The Fourth Circuit ruled recently in U.S. ex rel. Bunk v. Government Logistics N.V., No. 15-1088, 2016 WL 6695787 (4th Cir. Nov. 15, 2016), that the Relators had presented sufficient evidence to proceed to trial against Defendant Government Logistics (GovLog) based on the traditional fraudulent transaction theory of successor liability. The Court declined, however, to expand the scope of successor liability under the FCA to include the substantial continuation theory, which, as discussed here, would have allowed Relators to establish liability by showing merely that GovLog retained its predecessor’s employees, managers, assets, and operations, among other indicia of corporate continuity. See United States v. Carolina Transformer, 978 F.2d 832, 840 (4th Cir. 1992).
The Fourth Circuit will soon have the opportunity to clarify the circumstances under which successor liability may be imposed against an entity for False Claims Act judgments against its predecessor. Previously covered here, here, here, here, here, and here, the district court in United States ex rel. Bunk v. Birkart Globistics GmbH & Co. held that purported defendant GovLog could be defendant Gosselin’s successor in interest only if the plaintiffs – the Department of Justice and relators – could establish the elements of successor liability under the more-demanding common law rule instead of the more-lenient “substantial continuity” rule. Under the common law (or “traditional”) rule of successor liability, a corporation that acquires the assets of another corporation does not also assume its liabilities under the FCA unless either: (1) the successor agrees to assume liability; (2) the transaction is a de facto merger; (3) the successor is a “mere continuation” of the predecessor; or (4) the transaction is fraudulent.
Posted by Robert J. Conlan and David Schilling
In a recent decision, United States ex rel. Ceas v. Chrysler Group LLC, No. 12-CV-02870 (N.D. Ill. Jan. 28, 2015), a judge in the Northern District of Illinois provided guidance on the issue of successor liability for FCA claims in connection with a corporate asset sale in the bankruptcy context.
On April 30, 2009, Chrysler LLC (“Old Chrysler”) filed a pre-packaged Chapter 11 bankruptcy petition in the U.S. Bankruptcy court for the Southern District of New York. That same day, Old Chrysler agreed to sell to Chrysler Group LLC (“New Chrysler”) substantially all of its assets free and clear of claims and liabilities, except for a defined set of specific liabilities that New Chrysler assumed. The bankruptcy court approved the sale on June 1, 2009. Three years later, relator William Ceas, Jr. filed a complaint under the FCA claiming that Old Chrysler had made false statements to the United States regarding warranties on vehicles it sold to the government in 2004 and 2005. The United States declined to intervene, and Ceas continued to pursue the claims under the FCA’s qui tam provisions. New Chrysler moved to dismiss the complaint, including on the grounds that the Sale Order in the bankruptcy proceeding barred such claims against New Chrysler.
The court acknowledged that bankruptcy courts’ authority to approve a sale of assets free and clear of any claims is “an issue of some disagreement….” Order at 4 n.3. That is, Chapter 11 of the Bankruptcy Code provides only for the debtor’s sale of property “free and clear of any interest in such property.” 11 U.S.C. § 363(f) (emphasis added). Despite the potential for alternate readings, however, the district court was persuaded that the term “interest” in section 363(f) should be construed broadly, to include successor or transferee liability claims. Further, the court concluded, the Sale Order in issue “adopted a broad, inclusive definition of ‘claim,'” both as to timing and subject matter, and – when viewed in light of the Bankruptcy Code’s definition of “claim” – covered FCA and other fraud claims. Order at 4-5. In addition, the district court found, the Sale Order issued by the bankruptcy court affirmatively enjoined future litigation in conflict with the terms that order. Order at 5-6.
Notwithstanding these restrictive terms, the relator argued that his FCA claims were rooted in breach-of-warranty or product-liability claims, which New Chrysler had expressly assumed under the terms of the sale. The court rejected this argument, noting that the relator’s FCA claims did not constitute breach-of-warranty or products-liability claims, and even if they did the relator would not be authorized (under the FCA or otherwise) to pursue such claims on behalf of the government. Order at 7-8. Moreover, even though the relator’s FCA claims were “factually related” to product warranties, the district court refused to construe the language of the transfer agreement so broadly as to provide a “loophole for qui tam plaintiffs to seize upon[,] an unexpected and unwelcomed vulnerability for asset purchasers.” Order at 8.
The relator also argued that, despite the narrow language of the transfer agreement, New Chrysler was nonetheless liable for Old Chrysler’s violations of the FCA as its successor because FCA claims are not dischargeable in bankruptcy. The court agreed that FCA claims are not dischargeable in bankruptcy, see Order at 10 (citing 11 U.S.C. § 1141(d)(6)(A)), but also found that—distinguishing between a reorganization and an asset sale—the relator’s argument “misse[d] the mark” because New Chrysler was not the successor of Old Chrysler:
The elephant in the room is the notable distinction between a bankrupt entity that chooses to restructure and emerge under a traditional chapter 11 reorganization and an entity that elects an asset sale under § 363(f) of the Bankruptcy Code. Had Old Chrysler elected the former path, because the FCA claims (which arose prior to confirmation) cannot be discharged, Plaintiff would likely be entitled to proceed with his claims against the reorganized Old Chrysler today. However, because the bankruptcy court approved a § 363 sale of Old Chrysler’s assets free and clear of any successor claims or interests, Plaintiff’s claims lie solely against a now-defunct, potentially-successorless entity.
