Fresenius Medical Care Holdings, Inc., v. U.S.

The First Circuit Court of Appeals recently held that False Claims Act defendants can deduct portions of their civil settlement payments if the parties have not, in negotiating a settlement, agreed to the tax consequences and the payment is considered compensatory as opposed to punitive.

Between 1993 and 1997, several whistleblowers filed separate lawsuits against Fresenius Medical Care Holdings, Inc., an operator of dialysis centers.  Consequently, in 1995, the U.S. government opened its own civil and criminal investigations.  In 2000, the parties agreed to globally settle all claims for $486,334,232.

However, the parties’ settlement agreement remained silent as to how much of this sum was compensatory, a label that would permit Fresenius to deduct the payment in its yearly tax filings per the Internal Revenue Code, and how much was punitive, which would make the payment non-deductible.  The parties continued to negotiate and litigate these labels and ultimately agreed that $101,186,898 were for criminal fines (i.e., punitive), $192,550,517 were single damages for the civil False Claims Act violations (i.e., compensatory as Fresenius was making the government whole for the money fraudulently taken from it), and $65,800,555 constituted the whistleblowers’ statutory rewards (i.e., again, compensatory).

However, the parties could not agree on how to characterize the remaining $126,796,262, which likely resulted from either the False Claims Act’s treble damages clause or penalty payment provision.  Fresenius sought to label the entire payment as compensatory, which would entitle it to a refund on its taxes, but the government refused to agree.    The parties went before a trial court and Fresenius, in particular, as the taxpayer, presented evidence as to why it was entitled to the deduction.  Thereafter, the court asked the jury to determine what amount of the almost $127,000,000 was necessary to make the government whole as if Fresenius had never committed the fraud in the first place.  The jury found that $95,000,000 was compensatory in nature, and the trial court entered a judgment for Fresenius for $50,420,512.34, the amount of its refund.  The trial court also denied the government’s motions for judgment as a matter of law

The U.S. appealed, claiming that the trial court improperly denied its motion for judgment as a matter of law and issued incorrect jury instructions.  In Fresenius Medical Care Holdings, Inc. v. U.S., 2014 U.S. App. LEXIS 15536 (1st Cir. Aug. 13, 2014), the First Circuit Court of Appeals focused on the government’s first reason for appeal and affirmed the trial court’s holding.

Specifically, the Court noted that the Internal Revenue Code allows the deduction of ordinary expenses and explicitly precludes the deduction of any penalties.  The Court also noted that singular damages under the False Claims Act were plainly deductible as compensation to the government.  The Court reasoned that the trebled damages also constitute compensation because they account for the costs of bringing a False Claims Act action and for the time-value of the delay the government endures in receiving its singular damages in the first place.

Further, the Court held that the U.S.’ reliance on a Ninth Circuit ruling, Talley Industries, Inc. v. Commissioner, 116 F.3d 382 (9th Cir. 1997), was misplaced.  The Court noted that requiring the U.S. to always agree to the tax characterization of a settlement sum before a defendant could seek a tax deduction would grant the government inordinate bargaining power with regard to settlement negotiations.  Moreover, the Court held that such an approach would ignore the long-held beliefs that courts should explore the economic realities of transactions when the parties’ tax consequences are unclear and/or questionable and that settlement funds should be treated the same as if they were achieved in judgment for tax purposes.  Finally, the Court held that the government’s reliance on Talley was questionable—if the ruling itself already wasn’t—because of that lower court’s attempted exploration, on remand, of the economic realities of the payment, something that the government’s position in this case did not take into account.

Note that the Court perfunctorily addressed the government’s second contention regarding the improper jury instructions.  While the Court mainly referred back to its discussion pertaining to the motion for judgment as a matter of law, it did note that the government had sought the same allocation of deductible and non-deductible to the $127,000,000 that applied to the $359,537,970 that was already labeled as compensatory or punitive.  However, the Court held that this argument was tardy, as the government had not raised it before the trial court, and did not comment on its merits.