Legal Spotlight

  

U.S. Court of Federal Claims--Fraud Counterclaims Against Contractor and its Surety

In the July-August issue of Pipeline, the Legal Spotlight highlighted a decision of the U.S. District Court for the District of Columbia in United States ex rel. Scollick v. Narula, Case No.: 14-cv-01339-RCL (D.C.C. July 31, 2017), in which the court ruled that False Claims Act (FCA) allegations may be viable causes of action against surety companies, agencies, and bond producers. In an effort to keep its membership apprised of other important FCA cases that could impact the surety industry, the current Legal Spotlight discusses four U.S. Court of Federal Claims cases, consolidated into one action, Hanover Insurance Co. v. United States, No. 13-500C (Fed. Cl. filed July 22, 2013) (Hanover I is the lead case). Read the Opinion and Order for the case.
 
This Legal Spotlight addresses the Hanover I court’s September 15, 2017 Opinion and Order, by which the court allows the United States (Government) to amend its answers in three of the four consolidated cases to assert an affirmative defense and three counterclaims, based on the alleged fraud of the contractor and its surety. (The court denied the fourth amended answer as moot, as the Government had already answered in that case and raised the affirmative defense and fraud counterclaims.) The procedural history of this case is a morass of discovery machinations and legal mazes. It would make a terrific case study in a law school civil procedure class. But for purposes of this article, I will keep the procedural history abbreviated.

The plaintiffs in this case are Lodge Construction Company, Inc. (Contractor) and The Hanover Insurance Company (Surety), Lodge’s surety. The Contractor was awarded a contract with the Corps of Engineers (Corps) on August 24, 2010, concerning work on the Corps’ ongoing “Everglades Upgrade” project in South Florida. The Surety executed the performance and payment bonds on behalf of the Contractor for the contract. The contract was ultimately terminated for default on July 23, 1012. Pursuant to a Tender and Release Agreement, the Surety tendered a new contractor and paid the Corps $23,995,183.36, the difference between the amount paid to the new contractor to complete the work and the unpaid balance of the Corps’ contract with the Contractor.

In two of the four original cases, the Contractor and the Surety challenged the default termination and sought money damages. The Surety also asserted an equitable lien on any amounts recovered by the Contractor and entitlement to any funds recovered by the Contractor, pursuant to the indemnity agreement. The Surety submitted a certified claim for $24,476,106.47 in default termination damages to the Corps’ contracting officer. After the claim was denied, the Surety filed another action, asserting an equitable lien on all funds due in connection with the original contract, including any amounts that may become due to the Contractor. In none of its original four answers did the Government assert any affirmative defenses or counterclaims.

In the meantime, the parties engaged in massive discovery, with a number of extensions of time, now running through December 6, 2017. On April 6, 2017, the Government sought to amend its answers in all four consolidated cases, to assert (1) the affirmative defense that the Contractor’s claims are “barred by illegality as a result of submitting a false claim,” and (2) fraud counterclaims against the Contractor and the Surety for forfeiture and damages pursuant to the Special Plea in Fraud defense, the anti-fraud provision of the Contract Disputes Act (CDA), and the False Claims Act. With respect to all three counterclaims the Government alleges that the Surety is liable for the Contractor’s fraud.

With regard to the Special Plea in Fraud defense, the Government argues that the Contractor committed fraud when it submitted claims to the contracting officer so that the Government would pay the Contractor amounts to which it knows it is not entitled. The Government further contends that the Surety directly committed fraud by pursuing the Contractor’s entire claim in the court, including a fraudulent pass-through claim from the Contractor’s subcontractor.

Not surprisingly, the Contractor and the Surety opposed the Government’s motion, arguing that the motion is untimely, is an attempt to gain leverage, would cause undue prejudice, and is destined to fail. The Government replied to each response. In this Opinion and Order, the court addressed each argument of the Contractor and the Surety and found each without merit. Interestingly, and importantly, the court, in addressing the arguments against the proposed amendments, noted as follows:

        The issue at this stage of litigation is not the merits of defendant’s counterclaims, but whether the defendant has alleged specific facts describing plausible counterclaims such that its counterclaims are not futile and destined to fail.

The court then discussed the three statutory fraud counterclaims: the Special Plea in Fraud defense, the anti-fraud provision of the CDA, and the FCA. The court observed that, to prevail under the Special Plea in Fraud defense, also known as the Forfeiture Statute, the Government must prove that “Lodge and/or Hanover submitted false claims, knew those claims were false, and that their intent in submitting false claims was to defraud the government.” The claim forfeiture applies even when only part of the claim is fraudulent and applies both to claims submitted to contracting officers and claims filed in the Court of Federal Claims.

Congress enacted the anti-fraud provision of the CDA to prevent “the submission of baseless claims,” which contributes to the “so-called horsetrading theory where an amount beyond that which can be legitimately claimed is submitted merely as a negotiating tactic.” To recover under the CDA’s anti-fraud provision, the Government must “establish that the contractor made false or fraudulent statements in its submitted claim with an intent to deceive or mislead the government.”

A contractor is liable under the FCA by presenting a claim to the federal government that is false or fraudulent when the presentation is made with “scienter”—that is, when the contractor knew, was deliberately ignorant, or acted in reckless disregard of the falsity. The statutory penalty applies even if the government did not sustain damages by paying the claim. Certified claims may be a source of liability under both the CDA and the FCA.

In its analysis the court found that, if proven, the Contractor’s conduct and the Surety’s conduct as alleged by the Government would amount to fraud and would give rise to claims forfeiture under the Special Plea in Fraud defense, liability under the anti-fraud provision of the CDA, and liability under the FCA. The court further observed that, if the Contractor committed fraud, the Surety is liable for damages caused by the Contractor but not for its penalties (unless the bond so provides).

The bottom line is that the court allowed the Government to file amended answers in the consolidated cases to assert an affirmative defense and three counterclaims based on fraud against the Contractor and its Surety. It should be noted that the court did not hold that the Contractor and the Surety are liable or would be found liable. The court held that the Special Plea in Fraud defense, the anti-fraud provision of the CDA, and the FCA were viable counterclaims against the Contractor and its Surety.

NASBP will monitor this important case and update its membership accordingly.

The author of this article is Martha Perkins, General Counsel at NASBP. Martha Perkins can be reached at mperkins@nasbp.org or 202.686-3700.

This article is provided to NASBP members, affiliates, and associates solely for educational and informational purposes. It is not to be considered the rendering of legal advice in specific cases or to create a lawyer-client relationship. Readers are responsible for obtaining legal advice from their own counsels, and should not act upon any information contained in this article without such advice.