Earlier this month, the United States Court of Appeals for the Tenth Circuit issued a decision that provided further clarity on the False Claims Act’s standard for materiality.  The decision, United States ex rel. Janssen v. Lawrence Memorial Hospital, further demonstrated that materiality should be viewed through the eyes of the government customer rather than an hypothetical bystander.  The decision also reconfirmed that the FCA is not a “general antifraud statute” and that contractual or regulatory language conditioning payment on compliance will not necessarily prove that noncompliance was material.  Lawrence therefore serves as an important reminder to government contractors, practitioners, and other stakeholders about the significance of the materiality element in FCA litigation.

As government contractors and practitioners are likely aware, the U.S. Supreme Court issued a landmark FCA decision in Universal Health Services v. United States ex rel. Escobar.  In the opinion, the Court set a high bar for demonstrating the materiality of a violation of law, regulation, or contract to the government’s payment decision, emphasizing that FCA’s materiality standard is “rigorous” and “demanding.”  Now, a relator must show that the alleged misrepresentation likely would have had an effect on the government’s willingness to pay the contractor.  Moreover, where the government pays a claim despite knowing that certain requirements were violated, “that is very strong evidence that those requirements are not material.”  Covington has previously issued alerts about federal courts’ response to Escobar, and how to apply this high standard of materiality.

Case Summary & Ruling

In Lawrence, the qui tam relator attempted to lower the bar for materiality.  The relator primarily alleged that the defendant — who provided Medicare services — had misstated patients’ arrival times.  However, a third party investigator reviewed these allegations in 2014, identified a “quality issue” that overlapped with relator’s allegations, and presented its findings to the Centers for Medicare and Medicaid Services.  CMS took no further action in response to the investigative findings, and continued to pay the defendant for its work.  In the parlance of Escobar, CMS’ inaction—and continued payment—therefore provided “very strong evidence” that the noncompliance described by the relator was immaterial.

In response to this compelling evidence of immateriality, the relator made two primary arguments to suggest that the Court should nevertheless find defendant’s alleged misstatements to be material.  The Tenth Circuit rejected both of these arguments—and, in doing so, provided important lessons about the meaning of materiality under the FCA.

First, the relator insisted that the materiality standard should not be focused on the specific government customer’s actions, but rather what a hypothetical “reasonable” person would have done in the government customer’s shoes.  However, as the Tenth Circuit rightly pointed out, Escobar stated that materiality “look[s] to the effect on the likely or actual behavior of the recipient of the alleged misrepresentation.”  The test is subjective and not objective.  Accordingly, courts applying the FCA’s materiality standard will look exclusively at how the specific government customer would (or did) react to the alleged misrepresentations.

Second, the relator noted that Medicare regulations required the maintenance of accurate medical records as an “express condition of payment”—and claimed that this language constituted sufficient evidence of materiality.  The Tenth Circuit rejected that argument for three reasons:  (1) the regulations spoke only about the accuracy of records writ large, which was too generic and high-level to inform the materiality inquiry in this case; (2) regulatory language about a requirement constituting a condition of payment is not dispositive proof of materiality; and (3) as a factual matter, the alleged noncompliance did not go to the “essence of the bargain.”  As the Court’s analysis shows, contractual or regulatory language about the importance of compliance, standing alone, is unlikely to constitute sufficient evidence of materiality.

Key Takeaways

Consistent with Escobar, the Court’s opinion stressed that the FCA should not be viewed as a “general antifraud statute” that requires “perfect compliance” with every single regulatory and contractual requirement.  In the words of the Court:  “Substituting FCA liability for every failure to achieve perfect compliance with Medicare regulations would not only undermine the Government’s administrative program, but would render the FCA a general antifraud statute and tool for policing minor regulatory compliance issues, contrary to the Court’s directive in Escobar.”  The Court instead noted that its role was to determine whether the relator “demonstrated sufficiently widespread deficiencies that they would likely affect the Government’s payment decision.”  The relator had not made such a demonstration.  To the contrary, the alleged noncompliance affected “only a subset of a subset of the data provided” and therefore amounted to, at most, only “minor of insubstantial” noncompliance.

Although Lawrence concerned the area of Medicare compliance, the decision contains principles with applicability to all forms of United States government procurements.  Just as the FCA does not demand “perfect compliance” with all Medicare regulations, it also does not demand perfect compliance with every provision and clause of a complex regulatory regime like the Federal Acquisition Regulation (FAR) or Defense Federal Acquisition Regulation Supplement (DFARS).  It is not uncommon for procurement contracts to include blanket, generalized requirements to comply with “all applicable provisions of the FAR” or even “all laws and regulations,” but this does not mean some minor noncompliance with a FAR provision will doom a contractor to FCA liability.  As both Lawrence and Escobar make clear, not every procurement regulation will be considered material—even if it is framed as a “condition of payment.”  Instead, courts focus on how the government customer will actually respond when a regulation is not completely met.

Lawrence provides a clear example of the significance of the materiality standard in FCA cases.  Not every noncompliance will give rise to an FCA violation—particularly where the government is willing to accept the noncompliance and continue payment.  Government contractors, practitioners, and other stakeholders should keep in mind that government payment after knowledge of alleged violations may very well lead to an early dismissal.  Any contractor facing allegations of an FCA violation therefore should carefully plot a discovery strategy that maximizes its ability to gather evidence of government knowledge of the alleged misconduct and present that evidence in appropriate pretrial motions.