Last year, we wrote about a trial court’s decision to dismiss a False Claims Act (“FCA”) complaint regarding alleged Trade Agreements Act (“TAA”) non-compliances because the relator failed to plead fraud with “particularity” under Rule 9(b). That decision offered a sweeping rebuke of speculative FCA claims, and emphasized why it can be difficult to present a valid FCA claim based on a potential violation of a complex regulatory scheme like the TAA.
Last month, the United States Court of Appeals for the Seventh Circuit unanimously affirmed that decision in United States ex rel. Berkowitz v. Automation Aids, Inc., — F.3d — , 2018 WL 3567836 (7th Cir. July 25, 2018). In doing so, the Seventh Circuit provided additional guidance about various topics, including the Rule 9(b) standard for implied certifications and the power of the materiality defense. Our takeaways are below.
In Berkowitz, the relator — who happened to be a competitor of the defendants — claimed that the defendants sold non-TAA-compliant end products through the GSA Advantage website, and that the defendants impliedly certified TAA compliance upon submitting invoices to the government.
Because the relator was not an insider, he formulated his allegations “by comparing the sales other vendors made on the GSA Advantage online portal with certain product lists he obtained through the normal course of his business that identify the country of origin for various products.” Id. at *1. Through that analysis, he concluded that the defendants must have sold non-TAA-compliant end products to the government.
Enforcement of 9(b) Pleading Requirement Under Implied Certification Theory
As a preliminary matter, the Seventh Circuit explained that to plead fraud with “particularity” under Rule 9(b), the relator “must describe the ‘who, what, when, where, and how’ of the fraud—‘the first paragraph of any newspaper story.’” Id. at *2 (citations omitted).
Importantly, the Seventh Circuit also cited to the U.S. Supreme Court’s landmark decision in Universal Health Servs., Inc. v. United States ex rel. Escobar for the proposition that any “concerns about fair notice and open-ended liability in FCA cases based on an implied false certification theory should be ‘effectively addressed through strict enforcement of the Act’s materiality and scienter requirements.’” Berkowitz, 2018 WL 3567836, at *4 (emphasis added) (citations omitted).
The Seventh Circuit thus recognized the critical (and enhanced) role that Rule 9(b) plays in safeguarding defendants from generalized and flimsy FCA claims based on a theory of implied certification. This view is consistent with the lower court’s observation that “satisfying Rule 9(b) often will be tougher to do in implied certification cases than in cases with an outright affirmative misrepresentation . . . [because] usually it will be easier to set forth the specific details of a fraud scheme that is premised on affirmative lies than it is to sufficiently allege the specifics of a scheme based on material omissions.” United States ex rel. Berkowitz v. Automation Aids, Inc., No. 13-C-08185, 2017 WL 1036575, *7 (N.D.Ill. 2017) (emphasis in original).
Distinguishing Fraud from Mistake or Negligence
The relator generally alleged that the defendants sold non-TAA-compliant end products to the government based on a review of sales reports and product information, and alleged FCA liability based on a theory of implied false certification. The Court determined that these factual allegations did not satisfy the particularity requirement under Rule 9(b) because they did not “demonstrat[e] what occurred at the individualized transactional level for each defendant.” Berkowitz, 2018 WL 3567836, at *4 (emphasis added). “The fact that the defendants may have sold non-compliant products during a certain time period in violation of the TAA does not equate to the defendants making a knowingly false statement in order to receive money from the government. . . . At most, [the relator’s] allegations amount to claims that the defendants made mistakes or were negligent” with respect to TAA compliance, and did not rise to the level of fraud. Id. In other words, not every alleged non-compliance is fraud – especially a non-compliance which arises from a complex regulatory scheme like the TAA.
The relator also failed to allege that the defendants acted with reckless disregard. Although some defendants received a notice of non-compliance from GSA, the Court was quick to point out that the relator could not demonstrate that “the defendants who received the notices subsequently submitted claims for payment for these [non-compliant] products anyway or that any of the defendants received non-compliant warnings regarding actual product sales.” Id. at *5.
No Exceptions for Outside Whistleblowers
Although the Seventh Circuit “acknowledge[d] that it is difficult for a relator to allege with accuracy what occurs inside a competitor’s operations,” the Court explained that this “difficulty d[id] not relieve [the relator] of his obligation to adequately plead all of the elements of an FCA claim or to fully investigate his claim before filing a complaint.” Id. In other words, there is no relaxation of Rule 9(b) for outside whistleblowers.
Considering the Post-Escobar Materiality Defense
Finally, the Seventh Circuit commented about the post-Escobar materiality defense: “It also seems worth noting that the fact that the government has allegedly paid millions of dollars for the non-compliant products suggests that [the relator] cannot satisfy the materiality prong of the implied certification theory.” Id. (emphasis added).
This statement demonstrates again the power of the post-Escobar materiality defense. Favorable facts regarding government payment after knowledge of alleged violations may very well sway a Court’s view of a relator’s allegations and the case generally, and ultimately could lead to a dismissal.
Further, as we discussed in a recent article and a recent blog post, the post-Escobar materiality defense can be a critical tool for contractors looking to dismantle FCA claims based on alleged Buy American Act (“BAA”) or TAA non-compliances. Accordingly, contractors should consider keeping the government informed about potential sourcing issues/concerns because an open dialogue may help support a materiality defense down the road (and generally may foster a better relationship with the government customer).
The Seventh Circuit’s decision continues a recent trend of courts striking down FCA claims based on alleged BAA and TAA violations, and hopefully will deter relators (and the Department of Justice) from pursuing speculative claims based on complex regulatory schemes.
 By way of background, the TAA, as implemented in the FAR, generally waives the Buy American Act’s domestic preference requirements when a procurement is valued in excess of certain specified dollar thresholds or falls under a GSA schedule contract. When applicable, the TAA requires government contractors to deliver “U.S.-made end products” (i.e., end products that are “mined, produced or manufactured” or “substantially transformed” in the United States) or “designated country end products” (e.g., end products that are “wholly the growth, product, or manufacture” of or “substantially transformed” in certain foreign countries with which the U.S. has negotiated a trade agreement). An “end product” is defined under FAR part 25 as “those articles, materials, and supplies to be acquired for public use” by the government.