13 July 2021

D.C. Circuit Applies But-For Causation Standard, Weak Materiality Test to FCA Claims, While Concurrence Questions Viability of Fraudulent Inducement Theory

On July 6, 2021, the D.C. Circuit Court of Appeals affirmed in part and reversed in part a district court’s dismissal of the qui tam suit against IBM in United States ex rel. Cimino v. Int’l Bus. Machines Corp., No. 19-7139.  The relator alleged that IBM and the Internal Revenue Service (“IRS”) had entered into a software license agreement, but that upon learning that the IRS was uninterested in renewing the agreement, IBM fraudulently induced the IRS to extend the contract.  In particular, IBM allegedly collaborated with the auditor of the agreement, resulting in an audit finding that the IRS owed IBM $292 million for noncompliance with the contract’s terms.  IBM then offered allegedly to waive that fee in exchange for the IRS renewing the agreement.  The relator further alleged that once the new agreement was in place, IBM nonetheless collected $87 million of the noncompliance penalty by disguising that amount as fees for products and services that were never provided.  According to the relator, this scheme yielded FCA liability in two ways: first, IBM fraudulently induced the IRS to renew the agreement; second, IBM submitted false claims by billing $87 million for unprovided products and services.

The United States declined to intervene, and the district court granted IBM’s motion to dismiss in full.  With regard to fraudulent inducement, the district court held that the relator failed to plead that the doctored audit was the but-for cause of the IRS’s renewal of the agreement.  Further, the court determined that the relator failed to plead materiality.  The IRS, after all, continued to pay IBM many millions, even though some at the IRS had questioned the validity of the audit results.  As for the false claims theory, the court determined that the relator failed to meet the plausibility pleading threshold, because it was not credible to allege that the IRS “sat idly by in the face of” IBM’s alleged fraud, and supposedly paid millions for nothing in return.  Relator appealed.

The D.C. Circuit, in an opinion written for the panel by Judge Rao, first addressed the relator’s fraudulent inducement theory.  Preliminarily, the court noted that the FCA’s text does not expressly contemplate liability premised on fraudulent inducement into an agreement.  The FCA, after all, penalizes false claims, and never mentions fraudulently induced contracts.  Still, the court continued, the Supreme Court in U.S. ex rel. Marcus v. Hess “placed a common law gloss on the statute, interpreting it to also prohibit fraudulent inducement.”

But in a concurrence, Judge Rao questioned whether the Supreme Court in Hess ever meant to establish a fraudulent inducement cause of action separate and apart from the existence of false claims.  This is because in Hess, prices inflated by collusion appeared on the claims themselves, and thus “could be understood to involve actual false claims within the plain meaning of the FCA.”  Furthermore, as Judge Rao noted, interpreting the FCA expansively to prohibit fraudulently induced contracts, without any false claims, conflicts with recent Supreme Court jurisprudence that has “focused on the specific language” of the FCA.  Judge Rao also suggested that condoning a fraudulent inducement cause of action may constitute judicial overreach: “If Congress had wanted to create liability for fraudulent inducement, it easily could have employed more expansive language.”  Compounding that issue, Judge Rao continued, was another separation of powers concern: whether the qui tam mechanism unconstitutionally contravenes Article II’s vesting of all prosecutorial power in the president.  Judge Rao concluded her concurrence by inviting the Supreme Court to reconsider “whether fraudulent inducement is a separate cause of action under the FCA.”

Accepting the theory’s viability despite her concerns, Judge Rao’s panel opinion considered whether the district court was correct to employ the but-for causation standard.  Quoting the Supreme Court’s opinions in Escobar and Hess, the circuit court determined that Congress intended to incorporate common law elements of fraud into the FCA, except where the text suggests otherwise.  And common law fraud requires proximate and but-for causation.  Thus, the circuit court agreed with the lower court that the but-for test applies.  Nevertheless, the circuit court reversed the district court by determining that the relator had alleged but-for causation with plausibility and particularity, despite the fact that the complaint does little more than allege that the doctored audit results worried the IRS.  The court found such allegations sufficient adequately to allege that the IRS would not have renewed the agreement but for IBM’s misconduct.

The court also reversed the district court’s determination that the relator failed adequately to allege materiality.  The panel recognized that under Escobar’s materiality analysis, the government’s payment in full despite actual knowledge of fraud is very strong evidence of immateriality.  The panel further acknowledged that the IRS supposedly was aware of misconduct by IBM yet continued to make payments.  Nonetheless, the court held that the relator adequately pled materiality at the motion to dismiss stage, because he sufficiently alleged that the fraudulent audit could have influenced the government’s decision to renew.  The panel concluded that the district court’s dismissal “boils down to a disbelief that the IRS would pay IBM millions of dollars after learning that it had been hoodwinked,” but that at the motion to dismiss stage, “a judge’s disbelief of a complaint’s factual allegations” could not serve as an appropriate basis for dismissal.  In applying this watered-down materiality standard, the court dismissed arguments by amici that finding materiality here would open the floodgates to meritless FCA suits

Finally, the circuit court affirmed the district court’s dismissal of the relator’s claim that IBM presented false claims by billing the IRS for $87 million in noncompliance penalties disguised as fees for products and services never provided.  The relator failed to plead this claim with particularity because he never alleged who submitted the claims or when the claims were submitted.

The circuit court’s decision is available here.

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