Hartnett v. Physicians Choice Laboratory Services, LLC

IN THE UNITED STATES DISTRICT COURT

FOR THE WESTERN DISTRICT OF NORTH CAROLINA

CHARLOTTE DIVISION

CIVIL ACTION NO. 3:17-CV-00037-KDB-DCK

UNITED STATES OF AMERICA,

EX REL., TARYYN HARTNETT

AND DANA SHOCHED,

Plaintiffs,

v. ORDER

PHYSICIANS CHOICE

LABORATORY SERVICES, LLC;

DOUGLAS SMITH, PHILIP

MCHUGH AND MANOJ

KUMAR,

Defendants.

THIS MATTER is before the Court on Defendant Philip McHugh’s Motion to Dismiss

Complaint in Intervention (Doc. No. 73). The Court has carefully considered this motion and the

parties’ related briefs and exhibits, and it is ripe for decision. For the reasons discussed below, the

Court finds that Plaintiff United States of America (the “United States” or “Government”) has, in

the context of this motion to dismiss pursuant to Federal Rules of Civil Procedure 9(b) and

12(b)(6), adequately pled its asserted False Claims Act (“FCA”) and related state law claims.

Therefore, the Court will DENY the motion.

I. LEGAL STANDARD

A motion to dismiss under Federal Rule of Civil Procedure 12(b)(6) for “failure to state a

claim upon which relief can be granted” tests whether the complaint is legally and factually

sufficient. See Fed. R. Civ. P. 12(b)(6); Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009); Bell Atl. Corp.

v. Twombly, 550 U.S. 544, 570 (2007); Coleman v. Md. Court of Appeals, 626 F.3d 187, 190 (4th

Cir. 2010), aff'd, 566 U.S. 30 (2012). A court need not accept a complaint's “legal conclusions,

elements of a cause of action, and bare assertions devoid of further factual enhancement.” Nemet

Chevrolet, Ltd. v. Consumeraffairs.com, Inc., 591 F.3d 250, 255 (4th Cir. 2009). The court,

however, “accepts all well-pled facts as true and construes these facts in the light most favorable

to the plaintiff in weighing the legal sufficiency of the complaint.” Id. Construing the facts in this

manner, a complaint must contain “sufficient factual matter, accepted as true, to state a claim to

relief that is plausible on its face.” Id.

Ordinarily, a plaintiff need only make “a short and plain statement of the claim showing

that the pleader is entitled to relief.” Fed. R. Civ. P. 8(a)(2). Rule 9 of the Federal Rules of Civil

Procedure creates an exception to this notice pleading standard for “Pleading Special Matters,”

requiring, inter alia, that “[i]n alleging fraud or mistake, a party must state with particularity the

circumstances constituting fraud or mistake.” Fed. R. Civ. P. 9(b). Claims under the FCA must

meet the more stringent “particularity” pleading requirements of Rule 9(b). See United States ex

rel. Ahumada v. NISH, 756 F.3d 268, 280 (4th Cir.2014).

Specifically, for an FCA claim, Rule 9(b) requires that “an FCA plaintiff must, at a

minimum, describe the time, place, and contents of the false representations, as well as the identity

of the person making the misrepresentation and what he obtained thereby.” United States ex rel.

Wilson v. Kellogg Brown & Root, Inc., 525 F.3d 370, 379 (4th Cir.2008). However, “knowledge,

and other conditions of a person’s mind may be alleged generally.” See Fed. R. Civ. P. 9(b). The

Fourth Circuit has articulated four purposes of the Rule 9(b) pleading standard: (1) to put

defendants on notice of the conduct at issue so that defendants have sufficient information to

answer and defend themselves; (2) to protect defendants from frivolous lawsuits; (3) to avoid fraud

actions where the relevant facts are not known prior to discovery; and (4) to protect defendants

from negative consequences of being named as defendants in fraud actions, such as damage to

their goodwill and reputation. See Maguire Fin., LP v. PowerSecure Int'l, Inc., 876 F.3d 541, 546

(4th Cir. 2017); Harrison v. Westinghouse Savannah River Co., 176 F.3d 776, 784 (4th Cir. 1999).

