Editor’s Note: Since the Supreme Court decided Universal Health Services, Inc. v. United States ex rel. Escobar (Escobar), 136 S.Ct. 1989 (2016), several federal circuit courts and district courts have applied the ruling in a way that has limited False Claims Act (FCA) liability. (Click here to read our article in the March 2017 issue of Health Update: “Escobar’s Impact: Recent Application of ‘Materiality’ in Ninth Circuit.”) In the article below, we analyze how these lower courts have applied the heightened materiality standard set forth in Escobar, including what courts look to when deciding whether to dismiss FCA complaints on materiality grounds.

___________________________________________

Analysis of Recent Cases Applying the Heightened “Materiality” Standard

In United States ex rel. Petratos v. Genentech, Inc., 855 F.3d 481 (3d Cir. 2017), the Third Circuit affirmed the district court’s order dismissing an FCA complaint on the grounds that the relator could not establish materiality based on the guidance set forth in Escobar. The relator alleged that his former employer, Genentech, submitted false claims to the federal Medicare program when it suppressed data that caused doctors to certify incorrectly that a particular drug was “reasonable and necessary” for certain at-risk Medicare patients.

In affirming the district court, the Third Circuit reasoned that the relator did not dispute the district court’s findings that there were no allegations in the complaint that (i) the Centers for Medicare & Medicaid Services (CMS) would not have reimbursed these claims had the alleged reporting deficiencies been cured, (ii) knowledge of the noncompliance could influence the government’s decision to pay, or (iii) CMS consistently refused to pay claims like those alleged. Id. at 490. The relator had essentially conceded that the government would have paid the claims with full knowledge of the alleged noncompliance. Id. In fact, the relator admitted that he disclosed evidence to the government, but the Food and Drug Administration (FDA) continued to approve the drug, added three more approved indications of the drug and took no action against Genentech. Id. 

Therefore, the Third Circuit held that the misrepresentation was not material to the government’s payment decision. Id.The failure to plead allegations regarding the violation’s impact on the government’s payment decision rendered the complaint fatally deficient.

In Abbott v. BP Exploration & Production, Incorporated, 851 F.3d 384 (5th Cir. 2017), the plaintiff, a former control supervisor for oil company BP Exploration & Production, Inc. (BP), brought a lawsuit alleging that BP violated the FCA and the Outer Continental Shelf Lands Act (OCSLA) by falsely certifying compliance with various regulatory requirements in connection with a project that BP built and maintained (the BP project). Id. at 385-86. As a result of the lawsuit, the Department of the Interior (DOI) began reviewing BP’s compliance with those regulatory requirements, and eventually conducted a full investigation into the plaintiff’s allegations. Id. at 386. Although the DOI ultimately issued a report stating that the plaintiff’s allegations about the false submissions were unfounded and that there were no grounds for suspending operations of the BP project, the district court denied BP’s motion to dismiss. Id. After discovery, the district court granted summary judgment in favor of BP on all claims. Id.

On appeal, the Fifth Circuit affirmed the district court’s order. Id. at 387. The Fifth Circuit analyzed the materiality standard set forth in Escobar, noting that the standard was “demanding.” The Fifth Circuit also emphasized that it was not “sufficient for a finding of materiality that the Government would have had the option to decline to pay if it knew of the defendant’s noncompliance.” Id. (citing Escobar, 136 S.Ct. at 2004). Indeed, the plaintiff pointed to the following evidence to support that fact issues exist as to whether false certifications were material to support FCA claims: missing stamps, drawings not specifically marked as “As-Built,” BP internal procedures requiring “As-Built” markings, and testimony from a DOI official stating that the BP project wouldn’t have been approved had BP not certified its compliance with various regulations. Id. at 388.

The Fifth Circuit found this evidence insufficient, however, to overcome summary judgment under Escobar’s “demanding” materiality standard, given that the DOI report found that the BP project was in compliance with the regulations. Id. at 388. Therefore, when the DOI decided to allow the BP project to continue after a substantial investigation into the plaintiff’s allegations, that decision was “strong evidence” that the requirements in those regulations are not material. Id.

