The FCA continues to be the federal government’s primary civil enforcement tool for investigating allegations that healthcare providers or government contractors defrauded the federal government. In the coming weeks, we will take a closer look at recent legal developments involving the FCA. This week, we examine the Supreme Court’s opinion in Escobar and its impact on the question of the FCA’s materiality requirement.

In addition to tackling the viability of the implied certification theory of liability in Escobar, the Supreme Court also held that the FCA does not restrict liability to noncompliance with express conditions of payment, stating that “[w]hether a provision is labeled a condition of payment is relevant to but not dispositive of the materiality inquiry.”  The Supreme Court explained that any concerns about fair notice or open-ended liability without such a restriction on liability can be addressed through “strict enforcement” of the FCA’s “demanding” and “rigorous” materiality requirement, as well as the FCA’s scienter requirement. 

Significantly, the Supreme Court rejected the government’s and First Circuit’s “extraordinarily expansive view” of materiality—that any statutory, regulatory or contractual violation is material so long as the defendant knows that the government would be entitled to refuse payment were it aware of the violation.  Instead, the Supreme Court explained that the materiality requirement focuses on whether knowledge of noncompliance would affect “the likely or actual behavior of the recipient of the alleged misrepresentation,” not simply on whether the recipient’s behavior could have been affected.

The Supreme Court noted that the FCA’s materiality requirement safeguards defendants from FCA liability for “garden-variety breaches of contract or regulatory violations” and is not satisfied “where noncompliance is minor or insubstantial.”  To further delineate when the nondisclosure of a legal violation is material, it offered the following evidentiary guideposts:

  • It is not sufficient for a finding of materiality that the government “would have had the option to decline to pay if it knew of the defendant’s noncompliance.”
  • The government’s decision to “expressly identify a provision as a condition of payment is relevant, but not automatically dispositive” of the materiality inquiry.
  • It is evidence of materiality “that the defendant knows that the government consistently refuses to pay claims in the mine run of cases based on noncompliance” with a requirement.
  • It is “[v]ery strong evidence” of immateriality “if the government pays a particular claim in full despite its actual knowledge that certain requirements were violated.”
  • It is “[s]trong evidence” of immateriality “if the government regularly pays a particular type of claim in full despite actual knowledge that certain requirements were violated, and has signaled no change in position.”

Two of the most significant takeaways from Escobar are that statutory, regulatory and contractual violations by themselves may not be material, even if the provisions are expressly labeled as conditions of payment, and that the government’s decision to pay claims despite actual knowledge of violations is particularly good evidence of immateriality. Since Escobar, courts have varied in how they have applied these two aspects of the materiality analysis.

Several courts dismissed complaints that alleged only that the defendant violated a condition of payment or simply that the government would have denied payment if it had known of the noncompliance.  In U.S. ex rel. Lee v. Northern Adult Daily Health Care Center, 2016 WL 4703653 (E.D.N.Y. 2016), the relators alleged that the defendant violated statutes and regulations that were conditions of payment. The district court recognized that, while this allegation might have sufficed before Escobar, it could not meet the Supreme Court’s new standard.

In U.S. ex rel. Dresser v. Qualium Corp., 2016 WL 3880763 (N.D. Cal. July 18, 2016), the district court dismissed the government’s implied certification claims where the complaint asserted that the government would not have paid the defendants’ claims if it had known of their alleged noncompliance with Medicare regulations, “but [did] not explain why” that was the case.  A similar conclusion was reached in U.S. ex rel. Southeastern Carpenters Regional Council v. Fulton County, Georgia, 2016 WL 4158392 (N.D. Ga. Aug. 5, 2016), where the district court held that the defendant’s alleged statutory violations were not material even where the defendant’s contract required it to comply with the statute and made that compliance a condition of payment. According to the district court, these allegations were insufficient under Escobar to show that the statutory violations were “so central” that the government would have refused payment if it had known of the violations.

Other courts held that statutory, regulatory and contractual violations were material under Escobar.  In U.S. ex rel. Fisher v. IASIS Healthcare, LLC, 2016 WL 6610675 (D. Ariz. Nov. 9, 2016), the relators accused the defendant of violating regulatory and contractual provisions that required the defendant to provide truthful encounter data and medically necessary care.  The district court acknowledged that “[a] legal or contractual violation alone is not enough,” but found that the alleged violations were material because the government’s “payments were contingent on compliance with the terms and conditions of that contract.”

Similar reasoning was employed by the district court in Johnson v. District of Columbia, 144 A.3d 1120 (D.C. 2016), where the district court applied Escobar to the District of Columbia’s FCA and found materiality satisfied where the defendant submitted false information to hide its failure to meet certain performance benchmarks. The district court found the false statements were “undoubtedly” material because the defendant’s contract permitted the government to terminate the agreement or reduce payment for failure to meet those benchmarks or to comply with reporting requirements.