II. FACTS AND PROCEDURAL HISTORY1

Defendant Physicians Choice Laboratory Services, LLC (“PCLS”) is an independent

diagnostic laboratory specializing in urine drug testing (“UDT”). Defendants Douglas Smith and

Philip McHugh are two of the three founders, and current owners, of PCLS. The United States

alleges that PCLS has grown its business by convincing physicians to order UDTs for their patient

populations regardless of whether the tests were medically necessary for each patient. Further, and

more directly relevant to these proceedings, the Government contends that in addition to

aggressive marketing practices, Defendants engaged in several illegal schemes to provide

remuneration to doctors to induce them to refer tests to the laboratory in violation of the Anti-

Kickback Statute. 42 U.S.C. § 1320a-7b(b) (the “AKS”).

The United States alleges in detail three specific schemes that McHugh and the other

defendants planned and implemented that allegedly violated the AKS and caused fraudulent claims

to be submitted to Medicare. First, McHugh allegedly induced physicians to refer tests to PCLS

by providing office equipment and associated services to physicians in exchange for sending their

referrals to PCLS. Doc. No. 38 at ¶¶ 159-219. Second, McHugh allegedly entered an illegal

contract to pay co-defendant Manoj Kumar (“Kumar”) to send referrals to PCLS from two

physician practices that Kumar managed. Id. at 220-232. Finally, McHugh allegedly made large

loans to two physicians in exchange for their referrals to PCLS. Id. at 233-254. PLCS then

1 The facts described below are taken from the Complaint of the United States, Doc. No. 38.

allegedly submitted claims to Medicare for the testing services provided to the patients referred to

PCLS as a result of the alleged kickback schemes.

On January 7, 2014, a qui tam complaint generally relating to these and/or other allegations

was filed in the Eastern District of Tennessee under the qui tam provisions of the False Claims Act

(the “Tennessee Complaint”) against fifty (50) defendants, including defendant McHugh. On

November 10, 2014, relators Taryn Hartnett and Dana Schoched filed a qui tam complaint in the

Middle District of Florida (the “Florida Complaint”), against several defendants but not including

McHugh. Both the Tennessee and Florida Complaints were transferred to this Court in January

2017 and later consolidated into one action (Doc. No. 37).

On June 20, 2019, the United States filed its Complaint in intervention asserting numerous

claims related to PCLS, Douglas Smith and other defendants,2 including four counts against

defendant McHugh (Counts I & II under the False Claims Act; Count III payment by mistake and

Count IV unjust enrichment). Following the filing of the United States’ Complaint, the relators

elected not to pursue any of the remaining non-intervened claims and this Court entered an order

dismissing the non-intervened claims with prejudice as to the relators and without prejudice as to

the United States and the plaintiff states in the two qui tam complaints (Doc. No. 62). The United

States’ Complaint in intervention, Doc. No. 38 (the “Complaint”), is now the only operative

complaint in this case. In the present motion, McHugh seeks to dismiss each of the four counts

asserted against him in the Complaint.

2 Included in the Complaint were allegations against Kumar arising from the alleged scheme in

which he was involved. The Governments claims against Kumar have now been settled pursuant

to a Settlement Agreement in which Kumar agreed to pay to the United States over $649,000,

obtained a release from liability under the False Claims Act and for other claims, but did not admit

wrongdoing or liability. See Doc. No. 93-1.

III. DISCUSSION

In this action, the United States contends that McHugh and others violated the FCA by

knowingly causing the submission of false Medicare claims after engaging in illegal schemes to

provide remuneration to doctors to induce them to refer tests to PCLS in violation of the Anti-

Kickback Statute, 42 U.S.C. § 1320a-7b(b). McHugh contends that the Government has failed to

provide sufficient factual details to adequately plead its FCA claims under Rules 9(b) and 12(b)(6).

