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Fifth Circuit Reverses $663 Million Judgment Against Government Contractor Based on Escobar’s Demanding and Rigorous Materiality Standard.

Fifth Circuit Reverses $663 Million Judgment Against Government Contractor Based on Escobar’s Demanding and Rigorous Materiality Standard 

By:  John S. Pachter and Todd M. Garland

A recent Fifth Circuit decision applying the False Claims Act’s (“FCA”) materiality requirement reinforces the “demanding” standard established by the Supreme Court in Universal Health Services, Inc. v. United States ex rel. Escobar, 136 S. Ct. 1989 (2016).  In United States ex rel. Harman v. Trinity Industries Inc., 2017 WL 4325279 (5th Cir. Sept. 29, 2017), the government’s continued payment despite knowledge of alleged regulatory violations resulted in dismissal for want of materiality.

The Fifth Circuit overturned a $663 million jury verdict.  The court entered judgment in favor of defendant, holding the alleged fraud was not material to the government’s payment decision.

Facts in Trinity Industries

Trinity manufactured and sold a system designed to make guardrails safer during head-on collisions (the “ET-Plus” system).  Trinity sold the systems to highway contractors, which installed guardrails with the ET-Plus systems throughout the United States.  In 2000, the Federal Highway Administration (“FHWA”) approved Trinity’s system after testing established the system met federal safety standards, and the federal government reimbursed states that purchased guardrails with the system.  In 2005, Trinity modified the ET-Plus to accommodate increased use of SUVs.  Trinity’s report to FHWA addressing the modifications discussed some, but not all, of the changes.  There was uncontradicted testimony, however, that the changed units were tested in 2005.  FHWA approved Trinity’s modified system.

Joshua Harman, a qui tam relator, filed an FCA complaint alleging Trinity failed to disclose changes in the modified system, which was “a completely new product” from the original system approved by FHWA.  Harman had previously owned a business that competed with Trinity.  He intended to use the proceeds from his FCA claim to recapitalize the business and manufacture systems to compete with Trinity.  Harman sought to prove that the ET-Plus system was unsafe, leading to a recall of guardrails installed with the system and a potential “one-billion-dollar revenue opportunity windfall” for his company in replacing the guardrails with Trinity removed as a competitor.  In 2012, Harman presented his allegations to FHWA, which after an investigation affirmed that the modified ET-Plus system was eligible for reimbursement.

Before trial, FHWA released an official memorandum stating that Trinity’s system had been tested, met federal safety requirements, and remained eligible for reimbursement from 2005 to the present.  Trinity moved for summary judgment, which the district court denied.  After the jury returned a verdict for Harman, but before the district court entered judgment, an independent joint task force of state, federal, and foreign transportation officials examined over one thousand guardrails installed with Trinity’s system.  The federal government confirmed that Trinity’s system was compliant with federal safety standards.

After the task force released its findings and the federal government affirmed its approval of Trinity’s system, the district court entered a $663,360,750 judgment against Trinity, consisting of $175,000,000 in damages allegedly sustained by the government, trebled to $525,000,000, and $138,360,750 in civil penalties for 16,771 false claims—plus an additional $19,012,865 in attorney’s fees and costs.

The Fifth Circuit Decision

In reversing the jury, the Fifth Circuit held that Harman could not meet the FCA’s materiality requirement. 

The court addressed the “rigorous” materiality requirement “hammered home” in Escobar.  Materiality “looks to the effect on the likely or actual behavior of the recipient of the alleged misrepresentation.”  Allegations of fraud are not material when agencies affirm approval of a product after learning of FCA allegations.  In those instances, allowing an FCA claim to proceed would “turn the FCA into a tool with which a jury of six people could retroactively eliminate the value of [agency] approval and effectively require that a product be withdrawn from the market even when the [agency] itself sees no reason to do so.”  The FCA “exists to protect the government from paying fraudulent claims, not to second-guess agencies’ judgments about whether to rescind regulatory rulings.”

The FHWA insisted that Trinity’s “2005 changes did not affect the decision to purchase the end terminals either in the past or the future.”  In addition, FHWA’s official memorandum established “that despite the modifications, the modified ET-Plus became eligible in 2005” and continued to be eligible after FHWA learned of Harman’s allegations.  Under Escobar, “continued payment by the federal government after it learns of the alleged fraud substantially increases the burden on the relator in establishing materiality.” 

Moreover, FHWA’s rejection of Harman’s allegations that Trinity fraudulently sold unsafe systems, “if in error, risked the lives on our nation's highways, not just undue expense.”  If alleged statutory, regulatory, or contractual violations “involve potential for horrific loss of life and limb, the government has strong incentives to reject nonconforming products,” giving a “particular bite” to Escobar’s rigorous materiality standard.  The governmental did more than reimburse purchasers of guardrails with Trinity’s system; the government “never retracted its explicit approval, instead stating that an unbroken chain of eligibility existed since 2005.”

In its attempt to explain away the government’s payments, Harman unsuccessfully argued that the government approval was obtained through fraud.  According to Harman, Trinity failed to disclose results of failed crash tests.  Those tests, however, involved a separate experimental system, not the ET-Plus system sold by Trinity.  FCA liability only attaches if a defendant has an obligation to disclose omitted information.  Trinity was not obligated to disclose crash test results for a separate system.

Congress enacted the FCA “to vindicate fraud on the federal government, not second guess decisions made by those empowered through the democratic process to shape public policy.”  Trinity’s system, like any system, could only mitigate but not erase the risks posed by highway travel.  The government sets safety standards, and “such decision making is policy making, not the task of a seven-person jury.”  The determination whether Trinity’s product was unsafe was not for a jury, but was a policy determination for government officials balancing “the federal fisc, motorist safety, and other factors.”

A jury’s “determination of materiality cannot defy the contrary decision of the government,” the alleged victim.  “When the government, at appropriate levels, repeatedly concludes that it has not been defrauded, it is not forgiving a found fraud—rather it is concluding that there was no fraud at all.”

Conclusion

When the Supreme Court issued its June 16, 2016 decision in Escobar, some commentators predicted dire consequences for defendants because the Court upheld implied certification as a theory of liability under the FCA.  As we noted at the time, Escobar was a “balanced decision” that imposed rigorous requirements on scienter, materiality, and specificity of pleading fraud, thus serving to “restrict expansive theories of FCA liability urged by the Department of Justice and qui tam relators.”[1]  Trinity Industries affirms that the Supreme Court’s insistence on strict enforcement of the FCA’s materiality requirement has become a powerful defense for contractors accused of fraud.

 

[1] John S. Pachter and Todd M. Garland, A Sensible Outcome for False Claims in Universal Health Services, 106 Fed. Cont. Rep. (BNA) No. 4, at 97 (July 26, 2016).