Azer v. Connell

• Decision Date: 26 September 2002
• Docket Number: No. 01-55359.,01-55359.
• Parties: Morcos S. AZER; Doctor's Medical Laboratory, Inc., Plaintiffs-Appellants, v. Kathleen CONNELL; John Chen; Steven Fujimori; Joseph P. Munso; Al Schaden, Defendants-Appellees.
• Court: U.S. Court of Appeals — Ninth Circuit

306 F.3d 930

Morcos S. AZER; Doctor's Medical Laboratory, Inc., Plaintiffs-Appellants, v. Kathleen CONNELL; John Chen; Steven Fujimori; Joseph P. Munso; Al Schaden, Defendants-Appellees.

No. 01-55359.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted March 7, 2002.

Filed September 26, 2002.

COPYRIGHT MATERIAL OMITTED

Patric Hooper, Hooper, Lundy & Bookman, Los Angeles, CA, for the appellants.

Kenneth G. Lake, Deputy Attorney General, Los Angeles, CA, for the appellees.

Appeal from the United States District Court for the Central District of California; Gary A. Feess, District Judge, Presiding. D.C. No. CV-00-11008-GAF.

Before: WARDLAW, W. FLETCHER, Circuit Judges, and WHYTE,^* District Judge.

WILLIAM A. FLETCHER, Circuit Judge.

Plaintiffs Morcos S. Azer and his now-moribund company, Doctor's Medical Laboratory, Inc. ("DML"), bring this 42 U.S.C. § 1983 action against defendants Kathleen Connell, California's elected State Controller; John Chen, Chief of the Audits Division of the California Controller's office at all times relevant to this appeal; and Steven Fujimori, an audit manager in the Controller's office at all times relevant to this appeal (collectively, the "Controller Defendants"). The suit also names as defendants Joseph Munso and Al Schaden, who were employed by the California Department of Health Services ("DHS") at all times relevant to this appeal (collectively, the "DHS Defendants"). Munso was the acting or actual Chief Deputy Director of DHS. Schaden was the Chief of the Case Development Section of the Medical Review Branch of the Audits and Investigation Division of DHS. The plaintiffs allege that each defendant, in his or her individual capacity, wrongfully withheld nearly $3 million in payments to DML as part of a Medi-Cal fraud investigation. The district court granted defendants' motion to dismiss the suit as untimely. We reverse and remand.

I. Background

Azer was the sole shareholder and president of DML. Beginning in 1993, DML was licensed to provide clinical laboratory services to California's Medi-Cal program. Medi-Cal is California's health program for the indigent, and is operated under the federal Medicaid Act. More than 90% of DML's revenues came from Medi-Cal. Because two aspects of the Medicaid/Medi-Cal regulatory framework are pertinent to this appeal, we outline them briefly.

A. Regulatory Framework

In exchange for receiving federal Medicaid funds, states implementing state-level programs such as Medi-Cal must comply with the federal statutory and regulatory requirements of Medicaid. See 42 U.S.C. § 1396a; Wilder v. Va. Hosp. Ass'n, 496 U.S. 498, 502, 110 S.Ct. 2510, 110 L.Ed.2d 455 (1990); San Lazaro Ass'n, Inc. v. Connell, 286 F.3d 1088, 1092-94 (9th Cir.2002). Regulations implementing the Medicaid Act are promulgated by the federal Department of Health and Human Services ("HHS"). One statutory provision requires a state participating in Medicaid to designate a "single state agency" to administer its Medicaid plan. 42 U.S.C. § 1396a(a)(5). DHS is the single state agency designated to administer Medi-Cal. The designated state agency may not delegate to any other agency the authority to exercise discretion in administering the program. See 42 C.F.R. § 431.10(e). However, the single state agency may subcontract certain functions that do not involve a delegation of discretionary authority. See 42 C.F.R. §§ 434.4,.6, .10. For example, DHS contracts with a private entity, Electronic Data Systems ("EDS"), to review and process provider payments for services to Medi-Cal patients. See San Lazaro, 286 F.3d at 1093.

Another provision of federal law requires states to establish procedures to investigate Medicaid fraud and abuse, while also safeguarding the rights of health-care providers. See 42 U.S.C. §§ 1396a(a)(3), (a)(42); 42 C.F.R. §§ 447.200, 447.202, 455.12 .23. If an audit reveals overpayment to a provider, the provider is entitled to an administrative appeal of the audit findings. See Cal. Welf. & Inst.Code § 14171. Although DHS is permitted by federal regulation to withhold payments to a provider in cases of fraud or willful misrepresentation, such withholdings must be temporary. See 42 C.F.R. § 455.23(c). DHS may not recoup alleged overpayments to a provider until the administrative appeals process is complete. See Cal.Code Regs. tit. 22, §§ 51017, 51047(a).

