20 June 2018

Sixth Circuit’s Split Decision In Prather Highlights Persistent Questions About the Pleading Standard for Materiality After Escobar

Last week, the Sixth Circuit again resurrected the relator’s case in United States ex rel. Marjorie Prather v. Brookdale Senior Living Communities, Inc. (a discussion of the Sixth Circuit’s previous opinion is available here.  In a 2-1 decision, the majority held that the relator’s materiality and scienter allegations sufficed under Universal Health Services, Inc. v. United States ex rel. Escobar, 136 S. Ct. 1989 (2016).  The majority issued the decision over a vigorous dissent by Judge McKeague.  The gulf between the majority and the dissent reflects persistent questions about how Escobar applies at the pleading stage (see discussion here).

Brookdale Senior Living involves alleged false claims for home health services.  According to the relator, regulations require physicians to certify the necessity of home health care plans “at the time” the plans are established or “as soon thereafter as possible.”  42 C.F.R. § 424.22(a)(2).  The relator alleged that the defendant violated this timing requirement by obtaining physicians’ certifications months after patients’ care plans had been established.

The district court dismissed the complaint for failure to allege materiality under Escobar.  In Escobar, the Supreme Court explained that a regulatory violation is only actionable under the FCA if it is material to the government’s payment decision.  The materiality analysis is based on an analysis of a variety of factors such as whether the government has expressly conditioned payment on compliance with the regulation, whether the government routinely denies claims based on violations of the regulation at issue or has actually denied claims under the circumstances of the case, and whether the regulatory requirement goes to the essence of the government’s bargain with the defendant (see discussion of Escobar here).

Applying these standards, the district court held that the relator failed to allege materiality.  It agreed with the relator that compliance with the timing requirement was an express condition of payment but found that other Escobar factors weighed against the relator.  First, the complaint did not allege a single instance of a claim that the government denied because of a belated certification even though the timing requirement has been on the books for over fifty years.  That suggested that compliance with the timing requirement was not material to the government’s actual payment practices.  Second, guidance documents that the relator cited focused on medical necessity more than timing. That suggested that the timing requirement was not the essence of the government’s bargain with the defendant.  For these reasons, the district court concluded that the relator failed to allege materiality under Escobar.

The Sixth Circuit reversed.  The majority held that it was error for the district court to draw a negative inference from the relator’s silence about government payment practices.  On a motion to dismiss, all inferences must be drawn in the relator’s favor; therefore, that negative inference was improper.  Also, the guidance documents that the relator cited provided “some support” for her allegation that the timing requirement is an important mechanism for preventing fraud, and therefore essential to the government’s bargain with the defendant.  Weighing that allegation along with allegations that compliance with the timing requirement is an express condition for payment, the majority concluded that the complaint alleged materiality under Escobar.

Judge McKeague issued a resounding dissent.  In his view, the Sixth Circuit should have joined those courts that require materiality to be alleged with particularity under Rule 9(b).  Although Escobar did not address Rule 9(b), it characterized the materiality standard as “demanding.”  The dissent argued that this standard is more akin to particularity under Rule 9(b) than notice-pleading under Rule 8.  In all events, the relator had not alleged that the government routinely refuses to pay claims based on the alleged violations, or that it would have refused to pay particular claims under the circumstances.  According to the dissent, the government’s payment habits are the best evidence of materiality. Although the relator’s silence on that point did not hurt her case, it meant that she needed some other allegations to show materiality.  In the dissent’s view, the guidance documents the relator cited only further undercut her case because none indicated the importance of the timing requirement that the relator suggested.  According to Judge McKeague, the district court was correct and the relator failed to carry her burden of affirmatively alleging materiality under Escobar.

Unlike the district court, the majority and the dissent also addressed scienter.  The majority held that the relator plausibly alleged that the defendant acted with reckless disregard for the timing requirement because the relator alleged that the defendant instructed its staff to conduct only a cursory review of claims, disregarded the staff’s concerns, and acknowledged in an email that physicians might be uncomfortable signing untimely certifications. The dissent rejected these arguments, suggesting that the defendant could not have known that belated certifications violated the FCA before the Sixth Circuit issued its decision in Prather I.  Also, the relator’s allegations suggested that the defendants worked to ensure the certifications were in fact signed by physicians, as the regulations required.  The dissent argued that the complaint was therefore neutral on scienter and insufficient under Rule 8.

The majority and the dissent diverged on most aspects of the analysis but the fundamental difference of opinion was about the pleading standard for materiality after Escobar.  That disagreement reflects broader uncertainty about how courts should apply Escobar’s instruction that the materiality standard is a “demanding” one that operates on a motion to dismiss.  It also reflects uncertainty about how courts should analyze past government payment practices at the pleading stage.

The Department of Justice filed an amicus brief urging the court to adopt its view that past government inaction does not weigh against materiality unless it is clear that the government had actual knowledge of the violations at issue.  In the government’s view, the holistic approach that Escobar requires means that materiality will usually be a jury questions.  Government inaction will only be relevant at the pleading stage if the complaint leaves no question about what the government knew and when, and there is no suggestion that the agency chose to forgive what in fact constituted fraud.  From the government’s perspective, the district court erred by considering past payment practices relevant absent actual government knowledge of the alleged fraud.

The majority’s opinion largely aligns with the government’s view.  It holds that the government’s response to non-compliant claims cannot bear on materiality unless the government actually knew about the alleged violations.  It also holds that no negative inference can be drawn from the relator’s silence on past government practice.  As long as the relator has some other basis for alleging materiality, that will be enough for the relator to carry her burden in the Sixth Circuit.

Although the 2-1 vote resolves the debate about the pleading standard for materiality in the Sixth Circuit, it points to a broader debate that only the Supreme Court can resolve.  Cert petitions have already been filed raising questions about the standard for pleading materiality in the face of government inaction.  As the dissent points out, many courts apply a more stringent pleading standard than the one the Sixth Circuit articulated in Prather.  Until the Supreme Court weighs in, the fundamental debate in Prather will likely continue in cases percolating up through the lower courts.

The Sixth Circuit’s decision is available here.

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