Bond Producers Should Be Aware of New Pitfalls in False Claims Act Liability

Contractors doing business with the federal government should be prepared for increased enforcement of procurement laws and regulations — specifically in connection with the government’s enforcement of the Federal False Claims Act. Those contractors who do not take care to make sure they are in compliance with regulations governing their contracts are in for a bumpy ride. Surety bond producers should be aware of and make their contractors and subcontractors aware of these issues.

Background on the False Claims Act

Since the Federal False Claims Act was enacted over 150 years ago, Congress has steadily broadened its reach and sharpened its sting; and today it is the government’s most powerful regulatory weapon to combat fraud and abuse in the federal procurement system. In the last three years alone, total recoveries by the U.S. Department of Justice in False Claims Act cases have approached $10 billion and continue to grow.

In a False Claims Act case, the government (or an individual whistleblower) must demonstrate that the contractor submitted false information to the government in connection with some request for payment. The threshold for liability is much lower in a False Claims Act case than it would be in a common law fraud case, so the government’s burden in proving False Claims Act violations is not a particularly heavy one. The government/whistleblower does not even need to prove that the contractor intended to defraud the government, only that the contractor either knew that the information submitted to the government was false, or the contractor acted in reckless disregard of the truth or falsity of the information.   Subcontractors are also subject to potential False Claims Act liability, even though they have no direct contractual relationship with the government.  Because a prime contractor often passes subcontractor invoice information or other requests for payment directly onto the government without much independent review and validation, the government may assert False Claims Act violations directly against a lower-tier subcontractor.

These days, contractors must be very careful to vet all information submitted to the government in connection with the contractor’s pursuit and performance of a federal contract. Information contained in a contractor’s proposal and any related certifications concerning a contractor’s compliance with regulations or eligibility for award must be accurate and complete at all times. Moreover, any post-award requests for payment, whether they are a claim or invoice or request for progress payment, must be accurate, complete, and legally supportable. If a contractor submits any contract claim or request for payment to the government, it is effectively representing to the government that the amount requested is accurate, that the claim or request for payment is based upon a legitimate right to payment, and that there is no legal impediment that, if known, would cause the government to refuse payment. If a contractor misrepresents any of the foregoing in connection with its contract proposal, or any post-award claim or other request for payment, it can be liable for substantial civil penalties under the False Claims Act – and these are only the monetary penalties available to the federal government. The contractor could still face suspension or debarment in addition to the monetary penalties.

The financial consequences of False Claims Act violations can be harsh. A contractor found liable under the False Claims Act can be assessed large civil fines or damages, and usually faces both. In addition to the actual, direct damages the government may recover, potential fines alone range from $5,000 to $11,000 per violation. Damages under the remedy provisions of the False Claims Act can also be trebled (and that is after the assessment of penalties), which can turn even a minor violation into one that costs a contractor at least tens of thousands of dollars; often it is much more because of the multiplier effect of each violation. In short, where a contractor is accused of falsely certifying compliance with laws and regulations in order to receive a government payment, or where the government is induced to award a contract through false statements or information, all subsequent claims for payment made under the contract are treated as false claims. Because each request for payment represents a separate violation, False Claims Act cases can, and often do, easily skyrocket into hundreds of thousands or millions of dollars in damages and penalties, depending on the number and severity of violations.

Recent Trends in False Claims Act Enforcement

It becomes quickly obvious that a contractor’s failure to carefully verify its submissions to the government in connection with its government contracts can lead to bet-the-company mistakes as in the following recent case:

• A relatively small Ohio construction firm under contract with the U.S. Department of Transportation agreed to pay the government more than $500,000 to settle multiple False Claims Act violations misrepresenting its compliance with the small disadvantaged business subcontracting requirements in its prime contract. The company’s prime contract required it to award a certain percentage of materials and services under the prime contract to one or more qualifying disadvantaged small business subcontractors. The contractor allegedly misrepresented its compliance with those requirements to the government. The government discovered the contractor’s misrepresentation and took the view that, each time the contractor submitted a request for payment, it in effect certified it was eligible to receive payment because it was in compliance with all its contract requirements, including the requirement that it meet its small disadvantaged business subcontracting goals. The contractor paid a heavy price for its mistake.

A second recent trend in False Claims Act enforcement is the government’s willingness to use False Claims Act as an enforcement tool in its oversight of the various federal small business contracting programs. Of particular significance is the Small Business Jobs Act of 2010 (Public Law 111-240), where Congress has inserted a government-wide policy statement that contractors misrepresenting their size status in connection with a government contract could be prosecuted for that misrepresentation.

