As discussed in our December 2015 and May 2016 Federal Grant & Contract News for Nonprofits newsletters, in Universal Health Services v. Escobar, the U.S. Supreme Court (the Court) considered whether the theory of "implied certification" would remain a viable theory of liability under the federal False Claims Act (FCA). Last week, the Court upheld that theory. As the Court explained, under that theory, 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." However, for a recipient of federal funds to be liable under the FCA for violations of statutory, regulatory, or contractual requirements, those requirements must be "material." The Court’s decision largely examined what it meant for a statutory, regulatory or contractual requirement to be "material." Given that grants and cooperative agreements are largely governed by regulation, this is a significant doctrine for nonprofit federal grantees.

It is ultimately unsurprising that the Court adopted some form of the implied certification theory, as the theory itself was consistent with common-law fraud claims. It is the U.S. Department of Justice's expansive interpretation of the theory (primarily, which statutory, regulatory, and contractual requirements trigger an FCA violation) that has left contractors and grantees guessing where the line is between a run-of-the-mill unallowable cost and fraud liability under the FCA. Indeed, some representatives of the federal Offices of Inspector General have taken the position that all unallowable costs are tantamount to 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 goods and services provided. The difficulty with the Court's holding is that it sets forth a test that borrows from the language of contract law, while giving no thought to how the issue relates to federal government grants and cooperative agreements.

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."

Thus, when determining a violation of the FCA in a post-Escobar era, lower courts should be examining 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. However, fundamentally, grant agreements are, by definition, not for the acquisition of goods and services. Rather, grant and cooperative agreements are provided to fulfill a public purpose. 31 U.S.C. § 6304. To be allowable, costs must be necessary and reasonable toward that purpose. 2 C.F.R. § 200.403(a). It is uncertain how the Court’s articulation of the implied certification theory would apply to federal grant or cooperative agreement recipients.

Escobar does provide some guidance on when a noncompliance with regulation may be "material." 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."
  • "Materiality, in addition, cannot be found where noncompliance is minor and insubstantial."

While the question of materiality leaves open some uncertainty with regard to the circumstances under which that liability will attach, the Court's framework suggests a return to the true fraud issues that the FCA was created to combat, and a departure from the federal government'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 and debate in the very near future.

Given the current remaining uncertainty, as always, federal government contractors should establish effective internal controls to limit liability, including the following:

  • Establish your intent to comply. Grantees 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 your nonprofit 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 program requirements? Do those chosen in the organization have the appropriate knowledge to make the certification?
  • Maintain a written dialogue with your federal government customer. Consider whether to obtain federal government buy-in for tricky compliance decisions. As specifically set out in Escobar, the federal government's 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 quickly to resolve the issue.
  • Assess your weaknesses. Ethical federal 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 or area of focus? 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.