The Effect of Ambiguity on Scienter Under the False Claims Act

A recent Eleventh Circuit opinion addresses this question and provides an answer: Sometimes it does; sometimes it doesn’t.

Factual Background

Gerry Phalp and Matt Peoples were former salesmen for Lincare, Inc., a subsidiary of Lincare Holdings, Inc. Lincare supplies Medicare beneficiaries who suffer from chronic obstructive pulmonary disease (COPD) with oxygen, as well as respiratory and other therapy services.¹

Under the name Diabetic Experts of America, Lincare also conducts a business of supplying Medicare beneficiaries with diabetic-testing supplies. Diabetic Experts² regularly made sales calls to Lincare’s Medicare COPD customers, offering diabetic-testing items, including blood-test strips.

When submitting claims to Medicare for sales of diabetic-testing items, Diabetic Experts submitted authorizations, called assignments of benefits (AOBs),that the Medicare beneficiaries had given to Lincare in connection with the provision of COPD supplies.

These AOBs did not specifically refer to diabetic testing items. Instead, they were generic, stating that the Medicare beneficiary agreed (1) to rent or purchase “certain medical equipment, products, supplies, prescription drugs and/or associated services” either from “Lincare and its affiliates” or “Supplier and its affiliates;” (2) that Lincare would provide “HME [i.e., home medical equipment] and Supplies” or “DME [i.e., durable medical equipment];” and to assign Medicare benefits (i.e., authorize payments) to Lincare.

Medicare Regulations

Anti-Telemarketing Provisions

Medicare anti-telemarketing regulations generally prohibit a supplier from directly soliciting a Medicare beneficiary by telephone, subject to three exceptions:

(i) The individual has given written permission to the supplier to contact them [sic] by telephone concerning the furnishing of a Medicare-covered item that is to be rented or purchased.

(ii) The supplier has furnished a Medicare-covered item to the individual and the supplier is contacting the individual to coordinate the delivery of the item.

(iii) If the contact concerns the furnishing of a Medicare-covered item other than a covered item already furnished to the individual, the supplier has furnished at least one covered item to the individual during the 15-month period preceding the date on which the supplier makes such contact.³

Assignment of Benefit Provisions

Under Medicare’s AOB requirements,

A separate request for payment statement prescribed by CMS [the Centers for Medicare & Medicaid Services, which administers the Medicare program] and signed by the beneficiary (or by his or her representative) may be included in claims by reference, in the circumstances specified in paragraphs (b) through (d) of this section.⁴

Paragraph (d) states:

A signed request for payment statement retained in the supplier’s file may be effective indefinitely subject to the following exceptions:
….
(2) With respect to assigned claims for rental or purchase of DME, a new statement is required if another item of equipment is rented or purchased.⁵

Statutory Reference to Durable Medical Equipment

Medicare’s description of the term “durable medical equipment” or “DME” reads in part as follows:

The term ‘durable medical equipment’ includes iron lungs, oxygen tents, hospital beds … and includes blood-testing strips and blood glucose monitors for individuals with diabetes ….⁶

False Claims Act

A person violates the FCA if the person (1) “knowingly presents, or causes to be presented, a false or fraudulent claim for payment or approval” to the government or (2) “knowingly makes, uses, or causes to be made or used, a false record or statement material to a false or fraudulent claim.”⁷

Liability for a violation can be enormous: up to three times the amount of each claim (i.e., not just the excess above any valid amount), plus penalties as high as $21,563 per claim.⁸ For purposes of applying the FCA, every Medicare or Medicaid claim for reimbursement is considered a separate claim for payment.

Any person may file an action against a defendant for violation of the FCA.⁹ The filer is known formally as a relator and informally as a whistleblower. The action is called a qui tam action because it is brought on behalf of the United States as well as the relator. That is why the case caption always begins United States ex rel. The United States is a party in interest.

