Five Years Later, Issues From Mallela Continue To Be Litigated

It has been almost exactly five years since the New York Court of Appeals issued its decision in State Farm Mutual Auto. Ins. Co. v. Mallela,[1] establishing that a violation of a licensing requirement by a medical provider renders the provider ineligible to be reimbursed by an insurance company for no fault[2] claims that have been assigned to the provider by an individual allegedly involved in an automobile accident. The Court’s ruling in Mallela (the author’s firm represented the insurance carrier in this case) recognized that one such kind of licensing violation is the lack of ownership and/or control over a medical professional corporation by a licensed medical doctor, and it made it clear that insurance carriers may look beyond the face of the medical professional corporation’s licensing documents to identify a failure to abide by state law in this regard.

Mallela was a watershed decision – it already has been cited in more than 100 other opinions – and has provided great support for insurance company efforts to reduce fraudulent no fault claims. Because of the ruling’s great practical significance, however, both medical providers and insurance companies continue to litigate numerous issues left open by Mallela. None of these has yet reached the New York Court of Appeals. As discussed below, however, there is a great deal of appellate authority on a variety of these subjects.  This column is the first installment of a two-part series discussing Mallela issues.

Background

The Mallela case began when the State Farm Mutual Automobile Insurance Company filed a complaint in the U.S. District Court for the Eastern District of New York seeking a judgment declaring that it need not reimburse allegedly unlawfully incorporated medical professional corporations for no fault claims that had been assigned to them by their patients. The complaint also sought equitable relief and monetary damages against the defendants for unjust enrichment and fraud. State Farm alleged, in essence, that to obtain payments under the requirements of no fault insurance, the defendants evaded New York law prohibiting non-physicians from sharing ownership in and controlling medical professional corporations.[3]

According to the complaint, the unlicensed defendants paid physicians to use their names on paperwork filed with New York State to establish medical professional corporations. Once the medical professional corporations were established under the facially valid cover of the nominal physician-owners, the non-physicians actually operated and controlled the companies.

To maintain the appearance that the physicians owned the entities, the non-physicians caused the medical professional corporations to contract with management companies (owned by the non-physicians), which provided for the payment of exorbitant fees for routine services. In this manner, the actual profits generated by the medical professional corporation’s receipt of insurance payments did not go to the nominal owners but were channeled to the non-physicians through the payments to the management companies.[4]

The district court dismissed State Farm’s complaint, holding that the defendants’ alleged noncompliance with the licensing and incorporation statutes did not extinguish State Farm’s duty to pay, so long as the actual physicians had acted within the scope of their licenses in rendering care. On appeal, the U.S. Court of Appeals for the Second Circuit certified to the New York Court of Appeals the question whether “a medical corporation that was fraudulently incorporated under N.Y. Business Corporation §§ 1507, 1508, and N.Y. Education 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.” The New York Court of Appeals accepted the certification and answered that such corporations are not entitled to reimbursement.

In its unanimous decision, the Court pointed out that the no fault law requires insurance carriers to reimburse patients (or, as in this case, their medical provider assignees) for “basic economic loss.” It added that, interpreting the statute, the Superintendent of Insurance promulgated 11 N.Y.C.R.R § 65-3.16(a)(12), effective April 4, 2002, which excluded from the meaning of “basic economic loss” payments made to unlicensed or fraudulently licensed providers, thus rendering them ineligible for reimbursement. The Superintendent indicated that he promulgated the regulation to combat rapidly growing incidences of fraud in the no fault regime, which he identified as correlative with the corporate practice of medicine by non-physicians.

The Court rejected the defendants’ contentions that they were entitled to reimbursement even if fraudulently licensed, and that the regulation conflicted with the prompt payment goals of the no fault law, finding the regulation to be valid. The Court noted the defendants’ argument that insurance carriers looking beyond the face of licensing documents would “turn this investigatory privilege into a vehicle for delay and recalcitrance,” declaring that the regulatory scheme did not permit “abuse of the truth-seeking opportunity” that the regulation authorizes. Finally, the Court ruled that, noting that it rested its holding on the regulation declaring fraudulently licensed corporations ineligible for reimbursement, no cause of action for fraud or unjust enrichment would lie for any payments made by carriers before that regulation’s effective date of April 4, 2002.

