The US Supreme Court's landmark decision in Universal Health Services, Inc. v. United States ex rel. Escobar continues to reverberate through the lower courts. Earlier this week, the Seventh Circuit abandoned its "but for" causation test in False Claims Act (FCA) cases, abrogating precedent that stood for more than two decades, because of Escobar. See U.S. ex rel. Luce, No. 16-4093, 2017 WL 4768864 (7th Cir. Oct. 23, 2017). In the process, the court resolved a circuit split, joining courts of appeal that previously adopted a "proximate causation" standard for FCA cases.
This new consensus represents a positive development for FCA defendants, who may rely on Luce to combat expansive theories of liability from the whistleblower bar. In addition, Luce provides helpful guidance concerning Escobar's demanding materiality requirement.
Robert Luce was the owner of a home mortgage company called MDR. That company originated mortgages insured by the U.S. Department of Housing and Urban Development (HUD) under the Fair Housing Act (FHA). For every HUD-insured mortgage that MDR originated, MDR received a $450 processing fee and a commission.
To maintain the integrity of the FHA insurance program, HUD requires participating companies to submit a Yearly Verification Form (V-form) that provides "none of the principals, owners, officers, directors, and/or employees of the . . . mortgagee are currently involved in a proceeding and/or investigation that could result, or has resulted in a criminal conviction[.]"
In 2005, Luce was indicted for wire fraud, mail fraud, false statements and obstruction of justice. Yet MDR continued to file annual V-forms certifying none of its officers were subject to criminal proceedings. In 2008, Luce pleaded guilty to obstruction of justice and MDR amended its inaccurate V-forms. Thereafter, HUD debarred Luce, and MDR went out of business. In the three years between Luce's indictment and debarment, MDR originated 2,500 loans, 250 of which are in default. Of these, the vast majority were refinances of existing loans previously insured under the FHA.
The United States filed an FCA complaint against Luce in 2011. Ultimately, the district court granted the government's motions for summary judgment, finding Luce's false certifications were the "but for" cause of the government's losses and awarding $10.36 million in damages.
Luce appealed these rulings, making two Escobar-based arguments. First, Luce argued his misrepresentations to HUD failed to satisfy Escobar's demanding materiality requirement. Second, he argued that Escobar compelled the courts to adopt a "proximate causation" standard in FCA cases and, under that standard, the government's losses were not the reasonably foreseeable result of Luce's conduct.
The Supreme Court in Escobar endorsed the "implied false certification" theory of FCA liability. That theory provides there can be actionable "false" claims when the defendant fails to disclose noncompliance with a statutory, regulatory or contractual requirement that is "material to the Government's payment decision." Escobar, 136 S. Ct. at 1996. According to the Supreme Court, "if the Government regularly pays a particular type of claim in full despite actual knowledge that certain requirements were violated, and has signaled no change in position, that is strong evidence that the requirements are not material.” Id. at 2003-04.
In Luce, the district court held MDR's false V-forms were material to HUD's decision to continue insuring mortgages originated by that company. Luce disagreed. On appeal, he argued the district court erred by disregarding "evidence that would allow a reasonable jury to conclude that the V-forms were not material." Luce, 2017 WL 4768864, at *8. Of primary importance, Luce highlighted HUD's continued approval of insurance for new loans originated by MDR after the government learned about Luce's indictment through MDR's amended V-forms.
The Seventh Circuit rejected Luce's argument, stating the government's actions following discovery of the fraud "support, rather than undercut, a finding of materiality." Id. While HUD continued to insure MDR loans after the company amended its V-forms, the government also began debarment proceedings "without any prolonged period of acquiescence." Id. In the words of the Seventh Circuit, HUD "did not simply refuse payment in one instance, but terminated its relationship with the loan originator so that no future payments could be made." Id. at *7. These facts were sufficient to establish materiality under Escobar.
The Seventh Circuit was more receptive to Luce's position on causation. The FCA empowers the government to recover treble damages for losses sustained "because of" a false claim. 31 U.S.C. § 3729(a)(1). The Courts of Appeal have adopted competing interpretations of this causation element. Twenty-five years ago, the Seventh Circuit adopted a "but for" test. See U.S. v. First National Bank of Cicero, 957 f.2d 1362 (7th Cir. 1992). Under this test, the government's loss need not be "attributed directly" to the defendant's conduct. Luce, 2017 WL 4768864, at *9. Other Circuits have adopted a proximate causation test. Under this more rigorous standard, FCA claims may only proceed against defendants "who can fairly be said to have caused a claim to be presented to the government, while winnowing out those claims with only attenuated links between the defendant's specific actions and the presentation of the false claim." U.S. ex rel. Sikkenga v. Regence Bluecross Blueshield of Utah, 472 F.3d 702, 714 (10th Cir. 2006).
Luce argued that Escobar compelled the Seventh Circuit to abandon "but for" causation. Escobar states that, "absent other indication, Congress intends to incorporate the well-settled meaning of the common-law terms it uses." Escobar, 136 S. Ct. at 1999. The FCA does not define its causation element. However, at common law, liability for fraudulent misrepresentations is limited to "foreseeable" losses – ie, those losses a reasonable person would see as a likely result of his or her conduct. Luce claimed it was not foreseeable that he would be responsible for future borrower defaults on FHA loans originated because of his false V-forms.
The Seventh Circuit agreed with Luce's interpretation of the FCA. The court observed "nothing in the FCA contains any indication of an intent to depart from the common-law understanding of causation in fraud cases." Luce, 2017 WL 4768864, at *11. And, "[a]bsent other direction from Congress, we should assume that Congress did not stray far from the established common law." Id. at *13. Accordingly, the court overruled its 1992 decision in Cicero and remanded the case to the district court to apply the proximate causation standard.
Before Luce, the Supreme Court's Escobar decision was already having a profound impact on FCA litigation. However, the lower courts have focused on Escobar's explicit guidance concerning three of the four elements of an FCA claim: (1) falsity; (2) materiality; and (3) scienter. Escobar is silent on the fourth element, causation. Now, the Seventh Circuit has expanded Escobar's reach to completely alter the court's long-standing approach to causation in FCA cases. In doing so, the court has shifted in a defendant-friendly direction, making it more challenging for the government and whistleblowers to survive pre-trial motion practice.
Going forward, companies facing qui tam litigation should be mindful of Luce when crafting discovery plans and summary judgment motions. In particular, these companies should consider whether FCA plaintiffs have produced evidence sufficient to show the government's damages were the reasonably foreseeable result of the defendant's conduct. Moreover, these companies should focus on the government's conduct after learning about the alleged fraud. If the government continued to pay the relevant claims, or failed to take other remedial actions, the qui tam complaint may be defective from a materiality perspective.