Allegations of fraud in the student lending industry have led to a wave of False Claims Act litigation in that sector of the economy in recent years. On occasion, state agencies chartered to provide student loan financing and other assistance have been named as defendants in these suits. Last week, in United States ex rel. Oberg v. Kentucky Higher Educ. Student Loan Corp., 681 F.3d 575 (4th Cir. Jul. 18, 2012), the Fourth Circuit was asked to decide whether such agencies are “persons” subject to liability under the FCA. See 31 U.S.C. § 3729(a)(1)(a).

Relator sued four state agencies, including the Kentucky Higher Education Student Loan Corporation, alleging that they had defrauded the U.S. Department of Education by improperly inflating their loan portfolios eligible for federal student loan interest subsidies. The state agencies moved to dismiss, arguing that they are not “persons” subject to liability under the FCA.

The FCA does not define the term “person,” but the Supreme Court has concluded that it does not cover states. In Vermont Agency of Natural Resources v. United States ex rel. Stevens, 529 U.S. 765 (2000), the Court held that the word “‘person’ does not include the sovereign” and, thus, does not “does not subject a State (or a state agency) to liability.” Id. at 787-88, 780. On the other hand, the Supreme Court held that corporations are “presumptively covered by the term ‘person’” and, as a result, municipal corporations—i.e., cities and counties—are “persons” subject to suit under the FCA. Cook County v. United States ex rel. Chandler, 538 U.S. 119 (2003).

In Ogberg, the Fourth Circuit was asked to determine how to categorize state agencies that provide student loan financing. The court refused to adopt a hard and fast rule. Instead, it concluded that the “critical inquiry” is whether a state agency is subject to “sufficient state control” to render it part of the state and, thus, “not a ‘person’” under the FCA. 681 F.3d at 579. To determine the degree of “state control,” the Fourth Circuit adopted the same test courts apply to decide whether state agencies are “arms of the state” that qualify for sovereign immunity under the Eleventh Amendment. Id. That test involves several factors, including whether the state would pay any judgment against the defendant, and whether the state has the power to appoint the defendant’s officers and directors, control its funding, or veto its actions. The Fourth Circuit remanded to allow the district court to apply the test in the first instance.

In the last decade, three other circuits—the Fifth, Ninth, and Tenth—have addressed the question whether a state agency qualifies as a “person” under the FCA and, so far, all have agreed that the Eleventh Amendment “arm of the state” test is the proper route to the answer. As qui tam relators continue to pursue novel theories of liability in the student lending industry and other financial services contexts, additional state agencies are likely to face suits, and the “arm of the state” analysis will be critical in challenging those lawsuits.