The decision last Friday by the D.C. Circuit in United States v. Science Applications International Corp., No. 09-5385, 2010 WL 4909467 (D.C. Cir. Dec. 3, 2010), forcefully―and hopefully, finally―rejects the Department of Justice‟s (“DOJ”) longstanding yet irrational argument that “collective knowledge” can be used to prove intent under the civil False Claims Act. In a wide ranging unanimous opinion, the court also issued significant decisions on two other major issues: damages (in which it reversed the district court on grounds well settled in FCA jurisprudence) and implied certification (where it differed from the holdings in other circuits but emphasized the heavy burden FCA plaintiffs must meet in such cases).
The court‟s decision to vacate the judgment against the defendant and order a new trial on both liability and damages represents a major victory for the defense in SAIC. Most importantly, the court‟s determination that collective knowledge is “an inappropriate basis for [FCA] scienter” and is “inconsistent with the Act‟s language, structure, and purpose” extends the significance of this decision beyond the facts of this particular case, and will impact FCA litigation on a broad scale. DOJ had been arguing for over 20 years that the knowledge of every employee in a corporation or institution could be “collected” to form the basis for the intent necessary under the FCA. The panel‟s ruling rejecting DOJ‟s arguments exhibits a clear grasp of the stakes involved in FCA liability, and the court‟s sound assessment of the conflict between collective knowledge and the FCA‟s scienter standard should torpedo any further attempts by the government and qui tam relators to argue that the standard for knowledge under the FCA can be met through collective knowledge.
The decision also addressed two other major issues―implied certification and damages. In a first for the D.C. Circuit, the court explicitly accepted the implied certification theory of liability in FCA cases, but it also limited the scope of this potentially dangerous theory by requiring strict enforcement of the Act‟s materiality and scienter requirements and strengthening the scienter requirement in implied certification cases. The court also addressed the important issue of FCA damages―highly relevant in this case where the jury found that damages for purposes of the government‟s breach of contract claim were only $78, yet the district court imposed FCA damages of $6.49 million. Reversing that portion of the lower court‟s decision, the circuit court held that there is no irrebuttable presumption that expert services and advice are worthless if an organizational conflict of interest provision has been violated, and ruled that the damages must take into account the value of the goods and services―a key aspect in these types of cases.
The panel did not reach the issue of the retroactivity of FERA‟s amendments to liability in Section 3729(a)(1)(B), agreeing that the amendments had no impact in the case.
[The reader should note that the author‟s firm routinely represents SAIC on other matters but was not counsel of record in this case.]
Factual and Procedural Background
SAIC entered into a contract in 1992 with NRC to provide technical assistance for the agency‟s effort to evaluate dosages of recycled radioactive material that nuclear facilities could release for commercial use without the need for a license or regulation by the NRC. SAIC signed a second similar contract with NRC in 1999. The contracts incorporated organizational conflict of interest provisions that required SAIC to forego contractual or consulting arrangements that “may give rise to a conflict of interest with respect to the work being performed” under these contracts, requiring disclosure to and the written prior approval of the NRC to clear the conflict.
In 1999, in an open meeting at the NRC, a member of the public accused SAIC of violating the conflict of interest provisions in those contracts. Based upon the allegation that SAIC was involved in the recycling issue with other firms, the government terminated SAIC‟s contracts and brought suit under the FCA. The government‟s suit alleged violations of Sections 3729(a)(1) and (a)(2) of the FCA, based on allegations that SAIC‟s subcontracts and relationships in different company divisions relating to recycling radioactive materials in Oak Ridge, Tennessee violated the conflict of interest provisions in its contracts with NRC. SAIC nevertheless delivered reports and a regulatory options paper that NRC published in 1999.
After a lengthy trial, the jury found SAIC liable and the district court entered judgment against SAIC, awarding $78 in damages on the government‟s breach of contract claim, and $6.49 million in damages under the FCA. SAIC appealed, and the court of appeals reversed the district court, vacating the jury verdict and ordering a new trial consistent with its opinion.