Likewise, in U.S. v. Crumb, where the defendants allegedly falsified diagnoses on billed claims, the district court found the defendant’s failure to adhere to diagnostic requirements was material because the “services would not have been reimbursable unless they were provided for a covered diagnosis.”

The tension between these two lines of post-Escobar cases suggests that while some courts will hold that statutory, regulatory and contractual violations are not enough to satisfy the materiality requirement, even if they would entitle the government to deny payment, other courts will look closely at the specific provisions at issue to determine whether the alleged violations are material.  In a pre-Escobar case from last year, U.S. ex rel. Thomas v. Black & Veatch Special Projects Corp., 820 F.3d 1162, 1174 (10th Cir. 2016), the Tenth Circuit held that, in addressing materiality, it would “consider the purposes of the underlying contract and the significance of the relevant violation to that purpose in assessing whether the alleged violation may have affected the government’s payment decisions.”  This accurately describes the analysis latter courts have applied.

Some courts have used government knowledge as a basis for dismissing FCA claims.  In Sanford-Brown, the Seventh Circuit held that the relator failed to show materiality where government agencies, including the agency that paid the defendant’s claims, had “already examined [the defendant] multiple times over and concluded that neither administrative penalties nor termination was warranted.”  A similar result was reached in City of Chicago v. Purdue Pharma L.P., 2016 WL 5477522 (N.D. Ill. Sept. 29, 2016), where the district court held that the alleged violations were not material because the city continued to pay the defendant’s allegedly false claims after filing the lawsuit.  The district court rejected the city’s argument that it lacked actual knowledge that the claims were false, reasoning that the city could not disclaim actual knowledge of falsity after suing for a violation of the FCA.

In addition, several courts have dismissed complaints that did not allege government nonpayment. In Scharff v. Camelot Counseling, the district court dismissed the relator’s complaint where it did not “allege whether the government has refused to reimburse clinics that have engaged in conduct similar to [the defendant’s].”  2016 WL 5416494 (S.D.N.Y. Sept. 28, 2016); see also Knudsen v. Sprint Commc’ns. Co., 2016 WL 4548924 (N.D. Cal. Sept. 1, 2016) (“Knudsen’s single, conclusory paragraph alleging materiality is insufficient on this ground as well because it did not further allege that the government was unaware of the alleged PRC violations.”); U.S. ex rel. Ferris v. Afognak Native Corp., No. 3:15-cv-0150 (D. Alaska Sept. 28, 2016) (“The relator must allege some facts that show that the government actually does not pay claims if they involve the statutory violations in question.”).

And, in U.S. ex rel. Williams v. City of Brockton, 2016 WL 4179863 (D. Mass. Aug. 5, 2016), the district court held that the alleged statutory violations were not material because the government would pursue administrative remedies before denying payment.

Still, other courts have rejected defendants’ arguments regarding government knowledge. On remand from the Supreme Court in Escobar, UHS argued that its alleged violations could not be material because the government paid its claims after learning of the alleged noncompliance. 842 F.3d 103 (1st Cir. 2016).  The First Circuit disagreed, reasoning that the government’s “mere awareness of allegations concerning noncompliance” did not constitute “actual knowledge,” and that even if it did, there was no evidence that the government entity that actually paid the claims had actual knowledge. In other words, actual knowledge possessed by separate, non-paying government regulators would be irrelevant to materiality.

Likewise, in Rose v. Stephens Institute, 2016 WL 5076214 (N.D. Cal. Sep. 20, 2016), the district court found that the government’s decision not to take action against the defendant despite its awareness of the relator’s allegations was “not terribly relevant to materiality.”  Because the government “did not cite any reason for this decision,” the district court could not conclude that the government had actual knowledge of the violations or that it declined to act because it considered the violations immaterial.  The district court further found that the government’s decision to issue fines and enter monetary settlements for similar violations committed by other entities was evidence of materiality, even though the government had never terminated those entities’ participation in the program.

Finally, it is worth noting that the government-knowledge factor pre-dates Escobar, and several federal circuits have well-developed case law applying this factor. See U.S. ex rel. Thomas v. Black & Veatch Special Projects Corp., 820 F.3d 1162, 1174 (10th Cir. 2016); U.S. ex rel. Am. Sys. Consulting, Inc. v. ManTech Advanced Sys. Int’l, 600 F. App’x 969, 977 (6th Cir. 2015); Yannacopoulos v. Gen. Dynamics, 652 F.3d 818, 828, 831 (7th Cir. 2011); U.S. ex rel. Owens v. First Kuwaiti Gen. Trading & Contracting Co., 612 F.3d 724, 729 (4th Cir. 2010).  Courts likely will rely on this precedent as they continue to grapple with Escobar’s materiality standard.