Fresenius Medical Care Holdings, Inc. v. United States

United States Court of Appeals
For the First Circuit
No. 13-2144
FRESENIUS MEDICAL CARE HOLDINGS, INC.,
Plaintiff, Appellee,
v.
UNITED STATES OF AMERICA,
Defendant, Appellant.
APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MASSACHUSETTS
[Hon. Douglas P. Woodlock, U.S. District Judge]
Before
Thompson, Baldock* and Selya,
Circuit Judges.
Anthony T. Sheehan, Attorney, Tax Division, United States
Department of Justice, with whom Kathryn Keneally, Assistant
Attorney General, Tamara W. Ashford, Principal Deputy Assistant
Attorney General, Carmen M. Ortiz, United States Attorney, Gilbert
S. Rothenberg, Attorney, Tax Division, and Bruce R. Ellisen,
Attorney, Tax Division, United States Department of Justice, were
on brief, for appellant.
James F. Bennett, with whom William H. Kettlewell, Maria R.
Durant, Megan S. Heinsz, Collora LLP, and Dowd Bennett LLP were on
brief, for appellee.
August 13, 2014
*
Of the Tenth Circuit, sitting by designation.
SELYA, Circuit Judge. This tax-refund litigation
requires us to explore the uncertain terrain surrounding the tax
treatment of settlement payments made under the False Claims Act
(FCA), 31 U.S.C. §§ 3729-3733. We hold, as a matter of first
impression in this circuit, that in determining the tax treatment
of an FCA civil settlement, a court may consider factors beyond the
mere presence or absence of a tax characterization agreement
between the government and the settling party. While this holding
may be at odds with the decision in Talley Industries Inc. v.
Commissioner, 116 F.3d 382 (9th Cir. 1997), we are convinced that
generally accepted principles of tax law compel us to part company
with the Ninth Circuit.
The case before us involves the tax treatment of roughly
$127,000,000 paid to the government in partial settlement of a
kaleidoscopic array of claims. The district court concluded that
where, as here, the parties had eschewed any tax characterization,
the critical consideration in determining deductibility was the
extent to which the disputed payment was compensatory as opposed to
punitive. At trial, the court's jury instructions embodied this
conclusion and directed the jury's focus to the economic realities
of the situation. The jury split the baby and found that a large
chunk of the money ($95,000,000) was deductible. Accepting this
finding, the court ordered tax refunds which, with accrued
interest, totaled more than $50,000,000.
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The government appeals. We take note of the district
court's skillful handling of this complicated litigation, and we
affirm.
I. BACKGROUND
Fresenius Medical Care Holdings, Inc. is a major operator
of dialysis centers in the United States and around the world.
Between 1993 and 1997, whistleblowers brought a series of civil
actions against Fresenius1 under the FCA. The government paid heed
and, in 1995, a number of government agencies opened civil and
criminal investigations into Fresenius's dealings with various
federally funded health-care programs. Because the FCA was in
play, Fresenius faced potential liability for treble damages. See
31 U.S.C. § 3729(a).
In 2000, Fresenius entered into a complex of criminal
plea and civil settlement agreements with the government. These
agreements called for Fresenius to pay, in the aggregate,
$486,334,232, $101,186,898 of which was earmarked as criminal
fines. The remainder — $385,147,334 — was the price for
Fresenius's absolution from civil liability.
The civil settlement agreements released a gallimaufry of
claims against Fresenius (including claims under the FCA). Of
1
These actions were originally brought against National
Medical Care, Inc. (NMC), which thereafter was acquired by
Fresenius. For ease in exposition, we refer to Fresenius, NMC, and
NMC's subsidiaries, jointly and severally, as Fresenius.
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paramount pertinence for present purposes, these agreements
eschewed any commitment as to how the payments were to be treated
for tax purposes.
Despite the global nature of the settlement, a new
dispute soon enveloped the parties. This dispute centered on the
tax treatment of the sums paid. Over time, the parties pared the
scope of their dispute: they agreed that the amounts paid as
criminal fines, totaling $101,186,898, were not deductible; and
that, out of the payments required by the civil settlement
agreements, an amount equal to single damages under the FCA
($192,550,517) was deductible. They could not agree to the tax
treatment of the balance of the civil settlements ($192,596,817).
