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A False Claims Act Win for the Banks

Law360

Andrew W. Schilling

In the years following the financial crisis, the U.S. Department of Justice and the relators bar have aggressively used the False Claims Act to target banks and nonbank mortgage lenders and servicers, using increasingly creative theories of liability to hold these companies responsible for failing to adequately protect against financial loss to the government. Most recently, the Justice Department announced a settlement of $1.2 billion against Wells Fargo, which had been accused, among other things, of making false certifications to the U.S. Department of Housing & Urban Development in connection with its Federal Housing Administration lending program. In other cases involving FHA lending, the government has alleged that lenders lied not only about the quality of particular loans, but also when they made their annual compliance certifications to HUD, which broadly attest to compliance with FHA program requirements. This broad certification theory has met with fierce resistance by the mortgage industry, which insists that FCA liability cannot be premised on so broad a certification.

Last week, the Second Circuit decided a case outside of mortgage lending that may give the banks some additional ammunition against such an aggressive use of compliance certifications in FCA cases.

Background: The False Certification Theory and Mortgage Lending

In the recent series of FCA cases involving government lending, the government has not alleged a discrete, intentional fraud on the government, but rather has alleged a programwide, “reckless” failure on the part of the defendants to adequately protect the government from financial loss. In other words, the companies find themselves in the crosshairs of DOJ enforcement not because someone lined their pockets from some targeted fraudulent scheme, but because the government found evidence of some broader regulatory noncompliance that, it asserted, led the government to pay money it should not have paid, such as insuring loans that it would not otherwise have insured or (in the conventional lending context) buying loans it would not otherwise have bought.

But because mere regulatory noncompliance does not violate the FCA, the government has needed a hook to bring these cases under the rubric of the FCA. To that end, it has argued (successfully in several cases) that companies can be liable under the FCA for regulatory noncompliance if they make false certifications to the government that they were operating in compliance with the law or other federal program requirements when in fact they were not. This “false certification” theory of liability has posed a particular threat in the area of government-insured lending and servicing, where government agencies routinely require participating mortgagees to make broad certifications of regulatory compliance as a condition of participation in government programs.

In defense to these cases, defendants typically argue that most routine compliance certifications are simply too broad to support liability for any particular instance of noncompliance, and that a particular instance of regulatory noncompliance (even if it occurred) does not render such a broad certification false, let alone materially false. They have also argued that the false certification theory requires not only a showing of noncompliance, but also that compliance was a “condition of payment” of the government’s claim.

These two defenses have met with mixed success in the courts, with some courts willing to sustain complaints even when based on broad certifications of compliance, and some courts not requiring that the compliance be an explicit “condition of payment” of the claim. Faced with the prospect of treble damages, this level of uncertainty in the case law has surely contributed to the decision by some companies to settle these cases, often for hundreds of millions of dollars or more.

Originally published on www.law360.com. Reprinted with permission.