The Ninth Circuit in Rose Prunes the Thorns from Escobar's Rigorous and Demanding Materiality Requirement

On August 24, 2018, the Ninth Circuit issued a long-anticipated False Claims Act (FCA) opinion (U.S. ex rel. Rose v. Stephens, No. 17-15111, 2018 WL 4038194 (9th Cir. Aug. 24, 2018)), weighing in on how to apply the implied false certification theory and the materiality requirement in the wake of the Supreme Court's Escobar decision from two years ago (Univ. Health Servs., Inc. v. United States, 136 S. Ct. 1989 (2016) (Escobar)). The court's ruling narrowed the application of the implied false certification theory, but provided a generous interpretation of the materiality standard, making it a mixed bag for defendants.

The case was brought under the FCA, a federal fraud statute that permits private citizens called "relators" to bring suit on behalf of the United States for the submission of "false claims" to the government, provided that the claims are both false and material to the government's decision to pay. 31 U.S.C. § 3729. The defendant is an art school offering both undergraduate and graduate level liberal arts education. In order to qualify for certain grants through the Department of Education (DOE), the school entered into a "program participation agreement," pledging prospectively that it would follow certain requirements in its admission and education protocols. Among the requirements was one that forbade participants from rewarding admissions officers for enrolling more students. The school allegedly violated this incentive compensation ban when, according to the relators, it implemented a policy that awarded salary increases of up to $30,000 for admissions personnel with high enrollment numbers. The theory of liability articulated by relators is one of "implied false certification," meaning that every time the school requested funds through DOE, it impliedly certified that it was in full compliance with the program participation agreement, when in fact it knew that it was not because of its incentive program.

The district court had denied the defendant's motion for summary judgment in 2016, but following the Supreme Court's decision in Escobar clarifying the proper application of the implied certification theory, the district court certified several questions for interlocutory (essentially mid-case) appeal to the Ninth Circuit regarding the effect of Escobar on Rose. Prior to Escobar, some circuits had rejected implied certification as a theory entirely, while those that endorsed it applied it in a variety of ways. The Court in Escobar established the validity of implied certification once and for all, and held that the theory was viable at least when: (1) there are specific representations about the goods or services provided accompanying the claim for payment; and (2) the failure to disclose noncompliance with material requirements renders those representations "misleading half-truths." A question on appeal in Rose was whether these criteria constitute the only way to plead implied certification, or whether they are just one possible way. With its decision, the Ninth Circuit has now solidified its jurisprudence in holding that two-part standard as mandatory.

The Ninth Circuit also addressed the question of materiality. Escobar had clarified that just because compliance with the relevant regulation or contract term is a condition of payment (as the Ninth Circuit characterized compliance with the incentive compensation ban), that does not necessarily make compliance material to payment. Rather, the fact that compliance is a condition of payment is merely relevant, but not dispositive, of materiality. Materiality itself is found only where the violation in question would actually have caused the government to reject the claim for payment, had the government known about it. The Ninth Circuit re-analyzed the allegations in Rose in light of this guidance and found the evidence of materiality sufficient to survive summary judgment, as it extended beyond the mere fact that compliance with the participation agreement was a condition of payment under the grant program. Additional evidence of materiality included the magnitude of the alleged violation, and the fact that DOE had historically taken some action against schools found to have violated the incentive ban, including imposition of fines and requiring corrective actions.

The court's holding on materiality, which stands in contrast to the Seventh Circuit's holding in another post-Escobar case about violations of the same incentive compensation ban (U.S. ex rel. Sanford-Brown, Ltd., 840 F.3d 445 (7th Cir. 2016)), is not likely to sit well with defendants, particularly as relates to its interpretation of agency action. As pointed out in a fairly terse dissent by Judge Smith, the discussion of materiality lacks the rigor that the Supreme Court said must be applied when determining whether allegations meet this "rigorous" and "demanding" standard. The Ninth Circuit found that a reasonable trier of fact could find compliance with the ban material, noting that the government's pursuit against other schools of alternative sanctions, such as requiring corrective action or seeking penalties equal to less than the amount of the claims, indicated that the government "did care about violations of the incentive compensation ban and did not allow schools simply to continue violating the ban while receiving Title IV funds." But whether the government "cared" about violations is not the test dictated by the Supreme Court. The question is whether the noncompliance was so significant that the government likely would have refused payment in full had it known of it.

What This Means For You

With this decision, the Ninth Circuit has staked out a clear and unambiguous position on the mandatory application of Escobar's two-part test for implied certification. The upshot here is that defendants can press the government or relators to allege both "specific representations" about the goods or services, and to connect those representations to material omissions about noncompliance, or else risk dismissal. In practice, however, the Rose court's watered-down reading of materiality may offset any potential benefit to defendants gained by the strict reading of implied certification. In a world where a mere administrative penalty serves to prove materiality, materiality loses its bite—a bite that the Supreme Court seems to have wanted materiality to have. Particularly in light of the strong dissent by Judge Smith, it would be unsurprising if a petition for rehearing en banc follows here.

© Arnold & Porter Kaye Scholer LLP 2018 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.