The ruling in Universal Health Services, Inc. v. Escobar "rejects a system of government traps, zaps, and zingers that permits the government to retain the benefit of a substantially conforming good or service but to recover the price entirely—multiplied by three—because of some immaterial contractual or regulatory non-compliance." In the latest of a pattern of cases relying heavily on Escobar, a Florida district court vacated a multimillion-dollar jury verdict after finding none of the materiality required for a successful False Claims Act claim.

On January 11, the US District Court for the Middle District of Florida vacated a $350 million jury verdict after concluding that the relator had failed to offer any persuasive evidence that the alleged misrepresentations were “material” to the government’s decision to pay, as required for False Claims Act (FCA) liability to attach. US ex rel. Ruckh v. CMC II LLC et al., 2018 WL 375720 (M.D. Fla. Jan. 11, 2018) (hereinafter, Ruckh).

If allowed to stand, the verdict would have amounted, in the court’s view, to an “unwarranted, unjustified, unconscionable, and probably unconstitutional forfeiture . . . sufficient . . . to deter any prudent business from providing services and products to a government armed with the untethered and hair-trigger artillery of a False Claims Act invoked by a heavily invested relator.” Id. at *13.¹

The defendants were a skilled nursing home operator, its successor in interest, and two nursing homes. The relator, a former employee who worked at the two named facilities, claimed that the defendants submitted, or caused the submission of, up-coded claims and/or claims not adequately supported by written care plans in compliance with certain Medicare regulations.

The relator’s burden with respect to materiality, as stated by the court, was to show that the federal government, if aware of the “record keeping deficiency,” would have refused to pay for those “services rendered, products delivered and costs incurred.” Id. at *12. Instead, the district court found the evidence showed that the government was in fact aware of the underlying regulatory noncompliance (as repeatedly documented in administrative audit findings), but nonetheless continued to pay the defendants’ claims, which constituted “strong” and unrebutted evidence that the noncompliance was immaterial. See id. at *10 (discussing Universal Health Servs., Inc. v. Escobar, 136 S. Ct. 1989, 2003-04 (2016)).

Relying heavily on the US Supreme Court’s decision in Escobar, as well as on subsequent rulings in the First, Third, Fifth, and Ninth Circuits, the district court found the government’s knowledge of noncompliance to be determinative under these circumstances.2 The district court reasoned that implied certification is a theory that generally can only be recognized where the government is unaware of the alleged defect or “falsity” at the time it pays the claim: “[I]f the non-compliance is disclosed to, or discovered by, the United States, and if the United States pays notwithstanding the disclosed or discovered non-compliance, the False Claims Act provides a relator no claim ‘for implied false certification.’” Id. at *5 (citing Escobar, 136 S. Ct. 1989). Under Ruckh, government knowledge of the relevant facts at the time that it makes payment is a formidable defense to a theory of FCA liability based on implied certification.³

Ruckh skeptically allows that evidence can rebut any presumption of immateriality raised by the defense of government knowledge, but cautions that after a certain point, the burden of proving materiality under these circumstances becomes insurmountable: “[T]he government that continues to pay full fare for a product or service despite knowledge of some disputed practice, some non-compliance, or some other claimed defect, relentlessly works itself into a steadily tightening bind that at some point becomes disabling because the government (or the relator, who sues in the government’s stead) must prove that had the government known the facts the government would have refused to pay.” Id. at *22-23.

The district court was plainly concerned about the public policy implications of arbitrary and abusive FCA enforcement. The question, it said, was “whether on a large scale, on the scale of a major statewide provider of a scarce health care resource in a large and potent state, the federal government or the state government would refuse to pay the provider because of a dispute about the method or accuracy of payment after the government has permitted the practice to remain in place for years without complaint or inquiry.” Id. at *18-19. The district court further cautioned against the indiscriminate use of a highly punitive statute to enforce minor noncompliance, particularly where there are “more moderate, more proportional, or more efficacious remedies” available. Id. at *12.

Interestingly, the district court seemed to suggest in dicta that the relator bore a particularly heavy burden of establishing materiality under the facts of the case because the alleged fraud was of a large scale. The question would have been simpler had the case not been “ramped up” by the relator’s use of statistical sampling—the quality of which the district court questioned. See id. at *18. According to the court, the relator’s allegations concerned “a systemic dispute that forces a systemic challenge that requires systemic answers (and that offers the prospect of a systemic judgment creating a systemic danger with public consequences).” Id.

