Investigations and White Collar Defense

Recent Cases Under the Federal False Claims Act

Authors: Robert Fabrikant | Michael Bhargava 

Two federal circuit courts have recently issued major decisions involving the False Claims Act ("FCA") that promise to have a major impact on future litigation. In a case from the Sixth Circuit, the appeals court constricted FCA liability, holding that a company did not violate the FCA merely by seeking to maximize its profits in a way that was not clearly prohibited by statute or regulation, particularly when it sought legal counsel as to whether its actions were legal. In another case, the Ninth Circuit recently expanded potential FCA liability, holding that purposeful underbidding in order to win contracts can be the basis for FCA violations.

A. FCA Background

The FCA makes it illegal for companies to knowingly make false or fraudulent claims for payment to the federal Government.[1] Under the FCA, companies may not make such claims, nor may they make false records or statements that are material to getting paid by the Government. Companies may also be liable under the FCA if they improperly avoid paying the Government money that is owed. Companies will be liable only if they knowingly make false claims, which can include either actual knowledge of the falsity, deliberate ignorance of the falsity, or reckless disregard of the falsity. Claims may be brought directly by the Government, but are more often raised by whistle-blowers (or "relators") who file qui tam suits in which they share a significant share of any proceeds that result.

Recent years have brought a surge in FCA actions against Government contractors, with more than $9 billion in state and federal penalties in FY2012 alone, more than double the amount from the previous year. More than two-thirds of FCA cases involve alleged healthcare fraud, with military contracting contributing another significant share. Acting Assistant Attorney General Stuart Delery recently stated that he "ha[s] been struck by the sheer volume of the cases that are brought - and the recoveries that are obtained under this statute."[2] The recent recoveries for the Government have been "historic figures," making the FCA the "government's most potent civil weapon in addressing fraud against the taxpayers."[3] The FCA allows for treble damages plus steep statutory penalties, so claims can escalate quickly. Particularly in an era of tight budgets, the Government will be aggressive in investigating and prosecuting claims of fraud. As a result, Government contractors must be on guard for even the appearance of violations.

B. Sixth Circuit:  Profit-Maximizing by Itself Does Not Violate FCA

The recent appeals court decisions represent mixed results for Government contractors. In United States ex rel. Williams et al. v. Renal Care Group et al., the Sixth Circuit overturned the district court's decision granting summary judgment on a claim that Renal Care Group, Inc. ("RCG"), had violated the FCA because it arranged a corporate structure that would maximize Medicare reimbursements.[4] In fact, the Sixth Circuit granted summary judgment to the defendants, holding that they could not be held liable under the FCA for actions that were not clearly barred by regulations.

RCG (now part of Fresenius Medical Care) provides home-based dialysis services and equipment for patients suffering from end-stage renal disease. Medicare separates reimbursement for such treatment into two categories. For companies that provide both services and equipment, Medicare reimburses costs using what is known as "Method I" reimbursement. For companies that provided only equipment and supplies but no services, Medicare uses a fee-for-service "Method II" reimbursement that is typically higher than Method I for certain types of treatment. The higher Method II reimbursement, however, is not available for a supplier that is also "a provider of services [or] a renal dialysis facility." 42 U.S.C. § 1395rr(b)(1). In other words, RCG could be eligible for the higher reimbursements of Method II only if it did not also provide services along with its equipment and supplies.

In response to this incentive structure created by Congress, RCG decided in 1998 to create a wholly owned subsidiary (Renal Care Group Supply Company) that would provide only equipment and supplies for renal failure treatment, while the parent company RCG would continue to provide services along with the equipment. Although RCG would not be eligible for the higher Method II reimbursements, the subsidiary presumably would. The two companies nevertheless would have overlapping functions, sharing management teams, offices, payroll, insurance benefits, and human resource staffs. The employees of the subsidiary also would directly report to RCG employees. Finally, RCG would sweep the subsidiary's funds into its account nightly.

One officer of RCG objected that this scheme would be illegal. In an email, he wrote that this plan "is not in the best interests of our patients. . . . I do not think it is legal to force our patients into a Method II arrangement simply to increase profits of our Company. I do not wish to go to jail." In response, RCG sought legal clarification of the Medicare rules to determine whether this arrangement would be permissible. RCG's outside legal counsel contacted an official at the Health Care Financing Administration (now the Centers for Medicare & Medicaid Services) to discuss the proposed subsidiary, and the official responded that it would be legal if the subsidiary had its own Medicare provider number and were a separate company, which would be the case here. The legal counsel's memo concluded that the arrangement would be legal as long as the subsidiary were not merely a shell company whose purpose would be to maximize Medicare reimbursements. On this basis, RCG went ahead with the plan and, over a six-year span starting in 1999, the two companies took in more than $84 million in Medicare payments under both reimbursement methods.