Acting under protest, Fresenius filed amended tax returns
that took no deduction for this balance. Following an
administrative appeal, the government conceded that a further
figure equal to the amount owed to the FCA whistleblowers as qui
tam relators ($65,800,555), see id. § 3730(d), was deductible.
Fresenius then commenced a tax-refund action in the United States
District Court for the District of Massachusetts for the purpose of
determining the deductibility of the amount still in dispute
($126,796,262). See 26 U.S.C. § 7422.
After some preliminary skirmishing, the district court
convened a jury trial. At the close of all the evidence, the court
reserved decision on the government's Rule 50 motion for judgment
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as a matter of law and submitted the tax characterization question
to the jury. The jury found that $95,000,000 was deductible. The
court then denied the reserved motion.
In the aftermath of the jury verdict, the parties
stipulated to the verdict's tax effects. Thereafter, the court
entered judgment for Fresenius in the amount of $50,420,512.34, see
Fresenius Med. Care Holdings, Inc. v. United States, No. 08-12118,
2013 WL 1946216, at *1 (D. Mass. May 9, 2013), and denied the
government's renewed motion for judgment as a matter of law. This
timely appeal followed.
II. ANALYSIS
In this venue, the government advances two claims of
error. Its first claim of error challenges the district court's
denial of its motions for judgment as a matter of law and,
therefore, engenders de novo review. See Palmquist v. Shinseki,
689 F.3d 66, 70 (1st Cir. 2012). Its second claim of error
challenges the district court's jury instructions and, as framed,
likewise engenders de novo review. See DeCaro v. Hasbro, Inc., 580
F.3d 55, 61 (1st Cir. 2009) (explaining that de novo review obtains
when a claim of instructional error contends that jury instructions
failed to "capture the essence of the applicable law"). We address
these claims of error sequentially.
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A. Judgment as a Matter of Law.
The government moved for judgment as a matter of law at
the close of all the evidence and renewed its motion following the
verdict. See Fed. R. Civ. P. 50(b). Each time, the district court
rejected the government's motion. The government now challenges
these rulings.
When the denial of a Rule 50(b) motion is appealed, a
reviewing court must view the evidence in the light most flattering
to the verdict and must draw all reasonable inferences therefrom in
favor of the verdict. See Casillas-Díaz v. Palau, 463 F.3d 77, 80-
81 (1st Cir. 2006). The challenge will succeed only if reasonable
minds, viewing the evidence in this light, "could not help but
reach an outcome at odds with the verdict." Mandel v. Bos.
Phoenix, Inc., 456 F.3d 198, 208 (1st Cir. 2006) (internal
quotation mark omitted).
As a working principle, a motion for judgment as a matter
of law ordinarily falls into one of two generic categories. The
first (and most common) type of motion challenges evidentiary
sufficiency; that is, whether the evidence of record, when taken
most favorably to the nonmoving party, is adequate to prove a case
under an uncontroversial legal regime. See, e.g., Cook v. R.I.
Dep't of Mental Health, Retardation, & Hosps., 10 F.3d 17, 21 (1st
Cir. 1993). The second type of motion tests the applicable law;
its focus is less on the evidence and more on whether the verdict,
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as rendered, depends on an incorrect legal regime. See, e.g.,
Grande v. St. Paul Fire & Marine Ins. Co., 436 F.3d 277, 280-81
(1st Cir. 2006).
This case is of the latter stripe. The government
concedes (or, at least, does not contest) that the verdict is based
on a sufficient evidentiary foundation under the legal regime
explicated by the district court. It argues, however, that this
legal regime is faulty and that, under a correct legal regime, the
evidence is insufficient to sustain the verdict. We turn, then, to
the applicable law.
