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This is a guest post by Reed Smith partner Larry Sher, who was part of a team successfully representing Omnicare on a civil False Claims Act case before the United States District Court for the District of Maryland and the Fourth Circuit.  The rest of the defense team included Eric DubelierKatherine Seikaly, James Martin and Colin Wrabley.  As we have noted previously, there has been increasing overlap between the issues presented in cases under the False Claims Act (and state law mimics) and the sort of product liability cases we usually talk about here.

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Over the last few years, counsel for defendants in civil False Claims Act (“FCA”) cases have increasingly seen relators (the FCA version of plaintiffs) pushing the limits of the FCA to attempt to pressure defendants into costly settlements based on allegations that the defendant violated some regulation that really has nothing to do with the submission of any claim for money from the government, false or otherwise.  Last week the United States Court of Appeals for the Fourth Circuit confirmed that the FCA is meant to combat fraud and is not a “sweeping” catch-all mechanism to address all regulatory violations in the absence of actual fraud.

In United States ex rel. Rostholder v. Omnicare, Inc., No. 12-2431, the Fourth Circuit affirmed the dismissal of a relator’s FCA complaint (and denied leave to amend) under Fed. R. Civ. P. 12(b)(6) in a case that may have a significant impact on the future of healthcare related FCA actions in the Fourth Circuit and maybe elsewhere.  The Rostholder court held that because compliance with the Food and Drug Administration’s (FDA) Current Good Manufacturing Practices (cGMP) regulations is not a precondition for reimbursement under Medicare and Medicaid, violations of the cGMP regulations by themselves cannot form the basis for False Claims FCA claims.  No. 12-2431, slip op. (4th Cir. Feb. 21, 2014).

The Rostholder decision arose out of a qui tam lawsuit filed by a pharmacist/operations manager against Omnicare, the parent company of his former employer, Heartland Repack Services (Heartland). The relator alleged that Heartland and Omnicare (the nation’s largest nursing home pharmacy) operated a facility in Toledo, Ohio that packaged both penicillin and non-penicillin products in the same building, with allegedly inadequate separation and controls to prevent cross-contamination from Penicillin.  Months after he resigned from Heartland in 2006, the relator alleged he notified FDA of his concerns.  Thereafter, the FDA conducted an investigation and in 2007 issued a warning letter to Omnicare.  Months later, the relator filed his qui tam complaint alleging that the defendants were liable under the FCA because they caused pharmacies to seek Medicare and Medicaid reimbursement from the government for drugs that were not packaged in conformance with cGMP and therefore were “adulterated and misbranded, . . . not in their FDA-approved form, and thus ineligible for coverage under government programs.”

The government declined to intervene, meaning that it did not see the case as one worth pursuing itself, but in response to Omnicare’s motion to dismiss, it submitted a Statement of Interest in which it claimed that cGMP violations “may be relevant in FCA cases where the violations are significant, substantial, and give rise to actual discrepancies in the composition or functioning of the product.”

In late 2012, Judge Blake of the U.S. District Court for the District of Maryland granted Omnicare’s motion to dismiss the relator’s second amended complaint pursuant to Fed. R. Civ. P. 12(b)(6) finding that realtor “did not allege a false statement or a fraudulent course of conduct as required for an FCA claim.”  2012 WL 3300789 (D. Md. Aug. 14, 2012).

The relator had claimed that:  (a) Defendants’ cGMP violations gave rise to a legal presumption that ’Heartland’s  non-penicillin drugs actually were cross contaminated by penicillin; (b) such cross-contamination automatically barred the drugs from interstate commerce; and (c) Medicaid and Medicare Part D exclude payment for drugs that are not permitted in interstate commerce. Although the relator had no evidence of any actual contamination, and was forced to acknowledge that the Medicare and Medicaid statutes do not expressly require compliance with cGMPs or any other FDA safety regulations as a precondition to reimbursement, he implied that, since cGMP noncompliance supposedly renders drugs ineligible for payment under Medicaid and Medicare Part D, cGMP compliance could be deemed an implicit prerequisite to the government’s payment for drugs.