In 2005 two former employees of RCG sued for FCA violations, alleging that the subsidiary was not a separate company but merely a "billing conduit" for RCG. The Government intervened in 2007, and two years later it filed a summary judgment motion on only two elements of the claim, alleging that there was no material dispute that RCG's reimbursement claims were false and that they were material to Medicare payments. The Government claimed that the subsidiary was a mere alter ego of RCG that improperly sought Medicare reimbursements to increase its corporate profits. The district court not only granted the motion, but awarded summary judgment to the Government on the remaining elements of the claim, including knowledge of the false claims and damages of almost $83 million.

The Sixth Circuit reversed the district court, holding that trying to maximize profit under the incentive system created by Congress was not itself illegal. "[T]he United States focuses, somewhat obsessively, on evidence demonstrating that RCG sought Method II reimbursements for the sole purpose of increasing its profit margins. Why a business ought to be punished solely for seeking to maximize profits escapes us." Meanwhile, the Government and the district court ignored the jurisprudence on alter egos. Quoting the Supreme Court decision in Schenley Distillers Corp. v. United States, 326 U.S. 432, 437 (1946), the appeals court held that the Government and the district court could not disregard the corporate form "when its adoption was meant to 'secure its advantages and where no violence to the legislative purpose is done by treating the corporate entity as a separate legal person.' " The Government had not shown in any way that RCG's profit-maximizing corporate structure violated the terms or the purpose of the Medicare reimbursement system, which was designed to give patients more choice in durable medical equipment providers.

Similarly, the Sixth Circuit reversed the district court on the knowledge element of the claim. The Government had argued that RCG acted with reckless disregard as to the falsity of the claims, since the regulations were clear that wholly owned subsidiaries were ineligible for Method II reimbursements. However, the Sixth Circuit held that this was simply not the case, since the regulations were unclear at best on this point. Furthermore, the fact that RCG's outside legal counsel advised RCG that such a corporate structure was not illegal - based on the representations of a Government official - also showed no reckless disregard. So too did the fact that RCG was up front with the Government regarding the corporate structure. According to the court, RCG "consistently sought clarification on the issue, followed industry practice in trying to sort through ambiguous regulations, and was forthright with government officials over [the subsidiary's] structure. To deem such behavior 'reckless disregard' of controlling statutes and regulations imposes a burden on government contractors far higher than what Congress intended when it passed" the False Claims Act.

Finally, the Sixth Circuit also reversed the district court on an additional FCA count that RCG submitted false claims even though it knew that the subsidiary was not in full compliance with a series of complex Medicare requirements. According to the appeals court, "The False Claims Act is not a vehicle to police technical compliance with complex federal regulations. . . . The regulations set forth in the United States' complaint are conditions of participation, the violation of which does not lead to False Claims Act liability."

The Sixth Circuit's decision is a victory not only for RCG, but also for all contractors that are creative about increasing profit from Government contracts in ways that do not directly violate contractual terms or applicable regulations. This is particularly true when the contractors seek outside legal counsel and are transparent to the Government about their actions.

C. Ninth Circuit:  Purposeful Underbidding Does Violate the FCA

The Ninth Circuit also announced a major decision in United States ex rel. Hooper v. Lockheed Martin Corp.[5] There, the U.S. Air Force issued a request for proposals to provide "software and hardware used to support space launch operations at Vandenberg Air Force Base and Cape Kennedy."[6] The contract allowed the contractor to recover its actual costs of performance, as well as awards for meeting certain targets during the course of the contract. Although cost was not the most important factor in the Air Force's selection of a contractor, it was nevertheless an important factor.

According to deposition testimony cited by the relator, the Air Force deemed Lockheed's initial cost proposal to be too high. In response, Lockheed management asked the proposal team to lower the cost of the proposal even if the lower costs had no basis in the engineering proposal. When one employee, Mike Allen, protested that the cost could not be lowered based on what Lockheed was proposing, he was removed from the team. Lockheed eventually lowered the cost of its final proposal by almost 50% from the original proposal. However, Allen testified that the final cost estimate was based on "bad, bad guesses," but not false representations.[7] The relator also cited deposition testimony showing that Lockheed's proposal made false representations about the productivity rates used in calculating its final cost.