The foundational elements of the relevant tax law are
easily summarized. The Internal Revenue Code allows a business to
deduct all of its "ordinary and necessary expenses paid or incurred
during the taxable year." 26 U.S.C. § 162(a). Because tax
deductions "are matters of legislative grace[,] the taxpayer bears
the burden of proving entitlement to any deduction." MedChem
(P.R.), Inc. v. Comm'r, 295 F.3d 118, 123 (1st Cir. 2002) (citing
INDOPCO, Inc. v. Comm'r, 503 U.S. 79, 84 (1992)).
Congress has ordained that no deduction may be made "for
any fine or similar penalty paid to a government for the violation
of any law." 26 U.S.C. § 162(f). Implementing regulations provide
that the universe of nondeductible fines includes "civil
penalt[ies]" as well as amounts "[p]aid in settlement of
. . . potential liability" for any nondeductible fine or penalty.
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26 C.F.R. § 1.162-21(b). Withal, "[c]ompensatory damages
. . . paid to a government do not constitute a fine or penalty."
Id. So viewed, a critical distinction exists between items such as
fines or penalties (which are nondeductible) and items such as
compensatory damages (which are deductible).
This taxonomy interfaces awkwardly with the FCA's
provision for treble damages. See 31 U.S.C. § 3729(a). Single
damages are plainly compensatory and, thus, plainly deductible.
See 26 C.F.R. § 1.162-21(c) (providing, in example 1, for
deductibility of actual damages recovered under an analogous
statute). But that is not the end of the matter; some amounts in
excess of single damages generally are regarded as compensatory,
see Cook Cnty. v. United States ex rel. Chandler, 538 U.S. 119,
130-31 (2003), and therefore deductible. This makes good economic
sense: an enforcement action following a fraud brings new costs and
delays and requires a recovery of more than single damages to make
the government whole. See id.; see also United States v.
Bornstein, 423 U.S. 303, 315 (1976) (describing FCA multiple
damages as "necessary to compensate the Government completely for
the costs, delays, and inconveniences occasioned by fraudulent
claims"). Such additional costs may include — but are not limited
to — the expenses of prosecuting the action and the time-value of
the delayed receipt of single damages (generally represented by an
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imputation of interest). See, e.g., Chandler, 538 U.S. at 131; see
also Fresenius, 2013 WL 1946216, at *5-6.
While these legal principles are uncontroversial,
plotting the sometimes hazy line that separates the compensatory
from the punitive can be tricky business. See Chandler, 538 U.S.
at 130 (acknowledging that "the tipping point between payback and
punishment defies general formulation"). That difficult line-
drawing exercise is central to the case at hand.
At trial, Fresenius exhibited its recognition of the
dichotomy between compensatory and punitive payments. To this end,
it introduced evidence of the compensatory nature of the disputed
sums. The district court also recognized this dichotomy. It began
its appraisal by confirming that the civil settlement agreements
"unambiguously decline to address the punitive or compensatory
nature of the settlement payments for [tax] purposes." Fresenius,
2013 WL 1946216, at *7. In the absence of any agreement by the
parties, the court tasked the jury with determining "what amount
[was] necessary to put the government in the position it would have
been in had Fresenius not" engaged in the underlying misconduct.
In essence, the court — after placing the burden of proof on
Fresenius — asked the jury to measure deductibility in terms of the
economic realities of make-whole remediation.
The government takes umbrage with this approach. It
asseverates that the absence of an agreement between the parties as
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to whether the payments will be deductible defeats Fresenius's
claim of deductibility. In advancing this asseveration, the
government assigns talismanic significance to the presence or
absence of a tax characterization agreement between the settling
parties.
The government's position is founded almost exclusively
on the decision in Talley. Like this case, Talley involved the tax
treatment of an FCA settlement. See Talley, 116 F.3d at 384-85.
The Ninth Circuit started from the common understanding that FCA
multiple damages can serve either compensatory or punitive
purposes.2 See id. at 387. To the extent that the settlement sum
exceeded single damages, the court reasoned, the case presented a
question "as to the characterization and the purpose of" that
portion of the settlement. Id. Because the settlement agreement
failed to provide clarity, the court remanded to the Tax Court and
directed that this question be answered by examining "whether the
parties intended the payment to compensate the government . . . or
to punish" the taxpayer. Id. In the process, the court stressed
that the taxpayer bore the burden of proving eligibility for
deductions and, therefore, would suffer the consequences of any
lack of evidence as to the parties' intent. See id. at 387-88.
