US Supreme Court False Claims Act Decision in Escobar Has Significant Implications for Contractors

Marion T. Hack, Partner, Pepper Hamilton LLP
John H. Conrad, Associate, Pepper Hamilton LLP

On June 16, 2016, the U.S. Supreme Court ruled in the matter of Universal Health Services, Inc. v. United States ex rel. Escobar, 136 S. Ct. 1989 (2016), changing the legal landscape for False Claims Act qui tam claims concerning the implied false certification theory of liability. This article will discuss the Escobar holding and examine relevant considerations for contractors in light of this ruling.

In Escobar, a teenage patient received counseling under Massachusetts’ Medicare program at a mental health facility, Arbour Counseling Services, which is owned and operated by a subsidiary of Universal Health Services, Inc. As part of the counseling process, the staff at Universal diagnosed the patient and prescribed medication. The patient had an adverse reaction to the mediation and subsequently died of a seizure. It was later determined that four out of the five Universal employees that treated the patient were not properly licensed to provide mental health counseling, prescribe medications or offer counseling services without supervision. Specifically, the person who diagnosed the patient had her psychologist license application rejected by Massachusetts, and the person who prescribed the medication was actually a nurse who lacked authority to prescribe medication without supervision, in violation of 130 Code Mass. Regs. § 429.22, et seq. Escobar, 136 S. Ct. at 1997-98.

During this time frame, Universal submitted requests for payment to the government for its personnel under Massachusetts’ Medicare program. Universal submitted these payment requests despite its knowledge that its personnel was improperly classified under the billing codes used by Universal.

The False Claims Act Claim

In 31 U.S.C. § 3730(b)(1) it states, “A person may bring a civil action for a violation of section 3729 for the person and for the United States Government. The action shall be brought in the name of the Government.” These suits are referred to as “qui tam” suits. Further, 31 U.S.C. § 3729(a) provides, “any person who knowingly presents, or causes to be presented, a false or fraudulent claim for payment or approval . . . is liable to the United States Government for a civil penalty of not less than $5,000 and not more than $10,000,[1] . . . plus 3 times the amount of damages which the Government sustains because of the act of that person.”

Under the above provisions, the respondents in Escobar brought a qui tam suit, alleging that Universal had violated the False Claims Act and defrauded the government in billing for services that were not properly rendered as described in the billings, while failing to disclose serious breaches related to Massachusetts’ Medicare program. The respondents asserted that the government would not have reimbursed the claims had it known that it was billed for mental health services that were performed by unlicensed and unsupervised staff. Escobar, 136 S. Ct. at 1997-98.

Universal filed a motion for summary judgment to dismiss the respondents’ claims. The district court granted Universal’s motion “because none of the regulations violated by Universal was a condition of payment.” The U.S. Court of Appeals for the First Circuit reversed, holding that “every submission of a claim implicitly represents compliance with relevant regulations, and that any undisclosed violation of a precondition of payment (whether or not expressly identified as such) renders a claim ‘false or fraudulent.’” The First Circuit also held that the “regulations themselves provided conclusive evidence that compliance was a material consideration of payment.” Id. at 1998.

The U.S. Supreme Court rejected both the holding of the district court and the holding of the First Circuit and remanded to the district court for further determination of the matter utilizing the new standard for implied certification claims under the False Claims Act. Id. at 2004.

New Standard for Implied False Certification Claims

The Court in Escobar held:

[T]he implied false certification theory can, at least in some circumstances, provide a basis for liability. By punishing defendants who submit “false or fraudulent claims,” the False Claims Act encompasses claims that make fraudulent misrepresentations, which include certain misleading omissions. When, as here, a defendant makes representations in submitting a claim but omits its violations of statutory, regulatory, or contractual requirements, those omissions can be a basis for liability if they render the defendant’s representations misleading with respect to the goods or services provided.

Id. at 1999 (emphasis added).

In Escobar, Universal knowingly submitted payment applications that listed specific billing codes corresponding to certified and licensed personnel, where those individuals were not certified or licensed, thus misleading the government into paying the invoices. Id. at 1997. The Escobar Court clarified that the claims in the matter related to more than just demands for payment and that “representations that state the truth only so far as its goes, while omitting critical qualifying information[,] can be actionable misrepresentations.” Id. at 2000.

