The United State District Court for the Eastern District of New York recently dismissed an FCA complaint for failing to plead materiality under the standard announced in Universal Health Services, Inc. v. U.S. ex rel. Escobar, the Supreme Court’s landmark FCA opinion issued in June of this year. The case, U.S. ex rel. Lee v. Northern Adult Daily Health Care Center, 13-cv-4933, 2016 WL 4703653 (E.D.N.Y. Sept. 7, 2016), becomes one of the first to substantively apply Escobar and highlights the barrier the FCA’s materiality requirement poses to FCA relators in the wake of the Supreme Court’s ruling. It also suggests ways in which courts already are divided in their interpretation of Escobar.

The relators in Lee were former employees of Northern Adult, an adult day healthcare center in Brooklyn that provided health and social services to elderly and low-income registrants. The relators alleged that Northern Adult failed to supervise registrants, failed to provide physical and occupational therapy, and engaged in discriminatory practices that prevented minority registrants from receiving the full benefit of the services for which the government provided funds. According to the relators, these actions violated Title VI of the Civil Rights Act and DOH regulations that were conditions of payment. The relators argued that FCA liability attached because Northern Adult impliedly certified compliance with these rules and regulations when billing the government.

Prior to Escobar, Mikes v. Straus, 274 F.3d 687 (2d Cir. 2001), was the leading implied certification case in the Second Circuit. Mikes held that “implied false certification is appropriately applied only when the underlying statute or regulation upon which the plaintiff relies expressly states the provider must comply in order to be paid.” Like the Second Circuit, the Supreme Court in Escobar held that “[a] misrepresentation about compliance with a statutory, regulatory, or contractual requirement must be material to the Government’s payment decision in order to be actionable under the False Claims Act.” But, rather than adopting the condition-of-payment distinction as the sole test for materiality, the Supreme Court held that “[w]hether a provision is labeled a condition of payment is relevant to but not dispositive of the materiality inquiry.” The Supreme Court then provided other evidentiary guideposts for the materiality inquiry, which we have covered here.

Applying this reasoning, the district court in Lee acknowledged that “[w]hile [the relators’] argument may have sufficed to support an implied false certification claim under the standard in Mikes, it no longer suffices under the standard in [Escobar].” As a result, the district court dismissed the complaint, while allowing the relators to re-plead their allegations in light of Escobar, which had not been issued when the complaint was filed.

The dismissal should not be surprising, given the Supreme Court’s explicit rejection of the condition-of-payment distinction as a dispositive test for materiality. Still, it shows that Escobar already is affecting FCA litigants. Here, a complaint that previously might have survived a motion to dismiss no longer does. And, an FCA defendant, despite being accused of violating express conditions of payment, walked away from a motion to dismiss with a win.

Lee also points to areas of future disagreement in a post-Escobar world. Lee is consistent with another recent case, which we covered here, in which the court dismissed a complaint that “allege[d] in several places that the government would not have paid Defendants’ claims had they known of Defendants’ fraudulent conduct, but [did] not explain why.” U.S. ex rel. Dresser v. Qualium Corp., No. 5:12-cv-01745, (N.D. Cal. July 18, 2016). However, these two cases seem inconsistent with a third, in which the court found a defendant liable for violating certain requirements for which the government could contractually deny payment. See Johnson v. District of Columbia, No. 15-cv-59, — A.3d.–, 2016 WL 4261218 (D.C. Aug. 11, 2016).

Lee revealed a second area of uncertainty regarding the application of Escobar. The FCA defines materiality as “having a natural tendency to influence, or be capable of influencing, the payment or receipt of money or property.” In Escobar, the Supreme Court declined to decide whether the statutory definition of materiality controls in implied certification cases, instead reasoning that “under any understanding of the concept, materiality looks to the effect on the likely or actual behavior of the recipient of the alleged misrepresentation.” In Lee, the district court indicated that to satisfy the materiality requirement, the relators must allege “that the government would have refused reimbursement had it known of Northern Adult’s noncompliance.” How this squares with the FCA’s statutory definition of materiality is unclear; certainly, Lee requires more than a mere allegation that a violation is capable of influencing the government’s payment decision.

Escobar sends mixed signals on how courts should approach the issue of materiality. On the one hand, Escobar recognized the statutory definition of materiality and favorably cited common-law definitions of the concept that also rely on the “natural tendency to influence” standard. On the other hand, Escobar explained that merely alleging a violation of a condition of payment or that the government would have the option to decline payment for noncompliance may be insufficient to show materiality. Either of these factors seemingly would be capable of influencing the government’s payment decision. That the Supreme Court allowed for the possibility that circumstances might exist where those factors would be insufficient to show materiality suggests that a stronger showing, one more in line with Lee’s formulation, may be required. We should expect significant disagreement over this issue as the case law develops.

Law360 repurposed this blog content for an article titled “How Escobar Is Already Affecting FCA Litigants,” published on September 29, 2016, that is available online.