Courts Permit Mallela Claims against “Article 28” Facilities

It has been nearly a decade since the New York Court of Appeals ruled, in State Farm v. Mallela,[1] that a medical corporation was not entitled to be reimbursed by insurance companies under New York’s no-fault law and its implementing regulations[2] for medical services rendered by licensed medical practitioners where the medical corporation failed to comply with applicable licensing requirements by virtue of falsely representing that it was owned and controlled by a licensed physician when, in fact, it was owned and controlled by non-physicians. (The author and his firm represented the insurance company plaintiff in Mallela.)

As part of the continuing battle over no-fault insurance fraud,[3] one of the issues that recently has arisen since Mallela is whether the ruling should be applied not just to medical corporations licensed under New York’s Business Corporation Law (“BCL”) and Education Law but to other entities seeking to recover no-fault insurance benefits as assignees of individuals allegedly injured in automobile accidents.

This column will focus on one particular aspect of that issue, which has significant financial implications: the application of Mallela to so-called “Article 28” facilities, which are medical facilities such as hospitals and clinics that by law are permitted to be owned by non-physicians and are subject to other requirements and regulations enacted by the New York State Department of Health. Several courts have made it clear that, indeed, Mallela permits insurance carriers to refuse payments to such facilities when they are not in compliance with regulatory requirements.

The Elzanaty Case

The leading case, Allstate Ins. Co. v. Elzanaty,[4] arose when Allstate Insurance Company, Allstate Indemnity Company, and Allstate Property & Casualty Insurance Company sued various defendants in the U.S. District Court for the Eastern District of New York for insurance fraud. Allstate sought damages under the federal Racketeer Influenced and Corrupt Organizations Act (“RICO”)[5] and under New York state law for common law fraud, unjust enrichment, and unfair and deceptive business practices in violation of New York General Business Law § 349.

Allstate alleged that the defendants had engaged in insurance fraud by creating fictitious medical facilities under Article 28 of the Public Health Law.  These facilities held themselves out to Allstate as legitimately incorporated medical entities under New York state law, so that they could obtain payments from Allstate under New York’s no-fault insurance law, Allstate asserted.

The defendants moved to dismiss. Their principal argument was that where an Article 28 medical facility had been found to be in compliance with its applicable licensing requirements by the Health Department, the state administrative agency charged with its oversight, the facility could not be prevented from rightfully collecting what it was owed under the no-fault insurance scheme.

            In an extensive opinion, Eastern District Judge Arthur D. Spatt denied the defendants’ motion.

The Court Decision

In his decision, Spatt explained that health care providers may accept assignments of no-fault benefits and then, once they submit claims to insurance companies, the carriers must promptly process those claims. In particular, Spatt continued, insurers must request any necessary “verification” of claims within 10 days of receiving a completed claim.[6] Upon getting verification, insurers have 30 days within which to pay or deny a benefits claim.[7]

The court then pointed out that in order for a health care provider to be eligible for reimbursement, the provider must meet all relevant New York state or local licensing requirements.[8] As the court noted, under the BCL, all professional service corporations (“P.C.s”) that are licensed to practice medicine must be owned and controlled only by licensed physicians.[9] To obtain the necessary licensing, BCL § 1503 provides that a certificate of incorporation must list the names of all shareholders, directors, and officers, and must include documentation certifying that such individuals are licensed to practice medicine. Moreover, the court continued, New York assigns criminal penalties to those who fraudulently obtain a license[10] or who knowingly submit false documents to a public office.[11] Under Mallela, the court stated, if a P.C. is not actually owned and controlled by a licensed physician and thus is fraudulently incorporated, it may not submit assigned claims for no-fault insurance benefits.

As the court next observed, “Article 28” facilities are licensed and regulated by the Health Department. For example, the department oversees the establishment and construction of hospitals in New York pursuant to Article 28 of the Public Health Law and issues operating certificates specifying the kinds of services the facilities are authorized to provide. The court pointed out that this procedure was required only of clinics and hospitals – not of private physicians.

The court then explained that Allstate’s fraud and RICO claims rested on the assertion that the defendant Article 28 facilities were “improperly licensed,” thus rendering them ineligible to collect under New York’s no-fault law for the services they allegedly provided to Allstate’s injured insureds. The court rejected the defendants’ assertion that because the Health Department had continuously reviewed the facilities’ operations and determined to continue their certificate of authority, Allstate was precluded from asserting that the facilities were not in compliance with applicable regulations. Simply put, the court ruled, Allstate could claim that a medical facility did not comply with the Health Department’s Article 28 licensing requirements under the auspices of fraud, even though the department previously had confirmed its compliance. Allstate had “adequately stated a claim for fraud and RICO on the premise of improper licensing, despite the fact that the [d]efendants were approved and licensed by a state authority,” the court ruled.

The court based its conclusion on Mallela, explaining that Allstate impliedly was seeking to extend Mallela from the BCL context to the public health context, and it determined that it could do so. The court reasoned that similar to the idea under the BCL that only a licensed medical doctor could control a medical P.C., which was at issue in Mallela, a non-doctor could control a hospital but only under the strict circumstances found in the Department of Health regulations, including that there must be a medical director who “is a physician licensed by and currently registered with the New York State Education Department,” who “develops and recommends to the operator policies and procedures governing patient care in accordance with generally accepted standards of professional practice,” and who is “responsible for the supervision of the quality assurance program and for reporting the activities of the program to the operator.”

Judge Spatt found that Mallela made no distinction between health care providers incorporated as business entities pursuant to the BCL and health care providers licensed as Article 28 facilities under the Public Health Law. The court said that, given that the operative regulation, 11 NYCRR §65-3.16(a)(12), states that a provider of health care services is not eligible for reimbursement under Insurance Law § 5102 if the provider fails to meet any New York state or local licensing requirements, it agreed with Allstate and it rejected the defendants’ efforts to curtail the scope of Mallela.

Accordingly, the court concluded, Allstate properly could assert fraud and RICO causes of action despite the state’s licensing scheme and previous approvals, and there was no basis to dismiss the complaint simply because the Health Departmenthad issued Article 28 licenses to the defendants.

Conclusion

At least two other courts have reached the same result. In Government Employees Ins. v. Uptown Health Care Management,[12] Judge Frederic Block, relying to a large extent on Judge Spatt’s decision, denied a request by a number of Article 28 facilities to dismiss the insurers’ complaint against them, found that Mallela extended to Article 28 facilities, and ruled that the insurance companies could proceed with their fraud and RICO claims notwithstanding the Health Department’s prior approvals of the Article 28 facilities.  The author’s firm represented the insurance company plaintiffs in this case, which has settled.) 

Then, this past May, the Appellate Division, First Department, ruled that an insurance company “plainly” had the right to investigate whether the plaintiffs had been fraudulently licensed under Article 28 and, therefore, were ineligible to receive no-fault reimbursements.[13]

Neither the New York Court of Appeals nor the U.S. Court of Appeals for the Second Circuit has yet ruled on this issue. Unless these courts rule differently, insurance companies may bring insurance fraud actions against Article 28 facilities – and those facilities should ensure that they follow the requirements of the Public Health Law or face the conseq