United States: Why Escobar Materiality Rule Applies To California FCA

The federal False Claims Act – and its similar state law counterpart, the California False Claims Act – both provide for the possible recovery of treble damages, civil penalties and costs from any party who knowingly presents a false claim for payment to the government. The FCA and CFCA are potentially powerful anti-fraud enforcement statutes that could expose government contractors to expansive liability. But in order to succeed on an FCA or CFCA claim, the relator (sometimes called a "qui tam plaintiff") or the government must prove several demanding elements: (1) that the defendant presented a false claim for payment; (2) that the defendant did so knowingly, with deliberate ignorance, or in reckless disregard of the claim's falsity; and (3) that the falsity was material to the government's payment decision.¹

Although neither the FCA nor the CFCA contains an express materiality requirement, federal and California courts have found this requirement to be implicit in the respective statutes because it would not effectuate the intent of the acts to impose sweeping liability for a falsehood that was too insignificant to have influenced the government's decision to pay the claim.² Two years ago, in Universal Health Services v. U.S. ex rel. Escobar, a unanimous U.S. Supreme Court articulated a standard of materiality that has caused a notable shift in FCA litigation.³

Federal courts – including California district courts in several recent significant decisions – have regularly applied Escobar's "rigorous" and "demanding" materiality requirement to FCA claims, granting defendants' dispositive motions on materiality grounds in instances where the government continued to pay claims after becoming aware of allegations that such claims are fraudulent.⁴ This summer, for example, a California federal court in the Central District of California granted FCA defendants' motion to dismiss – relying heavily on Escobar – where it was clear from the complaint that the government continued paying after learning of the alleged noncompliance.⁵

When it comes to the materiality requirement under the CFCA, however, the impact of Escobar has been more sluggish. Still, federal courts that have addressed the issue appear to assume that Escobar's materiality standard applies to the CFCA. And while California state courts have yet to directly address the issue, it is likely that Escobar will – and indeed should – guide the materiality analysis under the CFCA as well.

Escobar's New Standard of Materiality Under the FCA

Prior to Escobar, many federal courts addressing FCA claims – and California state courts interpreting the CFCA – applied the Fourth Circuit's test for materiality: "whether the false statement [had] a natural tendency to influence agency action or [was] capable of influencing agency action."⁶ But in 2016, the U.S. Supreme Court articulated the standard for FCA materiality in Escobar.⁷ In Escobar, the Supreme Court made clear that the materiality requirement is "rigorous"⁸ and "demanding,"⁹ and that it should be strictly enforced to address "concerns about fair notice and open-ended liability" because "billing parties are often subject to thousands of complex statutory and regulatory provisions."¹⁰ Furthermore, the court explained that materiality cannot be found where a falsity is "minor or insubstantial" because the FCA is not "a means of imposing treble damages and other penalties for insignificant regulatory or contractual violations."¹¹ To this end, the court stressed that the FCA is not "an all-purpose antifraud statute" nor "a vehicle for punishing garden-variety breaches of contract or regulatory violation."¹²

Then, the Escobar court held that the materiality determination "look[s] to the effect on the likely or actual behavior of the recipient of the alleged misrepresentation."¹³ Here, the court made clear that the government's payment of a claim despite its actual knowledge that the defendant was in violation of certain requirements constitutes "very strong evidence" that those requirements were not material.¹⁴ Similarly, if the government regularly pays claims with the knowledge that contractors are in violation of specified requirements, that is "strong evidence" that such requirements were immaterial.¹⁵ Finally, the Escobar court recognized an additional requirement within the materiality analysis: the defendant must know its falsehood was material to the government's payment decision at the time it submitted its claim.¹⁶

Federal Courts Have Readily Applied Escobar's Rigorous Materiality Requirement

Escobar has caused a significant shift in FCA litigation. To begin, Escobar explicitly rejected the notion that materiality is "too fact intensive" to be decided before trial.¹⁷ Subsequently, federal courts have regularly dismissed FCA complaints and granted judgment as a matter of law to FCA defendants on materiality grounds.¹⁸ Second, federal courts have increasingly looked to the government's actual reaction to fraud allegations and expressed skepticism that an alleged or actual falsehood was material where the government has continued to pay the defendant's claims.¹⁹

