Healthcare Litigation

March 23, 2017

Escobar's Impact: Recent Application of "Materiality" in Ninth Circuit

By John M. LeBlanc, Partner, Healthcare Litigation | Andrew H. Struve, Partner, Healthcare Litigation | Katrina Dela Cruz, Associate, Litigation

Last year, a unanimous U.S. Supreme Court decided Universal Health Services, Inc. v. United States ex rel. Escobar (Escobar), 136 S.Ct. 1989 (2016), creating important implications for Federal False Claims Act (FCA) cases and, in particular, their viability. Generally, the FCA, 31 U.S.C. §§ 3729–3733, imposes liability on persons or entities who knowingly submit "false claims" for payment from federal funds or who improperly retain amounts received from the United States. Escobar endorsed one particular basis for liability under the FCA—the "implied false certification theory of liability," which holds that claimants impliedly certify compliance with certain statutes, regulations or contract requirements that are material conditions of payment, and therefore, that a claimant's failure to disclose any violation may render the claim false or fraudulent. The article below discusses Escobar's analysis regarding whether noncompliance is "material" under the FCA and the recent, subsequent application of the "materiality" standard by courts in the Ninth Circuit.

Brief Background on FCA Liability

Four elements are required to establish FCA liability: 1) a false statement or fraudulent course of conduct, 2) made with scienter, 3) materiality, and 4) causation. A "claim" can mean a direct request to the government for payment or a reimbursement request made to the recipients of federal funds under a federal benefits program, such as Medicaid. See 31 U.S.C. § 3729(b)(2)(A). The scienter requirement means the claimant must 1) have "actual knowledge of the [true] information," 2) "[act] in deliberate ignorance of the truth or falsity of the information," or 3) "[act] in reckless disregard of the truth or falsity of the information." 31 U.S.C. § 3729(b)(1)(A). The FCA also requires that the request be "material" to a false or fraudulent claim. 31 U.S.C. § 3729(a)(1)(B). "Material" means "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).

Escobar addressed the "implied false certification theory of liability," which treats a payment request as a claimant's implied certification of compliance with relevant statutes, regulations or contract requirements that are material conditions of payment, and treats a failure to disclose a violation as a misrepresentation that renders the claim "false or fraudulent."

The Escobar Ruling

In Escobar, a teenage beneficiary of Massachusetts' Medicaid program received counseling services from a subsidiary of defendant Universal Health Services, Inc. (Universal). 136 S.Ct. at 1993. The teen had an adverse reaction to a medication prescribed by a purported doctor at the facility, and ultimately died of a seizure. Id. Her parents brought a qui tam action under the FCA upon discovering that some employees at the facility were not licensed to provide mental health counseling, not authorized to prescribe medications and not qualified to offer counseling services without supervision. Id. The lawsuit alleged that the facility's reimbursement claims to Medicaid amounted to "false claims" under an "implied false certification theory of liability." Specifically, the victim's parents alleged that Universal defrauded Medicaid by submitting reimbursement claims that made representations about services provided by individuals not qualified to render the services or who did not possess the required licensing. Id.

The district court granted Universal's motion to dismiss, holding that the parents failed to state a claim under the "implied false certification theory of liability" because none of the regulations allegedly violated by the facility constituted a condition of payment. Id. The First Circuit reversed, reasoning that (i) every submission of a claim for payment implicitly represents compliance with relevant regulations, therefore any undisclosed violation of a precondition of payment renders a claim false or fraudulent; and (ii) regulations themselves provide conclusive evidence that compliance was a material condition of payment. Id.

The Supreme Court vacated and remanded the case, albeit agreeing that the implied certification theory can be a basis for liability where at least two conditions are met: (i) the claim for payment makes specific representations about the goods or services provided, and (ii) the party's failure to disclose noncompliance with material statutory, regulatory or contractual requirements makes those representations misleading "half-truths." Id. at 2001. Further, for a misrepresentation about purported compliance with a statutory, regulatory or contractual requirement to be actionable under the FCA, the misrepresentation must be material to the government's payment decision. Id. at 2002. The Supreme Court noted that the FCA's rigorous materiality standard looks to whether knowledge of the noncompliance would have actually affected the government's payment decision.

