A New York district court recently held in United States v. Strock that Escobar’s materiality standard applies, at a minimum, to express false certification and fraudulent inducement FCA theories in addition to the implied false certification theory at issue in Escobar. The court further held that the government failed adequately to plead materiality under Escobar and dismissed the case.
The government alleged that defendants falsely certified that their company, Veteran Enterprises Company, Inc. (VECO) was a service-disabled veteran-owned small business (SDVOSB) in order to obtain government contracts set aside for such businesses. The government alleged that the non-veteran defendants, who together owned and operated a separate contracting company unable to capitalize on contracts awarded to SDVOSBs, recruited and appointed a service-disabled veteran to serve as a mere figurehead in newly created VECO for the purpose of securing and profiting from SDVOSB awards. Although the recruited veteran was listed as the majority owner of VECO, he had almost no role in its management or operations, and had limited access to the business records for the company. The government’s FCA theory was that despite these facts, defendants falsely represented and certified to VECO’s qualification as an SDVOSB, and such false certifications fraudulently induced the government to award VECO $24 million in contracts for which it otherwise would have been ineligible, and thus each claim submitted under those contracts was false. Defendants filed a motion to dismiss, arguing, among other things, that the government had failed adequately to plead materiality under Escobar.
The court considered, as a threshold matter, whether Escobar’s materiality standard applied outside of the implied false certification context. Although the Second Circuit had not expressly addressed the issue, it had strongly signaled in a recent express false certification case on remand from the Supreme Court, U.S. ex rel. Bishop v. Wells Fargo & Co., that Escobar is not limited to implied false certification cases. Under the Second Circuit’s pre-Escobar decision in Mikes v. Straus, an FCA plaintiff proceeding under an express false certification theory was required to allege that the defendant submitted “a claim that falsely certifies compliance with a particular statute, regulation or contractual term, where compliance is a prerequisite to payment.” But the Second Circuit held in Bishop that Escobar abrogated that particularity requirement, reasoning that “strict enforcement of the FCA’s materiality and scienter requirements” would prevent the type of open-ended liability based on a general certification that the particularity requirement was designed to address. The Strock court concluded that the Second Circuit would not have abrogated Mikes’ particularity requirement if Escobar’s materiality standard had been limited to implied false certification theories, and thus the government’s express false certification and fraudulent inducement theories were properly analyzed under Escobar.
Applying Escobar, the court concluded that the government failed adequately to plead materiality. Even accepting as true, for purposes of deciding the motion to dismiss, that the defendants falsely certified their qualifications, the court reasoned that the government failed to allege that it expressly conditioned payment on compliance with SDVOSB contracting requirements or that it regularly refused to pay claims in the “mine run of cases” based on noncompliance with such requirements. Further, although the government alleged that VECO’s SDVOSB status was “important enough to warrant some level of investigation,” it failed to connect that investigation to the government’s payment decisions. The court found the government also failed to allege that it could have terminated VECO from previously awarded contracts based on the company’s earlier allegedly false certifications. The court dismissed the complaint without prejudice.
This may not be the end of the government’s campaign in Strock, however, as the government has filed a motion for reconsideration and still has the option of amending its complaint.