The defendants made several other successful arguments that were not addressed as extensively by the court. Most notably, the defendants successfully argued that the relator failed to set forth sufficient evidence that the management entity, which did not itself submit claims, caused any false claims to be presented because the relator failed to establish a causal connection between the defendants’ conduct and any specific false claim: “[A] scattering of claims in a smattering of facilities is [a] wholly insufficient basis from which to infer the existence of a massive, authorized, cohesive, concerted, enduring, top-down, corporate scheme to defraud the government.” Id. at *21.

Materiality Post-Escobar

Escobar establishes that materiality is a demanding element of any FCA action. Allegations of contractual or regulatory noncompliance alone cannot sustain an action—there must be specific demonstrable evidence that the government would not have paid the claim. Ruckh is only the most recent of a number of important decisions applying a meaningful materiality standard under the FCA post-Escobar and finding that regulatory noncompliance or mere contract deficiencies are not proper fraud actions.

Materiality is not established by any noncompliance with a contract, regulation, or statute that could have allowed the government to withhold payment. The government or the relator must show agency action that supports materiality. Further, while government knowledge does not preclude a finding of materiality where the theory of FCA liability is implied certification, in practice, most courts applying Escobar have found no materiality where the government had knowledge of the defect or noncompliance when its agency or contractor paid the claim.

In another US Department of Justice (DOJ) declined relator’s suit, discussed at length in Ruckh,⁴ the US Court of Appeals for the Fifth Circuit concluded that the materiality requirement was not met when there was unrebutted evidence that the government had continued to pay for the goods, called ET-Plus Units, notwithstanding knowledge of all the alleged misrepresentations at issue. US ex rel. Harman v. Trinity Indus., 872 F.3d 645 (5th Cir. 2017). Trinity Industries, Inc. and its subsidiary, Trinity Highway Products, LLC, engineer and manufacture guardrails, which are sold to the federal government and installed on highways across the United States. The Fifth Circuit focused on the fact that the government had agreed to purchase the goods with full awareness of the alleged deficiencies, had declined to intervene, and had not otherwise endorsed any of the relator’s allegations regarding the safety of the product: “When the government, at appropriate levels, repeatedly concludes that it has not been defrauded, it is not forgiving a found fraud—rather it is concluding that there was no fraud at all.” Id. at 670. The decision overturned a $663 million verdict.

The US Court of Appeals for the Third Circuit applied similar reasoning in finding materiality lacking in Petratos. There, the relator provided previously undisclosed safety data to the government, which the relator argued proved the drug company had made knowing misrepresentations to the US Food and Drug Administration (FDA) about its drug product Avastin. However, government agencies continued to purchase Avastin and the FDA made no effort to cause the company to modify its label or otherwise restrict its distribution once it had the safety information. 855 F.3d 481.

In US ex rel. McBride v. Halliburton Co., the US District Court for the District of Columbia likewise found no materiality when the government had complete information about the alleged noncompliance but continued to make payment. 848 F.3d 1027 (DC Cir. 2017). The relator alleged that KBR (a former subsidiary of Halliburton) submitted inflated “headcounts” for troops utilizing two recreation centers and claimed those headcounts caused the government to pay unreasonable costs. A government auditor had investigated the allegations without making any formal findings. And while a government contracting officer testified that he “might” have disallowed certain costs had he known, the DC Circuit, quoting Escobar, concluded, “At most, the statement amounts to the far-too-attenuated supposition that the Government might have had the ‘option to decline to pay.’” Id. at 1034.

In a decision that was granted certiorari and remanded following Escobar, the US Court of Appeals for the Fourth Circuit affirmed its original holding, which found the defendant liable under the FCA, albeit on different grounds. Triple Canopy, Inc. v. United States concerned the supply of adequately trained guards to work at foreign military compounds. 857 F.3d 174 (4th Cir. 2017). On remand, the judges noted that Triple Canopy’s alleged representations were precisely what Escobar contemplated when it described actionable “half-truths” or “representations that state the truth only so far as it goes, while omitting critical qualifying information.” Id. at 178. Relying primarily on the extensive effort of the defendant to cover up its misrepresentations, and the government’s decision not to renew the contract once becoming aware of the deficiencies, the court unsurprisingly concluded the misrepresentations were plainly material under Escobar.⁵

