Making Sense of Schutte: Supreme Court Rejects Objective Reasonableness Defense, but Leaves Plenty of Unresolved Questions (and Potential Defenses) For FCA’s Scienter Requirement

Yesterday, the Supreme Court issued its much-awaited opinion in U.S. ex rel. Schutte v. SuperValu, Inc. and U.S. ex rel. Proctor v. Safeway, Inc., handing down a unanimous decision reversing the Seventh Circuit and rejecting the application of Safeco’s “objective reasonableness” standard to the False Claims Act (FCA). The decision will have significant ramifications not only for FCA litigation pending in the Seventh Circuit, but in courts across the country, as multiple courts of appeals and district courts had also adopted an “objective reasonableness” requirement.

For those that haven’t been following this pair of cases as closely as those of us at Qui Notes, the Seventh Circuit held, relying on Safeco, that where a defendant adopts an objectively reasonable interpretation of an ambiguous legal requirement and was not warned away from its interpretation by authoritative guidance, the defendant’s subjective beliefs are legally irrelevant. The question presented to the Supreme Court was framed narrowly: “Whether and when a defendant’s contemporaneous subjective understanding or beliefs about the lawfulness of its conduct are relevant to whether it ‘knowingly’ violated the False Claims Act.”

Yesterday, the Supreme Court answered that narrow question, holding that Safeco is not applicable in the FCA context and that subjective knowledge is relevant under all three prongs of the FCA scienter standard (actual knowledge, deliberate ignorance, and reckless disregard). The Court reasoned that the FCA’s statutory text, interpreted in light of the common law of fraud, makes clear that “knowledge and subjective beliefs” are what matters under the FCA, "not … what an objectively reasonable person may have known or believed.” Op. 8. Safeco’s interpretation, the Court explained, was based on a “different mens rea standard” under the Fair Credit Reporting Act (FCRA), and its “interpretation was ultimately tied to FCRA’s particular text.” Id. at 13. The Court also chided courts that may have been tempted to rely upon Safeco in non-FCA contexts that Safeco does not “set forth [a] purely objective safe harbor” and does not “look to facts that the defendant neither knew nor had reason to know at the time he acted.” Id. at 14.

While the Court’s rejection of the Safeco objective reasonableness standard is a disappointment to the Schutte defendants and numerous amici urging the Court to affirm the Seventh Circuit’s reasoning (which we covered extensively here and here), the Court’s opinion is far from the knockout victory that the relators’ bar and the government were hoping for. Under yesterday’s decision, to prevail in an FCA case premised on the defendant’s violation of an ambiguous or unclear legal requirement, the plaintiff must present evidence showing that a defendant actually knew that its claims were false, or at minimum was aware of a substantial and unjustifiable risk that its claims were false. In other words, each prong of the scienter standard requires a showing of subjective intent; it is not enough to allege that the defendant’s interpretation was wrong and it should have known that.

Further, the Court’s opinion is limited to what several justices described as “the easy case” at oral argument — the case in which there is evidence that the defendant believed its interpretation was wrong but submitted claims based on that interpretation anyway. The Court made clear that Schutte and Proctor fell into that category, dedicating several paragraphs to describing the relators’ contemporaneous “evidence” (which the Court noted it was required to credit on summary judgment) that the defendants knew that their claims, based on what the words “usual and customary” prices meant, were inaccurate at the time that they submitted them. See Op. 4-6, 13. The Court did not hold that FCA liability could attach in what justices described at argument as “the hard case” — the case in which the defendant believed its interpretation was right (or at least didn’t believe its interpretation was wrong) but recognized there were other interpretations. And the Court’s focus on subjective intent strongly suggests that the Court would find no FCA liability in that context because there is neither actual knowledge of falsity nor disregard for a substantial and unjustifiable risk the claims were false.

In addition, the Court also addressed when the defendant must have the requisite subjective knowledge. It made clear that the knowledge must temporally align with the submission of a claim. That cuts both ways. On one hand, a defendant cannot avoid FCA liability by offering a post hoc interpretation that is inconsistent with a belief held at the time of claim submission. But on the other hand, a plaintiff cannot rely on knowledge that the defendant acquired after the claim was submitted to prove subjective intent at the time of claim submission. The Court explained: “We do not look to legal interpretations that respondents did not believe or have reason to believe at the time they submitted their claim.” Op. 14. The focus must be on “what the defendant thought when submitting the false claim.” Id. at 11.

Finally, the Court assumed without deciding that misrepresentations of law are not actionable under the FCA. Id. at 15. The Court, however, did not provide clear guidance on what constitutes a misrepresentation of law, holding that the alleged false statements in Schutte/Proctor were misrepresentations of fact: “Rather than saying ‘this is what usual and customary means,’ respondents essentially said, ‘this is what our usual and customary prices are.’” Id. at 16. This is one of the many issues that lower courts will be left to sort out in the wake of this opinion.

In short, while the Court’s rejection of Safeco’s objective reasonableness standard eliminates a powerful defense, there is reason to be hopeful that the Schutte decision will not open the floodgates to expansive FCA liability. The Court’s opinion is limited to situations where there is evidence of subjective knowledge at the time of claim submission and that the defendant adopted the incorrect interpretation anyway, and then made a misstatement of fact based on that interpretation. We at Qui Notes will be closely tracking how lower courts react to this opinion, so stay tuned.

© Arnold & Porter Kaye Scholer LLP 2023 All Rights Reserved. This blog post is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.