B. Audit Agreement between DHS and the Controller

In June 1997, DHS and the State Controller entered into an "interagency agreement" under which the Controller would perform audits and identify overpayments to providers. The agreement provided that although the Controller would perform audits, DHS would retain final authority to review all reports of overpayments identified by the Controller. See RCJ Med. Servs., Inc. v. Bonta, 91 Cal. App.4th 986, 999 n. 4, 111 Cal.Rptr.2d 223 (2001) (describing the 1997 agreement). In September 1997, pursuant to the inter-agency agreement with DHS, the State Controller Defendants ordered two financial auditors employed exclusively by the State Controller's office to conduct an unannounced, warrantless search of DML's business premises and to seize various documents and records. DML alleges that there were subsequent warrantless searches as well, and that the funds seized had been previously approved for payment. The defendants ultimately seized and withheld approximately $2,833,006.40 in Medi-Cal payments from DML. As a result of the seizures, DML was forced to close its laboratory, effective November 25, 1997.

C. DML's State Court Suits

In November 1997, DML filed suit in California state court seeking a declaration that the Controller had acted unlawfully in seizing and withholding the funds, and an order that the funds be released. The suit named as defendant only California State Controller Connell, in her official capacity. The trial court ruled in favor of DML, holding that although the Controller had the authority to audit DML, she had acted improperly in impounding the funds. The California Court of Appeal affirmed the trial court's holding that the Controller had improperly impounded the funds, and affirmed its order requiring the Controller to refund the payments seized from DML. See Doctor's Med. Lab., Inc. v. Connell, 69 Cal.App.4th 891, 898, 81 Cal.Rptr.2d 829 (1999). The appellate court reversed the trial court's holding that the Controller may conduct Medi-Cal audits. See id. at 897-98, 81 Cal.Rptr.2d 829.

Although the California Court of Appeal ordered the Controller to release all funds that EDS had approved for payment to DML "without prejudice to subsequent audits and claims for overpayment by DHS," id. at 898, 81 Cal.Rptr.2d 829, the Controller refused to release any funds. Instead, she petitioned for rehearing, and then appealed to the California Supreme Court. That court denied review on May 26, 1999.

Two days later, DHS defendant Munso sent a memorandum to the Controller's office stating:

We understand that the California Supreme Court has refused to overturn the decision of the Court of Appeal.... We further understand that this means that your office is now compelled to release Medi-Cal payments previously withheld from [DML]. Based on information available, we have determined that we have reliable evidence of fraud or willful misrepresentation by [DML]. Therefore, we are requesting that you withhold any Medi-Cal payments based on adjudicated claims ... pursuant to our authority in 42 CFR section 455.23[the "temporary withholding" provision].

After Munso's memorandum was sent, DHS defendant Schaden informed plaintiffs that DHS was "temporarily withholding" all of the Medi-Cal payments in question because it had determined that there was fraud or misrepresentation by DML. In response to Munso's memorandum, the Controller's office delivered to DHS a warrant payable to DML for $2,218,274. DHS, in turn, refused to release the funds to DML.

DML returned to state court seeking to compel the Controller to comply with the order that it refund the money to DML. Both the trial court and the Court of Appeal rejected the Controller's argument that it could not refund the payments to DML because it had turned the warrant over to DHS. See Doctor's Med. Lab., Inc. v. Connell, No. B134090 (Cal.App.Ct. June 28, 2000) (unpub.order). The Court of Appeal concluded that because the payments had been withheld for more than two and a half years, the withholding could not be termed "temporary" pursuant to the relevant regulation. See 42 C.F.R. § 455.23(c).

The Controller finally released some of the money owed to DML in June 2000. The balance of the money was refunded in November 2000.

D. The Current Suit

Azer and DML filed this complaint on October 16, 2000, seeking relief under 42 U.S.C. § 1983. Suits under 42 U.S.C. § 1983 by corporate plaintiffs are permissible. See Cal. Diversified Promotions, Inc. v. Musick, 505 F.2d 278, 283 (9th Cir.1974). To establish a prima facie case under 42 U.S.C. § 1983, a plaintiff must demonstrate that (1) the action complained of occurred "under color of law," and (2) the action resulted in a deprivation of a constitutional right or a federal statutory right. McDade v. West, 223 F.3d 1135, 1139 (9th Cir.2000) (citing Parratt v. Taylor, 451 U.S. 527, 535, 101 S.Ct. 1908, 68 L.Ed.2d 420 (1981), overruled on other grounds by Daniels v. Williams, 474 U.S. 327, 330-31, 106 S.Ct. 662, 88 L.Ed.2d 662 (1986)).

The four counts of the complaint allege: (1) the Controller's warrantless search of DML's premises and her seizure of papers and payments constitute a violation of plaintiffs' Fourth Amendment rights; (2) the initial seizure of Medi-Cal funds approved for payment to DML and the continuing withholding of those funds constituted a violation of plaintiffs' due process rights under the Fifth and Fourteenth Amendments; (3) defendants deprived plaintiffs of their right under 42 U.S.C. § 1396a(a)(5) and 42 C.F.R. §...