The Escobar decision, one year later

One year has passed since the U.S. Supreme Court issued its highly anticipated ruling in Escobar addressing the scope and application of the False Claims Act—and it would appear government contractors have the upper hand.

As one of the government’s chief weapons against fraud, the False Claims Act (FCA) imposes liability on companies that knowingly make, or induce the submission of, false or fraudulent claims for payment or reimbursement to the federal government. Gradually, however, a split has developed among courts hotly contesting an expanded theory of FCA liability: the so-called “implied false certification” theory.

Such a theory—contested by whistleblowers and backed by the Department of Justice—holds that when a company submits a claim for payment to the government, it implicitly certifies compliance with all material statutory, regulatory, or contractual terms. Under that theory, failure to disclose a violation of, or non-compliance with, any of those legal requirements makes the claim for payment false or fraudulent and could result in FCA liability.

But companies that do business with the federal government repeatedly have argued—and some circuit courts have agreed—that the implied certification theory applies only if the underlying statute or regulation “expressly” states that the contractor must comply to be paid. Other circuit courts have disagreed with that argument, applying a less rigid test on what constitutes materiality.

In June 2016, the U.S. Supreme Court in the case of Universal Health Services v. United States ex rel. Escobar validated the implied certification theory, while also applying a rigorous “materiality” standard that courts must now follow. In Escobar, the court noted that the FCA is not “a vehicle for punishing garden-variety breaches of contract or regulatory violations.”

In the twelve months following Escobar, perhaps the most significant victory for government contractors is the “rigorous” and “demanding” materiality test that has been established, thus providing added legal protections. Escobar represents “a turning of the tide a little bit,” Scott Jones, a partner at Locke Lord, said during a recent Webinar sponsored by The Knowledge Group. “Without a heightened materiality standard to be applied, all too often you can have lawsuits that could be worth hundreds of millions, if not billions, of dollars that turn on a technical violation of a statute or regulation.”

Another realized benefit from Escobar is that “it also gives us, as defense counsel, the opportunity to be entitled to take broader discovery than we might otherwise be allowed to take,” Jones said. Often, when defense lawyers are involved in deposition against the government and are trying to get discovery from the government, “that can be pretty difficult,” he said, but the materiality test established by Escobar, entitling defense lawyers to find out what the government knew and how it responded, “opens the door a little bit.”

Brian Tully McLaughlin, a partner in the government contracts group at law firm Crowell & Moring, puts it directly: “The Escobar decision is the most significant FCA decision in years and likely will remain so for years to come.”

Since Escobar, it’s no longer enough for the government or whistleblowers simply to claim something is “material.” They must show more than that; they must show how and why something is, in fact, material.

“The Escobar decision is the most significant FCA decision in years and likely will remain so for years to come.”
Brian Tully McLaughlin, Partner, Crowell & Moring

The broader implications of the case are especially significant at time when FCA activity continues to climb, both in annual recoveries and the number of whistleblower cases. In fiscal year 2016, for example, the Department of Justice recovered over $4.7 billion in settlements and judgements from FCA cases—the third-highest annual recovery in FCA history.

Payment in the face of non-compliance. In the wake of Escobar, corporate defendants are more likely to prove victorious in FCA cases where the government continued to make payments after having actual knowledge of the alleged false claim. “If you have a government payor that consistently pays claims, despite knowing that those requirements are being violated, the court has held that that constitutes very strong evidence that those requirements are, in fact, not material,” Jones said.

One example is the case McBride v. Halliburton, which concerned allegations made by a whistleblower that Kellogg Brown and Root (KBR) inflated headcount data that purported to track the number of troops who frequented KBR’s recreation centers.

The district court granted summary judgment in favor of KBR after finding that the whistleblower failed to present evidence that the alleged headcount practices were material to the government’s decision to pay. KBR appealed, and the D.C. Circuit Court of Appeals, relying on Escobar, affirmed summary judgement. In that case, the court held that the headcount data could not have been material because the Defense Contract Audit Agency had not disallowed any charged costs after investigating the whisteblower’s allegations.