Omnicare argued that the relator’s legal contention that cGMP violations render drugs ineligible for Medicaid and Medicare Part D reimbursement was erroneous and insupportable.  Omnicare demonstrated below and on appeal that even assuming that Repack’s non-penicillin drugs were (1) presumed to be contaminated and (2) barred from commerce, there is nothing in the Medicaid and Medicare Part D statutes and regulations Relator cites that establishes the drugs were ineligible for reimbursement, or that the Defendants knew (or should have known) of such purported ineligibility. To the contrary, Omnicare pointed out, the Centers for Medicare and Medicaid Services (“CMS”) themselves have stated clearly that the “definition of a [Medicare] Part D drug is not based on the final form of the drug as dispensed to the beneficiary….” 70 Fed. Reg. 4194, 4231 (Jan. 28, 2005) (emphasis added).  Omnicare was able to demonstrate that neither 42 C.F.R. § 423.100 nor 42 U.S.C. § 1396r-8(k)(2)(A)(i), the only statute and regulation directly relied upon by the relator, supported the legal interpretation the relator urged.

The Fourth Circuit affirmed the District Court’s dismissal.  It acknowledged that drugs not packaged in conformance with cGMP are “adulterated” within the meaning of the Food, Drug and Cosmetic Act (FDCA).  In an FCA case, however, the court reasoned, the relevant question is not whether the drugs were “adulterated,” but whether they were reimbursable under Medicare and Medicaid. Under Medicare and Medicaid the government will only reimburse “covered outpatient drugs,” which are defined by statute as drugs “approved for safety and effectiveness under the Food, Drug, and Cosmetic Act.”  The court concluded that “once a new drug has been approved by the FDA and thus qualifies for reimbursement under the Medicare and Medicaid Statutes, the submission of a reimbursement request for that drug cannot constitute a ‘false’ claim under the FCA on the sole basis that the drug has been adulterated as a result of having been processed in violation of FDA safety regulations.”  Op. at 15.  In other words, since the FDA never saw fit to rescind its approval of the drug in question, its purported “adulteration” under the FDCA is not a fact upon which an FCA claim may be based.

Omnicare argued further that the government has ample authority to address and remedy cGMP violations without the need for FCA liability.  The FDCA confers “complete discretion” on the Secretary of the Department of Health and Human Services (“HHS”) to enforce the FDCA’s provisions.  The FDA and the HHS Secretary have broad powers to regulate drug packaging and enforce cGMP regulations, including the power to initiate “regulatory action” directly against the person or entity responsible for packaging drugs in violations of cGMPs.  See 21 C.F.R. § 210.10(b) (providing that a drug packaged in violation of cGMPs—and the person responsible for the packaging—”shall be subject to regulatory action”).

As for drug approval, Omnicare demonstrated that Section 505 of the FDCA, 21 U.S.C. § 355, provides the mechanism for approval of new drugs by FDA, stating that if the HHS Secretary finds that “the methods used in, and the facilities and controls used for, the manufacture, processing, and packing of such drug are inadequate to preserve its identity, strength, quality, and purity,” the Secretary shall issue an order refusing to approve the application. 21 U.S.C. § 355(d). Section 505 of the FDCA makes no express reference to cGMP regulations. Op. at 15.  Notably, however, Section 505 of the FDCA gives the HHS Secretary the authority to suspend the approval of a new drug application immediately if the Secretary “finds that there is an imminent hazard to the public health.” 21 U.S.C. § 355(e). The HHS Secretary may also withdraw the approval of an application if the Secretary finds that the packaging of drugs is not adequate “to assure and preserve its identity, strength, quality, and purity. . . .” Id.  Indeed, as Omnicare pointed out, the FDA itself has stated, cGMP violations do “not mean that there is necessarily something wrong with the drug” at all. See Facts About Current Good Manufacturing Practices (cGMPs), available here.  Moreover, CMS itself has stated that “the definition of a ‘covered outpatient drug’ also allows … for CMS reimbursement of drugs that could be unlawfully marketed unapproved drugs under the FDCA.” See Appendix B, Office of Inspector General Report: FDA’s Approval Status of Drugs Paid for by Medicaid, No. OEI-03-08-00500 (Nov. 1, 2010).