A critical determination in the new Escobar standard is whether the statements made qualify as actionable misrepresentations. The Court in Escobar provided examples of some statements that create actionable misrepresentations to guide future litigation. When a seller of property reveals that there are two new roads near a property for sale, but fails to disclose that a third potential road might bisect the property, the seller has omitted key information that would “materially affect the value of the purchase.” Id. (citing Junius Const. Co. v. Cohen, 257 N.Y. 393, 400 (1931)). An applicant for a position at a college makes actionable misrepresentations when his résumé lists prior jobs and then retirement, but fails to disclose that his “retirement” involved time in prison for a $12 million bank fraud. Id. (citing Sarvis v. Vermont State Coll., 172 Vt. 76, 78, 80-82 (2001)). Both of these examples point to the need for the misrepresentation to affect the basic value of the goods or services to be provided in order to be an actionable misrepresentation.

The Escobar Court also held a critical factor was that the “misrepresentation about compliance with a statutory, regulatory, or contractual requirement must be material to the Government’s payment decision in order to be actionable under the False Claims Act.” Id. at 1996 (emphasis added). The Court also held that liability is not limited to cases where the requirements involved were expressly designated as conditions of payment. Id. at 2001. To assist in interpreting this standard, the Court provided an example of a material misrepresentation. When a contract involves the supply of guns, and the contract does not state that the guns must actually shoot, but the supplier knows that the government routinely rescinds contracts if the guns do not shoot, the supplier has “actual knowledge” of the materiality of that requirement. Further, the seller’s failure to appreciate the materiality of that condition would amount to “deliberate ignorance” or “reckless disregard” of the falsity of the information. Id. at 2001-02. The Court also cited to United States ex. rel. Marcus v. Hess, where two contractors violated a non-collusion bidding requirement and withheld that information. This was implicit false certification because the government would not have funded the subsequent payments had it known of the violation. Id. at 2003 (citing Marcus, 317 U.S. 5379, 543 (1943)).

In the construction context, misstatements concerning the types of materials supplied or the qualifications of the individuals whose labor is billed could implicate this implied false certification theory of the False Claims Act. For example, consider a construction contract that calls for a specific material or equipment that is required to meet specified quality or regulatory requirements. If the contractor knowingly supplies a different and lesser quality item and then bills for the government per the schedule of values including the originally specified item, then the contractor may be liable for implicitly submitting a false claim. Where a design/build contract calls for engineering or oversight services to be performed by a licensed engineer, or where a construction management contract calls for licensed or certified personnel to perform services, and where the contractor supplies unlicensed or uncertified personnel for the positions involved, an implied false certification claim is possible. Another example is a time and material construction contract that specifies categories of workers, depending on specific worker classifications and training levels. If the contractor provides labor that does not meet those specified classifications within the contract (e.g., supplying apprentice labor and billing for journeymen), and the contractor submits billing for personnel based on the classifications that do not match the personnel qualifications, the contractor is potentially liable for an implied false certification claim.

In all of these possible scenarios posed above, contractors need to be vigilant in verifying that the labor or materials supplied by the contractor or its subcontractors do in fact meet the specifications and/or regulatory requirements for any project. Otherwise, the contractor could be exposed to significant per act penalties and treble damages under the False Claims Act. Should any of these issues arise, a contractor should seek assistance in resolving the matter at the earliest time to avoid or minimize the potential penalties.

[1] The government revised the penalties in 2015 via 28 C.F.R § 85.3(a)(9) to a minimum of $10,781 and a maximum of $21,563 per occurrence.

Article originally posted August 26, 2016 on Constructlaw, an update and discussion of recent trends in construction law and construction, maintained and edited by Pepper Hamilton's Construction Law Practice Group. 

Materials "Considered" by Construction Expert Are Off Limits

The Rhode Island Supreme Court, in Cashman Equipment Corporation, Inc. v. Cardi Corporation, Inc. interpreted Rule 26 of the R.I. Superior Court Rules of Civil Procedure to hold that the Plaintiff subcontractor could not discover all materials that the Defendant general contractor's testifying expert considered when formulating his opinions.

