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Materiality after Escobar: Why Government Behavior after a Defendant Presents a False Claim Is Not Dispositive

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In Universal Health Servs., Inc. v. United States ex rel. Escobar, 136 S. Ct. 1989 (2016), the Supreme Court resolved a circuit split over the implied false certification theory of liability under the False Claims Act (FCA). As opposed to express false certification, where the defendant allegedly has made an affirmative false statement regarding its compliance with underlying statutory or regulatory requirements, implied false certification is based on the defendant's failure to disclose its noncompliance with these requirements. In Escobar, the Court upheld implied false certification as a valid theory of liability under the FCA, but tightly circumscribed its scope through a "rigorous" interpretation of the Act's materiality and scienter requirements, holding 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." Escobar, 136 S. Ct. at 1996.

The materiality inquiry under the FCA, post-Escobar, is theoretically elegant but has led to confusion and disagreement in practice. The FCA itself defines "material" as "having a natural tendency to influence, or be capable of influencing, the payment or receipt of money or property." 31 U.S.C. § 3729(b)(4). In Escobar, the Court endorsed the "natural tendency" test for materiality and followed the existing two-part common-law tort standard of materiality in articulating this test. A misrepresentation is material, first, if "a reasonable man would attach importance to [the misrepresented information] in determining his choice of action in the transaction"; or second, if "the defendant knew or had reason to know that the recipient of the representation attaches importance to the specific matter 'in determining his choice of action,' even though a reasonable person would not." Statement of Interest of the United States in Connection with Relator's Rule 59(e) Motion to Alter Judgment (May 8, 2017) at 3, United States ex rel. Kolchinsky v. Moody's Corp., No. 1:12-cv-01399-WHP, 2017 WL 825478 (S.D.N.Y.), citing Escobar, 136 S. Ct. at 2002-03. In either case, the Court makes clear, the proper object of the inquiry is the effect of defendant's misrepresentation on the government's decision to pay the claim. Escobar, 136 S. Ct. at 2002.

By contrast, the operating instructions for the implementation of this materiality standard are less clear. The Escobar Court listed various factors that lower courts may use to pursue holistic assessments of materiality under the FCA, but did not specify how these factors are to be weighed against each other. Further, these factors are not exhaustive, but merely representative of how a court may evaluate the materiality evidence before it (see, e.g., United States ex rel. Escobar v. Universal Health Servs., Inc., 842 F.3d 103, 110 (1st Cir. 2016) ("[t]he [Supreme] Court…laid out several factors that might contribute to determining materiality"). Two factors support an objective assessment of materiality under the first prong of the natural tendency test, looking to the importance the proverbial reasonable person would attach to a misrepresentation: on the one hand, whether the misrepresentation goes "to the very essence of the bargain," or on the other, whether the noncompliance is "minor and insubstantial." Id. at 2002-­03. The remaining factors provide examples of evidentiary support that may be used to assess materiality under either prong of the natural tendency test, whether trying to ascertain whether a particular requirement was objectively material or inquiring into the defendant's knowledge of the subjective importance the government placed on compliance with a particular requirement: for example, the government's decision to mark compliance with a given statutory or contractual requirement as a condition of payment, or the government's past behavior in paying or not paying similar claims "despite actual knowledge that certain requirements were violated." Id. at 2003-04. The factors encompassing government behavior, then, are relevant in determining what the defendant knew or should have known about the subjective importance that a specific government agency placed on compliance with a particular statutory or contractual requirement at the time the defendant made the representation in question, and can also be used to help a court determine the types of requirements that should be considered objectively material to the "bargain" at hand.

Defendants in recent implied false certification cases have argued, in the wake of Escobar, that where the government has continued to pay defendant's claims despite knowledge of the FCA allegations against it, this payment behavior shows that the noncompliance at issue is not material. (See listing of authority below for a comprehensive overview.) Though defendants have made much of Escobar's statement that the government's payment of "a particular claim in full despite its actual knowledge that certain requirements were violated…is very strong evidence that those requirements are not material," Escobar, 136 S. Ct. at 2003, it must be remembered that this factor was offered as a means of conducting the materiality analysis under the standard the Court established earlier in the decision. Thus, the relevant inquiry under Escobar is what the government's payment decision indicates, as evidence, either about what constitutes "the essence of the bargain" under the first (objective) prong of the two-part materiality standard, or about what this payment behavior would—or should—have indicated to the defendant regarding the subjective importance the government placed upon compliance with the given statutory or contractual requirement under the second (subjective) prong of the tort-based materiality standard.