In particular, federal circuit courts have given weight to factors such as whether the government has renewed its contract with the defendant; whether it has disallowed reimbursement costs charged by the defendant; what action if took after conducting an investigation into or an audit of the defendant's claims; whether it has intervened in an FCA action brought by a relator; and whether it has taken any other action favorable to or against the defendant.²⁰ Lastly, some federal courts – including one recent decision out of the Southern District of California – have enforced the additional "knowledge of materiality" requirement articulated in Escobar, and have granted dispositive motions for defendants where the relator or the government has failed to allege or offer evidence that the defendant knew its falsity was material to the government's payment decision when it submitted its claim.²¹

Recently, in Ling v. City of Los Angeles – a lawsuit where the United States notably intervened in claims brought against a government defendant, the City of Los Angeles – U.S. District Judge Philip Gutierrez granted the FCA defendants' motion to dismiss on materiality grounds in a detailed, 55-page opinion.²² Ling involved a question regarding the materiality of the city of Los Angeles' representations that it would create accessible housing in exchange for receiving federal housing funds.²³ The court concluded that Escobar's assertion that continued government payment after learning of the defendants' noncompliance was "very strong evidence" of immateriality was ultimately dispositive in this case.²⁴

Specifically, "the complaint's allegations leave no doubt that the Government knew of Defendants' alleged misconduct in at least 2011 or 2012, and continued to provide the Entitlement Funds regardless," distinguishing it from other cases where allegations continued payment was not dispositive.²⁵ Still, Judge Gutierrez gave the government another opportunity to replead, allowing leave to amend in order to allege additional facts in its complaint that would "satisfy the standards of both Rule 9(b) and Escobar."²⁶ But the court warned the United States that various arguments and allegations that are currently not included in the complaint – e.g., that the government essentially had no choice but to continue paying the claims "given the importance of the services that the funding facilitates and the unavailability of an alternative recipient of funds" – "might ... be sufficient to counter Defendants' evidence. However, those lines of reasoning would need to be included in the complaint, and more fully developed, in order to serve this purpose."²⁷

Materiality Under the California False Claims Act: Contreras or Escobar?

Given the sweeping impact of Escobar on FCA litigation, a key question in CFCA context is: Does Escobar also define the CFCA's materiality standard?

The CFCA's materiality standard was first defined by City of Pomona v. Superior Court.²⁸ In that case, California's Second Appellate District stated, "[g]iven the lack of California authority and the very close similarity of [the CFCA] to the [FCA], it is appropriate to turn to federal cases for guidance in interpreting the [CFCA]."²⁹ Then, the court proceeded to adopt the federal Fourth Circuit's test for materiality under the FCA: "whether the false statement [had] a natural tendency to influence agency action or [was] capable of influencing agency action."³⁰

Roughly a decade later, California's First Appellate District applied the "natural tendency" test in San Francisco Unified School District ex. rel Contreras v. First Student Inc.³¹ In Contreras, qui tam plaintiffs alleged that the defendant bus company had billed the school district for student transportation services while it was in breach of contractual provisions that required its buses to be adequately maintained and to comply with specified federal and state safety and emissions standards.³² The trial court granted summary judgment to the defendant on the ground that no reasonable juror could find that the defendant's compliance with the contractual terms at issue was material to the government's payment decision, because the district had continued to make payments to the bus company and even extended the contract after it had become aware of the allegations of fraud.³³

On appeal, the Contreras court reversed, holding that the CFCA's materiality test "focuses on the potential effect of the false statement when it is made, not on the actual effect of the false statement when it is discovered" and, consequently, that the government's actual reaction cannot be dispositive on the issue of materiality.³⁴ Under this test, the court concluded that a reasonable juror could find that the bus company's compliance with the specified contractual provisions was material, due to the provisions' important purpose in protecting students' health and safety, the contractual language, and the district's demand that noncompliant buses be removed from service.³⁵

Since Escobar, both federal district courts that have considered the CFCA's materiality requirement have cited Escobar as the standard governing materiality for the purposes of both the FCA and the CFCA.³⁶ But in California state court cases, the attorney general of California has twice submitted amicus briefs taking the position that Contreras is controlling under the CFCA.³⁷ According to the attorney general, while it had been proper for the Contreras court to turn to FCA case law when there was no CFCA precedent, now it would be inappropriate for California courts to look to the new FCA case law because there is a CFCA case on point: Contreras.³⁸ In response, the only California court of appeal to consider the matter appeared to reject the attorney general's argument in an unpublished opinion in Los Angeles County Metropolitan Transportation Authority v. Parsons-Dillingham.³⁹ Although unpublished opinions have no precedential effect and may not be cited to California courts as persuasive authority,⁴⁰ the case may nonetheless provide a preview of how California courts should rule on this issue in the future.