The underlying matter concerned work on a bridge that spans the Sakonnet River in eastern Rhode Island.  Plaintiff served as the bridge foundation subcontractor on the project. Plaintiff alleged that it incurred additional costs because the Defendant general contractor issued a defectively designed cofferdam and materials to Plaintiff.  Defendant disagreed and tapped an engineering expert who opined that cofferdam design was not defective.  Plaintiff sought to investigate the underpinnings of that opinion and requested "all materials and documents, less core attorney work product, including all computer models and drafts of materials and documents, developed and considered by [Defendant's] testifying expert . . . in the process of formulating his written expert opinions.”  Defendant refused to produce the drafts of its expert's models and documents.  Plaintiff retorted with a motion to compel thatthese materials "considered" by the expert were within the scope of Rule 26, were discoverable, and were necessary to "assure effective cross-examination of testifying experts." The Superior Court disagreed and denied the motion to compel.

On writ of certiorari on the interlocutory issue, the Supreme Court started with the section of Rule 26 that embraces expert discovery:
A party may through interrogatories require any other party to identify each person whom the other party expects to call as an expert witness at trial, to state the subject matter on which the expert is expected to testify, and to state the substance of the facts and opinions to which the expert is expected to testify and a summary of the grounds for each opinion. A party may depose any person who has been identified as an expert expected to testify when the expert interrogatory has been responded to by the other party.

Rule 26(b)(4)(A) of the R.I. Superior Court Rules of Civil Procedure.  With a nod to the reasonableness of the Plaintiff's request, but constrained by this plain language in the rule, the Court concluded that investigation of experts "is confined by its very terms to discovery through interrogatories or deposition." As a result, Plaintiff was not entitled to review Defendant's expert's documents considered.  The Court went on to hint that a rule change may be in order.

After reaching this decision, the Supreme Court observed that Rhode Island's current Rule 26 diverges from the current Federal Rule, which does require a party to disclose a testifying expert witness's report along with, inter alia, "the data or other information considered by the witness in forming the opinions."
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The author, Katharine Kohm, is a committee member for The Dispute Resolver. Katharine practices construction law and commercial litigation in Rhode Island and Massachusetts. She is an associate at Pierce Atwood, LLP in Providence, Rhode Island. She may be contacted at 401-490-3407 or kkohm@PierceAtwood.com.

Is 30 Days Enough Time to Fully Arbitrate and Issue an Award for a Claim on a Partial Parking Garage Collapse? Federal Court Says Let the Arbitrator Decide

The plaintiff in Tribal Casino Gaming Enterprise v. W.G. Yates & Sons Construction Company et al entered into a contract for the expansion of an existing facility at Harrah’s Cherokee Casino in Cherokee, North Carolina with defendants in April of 2008.  The project included the construction of two parking structures, one, an eight level 2,300 space facility and the other a six level, 1,200 space facility connected to the hotel structure.  Defendant then contracted with its co-defendant to furnish and erect the precast parking garages. An arbitration clause contained within the prime contract stated in part that:

“Any controversy or claim arising out of or relating to this  Agreement shall…be settled by binding arbitration in accordance with the Commercial Arbitration Rules of the American Arbitration Association…The parties agree that the only grounds for appeal of any arbitration award…shall be...where the arbitrators were guilty of misconduct in refusing to postpone the hearing, upon sufficient cause shown, or in refusing to hear evidence pertinent and material to the controversy, or any other misbehavior by which the rights of any party have been prejudiced…The arbitration panel shall be required to render a decision within thirty (30) days after being notified of their selection.”

In February of 2015, a ramp located in the hotel parking garage partially collapsed and the plaintiffs filed suit in February 2016 for damages related to breach of contract, breach of warranty, negligence, gross negligence, and unfair and deceptive trade practices. Plaintiff also filed a demand for arbitration with the AAA at that time.  In May 2016, plaintiff filed a motion to stay pending arbitration and to compel arbitration, and then chose its designated arbitrator. This gave the defendants fifteen days to designate its arbitrator, and then gave those arbitrators fifteen days to select the third member of the panel, with a final decision having to be rendered thirty days later.  Defendants jointly filed a motion to stay the arbitration.