If the government elects to intervene in a qui tam case, the relator is entitled to receive between 15 percent and 25 percent of the government’s ultimate recovery, plus attorneys’ fees and expenses. If the government does not intervene, the relator’s share is 25 percent to 30 percent of the government’s recovery, plus attorneys’ fees and expenses.¹⁰

The Qui Tam Complaint

Phalp and Peoples filed a qui tam action in the United Stated District Court for the Southern District of Florida against “Lincare Holdings, Inc., and Lincare, Inc. d/b/a Diabetic Experts of America.” The complaint cited as examples six Medicare beneficiaries to whom Diabetic Experts had marketed diabetic testing supplies for which the company then billed Medicare.

The theory of the relators’ complaint was that in its submission of claims to Medicare, Diabetic Experts:

(1) violated the Medicare anti-solicitation prohibition when it telephoned Lincare’s COPD customers; and

(2) violated Medicare’s AOB requirements by (a) relying on AOBs signed by Lincare’s COPD customers and (b) failing to obtain and submit a new AOB for each item sold, as required for DME sales.

When Diabetic Experts submitted claims to Medicare, the theory concluded, it impliedly -- and falsely -- certified compliance with these Medicare regulations, thereby violating the FCA.

The relators’ theory rested on two premises. The first was that that Lincare’s COPD operations and its Diabetic Experts operations constituted two separate entities. If so, then Diabetic Experts was making cold calls -- i.e., not calls to existing customers -- in violation of Medicare’s anti-solicitation prohibition, and was relying on false AOBs -- i.e., AOBs given to an entity other than Diabetic Experts. The second premise was that the diabetic supplies fell within the definition of DME and therefore required a new AOB for each sale.

July 2015 District Court Ruling

In July 2015 the district court ruled on the defendants’ motion for summary judgment. It was a solid victory for the defense.

Lincare and Diabetic Experts Are a Single Entity

First, the court concluded that “Diabetic Experts is a fictitious name used by Lincare” rather than a separate entity. Diabetics Experts had never been established as a separate legal entity. That meant that when Diabetic Experts personnel telephoned customers who were, or had within the past 15 months been, COPD customers of Lincare, the calls fell within the third of the three exceptions to the anti-solicitation prohibition.

Similarly, it meant that when Lincare COPD customers signed AOBs, the AOBs were effective for Diabetic Experts customers, as well.

Diabetic Testing Items Are Not DME

The relators argued that 42 U.S.C. § 1395x(n), titled “Durable Medical Equipment,” confirmed that blood strips and other diabetic testing items were in fact DME. After all, the regulation expressly states, “the term ‘durable medical equipment’ includes … blood-testing strips and blood glucose monitors for individuals with diabetes.”

The defendants countered that the items were not DME or even equipment of any kind; they were supplies.

The court sided with the defendants, citing a decision by the federal court for the District of Maine for the proposition that although 42 U.S.C. § 1395x(n) “‘includes a non-exclusive statutory list of representative medical equipment,’ it does not specifically define the term DME.” Nor does the section address “how to determine whether a covered item of DME is considered a piece of equipment or a supply for assignment of benefit purposes.”¹¹

The court cited two authorities to conclude that the defendants’ position was correct. First, Medicare regulations distinguish between “durable medical equipment,” defined in 42 C.F.R. § 414.402(1) and “supplies necessary for the effective use of DME,” defined in 42 C.F.R. § 414.402(2).

Second, in 2011 when CMS proposed the regulations that now define “supplies” and “equipment,” the Background section of the announcement stated:

We propose that supplies are defined as “health care related items that are consumable or disposable, or cannot withstand repeated use by more than one individual.” We propose that medical equipment and appliances are “items that are primarily and customarily used to serve a medical purpose, generally not useful to an individual in the absence of an illness or injury, can withstand repeated use, and can be reusable or removable.¹²

Accordingly, the court concluded that the items sent by Diabetic Experts to the six exemplar beneficiaries were supplies rather than DME. Therefore, the AOBs were appropriate.

The Case Does Not Demonstrate Scienter

The court then addressed the concept of scienter: a necessary element of a valid claim under the FCA. The analysis relied heavily on the Eleventh Circuit’s statement of the scienter standard in Urquilla-Diaz v. Kaplan University:¹³

For liability to attach, the relator must show that the defendant acted knowingly, which the Act defines as either actual knowledge, deliberate ignorance, or reckless disregard …[T]he statute’s language makes plain that liability does not attach to innocent mistakes or simple negligence.