Indeed, Escobar should now guide the materiality analysis under the CFCA. As noted above, Contreras relies on federal case law that has been abrogated by the U.S. Supreme Court's unanimous decision in Escobar and by subsequent lower federal court decisions.⁴¹ And – as seen in Pomona and Contreras – California courts have repeatedly looked to FCA decisions when construing the CFCA.⁴² Escobar has importantly cemented a rigorous and demanding FCA materiality standard. Because Contreras is founded on now-abrogated federal case law, Escobar is now the best articulation of the CFCA's materiality standard. All three courts to consider this issue – two federal district courts and one California appellate court in an unpublished opinion – have reached this same conclusion. Although these decisions are not binding on California courts, it is only a matter of time before a California court makes clear that Escobar applies to CFCA materiality as well.

*Liam O'Connor, a student at the University of Virginia School of Law, contributed in the preparation of this article.

Footnotes

1 See 31 U.S.C. § 3279(a); Cal. Gov. Code § 12651(a); see also Universal Health Servs. v. U.S. ex rel. Escobar (Escobar), 136 S. Ct. 1989, 1996 (2016); City of Pomona v. Super. Ct. (Pomona), 89 Cal. App. 4th 793, 802 (Cal. Ct. App. 2001).

2 See S.F. Unified Sch. Dist. ex rel. Contreras v. Laidlaw Transit, Inc. (Laidlaw), 182 Cal. App. 4th 438, 454 (Cal. Ct. App. 2010) (looking to federal cases interpreting the FCA). Congress amended the FCA in 2009 to define "material" as "having a natural tendency to influence, or be capable of influencing, the payment or receipt of money or property." 31 U.S.C. § 3729(b)(4). The following year, the California legislature amended the CFCA to adopt a nearly-verbatim definition. Cal. Gov. Code § 12650(b)(4) ("'Material' means having a natural tendency to influence, or be capable of influencing, the payment or receipt of money, property, or services.").

3 136 S. Ct. 1989.

4 Id. at 1996, 2002–03, 2004 n. 6. See cases cited infra notes 20–22.

5 United States of Am. ex rel. Mei Ling et al. v. City of Los Angeles et al. (Ling), No. CV 11-974 PSG (JCX), 2018 WL 3814498, (C.D. Cal. July 25, 2018).

6 U.S. ex rel. Berge v. Trs. of Univ. of Ala., 104 F.3d 1453, 1459 (4th Cir. 1997); San Francisco Unified School District ex. rel Contreras v. First Student, Inc., 224 Cal.App.4th 627, 638 (Cal. Ct. App. 2014).

7 Escobar, 136 S. Ct. 1989. Though Escobar discussed materiality in the context of an implied certification case, its materiality requirements have since been extended to all types of FCA cases. See, e.g., Bishop v. Wells Fargo & Co., 870 F.3d 104, 106 (2d Cir. 2017) (applying the Escobar materiality standard to an express false certification case); United States ex rel. Forcier v. Computer Sciences Corp., 12 Civ. 1750 (DAB), 2017 WL 3616665 (S.D.N.Y. Aug. 10, 2017) ("{w}hether asserted on a theory of factual falsity or legal falsity, a false claim must have influenced the government's decision to pay); United States v. Strock, No. 15-CV-0887-FPG, 2018 WL 647471, at *11 (W.D.N.Y. Jan. 31, 2018) (concluding "that Escobar's materiality standard applies to all of Plaintiff's claims brought under § 3729(a)(1)(A) regardless of whether those claims were brought under a theory of implied false certification, express false certification, or fraudulent inducement.").

8 Id. at 1996, 2002, 2004 n. 6.

9 Id. at 2003.

10 Id. at 2002–03.

11 Id.; see also State v. Altus Fin., S.A. (Altus Finance), 116 P.3d 1175, 1186 (Cal. 2005) ("{S}pecific remedies under the CFCA are available not for any fraud against the government but rather one which leads to potential or actual injury to the public treasury and the taxpayer.").

12 Id.

13 Id. at 2002 (quoting 26. R. Lord, Williston on Contracts (4th ed. 2003) § 69:12, p. 549).

14 Id. at 2003.

15 Id. at 2003–04.

16 Id. at 1996 ("What matters is not the label that the Government attaches to a requirement, but whether the defendant knowingly violated a requirement that the defendant knows is material to the Government's payment decision.").