- The FCA’s “Knowledge” Requirement Cannot Be Met by Using the “Collective Knowledge” of the Company or Institution
Ever since the First Circuit‟s decision over 20 years ago in a criminal money laundering case, United States v. Bank of New England, 821 F.2d 844 (1st Cir. 1987), DOJ has been arguing that the “collective knowledge” theory can be used to prove the scienter necessary under the civil FCA. Use of this argument is particularly inappropriate in FCA cases involving large corporations such as SAIC, since, according to the First Circuit, it allows the aggregation of the knowledge of all corporate employees so that a corporation or institution can have the necessary “knowledge” or “scienter” even if no single individual has the necessary intent. Worse, the “collective knowledge” theory was actually dicta in the Bank of New England case because there was adequate evidence that a single bank manager had the requisite knowledge to find the bank liable in that case. While DOJ routinely argues this as a basis for FCA liability, until the district court‟s decision in SAIC, they had been remarkably unsuccessful in getting a court to agree to the theory. See John T. Boese, Civil False Claims and Qui Tam Actions § 2.08[B] (Aspen Publishers, Wolters Kluwer Law & Business) (3d ed. & Supp. 2010-1).
The panel in SAIC emphasized that, given the high stakes in FCA litigation, the FCA‟s scienter or knowledge standard must be strictly enforced. The court found that the district court‟s instruction to the jury that it could find that SAIC acted “knowingly” based on the “collective knowledge” of its employees, without requiring any particular employee to know both that the claims were false and that the company acted in reckless disregard or deliberate ignorance of the falsity, was at odds with this construction of the FCA. The panel noted that even in non-FCA cases, the circuit had expressed “skepticism about corporate intent theories that rely on aggregating the states of mind of multiple individuals,” and that no circuit had applied collective knowledge theory to the FCA. Recognizing that the FCA does not require proof of specific intent, the court nonetheless found that collective knowledge was an “inappropriate basis” for scienter because
it effectively imposes liability, complete with treble damages and substantial civil penalties, for a type of loose constructive knowledge that is inconsistent with the Act's language, structure, and purpose. 2010 WL 4909467, at *13.
The court noted that, under the FCA, liability could be based on constructive knowledge only when defendants acted with “reckless disregard” or “deliberate ignorance,” and an innocent mistake or negligence remain defenses to liability. The court emphasized that collective knowledge conflicts with this statutory standard:
Lacking such balance and precision, the "collective knowledge" theory allows "a plaintiff to prove scienter by piecing together scraps of 'innocent' knowledge held by various corporate officials, even if those officials never had contact with each other or knew what others were doing in connection with a claim seeking government funds." United States ex rel. Harrison v. Westinghouse Savannah River Co., 452 F.2d 908, 918 n.9 (4th Cir. 2003). In other words, even absent proof that corporate officials acted with deliberate ignorance or reckless disregard for the truth by submitting a false claim as the result of, for instance, a communication failure, the fact-finder could determine that the corporation knowingly submitted a false claim. In this case, the district court's instruction goes even further, drawing no distinction between the knowledge of corporate officers and that of potentially thousands of ordinary employees, including the knowledge of all employees in the "collective pool" of information imputed to the corporation. Id. at *14.
Thus, the court found that the proper standard for knowledge excludes “collective knowledge.” It found that the district court‟s instruction allowed the jury to find that SAIC knowingly submitted false claims where no individual at SAIC had all of the necessary knowledge to meet the FCA‟s knowledge requirement. Because the district court‟s instruction to the jury was erroneous and prejudicial, the court vacated the verdict and ordered a new trial.