Under the Urquilla-Diaz standard, the term “deliberate ignorance” as used in the statutory definition of “scienter,” “plainly demands even more culpability than that needed to constitute reckless disregard.”

Applying this standard, the court declared that even if the relators’ “best evidence” -- two email conversations in March and October 2009 -- regarding Diabetic Experts’ knowledge could arguably demonstrate scienter with regard to the AOBs, the evidence could not possibly demonstrate scienter with regard to the telephone solicitations. The court proceeded with the scienter analysis of the AOBs.

This is the point at which the court addressed the effect of ambiguity in the allegedly violated authority. Significantly, the court expressly declined to rule that the AOB-related authorities were in fact ambiguous. Nevertheless, it made a number of declarations regarding the effect of ambiguity on scienter, including the following:

[A] defendant’s “reasonable interpretation of any ambiguity inherent in the regulations belies the scienter necessary to establish a claim of fraud under the FCA,” quoting U.S. ex rel. Ketroser v. Mayo Foundation.¹⁴

To prevail under the False Claims Act, “relators must show that there is no reasonable interpretation of the law that would make the allegedly false statement true,” quoting U.S. ex rel. Hixson v. Health Management System.¹⁵

The court granted defendants’ motion for summary judgment, in effect ruling that

(1) the relators had failed to demonstrate that the defendants had violated the Medicare anti-solicitation prohibition;

(2) the relators had failed to demonstrate that the defendants had violated the Medicare AOB requirement by relying on COPD beneficiaries’ AOBs for sales of diabetic testing items; and

(3) the relators had failed to demonstrate that the defendants had violated legal authorities requiring a new AOB for each item of DME; but if the defendants had done so, and if those authorities were ambiguous, and if any interpretation of the ambiguity would render defendants’ action non-violative, then relators had failed to demonstrate scienter.

The court closed its opinion with a reminder to the parties that they had agreed that this summary judgment motion did not dispose of the entire case and that they should submit a joint status report regarding what issues remained open.

January 2016 District Court Ruling

In January 2016 the case was again before the trial court on competing motions for summary judgment, the relators having supplemented their complaint with allegations that Diabetic Experts had made sales calls to customers of Lincare affiliates Med4Home and Lincare Pharmacy Services, using and relying on the Lincare Holdings’ patient data base. The relators provided three new exemplars of calls made by Diabetic Experts to Med4Home customers, resulting in Medicare claims.

In its review of the procedural history of the case, the court included a footnote that characterized its July 2015 ruling this way: “In its July Order, the Court found, as an alternative and independent ground for partial summary judgment in favor of Defendants on the Original Exemplars, that there was no record evidence presented to support a jury finding that Defendants had scienter for those claims.”¹⁶

The court ruled that the three new Medicare beneficiaries to whom the calls were made had consented to the calls by executing consent forms allowing contact by “Lincare and its affiliates.”

The relators argued that they had personal knowledge of other calls that violated the anti-solicitation prohibition. But the court ruled that they had not demonstrated their knowledge sufficiently to establish a factual issue. What’s more, such knowledge as they demonstrated had come largely through the process of discovery in the instant case. It is black letter FCA law that relators must have direct and personal knowledge of the submission of false claims before discovery takes place.¹⁷

The Eleventh Circuit

The relators appealed both the July and January 2016 orders to the Eleventh Circuit. On May 26, 2017 that court issued its opinion¹⁸ -- declaring that sometimes but not always ambiguities in an applicable legal authority can serve to defeat a finding of scienter on the part of a defendant in a FCA case.

The Telephone Calls

With regard to the telephone solicitations cited by relators as FCA violations, the appellate court agreed with the lower court’s conclusion and with its reasoning: the calls that were the subject of the July order fell squarely within the third of the three exceptions (i.e., sales within the previous 15 months to the person called) to the anti-solicitation prohibition and therefore violated neither the prohibition nor the FCA. The calls that were the subject of the January order fell squarely within the first exception (i.e., written consent of the person called) and therefore violated neither the prohibition nor the FCA.