The court in United States ex rel. Williams v. City of Brockton undertook such an analysis where defendants argued that the government's continuous funding of grants in support of community policing initiatives, despite its knowledge of allegations of noncompliance with civil rights laws, showed that these requirements were not material to the government's payment decision. No. 12-cv-12193-IT, 2016 WL 7429176, at *6-7 (D. Mass. Dec. 23, 2016).The Williams court emphasized the importance of a "holistic review of materiality" and concluded that because the program sought to promote community-based policing and because discriminatory practices would directly undermine this goal, "the centrality of racially-neutral and non-discriminatory policing to the…program is strong evidence that a grantee's non-compliance would have the tendency to influence the DOJ's decision to award the grant." Id. Though defendants argued that the DOJ's ongoing community policing grant awards to the City of Brockton after FCA lawsuits were filed show that compliance with civil rights laws was not material to the government's payment decision, the court explicitly rejected this argument, first by noting that the government's notice of these lawsuits did not constitute actual knowledge as contemplated by the Escobar Court, and second, by holding that "even assuming the DOJ possessed actual knowledge, this is not determinative in the court's holistic review of materiality." Id.at *6. In essence, the Williams court did not view the government's payment decisions as a valid indication to defendant that noncompliance with statutory civil rights requirements was acceptable to the government under the second prong of the Escobar materiality standard, and further applied an objective analysis under the first prong to determine that civil rights compliance "went to the essence" of this particular bargain. Further, the Williams decision takes into account the core objectives of the given legislative scheme at issue as critical to both objective and subjective determinations of materiality.

Other courts and commentators have further called into question the evidentiary weight of the government's payment decision in the face of knowledge of fraud. First, Escobar clearly states that the government must have actual knowledge of the fraud, and make the payment regardless, in order for this factor to weigh in favor of materiality. Escobar, 136 S. Ct. at 2003. "Actual knowledge" indicates that mere knowledge of allegations of fraud is insufficient: the government would not have actual knowledge until the given FCA case is resolved in favor of the government and/or relators, possibly years later. See, e.g., United States ex rel. Brown v. Pfizer, Inc ., No. 05-6795, 2017 WL 1344365, at *11 (E.D. Pa. Apr. 12, 2017). The requirement of "actual knowledge" also indicates that the particular government agency making the payment decision, and perhaps even the responsible party within that agency, must have actual knowledge of the noncompliance. This means that an FCA complaint filed with the DOJ of which the victim agency is unaware would not constitute "actual knowledge" that would trigger an inquiry into the meaning of the government's ongoing payment decisions. See United States v. Pub. Warehousing Co. KSC, No. 1:05-CV-2968-TWT, 2017 WL 1021745, at *6-7 (N.D. Ga. Mar. 16, 2017).

Second, there are other reasons why the government may continue to pay claims even with actual knowledge of noncompliance. These reasons may be so compelling that they outweigh the government's compliance concerns, even though these concerns may be very material. For example, the government may wish to "avoid excessive costs associated with terminating contractual payments," Statement of Interest of the United States in Kolchinsky at 7, citing United States ex rel. Harrison v. Westinghouse Savannah River Co., 352 F.3d 908, 917 (4th Cir. 2003), or may wish to ensure that a government contractor continues to provide an essential service (e.g., where a hospital may have submitted false claims to Medicare, but is a crucial source of health services to the local community and it is impractical and unwise to discontinue such services). It is within the government's right "to choose among a variety of remedies, both statutory and administrative, to combat fraud," and thus the government need not terminate payments immediately to preserve its right to contest this fraud through other means. Id., citing United States ex rel. Onnen v. Sioux Falls Indep. Sch. Dist., 688 F.3d 410, 414-15 (8th Cir. 2012); see also Rose v. Stephens Institute, No. 09-cv-05966-PJH, 2016 WL 507214, at *6 (N.D. Cal. Sept. 20, 2016), appeal filed Jan. 20, 2017 ("Nothing in Escobar suggests that actions short of a complete revocation of funds are irrelevant to the court's materiality analysis"); United States ex rel. Brown v. Celgene Corp., No. CV 10-03165-GHK (SSx), 2016 WL 7626222, at *13 (C.D. Cal. Dec. 28, 2016) ("The fact that the government sometimes exercises its discretion to excuse non-compliance with a requirement does not establish that the requirement is immaterial as a matter of law"). In sum, evaluating the import of the government's decision to continue or stop payments upon acquiring actual or constructive knowledge of fraud or noncompliance requires a fact-rich analysis and is not a rigid or simplistic determination (see appendix below for numerous examples where courts have undertaken just such a holistic analysis).