17 Id. at 2004 n. 6.

18 See cases cited in infra note 20.

19 See cases cited in infra note 20.

20 See, e.g., U.S. ex rel. Berg v. Honeywell Int'l, Inc., No. 17–35083, 2018 WL 3237518 (9th Cir. July 3, 2018) (affirming summary judgement for defendant partially on materiality grounds where government continued to pay claims up to five years after it became aware of fraud allegations and up to four years after it conducted its own audit); U.S. ex rel. Spay v. CVS Caremark Corp., 875 F.3d 746 (3d Cir. 2017) (affirming summary judgement for defendants on materiality grounds where the government had regularly paid similar claims despite its knowledge that the some information in those claims was inaccurate); U.S. ex rel. Petratos v. Genentech Inc., 855 F.3d 481 (3d Cir. 2017) (affirming dismissal of complaint on materiality grounds where the government did not withdrawal approval of a drug, approved three more indications of the drug, declined to intervene in the FCA action, and took no other action against the defendant after becoming aware of fraud allegations); U.S. ex rel. Harman v. Trinity Indus. Inc., 872 F.3d 645 (5th Cir. 2017) (reversing jury verdict for relator and granting judgment as a matter of law to defendant on materiality grounds where the government continued to pay claims after becoming aware of and investigating fraud allegations, refused to intervene in the FCA action, and took no other regulatory action against the defendant, and where eight of nine states refused to intervene in parallel actions under state false claims acts); Abbott v. BP Expl. & Prod., Inc., 851 F.3d 384 (5th Cir. 2017) (affirming summary judgement for defendant on materiality grounds where the government had not taken any action against the defendant after Congress had conducted hearings and a federal agency had conducted an investigation and issued a report finding the defendant to be in compliance with the regulations at issue); U.S. ex rel. Kelly v. Serco, Inc., 846 F.3d 325 (9th Cir. 2017) (affirming summary judgement for defendant partially on materiality grounds where the government continued to pay claims, despite its knowledge that the defendant was in violation of certain requirements); U.S. ex rel. McBride v. Halliburton Co., 848 F.3d 1027 (D.C. Cir. 2017) (affirming summary judgment for defendants on materiality grounds where the government continued to pay claims and did not disallow any charged costs after becoming aware of and investigating fraud allegations); U.S. ex. rel. D'Agostino v. ev3, Inc., 845 F.3d 1 (1st Cir. 2016) (affirming dismissal of complaint partially on materiality grounds where the government continued to pay clams after becoming aware of fraud allegations); U.S. v. Sanford-Brown, Ltd., 840 F.3d 445, 447 (7th Cir. 2016) (affirming summary judgment for defendant partially on materiality grounds where the government had "already examined" the alleged misconduct "multiple times over and concluded that neither administrative penalties nor termination was warranted"). Cf. United States ex rel. Rose v. Stephens, No. 17-15111, 2018 WL 4038194 (9th Cir. Aug. 24, 2018) (concluding that a reasonable trier of fact could find that noncompliance was material when considering evidence that compliance was not only an express condition of payment, but also the magnitude of the alleged violation and the fact that the agency had imposed fines in other instances of noncompliance); U.S. ex rel. Badr v. Triple Canopy, Inc., 857 F.3d 174 (4th Cir. 2017) (reversing dismissal and reinstating complaint where the government did not renew its contract with the defendant and immediately intervened in the FCA litigation after becoming aware of fraud allegations); U.S. v. Luce, 873 F.3d 999 (7th Cir. 2017) (reversing summary judgment for the government, and affirming finding of materiality where the government continued to issue loans to the defendant but also immediately brought successful debarment proceedings against defendant after it became aware of fraud allegations). But see U.S. ex rel. Campie v. Gilead Scis., Inc., 862 F.3d 890 (9th Cir. 2017) (reversing dismissal and reinstating complaint where the government continued to pay claims and did not withdrawal drug approval after becoming aware of fraud allegations), petition for cert. filed (U.S. Jan. 3, 2018) (No. 17–936).