- FCA Liability May Be Based on Implied Certification But Strict Enforcement of Materiality and Scienter Requirements is Required
SAIC also challenged the jury‟s verdict on the ground that the NRC contract did not make compliance with the conflict of interest provision an express condition to payment. The panel rejected this basis for the appeal as neither required by the statute nor by circuit precedent, thus declining to establish a rule that required an FCA plaintiff to demonstrate not only that a federal contractor failed to disclose a violation of a material condition to the government‟s payment decision, but also to show that the condition was an express prerequisite to payment. Instead, the court held that the plaintiff must show that the contractor “withheld information about its noncompliance with material contractual requirements” and that this could be established “through testimony demonstrating that both parties to the contract understood that payment was conditional on compliance with the requirement.” However, the court clearly grasped the risks of abuse under this theory, and it limited the scope of implied certification liability by requiring “strict enforcement of the Act‟s materiality and scienter requirements.” The court explained the reason for this strict enforcement requirement:
Even though we have rejected SAIC's effort to cabin the implied certification theory, we fully understand the risks created by an excessively broad interpretation of the FCA. As SAIC compellingly points out, without clear limits and careful application, the implied certification theory is prone to abuse by the government and qui tam relators who, seeking to take advantage of the FCA's generous remedial scheme, may attempt to turn the violation of minor contractual provisions into an FCA action. In our view, however, instead of adopting a circumscribed view of what it means for a claim to be false or fraudulent, this very real concern can be effectively addressed through strict enforcement of the Act's materiality and scienter requirements. Id. at *10.
Under the court‟s rule, the materiality requirement must be enforced “rigorously,” to
ensure that government contractors will not face "onerous and unforeseen FCA liability" as the result of noncompliance with any of "potentially hundreds of legal requirements" established by contract. Appellant's Reply Br. 12. Payment requests by a contractor who has violated minor contractual provisions that are merely ancillary to the parties' bargain are neither false nor fraudulent. Id.
The court recognized that the evidence at trial was in conflict, since there was evidence that the conflicts would not have been a basis for the agency to deny payment. Because the record also contained evidence that the conflict of interest provisions in SAIC‟s contract were “far from minor,” however, the court did not disturb the jury‟s verdict on that ground.
The court of appeals made one more critical ruling regarding scienter. In the course of discussing the scienter requirement in implied certification cases, the court emphasized the rational, but rarely stated, burden that an FCA plaintiff must prove not only that the defendant "knew" that the claim was false, but also that the defendant "knew" that compliance with that obligation was "material" to the government's decision to pay. As the court held:
FCA section 3729(a)(1) imposes liability only when a person "knowingly presents, or causes to be presented . . . a false or fraudulent claim." Establishing knowledge under this provision on the basis of implied certification requires the plaintiff to prove that the defendant knows (1) that it violated a contractual obligation, and (2) that its compliance with that obligation was material to the government's decision to pay. If the plaintiff proves both, and does so based on the proper standard for knowledge―which as we explain below excludes "collective knowledge," . . .―then it will have established that the defendant sought government payment through deceit, surely the very mischief that the FCA was designed to prevent. Id.
This particularly important holding means that, in implied certification cases, a defendant can argue (and the government or qui tam relator has the burden of proving otherwise) that the defendant was not aware that violation of an "implied" provision or requirement was a basis to deny payment on the claim.
The court did not discuss whether this burden will also apply in express certification cases, although in such cases, where the causation relationship between the obligation and the payment decision is expressly stated, that burden should be easier to meet.
- Damages Under the FCA Must Consider the Value That the Government Received Under the Contract
The court also rejected the district court‟s instruction to the jury that their calculation of damages “should not attempt to account for the value of services, if any, that SAIC conferred upon the Nuclear Regulatory Commission.” The court of appeals found that this instruction was flawed because it required the jury to assume that SAIC‟s services had no value. This was particularly egregious in this case because the jury had already decided that actual damages to the government, as measured for purposes of the alternative breach of contract claim, were $78. The panel pointed out that, under the benefit of the bargain framework that applied in this case, damages should be calculated by determining the amount the government paid minus the value of the goods or services provided, which is the standard measure under the FCA. Indeed, the evidence showed that the NRC continued to use SAIC‟s work product after its contract with SAIC was terminated in 1999, and an NRC project manager testified that SAIC‟s “actual work product „constituted the opposite of a conflict,‟ . . . due to its transparency and fairly conservative results.” The jury instruction erroneously removed this calculation from the case, and established an irrebuttable presumption that the services of an expert are worthless where a violation of a conflict of interest requirement has occurred. Because the district court‟s instruction to the jury required them to assume that SAIC‟s services had no value, the court vacated and remanded the damages for a new trial.