Escobar also left open the question of the relevance of the government's declination of an FCA claim to the materiality inquiry. Defendants might argue that government declination could be seen as an indication that the government does not find compliance with the given statutory or contractual requirement to be material. However, this argument is inapposite to the proper materiality inquiry under Escobar, which, again, is constrained by the two-part standard provided by the Court. First, it is the Department of Justice that ultimately decides whether to intervene in an FCA case, and this decision is not always based on the underlying merits of the case; at times, the DOJ may simply have other, more pressing matters, and must exercise its prosecutorial discretion to triage the potential cases it could pursue in the face of limited resources. Thus, declination does not always reflect the position of the victim agency as to the materiality of the noncompliance at issue. Because materiality must always be assessed with respect to the government party at the other end of the bargain from the defendant, i.e., the victim agency, this distinction is important and merits fact determination where at issue in an FCA litigation.

Additionally, the FCA explicitly provides for plaintiff-relators to continue the suit after government declination via its qui tam provision, § 31 U.S.C. 3730(c)(3), and indeed incentivizes such plaintiff-relators by enabling them to receive a higher portion of any award than relators in cases where the government intervenes. § 31 U.S.C. 3730(d). Interpreting government declination as prima facie evidence that the noncompliance at issue is immaterial effectively reads these qui tam provisions out of the statute, which cannot have been the intent of the Escobar Court.

Even where the government's choice not to intervene is in fact reflective of the perspective of the victim agency, the relevant question is what the defendant knew or believed at the time of submitting the allegedly false claim. Materiality is not an abstract, independent concept, but rather is tied to the alleged misrepresentation. Because the government's decision not to intervene by definition always comes after the conduct at issue took place, it cannot affect the defendant's knowledge of the subjective importance the government placed on compliance with a particular requirement at the time the defendant made the representation, under the second (subjective) prong of the Escobar materiality standard. In United States ex rel. Schaefer v. Family Med. Ctrs. of S. Carolina LLC, the court held that "[t]he natural tendency test properly focuses upon the presentment of a false or fraudulent claim, rather than actual payment on that claim" (emphasis added). No. 3:14-382-MBS, 2016 WL 6601017, at *4 (D. S.C. Nov. 8, 2016). Government knowledge and behavior may be able to "negate the scienter element of a FCA violation," if a defendant reasonably relied on, say, patterns of government payment of similar claims despite noncompliance, but "the proper focus with respect to materiality is the influence of the false statement at the time of presentment." Schaefer at *4, citing United States ex rel. Burlbaw v. Orenduff, 548 F.3d 931, 951 (10th Cir. 2008).

Government knowledge and purported tacit approval of noncompliance, as evidenced by government behavior with respect either to payment or to declination, are not defenses to FCA liability. Further, the second prong of the materiality inquiry must be analyzed in tandem with the FCA's scienter requirement, as"[t]he circumstances surrounding the government's knowledge are relevant only where they are incompatible with a defendant's scienter." Brief of Amicus Curiae Taxpayers Against Fraud Education Fund Supporting Appellant (May 20, 2016) at 18, United States ex rel. Spay v. CVS Caremark Corp., No. 15-3548 (3d Cir.) The factors that the Escobar Court suggested as a means of implementing the materiality standard established in that decision are best regarded as types of evidence that can be marshaled to determine either whether a misrepresentation went to the "essence of the bargain" from the perspective of a reasonable person, or whether a defendant knew or had reason to know that its misrepresentation would be material to the government, even if a reasonable person would not. Therefore, these factors must be evaluated from the perspective of the defendant at the time when the misrepresentation was made. This excludes any government behavior that happened after the false claim at issue was filed, unless that behavior can be shown to be indicative of what the defendant reasonably would have thought before filing the claim. Government behavior taking place after the defendant's presentment of a false claim, whether with respect to payment or declination, is thus completely irrelevant to the second (subjective) prong of the materiality inquiry. Government behavior is possibly indicative of the objective materiality of a particular type of noncompliance, and may help a court to evaluate whether particular statutory, regulatory, or contractual requirements "go to the essence of the bargain" at hand, where such "essence" is not otherwise apparent.