Government intervention in FCA cases. Another consideration in some FCA cases has been whether the government’s decision to intervene in a whistleblower case is evidence of the government’s view of the merits of an action. In large part, courts have agreed with the government’s position that it is not.

ESCOBAR DECISION

The excerpt below from Universal Health Services v. United States ex rel. Escobar explains the U.S. Supreme Court's decision in the case.
We first hold that, at least in implied false certification theory can be a basis for liability. Specifically, liability can attach when the defendant submits a claim for payment that makes specific representations about the goods or services provided, but knowingly fails to disclose the defendant’s non-compliance with a statutory, regulatory, or contractual requirement. In these circumstances, liability may attach if the omission renders those representations misleading.
We further hold that False Claims Act liability for failing to disclose violations of legal requirements does not turn upon whether those requirements were expressly designated as conditions of payment. Defendants can be liable for violating requirements even if they were not expressly designated as conditions of payment. Conversely, even when a requirement is expressly designated a condition of payment, not every violation of such a requirement gives rise to liability. What matters is not the label the government attaches to a requirement, but whether the defendant knowingly violated a requirement that the defendant knows is material to the government’s payment decision.
Source: Universal Health Services v. Escobar

Some circuit courts, however, have found the government’s decision to intervene—or not to intervene—relevant in determining the materiality of an alleged false claim. For example, in one recent case, U.S. ex rel Petratos v Genentech, the 3rd Circuit on May 1 issued an opinion, in which it indicated, in part, that the Department of Justice’s decision not to intervene did weigh against a finding of materiality, observing that the agency “has taken no action against Genentech and declined to intervene in this suit.”

“This raises a significant question as to the impact that the government’s intervention decision can, and should, have on the fate of a qui tam action,” McLaughlin says.

Defendant’s knowledge of non-compliance. Where government contractors are less likely to prevail in an FCA case is cases in which the allegations concern misconduct, such as altered invoices. Where a case concerns allegations in which billing numbers were changed or where shell companies were in place, for example, “that’s going to make it more difficult to get the case dismissed,” says Thomas Zeno, of counsel with Squire Patton Boggs.

Another factor that courts must weigh carefully in assessing misconduct is the question of what is central to a regulatory scheme. In Escobar, for example, the court had determined that the mental health counselor who prescribed medication to a patient who fatally suffered an adverse reaction, without the appropriate qualifications to do so, was central to the regulatory scheme in that case.

In other FCA cases, however, determining what is central to a regulatory scheme will require a case-by-case analysis. “If it’s not important, then the case will get dismissed,” Zeno says. “If it is important, the case probably will not be dismissed.”

Unsettled questions. Additionally, Escobar has raised many unsettled questions “with seemingly conflicting answers, so far, among the lower courts,” McLaughlin notes. One of those questions, he says, is whether materiality is measured based only on what the government knew at the time it paid the claims, or can notice to the government after payment, or after performance of a contract has ended, be relevant?

Another unanswered question, McLaughlin adds, is what sort of knowledge the government needs to have: knowledge of actual non-compliance or do allegations of non-compliance count, as well?

Finally, there is the question of what exactly satisfies the implied certification theory. In Escobar, the Supreme Court held that ‘‘implied certification theory can be a basis for liability, at least where two conditions are satisfied: first, the claim does not merely request payment, but also makes specific representations about the goods or services provided; and second, the defendant’s failure to disclose non-compliance with material statutory, regulatory, or contractual requirements makes those representations misleading half-truths.’’

“The question is, do you have to satisfy each of those two tests every time?” says Zeno. “The answer isn’t clear.” Some courts have found that both conditions must be met, whereas other courts have found that an allegation of non-compliance is enough. That might be the next issue the Supreme Court will have to decide.

As courts continue to sort out questions that have yet to be resolved, the scope of Escobar continues to expand beyond federal false claims and is now also being applied in cases involving states and municipalities, as well. “So it’s really setting the national standard,” says Zeno.

Moving forward, compliance will always be a company’s best defense in an FCA case. “The best way for a company to win a false claims lawsuit is to never to have one filed in the first place,” Zeno says. “That means do the testing of your claims; audit them. Make sure that you’re being diligent in what you submit to the government for payment.”