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In One of the First Cases Following Escobar, Appeals Court Imposes High Standard for Establishing Knowledge Where Underlying Statutory Obligations Are Ambiguous and Rejects Automatic Scienter Defense Merely Because An Accountant Had Been Consulted

The Seventh Circuit affirmed summary judgment for defendants in United States ex rel. Sheet Metal Workers Int'l Assoc. v. Horning Investments, LLC, 2016 WL 3632616 (7th Cir. July 7, 2016), indicating that there is a high bar for establishing "knowing conduct" when defendants are accused of falsely certifying compliance with an ambiguous law.

The case alleged violations of the Davis-Bacon Act, which sets minimum rates of pay and fringe benefits for employees working on federal construction projects.  The employer, Horning, deducted a flat $5 per hour contribution from union members' paychecks, which was paid into an insurance benefit trust.  The Union, acting as a Relator under the False Claims Act, alleged that this deduction from each employees' paycheck-regardless of whether the employee was eligible for benefits and without tying the deduction to an actual  benefit received by employees - meant that Horning was paying its employees less in fringe benefits than was required under Davis-Bacon. The Union brought this action, in which it alleged that Horning's Certified Payroll Reports and its eight applications for payment (along with the certifications of Davis-Bacon compliance appearing in both types of documents), violated the False Claims Act. Id. at *2.  The district court granted summary judgement for the defendants.

The panel split.  Chief Judge Diane Wood, together with Judge Easterbrook, held that the claims did not survive summary judgment because there was a lack of evidence to show that the employer acted with knowledge that its claims were false.  After a fairly lengthy discussion of the nitty-gritty details of the Davis-Bacon Act provisions applicable to fringe benefits, the court determined that the Union had easily established that the employer made statements to receive money from the government, id. at 3, and that the case might fall within that category where " 'liability can attach when the defendant submits a claim for payment that makes specific representations about the goods or services provided, but knowingly fails to disclose the defendant's noncompliance with a statutory, regulatory, or contractual requirement. In these circumstances, liability may attach if the omission renders those representations misleading.' Universal Health Servs., 136 S.Ct. at 1995." Horning Investments, LLC, 2016 WL 3632616 at *3-4.   Ultimately, though, the majority concluded that it could not and would not decide whether there was any violation of the Davis-Bacon Act because the only issue it needed to address was the FCA issue whether "there is enough ambiguity about this matter that we cannot infer that Horning either knew or must have known that it was violating the Davis-Bacon Act."  Id. at *4.

In an interesting side note, the court discussed whether a defendant's claimed reliance on its accountant in dealing with its legal requirements would necessarily establish that the defendant could not have acted knowingly when it submitted the claims, even if an agency or court subsequently determined that the claims were false.  Although the court acknowledged that such reliance could sometimes defeat scienter, the notion that such reliance was a virtual bar was rejected:

A defendant may not rely on this type of advice, however, unless she establishes that (1) before taking action (2) she "in good faith sought the advice of [the professional] whom [she] considered competent," (3) about the lawfulness of her future conduct, (4) she made a "full and accurate report" of all relevant facts to the professional, and (5) she acted in strict accordance with the advice. United States v. Cheek, 3 F.3d 1057, 1061 (7th Cir. 1993) (on remand from Supreme Court, internal quotation marks omitted) (quoting Liss v. United States, 915 F.2d 287, 291 (7th Cir. 1990)).  Horning did not develop the facts that were needed to provide a basis for an "advice-of-accountant" defense. We do not know precisely what it told its accountants, whether they provided all necessary details, or what exactly the accountants recommended.

Horning Investments, LLC, 2016 WL 3632616 at *5.

Judge Richard Posner dissented, finding that an employer experienced with federal projects like Horning must have known or been charged with knowing about the requirements of the Act. According to Judge Posner, if defendants did not know, "it must have been because they closed their eyes to those requirements-a good example of ostrich behavior, itself a good example of deliberate indifference within the meaning of the False Claims Act."  Id. at *7 (Posner, J., dissenting).  In part because the Union alleged that some of the so-called deductions actually went to the company's owner and cronies, and that the company falsely claimed the $5 of "fringe benefits" it took out of each worker's hourly salary went to "appropriate programs for the benefit of such employees," there was at least a factual question as to whether defendants had acted knowingly for purposes of the FCA.  As he explained, if a defendant " 'makes representations in submitting a claim but omits its violations of statutory, regulatory, or contractual requirements, those omissions can be a basis for liability if they render the defendant's representations misleading with respect to the goods or services provided.' Universal Health Services, Inc. v. United States, supra, 136 S.Ct. at 1999. That's this case."  Horning Investments, 2016 WL 3632616, at *7 (Posner, J., dissenting).

For whistleblowers going forward, this case demonstrates the importance of inside information about how a company came to make the decision it made, as well as specific evidence about the conduct and consequences of the company's decision.  The opinion should also help counsel obtain full discovery about any legal or accounting advice that a company claims it received, including exactly what was - or was not - disclosed to the accountant or attorney.

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