In the FCA litigation context, relators should, where possible, allege and develop facts in support of reasons other than lack of materiality why the relevant government agency continued payment, and should rely on other Escobar factors to develop their own arguments in support of materiality. For example, at the pleadings stage, relators can argue that compliance with the statutory, regulatory, or contractual requirements at issue is core to the objectives of the overall policy scheme, and emphasize and cite factors relevant to the materiality inquiry that do not relate to the government's payment behavior, in order to give the court context for its holistic evaluation of materiality. At the summary judgment stage, relators can flesh out the evidentiary picture by proving facts that would tend to show that the defendants did not take, or should not have taken, particular government behaviors as evidence of the subjective importance the victim agency placed on compliance with a given requirement. Further, at this stage of the litigation relators may have the opportunity to develop facts about the government's actual knowledge of noncompliance and the actual rationale of the victim agency in continuing payment and/or the DOJ in declining the case. Relators should seek to develop facts that would tend to support other factors in the materiality analysis (e.g., what constitutes the "essence of the bargain"), and should proactively allege these facts in the complaint, where possible, in order to increase the chances of surviving a motion to dismiss. At all stages of litigation, courts, in turn, should recognize the broad discretion afforded to the government when faced with allegations of noncompliance or fraud and should further ensure that government behavior is evaluated with regard to the government's actual knowledge of fraud.

This is a rapidly developing area of law, and courts' interpretations of the FCA materiality standard pursuant to Escobar will certainly continue to evolve. Below is a selection of recent cases of interest.

Courts holding that government behavior is not dispositive of the materiality inquiry under Escobar upon a motion to dismiss:

  • United States ex rel. Emanuele v. Medicor Associates, No. 10-245 Erie, 2017 WL 1001581, at *19 (W.D. Pa. Mar. 15, 2017) (where there was no evidence that the government consistently refused to pay claims based on Stark Act noncompliance, "public records suggest[] that health care providers have paid penalties after self-reporting similar violations on at least nine occasions since 2009...In the absence of any evidence to the contrary, this factor weighs slightly in favor of materiality.")
  • United States v. Quicken Loans Inc., No. 16-cv-14050, 2017 WL 930039, at *18 (E.D. Mich. Mar. 9, 2017) (where Quicken did not comply with FHA underwriting requirements, court held that violation was material because it goes to the "essence of the bargain" despite the fact that the complaint did not allege government nonpayment)
  • United States ex rel. Escobar v. Universal Health Servs., Inc., 842 F.3d 103, 111-12 (1st Cir. 2016) (finding no evidence that MassHealth had actual knowledge of the violations at the time of its payments, and holding that its payments to the hospital unrelated to the treatment of Yarushka Rivera are not relevant to the materiality inquiry)

Courts addressing issue of government payment behavior with respect to the materiality inquiry in depth, and finding for plaintiff-relators at the motion to dismiss and at the summary judgment stages:

  • United States ex rel. Brown v. Pfizer, Inc ., No. 05-6795, 2017 WL 1344365, at *11 (E.D. Pa. Apr. 12, 2017) ("The mere fact that the government has continued to pay and approve claims for Vfend even after Relators' allegations in 2005 is insufficient to establish that Relators' claims lack materiality. As the First Circuit held [in Escobar II], mere knowledge of allegations regarding noncompliance is insufficient to prove actual knowledge of noncompliance…. Absent evidence that the government had actual knowledge of Defendant's fraud, we find the government's continued payments of Vfend claims insufficient to establish that Relators' claims fail for lack of materiality.")
  • United States v. Pub. Warehousing Co. KSC, No. 1:05-CV-2968-TWT, 2017 WL 1021745, at *6-7 (N.D. Ga. Mar. 16, 2017) ("But just because one agency within the vast bureaucracy of the federal government has knowledge of a contractor's wrongdoing does not mean that the Defendants have a 'government knowledge' defense. The issue is whether the actors actually involved in the contractual relationship are aware of the alleged fraud"; "The more essential the continued execution of a contract is to an important government interest, the less the government's continued payment weighs in favor of the government knowledge defense")
  • Rose v. Stephens Institute, No. 09-cv-05966-PJH, 2016 WL 5076214, at *6 (N.D. Cal. Sept. 20, 2016), appeal filed 20, 2017 ("Nothing in Escobar suggests that actions short of a complete revocation of funds are irrelevant to the court's materiality analysis. Here, the government's corrective reforms, fines, and settlement agreements show that it considered the ICB to be an important part of the Title IV bargain, and that it took action against schools based on ICB noncompliance. These actions show that ICB noncompliance was 'capable of influencing' the government's payment decisions. 31 U.S.C. § 3729(b)(4). At the least, relators have shown that there is a triable issue as to whether the ICB is material under the Escobar standard.")
  • United States ex rel. Brown Celgene Corp., No. CV 10-03165-GHK (SSx), 2016 WL 7626222, at *12­­­­-13 (C.D. Cal. Dec. 28, 2016) (non-disclosure regarding claims for off-label prescriptions was material because the condition that Medicare Part D reimburse only for medically accepted indications was "an essential feature of the Medicare Part D program…Escobar does not foreclose the possibility that a statutory requirement may be so central to the functioning of a government program that noncompliance is material as a matter of law"; "The fact that the government sometimes exercises its discretion to excuse non-compliance with a requirement does not establish that the requirement is immaterial as a matter of law")
  • United States ex rel. Williams v. City of Brockton, No. 12-cv-12193-IT, 2016 WL 7429176, at *6-7 (D. Mass. Dec. 23, 2016) ("even assuming the DOJ possessed actual knowledge, this is not determinative in the court's holistic review of materiality")
  • United States v. Savannah River Nuclear Solutions, LLC, No. 1:16-cv-00825, 2016 WL 7104823, at *23-24 (D. S.C. Dec. 6, 2016) ("Here, common sense suggests that the alleged unallowability of the challenged costs would influence the DOE's decision to pay them, and Defendants' alleged conduct in covering up the costs suggests that they would be material to the DOE. These allegations are sufficient for purposes of satisfying the materiality requirement at this stage.")
  • United States ex rel. Schaefer v. Family Med. Ctrs. of S. Carolina LLC, No. 3:14-382-MBS, 2016 WL 6601017, at *4 (D. S.C. Nov. 8, 2016) ("Finally, Defendants assert that the United States failed to establish materiality because the government has continued to pay all claims submitted for payment. The court disagrees. The Fourth Circuit has determined that materiality of a false statement turns on whether the false statement has a natural tendency to influence agency action or is capable of influencing agency action. United States ex rel. Berge v. Bd. of Trustees, 104 F.3d 1453, 1460 (4th Cir. 1997). The natural tendency test properly focuses upon the presentment of a false or fraudulent claim, rather than actual payment on that claim. United States ex rel. A+ Homecare, Inc. v. Medshares Management Group, Inc., 400 F.3d 428, 445 (6th Cir. 2005). Although the government's knowledge of an alleged false claim can negate the scienter element of a FCA violation, United States ex rel. Burlbaw v. Orenduff, 548 F.3d 931, 951 (10th Cir. 2008), the court concludes that the proper focus with respect to materiality is the influence of the false statement at the time of presentment.")

Courts holding that the two conditions of implied false certification liability mentioned in Escobar—that "the claim does not merely request payment, but also makes specific representations about the goods or services provided; and…the defendant's failure to disclose noncompliance with material statutory, regulatory, or contractual requirements makes those representations misleading half-truths," Escobar, 136 S. Ct. at 2001—are neither exhaustive nor rigid:

  • Rose v. Stephens Institute, No. 09-cv-05966-PJH, 2016 WL 5076214, at *5 (N.D. Cal. Sept. 20, 2016), appeal filed 20, 2017 ("In sum, Escobar did not establish a rigid two-part test for falsity that must be met [in] every single implied certification case")
  • United States ex rel. Brown Celgene Corp., No. CV 10-03165-GHK (SSx), 2016 WL 7626222, at *9 (C.D. Cal. Dec. 28, 2016) ("Nor were the two conditions intended to describe the outer reaches of FCA liability: the Court stated that liability could be found 'at least' where these conditions were satisfied")
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