Order at 11.
The court acknowledged that, as “one way around this predicament,” the agreement between Old and New Chrysler (and the Sale Order) could have been written to expressly impute FCA liability to the Section 363 purchaser. Order at 11 (citing In re Haven Eldercare, LLC, 2012 WL 1357054, at *6 (Bankr. D. Conn. 2012) (“nothing in this Sale Order shall limit the federal government’s right to pursue or collect any claim for civil fraud under the False Claims Act”)). However, no such provision was made a term of the transfer between Old and New Chrysler. Order at 12 (“[A]bsent any controlling guidance to the contrary, the Court is inclined to uphold the plain language of the Sale Order, absolving New Chrysler of successor liability for all claims not expressly assumed in the [Master Transaction Agreement], including Plaintiff’s FCA claims.”).
The Ceas decision thus provides a useful template for understanding the limited circumstances in which liability for FCA claims might be extinguished in bankruptcy cases. A copy of the district court’s opinion and order can be found here.
Late last month, in a closely watched False Claims Act case (about which we have previously written here, here, and here), a federal judge in the Eastern District of Virginia rejected the government’s argument that Government Logistics NV (“GovLog”) should be held liable for a $100 million FCA judgment against Belgian shipping company Gosselin World Wide Moving NV (“Gosselin”) under a theory of successor liability.
On August 4, 2014, a jury levied a verdict of $100.6 million in damages and $24 million in civil penalties against Gosselin based on a finding that its repeated submissions of false invoices for moving services amounted to thousands of individual violations of the federal False Claims Act. After the verdict, and DOJ’s ensuing difficulties collecting a judgment from Gosselin, which had sold its US business assets to GovLog, the government sought to hold GovLog liable for the verdict against Gosselin on the theory that GovLog was Gosselin’s successor in interest.
In September 2014, Judge Anthony Trenga ruled that GovLog could be Gosselin’s successor in interest only if the government could establish the elements of successor liability under the more-demanding common law rule instead of the more-lenient “substantial continuity” rule. Under the common law (or “traditional”) rule of successor liability, a corporation that acquires the assets of another corporation does not also assume its liabilities under the FCA unless either: (1) the successor agrees to assume liability; (2) the transaction is a de facto merger; (3) the successor is a “mere continuation” of the predecessor; or (4) the transaction is fraudulent. Judge Trenga ordered the parties to brief the question of successor liability, requesting that the parties devote particular attention to whether GovLog’s acquisition of Gosselin would satisfy the fraudulent transfer prong.
On December 23, 2014, Judge Trenga granted summary judgment in favor of GovLog, holding that the plaintiffs had neither adequately pleaded nor submitted sufficient evidence to establish that GovLog was a successor to Gosselin. On the court’s invitation, Plaintiffs had pursued the “fraudulent transaction” prong of establishing successor liability, contending that Gosselin had transferred its US business to GovLog fraudulently for the purpose of avoiding paying a judgment in this or other cases. The court noted that there was insufficient evidence to prove that Gosselin intended through its transaction with GovLog to avoid or delay payment judgment creditors. But, the court went on, even if there had been sufficient evidence to prove the plaintiffs’ contentions, “alleged intent, restructuring [to avoid liability], and knowledge [that judgment creditors would have difficulty collecting a judgment], standing alone, would not be sufficient to impose successor liability.” Otherwise, the court reasoned, “imposing liability under a fraudulent transaction theory without a fraudulent transaction, solely because of the incidental effects of that transaction, turns that theory, in effect, into a theory of strict liability.” Thus, the court concluded, GovLog could not be held liable for Gosselin’s FCA judgment. A copy of the court’s ruling on the successor liability issue in the combined cases U.S. ex rel. Bunk v. Gosselin World Wide Moving, No. 1:02-cv-01168 (E.D. Va.), and U.S. ex rel. Ammons v. Gosselin World Wide Moving NV, No. 1:07-cv-01198 (E.D. Va.) can be found here.
Posted by Scott Stein and Brenna Jenny
On December 8, 2014, a district court in the Southern District of Georgia dismissed FCA claims brought against the corporate parent and affiliates of a hospital, rejecting the government’s attempt to hold these associated corporations liable for the hospital’s alleged reverse false claims violations. See U.S. ex rel. Schaengold v. Mem’l Health, Inc., No. 11-cv-0058 (S.D. Ga. Dec. 8, 2014).