The court affirmed those portions of the two orders without reservation.

The AOBs

With regard to the AOBs, the appellate court agreed with the trial court that the evidence offered by the relators as to the defendants’ state of mind was insufficient to survive summary judgment.

The appellate court also agreed that ambiguities in the legal authority a defendant is alleged to have violated may in some cases serve to defeat a finding of scienter.

The court declined to say that the Medicare AOB authorities were ambiguous, but did acknowledge, “There is nothing in the plain language of 42 C.F.R. § 424.36(a) that would put Defendants on notice that Diabetic Experts’ use of AOBs given to Lincare were not compliant with Medicare regulations.”¹⁹

Therefore, the summary judgment order was affirmed as to the AOBs as well as to the telephone calls.

The Ambiguity Standard

Nevertheless, the appellate court went out of its way to rule that “the district court applied an erroneous scienter standard” and to explain both the nature of the district court’s error and the correct scienter standard. The exposition is all the more noteworthy because the court could have avoided the issue altogether. After all, the district court had expressly held that the defendants had not violated AOB regulations and had expressly declined to rule that the regulations were ambiguous.

The appellate court was clearly concerned that the district court’s discussion of ambiguity and scienter was just plain wrong and needed to be corrected. The essence of the error was “the conclusion that a finding of scienter can be precluded by a defendant’s identification of a reasonable interpretation of an ambiguous regulation that would have permitted its conduct” and the corollary that “a defendant’s reasonable interpretation of any ambiguity inherent in the regulations belies the scienter necessary to establish a claim of fraud under the FCA.”²⁰

In the view of the appellate court, not every ambiguity can serve to defeat scienter. Even when an authority is ambiguous, a court must determine whether the defendant in the case at hand actually knew or should have known that its conduct violated the authority, notwithstanding the ambiguity.

The court described a practical problem with the district court’s formulation this way: a defendant “could avoid liability by relying on a ‘reasonable’ interpretation of an ambiguous regulation manufactured post hoc, despite having actual knowledge of a different authoritative interpretation.”²¹ In such a case the element of scienter would be present even though the regulation was ambiguous.

What’s more, a government contractor has a duty to inquire into the proper interpretation of an ambiguous authority. As the Senate Report accompanying the 1986 amendment of the FCA definition of “knowingly” stated, “… those doing business with the Government have an obligation to make a limited inquiry to ensure the claims they submit are accurate.”²²

But in the case at hand, even when this appropriate -- and for relators, easier -- scienter standard is applied, relators Phalp and Peoples still failed it. They could not demonstrate that the defendants knew or should have known that their practice with respect to the AOBs violated Medicare regulations:

There is nothing in the plain language of 42 C.F.R. § 424.36(a) that would put Defendants on notice that Diabetic Experts’ use of AOBs given to Lincare were not compliant with Medicare regulations.²³

Having corrected the standard for considering the effect of ambiguity in a legal authority in determining scienter under the FCA, the court declared the lower court’s July and January orders “Affirmed as Modified.”

A Peculiar Disagreement

The disagreement between the Southern District of Florida and the Eleventh Circuit is a peculiar one, noteworthy for being conspicuously narrow, emphatic, and theoretical.

Narrow

The disagreement between the two courts is narrow. Despite the number of pages consumed by the three opinions, the sole issue is whether ambiguity in the allegedly violated legal authority serves, in and of itself, to defeat a finding of scienter in an FCA action. The district court insisted that the answer was yes; the Eleventh Circuit said no. And, of course, the Eleventh Circuit’s opinion trumps the district court’s.

Emphatic

The context of the district court’s two opinions and the context of the Eleventh Circuit’s opinion demonstrate each court’s emphasis in stating its opinion. It is clear that neither court was required to state an opinion on the ambiguity issue. Rather, each went out of its way to do so.

That is particularly true of the district court. A quick skimming of the decisions -- as well as several of the court’s comments -- gives the impression that the court faced a situation in which (1) the defendant violated a legal authority, (2) that legal authority was ambiguous, and (3) the ambiguity precluded a finding of scienter on the part of the defendant.