The Fourth Circuit agreed with Omnicare, recognizing “[w]hen an agency has broad powers to enforce its own regulations, as the FDA does in this case, allowing FCA liability based on regulatory non-compliance could ‘short-circuit’” the government’s remedial process designed to address such non-compliance.  Op. at 17.

The court also rejected the relator’s argument that because cGMP compliance is “material” to the government’s reimbursement decision, his claims should not have been dismissed, finding that relators “must allege both materiality and a ‘false statement or fraudulent court of conduct’ as distinct elements of an FCA claim.”  Id. at 16.  Because the court concluded that “adulterated drugs are subject to reimbursement by Medicare and Medicaid,” it held that “any claim for payment cannot be ‘false.’”  Id. at 16, n.7

Further, the court refused the relator’s effort to recharacterize his FCA claims under a different theory – for implied certification or “worthless services.”  As to the latter, the relator attempted to recast on appeal his FCA claims as a worthless services or substandard goods type case asserting that Fourth Circuit precedent “must be interpreted to accommodate an ordinary instance of substandard goods,” which he defined as a claim for payment for goods that fail to comply with “quality” requirements in “contractual, statutory or regulatory provisions.”  In response, Omnicare successfully argued that the relator had not alleged a worthless goods case and further that a regulatory violation or the provision of “substandard goods” does not support FCA liability unless the defendant committed fraud in connection with that conduct.

In explaining its rationale, the court emphasized that the FCA is a statute meant to protect the government from fraud, and is not “a sweeping mechanism to promote regulatory compliance” through private enforcement of the FDCA.

The court affirmed the District Court’s refusal to allow the relator to amend his complaint a third time finding “[a]ny amendment would have been futile in light of our holding that adulterated drugs are not barred from reimbursement by Medicare and Medicaid and, therefore, claims for reimbursement for these drugs cannot be ‘false’ under the FCA.”  Id. at 19.

The Fourth Circuit’s Rostholder decision provides new support for an important defense in FCA cases based on cGMP – and other FDCA − violations, particularly in the circuits ((Fourth, Fifth and Seventh) that have not adopted the implied certification theory of liability. Under the judicially created doctrine of implied certification allowed in these Circuits, a mere request to the government for payment implicitly represents material compliance with the contract, as well as relevant statutes and regulations.

Defense practitioners may attempt to extend the Fourth Circuit’s reasoning in Rostholder to other kinds of FDCA violations or to violations of other statutes and implementing regulations concerning FDA approval, such as those governing medical devices, asserting that once the FDA approves a drug there cannot be FCA liability if it turns out the defendant was reimbursed by Medicare or Medicaid for a drug or device that was manufactured or sold in violation of an agency regulation.  Apart from being unable to demonstrate any fraud, the Rostholder case did not present facts where the violations were significant enough that the relator could credibly assert that the drugs were worthless, ineffective or unsafe, so application of the court’s holding to those distinct circumstances is uncertain.  It is likely, however, that the government and future relators will attempt to limit Rostholder to its facts and will attempt to preserve their  right to assert in other future cases that “significant or substantial cGMP violations which give rise to actual discrepancies in the composition or functioning of the product” (e.g., affecting the drug’s purity, strength, or safety) should still suffice to support FCA claims. United States Statement of Interest at 5; see also 21 U.S.C. § 351(b), (c).  Where the basis of the FCA lawsuit, however, rests solely on the basis of an alleged violation of a cGMP or similar agency rule or regulation, the Fourth Circuit’s Rostholder decision will be helpful and persuasive precedent to prevent the FCA from being used improperly as a means of FDCA enforcement by private parties.