Justice Thomas, writing for the Court, focused upon what can and cannot be considered material in this context. The Court explained that a misrepresentation is not necessarily material merely because the government designates compliance with a particular statutory requirement as a condition of payment (although such a designation is relevant). Nor, for that matter, is materiality conclusively established where the government would have had the option to decline payment if it knew of the party's noncompliance.

The Court instead turned the focus of the materiality inquiry to the party's knowledge and intended effect on the recipient, specifically "[w]hether the defendant knowingly violated a requirement that the defendant knows is material to the Government's payment decision." Id. at 1996. Proof of materiality could include evidence that the defendant knew that the government consistently refuses to pay claims based on noncompliance with the particular requirement. Conversely, if the government regularly pays a particular claim in full despite actual knowledge of noncompliance with a particular requirement, that is strong evidence that the requirement is not material.

Application of the Test for Materiality in the Ninth Circuit

Subsequent to Escobar, courts in the Ninth Circuit have displayed a measure of frustration with the Supreme Court's "guidance" on materiality. In September 2016, just five months after Escobar, one trial court in the Northern District of California pointed out potential conflicts from Escobar which focus the materiality inquiry on the likely or actual behavior of the recipient of the alleged misrepresentation. Rose v. Stephens Institute, Case No. 09-cv-05966-PJH, 2016 WL 5076214 (N.D. Cal. Sept. 20, 2016).

In Rose, relators brought a qui tam action against the Academy of Art University (AAU), alleging that the AAU fraudulently obtained funds from the U.S. Department of Education (DOE) by falsely alleging compliance with Title IV of the Higher Education Act, which generally prohibits any incentive payment based directly or indirectly on success in securing enrollments or financial aid to persons engaged in any student recruiting or admissions activities. 2016 WL 5076214, at *1. In its motion for reconsideration of the court's order denying summary judgment, the AAU argued that any noncompliance with the incentive compensation ban (ICB) was not material under Escobar.

The court, in denying the defendant's motion for reconsideration, concluded that the relators had raised a genuine issue of material fact as to materiality post Escobar. The district court recited the materiality factors: (i) whether the provision was a condition of payment, (ii) whether the government consistently refuses to pay claims in the mine run of cases based on noncompliance, or (iii) whether the government routinely pays a particular claim in full despite its actual knowledge of noncompliance. 2016 WL 5076214, at *6. In denying the motion for reconsideration, the district court found unpersuasive AAU's arguments that the DOE did not take any action against the AAU despite its awareness of the allegations in the case, and the DOE only rarely revoked a school's Title IV funds based on an ICB violation.

Another Ninth Circuit case, United States ex rel. Kelly v. Serco, Inc., 846 F.3d 325 (9th Cir. 2017) applied Escobar in its materiality analysis, and affirmed a district court's grant of summary judgment in favor of a government contractor, Serco. In Serco, a relator asserted that Serco violated material contractual requirements, because Serco's monthly cost reports allegedly did not comply with certain guidelines in the American National Standards Institute/Electronic Industries Alliance Standard 748 (ANSI–748).

In affirming the grant of summary judgment, the Ninth Circuit noted that the government did not rely upon Serco's cost reports in deciding whether to pay claims. The Ninth Circuit also paid particular attention to the reasoning in Escobar: "if the Government pays a particular claim in full despite its actual knowledge that certain requirements were violated, that is very strong evidence that those requirements are not material." 846 F.3d at 334. The Ninth Circuit noted that the government accepted Serco's cost reports despite knowing that such cost reports were not in compliance with ANSI–748.

Serco's adoption of the rigorous enforcement of the FCA's materiality requirement signals a limit to the implied certification theory following Escobar. This point is underscored through Ninth Circuit's explicit statement that courts can properly dismiss an FCA claim on summary judgment or a motion to dismiss based on the claimant's failure to meet the rigorous standard for materiality under the FCA.

Conclusion

As health insurance companies have increasingly been the targets of qui tam suits stemming from the application of the FCA to Medicaid payments to health insurers, the Supreme Court's ruling in Escobar is significant. It is no longer sufficient to demonstrate materiality by establishing that the government would have had the option to decline payment if it knew of the party's noncompliance. Nor would a simple showing of noncompliance with statutory, regulatory or contractual requirements be considered automatically material. Rather, it must be established that noncompliance would have actually affected the government's payment decision.