On November 6, 2020, Judge Royce C. Lamberth of the United States District Court for the District of Columbia issued a key ruling in United States ex rel. Scollick v. Narula further outlining the contours of the False Claims Act’s (“FCA”) hotly debated “materiality” requirement. Under the FCA, private individuals known as “realtors” are able to bring qui tam lawsuits on behalf of the United States when they possess inside knowledge of parties presenting fraudulent claims for payment to the federal government.
This long-running FCA case was filed by relator Andrew Scollick in 2014 alleging, in relevant part, Optimal Solutions and Technologies, Inc., along with its two highest level directors (collectively the “OST Defendants”), caused false claims for payment to be presented to the United States under service-disabled veteran-owned small business (“SDVOSB”) construction contracts. The OST Defendants allegedly facilitated the creation and operation of a sham SDVOSB company named Centurion Solutions Group, LLC (“CSG”). CSG was awarded multiple set-aside SDVOSB construction contracts and received millions of taxpayer dollars under those contracts.
Many government agencies, under a Congressional enacted statutory mandate, set aside certain construction contracting opportunities exclusively for companies that meet strict SDVOSB requirements, such that a service-disabled veteran of the United States military both owns and controls the company. This contracting arena has become ripe with fraud over the past several years with many fraudsters setting up companies using only a figurehead service-disabled veteran while they actually control the business.
Previously in this litigation, Mr. Scollick has prevailed with several key holdings on the cutting edge of FCA litigation including a previous decision by Judge Lamberth finding that the insurance companies which provided required bonding for the SDVOSB contracts could be held liable under the FCA if they had knowledge that the work would not be performed by an SDVOSB compliant company. His latest victory deals directly with a current hot button topic in FCA litigation, the issue of materiality after the 2016 Supreme Court case Universal Health Services, Inc. v. United States ex rel. Escobar. In Escobar, the Supreme Court validated a legal theory under the FCA known as the implied false certification theory whereby, in certain circumstances, a claim for payment can be considered false if it “fails to disclose the defendant’s violation of a material statutory, regulatory, or contractual requirement.”
The Supreme Court’s opinion went on to hold that any misrepresentation under the implied false certification theory had to meet the FCA’s “materiality” requirement, i.e., that the misrepresentation had “a natural tendency to influence, or [was] capable of influencing,” the government’s decision to pay a claim. The Escobar opinion provided several factors which lower courts could use to aid in their materiality analysis. Since the Escobar decision, FCA defendants have increasingly, and relatively successfully, used materiality and the Escobar factors as a means to stave off liability. Courts around the country still grapple with materiality in the wake of Escobar and Judge Lamberth’s recent decision provides some much needed clarity and cogent logic to the debate.
In the Scollick case, the OST Defendants sought dismissal by arguing that the complaint failed to meet the “materiality standard recently set by the Supreme Court in [Escobar].” The OST Defendants argued that it was insufficient to allege that the “OST Defendants’ misrepresentation of CSG as an SDVOSB was material to CSG’s eligibility to bid on SDVOSB set-aside contracts,” but that Mr. Scollick had to demonstrate “that this misrepresentation was material to the government’s decision to pay CSG for its work under those contracts.” This distinction originated from a recent opinion out of the Western District of New York, United States v. Strock, 2019 WL 4640687, which recently announced this judicially imposed nuance that helped shield other alleged SDVOSB fraudsters from FCA liability. The United States is currently appealing that decision in the Strock Case before the Second Circuit.
However, the district court rejected the OST Defendants’ argument and the reasoning in Strock. Instead, it held that in cases like here, where the government is induced to award the contract initially through fraud, Escobar’smateriality analysis is inapplicable as the Supreme Court has previously indicated that materiality element is “baked in” to this so-called “fraud in the inducement” theory. Under this theory, the fraud at issue must have caused the government to issue the contract in the first instance. Thus, the district court reasoned that “if a defendant secures a government contract through fraud, the only way the defendant can be paid for work performed under that contract is through the same fraud.” In other words, “a fraudulent statement that secures a government contract will always be material to the government’s decision to pay the contractor under the agreement.”
Relying on Supreme Court precedent covering the fraud in the inducement theory, the district court found that since “the initial fraud in procuring the contract ‘taint[s] all subsequent actions, including the defendant’s submission of claims to the government for payment under the contract,’” it is unnecessary and improper to apply an Escobar style materiality analysis to every payment decision the government makes under a fraudulently induced contract. The district court further pointed out that this was made clear by the Supreme Court itself in Escobar since holding otherwise “would create the ‘arbitrar[y]’ result that ‘misrepresenting compliance with a requirement that the Government expressly identified as a condition of payment could expose a defendant to liability,’ whereas ‘misrepresenting compliance with a condition of eligibility to even participate in a federal program when submitting a claim would not.’”
In sum, the court held that an FCA plaintiff “need only allege that false statements induced the government to award the contract, not also that those false statements were material to the government’s decision to pay the party under the contract.” Applying this holding to the facts of the case, relator Scollick needed only to allege that the fraudulent misrepresentation of CSG as an eligible SDVOSB entity caused the government to award the disputed SDVOSB contracts. There was no requirement to show that each payment made by CSG under these contracts by the Government were also materially affected by fraud. Judge Lamberth held that the allegations by relator Scollick satisfied this standard, denied the OST Defendants’ motion to dismiss, and the case will continue to move forward.