In United States ex rel. Harman v. Trinity Industries Inc., 872 F.3d 645 (5th Cir. 2017), the relator alleged that manufacturer Trinity Industries Inc. knowingly and falsely certified that its guardrail end terminals had been approved for reimbursement by the Federal Highway Administration (FHWA) to induce state governments to use end terminals and seek reimbursement from the FHWA. Id. at 649-650. Trinity lost at summary judgment, at trial and on post-trial motions, resulting in the entering of final judgment against Trinity in the amount of $664 million. The district court denied Trinity’s motion for a new trial, which Trinity appealed. Id. at 651.

On appeal, the Fifth Circuit overturned the $664 million judgment, holding that Trinity’s alleged failure to disclose changes to its guardrail end terminals was not material, as required to support the relator’s FCA claim. Id. at 652-53. In so holding, the Fifth Circuit recognized other circuits’ guidance on the impact of the government’s continued payment, and noted that “though not dispositive, continued payment by the federal government after it learns of the alleged fraud substantially increases the burden on the relator in establishing materiality.” Id. at 661-63.

In Trinity, the relator’s allegations that Trinity failed to disclose changes to its guardrail end terminals were presented to the government prior to the lawsuit. Even after being briefed on the allegedly material design changes, the government concluded that payment for the system was still proper. Id. at 650-651, 665, 667. Indeed, FHWA issued a memorandum explaining that the challenged guardrail end-cap design had been tested and that there was “an unbroken chain of eligibility for Federal-aid reimbursement.” Id. at 665. Therefore, based on the fact that the government continued payment under these circumstances, the relator could not meet the heightened materiality standard.

It is important to note, however, that in a recent case, the Ninth Circuit reversed dismissal under Rule 12(b)(6) for failure to state a claim, holding that questions of materiality remained even where the FDA continued to pay for the drug. In United States ex rel. Campie v. Gilead Sciences, Inc., 862 F.3d 890 (9th Cir. 2017), two former employees of Gilead Sciences, Inc., a large drug producer, filed suit against Gilead under the FCA, alleging that Gilead made false statements about its compliance with FDA regulations regarding certain HIV drugs, resulting in the receipt of billions of dollars from the government. Id. at 895. In particular, the relator alleged that Gilead utilized an unapproved vendor in China for a critical component of its HIV drugs for at least two years before the FDA approved the vendor. The district court dismissed the relators’ second amended complaint with prejudice, on the ground that the relators failed to allege that Gilead made a false statement related to a material precondition for payment. Id at 899.

On appeal, the Ninth Circuit reversed, rejecting Gilead’s argument that the violation was not material to the government’s payment decision, because the government continued to pay for the medications after it knew of the FDA violations. Id. The Ninth Circuit reasoned that (1) questions remained as to whether the approval by the FDA was itself procured by fraud; (2) other potential reasons existed for continued approval that prevented judgment for the defendant on 12(b)(6); and (3) the continued payment came after the alleged noncompliance had terminated and “the government’s decision to keep paying for compliant drugs does not have the same significance as if the government continued to pay despite noncompliance.” The Ninth Circuit also noted that the parties disputed what exactly the government knew and when, calling into question its “actual knowledge” that certain requirements were violated. Id.at 907.

Conclusion

In summary, courts have demonstrated that they are willing to dismiss FCA complaints in the early stages of the litigation, especially if the complaint does not allege any facts establishing materiality. Moreover, if the defendant can establish that an alleged violation did not affect the government’s decision to pay a claim, e.g., if the government agency still paid the claim notwithstanding being on notice of alleged noncompliance, this is powerful evidence that can help a defendant defeat FCA liability, potentially even at the motion-to-dismiss stage.

In essence, the key to materiality appears to be government action or inaction after knowledge of the noncompliance, and defendants should try to obtain information regarding whether the government still paid the claims despite such knowledge. Based on a review of the cases to date, it is clear that the heightened materiality standard has real teeth and has made it more difficult for qui tam plaintiffs to plead materiality properly and move past the pleadings stage or ultimately succeed in their FCA claims.