In fact, however, none of the three enumerated factors was present. The court never found that the authorities were ambiguous. In fact, it expressly declined to do so.²⁴

The court said flatly that Lincare did not violate the telephone regulations. As for the AOB authorities, the court said that Lincare did not violate them, but that if it had, and if those regulations were ambiguous (a matter on which the court declined to rule), then that ambiguity would preclude a finding of scienter.

Under the circumstances, it is clear that the court went out of its way to make its point that ambiguity defeats scienter. The court did not need to say so; it wanted to.

The appellate court, too, went out of its way, albeit not as far out of its way as the lower court, to make its point. The lower court’s statements about ambiguity were unnecessary -- even gratuitous. That meant that they were dictum and therefore technically not authoritative or binding. Accordingly, the appellate court could have let them pass without comment.

But the appellate court was plainly concerned that, authoritative or not, the district court’s statements were just plain wrong and might, if not corrected by higher authority, lead to further erroneous opinions.

Therefore, the appellate court issued an opinion expressly disapproving the lower court’s statements on ambiguity and scienter and explaining its rationale. In doing so, the court did not make new law or chart a new course. Rather, it chastised the district court for veering off the course established by such Eleventh Circuit precedents as U.S. v. R&F Properties of Lake City.²⁵

Theoretical

The same factors that demonstrate that the district court’s comments on ambiguity were unnecessary and that would have allowed the Eleventh Circuit to ignore them also demonstrate how purely theoretical the discussion was at both levels. The courts were not dealing with a defendant that had violated any legal authority. And neither court ever stated that the legal authorities were actually ambiguous. Indeed, the district court expressly said that it would not declare them ambiguous. In that sense both courts were playing a game of what if?

Nevertheless, the narrowness of the issue and the sharpness of the disagreement between the two courts serve to provide clear guidance: Scienter is determined by asking what the defendant knew or should have known. Ambiguity in the legal authority may be relevant, but only insofar as it bears on that question.

***

¹ The factual and procedural statements are taken from US ex rel. Phalp v. Lincare Holdings, Inc., Case No. 10-cv-21094-KMW, order issued July 13, 2015, 116 F. Supp.3d 1326 (S.D. Fla. 2015), and order issued Jan. 11, 2016.

² For the sake of clarity, the Lincare operating as Diabetic Experts is denoted simply as “Diabetic Experts.”

³ 42 U.S.C. § 1395m(a)(17).

⁴ 42 C.F.R. § 424.40(a).

⁵ 42.C.F.R. § 424.40(d).

⁶ 42 U.S.C. § 1395x(n), italics added.

⁷ 31 U.S.C. § 3729(a)(1), italics added.

⁸ 31 U.S.C. § 3729(a).

⁹ 31 U.S.C. § 3729(b).

¹⁰ 31 U.S.C. § 3729(d).

¹¹ Citing Currier v. Leavitt, 490 F.Supp.2d 1, 3 (D. Me. 2007), italics added.

¹² Prop. Rule clarifying 42 C.F.R. Part 440, 76 Fed. Reg. 41032-01, 41034 (July 12, 20110).

¹³ Urquilla-Diaz v. Kaplan University, 780 F.3d 1039, at 1095, n. 15 (11th Cir. 2015).

¹⁴ 729 F.3d 825, 831-31 (8th Cir. 2013).

¹⁵ 613 F.3d 1186, 1191 (8th Cir. 2010).

¹⁶ Jan. 2016 order, n. 2, at 2 & 3.

¹⁷ Rockwell International Corp v. U.S., 549 U.S. 457, 476 (U.S. 2007).

¹⁸ U.S. ex rel. Phalp v. Lincare Holdings, Case 16-10532, opinion filed May 26, 2017 (11th Cir. 2017).

¹⁹ Id., at 14.

²⁰ Id., at 12, italics added.

²¹ Id., at 12&13.

²² S. Rep. 99-345, at 6-7 (1986), reprinted in 1986 U.S.C.C.A.N. 5266, 5271-72.

²³ U.S. ex rel. Phalp, at 14 (11th Cir.).

²⁴ July 2015 opinion, at section II(C)(5).

²⁵ 433 F.3d 1349 (11th Cir. 2005).