The Court began its analysis by presenting the plaintiff’s argument that the arbitration is enforceable against the defendant based upon the Federal Arbitration Act and the North Carolina Revised Uniform Arbitration Act.  In turn, the defendants do not challenge the validity of the contract, but “contend that [plaintiff’s] claim falls outside the scope of the arbitration clause, or alternatively, that the arbitration clause itself is unenforceable due to its unreasonably short time period within which the arbitration panel must render a decision.” The Court next proceeds to examine if the claim itself is arbitrable.

In order to determine whether the claim itself is arbitrable, the Court begins by pointing to the fact that the contract was signed in 2008. The 2007 AAA’s commercial rules regarding arbitrability read, “"The arbitrator shall have the power to rule on his or her own jurisdiction, including any objections with respect to the existence, scope or validity of the arbitration agreement."  The Court contrasts this to the 2013 update which states, “"The arbitrator shall have the power to rule on his or her own jurisdiction, including any objections with respect to the existence, scope, or validity of the arbitration agreement or to the arbitrability of any claim or counterclaim."  By not incorporating similar language to the AAA’s 2013 rules on arbitrability, the Court finds that it has the jurisdiction by stating, “the language that the parties actually incorporated into their agreement, however, only delegated the substantive arbitrability issues of existence, scope and validity. As to all other issues of substantive arbitrability, including enforceability, the presumption is not rebutted, and these issues are left for the Court.”

Finding that it had the jurisdiction to rule on the arbitrability of the plaintiffs claim, the Court presented the defendant’s arguments that the clause is unenforceable because of, “contractual impossibility due to unreasonable time constraints, or constitutional invalidity based upon due process and fundamental fairness.” The court does agree with the defendant that allowing an arbitration panel thirty days to review and assess liability for a partial-collapse of a parking garage years after the project was completed “would be a Herculean feat, if not utterly impossible.” But the Court does not find that the arbitration provision is unenforceable. 

The Court acknowledged that such a thirty day arbitration clause is desirable and even necessary for mid-construction disputes because some issues arise that would require immediate attention, but the contract’s arbitration clause does consider such issues or claims that are more complex and require an extended period of deliberation. “The arbitration clause provides that an arbitration award may be vacated for misconduct of the arbitration panel if the panel, upon sufficient cause, (1) refuses to postpone the hearing, or (2) refuses to hear evidence pertinent and material to the controversy.”  The Court found that the arbitration panel does possess the power to “extend the date for the final disposition hearing and to set discovery deadlines within that timeframe.”  Accordingly, the arbitration clause is not unconscionable, illegal, or unconstitutional, and it does not render the arbitration provision unenforceable.

The Defendant’s motion to hold the arbitration clause unenforceable was denied. 

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The author, Brendan Carter, is a contributor to The Dispute Resolver and a former Student Division Liaison to the Forum on Construction Law.  He is an attorney and a Senior Consultant with Navigant’s Global Construction Practice based out of Boston, MA.  He may be contacted at 617.748.8311 or brendan.carter@navigant.com.

In the U.S. Fifth Circuit, It Remains Undecided Whether Manifest Disregard of the Law or an Award’s Violation of Public Policy Are Grounds to Vacate an Arbitration Award

While most posts on this blog usually discuss notable court decisions that resolve otherwise undecided issues, this post discusses a recent case that is notable because the court did not resolve an undecided issue of law in that circuit, deciding the case instead on a factual ground and never reaching legal question presented. 

In McKool Smith, P.C. v. Curtis International, Limited, 2016 WL 2989241 (5th Cir. 2016), the U.S. Fifth Circuit addressed a party’s claim that an arbitrator’s alleged manifest disregard of the law and the award’s alleged violation of public policy remained grounds for vacating an arbitrator’s award. 

