As previously discussed as a part of our ongoing FCA Fundamentals series, the False Claims Act (FCA) is the federal government’s most important and most effective tool for fighting fraud. While Congress has substantially expanded the scope of the FCA since its inception during the Civil War, courts have recognized that the FCA was “not designed to reach every kind of fraud practiced on the Government” and is not intended to be a “vehicle for punishing garden-variety breaches of contract or regulatory violations.” Rather, the FCA applies only to false or fraudulent claims or omissions that are “material” to the government. So what is materiality?

Escobar Sets the Bar for Materiality

Section 3729(b)(4) of the FCA defines materiality as “having a natural tendency to influence, or be capable of influencing, the payment or receipt of money or property.” But for many years courts struggled to apply this definition in FCA litigation, and no consistent standard prevailed among the courts of appeals.

Then in 2016, the U.S. Supreme Court issued a groundbreaking and unanimous decision in Universal Health Servs., Inc. v. U.S. ex rel. Escobar that clarified the strength of the FCA’s materiality requirement and provided guidance on the materiality analysis. In Escobar, the Court held that a misrepresentation must meet the FCA’s “rigorous” and “demanding” materiality requirement to be a basis for liability. Using tort and contract law as a guide, the Court found that materiality “look[s] to the effect on the likely or actual behavior of the recipient of the alleged misrepresentation.” The Court then identified several non-exhaustive factors to help courts determine if a false statement or omission would be considered material to the government’s payment decision. These factors include:

  • Whether the government has expressly identified compliance with a specific statutory, regulatory, or contractual requirement as a condition of payment.
  • Whether the government generally refuses to pay claims that fail to meet the specific statutory, regulatory, or contractual requirement.
  • Whether the government has continued to pay claims despite actual knowledge of noncompliance with the requirement.
  • Whether the alleged noncompliance is considered minor or insignificant, or if it goes to the “very essence of the bargain.”

The Court was clear that while each of these factors may be relevant to materiality, none is dispositive. Still, the Court noted that some factors, particularly the government’s continued payment of claims despite knowledge of noncompliance, are considered “very strong evidence that those requirements are not material.”

How the Escobar Test Is Applied

In the years following the Court’s decision in Escobar, lower courts have developed certain guidelines when applying the test laid out in Escobar. Prior to Escobar, courts routinely found sufficient proof of materiality when the government simply showed that regulatory compliance was required as a condition of payment. However, the Court in Escobar explicitly stated that the government’s decision to label compliance as a condition of payment is not automatically dispositive of materiality. As a result, Escobar has made it substantially more difficult for relators or the government to plead materiality in the complaint, while simultaneously offering defendants new avenues to challenge the materiality requirement.

In light of Escobar, many lower courts have adopted a more “holistic” approach to determining materiality, with no one factor being necessarily dispositive. Instead, the intent is to focus primarily on the overall effect on the likely or actual behavior of the government entity that receives the alleged misrepresentation. This fact-intensive approach to determining materiality has left many courts reticent to dismiss lawsuits at the early stages, leaving the ultimate determination of materiality to the finder of facts. Of course, the Court in Escobar stated that this deference was unnecessary, despite the fact-intensive nature of the factors, because even at those early stages, “[t]he standard for materiality that we have outlined is a familiar and rigorous one.”

But while many lower courts have adopted this holistic approach, not all of the factors outlined in Escobar are treated equally. Notably, since the Court specifically noted that continued government payment is “very strong evidence” of a lack of materiality, post-Escobar materiality cases often revolve around whether the relator has sufficiently pleaded that the government regularly refuses to pay claims based on the alleged noncompliance. This emphasis on the government’s conduct and whether it has paid or denied similar claims in the past has provided FCA defendants with a valuable defense at the early stages of litigation, including the motion to dismiss and motion for summary judgment.

Unsurprisingly, relators and the Department of Justice (DOJ) have resisted this emphasis on continued government payment, attempting to shift the discussion back to whether the falsity had the “natural tendency to influence” the government’s decision. The DOJ has argued that “an agency’s continued payment of claims to a potential FCA defendant who faces public allegations of fraud is insufficient – by itself – to establish that the alleged fraud is immaterial.” Nonetheless, the DOJ has acknowledged that “[a]lthough Escobar left open the possibility that a violation may be material even if the government continued to pay with full knowledge of that violation such cases are exceedingly rare.”

While the DOJ’s proffered “natural tendency” standard has allowed some relators to survive the motion to dismiss stage as the parties develop the relevant facts in the case, this tactic has been less successful at summary judgment. In line with Escobar’s holding, lower courts have continued to place more emphasis on whether the government has previously denied claims based on the alleged noncompliance. In these situations, courts have routinely granted summary judgment for defendants when proof that the noncompliance had no impact on the government’s payment decision.

For more information about materiality or the False Claims Act, please subscribe to this blog or contact a member of the Bass, Berry & Sims Healthcare Fraud & Abuse Task Force.