As discussed in our prior alerts, in Universal Health Services v. Escobar, the U.S. Supreme Court considered whether the theory of "implied certification" would remain a viable theory of liability under the False Claims Act (FCA). Last week, the Court upheld the theory. As the Court explained, when "a defendant makes representations in submitting a claim but omits its violations of statutory, regulatory, or contractual requirements, those omissions can be a basis for liability if they render the defendant's representations misleading with respect to the goods or services provided." For a contractor to be liable under the FCA for violations of statutory, regulatory, or contractual requirements, however, those requirements must be "material." Determining whether a statute, regulation, or contractual requirement is "material" was the primary subject of the Court's analysis.

While there is a temptation to read the Court's decision in Escobar as a win for the Department of Justice because determining the "materiality" of a requirement is a fact-intensive standard, in fact, the government contracts sky is not actually falling any more than it was when implied certification initially became a theory under the FCA. Indeed, it is ultimately unsurprising that the Court adopted some form of the implied certification theory, as the theory itself is consistent with common-law fraud claims, which are necessarily fact-intensive. Rather, the problem for contractors has been that some of the courts have recognized DOJ's expansive interpretation of the theory (primarily, which statutory, regulatory, and contractual requirements trigger an FCA violation), which has left the industry guessing where the line is between breach of contract and fraud. Escobar seeks to address this issue by providing critical guideposts for determining which statutory and regulatory requirements are really material, such that a failure to disclose noncompliance with these requirements undermines the parties' basic representations about the core goods and services contracted for by the government.

Specifically, the Court held that implied certification could be a basis for FCA liability when

  1. "the claim does not merely request payment, but also makes specific representations about the goods or services provided"; and
  2. "the defendant's failure to disclose noncompliance with material statutory, regulatory, or contractual requirements makes those representations misleading half-truths."

Therefore, Courts should examine what goods and services the parties fundamentally contracted for (i.e., the reason for the contract), and whether the failure to disclose a noncompliance undermines the parties' representations related to those goods and services. Of particular note:

  • The Court repeatedly emphasized that "[n]ot every undisclosed violation of an express condition of payment automatically triggers liability," and it is insufficient "for a finding of materiality that the Government would have the option to decline to pay if it knew of the defendant's noncompliance." Thus, it appears that the Court believes any analysis of whether an implied certification constitutes a false claim should focus on the conditions and representations made that are central to the goods and services to be provided.
  • "Materiality, in addition, cannot be found where noncompliance is minor and insubstantial." Again, the Court seems to be requiring a showing that noncompliance significantly relates to the goods and services being performed. This standard may ultimately exclude many of the FAR requirements that express government preferences but do not relate to the specific goods and services being provided.
  • The Court also pointed to the parties' course of conduct as one way of determining which noncompliances were material. For example, "if 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."

Thus, while the question of materiality leaves some uncertainty with regard to the circumstances under which that liability will attach, the Court's framework suggests a return to the true contract fraud issues that the FCA was created to combat, and a departure from the Department of Justice's recent use of the statute as "a vehicle for punishing garden-variety breaches of contract or regulatory violations." Where the line between "garden-variety breaches" and material misrepresentations lies, while open at the moment, will undoubtedly be the subject of significant litigation in the very near future.

Given the uniformity of many FAR provisions, this litigation may prove helpful in bringing consistency to the industry regarding what provisions are really part of the goods and services provided for such that their violation could constitute fraud. Obviously, the materiality of these provisions will need to be addressed by the district and circuit courts, on a case-by-case basis, over the next few years, which could make it difficult for a contractor to win on a motion to dismiss absent another jurisdictional argument.

Therefore, given the current remaining uncertainty regarding the implied certification theory, government contractors should prepare for the government to take aggressive positions on what is truly "material" to the contract by establishing effective internal controls to limit liability, including the following:

  • Establish your intent to comply. Contractors should document all decisions, as well as the supporting rationale, to demonstrate their deliberate, good faith efforts to comply with all statutory, regulatory, and contractual provisions.
  • Review your certification process. Determine who will be charged with ensuring that the company is up to date on its certification requirements. Are they the right people? What representations are you making, and how could they be wrong, particularly as they relate to the core contract provisions? Do those chosen in the company have the appropriate knowledge to make the certification?
  • Maintain a written dialogue with your government customer. Consider whether to obtain government buy-in for tricky compliance decisions. As specifically set out in Escobar, the government decision to pay with knowledge of potential noncompliances may negate materiality.
  • Develop a crisis mitigation plan. When you receive a report of noncompliance, document your response and work to resolve the issue.
  • Assess your weaknesses. Ethical contractors and grantees seek not only to respond to issues as they arise, but to proactively determine where they are uniquely vulnerable to potential fraud and noncompliance. What are the red flags in your industry? In particular, revisit your ethics and compliance program on an annual basis, and if you have not established one, now is a good time to make that investment.