2
At the time material to the Talley decision, the FCA
provided for double damages rather than treble damages. See
Talley, 116 F.3d at 386-87. We agree with the parties and the
district court that, for present purposes, this distinction makes
no difference.
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The government argues that the Talley court's analytic
approach creates a rule requiring that any FCA civil settlement
sums in excess of single damages (except, perhaps, whistleblowers'
fees) be treated as punitive fines (and, thus, nondeductible)
unless the parties have manifested a contrary intention. As the
government reads Talley, that manifested intent can be proven only
by showing a tax characterization agreement between the government
and the taxpayer. In its view, Talley suggests that economic
reality has no bearing. Building on this foundation, the
government argues that the court below should have entered judgment
in its favor as a matter of law once it found that the parties had
abjured any tax characterization agreement.
We cannot accept the government's rationale. A rule that
requires a tax characterization agreement as a precondition to
deductibility focuses too single-mindedly on the parties'
manifested intent in determining the tax treatment of a particular
payment. Such an exclusive focus would give the government a whip
hand of unprecedented ferocity: it could always defeat
deductibility by the simple expedient of refusing to agree — no
matter how arbitrarily — to the tax characterization of a payment.
Moreover, an exclusive focus on manifested intent, such
as the government proposes, would be an anomaly in tax law. When
mulling transactions between private parties, courts that are
required to make tax characterizations typically look to substance
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— that is, the economic reality of the particular transaction,
objectively viewed — rather than to the form chosen by the parties.
See, e.g., United States v. Eurodif S.A., 555 U.S. 305, 317-18
(2009); Boulware v. United States, 552 U.S. 421, 429-30 (2008);
Neb. Dep't of Revenue v. Loewenstein, 513 U.S. 123, 134 (1994);
Frank Lyon Co. v. United States, 435 U.S. 561, 573 (1978);
Helvering v. F. & R. Lazarus & Co., 308 U.S. 252, 255 (1939);
Palmer v. Bender, 287 U.S. 551, 555-56 (1933). Logic suggests that
this approach ought to apply equally to the tax treatment of
settlement payments. See, e.g., Francisco v. United States, 267
F.3d 303, 321-22 (3d Cir. 2001); Delaney v. Comm'r, 99 F.3d 20, 23-
24 (1st Cir. 1996). In that context, too, "court[s have] the right
— indeed, the duty — to look beyond the language subscribed to by
the parties." Rozpad v. Comm'r, 154 F.3d 1, 4 (1st Cir. 1998)
(internal quotation marks omitted). Substance matters.
This is not to say that the intent of the settling
parties is immaterial. It is not. See Francisco, 267 F.3d at 319
(explaining that the "intent of the payor" of a settlement, though
not dispositive, is often "the most persuasive evidence of the
nature of claims settled"). If the government and a defendant
settle an FCA claim and specifically agree as to how the settlement
will be treated for tax purposes, it is hard to envision any reason
why a reviewing court should not honor that agreement.
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But that is not this case. Here, the parties did not
agree on the tax characterization of the civil settlement payments
(indeed, during the negotiations leading to the settlement, the
government apparently refused to discuss tax consequences).
Rather, the parties' manifested intent with respect to
deductibility was expressed as an agreement not to agree; they
intentionally left the question open. Under generally accepted
principles of tax law, a court's inquiry should then shift to the
economic realities of the transaction.
The government resists this common-sense approach.
Relying solely on Talley, it argues that the FCA settlement context
is special and that economic reality is irrelevant.3 It insists
that the only pertinent inquiry is one that seeks to determine
whether a tax characterization agreement exists between the
government and the settling party. We disagree.
Talley offers an indistinct beacon by which to steer.
