On October 5, 2016, the Court of Appeals for the Third Circuit remanded a "reverse" False Claims Act (FCA) case to the District Court for the Eastern District of Pennsylvania for further proceedings. The court's decision in United States ex rel. Custom Fraud Investigations, LLC v. Victaulic Company, Case No. 15-2169 (3d Cir., Oct. 5, 2016), breathes new life into a case that was previously dismissed by the district court in September 2014, and provides extensive discussion about how reverse claims operate in the era of the 2009 Fraud Enforcement and Recovery Act (FERA) amendments.
The case involves nondiscretionary import regulations—set forth in the Tariff Act of 1930—that apply to the pipe fitting industry. These regulations mandate that pipe fittings manufactured outside the United States must be marked with the country of origin; in contrast, pipe fittings manufactured in the United States are typically unmarked. Failure to properly mark foreign-manufactured pipe fittings results in a 10 percent ad valorem that accrues from the time of importation. Furthermore, if improperly marked goods are discovered by customs officials, the importer has three options: (1) re-export the goods; (2) destroy the goods; or (3) mark them properly to be released for sale in the United States. Since customs officials largely rely on importers to self-report any duties that are owed at the time of import, it is possible for improperly marked pipe fittings to enter the United States' stream of commerce. To the extent that improperly marked pipe fittings are discovered after they have entered the market, the 10 percent ad valorem is due immediately, retroactive to the date of importation.
Victaulic—a manufacturer of pipe fittings both in and outside the United States—is subject to these regulations. Custom Fraud Investigations, LLC (CFI)—characterized by Victaulic as a "false claims act troll"—is made up of "former insiders from the pipe fitting industry" and was noted by the Third Circuit as "appear[ing] to be a legal entity created solely for the purpose of bringing this case." CFI alleges that Victaulic imported approximately 83 million pounds of pipe fittings, but that only a small fraction of its fittings were appropriately marked as being manufactured outside the United States. CFI's analysis of Victaulic's pipe fittings sold in the United States involved a combination of a statistical analysis of shipping manifests and a further review of select listings of pipe fittings sold online on eBay. Based on the results of this analysis, CFI alleged in its complaint that "Victaulic is able to successfully (albeit unlawfully) import its unmarked pipe fittings into the United States by knowingly failing to pay or disclose to the CBP [Bureau of Customs and Border Protection] the marking duties the company owes . . . by, among other things, falsifying its entry documents and otherwise concealing the foreign source of its pipe fittings such that CBP will not detect the company's fraud." CFI alleges that Victaulic's failure to pay the duties owed on foreign-manufactured pipe fittings constitutes reverse false claims under 31 U.S.C. § 3729(a)(1)(G).
The district court noted that it did not believe that reverse false claims covered Victaulic's failure to pay marking duties, relying in large part on the Sixth Circuit's decision in American Textile Manufacturers Institute, Inc. v. The Limited, Inc. v. The Limited, Inc., et al., 190 F.3d 729 (6th Cir. 1999) (ATMI). The ATMI ruling, which predated the FERA amendments, held that (1) the term "obligation" should be afforded "a different, and more limited, meaning" than the word "claim" in the FCA; and (2) that liability for reverse false claims should be viewed more narrowly than general FCA liability. Id. at 736. The Third Circuit panel fundamentally disagreed, ruling 2-1 to remand the case to the district court based on the "plain text" of the FCA. Acknowledging the impact of the FERA amendments on the relevance of AMTI, the Third Circuit noted that "the FCA's reverse claims provision is clear: any individual who 'knowingly conceals or knowingly and improperly avoids or decreases an obligation to pay or transmit money or property to the Government' may be subject to liability."
However, the Third Circuit did not remand without acknowledging that it was "skeptical" of CFI's analysis methodology, noting that "there is little evidence to show that CFI's unusual procedure of reviewing eBay listings is an accurate proxy for the universe of Victaulic's products available for sale in the United States." Ultimately, the Third Circuit ruled that its "skepticism is misplaced at the Rule 12(b)(6) stage" and also determined that CFI's complaint survives Rule 9(b)'s heightened pleading standard, providing Victaulic adequate notice of the claims against it. The Third Circuit determined that failure to pay marking duties for imported pipe fittings "may give rise to reverse FCA liability" and held that the district court abused its discretion in denying CFI's motion for leave to amend its complaint.
Notably, the Third Circuit also acknowledged that an awareness of "the great expense and difficulty that may accompany False Claims Act discovery and the burden on defendants and their shareholders and investors of having unresolved allegations of fraudulent conduct in pending proceedings." To that end, the Third Circuit reviewed the December 2015 amendments to the Federal Rules of Civil Procedure—which place greater emphasis on judicial involvement in discovery and case management and encourage great cooperation among counsel—and noted that this case "will require the active involvement of the District Court, in conjunction with counsel and their clients, to limit the expense and burden of discovery while still providing enough information to allow CFI to test its claims on the merits." The Third Circuit's consideration of the burden on corporate defendants is a positive development for corporate defendants facing the ever-growing threat of FCA litigation. We will continue to monitor this case on remand to the E.D. Pa. and will report on any additional developments.
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