May 8, 2017

Third Circuit Fortifies the False Claims Act's Materiality Requirement

4 min

Almost a year ago, as we previously reported, the Supreme Court held in Universal Health Services v. Escobar that the False Claims Act (FCA) proscribes the false implied certification of compliance with federal statutes, regulations, and contractual provisions. Importantly, however, the Court determined that for a contractor and grantee to be liable under the implied certification theory, the statutory, regulatory, or contractual requirement with which the contractor or grantee impliedly certifies compliance must be "material" to the government's decision to pay the contractor's or grantee's claim. By establishing guideposts for determining materiality, the Court sought to restore the sometimes blurry line between actionable fraud—the target of the FCA—and mere regulatory noncompliance or breach of contract. But contractors and grantees feared that there remained a practical problem: because the inquiry into "materiality" is often fact-intensive, trial courts might be reluctant to dismiss claims at the pleading stage for failure to adequately allege materiality, meaning that FCA defendants would continue to incur staggering discovery costs if they were to choose to litigate and would thus continue to have strong incentives to negotiate settlements of even meritless claims early. The Supreme Court dropped a footnote in Escobar rejecting the assertion that materiality is too fact-intensive to permit either pleading-stage dismissal or summary judgment, but contractors and grantees weren't sure lower courts would listen.

This week, at least one lower court listened. In United States ex rel. Petratos v. Genentech Inc., the U.S. Court of Appeals for the Third Circuit found that, because a qui tam relator did not adequately plead materiality, his complaint should be dismissed. In Petratos, a former employee alleged that Genentech's purported suppression of certain data about a cancer drug caused doctors to submit claims for Medicare reimbursement that were not "reasonable and necessary" for proper medical treatment, as federal law requires. The district court dismissed the relator's case on the ground that the submitted Medicare claims were not "false." The Third Circuit disagreed with the district court's rationale, but affirmed on the ground that the alleged suppression of the data was not material to the government's decision to pay the Medicare claims.

The court concluded that the relator did not meet the "high" standard for pleading materiality for multiple reasons: the relator "conceded" that the government would have paid the claims despite fully knowing of the alleged noncompliance by simply failing to allege in his complaint that the government would not have paid the claims, and then by not disputing the district court's finding of that failure on appeal; the relator failed to allege that the government's knowledge of the alleged violation could influence its decision to pay the claims; and the relator actually acknowledged in briefing in the district court that the Food and Drug Administration (FDA) "would not 'have acted differently had Genentech told the truth.'" Notably, however, the court did not stop there. In assessing whether Genentech's purported conduct was material to the government's decision to pay the Medicare claims, the court went outside the pleadings to examine how the government had, in fact, responded to Genentech's alleged data suppression. The court cited FDA's failure to require Genentech to revise the drug's label or initiate agency proceedings after learning of the relator's allegations, as well as the Department of Justice's (DOJ) failure to take action against Genentech for six years after learning of Genentech's alleged noncompliance and DOJ's decision not to intervene in the action.

The Third Circuit's decision in Petratos demonstrates that Escobar has teeth. The materiality guideposts established in Escobar do not simply provide contractors and grantees a factual defense to FCA claims at trial. They potentially provide grounds for dismissal at the pleading stage, even authorizing courts to consider uncontroverted but outside-the-pleadings facts about the government's real-world behavior to determine whether a relator has adequately alleged materiality. As a result, as Petratos shows, Escobar could embolden contractors and grantees to fight dubious claims and diminish what have often been strong incentives to settle such claims early.