Court Rejects the First Circuit's "Expansive View" of the Theory by Articulating "Rigorous" Standards of Materiality

Yesterday, the U.S. Supreme Court issued a long-anticipated decision on the viability of the “implied certification” theory of liability under the False Claims Act (FCA). In Universal Health Services, Inc. v. United States ex rel. Escobar, a unanimous Court affirmed the viability of the implied certification theory, which had been split among the circuit courts. Implied certification is a judicially created theory under the FCA that establishes liability for a contractor or provider, who although delivered or performed the materials or services claimed, violated a contract, statute or regulation as a condition of payment even though the provider or contractor did not expressly certify compliance with the contract, statute or regulation as a condition of payment. In a move certain to spur further litigation, however, the Court may have softened that blow by restricting the theory’s reach in establishing a more “rigorous” and “demanding” materiality standard.

Escobar involved claims against a Medicaid provider of mental health services whose staff members had purportedly misrepresented their qualifications to the federal government to obtain Medicaid provider credentials associated with job titles for which they were not qualified. After a patient suffered an adverse reaction to medication prescribed by a nurse who had represented herself as a licensed psychiatrist, the patient’s mother and stepfather discovered these staffing issues, and shortly thereafter filed a civil False Claims Act suit under the FCA’s qui tam provisions, relying on a theory of implied false certification. After dismissal in the district court, the First Circuit Court of Appeals reversed, holding that the defendant’s failure to disclose its noncompliance with a “condition of payment” constituted an implied false certification under the FCA, even where the statute, regulation or contract did not expressly set forth the condition of payment. Troubling in the First Circuit’s opinion was the notion that the mere allegation of noncompliance with the contractual, statutory or regulatory terms was sufficient. On appeal, the Supreme Court affirmed the general proposition that “at least in certain circumstances, the implied false certification theory can be a basis for liability,” but it explicitly rejected the wholesale “expansive view” of implied certification adopted by the First Circuit.

While not unexpected, the Court’s affirmation of the implied certification theory is nevertheless a disappointing result for contractors and providers. The theory has imposed substantial costs on businesses transacting with the federal government, due to the highly contextual, fact-intensive nature of determining which omissions are “material” enough to create liability. Even in circumstances where the undisclosed noncompliance is likely immaterial, many courts have considered the question to be a factual one reserved for a jury, allowing plaintiffs to survive early stages of litigation and imposing significant discovery costs, or otherwise driving businesses into settling cases of dubious merit to avoid the costs of going to trial.

For businesses concerned about those features of the theory, however, the Court offered some relief. Acknowledging concerns about “fair notice and open-ended liability” that have attended the confusion over which implied certifications create liability, the Court added to its decisions that those concerns are to be addressed by the FCA’s requirements that a false claim be material and made “knowingly,” and admonished lower courts to police these requirements more rigorously. In clarifying the standard for materiality, the Court rejected formalistic tests based on whether a requirement is labeled a condition of payment, or otherwise entitled the government to decline payment when breached. Instead, the Court directed that materiality must be assessed based on the government’s actual and expected conduct with regard to the requirement at issue; if the government habitually ignores a requirement, the Court reasoned, it cannot be considered material. Moreover, the Court confirmed that the FCA’s knowledge requirements extend to this materiality inquiry, implying that a defendant may only be found liable if it actually knows the noncompliance is material to the government’s payment decision. Finally, in a footnote sure to be heavily cited, the Court rejected the argument that these standards are too complex to be decided by judges in a motion to dismiss, opening up the possibility that defendants may be able to dispose of implied certification suits much more quickly and cost-effectively than in the past. Given the fact-intensive and potentially subjective nature of the materiality and scienter analyses, it will be interesting to follow how the district courts actually address these issues at the dismissal stage and, likewise, whether the government, which bears the burden of proof, will be more careful in its decisions to intervene where materiality may not be clear for the court or jury.

Because the full implications of this decision will not be known until lower courts begin attempting to enforce the Court’s clarified standards, contractors and participants in federal reimbursement programs must remain wary. In the meantime, because these standards are based in part on the government’s own conduct, businesses contracting with the federal government should keep a close eye on their government partners’ payment practices in order to have a firm grasp of which requirements may be considered material should any issues arise.