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By NEIL MERKL, a partner at Kelley Drye & Warren LLP; CLIFFORD KATZ and MICHAEL J. MALONEY, litigation associates at Kelley Drye & Warren LLP, assisted in the preparation of this article.

The federal False Claims Act allows the U.S. Department of Justice or private persons acting on the government's behalf to sue anyone that made a "false claim" for government funds.

The False Claims Act grants private whistleblowers who bring evidence of fraud to the government's attention a bounty paid from any recoveries by the government from cases brought under the act.

What began as narrowly drawn legislation intended to protect Union soldiers from botulism and defective ammunition, however, has morphed into a multibillion-dollar private litigation industry, targeting defendants that have nothing to do with the defense industry or who may not even contract with the government or receive government money.

The insurance industry and other financial institutions are increasingly becoming targets of these actions as bigger recoveries become more publicized.

The False Claims Act allows recovery of treble damages on top of attorneys' fees, fines and other penalties. According to a Nov. 22, 2010, Department of Justice press release, recoveries under the law since January 2009 have exceeded $5.4 billion.

Comparatively few claims were brought under the False Claims Act over the first 100 years of its existence because the statute was narrowly construed by the courts and its usefulness was limited by built-in procedural limitations.

This all changed in the 1980s. In 1986, amid widely publicized defense contracting scandals in which the government was shown to have overpaid by hundreds of dollars for items like hammers and toilet seats, Congress amended the False Claims Act to remove procedural and jurisdictional hurdles and to increase potential recoveries.

An organized plaintiffs' bar has grown and become more aggressive, supporting plaintiffs who could share in 15 percent to 30 percent of any recovery by the government. As much as $2 billion of the $2.4 billion in settlements and judgments recovered under the False Claims Act in fiscal year 2009 originated from lawsuits filed by private plaintiffs.

More recently, 28 states have joined the party, passing their own state versions of the False Claims Act to recover payments made by state governments. False Claims Act litigation has grown exponentially in industries like the healthcare industry, where government participation has grown through the Medicare and Medicaid programs.

As the federal government's participation in the private economy grows, so does the reach of the False Claims Act. A recent case in Iowa, United States v. Hawley, brought against an insurance agent and his crop insurance agency, Hawley Insurance Inc., illustrates the indirect exposure of insurance professionals under the False Claims Act.

The Federal Crop Insurance Corporation (FCIC), which is owned by the U.S. Department of Agriculture, reinsures private insurers that offer crop insurance to farmers.

Hawley had his own agency. He worked as a private insurance agent for North Central Crop Insurance Inc., selling multiperil crop insurance policies reinsured through FCIC, which subsidized portions of the policy premiums.

Farmers buying the policies must certify in their policy applications, which also are signed by the agents, that they have a valid insurable interest in the insured crop.

In this case, Hawley sold two North Central policies to farmers who later admitted they did not have insurable interests in the crops they insured. The farmers submitted claims to North Central, which paid them. Portions of the paid claims were reinsured by the FCIC. The government later prosecuted the farmers for insurance fraud and entered into civil settlements with them.

Afterward, the government sued Hawley and his agency under the False Claims Act for treble damages and penalties, alleging he "caused" the farmers to obtain the coverage and receive the claim payments.

Hawley argued, among other things, that he had no liability under the False Claims Act because he himself never made a claim to the government for payment. The payments were made to the farmers, not Hawley. North Central paid the claims, not the government. The false applications showing insurable interest, moreover, were not presented to the government; they were presented to North Central.

Hawley lost all his arguments. The court held it was enough that government funds were used to reimburse North Central under the reinsurance agreement. Hawley was effectively responsible for a false reinsurance claim submitted by North Central by virtue of his submitting an application for coverage with a misrepresentation in it.

The court left it for a jury to determine whether Hawley started a chain of events that led to the ultimate submission and payment of a false claim by the federal government, simply by submitting the application for coverage to the insurance carrier.

A jury would be permitted to determine whether Hawley knew it was a foreseeable consequence that submitting a bad application could lead to payment of a false claim.

In 2009, while the Hawley case was pending, Congress amended the False Claims Act to clarify that any false statement "having a natural tendency to influence or be capable of influencing" the government's decision to make payment may be actionable.

The opinion in the Hawley case does not address situations in which an agent unknowingly submits a policy application with a false statement. It also leaves open the question of under which circumstances an insurer could be liable under the False Claims Act for seeking a reinsurance recovery for a claim paid on a policy that is later determined to have been issued based on a material misrepresentation.

The statute would appear to exclude a situation in which the agent or the company does not know of the false statement, since the false claim must be submitted knowingly. On the other hand, whether and to what extent an agent or insurer "knows" and "should know" a statement in an application is false can be a source of dispute.

A similarly broad interpretation of the False Claims Act was applied to a disability insurer in a 2010 federal court case in Massachusetts, United States v. Unum Group.

One of its companies, Unum LTD, sells disability policies. As a condition to receiving continued benefits under its own policies, Unum required that disabled claimants submit disability claims for benefits to the Social Security Administration. Social Security payments offset Unum payments. Two Unum policy claimants applied for Social Security benefits and certified to Social Security that they were disabled; they told Social Security that they filed under Unum's directions. Social Security rejected their claims for benefits.

A private person, on behalf of the government, sued Unum under the False Claims Act, saying that Unum "caused" the insureds to file false Social Security claims.

The lawsuit claimed that Unum should have known that the insureds were not disabled within the meaning of the Social Security Act, even though Unum was actually paying them because Unum concluded they were disabled under its own policies.

Unum never filed a claim with the government. Unum never received a payment from the government. The insureds never received a payment from the government.

The court held that Unum could be legally responsible under the False Claims Act because Unum caused someone else to submit a false claim. It did not matter that the claimants filled out the Social Security claim forms independently, and that the government made its own independent decision based on its own investigation of the evidence of disability. Unum could be liable for each of the claims it caused to be submitted.

Any company or individual selling or underwriting insurance that is reinsured by the federal government or where claims practices influence the conduct of insurers who are reimbursed by the government, needs to be cognizant of the potential exposure under the False Claims Act.

They should ensure that their claims handling and underwriting practices can withstand scrutiny under the FCA and will protect them from exposure to the extent possible.

May 1, 2011

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