Commission-Based Sales Agreements for Medical Supplies and Equipment: More Whistleblower Activity on the Horizon?

HIGHLIGHTS:

• The common industry practice of compensating independent contractor sales representatives on a "percentage of sales" commission basis may be creating an enhanced risk of False Claims Act liability for illegal kickbacks in light of a recent decision from the U.S. Tenth Circuit Court of Appeals.
• It is important for those who provide goods and services that are reimbursed by federal healthcare programs (including manufacturers and distributors of medical devices, surgical implants, pharmaceuticals, DME and related supplies and services) to evaluate the structure of their upstream and downstream relationships in order to both maximize the benefit of those relationships while simultaneously minimizing potentially significant False Claims Act exposure.  

Whistleblower activity has exploded at both the state and federal levels, so it is more important than ever for companies to take careful measures to avoid business practices that could trigger potential False Claims Act liability. Amendments to the False Claims Act (FCA), in combination with amendments to the Medicare/Medicaid anti-kickback statute (AKS) and widespread promotion of whistleblower cases by the plaintiffs' bar have made what was once a remote risk now a compliance imperative. Every current or former employee, every vendor, every customer and every outside contractor is a potential "bounty hunter" who has little to lose by filing a complaint – even if the allegations turn out to be wrong.

No industry has experienced more FCA enforcement than the healthcare industry and suppliers of medical goods and services. As an industry in which certain business practices that are normally considered legal and sound in other sectors of the economy are rendered illegal upon the introduction of reimbursements made directly or indirectly, in whole or in part, by federal healthcare programs, careful review of current procedures is imperative. One business practice in widespread use – compensating independent sales representatives using percentage-based commissions – has recently been the subject of a federal court of appeals opinion that left undisturbed a District Court's summary judgment decision finding such an arrangement to be unlawful as an illegal kickback. Although the case was not decided in the context of the FCA, its implications and application to FCA liability is clear.

Lessons Learned from the Joint Technology Decision

In the recent decision of Joint Technology, Inc. v. Weaver, 2014 WL 2199373 (10th Cir. May 28, 2014), the U.S. Court of Appeals for the Tenth Circuit affirmed the decision of a District Court that had invalidated a contract based on its finding that a percentage-based compensation arrangement between a distributor of durable medical equipment (DME) and its independent outside contractor sales agent was a violation of the AKS. According to the facts of the case, Joint Technology, Inc. entered into a contract in 2008 with an independent sales agent ("Weaver"), under which Weaver's compensation was calculated as a percentage of the sales of DME he generated for Joint Technology. Weaver terminated the contract approximately three years later, and Joint Technology subsequently filed suit alleging that Weaver had breached the contract. As a defense, Weaver asserted that the contract's commission-based compensation was a violation of the AKS, thereby rendering the contract illegal and unenforceable under the law applicable to the case. Joint Technology argued that the compensation arrangement fell within a safe harbor of the AKS and was not illegal – but the District Court disagreed with Joint Technology and granted summary judgment in favor of Weaver on the grounds that a rational jury would conclude that the contract violated the AKS and was therefore unenforceable under Oklahoma law. On appeal to the Tenth Circuit, the court "review[ed] the district court's rulings on summary judgment and ... affirm[ed] the judgment of the district court in [the] appeal." Id.

While Joint Technology is not the first civil case between private parties to find a commission-based compensation arrangement illegal under the AKS, what sets this case apart is the fact that the decision was affirmed by a federal court of appeals and therefore carries significant weight and has high visibility in the present whistleblower climate. In addition, unlike earlier cases, this decision has been handed down after the Patient Protection and Affordable Care Act amended the AKS to:

• clarify that an AKS violation can occur without a person having either actual knowledge of the AKS or specific intent to violate it (thereby resolving a prior split among courts as to the statute's "knowingly and willfully" element)
• make any claim that includes items or services resulting from a violation of the AKS a false or fraudulent claim for purposes of the FCA

This case therefore brings the potentially problematic nature of commission-based compensation arrangements for medical supplies and services into sharp focus. Given the widespread use of these types of commission-based arrangements and the huge number of annual transactions involved, these arrangements become attractive targets for whistleblowers and their attorneys who can potentially reap extensive financial rewards for their reporting.

FCA Consequences Are Wide Reaching and Potentially Devastating

In addition to the potentially detrimental, or even ruinous, financial consequences that can arise under the FCA, other potential issues that could arise under a compensation arrangement deemed to be illegal include:

• exclusion from federal healthcare programs
• government election to intervene in a qui tam action
• government election to bring criminal prosecution
• deferred prosecution and corporate integrity agreements
• fines, civil penalties and treble damages
• lack of contract enforceability
• due diligence concerns in M&A, financing, and private equity placements
• self-reporting considerations
• public company disclosure obligations
• investor derivative actions and business judgment rule inapplicability

Given the long-standing and widespread use of percentage-based commissions to compensate independent contractors in the medical goods and services supply chain, the industry would be well-served to renew past, but previously unsuccessful, efforts to lobby for a practical and workable safe harbor to cover these types of arrangements. Pending such an outcome, however, companies and individuals alike must be wary of the current and ever-changing legal environment in which they operate. Along these lines, and in light of the issues highlighted by the Joint Technology case, companies and individuals at all levels in the healthcare goods and services supply chain – from manufacturers to independent distributors – should evaluate their existing distribution, consignment and/or sales agency agreements to ascertain their legal compliance and level of risk and, where necessary, make adjustments to those relationships to maximize their value while simultaneously minimizing potentially significant FCA exposure.

Diverse Industries Are Impacted by Whistleblower Allegations

Regardless of the industry, whistleblower allegations can be extremely costly to defend while also wreaking havoc on a company’s reputation. Holland & Knight's Healthcare and Life Sciences Team assists the full range of industry participants – including pharmaceutical, medical device, biotechnology, clinical laboratory and tissue banking companies, as well as private equity firms that invest in these types of companies – in all aspects of their operations. Our experienced team includes attorneys from across the firm who concentrate on the areas of law impacting healthcare entities, including compliance, litigation and dispute resolution, healthcare reform, regulatory law, legislative action, labor and employment, corporate, tax and general transactional issues, among others. Additionally, lawyers in the firm counsel companies and individuals in numerous other industries on FCA and other issues, including compliance, insurance, white collar defense and employment.
  

To ensure compliance with Treasury Regulations (31 CFR Part 10, §10.35), we inform you that any tax advice contained in this correspondence was not intended or written by us to be used, and cannot be used by you or anyone else, for the purpose of avoiding penalties imposed by the Internal Revenue Code.

Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem. Moreover, the laws of each jurisdiction are different and are constantly changing. If you have specific questions regarding a particular fact situation, we urge you to consult competent legal counsel.