A spirited appeal is likely to ensue, but the Ruckh decision—on the heels of the DOJ’s dismissal of its FCA action against HCR ManorCare for medically unnecessary therapy services and after a judicial finding that the case never should have been brought—illustrates justifiable judicial concern over the thin legal theories and evidentiary approach to seeking punitive fraud liability for clinical duels or subjective retrospectives on so-called “adequate documentation deficiencies” that are then extrapolated to catastrophic punitive liability. US ex rel. Ribik v. ManorCare, Inc., et al., Case No. 1:09cv13-CMH-HCB (E.D. Va.).⁶In truth, these are not real fraud cases and should not be pursued as such in a misguided zeal to achieve huge punitive monetary awards against healthcare providers. The Ruckh decision confronts these concerns in a colorful and meaningful way, and the concerns should be given thoughtful review by practitioners, enforcers, and policymakers.

Takeaways

Evidence that the government continues to make payments for goods or services notwithstanding information about their deficiencies or regulatory or contractual noncompliance establishes a very strong presumption that the alleged defect, violation, or misrepresentation was immaterial and does not support FCA liability. This information should be developed and assessed early on in an investigation and litigation.

Providers and contractors should be alert to situations where the government prematurely seeks prelitigation remedies simply to show that allegations are material (payment suspensions, disenrollments). Many government programs have draconian preemptive administrative remedies that do not allow for judicial review or a hearing. The DOJ may seek to pressure federal agencies to take administrative actions during the pendency of an investigation to support its view of materiality under the FCA.

Courts remain deeply concerned that the FCA is being used for contract disputes and regulatory violations that are remedies under an administrative structure and for deficiencies in documentation or otherwise that simply carry no badge of fraud.

The government’s failure to intervene in an FCA suit coupled with a provider’s or contractor’s continued participation in a government program or contract without any agency action regarding the allegations is some indication that the misrepresentations are not material to the government’s decision to pay.

While there is a body of defense-friendly case law developing in the post-Escobar world—and it appears that the materiality requirement does in fact have teeth—not all jurisdictions are going quite has far as Ruckh. It should not be taken for granted that government knowledge will serve as an absolute defense as to materiality, but it should be considered and, if available, argued aggressively.

[1] The relator, Angela Ruckh, was a registered nurse who worked briefly for one of the defendant’s facilities training minimum data set (MDS) coordinators. Her complaint, originally filed in 2011, had alleged “flagrant” up-coding. Her allegations of systemic conduct were premised, at least in part, on statistical sampling and extrapolation, not on any direct or substantial experience from her brief employment at two facilities.

[2] See Ruckh, 2018 WL 375720, at *4 (explaining that “several circuit courts have elaborated and faithfully applied Escobar’s instructions”); see generally D’Agostino v. ev3, Inc., 845 F.3d 1 (1st Cir. 2016); US ex rel. Petratos v. Genentech, Inc., 855 F.3d 481 (3d Cir. 2017); Abbott v. BP Expl. & Prod., Inc., 851 F.3d 384 (5th Cir. 2017); US ex rel. Harman v. Trinity Indus., Inc., 872 F.3d 645 (5th Cir. 2017); US ex rel. Kelly v. Serco, Inc., 846 F.3d 325 (9th Cir. 2017).

[3] There are meaningful differences between government knowledge as a defense to materiality and government knowledge as a defense to scienter. Government knowledge is only an effective defense to scienter if “the defendant knew what the government knew.” See US ex rel. Spay v. CVC Caremark, 017 WL 5491935 (3d Cir. Nov. 16, 2017).

[4] See Ruckh, 2018 WL 375720, at *22. The district court wrote, “A closer reading of Harman persuades the disinterested reader that Judge Higginbotham finds the government’s continued performance after non-compliance more consequential than his words explicitly reveal.”

[5] On August 14, 2017, the defendants in Triple Canopy filed a second petition with the Supreme Court, asserting a circuit split among the Third, Fourth, and Ninth Circuits’ decisions post-Escobar and asking the Supreme Court to address whether merely submitting a request for payment that does not contain specific misrepresentations can give rise to implied certification FCA liability. The petition was later voluntarily dismissed. US ex rel. Badr v. Triple Canopy, Inc., 857 F.3d 174 (4th Cir. 2017).

[6] See also United States v. AseraCare, Inc., 2016 US Dist. LEXIS 42986 (N.D. Ala. 2014) (concluding that competing subjective expert clinical opinions over medical necessity cannot give rise to falsity for purposes of the FCA).