The case arose from an arbitration award in favor of a law firm, McKool Smith, P.C. (“McKool”) against its client, Curtis International, Limited (“Curtis”), following McKool’s representation of Curtis in a prior patent litigation.  Curtis sought to vacate the award, claiming that the arbitrator manifestly disregarded the law by allowing McKool to recover for block-billed time entries and that the award violated Texas public policy for similar reasons.

The court noted that, since the U.S. Supreme Court’s decision in Hall Street Associates, L.L.C. v. Mattel, Inc., 552 U.S.576, 128 S.Ct. 1396, 170 L.Ed.2d 254 (2008), the court had acknowledged that arbitration awards only could be overturned on statutory grounds under the Federal Arbitration Act.  However, Curtis urged the Fifth Circuit to rule - as other courts have ruled - that an arbitrator’s manifest disregard of the law or an award’s violation of public policy were statutory grounds because in those situations arbitrator has “exceeded [his or her] powers” within the meaning of 9 U.S.C. § 10(a)(4).

The 5th Circuit, however, held that, even if the court were to consider that manifest disregard of the law or violation of public policy were statutory grounds to vacate an arbitration award, the arbitrator in the pending case had not manifestly disregarded the law and the award did not violate Texas state public policy.  Therefore, in the 5th Circuit, whether manifest disregard of the law or violation of public policy are statutory grounds for vacating an award remains unresolved.

For your reference, linked here is a copy of the 5th Circuit’s unpublished decision.

Western District of Virginia Confronts Several Legal Issues That Frequently Impact Multi-Party Construction Disputes – Economic Loss, Damage to Other Property, Third Party Beneficiary Status, Warranties, Subrogation, and Third-Party Joinder

Robert A. Gallagher, Associate, Pepper Hamilton LLP

Allstate Insurance Company v. Structures Design/Build, LLC, 2016 U.S. Dist. LEXIS 34349 (WD VA March 17, 2016)

This construction dispute case arises from a failed pipe connector that caused water damage to a facility and insured personal property, which Hillel at Virginia Tech, Inc. (“Hillel”) owned in Blacksburg, Virginia. Hillel contracted Structures Design/Build, LLC (“Structures”) to design and construct the facility. Structures, in turn, subcontracted PJ Little Plumbing, Inc. (“PJ”) for plumbing and mechanical installation. PJ purchased the failed pipe connector from CMC Supply, Inc. (“CMC”). Allstate Insurance Company (“Allstate”) insured Hillel for the damage to the facility and the personal property.

As Hillel’s subrogee, Allstate filed a complaint against Structures and PJ. Allstate sued Structures for various state law claims. It sued PJ for negligence and breach of express and implied warranties. PJ filed a third-party complaint to join CMC on a breach of implied warranty theory. PJ and CMC moved to dismiss the claims against them.

The court granted in part and denied in part PJ’s motion. It dismissed the negligence claim against PJ with respect to damages arising from harm to the facility, because the facility was the subject of Hillel’s construction contract. The court denied the motion with respect to damages to personal property stored within the facility, because it represented damage to other property. The court denied PJ’s motion to dismiss Allstate’s implied warranty claim because it found Hillel to be a third party beneficiary to PJ’s subcontract with Structures, and all such construction contracts in Virginia contain an implied warranty to perform services in a good, safe, and workmanlike manner, free of defects. The court dismissed Allstate’s express warranty claim because it failed to plead sufficient facts to support the existence of any express warranty between PJ and Hillel.

The court granted CMC’s motion in its entirety. The court held that PJ’s third-party complaint failed to state a claim for derivative liability under Rule 14 of the Federal Rules of Civil procedure because it alleged facts that were factually distinct from those alleged in the original complaint. PJ alleged that CMC was liable to Hillel because it manufactured a defective connector, whereas Allstate alleged that PJ was liable on the basis that it improperly installed or selected an unsuitable connector. The court noted that if Allstate succeeded in proving that PJ failed to properly install or select the connector it would do little to support PJ’s claim against CMC that the connector was defective.
The following summarizes the court’s reasoning for its conclusions:

Allstate’s Negligence Claim Against PJ

PJ argued that the economic loss doctrine barred Allstate’s negligence claim. The court considered two factors: (i) whether the alleged breach involved duties outside of those assumed under contract, and (ii) whether the property damage included property that was not subject to the agreement between the parties. The court first found that the complaint failed to allege that PJ breached any duty imposed by law, as opposed to the parties’ contract.

