The Materiality Regime

Hutcheson's approach provided a much-needed reconsideration of the falsity analysis under the FCA separate from the certification constructs. The Act simply requires that a claim in question be materially false and knowingly submitted or caused to be submitted by the defendant. [FN93] It is materiality, therefore, that is at *127 the crux of falsehood. [FN94] However, Hutcheson did not entirely discard the certification constructs; it merely advised against relying on certification constructs as the sole basis for falsity under the FCA. In that sense, Hutcheson did not go far enough.

As correctly identified by the First Circuit and for the reasons outlined throughout this Article, the judicially created constructs of certification have created artificial barriers that obscure and distort the remedial goals of the FCA, without providing anything of value in return. [FN95] First, these judicial constructs have failed to protect the integrity of the FCA regime by circumscribing liability to the correct scope of cases without being under-inclusive or over-inclusive. Secondly, these judicial constructs have failed to simplify analysis or unify the governing jurisprudence to create predictability in the application of the Act. Thirdly, by usurping the materiality requirement of the Act, these judicial constructs have failed to follow the very text of the statute they were designed to advance. In every material respect, [FN96] therefore, these judicial constructs have failed and should be abandoned in favor of a pure application of the text of the FCA.

Liability under the FCA requires exclusively that the violated rule be material to the government's decision to contract or pay and that the defendant act with the requisite scienter (e.g., knowingly) in submitting or causing the submission of the materially false claim. [FN97] The meaning of both elements is well developed *128 in the FCA case law, which contains ample guidance to safeguard the proper scope of the Act. [FN98] If both elements are proven in any given case, FCA liability is appropriate.

Generally, the defendant "knowingly" submits a false claim if it acts with actual knowledge of the falsity of the claim or deliberate ignorance of the truth or falsity of the claim. [FN99] Because the certification theories never affected the scienter requirement for FCA liability, this Article does not canvass the law that addresses what constitutes a "knowing" submission of a false claim under the FCA. [FN100] Instead, the remainder of this Article is dedicated to fleshing*129 out the concepts of materiality that this author believes should exclusively govern "falsity" under the FCA.

Unlike the certification theories discussed in this Article, the framework for evaluating the materiality of a rule is not complex. Materiality has been defined as any statement, express or implied, that has "'a natural tendency to influence, or [is] capable of influencing, the decision of the decision-making body to which it was addressed."' [FN101] In other words, when a representation of compliance with a rule--however and wherever expressed--would have a tendency of influencing the government to pay, then the rule is material to payment.

The government or the relator prosecuting a case on behalf of the government carries the burden of proving the materiality of the rule, proving by a preponderance of the evidence that compliance with the rule is material to the government's decision to pay. [FN102] At the pleading phase, the government's burden is merely to show the plausibility that the rule is material to the payment decision. [FN103]

Contrary to the capricious formalities advanced by certification theories (that a condition to payment be found in one place or another or be declared in one way or another), a rule can be material regardless of whether it appears in a legislatively enacted source, contract, or other formal place. Indeed, while "[e]xpress contractual language may 'constitute dispositive evidence of materiality,' . . . materiality may be established in other ways, 'such as through testimony demonstrating that both parties to the contract understood that payment was conditional on compliance with the *130 requirement at issue."' [FN104] To the extent the rule in question does appear in a written source, courts must specially focus on the importance to payment that the text places on compliance with the rule. The inquiry requires "analysis focus[ing] on the underlying contracts, statutes, or regulations themselves to ascertain whether they make compliance a prerequisite of the government's payment." [FN105] In other words, where a text provides that the government expects compliance with a rule as a condition to payment, that text should not be lightly overcome, if at all, through extraneous evidence that contradicts the meaning of the text. However, the rule need not appear in a particular text or state that it is a condition of payment in order for it to be material to payment.

It is important to emphasize that, in having to prove that compliance with a rule is material to payment, the government and the relator need not prove that the government would not have actually paid the claim had it known of the non-compliance, but rather that it may not have paid. [FN106] The reason is simple. Judging a priori the materiality of required compliance with a rule appropriately incentivizes defendants to observe compliance with all material rules of a government program at the time the claim is made. [FN107] *131 The opposite approach would create a perverse incentive for defendants to ignore compliance with material rules of a program in the hopes of arguing after claim submission that the government would have paid the claim anyway. In sum, the meaning of materiality is well developed in FCA jurisprudence and, coupled with the scienter requirement of the FCA, should provide the exclusive framework for deciding "falsity" in FCA cases.