The April 4, 2002 Deadline

A number of courts since Mallela have decided that insurance carriers may deny all bills under the Mallela rationale after the regulation’s effective date of April 4, 2002, regardless of the date of treatment. For example, in Allstate Ins. Co. v. Belt Parkway Imaging, P.C.,[5] the Appellate Division, First Department, affirmed a decision by the Supreme Court, New York County, permitting the insurer to withhold payments for claims that the medical provider had made before April 4, 2002, and sustaining the insurer’s affirmative defenses based on the defendants’ improper corporate form.

The First Department found that Mallela was dispositive as to the insurer’s fraud and unjust enrichment claims, and rejected the medical provider’s argument that the regulation was improperly “retroactive” as well as their attempt to distinguish Mallela by saying that their claims rest on the common law, not just on the regulation. The First Department concluded that, with respect to bills that the insurer had not yet paid, the clear import of the regulation was that as of April 4, 2002, defendants were no longer eligible to be paid, even if they had already performed services.[6]

The 30-Day Rule

New York’s no fault law generally requires an insurer to pay or deny a no fault claim from a medical provider within 30 days of a request (the “30-day rule”)[7] and to assert defenses (other than “no coverage defenses”), including defenses related to billing fraud based upon lack of medical necessity or excessive fees, to be asserted in a denial within the 30 day time frame or such defenses are waived. Numerous cases have held that the defense of a licensing violation is not governed by the 30-day rule as similar to a coverage defense.[8]

In Fair Price Medical v. Travelers Ins.,[9] however, the Court of Appeals decided that, under the circumstances of that case, which involved the claim that the medical supplies billed for had never been provided, an insurance company that had denied claims after 30 days was precluded from offering a fraud defense to its refusal to pay. Numerous courts since then have considered the application of the 30-day rule following Fair Price to the Mallela defense in a variety of circumstances.

Most courts have found that Fair Price does not impact the rule that the 30-day rule does not affect Mallela defense. For example, the court in Eastern Medical P.C. v. Allstate Ins. Co.,[10]rejected the contention that the rule in Fair Price had reshaped the analysis of fraud-based defenses so as to make a Mallela fraudulent incorporation defense untimely if not made within the 30 day denial period.  The Eastern Medical court found that the Mallela defense was not predicated upon a policy exclusion or the extent of coverage provided by a contract of insurance but rather upon a statutory defense arising from a claimant’s failure to comply with applicable sections of the Business Corporation, Limited Liability and Education Laws. Hence, the regulation relied on by the Mallela court was “a condition precedent with which all claimants must comply in order to receive benefits.” Therefore, the Eastern Medical court found, Fair Price did not alter prior precedent that a fraudulent incorporation defense “is a non-waivable defense and is therefore not subject to the 30-day preclusion rule.”[11]

Moreover, it has been held that the 30-day rule does not bar motions to amend pleadings to add a Mallela defense after the 30-day period. In New York First Acupuncture, P.C. v. State Farm Mutual Automobile Ins. Co.,[12] the Appellate Term, Second Department, affirmed a decision by the Queens County Civil Court that granted the insurer’s motion seeking to amend its answer to include the defense of fraudulent incorporation, finding that the plaintiff’s contention that the defense of fraudulent incorporation had to be asserted in a timely denial of claim form was “without merit.”[13]

Separate and apart from the lack of applicability of the 30-day rule to a Mallela defense to a suit seeking payment of a denied bill is the lack of applicability of the 30-day rule to affirmative lawsuits under common law theories of fraud and unjust enrichment by insurance carriers to recover monies previously paid. For example, the court in State Farm Mutual Automobile. Ins. Co. v. CPT Medical Servs. P.C.[14] found that the insurer was not precluded from bringing an action alleging fraud and unjust enrichment merely because it had not discovered the defendants’ alleged fraud within the 30 day claims period. Among other reasons, the district court noted that the Department of Insurance had opined that nothing in the Insurance Law’s creation of the 30-day rule was intended to impact common law claims.