The court next found that damage to the facility could not be recovered in tort because it represented only economic loss. According to the court, Hillel had purchased a “package” for the construction of its facility and one component of that package – the pluming work – damaged other parts of the construction package. The court found the case of Sensenbrenner v. Rust, Orling & Neale, Architect, Inc., to be instructive. 374 S.E.2d 55 (Va. 1988). In Sensenbrenner, the owner contracted a building company to design and construct a house with a pool. When a defect in the pool caused damage to the house’s foundation, the owner sued in tort to recover for damages to the pool and the house. The Virginia Supreme Court found that the owner alleged nothing more than “disappointed economic expectations,” because the owner contracted for the purchase of a package, which was “alleged to have been defective” as “one or more of its component parts was sufficiently substandard as to cause damage to the other parts.”

The court, however, held that Allstate could recover for damage to the personal property stored at the facility because that property was not part of Hillel’s contractual package for the construction of the facility. The court noted that PJ had appeared to concede that this part of Allstate’s claim could go forward. The court did not allow the mere existence of this other property damage to open the door for recovery for damages that related to property within the construction package. So the court permitted Allstate to proceed on its negligence claim against PJ for only damages to the personal property stored at the facility.

Allstate’s Breach of Warranty Claim Against PJ

Allstate alleged that PJ breached express and implied warranties. PJ argued that Allstate could not support its claims because neither Hillel nor Allstate had a contract with it. The court found that while PJ did not contract directly with Hillel, it was the third party beneficiary to PJ’s subcontract with Structures, because the subcontract contained several provisions whereby PJ agreed to provide indemnity to Hillel. Although the court found one of the indemnity provisions void under Virginia’s anti-indemnity laws, it believed that the remaining provisions were sufficient to show that Hillel was an intended beneficiary of the subcontract.

Notwithstanding Hillel’s status as a third party beneficiary to the subcontract, the court dismissed Allstate’s express warranty claim because Allstate failed to allege sufficient facts to support the existence of any express warranty between PJ and Hillel. The court concluded that Allstate had sufficiently stated a claim for breach of the implied warranty found in all construction contracts in Virginia, which require contractors to perform its services in a “good, safe, and workmanlike manner free from defects and in accordance with all applicable codes and standards.”

PJ’s Third-Party Complaint to Join CMC

CMC moved to dismiss the third-party complaint on the basis that it failed to state a claim for derivative liability under Rule 14 of the Federal Rules of Civil Procedure. Under Rule 14, a party may not implead a third-party merely because he may be liable to plaintiff. In other words, a third-party complaint that alleges “it’s him, not me” is improper under Rule 14. CMC argued that PJ’s third-party complaint simply contended that CMC was liable directly to Hillel because it manufactured a defective part, which if true wholly, or partly, excused PJ from liability.

According to the court, Rule 14 cannot be used to bring in matters that merely have some relationship to the original action. The court found that the original complaint’s allegations were factually distinct from those in the third-party complaint. PJ alleged that CMC was liable to Hillel for its damages because it manufactured a defective part, whereas Allstate alleged that PJ was liable for installing a connector that was not equipped to handle the high temperatures in the facility’s hot water system.

The court concluded that Allstate’s dispositive question was whether the connector was properly installed or selected, not whether it was properly manufactured. So if Allstate succeeded in proving that PJ failed to properly install the connector in the hot water system, such a claim would do little to support PJ’s claim against CMC that the connector was defective. The court also noted that PJ failed to allege that the parties were joint tortfeasors or that it had a right to indemnity or contribution from CMC if it were held liable to Allstate. The court ultimately dismissed PJ’s third-party complaint against CMC because it violated Rule 14 and because CMC’s dismissal promoted judicial economy and fairness.

Article originally posted July 14, 2016 on Constructlaw, an update and discussion of recent trends in construction law and construction, maintained and edited by Pepper Hamilton's Construction Law Practice Group.