Consider, for example, the erroneous results the express and implied certification theories would lead to in the following hypothetical. Assume that pharmaceutical company ABC enters into a contract with a hospital whereby the hospital agrees to have its pharmacy dispense ABC's drug X, rather than the competitor's drug Y, in order to obtain a discount on another very popular ABC drug. Assume the discount is not a kickback under applicable law. As a result, every time a physician writes a script for drug Y, the hospital pharmacy dispenses drug X and bills Medicare and Medicaid. Drug X is not more efficacious than Drug Y, but Drug X does cost more than Drug Y. Assume further that state law does not allow hospitals to dispense a prescription drug without a valid order from the treating physician, that the Code of Federal Regulations makes compliance with state law a condition of participation in Medicare (but that no written authoritative source states that compliance with this state law is a condition of payment), and that the hospital expressly certified compliance with all state laws in both its provider participation agreement and in its periodic cost reports submitted to CMS (the Agency which administers Medicare and Medicaid).

Under those circumstances, the hospital has knowingly violated state law in order to improperly enrich itself at the expense of Medicare and Medicaid, harming the integrity of those programs. The hospital's conduct, however, would not be actionable under express certification theory because its express certification of compliance is too broad under that construct. It would also fail as a cause of action under the implied certification theory because the state law in question does not expressly state that the hospital must comply with it in order to be paid, and there is no written authoritative source (such as a contract between the programs and the hospital) that pre-conditions payment on hospital compliance with this state law. This embodies the quintessential question of materiality that only a materiality regime can properly address.

*132 In a materiality regime, the government or the relator would simply have to show that if the government had known of the hospital's conduct, the decision to reimburse the hospital would have been affected. Such a showing would simply require evidence that the government relies on a number of material assumptions when it agrees to and reimburses hospital pharmacies for prescription drugs. One such material assumption is that prescription drugs will only be dispensed at the valid order of a treating physician. The reason that such an assumption is material to reimbursement is that the government only pays for drugs that a physician--in his independent medical judgment, formed after extensive medical training and consultation with his patient-- determines is needed for treatment. Failure of this basic safeguard threatens the integrity of our health care system in numerous ways, one of which is that it shifts treatment decisions from being driven by patient need to being driven by a third party's desire for financial gain. Given the foregoing, one can easily see that the government would be able to show that compliance with the rule in question is material to payment and that a claim for payment while this rule was violated would be legally false under the FCA, so long as the hospital submitted such claim knowingly. In sum, only under a materiality regime would the hospital's knowing conduct be actionable under the FCA.

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[FN93]. See id. at 388 n.12 ("The parties contest the proper place of this materiality requirement in the analysis under the FCA. Hutcheson argues that a claim can only be legally false or fraudulent if the legal defect is material. Blackstone argues . . . that these are two separate inquiries, such that a claim can be false or fraudulent without being materially so. We decline to resolve this semantic dispute, which has no bearing on the outcome of this case. It is uncontested that only false or fraudulent claims that are materially false or fraudulent can give rise to liability under the FCA."); see also United States ex rel. Nowak v. Medtronic, Inc., 806 F. Supp. 2d 310, 342 (D. Mass. 2011) ("In order to establish liability under s 3729(a)(1), the plaintiff must demonstrate that the defendant '(1) present[ed] or cause[d] to be presented . . . a claim for approval or payment, where (2) that claim is false or fraudulent, and (3) the action was undertaken 'knowingly,' in other words, with actual knowledge of the falsity of the information contained in the claim, or in deliberate ignorance or reckless disregard of the truth or falsity of that information."' (quoting United States ex rel. Karvelas v. Melrose-Wakefield Hosp., 360 F.3d 220, 225 (1st Cir. 2004) and 31 U.S.C. s 3729(a)(1)(b) (2006 & Supp. V 2011))).

[FN94]. See Hutcheson, 647 F.3d at 392 ("We first address whether the claims at issue here misrepresented compliance with a precondition of payment so as to be false . . . and then address whether those misrepresentations were material.").

[FN95]. As the Supreme Court of the United States has amply recognized, in writing the FCA, "Congress wrote expansively, meaning 'to reach all types of fraud, without qualification, that might result in financial loss to the Government."' Cook Cnty. v. United States ex rel. Chandler, 538 U.S. 119, 129 (2003) (quoting United States v. Neifert-White Co., 390 U.S. 228, 232 (1968)). Congress did not write the FCA only to reach frauds "expressly" or ""implicitly certified" that appear in one document or source to the exclusion of some others, as these certification theories would require.

[FN96]. Pun intended.

[FN97]. See United States ex rel. Hendow v. Univ. of Phx., 461 F.3d 1166, 1172 (9th Cir. 2006) ("So long as the statement in question is knowingly false when made, it matters not whether it is a certification, assertion, statement, or secret handshake; False Claims liability can attach." (emphasis added)).

