Materiality matters: post-Escobar materiality analyses by district courts result in dismissal of relators' FCA claims

July 19, 2016

Government Investigations & White Collar Defense Alert

Author(s): John Ruskusky, Emily Crandall Harlan

The Supreme Court’s recent unanimous decision endorsing the controversial theory of implied certification as a basis for False Claims Act (FCA) liability, Universal Health Services Inc. v. United States ex rel. Escobar (No. 15-7, 2016 U.S. LEXIS 3920, June 16, 2016), is a game-changer for FCA cases and investigations—including many potential advantages for defendants. Indeed, as recent federal district court opinions citing Escobar show, the Court’s decision yields fertile ground for defenses based on the materiality requirement of the FCA, including at the pleading stage. In decisions applying the materiality standard announced by the Escobar Court, federal judges in the Eastern District of Washington and the Northern District of Alabama recently have dismissed relators’ FCA claims for their failure to identify with sufficient particularity, inter alia, the materiality of the allegedly false representations made by the defendants. United States ex rel. Voss v. Monaco Enterprises, No. 12-46, 2016 U.S. Dist. LEXIS 86254 (E.D. Wash. July 1, 2016); United States ex rel. Creighton v. Beauty Basics Inc., 2016 U.S. Dist. LEXIS 83573 (N.D. Ala. June 28, 2016).

In Escobar, the Supreme Court upheld implied certification as a theory of liability, but not without announcing important limitations on its reach. The Court held that two conditions must be met before liability based on implied certification will attach: first, the claim must not only request payment, but also must contain specific representations about the goods or services provided by the claimant; and second, the claimant’s “failure to disclose noncompliance with material statutory, regulatory or contractual requirements makes those representations misleading half-truths.”

The Escobar Court also repeatedly emphasized the importance of a strong materiality element. Whether a statutory, regulatory, or contractual requirement is material requires a case-by-case, fact-based analysis. Noting that the FCA is not “a vehicle for punishing garden-variety breaches of contract or regulatory violations,” and that materiality is a “rigorous” and “demanding” standard, the Court stated that materiality will not be found “where noncompliance is minor or insubstantial.” What qualifies as “minor or insubstantial” will depend on the facts of the case at issue—though, as the Court explained, the government’s past conduct can be relevant: “[I]f 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, that is strong evidence that the requirements are not material.” The Court’s confirmation of the demanding materiality standard makes clear that a determination of materiality must be made under both objective and subjective standards. The Escobar decision thus curtails the common government and relator argument that materiality can be found where there is an alleged or conclusory “tendency to influence” even if there is no evidence of actual influence.

In addition to putting teeth in the materiality standard, the Escobar Court specifically addressed the pleading requirements for facts supporting materiality. The Court confirmed that such facts must be pled “with plausibility and particularity,” in accord with Federal Rules of Civil Procedure 8 and 9(b). In other words, a qui tam relator (or the government if it elects to intervene) must allege specific facts relating to materiality in his or her complaint. Pleading materiality “upon information and belief,” or in conclusory or vague terms, will not be sufficient.

It is on this point that the Eastern District of Washington (in United States ex rel. Voss) and the Northern District of Alabama (in United States ex rel. Creighton) recently seized. Dismissing all of the qui tam relators’ FCA claims (without prejudice in Voss; with prejudice in Creighton) for failure to satisfy Rule 9(b), the courts noted that the relators had failed to set forth facts sufficient to identify the materiality of the allegedly false representations made by defendants. Referring to Escobar, the Voss court emphasized the necessity of pleading with particularity, noting that “[l]imits on FCA liability are to be addressed through strict enforcement of the materiality and scienter requirements.”

The district courts’ decisions in Voss and Creighton are but the tip of the iceberg in terms of the effect of Escobar on materiality determinations in pending FCA cases. On the same day it decided Escobar, the Supreme Court vacated the judgments in and remanded three other FCA cases, each of which raise materiality issues: Triple Canopy, Inc. v. United States ex rel. Badr, No. 14-1440; Weston Educ., Inc. v. United States ex rel. Miller, No. 15-404; and United States ex rel. Nelson v. Sanford-Brown Ltd., No. 15-729.

Additionally, at least one other federal district court soon will be poised to analyze materiality in light of Escobar, this time at the summary judgment stage. At the end of June, a judge in the Northern District of California granted defendants leave to file a motion for reconsideration predicated on the changes in the law—specifically, the “more rigorous materiality analysis”—announced by Escobar. Rose v. Stephens Institute, No. 09-5966, 2016 U.S. Dist. LEXIS 82605 (N.D. Cal. June 23, 2016). In their recently filed motion for reconsideration, the defendants (whose pre-Escobar summary judgment motion was denied, and who did not address materiality in moving for summary judgment) argue that the Escobar decision compels the court to look anew at the sufficiency of the relator’s allegations, and at the evidence, with regard to materiality.

As these first decisions in the wake of Escobar affirm, courts in all stages of FCA litigation will have to grapple with how to apply the Escobar guidance on a case-by-case basis, in the absence of a bright-line rule. Furthermore, individuals and companies in the crosshairs of FCA investigations will now find themselves on firmer ground when engaging with the government and/or relators concerning evidence of materiality. The Court’s holding in Escobar pushes back on the use of the FCA as a blunt instrument for policing compliance with statutes, regulations, and contracts. In the developing post-Escobar landscape, materiality must pass both objective and subjective scrutiny for FCA liability to attach.

The foregoing has been prepared for the general information of clients and friends of the firm. It is not meant to provide legal advice with respect to any specific matter and should not be acted upon without professional counsel. If you have any questions or require any further information regarding these or other related matters, please contact your regular Nixon Peabody LLP representative. This material may be considered advertising under certain rules of professional conduct.

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