Editor’s Note: This is the first in a five-part series on how U.S. district courts and courts of appeal have applied the materiality standard set forth in Universal Health Services, Inc. v. U.S. ex rel. Escobar.
In Escobar, the Supreme Court described several factors that a district court should consider in assessing whether a particular contractual, regulatory, or statutory violation was material to a government’s decision to pay. One of those factors was whether a “reasonable man [acting on the Government’s behalf] would attach importance to [the representation] in determining his choice of action in the transaction.” at 2003. It follows that a reasonable person would not attach importance to a violation that is “minor or insubstantial.” Universal Health Servs., Inc. v. U.S. ex rel. Escobar, 136 S. Ct. 1989, 2003 (2016) (emphasis added). So how have the district courts handled this “reasonable man” objective standard? And what types of violations are minor or insubstantial? This article explores the answers to those questions.
One district court has found significance not in whether a particular issue is regulated, but whether a defendant’s compliance with that regulation influenced the government’s decision to pay.
That the Government or a federal agency found a particular issue important enough to regulate speaks little to the intended consequence of noncompliance. . . . Ultimately, the relevant inquiry is whether the Government’s payment decision was influenced by claimant’s purported compliance with a particular requirement, not whether a given issue has been deemed worthy of regulation.
U.S. ex rel. Schimelpfenig v. Dr. Reddy’s Labs. Ltd., 2017 WL 1133956 (E.D. Pa. Mar. 27, 2017).
Thus, in cases where the Government’s payment decision was affected by noncompliance, courts were more likely to find such violations “material” for purposes of the FCA. For example, in Scott Rose v. Stephens Institute, 2016 WL 5076214 (N.D. Cal. Sept. 20, 2016), the court relied on the government’s actions taken against other parties that violated the regulatory provision at issue. The court noted that the Department of Education recovered tens of millions of dollars against these parties by opening incentive compensation ban cases against them. Such enforcement activity, the court held, showed the government was concerned about violations and that such violations were material to the government’s decision to pay. The court also found that enforcement became more aggressive over time. The government also eliminated various regulatory safe harbors as time went on. These changes in policy demonstrated that the violations were indeed material to the government.
Other courts have used the “reasonable person” standard to find certain de minimis violations to be minor or insubstantial. For example, in Grabcheski v. American International Group, Inc., 2017 WL 1381264 (2nd Cir. Apr. 18, 2017), the Court held that a relator failed to state a claim because he did not allege how a 0.4% difference in value would have affected whether the parties would have entered into an agreement.
In contrast, in U.S. ex rel. Emanuele v. Medicor Assocs., 2017 WL 1001581 (W.D. Pa. Mar. 15, 2017), the court found that the failure to adhere to a Stark Law exception’s ‘writing’ requirement was not “minor or insubstantial.” The Stark Law generally prohibits a physician from referring Medicare patients for designated health services to an entity with which the physician maintains a financial relationship. Many exceptions to that general prohibition require the financial relationship at issue to be “set out in writing.” See, e.g., 42 C.F.R. § 411.357(d). In finding that the ‘writing’ requirement was not “minor or insubstantial,” the court explained, “[c]ompliance with the writing requirement permits a reviewer to analyze the timeframe, rate of compensation, and the identifiable services contemplated in the arrangement to determine whether any portion is based on the volume or value of physician referrals.” Emanuele, 2017 WL 1001581, at *18. The requirement, therefore “plays a role in preventing fraud and abuse.” Id. (quoting 80 Fed. Reg. 70886, 71333-71334). Because of the writing requirement’s role in preventing fraud in abuse, the Emanuele court held that the writing requirement “go[es] to the very ‘essence of the bargain’ between the government and health care providers with respect to Stark [Law] compliance.” Emanuele, 2017 WL 1001581, at *18 (quoting Escobar, 136 S. Ct. at 2003 n.5).
Under the reasonable person standard for evaluating whether a violation is minor or insubstantial, a defendant cannot, as a defense, claim “the Agency did not know of the violation and therefore the violation did not matter.” It does not matter that the Agency did not actually know of the alleged violation. It matters only whether knowledge of a violation would have affected the Agency’s payment decision if it had known. So, for example, in U.S. v. Savannah River Nuclear Solutions, LLC, 2016 WL 7104823 (D.S.C. Dec. 6, 2016), “[t]he fact that the common law’s test of materiality in the tort context would not require the plaintiff to be aware of the representation supports the court’s conclusion that the DOE’s not being aware of FFS’s certifications is not dispositive of materiality.” Id. at *23. The court also observed that “common sense suggests that the alleged unallowability of the challenged costs would influence the DOE’s decision to pay them, and Defendants’ alleged conduct in covering up the costs suggests that they would be material to the DOE.” Id. at 24.
In short, a reasonable person’s payment decision is likely to be influenced only by significant violations. A simple way to distill this test is to consider whether the agency would have paid the claim had it known of the defendant’s violation. Compliance issues that would not cause the agency to deny payment would not likely trigger FCA liability under an implied certification theory.