Recent Decisions Provide Further Guidance on Application of Escobar’s Materiality Standard

Two recent court decisions ruled in favor of relators on the issue of materiality under the standard set forth in Universal Health Services, Inc. v. United States ex rel. Escobar, 136 S. Ct. 1989, 2001 (2016). On May 7, 2019, the Fifth Circuit reversed a decision by the Southern District of Texas, which had held that relators had failed to sufficiently plead materiality. And on May 8, 2019, the Eastern District of California denied a motion to dismiss premised on failure to adequately plead materiality.

In United States of America ex rel. Lemon v. Nurses to Go, Inc., No. 18-20326 (5th Cir.), former employees at Nurses to Go, filed suit against their employer, the president of Nurses to Go, and certain hospice providers in the Southern District of Texas. Relators alleged that they discovered irregularities in Defendants’ billing practices to Medicare for hospice services, including errors with respect to certifications, and billing for deceased patients. The district court granted Defendants’ motion to dismiss, holding that Relators had failed to plead materiality.

On appeal, the Fifth Circuit reversed the district court decision, holding that “in light of Escobar we find that Relators have alleged material violations.” The Fifth Circuit found that the district court had erred for three primary reasons. First, the court found that the violations alleged are conditions of payment because the relevant statute provides that payment for hospice services may only be made if certain requirements are met, and Relators’ claims were based on Defendants’ fraudulent certifications of compliance with these requirements. Second, the court held that Relators raised a reasonable inference that the government would deny payment if it knew about Defendants’ alleged violations because the government had taken enforcement actions against other hospice providers based on similar violations. However, the Fifth Circuit went on to state that a relator does not necessarily need to allege in the complaint specific prior government actions prosecuting similar claims in order to meet this standard. Finally, because the court held that the government would deny payment if it knew of the alleged violations, it also held that the government would “attach importance to it,” and found that Defendants’ argument that they actually provided the services they billed for missed the point. The key, according to the court, is that Defendants cannot provide and charge for these services without certifying that the patients are first eligible for those services under the terms of eligibility set forth by the government.

In the second case, United States of America ex rel. Markus v. Aerojet Rocketdyne Holdings, Inc. et al., No. 2:15-cv-2245 (E.D. Cal.), a former Senior Director of Cybersecirty, Compliance and Controls at Aerojet, Brian Markus, filed suit in the Eastern District of California alleging that Aerojet fraudulently entered into contracts knowing that it did not meet the minimum standards required to be awarded a government contract. Aerojet develops and manufactures products for the aerospace and defense industry, and its primary customers include the Department of Defense and NASA. Relator alleged that Aerojet failed to meet the minimum cybersecurity requirements to be awarded contracts funded by the Department of Defense or NASA, that Aerojet knew this, and that Aerojet repeatedly misrepresented its compliance with these requirements in communications with government officials. While he was employed, Relator refused to sign documents that Aerojet was in compliance with such guidelines, contacted the company’s ethics hotline, and filed an internal report. He was terminated two months later. He then filed suit, alleging claims under the FCA, as well as various employment-related claims.

Aerojet filed a motion to dismiss Relator’s FCA claims, arguing that Relator insufficiently pled facts as to materiality under the standard provided in Escobar, setting forth four arguments, all of which were rejected by the court.

First, Aerojet argued that it disclosed to the government that it was not compliant. The court determined that Relator had alleged with sufficient particularity that it did not fully disclose the extent of its noncompliance, and partial disclosure does not relieve Aerojet of liability.

Second, Aerojet contended that the fact that the Department of Defense and NASA have continued to contract with Aerojet since the government’s investigation into the allegations of the complaint and the fact that the government did not intervene undermine any contentions of materiality. But the court found that neither continued approval nor lack of intervention are dispositive on a motion to dismiss, and that there is no reason to believe that a decision not to intervene is a comment on the merits of the case.

Third, Aerojet argued that its noncompliance does not go to the central purpose of any of the contracts, as the contracts pertain to missile defense and rocket engine technology, not cybersecurity. Again, the court found this argument unavailing because misrepresentations as to compliance with the cybersecurity requirements could have influenced the extent to which Aerojet could have performed the work under the contract.

Fourth, Aerojet argued that neither the Department of Defense nor NASA expected full technical compliance with its cybersecurity requirements because they government has continuously amended its regulations and promulgated guidance attempting to ease the burdens of compliance on the industry. But the court found that, even if full technical compliance was not expected, Relator had properly pled that the extent to which a company was technically compliant still mattered to the government’s decision to enter into a contract.

In light of the above, the court found that Relator plausibly pled that Aerojet’s alleged failure to fully disclose its noncompliance was material to the government’s decision to enter into and pay on the relevant contracts.

Three years after the Escobar decision, the landscape around materiality continues to evolve, and although these cases quote from Escobar noting that “the materiality standard is demanding,” both of these courts give significant leeway to relators with respect to the sufficiency of their pleading on materiality.