[FN98]. Two of the Circuit Courts of Appeal agree with the author. See United States v. Sci. Applications Int'l Corp., 626 F.3d 1257 (D.C. Cir. 2010), where the court rejected the defendant's argument that legal preconditions of payment must be expressly designated as such to give rise to false claims, stating that "nothing in the statute's language specifically requires such a rule" and that adopting one could "foreclose FCA liability in situations that Congress intended to fall within the Act's scope." Id. at 1268. Instead, it calls for "strict enforcement of the Act's materiality and scienter requirements." Id. at 1270; see also Hutcheson, 647 F.3d at 388 (1st Cir. 2011) ("We are not persuaded . . . by the concerns that prompted the Second Circuit to adopt such a [certification] rule in Mikes . . . . The court reasoned that to find [standard of care] claims false or fraudulent would allow the government and relators to supplant private plaintiffs in medical malpractice suits. . . . [O]ther means exist to cabin the breadth of the . . . FCA. The text of the FCA and our case law make clear that liability cannot arise under the FCA unless a defendant acted knowingly and the claim's defect is material.").

[FN99]. "Knowing" behavior includes "ostrich-like" behavior of burying one's head in the sand and refusing to learn information that an individual exercising reasonable judgment would have reason to know. See, e.g., Laymon v. Bombardier Transp. (Holdings) USA, Inc., No. 05-169, 2009 WL 793627, at *12 (W.D. Pa. Mar. 23, 2009). Reckless disregard is a linear extension of "gross negligence" and lies on a spectrum between gross negligence and intentional harm. Id.

[FN100]. The scienter requirement requires that a plaintiff show that the defendant "knows" (as defined by the Act), that (1) it violated a term and (2) that the term was material to the government's decision to pay. See supra text accompanying notes 5-7; see also SAIC II, 626 F.3d at 1271; Laymon, 2009 WL 793627, at *12 (laying out in extensive detail the standards for "knowing" and "knowingly" under the Act and holding that "a defendant's state of mind typically should not be decided on summary judgment").

[FN101]. United States v. Gaudin, 515 U.S. 506, 509 (1995) (quoting Kungys v. United States, 485 U.S. 759, 770 (1988)).

[FN102]. See, e.g., United States v. Kellogg Brown & Root Servs., Inc., 800 F. Supp. 2d 143, 158 (D.D.C. 2011) ("The materiality prong requires the government to 'prove by a preponderance of the evidence that compliance with the legal requirement in question is material to the government's decision to pay."' (quoting SAIC II, 626 F.3d at 1271)).

[FN103]. See, e.g., id. ("At this stage of the proceedings, . . . the government has stated enough to draw the inference that the provisions in question are material to the government's decision to pay. 'So long as the pleadings suggest a plausible scenario to show that the pleader is entitled to relief, a court may not dismiss."' (quoting Atherton v. District of Columbia, 567 F.3d 672, 681 (D.C. Cir. 2009))).

[FN104]. United States ex rel. Hutcheson v. Blackstone Med., Inc., 647 F.3d 377, 394 (1st Cir. 2011) (quoting) SAIC II, 626 F.3d at 1269), cert. denied, 132 S. Ct. 815 (2011).

[FN105]. United States ex rel. Conner v. Salina Reg'l Health Ctr., Inc., 543 F.3d 1211, 1218 (10th Cir. 2008); see also United States ex rel. Lemmon v. Envirocare of Utah, Inc., 614 F.3d 1163, 1168-69 (10th Cir. 2010).

[FN106]. See, e.g., Lemmon, 614 F.3d at 1169 (holding that the government must only show that had it "known of the falsity [of the claims submitted], it may not have paid").

[FN107]. See, e.g., Laymon v. Bombardier Transp. (Holdings) USA, Inc., No. 05-169, 2009 WL 793627, at *11 (W.D. Pa. Mar. 23, 2009) (citations omitted) ("[D]espite Bombardier's position to the contrary, the actual effect of the falsity of the reports upon Bombardier's decision to pay is not controlling on the materiality issue. Rather, the focus is on the 'potential effect of the false statement when it is made.' That is, a party will be held liable for a false statement or course of conduct 'if it has a natural tendency to influence agency action or is capable of' influencing the government's funding decision, not whether it actually influenced the government." (quoting United States ex rel. Harrison v. Westinghouse Savannah River Co., 352 F.3d 908, 916 (4th Cir. 2003) and United States ex rel. Wilson v. Kellogg Brown & Root, Inc., 525 F.3d 370, 378 (4th Cir. 2008))).