When reviewing Lockheed's proposal, the Air Force remarked that Lockheed was "optimistic about some of the inputs to the methodology, resulting in an overstated potential for cost savings."[8] It also determined that Lockheed had unrealistically understated its risks of not performing. Nevertheless, the Air Force determined that Lockheed's proposal provided the best value, even if there was risk of cost overruns.[9] It awarded Lockheed the contract, and Lockheed received more than $900 million for performing the contract.[10]

The relator was not involved in the submission of the proposal, but sued under the False Claims Act after he was terminated, claiming that he was fired for investigating the fraud that he alleges in his complaint. After the Government declined to intervene in the case, the relator continued to prosecute it. The district court eventually granted summary judgment to Lockheed on the basis that relator could not prove his allegations, and the relator appealed to the Ninth Circuit.

In a case of first impression, the Ninth Circuit determined whether the knowing submission of an underbid on a cost-plus contract could violate the FCA. Lockheed argued that it could not, since "estimates of what costs might be in the future are based on inherently judgmental information, and a piece of purely judgmental information is not actionable as a false statement."[11] Although the Government did not intervene in the case on the relator's behalf, it filed an amicus brief arguing that false information in a proposal or a knowing underbid were false statements under the FCA.

The Ninth Circuit sided with the relator and the Government, holding that knowing underbidding could violate the False Claims Act. It concluded that "false estimates, defined to include fraudulent underbidding in which the bid is not what the defendant actually intends to charge, can be a source of liability under the FCA."[12] It relied on the Supreme Court's 1943 decision in United States ex rel. Marcus v. Hess,[13] as well as on decisions of the First and Fourth Circuits. In Marcus, the Court dealt not with fraudulent underbidding, but collusive bidding for Public Works Administration projects. The bidders were members of an association of electrical contractors who structured their bids so that a preselected bidder would have the lowest cost.[14] The Court held that these actions were barred by the False Claims Act, since the Government's payments were "induced by the respondents' frauds."[15]

Subsequent courts expanded this "fraud-in-the-inducement" theory of FCA liability. The Fourth Circuit, for example, held that "fraud surrounding the efforts to obtain the contract or benefit status, or the payments thereunder" could violate the FCA.[16] There, the relator alleged that the defendant made false statements to the Department of Energy regarding the need for and cost of a subcontractor, which caused the DOE to approve the subcontract.[17] Although the case did not involve a specific request for payment, the Fourth Circuit held that the term "false or fraudulent claim" was intended by Congress to be interpreted broadly. As a result, it could encompass statements made to induce the Government to enter into a contract.[18] The court also rejected the defendant's claim that its cost estimate of the subcontract was only that, an estimate. It explained that "an opinion or estimate carries with it an implied assertion, not only that the speaker knows no facts which would preclude such an opinion, but that he does know facts which justify it."[19] The First Circuit later expanded on the Fourth Circuit's holding, explaining that the expression of opinions by applicants for social security could be false statements under the FCA "where the speaker knows facts which would preclude such an opinion."[20]

Relying on these opinions by its sister circuits, the Ninth Circuit concluded that the purposeful underbidding alleged in Hooper could violate the False Claims Act, even though the bid was merely an estimate of what the eventual costs would be. It held that "false estimates, defined to include fraudulent underbidding in which the bid is not what the defendant actually intends to charge, can be a source of liability under the FCA."[21]

The Ninth Circuit's decision in Hooper expands the range of activities that can incur False Claims Act liability. It confirms that knowingly false statements made by Government contractors at any time during contract formation or performance of the contract can create liability for the contractor. Contractors must be certain when submitting bids that they are based on reliable information and estimates that can withstand subsequent scrutiny.

[1] 31 U.S.C. § 3729.
[3] Id.
[4] No. 11-5779, slip op. (6th Cir. October 5, 2012).
[5] 688 F.3d 1037 (9th Cir. 2012).
[6] 688 F.3d at 1041.
[7] Id. at 1042.
[8] Id.
[9] Id. at 1050.
[10] Id. at 1042. 
[11] Id. at 1047.
[12] Id. at 1049.
[13] 317 U.S. 537 (1943).
[14] Id. at 539 n.1.
[15] Id. at 542.
[16] United States ex rel. Harrison v. Westinghouse Savannah River Co., 176 F.3d 776, 788 (4th Cir. 1999).
[17] Id. at 791.
[18] Id. at 786.
[19] Id. at 792 (quotations omitted).
[20] United States ex rel. Loughren v. Unum Group, 613 F.3d 300, 310-12 (1st Cir. 2010).
[21] Hooper, 688 F.3d at 1047 n.5.



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