In two recent decisions, the Ninth and Third Circuits knocked down Justice Department and relator efforts to weaken the FCA’s falsity and scienter standards.

On August 24, 2018, in United States ex rel. Rose v. Stephens Institute, a Ninth Circuit panel confirmed that, under the Supreme Court’s watershed decision in Universal Health Services, Inc. v. United States ex rel. Escobar, false certification liability may not be imposed unless a two-condition test is satisfied: (1) the defendant’s claim for payment must have included “specific representations” about the goods or services provided that (2) render the claim misleading. This decision deals a blow to the Justice Department’s repeated arguments that the Supreme Court did not mandate such a two-part test.

In addition, earlier this month, in United States ex rel. Streck v. Allergan, the Third Circuit, albeit in a nonprecedential decision, reinforced the FCA’s scienter standard by holding that no liability can attach where the violation is predicated on an ambiguous statute or regulation for which the defendant’s interpretation is not objectively unreasonable. This case, like a 2015 decision of the D.C. Circuit that endorsed the same principle, represents an important check on government and relator efforts to craft FCA violations based on purported noncompliance with unclear statutory, regulatory, or contractual language.

The Ninth Circuit Finds the Escobar Two-Part Test for “Falsity” Mandatory

In Universal Health Services, Inc. v. United States ex rel. Escobar, 136 S. Ct. 1989, 1995 (2016), the Supreme Court held that the implied false certification theory can, “at least in some circumstances,” provide a basis for liability. Because the terms “false” and “fraudulent” are not defined in the FCA, the Court looked to the common law for their definition and found that common law fraud has long encompassed certain misrepresentations by omission. The Court reasoned that the FCA also encompasses this type of misrepresentation, and, in so holding, set forth two preconditions to liability:

we hold that the implied certification theory can be a basis for liability, at least where two conditions are satisfied: first, the claim does not merely request payment, but also makes specific representations about the goods or services provided; and second, the defendant’s failure to disclose noncompliance with material statutory, regulatory, or contractual requirements makes those representations misleading half-truths.

136 S. Ct. at 2001.

Since the Supreme Court’s decision, the Justice Department has engaged in a widespread campaign to discredit the significance of this statement in Escobar, arguing repeatedly to courts—even in declined qui tam cases (through a “Statement of Interest” or amicus brief)—that the two conditions articulated by the Supreme Court are not mandatory. While district courts have arrived at different conclusions on the mandatory nature of the two-condition test, and at least two appellate courts (including the Ninth Circuit) rendered decisions that considered the two conditions to be mandatory,1 no appellate court had squarely addressed the issue until the recent Ninth Circuit decision in United States ex rel. Rose v. Stephens Institute, No. 17-15111, 2018 WL 4038194 (9th Cir. Aug. 24, 2018). The district court set the stage for the Ninth Circuit to directly address the issue in Rose by stating that “Escobar did not establish a rigid two-part test for falsity that must be met in every single implied certification case.” United States ex rel. Rose v. Stephens Inst., No. 09CV05966-PJH, 2016 WL 5076214, at *5 (N.D. Cal. Sept. 20, 2016). Following that district court set-up, FCA practitioners waited expectantly for the Ninth Circuit’s decision, which followed extensive briefing and oral argument, including participation by the United States as amicus curiae.

Ultimately, upon finding that two earlier Ninth Circuit panels appeared to require Escobar’s two-condition test, the Rose panel unanimously disagreed with the district court. The panel noted that, while the Supreme Court did not state in Escobar that its two conditions were “the only way to establish liability under an implied false certification theory,” the Ninth Circuit’s post-Escobar cases appeared “to require Escobar’s two conditions nonetheless.” Rose, 2018 WL 4038194, at *4 (emphasis in original). Reasoning that it was bound by the prior panel decisions of the Circuit, the court concluded:

Relators must satisfy Escobar’s two conditions to prove falsity, unless and until our court, en banc, interprets Escobar differently.

Id.

The Third Circuit Properly Applies Rigorous FCA Scienter Standard

In United States ex rel. Streck v. Allergan, Inc., No. 17-1014, slip op. (3d Cir. Aug. 16, 2018), the Third Circuit affirmed the dismissal of a long-running FCA case on the grounds that the relator could not show that the defendants acted with the requisite scienter in the face of an ambiguous pharmaceutical price regulation. The Third Circuit’s decision is noteworthy because it adopts the “objectively reasonable interpretation” test for FCA scienter. This test, also applied by the D.C. Circuit in United States ex rel. Purcell v. MWI Corp., 807 F.3d 281 (D.C. Cir. 2015), does not require the defendant to prove that the interpretation was endorsed by the Government or even the correct interpretation of the language in question.

In Allergan, the ambiguity arose from the definition of “Average Manufacturer Price” (“AMP”), which affects Medicaid reimbursements for prescription drugs. The Third Circuit held that the AMP definition was ambiguous because it was susceptible to multiple interpretations. The court, citing Purcell, went on to establish the following test:

Basing a defense on a reasonable, but erroneous, interpretation of a statute includes three distinct inquiries: (1) whether the relevant statute was ambiguous; (2) whether a defendant’s interpretation of that ambiguity was objectively unreasonable; and (3) whether a defendant was 'warned away' from that interpretation by available administrative and judicial guidance.

Slip op. at 10. Applying this test, the appellate court affirmed dismissal of the complaint, observing that “[a]lthough we are not prepared to say that this is the best interpretation of the statute, we nevertheless are confident that—at the very least—it was not objectively unreasonable to act in accordance with such an interpretation.” Slip op. at 17.

Takeaways

The issue of whether the Escobar two-condition test for false certification liability is mandatory is now decided in the Ninth Circuit—at least absent en banc consideration. The Ninth Circuit’s holding that the Escobar two-condition test is mandatory is directly at odds with the Justice Department’s regularlyadvocated position on the question. However, it is unlikely that the Justice Department simply will relent given the Ninth Circuit’s decision. While the Rose case itself appears to be an imperfect vehicle for further challenge by the Government, since the Ninth Circuit held that there was sufficient evidence that the two-condition test was satisfied, the Government can be expected to maintain its position in other jurisdictions, hoping to create a circuit split that renders the issue ripe for Supreme Court review at some point.2

The Justice Department was particularly displeased with the Purcell decision, not only because the D.C. Circuit reversed a jury verdict, which led to judgment for the defendant, but because of the potential repercussions of the Purcell ruling on other cases. See FraudMail Alert No. 15-11-25. Now, those repercussions are being felt. The Third Circuit’s decision in Allergan, even though non-precedential, is a common sense ruling that should further dampen Justice Department and relator enthusiasm for pursuing FCA actions predicated on alleged non-compliance with ambiguous statutory, regulatory, or contractual language.