The United States argues in response that its Complaint describes McHugh’s schemes in detail and

pleads facts that explain who was involved in the schemes, what the schemes were, and when,

where and how the schemes were implemented. Thus, according to the Government, the Complaint

clearly makes McHugh aware of the particular circumstances for which he will have to prepare a

defense at trial. As discussed below, this Court agrees with the United States that the Complaint

pleads the schemes in which McHugh was allegedly involved with sufficient detail to satisfy the

applicable pleading rules.

Specifically, the United States alleges McHugh violated two provisions of the FCA. First,

the Government alleges that McHugh violated 31 U.S.C. § 3729(a)(1)(A) because he

knowingly caused the submission of false or fraudulent Medicare claims for payment or approval

to the United States. Section 3729(a)(1)(A) states that any person who “knowingly presents, or

causes to be presented, a false or fraudulent claim for payment or approval…” has violated the

FCA. Second, the Government alleges McHugh violated Section 3729(a)(1)(B) by causing PCLS

to make false records material to false or fraudulent claims. Section 3729(a)(1)(B) states that any

person who “knowingly makes, uses or causes to be made or used, a false record or statement

material to a false or fraudulent claim…” has violated the FCA.

To prove a violation of the FCA, a plaintiff must allege four elements: 1) a false statement

or fraudulent course of conduct; 2) made with the requisite scienter; 3) that is material; and 4) that

results in a claim to the Government. United States ex rel. Badr v. Triple Canopy, Inc., 775 F.3d

628, 634 (4th Cir. 2015) (vacated and remanded on other grounds.) “Scienter under the FCA

encompasses actual knowledge, deliberate indifference, and reckless disregard, but does not

require proof of specific intent to defraud.” Id. citing 31 U.S.C. § 3729(b)(1).

AKS makes it a violation, inter alia, to “knowingly and willfully offer[ ] or pay[ ] any

remuneration (including any kickback, bribe, or rebate) directly or indirectly, overtly or covertly,

in cash or in kind” to induce the referral of business reimbursable under a federal health care

program. 42 U.S.C. § 1320a-7b(b)(2). A person “who offers or pays remuneration to another

person violates the [AKS] so long as one purpose of the offer or payment is to induce Medicare or

Medicaid patient referrals.” United States vs. McClatchey, 217 F.3d 823, 835 (10th Cir. 2000); see

also United States v. Greber, 760 F.2d 68, 69 (3rd Cir. 1985) (“if one purpose of the payment was

to induce future referrals, the Medicare statute had been violated”).

A violation of the AKS also requires the United States to show that the defendant acted

“knowingly and willfully.” For the purposes of the AKS, a person acts willfully if he knew the

conduct was wrongful or the act was committed voluntarily and purposely, with the intent to

disobey or disregard the law. United States v. Starks, 157 F.3d 833, 838 (11th Cir. 1998); United

States v. Jain, 93 F.3d 436, 441 (8th Cir. 1996) (violations of AKS requires only “proof that

[Defendant] knew that his conduct was wrongful, rather than proof that he knew it violated ‘a

known legal duty.’”). Thus, a person can violate AKS without knowing of AKS or having the

specific intent to violate the section. Id. § 1320a-7b(h). “Indeed, the giving or taking of kickbacks

for medical referrals is hardly the sort of activity that a person might expect to be legal.” Starks,

157 F. 3d at 838.

An AKS violation resulting in a federal health care payment automatically constitutes a

false claim under FCA. United States ex rel. Lutz v. United States, 853 F.3d 131, 135 (4th Cir.

2017) (citing 42 U.S.C. § 1320a-7b(g)). Therefore, in summary, the United States must, at this

stage of the case, plausibly establish (in accordance with the applicable pleading requirements)

that McHugh violated the AKS resulting in claims submitted to Medicare.