In addition, the Small Business Jobs Act greatly expands the potential damages available against a contractor found to have misrepresented its size.  In the past, the government could only assert limited damages against a contractor if it received the benefit of satisfactory services from the contractor. That is no longer the law. The recent expansion of the False Claims Act now provides the government a new damages tool called the “Presumed Loss Rule.” The “Presumed Loss Rule” establishes a presumption that, where a contractor misrepresents its size, and in doing so improperly obtains a small business set-aside contract, the government suffers a loss equal to the amount of the contract. Accordingly, the government is now within its rights to recover the total dollar value of the contract from the contractor, even where the contractor, whether eligible or not, satisfactorily performed the contract requirements. In short, a contractor that is found liable under the False Claims Act for misrepresenting its size status may be required to pay damages of triple the contract value, plus penalties for each violation. Given the enormous penalties now at stake, contractors must be very careful to confirm whether they are in fact eligible to compete for and win a small business set-aside contract before they bid, lest thy risk forfeiture of all contract proceeds, plus treble damages and penalties.

The government’s recent increased emphasis on setting aside contracting dollars for the benefit of small businesses has also increased the competition for these set-aside contract opportunities and has enticed large businesses to team with small contractors to capture a piece of the small business contracting pie. Often small business prime contractors must partner with larger subcontractors just to achieve the bandwidth to perform larger bundled requirements. As a result, some large contractors have intentionally positioned themselves to keep the lion’s share of profits under small business set-aside contracts themselves while using eligible small contractors as fronts to obtain lucrative set-aside contracts. These types of covert arrangements have also become a primary focus of the government’s contracting enforcement activities. Such was the case in the following cautionary tale:

• A large contractor set up two 8(a) businesses as “pass through” companies to obtain 8(a) set-aside contractors. When an 8(a) award was protested, the government determined that the 8(a) contractors had very little, if any, involvement in the performance of the awarded contracts; and the large contractor was covertly driving the pursuit, capture, and performance of the 8(a) set-aside contracts awarded to the small contractors. The government found the large company liable and, in addition to monetary penalties, suspended the large contractor from all government contracting.

With the slow economic recovery, more contractors are looking to jump into the federal contracting marketplace. Although federal budgets are undeniably tight, the federal market is often perceived as much more recession-proof and increasing numbers of companies see the federal market as a potential source of revenue when commercial contracting opportunities become scarce. However, many companies trying to break into federal contracting often ignore or do not fully understand the complicated obligations and requirements attached to federal contracts. No matter how complicated and overwhelming government contracting may seem to a newbie contractor, it is the contractor’s responsibility to read, understand, and comply with all of the requirements in and applicable to a federal contract. Companies without the experience and knowledge concerning the applicable regulations and unique contract requirements may expose themselves not only to the possibility of failing to win business, but also to the likelihood of losing money and facing civil penalties for False Claims Act contracting violations.

A recent case underscores the importance of knowing the unique restrictions placed on government contractors and the potential liability a contractor may unwittingly face for its ignorance of the rules:

• A former employee of a government contractor agreed to pay the United States $11,000 to settle allegations that he accepted illegal kickbacks from a subcontractor. The alleged kickbacks from the subcontractor were relatively minor–a restaurant gift certificate and some baseball tickets–in all, only about $500 worth of gifts. The employee was one of about two dozen employees who received gifts from the same subcontractor.  In return for the gifts, the prime contractor purchased over $3.9 million in materials from subcontractor. In a subsequent federal investigation and lawsuit against the prime and subcontractor, the Department of Energy (DOE) stated that the government would not have approved any of the amounts used to pay the subcontractor if the DOE had known the prime contractor’s employees were accepting kickbacks.  Thus, the prime contractor’s claims for payment under its federal contract were fraudulent because the contractor, by submitting a request for payment, was in essence certifying its compliance with regulations applicable to its contract, including the regulation prohibiting the prime contractor from accepting kickbacks from its subcontractors.

Conclusion

The implications of recent changes in the False Claims Act are obvious: contractors must be diligent to make sure that any required certifications, proposal statements, claims and requests for payment, and any other information submitted to the government in connection with the pursuit and performance of federal contracts is accurate and complete and legally supported. In the current enforcement environment, the stakes are simply too high to do anything less.

The author of this article is Heather A. James, Esq., Counsel at Whiteford, Taylor & Preston, LLP. She can be reached at hjames@wtplaw.com.

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.