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. 

The Supreme Court of the United States To Review California’s Contract Severance Rule as Applied to Agreements to Arbitrate.

On its docket this term, the Supreme Court of the United States will consider MHN Government Services, Inc. v. Zaborowski, case no. 14-1458, and whether the Federal Arbitration Act (“FAA”) preempts the application of a California statute.  California's law affords courts discretion when faced with agreements containing unconscionable provisions -- strike entirely or sever and save.  At issue is whether, in practice, the application of this law to arbitration agreements has resulted in more striking than saving.  If history is a guide to the possible outcome, consider that in 2011 in AT&T Mobility LLC v. Concepcion, 563 U.S. 333 (2011) , the Court’s 5-4 majority struck down another California rule, concerning class-action prohibitions in arbitration agreements, because it “interfere[d] with fundamental attributes of arbitration” in violation of the tenets of the FAA.

Underlying the Zaborowski dispute are military consultants who were classified as independent contractors rather than employees.  As a result of this classification, the consultants did not receive overtime compensation and asserted various claims against their defendant employer.   In turn, the defendant employer, relying the parties’ services contract, moved to compel mandatory arbitration.  To oppose arbitration, the plaintiff consultants argued that many terms in the arbitration agreement were unconscionable and therefore the whole arbitration agreement was unenforceable.

The district court agreed with the plaintiffs and held, inter alia, that certain terms—including the limitations period of only 6 months, a punitive damages waiver, and an arbitrator-selection procedure that permitted the defendant employer to limit the universe of possible arbitrators to three from which the plaintiffs could select one— were “overly harsh,” “generated one-sided results,” and therefore were unconscionable.  Zaborowski v. MHN Gov't Servs., Inc., 936 F. Supp. 2d 1145, 1153, 1156 (N.D. Cal. 2013).  The district court then went a step further.  It acknowledged that Cal. Civ.Code § 1670.5(a) gives courts the authority either save contracts by striking the unconscionable portions or refuse to enforce contracts altogether.  Here, the district court held that the agreement was both procedurally and substantively unconscionable and was so permeated with these one-sided terms that it declined to save the agreement by severing them.  Id. at 1157.  The court denied the motion to compel arbitration.

As an aside, consider that at issue in this matter was whether there was unconscionability in the arbitration agreement, not whether the plaintiffs were unconscionably induced into making the arbitration agreement.  Where the AAA Rules are incorporated into the agreement, as here in Zaborowski, the arbitrator has specific authority to decide “objections with respect to the existence, scope, or validity of the arbitration agreement.” AAA Commercial Rules at R-7.  Consider whether the district court could have declined to address the plaintiffs’ unconscionability arguments and left them for the arbitrator to decide.  See, e.g., Brennan v. Opus Bank, 796 F.3d 1125, 1127 (9th Cir. 2015) (holding that the determination whether the arbitration clause is substantively or procedurally unconscionable belongs to the arbitrator especially where the AAA Rules are incorporated to the agreement).

The defendant employer appealed to the 9^th Circuit, where the decision was affirmed.  Zaborowski v. MHN Gov't Servs., Inc., 601 F. App'x 461 (9th Cir. 2014).  The appellate court noted that although “Federal Arbitration Act expresses a strong preference for the enforcement of arbitration agreements,” there was no federal preemption concern because the FAA does not “license a party with superior bargaining power to stack the deck.”  Id. at 464.  It therefore concluded that the district court did not err when it applied California law and declined to sever unconscionable provisions.  Id.   There was a dissent that sided with preemption.  The dissenting judge explained that the application of the California law, as here, rejecting arbitration agreements will cause a “disproportionate impact on arbitration agreements” that is in fact preempted by the FAA.  Id. at 465 (citing AT&T Mobility LLC v. Concepcion, 563 U.S. 333 (2011) (which held that the Federal Arbitration Act preempts California’s rule regarding the unconscionability of class arbitration waivers in consumer contracts)).

On October 1, 2015, the Supreme Court of the United States agreed to hear this preemption argument on certiorari.   The petitioner employer staged the question before the Court as an unequal application of law.   It recognized that the California law purports to be neutral and applicable to all contracts.  But in practice the law has a “disproportionate impact on arbitration agreements” especially here where the subject arbitration agreement contained its own provision for excising invalid terms, which was not given effect.  The petitioner asserted that the “California courts show a clear preference against enforcing an agreement to arbitrate” and have used this California law as their vehicle for this agenda.  The petitioner then presented a history of the disparate treatment citing various general contract vs. arbitration contract cases.  It observed that the California Supreme Court’s precedent that “multiple unconscionable provisions will render an arbitration agreement’s purpose unlawful” necessarily treats arbitration contracts differently than other contracts under the California law.  Armendariz v. Found. Health Psychcare Servs., Inc., 6 P.3d 669, 697 (Cal. 2000).  The Petitioner concluded that because the “FAA preempts state-law defenses that single out or otherwise burden arbitration agreements more than any other contract,” this California law must be preempted by the FAA.

For their part, the Respondents focused on the facially neutral language of the California law as applicable to all contracts.  They also observed that the law directed courts, as the district court did here, to exercise discretion whether to sever the terms or reject the contract altogether.   The respondents emphasized the instant arbitration agreement contained five unconscionable provisions, not just one or two, that went to material, as opposed to collateral, issues of arbitration relationship.  They noted also that numerous other courts have refused to enforce this very same agreement.

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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.