The government intervened as to one count of the relator’s qui tam action, which alleged that defendant Memorial Health, Inc., its wholly-owned subsidiary Memorial Hospital, and a physician group (“MHUP”) wholly-owned by another Memorial Health subsidiary, violated the FCA by failing to timely return overpayments received by Memorial Hospital. According to the relator (the former CEO of Memorial Health and Memorial Hospital), Memorial Health and affiliated entities (collectively, “Memorial System”) employed the physicians of MHUP and paid compensation at levels above fair market value rates. As a result, these compensation arrangements between referring physicians and healthcare entities could not meet the Stark Law’s exception for “bona fide employment relationships,” which requires fair market value compensation. The Stark Law requires any funds received in violation of the law to be refunded within sixty days of collection. Under this theory, by submitting a cost report including services obtained in violation of the Stark Law, yet certifying that the services identified in the report complied with all applicable laws, the hospital concealed an obligation to refund overpayments to the government.
Although this theory of FCA liability is premised on the submission of cost reports, the government and the relator attempted to impute liability on additional corporate entities that did not submit any cost reports for these physicians’ services. Memorial System’s Board of Directors had previously discussed potential fair market value concerns with their compensation arrangements with MHUP. The government argued that because Memorial Health and all other relevant subsidiaries operated as a unitary health system controlled by a centralized management team, which was aware of the alleged Stark Law violations, all of the related entities were liable for the hospital’s submitted claims.
The court rejected the proposition that “merely being a parent, or an associated corporation, of a subsidiary that commits an FCA violation” can be sufficient to support FCA liability for a subsidiary’s violations. Instead, related entities can only be liable if they were directly involved in the submission of claims, or if veil-piercing is appropriate. The court quickly concluded that, although the other entities were involved in arrangements that ultimately culminated in the submission of allegedly false claims to the government, the absence of any allegations that they were directly involved in causing the submission of falsely certified cost reports warranted dismissal. The court also concluded that veil-piercing was inappropriate. Noting that overlapping management generally does not merit veil-piercing, the court ruled that even if all entities could be considered “alter egos,” there as no allegation that failure to pierce the corporate veil would result in injustice. The government was granted twenty days to amend its complaints and replead its claims against the hospital’s affiliated entities.
A copy of the court’s decision is available here.
On August 4, 2014, a federal jury in the Eastern District of Virginia levied a verdict of $100.6 million in damages and $24 million in civil penalties against Belgian shipping company Gosselin World Wide Moving NV (“Gosselin”), based on a finding that Gosselin’s repeated submissions of false invoices for moving services amounted to thousands of individual violations of the federal False Claims Act (a case we previously wrote about here and here). However, the government is seeking to hold a third-party, Government Logistics NV (“GovLog”), liable for the verdict against Gosselin under the theory of successor liability.
Whether and how successor liability can be assessed is a critical issue underlying many False Claims Act cases, especially given the magnitude of the potential exposure FCA cases routinely involve. Courts around the country have split on which rule to apply in the False Claims Act context. As Judge Trenga explained, under the common law (or “traditional”) rule of successor liability, a corporation that acquires the assets of another corporation does not also assume its liabilities unless either: (1) the successor agrees to assume liability; (2) the transaction is a de facto merger; (3) the successor is a “mere continuation” of the predecessor; or (4) the transaction is fraudulent. More recently, some courts in assessing successor liability under the FCA have turned to what is known as the “substantial continuity” test, which had previously been confined mostly to the labor context. Under that approach, successor liability is established based on a flexible, easier-to-satisfy, multi-factor analysis that considers: (a) whether the business of both companies is essentially the same; (b) whether the employees of the new business are doing the same jobs; and (c) whether the new entity has the same production processes and customers.
U.S. District Judge Anthony Trenga ruled on September 12, 2014, that relator may recover from GovLog only if plaintiffs can establish that GovLog is Gosselin’s successor in interest using the more-demanding common law rule instead of the more-lenient “substantial continuity” rule. Although noting that many courts have used the substantial continuity test in contexts beyond labor cases, and even in FCA cases, Judge Trenga reasoned that the Supreme Court’s decision in United States v. Bestfoods, 524 U.S. 51 (1998), states that a federal statute may abrogate common-law corporate-liability precepts only if the statute does so in express terms. Because the False Claims Act contains no provisions that would modify the common law of successor liability, the court held, there is no justification for imposing a less-stringent standard. In the court’s order, Judge Trenga requested that the parties pay particular attention in their arguments to whether GovLog’s acquisition of Gosselin would satisfy the fraudulent transfer prong.
The cases are U.S. ex rel. Bunk v. Gosselin World Wide Moving, No. 1:02-cv-01168 (E.D. Va.), and U.S. ex rel. Ammons v. Gosselin World Wide Moving NV, No. 1:07-cv-01198 (E.D. Va.).