21 U.S. ex. rel. Durkin v. Cty. of San Diego (Durkin), No.: 15cv2674-MMA (WVG), 2018 WL 3361148, at *5 (S.D.C.A. July 10, 2018) ("The Supreme Court construed the scienter requirement together with the materiality requirement to mean that a claimant must not only know about a violation of a particular statutory or regulatory provision, but that the claimant must also know that compliance with that provision is material to the government's payment decision."); U.S. v. Salus Rehab. LLC (Salus), 304 F.Supp.3d 1258, 1262 (M.D.F.L. 2018) ("In other words, the False Claims Act requires the relator to prove both that the non-compliance was material to the government's payment decision and that the defendant knew at the moment the defendant sought payment that the non-compliance was material to the government's payment decision.").

22 No. CV 11-974, 2018 WL 3814498, at *22 (C.D. Cal. July 25, 2018).

23 Id. at *2.

24 Id.

25 Id. at *18.

26 Id. at *22.

27 Id. at *21-22.

28 89 Cal. App. 4th 793.

29 Id. at 802.

30 Id. (quoting U.S. ex rel. Berge v. Trs. of Univ. of Ala., 104 F.3d 1453, 1459 (4th Cir. 1997)).

31 224 Cal. App. 4th 627, 638 (Cal. Ct. App. 2014).

32 Id. at 630–31.

33 Id. at 639.

34 Id. at 642 (citing federal cases).

35 Id. at 644–45. The Court did note, however, "{A} showing in a motion for summary judgement or at the trial that the alleged breach would not have affected the payment decision will defeat a CFCA claim." Id. at 645 (citing Laidlaw, 182 Cal. App. at 456).

36 U.S. v. Gatan, Inc. (Gatan), No. 2:12–cv–00106–MCE–CKD, at *4–5 (E.D.C.A. Nov. 27, 2017), appeal docketed sub nom., Bailey, et al. v. Gatan, Inc., No. 17-17530 (9th Cir. Dec. 22, 2017); U.S. v. Somnia, Inc., No. 1:15–cv–00433–DAD–EPG, at *1–2, 8–9 (E.D.C.A. Feb. 2, 2018). In a third case, United States v. Boston Sci. Corp., No. 11-CV-2453 (JNE/SER), 2017 WL 3732099, at *5 n.2 (D. Minn. Aug. 29, 2017), the court applied an identical materiality standard under the CFCA and FCA, but noted that "{t}he parties agree that analysis of Higgins' second claim, which alleges violation of the California False Claims Act, should be consistent with an analysis of the federal claim."

37 E.g., Amicus Brief of the Cal. Attorney Gen. at *4, L.A. Cty. Metro. Transp. Auth. v. Parsons-Dillingham Metro Rail Constr. Manager Joint Venture, No. B255450, 2018 WL 1044591 (Cal. App. 2 Dist. Feb. 26, 2018) {hereinafter MTA Amicus Brief}; Amicus Brief of the Cal. Attorney Gen. at *5–8, Overaa v. Super. Ct. of Cal. for the Cty. of Alameda, No. A152801, 2017 WL 6371761 (Cal. App. 1 Dist. Dec. 5, 2017) {hereinafter Overaa Amicus Brief}.

38 MTA Amicus Brief at *9–10; Overaa Amicus Brief at *10.

39 L.A. Cty. Metro. Transp. Auth. v. Parsons-Dillingham Metro Rail Constr. Manager Joint Venture (MTA), No. B255450, 2018 WL 1044591, at *6 n. 11 (Cal. App. 2 Dist. Feb. 26, 2018) ("In its answer to the amicus brief {the defendant} explains that {Escobar} was decided after the federal circuit opinions upon which the Contreras court relied and points out, as discussed, that Escobar made clear the actual effect of an alleged false statement is 'very strong evidence' of whether that statement was material." (citation omitted)). Although the MTA Court affirmed the judgment for the defendant on falsity grounds, it stated that it alternatively could have rested its decision on materiality grounds. MTA, No. B255450, at *9 n. 16 (citing Escobar, 136 S. Ct. at 2002–03).

40 Cal. R. 8.1115(a).

41 See cases cited supra note 20.

42 See Altus Finance, 116 P.3d at 1184 ("{T}he CFCA 'is patterned on similar federal legislation' and it is appropriate to look to precedent construing the equivalent federal act." (citations omitted)); Pomona, 89 Cal. App. 4th at 802 ("Given the lack of California authority and the very close similarity of {the CFCA} to the {FCA}, it is appropriate to turn to federal cases for guidance in interpreting the {CFCA}.").>

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