Insurers Tapped to Pay Growing Number of False Claims Act Actions

A growing number of False Claims Act investigations combined with recent court decisions that found insurers liable for the cost of settlements may spell trouble for commercial liability insurers.

Policyholder attorney Geoffrey B. Fehling, with Hunton Andrews Kurth in Washington D.C., noted two court decisions this year that rejected insurer arguments that payments made to settle fraud allegations were uninsurable.

Fehling said that the U.S. Justice Department announced in January that it had initiated more False Claims Act this year than in any year since 1994. He said policyholders should take heart that they will be able to look to their insurers to defend them.

“Alleged fraud is very different than actual fraud,” he said in an interview.

The Delaware Superior Court ruled on July 14 that Ace American and other insurers that issued directors and officers and employment practices liability policies were liable for the $18 million cost of defending and settling a whistleblower complaint against Guaranteed Rate Inc. that alleged the underwriting company had failed to comply with quality-control requirements for government-backed mortgages.

U.S. District Court Judge Franklin U. Valderrama in Chicago ruled on Oct. 8 that Federal Insurance Co. was required to pay the $10 million policy limit to Astellas Pharma as compensation for the drug manufacturer’s $100 million settlement with the Justice Department. Federal prosecutors accused the company of violating the False Claims Act by boosting sales of a drug used to treat prostate cancer by steering patients to charities that paid their Medicare co-pays. Federal rules prohibit pharmaceutical companies from offering incentives to drive sales.

The decision noted that $50 million of the settlement agreement was labeled as restitution. If that amount had been identified as disgorgement of profits, the claim would have been uninsurable.

Fehling noted that in both rulings, the policyholders were accused of illegal acts but there had been no final adjudication. Valderrama found no authority to support Federal’s argument that because Astellas agreed to pay double the amount of the government’s alleged losses, the settlement payment amounted to punitive damages, which cannot be covered by insurance. The False Claims Act allows penalties of up to three times the amount of actual damages.

Valderrama rejected the assertion that Astellas’ payment was an uninsurable “disgorgement of ill-gotten gains.”

“Illinois law recognizes a distinction between the legal remedy of ‘damages’ and the ‘restitution’ of unjust gains,” the judge’s order says.

Valderrama granted summary judgment in favor of Astellas. The drug company is pursuing an additional $10 million in coverage from two other insurers.

The Justice Department did not routinely identify settlement payments as restitution until after passage of the Tax Cut and Jobs Act, signed into law by President Donald Trump in 2017.

Historically, the Internal Revenue Code prohibited taxpayers from deducting any payments to the government for fines or penalties. The 2017 legislation, however, allows deductions for amounts paid as restitution for damage or harm caused by a potential violation of law, or paid to come into compliance with the law, as long as they are identified as “restitution” in the agreement, according to an article by the Gibson Dunn law firm.

After passage of the law, the Internal Revenue Service asked the Justice Department to change its standard settlement form for False Claims Act violations to identify any amount of the payment that is “restitution” for civil damages, said Jonathan M. Phillips, a Gibson Dunn partner in Washington D.C. who defends organizations against False Claims Act allegations.

The amount identified as restitution is completely at the discretion of prosecuting attorneys; the defendant has no input other than to provide documentation, according to Greenberg Traurig shareholder Marvin Kirsner, who specializes in tax law.

“There must be evidence to support that the payment was, in fact, paid as restitution to make a victim whole,” Kirsner said in an email. “I have advised colleagues who have said that government attorneys are very sensitive to this issue, and will not merely agree to identify the settlement payments as restitution, unless the documents can establish that the payment is, in fact, for the purpose of restitution.”

The tax code change, however, does provide defense attorneys with an incentive to ensure that any False Claims Act settlements clearly identify any amounts that are being paid as restitution, Kirsner said. The Illinois and Delaware decisions may give policyholders another reason to avoid any settlement agreements that identify the amounts paid as “disgorgement.”

The number of government False Claims Act actions has been growing over the years. In 2001 there were about 400 prosecution; in 2020 there were more than 900, according to Justice Department statistics. The vast majority of the actions are usually initiated by whistleblowers, who can collect from 15% to 30% of the amount recovered.

The amount recovered does not necessarily follow the number of False Claims Act actions. The Justice Department recovered $2.2 billion in 2020, the least amount recovered since 2008, even though it initiated a record number of actions.

But 2020 was unusual in another way: The government initiated 250 False Claims Act actions, almost double the typical number filed each year.

Phillips, the Gibson Dunn attorney, said increased government spending during the COVID-19 pandemic, such as the Paycheck Protection Act and government grants to hospitals to treat infected patients, will likely lead to a greater number of False Claims Act prosecutions. Increased government spending being pushed by the Biden administration may also drive up the number of actions.

Phillips said the advent of litigation finance companies has led to an increase in the caliber of legal professionals that pursue whistleblower claims. Investor funding gives law firms the staying power to finance thorough investigations, he said.

He said the federal government has also learned how to better analyze its databases to mine for leads.

“They see it as information that is already in their hands, so why not use it,” he said.