Third Circuit Issues Decision on “Reverse False Claims” Provision

In United States ex rel. Customs Fraud Investigations, LLC v. Victaulic Co., 839 F.3d 242 (3d Cir. Oct. 5, 2016), the Third Circuit Court of Appeals clarified the scope of the so-called reverse false claims provision of the False Claims Act (“FCA”) by holding that “failure to pay marking duties may give rise to reverse false claims liability.” Id. at *35. Reverse false claims arise when an entity knowingly and improperly avoids paying funds that it owes to the Government. This form of FCA liability is distinct from the liability that is triggered by traditional false claims in that it is based not on a false claim for payment but rather on the failure of a defendant to pay the Government an amount that it rightfully owes.

The relators in the case alleged that Victaulic had failed to properly pay customs duties on imported pipe fittings. Specifically, the relators alleged that Victaulic knowingly failed to properly stamp its pipe fittings with the name of the foreign countries where the pipe fittings were made, and then released the products for sale in the United States. In so doing, the relators alleged that Victaulic concealed its obligation to pay the 10% ad valorem duty that is automatically imposed upon import of such unmarked merchandise and due upon its release into the United States market. The relators did not allege that the Government ever demanded, or was even aware of the duty payments that Victaulic owed. After the district court dismissed the relators’ claims with prejudice, the principle question that the appellate court decided was whether such an unassessed, but a properly owed customs duty constitutes an “obligation” to pay the Government money for purposes of establishing FCA liability. The Court answered that question in the affirmative. Id. at *35.

In reaching its holding, the Court relied on two changes that the 2009 Fraud Enforcement and Recovery Act (“FERA”) amendments made to the FCA, which “broadened the scope to which reverse false claims liability would attach.” Id. at *21. Specifically, the Court pointed to the removal of the requirement that a defendant make a false statement or use a false record to avoid paying an obligation to the Government, and to the addition of the statutory definition of “obligation.” Id. The removal of the requirement that a defendant make a false statement or record in its effort to avoid paying the Government means, as the Court stated, that “mere knowledge and avoidance of an obligation is sufficient, without the submission of a false record, to give rise to liability.” Id. at *26. That being the case, where defendants know they owe a sum to the Government but keep that knowledge to themselves, defendants may be held liable for reverse false claims, even if they never make any representations to the Government about the amount they owe. Id.

In reaching its decision, the Court also relied on the statutory definition of “obligation.” Id. at *21. The FERA amendments defined “obligation” to mean “an established duty, whether or not fixed, arising from an express or implied contractual, grantor-grantee, or licensor-licensee relationship, from a fee-based or similar relationship, from statute or regulation, or from the retention of an overpayment.” Id., quoting 42 U.S.C. § 3729(b)(3) (2009). This definition, the Court explained, was “in part, a reaction to the decision in American Textile Manufacturers Institute, Inc. v. The Limited, Inc…which held that the term ‘obligation’ should be afforded a different, and more limited, meaning than the meaning afforded the word ‘claim’ in the FCA, and that reverse false claims liability should be viewed more narrowly than general false claims liability.” Id. at 21-22 (internal quotations omitted). The Court turned to the legislative history of FERA to support its position that the new definition of “obligation” gives rise to reverse false claims liability in situations such as those alleged in the relators’ complaint. Id. at *22-23. The Court noted that the Senate Report on FERA specifically stated that the new definition of the term “obligation” was intended to cover not only fixed amount debt obligations to the government, but also any scenario in which an entity has a “duty to pay the Government money, whether or not the amount owed is fixed.” Id., quoting S. Rep. 111-10, at *14 (2009). The Court noted that it was of “particular importance” that the Senate Report explicitly discussed “customs duties for mismarking country of origin” and stated that those customs duties were not only intended to be covered by the FERA amendments, but that the new language made it obvious that “customs duties clearly fall within the new definition of the term ‘obligation.’” Id. at *23.

After holding that failure to pay certain duties can give rise to FCA liability, the Court briefly addressed two other arguments that Victaulic put forward in its attempt to avoid liability. First, the Court rejected the notion that the relators’ statistical sample of the secondary market for Victaulic pipe fittings could not support a plausible claim that Victaulic had not properly marked its pipe fittings, and therefore owed customs duties. The Court noted that although it was “skeptical” of the relators’ sampling methods, “such skepticism is misplaced at the Rule 12(b)(6) stage” when all reasonable inferences must be made in favor of plaintiffs. Id. at *33.

The Court then turned to the defendant’s argument that the relators’ claims should be dismissed because they did not include certain specific information about particular claims. The Court stated that it was bound to accept the relators’ allegations as true at the motion to dismiss stage, and that “the way marking duties are assessed provides an opportunity for fraud.” Id. at *34-35. Furthermore, the Court reasoned “that only Victaulic has access to the documents that could prove or disprove [the relators’] well-pled allegations.” Id. Thus, the fact that the relators may not have included certain specific information related to particular reverse false claims did not undermine the viability of their allegations that Victaulic had knowingly concealed the customs duties it owed to the Government. Id.