Gibson, Dunn & Crutcher's Wayne Smith and Timothy Hatch have built an impressive record defending ITT Educational Services Inc. against long-running claims that it violated rules governing how for-profit education companies manage their businesses and compensate student recruiters. As we've reported, Hatch's work for ITT beginning more than a decade ago helped Gibson Dunn establish itself as a go-to defense firm for the for-profit education industry.

On Monday, however, Gibson Dunn hit a serious snag in its defense of ITT, which remains squarely in the sights of lawmakers and plaintiffs lawyers targeting for-profit education companies.

In a major reversal, the U.S. Court of Appeals for the Seventh Circuit resuscitated a whistleblower's False Claims Act lawsuit against ITT, throwing out an Indianapolis judge's August 2011 decision dismissing the case. Not only that, the appellate court vacated a scathing $400,000 sanctions order against the whistleblower's lawyers at Motley Rice and two other plaintiffs firms. And finally, in what could be interpreted as a rebuke to U.S. District Judge Tanya Walton Pratt, the Seventh Circuit ordered the case assigned to a new judge to oversee summary judgment briefing and a potential trial.

The Seventh Circuit panel rejected Pratt's finding that a Mississippi plaintiffs lawyer named Timothy Matusheski had recruited a "know-nothing" whistleblower to sue ITT for defrauding government aid programs based on public information about ITT's admissions and recruiter compensation practices. Pratt had ruled that "Matusheski plucked a prospective plaintiff out of thin air and tried to manufacture a lucrative case." But the appeals court concluded that whistleblower Debra Leveski presented substantial new allegations based on her decade-long employment with ITT, giving the federal courts jurisdiction to hear her case. Moreover, the panel ruled that Matusheski and his co-counsel at Motley Rice and Plews Shadley Racher & Braun did nothing wrong in approaching Leveski or helping her to press her case.

As we've previously explained, Motley Rice had the bad luck of entering the case in May 2011, less than a year after it was reassigned to Judge Pratt from another federal judge who had twice refused to dismiss it. Pratt issued her ruling tossing the case less than three months later, agreeing with ITT that Leveski and her lawyers based their allegations on already-public information gleaned from prior litigation and other sources. The firm's luck got worse last March, when Pratt sanctioned Motley Rice along with Matusheski and Plews Shadley for pursuing "frivolous" claims.

Motley Rice's Mark Labaton, who argued the appeal at the Seventh Circuit, praised the court for Monday's "thorough and comprehensive" opinion. Labaton told us that the ruling, authored by Circuit Judge John Daniel Tinder, made it clear that Leveski was an original source of her allegations and that she had extensive first-hand knowledge backing her claims. And he blasted ITT's litigation strategy, claiming that "the opinion shows that the company has really used outrageous tactics to try to intimidate Ms. Leveski and her legal team into dropping the case."

Labaton added in an email that an expert's report had pegged damages in the case as potentially reaching hundreds of millions of dollars and perhaps topping $1 billion. Damages may be trebled under the False Claims Act.

Gibson Dunn's Smith, who argued for ITT, told us there were "a number of flaws" in the Seventh Circuit's ruling, and he emphasized that the appellate court didn't rule on the merits of Leveski's claims. "We're absolutely confident that we'll prevail," Smith said.