The case is distinguishable on its facts and its message is
unclear. If Talley stands for the proposition asserted by the
3
One reason that the FCA context is special, the government
suggests, is that the government is a party both to the settlement
agreement and to the tax dispute. But the tax treatment of a
transaction is determined by the provisions of the Internal Revenue
Code, and the fact that one party to a transaction is the
government itself does not alter this truism. See Wash. Mut. Inc.
v. United States, 636 F.3d 1207, 1221 (9th Cir. 2011).
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government,4 then Talley is incorrectly decided and does not
deserve our allegiance.
The government's proposed rule is also in serious tension
with yet another fundamental tenet of tax law. This tenet holds
that amounts paid or received in settlement should receive the same
tax treatment, to the extent practicable, as would have applied had
the dispute been litigated and reduced to judgment. See, e.g.,
Lyeth v. Hoey, 305 U.S. 188, 196 (1938); Freda v. Comm'r, 656 F.3d
570, 574 (7th Cir. 2011); Alexander v. IRS, 72 F.3d 938, 942 (1st
Cir. 1995). The government's position here inters that tenet in
the graveyard of forgotten canons.
When an FCA claim is tried rather than settled, there
will perforce be no characterization agreement available to guide
the tax treatment of awarded damages. Nevertheless, some portion
of the award beyond single damages may subsequently be found to
have a compensatory purpose. See Chandler, 538 U.S. at 130-31;
Bornstein, 423 U.S. at 315. Hence, that portion of the award will
4
It is debatable whether Talley actually stands for this
proposition. Although the government's reading is not an unnatural
one, it may be seeing more in Talley than the decision portends.
On remand following the Ninth Circuit's decision in Talley, the Tax
Court appeared open to considering the economic substance of the
settlement, but was unable to go down that path because the parties
had not developed an appropriate factual record. See Talley Indus.
Inc. v. Comm'r, 77 T.C.M. 2191, 2196 (1999) (noting that
"[n]either party made a serious effort to quantify the Government's
actual losses in excess of its 'singles' damages"), aff'd, 18 F.
App'x 661 (9th Cir. 2001). In contrast, Fresenius meticulously
developed just such a record.
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be deductible. See 26 C.F.R. § 1.162-21(b). The same result
logically should obtain in the settlement context. Thus, a rule
that requires a tax characterization agreement as a precondition to
deductibility would produce an infelicitous asymmetry.
We are not insensitive to the government's fear that
refusing to require a tax characterization agreement not only makes
the eventual deductibility of settlement payments difficult to
predict but also may create perverse incentives.5 But such policy
considerations cannot trump either the clear statutory and
regulatory language conferring deductibility upon compensatory
payments or the case law's sensible emphasis on economic reality.
The government also predicts that if we reject its
proffered rule, the result will be the frustration of public
policy. This is so, it says, because those who violate the FCA
should, when brought to book, be made to feel the sting of
punishment. This prediction overlooks the provenance of section
162(f), which expressly disallows deductions for fines and
penalties. That statute represents Congress's codification of
earlier precedent that was concerned with exactly the same policy
5
The government conjures up a parade of horribles suggesting,
for example, that corporations may stall settlement negotiations in
order to build up imputed interest. Despite these glum
predictions, we are confident that the world will remain firmly on
its axis. Viewed in real-world terms, we think that — if we may
borrow a phrase — the government's "[p]resent fears [a]re less than
horrible imaginings." William Shakespeare, Macbeth, act 1, sc. 3
(circa 1606).
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considerations that the government now seeks to invoke. See
Stephens v. Comm'r, 905 F.2d 667, 672 (2d Cir. 1990) (limning
background to passage of amendments to section 162); see also Tank
Truck Rentals, Inc. v. Comm'r, 356 U.S. 30, 35 (1958) (prohibiting
deductibility, before passage of section 162(f), where such
treatment would severely frustrate sharply defined governmental
interest). Because Congress has calibrated this balance, we
decline the government's invitation that we recalibrate it by
judicial fiat.
To say more about this matter would be to paint the lily.
We hold that, in determining the tax treatment of an FCA civil
settlement, a court may consider factors beyond the mere presence
or absence of a tax characterization agreement between the
government and the settling party. Because the district court
charged the jury in accordance with this legal regime and the
government has not argued that the evidence of record is
insufficient to support the jury's verdict, the government's
motions for judgment as a matter of law were appropriately denied.