The Government alleges that McHugh violated the Anti-Kickback Statute in three ways,

by: (1) inducing referrals through providing medical diagnostic equipment (analyzers) to

physicians; (2) paying co-defendant Kumar to send referrals to PCLS from two physician practices

that he managed; and (3) inducing referrals through loans to two physicians. The United States

summarizes the sufficiency of its allegations of these schemes as follows:

The Complaint provides every detail necessary for pleading fraud under Fed

R. Civ. P. 9(b). First, the Government alleges that McHugh engaged in multiple

kickback schemes to knowingly and willfully induce referrals for excessive UDTs.

Complaint at Page 1 and ¶ 126. The Government describes: 1) the type of testing

involved (Complaint at ¶¶ 72-90); 2) Medicare’s requirements for payment of such

tests (Id. at ¶63-69); and 3) PCLS’s business practices and billing for UDTs (Id. at

¶¶ 91-125). The Complaint then details each of McHugh’s fraudulent schemes: 1)

the provision of analyzers to physicians to induce UDT referrals to PCLS (Id. at ¶¶

159-219); 2) paying Defendant Kumar to deliver UDT referrals from the offices of

Drs. Masimore and Shah (Id. at ¶¶220-232); and 3) providing loans to physicians

in exchange for UDT referrals to PCLS (Id. at ¶¶ 233-254).

In every scheme, the United States has pled the who, what, when, where

and how of the fraud: 1) Participants in the kickback schemes are identified by

name (who); 2) the remuneration used to induce the physicians is identified in each

scheme (what); 3) when the AKS violations occurred and subsequent submission

of tainted claims are identified in each scheme (when); 4) the physician practices

that provided referrals to McHugh’s lab are each identified (where); and 5)

McHugh’s actions in planning and implementing each scheme are described in

detail (how). Finally, the United States has identified the number of claims

submitted to Medicare and the amount Medicare paid for the claims caused by the

inducement schemes. Id. at ¶¶ 203 (Johnson analyzer), 219 (Nickels analyzer), 230-

231(Kumar commissions), 244 (Florete loan), and 254 (Jayachandran loan).

Doc. No. 80 at 7-8. See also Id. at 8-14 (describing the allegations establishing each scheme

in more detail).

The Court finds that these allegations are indeed sufficient to meet the Government’s Rule

9 and Rule 12 pleading burdens on a motion to dismiss. The Complaint pleads facts that explain

the “who, what, when, where and how” related to the schemes and plainly provides McHugh

enough detailed information on the alleged wrongful conduct to allow him to defend against the

allegations. Further, it appears readily apparent that this case is neither frivolous nor an improper

fishing expedition in search of facts to support a speculative claim. Therefore, the Court will deny

the motions to dismiss the United States’ FCA claims against McHugh.

Similarly, the Court finds that the United States has sufficiently pled its state law claims

for payment by mistake of fact and unjust enrichment (Counts III and IV) at this early stage of the

case. As McHugh acknowledges, courts consider “unjust enrichment and payment by mistake

claims together, as they arise out of the same common law restitution principles.” United States v.

Massenburg, No. 2:03-0437, 2004 WL 2370694, at *6 (S.D. W.Va. Oct. 21, 2004). The United

States has alleged that McHugh is an owner of PCLS, a closely held company. As such, it is

reasonable to infer for the purposes of this motion that McHugh directly benefited and was thus

unjustly enriched by the alleged illegal schemes that resulted in millions of dollars of improper

Medicare payments to PCLS. The Government’s claims of unjust enrichment and payment by

mistake of fact will accordingly be allowed to proceed, without prejudice to McHugh’s right to

raise his arguments against these claims again in a summary judgment motion if discovery fails to

establish that he was personally unjustly enriched by any unlawful scheme.

IV. ORDER

NOW THEREFORE IT IS ORDERED THAT:

1. Defendant Philip McHugh’s Motion to Dismiss Complaint in Intervention (Doc.

No. 73) is DENIED; and

2. This case shall proceed to discovery and further proceedings on the merits on

the remaining claims in the absence of a voluntary resolution of the dispute

among the parties.

SO ORDERED ADJUDGED AND DECREED.

Signed: February 5, 2020

Kenneth D. Bell ey,

United States District Judge il of