State Farm v. Mallela

In State Farm Mut. Auto. Ins. Co. v Mallela, (4 NY3d 313 [2005]), an action for, inter alia, a declaratory judgment brought by an insurer against defendants allegedly operating the same type of scheme allegedly involved in the case at bar, the Court of Appeals held that, on the basis of 11 NYCRR 65-3.16(a)(12), insur-ers may deny no-fault payments to fraudulently incorporated health care providers to which patients have assigned their claims. The Court of Appeals held that an insurer may withhold payment for medical services provided by "fraudu-lently incorporated" enterprises to which patients have assigned their no-fault claims. In Mallela, unlicensed individuals paid physicians to use their names on certificates of incorporation and other documents filed with the Department of State to establish medical service corporations (4 NY3d at 319). Once the medical service corporations were established under the cover of the nominal physi-cian-owners, the nonphysicians actually operated the companies (id.). The nonphysicians caused the corporations to hire management companies owned by the nonphysicians, which billed the medical corporations at inflated rates for routine services (id. at 319-320, 827 NE2d 758, 794 NYS2d 700). Thus, the corporations' profits did not go to the nominal owners but were channeled to the nonphysicians who owned the management companies. The court held that although the patients received appropriate care from licensed professionals, the insurers could withhold payment for no-fault benefits. The New York Court of Appeals held that a medical corporation that was fraudulently incorporated under N.Y. Business Corporation Law 1507, 1508, and NY Education Law 6507(4)(c), is not entitled to reimbursed by insurers, under New York Insurance Law 5101, et. seq., and its implementing regulations, for medical services rendered by licensed medical practitioners. The Court reasoned that insurance regulation 11 NYCRR 65-3.16(a)(12) excluded from the meaning of "basic economic loss" payments made to unlicensed or fraudulently licensed providers and thus rendered such providers ineligible for reimbursement. (Id. at 320). The Court stated that "on the strength of this regulation, carriers may look beyond the face of licensing doc-uments to identify willful and material failure to abide by state and local law." The Court of Appeals upheld the Insurance Department's regulation and held that a medical corporation that was fraudulently incorporated under Business Corporation Law 1507 and 1508, and Education Law 6507 (4) (c) is not entitled to be reimbursed by insurers, under Insurance Law 5101 et seq. Business Corporation Law 1507 and 1508, as applied to this action, prohibit non-chiropractors from owning any shares of or serving on the board of a professional corporation authorized to provide chiropractic services. In Mallela (4 NY3d at 322), the Court found that in the licensing context, carriers will be unable to show "good cause" unless they can demonstrate behavior tantamount to fraud and that technical violations will not do. In every case where 11 NYCRR 65-3.16 (a) (12) has been successfully used as a complete and non-precludible defense in a no-fault action, the provider has been found to have committed violations of Business Corporation Law 1507 and 1508 and Education Law 6507 (4) (c) and appears to have never been based upon impermissible fee-splitting alone. The issue in this case is the definition of the term "li-censing requirement." The Court in Mallela (at 321) highlighted that the medical service corporation in that case "exists to receive payment only because of its willfully and materially false filings with state regulators." Furthermore, the Court noted in footnote 2 that the Superintendent of Insurance promulgated 11 NYCRR 65-3.16 (a) (12) "to combat rapidly growing incidences of fraud in the no-fault regime, fraud that he has identified as correlative with the corporate practice of medicine by nonphysicians" (Mallela at 320 n 2). In State Farm v. Mallela (4 NY3d 313, 827 NE2d 758, 794 NYS2d 700 (2005)), the United States Court of Appeals for the Second Circuit certified a question that asked the New York State Court of Appeals whether under the New York State No-Fault Law and implementing regulations, insurance carriers may withhold payment for medical services provided by fraudulently incorporated enterprises to which patients have assigned their claims. The New York State Court of Appeals concluded that they may. In Mallela, the facts are as follows: State Farm filed a complaint in the United States District Court for the Eastern District of New York seeking a judgment declaring that it need not reimburse defendants, fraudulently incorporated medical corporations, for assigned claims submitted under the No-Fault Law. The complaint sought equitable relief and damages against defendant companies and individuals for unjust enrichment and fraud. State Farm alleged, in essence, that to obtain payments from the carriers under the requirements of no-fault insurance, the defendants willfully evaded New York law prohibiting nonphysicians from sharing ownership in medical service corporations. (See Mallela at 319.) According to the complaint in Mallela, the unlicensed defendants "paid physicians to use their names on paperwork filed with the State of New York to establish medical service corporations." (Id.) "Once the medical service corporations were established under the facially valid cover of the nominal physician-owners, the nonphysicians actually operated the companies." (Id.) "To maintain the appearance that the physicians owned the entities, the nonphysicians caused the corporations to hire management companies (owned by the nonphysicians), which billed the medical corporations inflated rates for routine services." (Id. at 319-320.) As a result, "the actual profits did not go to the nominal owners but where channeled to the nonphysicians who owned the management companies." (Id. at 320.) The United States District Court "dismissed State Farm's complaint, holding that defendants' noncompliance with the licensing and incorporation statutes did not extinguish State Farm's duty to pay, so long as the actual providers acted within the scope of their licenses in rendering care." (Id.) On appeal, "the Second Circuit ... certified to the Court of Appeals of the State of New York the question whether "'a medical corporation that was fraudulently incorporated under N.Y. Business Corporations Law 1507, 1508 and N.Y. Educational Law 6507 (4) (c) is entitled to be reimbursed by insurers, under New York Insurance Law 5101 et seq., and its implementing regulations, for medical services rendered by licensed medical practitioners.'" (Id.) The New York Court of Appeals accepted the certification and held that such corporations are not entitled to reimbursement. The Court held that the Superintendent of Insurance's "regulation allowing carriers to withhold reimbursement from fraudulently licensed medical corporations governs this case. The Court held that on the strength of this regulation, carriers may look beyond the face of licensing documents to identify willful and material failure to abide by state and local law." (Mallela at 321.) However, the Court was clear that the regulatory scheme set up by the State of New York "does not permit abuse of the truth-seeking opportunity that 11 NYCRR 65-3.16 (a) (12) authorizes." (Id. at 322.) Indeed, the Superintendent's regulations themselves provide for agency oversight of carriers and demand that carriers delay the payment of claims to pursue investigations solely for good cause. (Id.)