The next installment of this column will consider other topics that continue to be litigated under Mallela, including discovery, summary judgment, and trial issues.

[1] 4 N.Y.3d 313 (2005). The authors’ firm represented the insurance carrier in this case.

[2] See Insurance Law § 5101 et seq.

[3] See, e.g., Business Corporations Law § 1507 (“A professional service corporation may issue shares only to individuals who are authorized by law to practice in this state a profession which such corporation is authorized to practice….”).

[4] State Farm did not allege that the actual care received by patients was unnecessary or improper. State Farm’s complaint centered on fraud in the corporate form rather than on the quality of care provided.

[5] 33 A.D.3d 407 (1^st Dep’t 2006).

[6] See, also, Multiquest, P.L.L.C. v. Allstate Ins. Co., 20 Misc. 3d 136A (App. Term 2d Dep’t 2008); Metroscan Imaging P.C. v. Geico Ins. Co., 13 Misc. 3d 35 (App. Term 2d Dep’t 2006); St. Paul Travelers Ins. Co. v. Nandi, 15 Misc. 3d 1145A (Sup. Ct. Queens County 2007).

[7] Insurance Law § 5106(a).

[8] Midwood Acupuncture, P.C. v. State Farm Mutual Automobile Ins., Co., 14 Misc.3d 131(A) (App. Term, 2d Dep’t 2007); Multiquest, P.L.L.C. v. Allstate Ins. Co., 17 Misc.3d 37 (App. Term, 2d Dep’t 2007); Crossbay Acupuncture, P.C. v. State Farm Mut. Auto. Ins. Co., 15 Misc. 3d 110 (App. Term 2d Dep’t 2007); Midwood Acupuncture, P.C. v. State Farm Mut. Auto. Ins. Co., 14 Misc. 3d 131(A) (App. Term 2d Dep’t 2007); First Help Acupuncture P.C. v. State Farm Ins. Co., 12 Misc. 3d 130(A) (App. Term 2d Dep’t 2006).

[9] 10 N.Y.3d 556 (2008). The authors’ firm submitted an amicus curiae brief in support of Travelers.

[10] 19 Misc. 3d 775 (Dist. Ct. Nassau Co. 2008).

[11] See, also, Lenox Hill Radiology and MIA, P.C. v. Global Liberty Ins. Co. of New York, 24 Misc. 3d 1225A (Civ. Ct. Richmond Co. 2009).

[12] 2009 N.Y. Slip Op. 52217U (App. Term 2d Dep’t Oct. 23, 2009).

[13] The memorandum opinion by Judge Joseph G. Golia, concurring in the result, is particularly noteworthy; Judge Golia pointed out that “it is inconceivable that a Mallela defense of fraudulent incorporation could ever create prejudice or surprise that resulted directly from the delay in raising such defense.” As explained by Judge Golia, “it is extremely unlikely that an individual who creates a fraudulent entity for the purpose of defrauding an insurance company would forget that he/she did so and be prejudiced or surprised when it was discovered.”

[14] 2008 U.S. Dist. LEXIS 71156 (E.D.N.Y. Sept. 5, 2008); see, also, State Farm Mutual Automobile Ins. Co. v. Grafman, 2009 U.S. Dist. LEXIS 86451 (E.D.N.Y. Sept. 21, 2009) (collecting cases) (the authors’ firm represented an insurance carrier in this case).

This article is reprinted with permission from the January 8, 2010 issue of the New York Law Journal. Copyright ALM Properties, Inc. Further duplication without permission is prohibited. All rights reserved.