B. Jury Instructions.
The government's remaining claim of error need not detain
us. This claim of error implicates the district court's jury
instructions. For the most part, this claim rests on the same
argument that we considered and rejected in Part II. A, supra.
Those arguments are no more persuasive in the context of jury
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instructions and, to the extent that they are repeated, we reject
the claim of instructional error out of hand.
The government does, however, offer one additional
remonstrance: it calumnizes what it calls the district court's
"residual approach" to the question of deductibility. This
approach is exemplified, the government says, by the court's
instruction that payments can only be considered punitive if they
are "above what is necessary" to compensate the government.
Before us, the government faults this rationale, arguing
that there is no basis to assume either that settlement payments
must be applied to compensatory damages first or that, in
settlement negotiations, the government is conceding punitive
dollars first. Settlement negotiations, after all, require some
level of compromise, with parties seeking agreement on a mutually
acceptable discount from the face value of the claim. The
government suggests that it would make more sense to apply this
settlement discount evenly across the deductible and nondeductible
portions of the underlying claim.
The government's argument has a patina of plausibility.
When multi-faceted claims are settled, courts sometimes have upheld
tax allocations that apply the settlement discount pari passu
across the deductible and nondeductible portions of the original
claim. See, e.g., Francisco, 267 F.3d at 323; Rozpad, 154 F.3d at
4-5; Delaney, 99 F.3d at 25-26.
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Delaney provides an apt illustration of this praxis.
There, the taxpayer won a tort judgment of $287,000, out of which
$175,000 (61%) was excludable from taxable income as personal
injury damages. See Delaney, 99 F.3d at 22. The remainder of the
judgment constituted taxable income (prejudgment interest). See
id. While an appeal was pending, the parties settled for $250,000.
See id. The Internal Revenue Service prorated the settlement along
the lines indicated by the judgment and determined that only 61%
was excludable from taxable income. See id. We upheld that
proration. See id. at 25-26.
We need not — and do not — reach the merits of this
argument. Though it has some plausibility, it comes too late. The
government did not clearly articulate this argument in the district
court and, in all events, did not raise it in its post-charge
objections to the jury instructions.6 See Fed. R. Civ. P. 51. We
have held, with a regularity bordering on the monotonous, that
claims of instructional error not seasonably advanced in the trial
6
At oral argument, the government asserted that its request
to have the district court instruct the jury in line with its
version of the Talley rule, see text supra, encompassed this point.
But Talley does not support the point. Moreover, we have carefully
reviewed both the government's proffered instructions and its
objections to the district court's charge; and we find nothing in
them that resembles the "priority" argument that the government
makes on appeal. The fact that acceptance of the Talley rule would
have rendered the question of priority moot does not excuse either
the government's failure to request the instruction or its failure
to object to the instruction's omission from the charge as given.
See Romano v. U-Haul Int'l, 233 F.3d 655, 662-63 (1st Cir. 2000).
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court are waived and cannot be broached for the first time on
appeal. See, e.g., Ji v. Bose Corp., 626 F.3d 116, 125 (1st Cir.
2010); Muñiz v. Rovira, 373 F.3d 1, 6-7 (1st Cir. 2004); Davis v.
Rennie, 264 F.3d 86, 100 (1st Cir. 2001); Wells Real Estate, Inc.
v. Greater Lowell Bd. of Realtors, 850 F.2d 803, 809 (1st Cir.
1988). So it is here.7
III. CONCLUSION
We need go no further. For the reasons elucidated above,
the judgment of the district court is
Affirmed.
7
To be sure, we have some highly circumscribed discretion to
reach out for and review unpreserved claims of instructional error.
See Muñiz, 373 F.3d at 7. But this discretion is reserved for
exceptional cases and must be exercised sparingly. See id.;
Toscano v. Chandris, S.A., 934 F.2d 383, 385 (1st Cir. 1991). The
case at hand falls within the general waiver rule, not within the
long-odds exception to it.
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