In 1994, Congress clarified that Method II payments could be made only to entities that did not supply dialysis facilities, and it required these entities to obtain a supplier number before billing Medicare.

Renal Care Group (“RCG”) supplied dialysis equipment and services to dialysis facilities and home dialysis patients. After making a comparison of the two reimbursement methods, RCG, the defendant company, figured out that it could increase receipts and lower overhead if it billed more under Method II. RCG then created RCG Services Company (“RCGSC”), a wholly owned subsidiary that only supplied home dialysis patients, and RCGSC obtained a separate Medicare supplier number. From 1999 to 2005, Medicare reimbursed RCG and RCGSC $84 million under Method II.

Two former RCG employees brought a qui tam suit alleging that (1) RCG created RCGSC as a sham corporation in order to increase Medicare reimbursements, and (2) RCGSC knowingly submitted false claims because it failed to comply with Medicare standards and requirements. The government intervened in the case and moved for summary judgment on the issues of falsity and materiality as to the first claim, and the defendants moved for summary judgment on all counts. The district court granted the government’s motion. Even though the government did not seek summary judgment on the issue of knowledge, the court nevertheless issued a final judgment in favor of the government on that issue and awarded more than $82 million in FCA damages and penalties. The defendants appealed.

Last week, the Sixth Circuit reversed, and, in a remarkable decision, ordered summary judgment for the defendants on the false claim counts.

The Falsity Requirement

The Sixth Circuit accepted the district court’s finding that “RCG’s creation, operation and control of RCGSC was to receive the higher Method II payments,” but observed that neither the lower court nor the government had explained why this was improper under Medicare:

As became clear during oral argument, the United States focuses, somewhat obsessively, on evidence demonstrating that RCG sought Method II reimbursements for the sole purpose of increasing its profit margins. . . . Why a business ought to be punished solely for seeking to maximize profits escapes us.

Slip op. at 9. This proof failure meant that the primary requirement for FCA liability—the falsity of the claim—had not been established. The court specifically rejected the government’s argument that Medicare’s regulations made clear that a wholly owned subsidiary could not submit claims under Method II. In reaching its decision, the court examined the purposes of the bifurcated reimbursement structure, which were to ensure that dialysis patients would have a broader range of suppliers so that they could make cost comparisons and make their own arrangements for supplies and equipment. The court then concluded that allowing RCGSC to receive reimbursement under Method II did not violate these purposes, and that the structure of RCG and RCGSC was not clearly inconsistent with the goals of the payment scheme. Chief District Judge Rosen wrote a separate concurring opinion to emphasize that the governing statutory and regulatory scheme provided “virtually no signposts” for resolving the key “falsity” question in the case, which was RCGSC’s eligibility for Method II payments.

The Knowledge Requirement

Turning to the issue of intent on which the district court had also granted summary judgment for the government, the court was persuaded by the fact that there was no claim that RCG or RCGSC officials had actual knowledge that submission of Method II claims by a wholly owned subsidiary violated Medicare. As a result, liability under the FCA had to be based on defendants’ “reckless disregard” for the truth or falsity of the claims. To resolve this issue, the court of appeals first cited decisions in other circuits that defined “reckless disregard” under the FCA as “an aggravated form of gross negligence” and as “on a continuum between gross negligence and intentional harm,” and the court adopted this standard as it analyzed the underlying conduct. The court considered not only the defendants’ efforts to determine what Medicare’s regulations required and RSGSC’s compliance with the requirements (incorporating separately and acquiring its own Medicare supplier number), but also the industry practice that openly encouraged Method II reimbursement, the defendant’s request for advice from counsel, and the government’s awareness of RCGSC’s structure.1 The court concluded:

[T]he defendants were not in reckless disregard of the truth or falsity of their claims. Rather, they consistently sought clarification on the issue, followed industry practice in trying to sort through ambiguous regulations, and were forthright with government officials over RCGSC's structure. To deem such behavior “reckless disregard” of controlling statutes and regulations imposes a burden on government contractors far higher than what Congress intended when it passed 31 U.S.C. §3729(b)(1)(A)(iii).

Slip op. at 12. The Sixth Circuit’s assessment of the knowledge element in Williams adds to the growing body of case law emphasizing the need for strict adherence to the FCA’s scienter standards. See, e.g., United States v. Science Applications Int’l Corp., 626 F.3d 1257 (D.C. Cir. 2010); United States ex rel. K & R Ltd P’ship v. Massachusetts Hous. Fin. Agency, 530 F.3d 980 (D.D.C. 2008). See also FraudMail Alert No. 10-12-06 (discussing SAIC decision); FraudMail Alert No. 08-07-09 (discussing K & R decision). See generally John T. Boese, Civil False Claims and Qui Tam Actions §2.06[C] (Wolters Kluwer Law & Business) (4th ed. 2011 & Supp. 2012-2) (discussing intent after 1986 FCA amendments).

The Materiality Requirement

In a separate part of the decision dealing with an alternative argument for liability, the court rejected the government’s second FCA claim—that defendants failed to comply with durable medical equipment supplier standards, including warranties, filling orders from its inventory, and maintaining an appropriate place of business. The court concluded that these standards were “conditions of participation” that, even if violated, did not render the claims materially false. The court held that “[t]he False Claims Act is not a vehicle to police technical compliance with complex federal regulations,” and it cited a number of decisions in other jurisdictions with the same holding. Slip op. at 12-13 (citing United States v. Southland Mgmt. Corp., 326 F.3d 669 (5th Cir. 2003) (en banc); United States ex rel. Wilkins v. United Health Group, Inc., 659 F.3d 295 (3d Cir. 2011); United States ex rel. Landers v. Baptist Mem’l Health Care Corp., 525 F. Supp. 2d 972 (W.D. Tenn. 2007)).

Conclusion

In reversing the lower court’s decision and rejecting its perfunctory analysis of three key requirements for FCA liability—a wholly defective analysis that resulted in the award of more than $82 million in treble damages and penalties—the Sixth Circuit demonstrated the need for strict adherence to the requirements for FCA liability. The government and relators bear the burden of proof in establishing falsity, materiality, and knowledge—not only in health care cases, but across the full spectrum of FCA litigation. But this decision is most important for what it says about government enforcement in the face of a good faith attempt by a defendant to comply with complex government regulations.

The Williams decision is another reminder that the False Claims Act has limits, a principle that the government and relator's counsel seem to ignore in many cases. The Sixth Circuit has reminded the government again that taking advantage of legal loopholes is not fraud. But it also reminded those who take government money that they must act in good faith in dealing with the government. Those who deal with the government are allowed to maximize their profits, but they must be able to demonstrate their good faith and, in many cases, seek competent advice as to the legality of their actions. The Sixth Circuit has now assured them that, if they do so, they are protected from FCA liability.