TWENTY EIGHTH ANNUAL SOUTHERN SURETY AND FIDELITY CLAIMS

Transcription

1 TWENTY EIGHTH ANNUAL SOUTHERN SURETY AND FIDELITY CLAIMS CONFERENCE Nashville, Tennessee th st APRIL 20 & 21, 2017 FALSE CLAIMS ACT PRESENTED BY: BRIAN R. GAUDET, ESQ. Coats Rose, P.C. 9 Greenway Plaza, Suite 1100 Houston, Texas THOMAS H. DUKE AmTrust Surety 2591 Dallas Parkway, Suite #105 Frisco, Texas COURTNEY M. LYNCH, LAW CLERK Coats Rose, P.C. 9 Greenway Plaza, Suite 1100 Houston, Texas 77046

2 False Claims Act I. Introduction Each year, contractors enter into agreements to provide certain materials or perform certain services for the Federal Government. If all goes well, both parties obtain what each bargained to obtain. However, in some cases, the contractor will untruthfully represent its certifications in order to obtain the contract, the contractor may produce a project that fails to conform to the contract requirements, or the contractor attempts to creatively bill the project to make up for financial difficulties encountered along the way. Each of these scenarios causes potential catastrophic problems for the contractor engaged in these activities as well as potential problems for a surety company who steps in to assume the contractors work and claims. Many papers and presentations have been written on this topic. The purpose of this paper is not to duplicate those efforts, but to simply review the most pertinent part of the False Claims Act and give the surety professional some food for thought when their principal gets into trouble on a federal project. The False Claims Act ( FCA or the Act ) creates liability for anyone, contractor or not, who obtains government payment on a claim that is knowingly false in some regard. 1 The FCA protects all areas of federal contracting; therefore, its provisions are commonly confronted in the construction industry. Because the Miller Act requires that federal construction projects be bonded, a substantial portion of bonded projects across the country require direct, or indirect, requests for payment from the federal government. Certainly when a surety steps in and tries to recover contract balances from the government, it subjects itself to the FCA. If the surety ends up passing along bad claims or requests for improper work, this can directly affect the surety. Accordingly, surety claims representatives need to be familiar with, and understand the FCA s requirements. This paper begins by discussing the FCA s grounds for liability, followed by a discussion of the Act s key elements. Next, the paper explores how attempts to conceal payment obligations owed to the government can create a reverse false claim. After addressing the types of behaviors that may lead to violations of the FCA, the paper concludes with a discussion of how, in the end, the surety may become liable for an FCA violation. II. False Claims Act Grounds for Liability The provisions of the FCA set forth a variety of ways in which one may violate the FCA. For those in the construction and surety industries, there are four types of violations that are the most common. One violates the FCA when he/she: (1) knowingly presents, or causes to be presented, a false or fraudulent claim for payment or approval; 2 (2) knowingly makes, uses, or causes to be made or used, a false record or statement material to a false or fraudulent claim; 3 (3) has possession, custody, or control of property or money used, or to be used, by the Government and knowingly delivers, or causes to be delivered, less than all of 1 31 U.S.C U.S.C. 3729(a)(1)(A) U.S.C. 3729(a)(1)(B). 2

3 that money or property; 4 and (4), knowingly makes, uses, or causes to be made or used, a false record or statement material to an obligation to pay or transmit money or property to the Government, or knowingly conceals or knowingly and improperly avoids or decreases an obligation to pay or transmit money or property to the Government[.] 5 In simpler words, the FCA prohibits any fraudulent claim for payment of money from the Government. In addition, the FCA applies to all knowingly false statements made in support of a fraudulent claim. III. False Claims Act Key Elements and Definitions In United States v. Basin Elec. Power Coop., the Eighth Circuit Court of Appeals clearly identified the elements of an FCA violation. 6 The court explained, A prima facie case under the statute requires that (1) the defendant made a claim against the United States; (2) the claim was false or fraudulent; and (3) the defendant knew the claim was false or fraudulent. 7 Additionally, if the violation is based upon a false statement or record used to support a fraudulent claim, the statement or record must also be (4) material to the false claim. 8 As stated above, the first condition of an FCA violation is the presence of a claim. As defined in the FCA, 9 a claim is a request for money or property made to an officer, employee, or agent of the United States[.] 10 A claim also includes requests for payment made to a Government contractor, grantee, or other recipient, if the money or property is to be spent or used on the Government s behalf or to advance a Government program or interest[,] 11 so long as the Government provides the payment or will reimburse for any portion of the money or property[.] U.S.C. 3729(a)(1)(D) U.S.C. 3729(a)(1)(G) F.3d 781, 803 (8th Cir. 2001). 7 Id. 8 See 31 U.S.C (b)(2) U.S.C (a)(1)(b),(g) U.S.C (b)(2)(a)(i) U.S.C (b)(2)(a)(ii) U.S.C (b)(2)(a)(ii)(i). A claim (A) means any request or demand, whether under a contract or otherwise, for money or property and whether or not the United States has title to the money or property, that (i) is presented to an officer, employee, or agent of the United States; or (ii) is made to a contractor, grantee, or other recipient, if the money or property is to be spent or used on the Government s behalf or to advance a Government program or interest, and if the United States Government (I) provides or has provided any portion of the money or property requested or demanded; or will reimburse such contractor, grantee, or other recipient for any portion of the money or property which is requested or demanded; and (B) does not include requests or demands for money or property that the Government has paid to an individual as compensation for Federal employment or as an income subsidy with no restrictions on that individual s use of the money or property[.] 31 U.S.C (b)(2). 3

4 Second, the FCA requires that the claim is false. The element of falsity encompasses more than just the request for money. Instead, it extends to false statements made with the purpose of procuring government contracts, 13 false statements made in loan applications to federal agencies, 14 and false certifications of qualification for certain federal programs. 15 The third element of an FCA violation is knowledge. Unlike common law fraud, the FCA does not require a specific intent to deceive, but it does require that the defendant had knowledge that the submitted claim was false. 16 The Act describes knowing as one of three things: (1) actual knowledge, (2) deliberate ignorance, or (3) reckless disregard of the false information. 17 When a claim is falsely submitted due to an innocent mistake, or even through negligence, the claim is not actionable under the FCA. 18 It is important to realize that the threshold of knowledge is much lower than it initially sounds. Deliberate ignorance or reckless disregard meets this threshold. Accordingly, a surety representative who simply passes on its contractors request for equitable adjustment without reviewing the claim itself could have sufficient knowledge to trigger liability. Finally, the FCA requires that a false statement or record used to support a fraudulent claim be material. 19 The term material means having a natural tendency to influence, or be capable of influencing, the payment or receipt of money or property. 20 As the U.S. Supreme Court recently stated in Universal Health Services, Inc. v. United States ex rel. Escobar, The materiality standard of the False Claims Act is demanding. 21 A statement is material only if it affects the government s decision to pay. 22 IV. Reverse False Claims under the False Claims Act A Reverse False Claim occurs when one uses a material false statement or record to avoid payment to, rather than obtain payment from, the Government. In both situations, the Government is fraudulently deprived of funds. Under the text of the FCA, a Reverse False 13 See Universal Health Services, Inc. v. United States ex rel. Escobar, 136 S. Ct (2016). 14 United States v. Neifert-White Co., 390 U.S. 228, 233 (1968). 15 Ab-Tech Constr. v. United States, 31 Fed. Cl. 429 (Ct. Fed. Cl. 1994). 16 United States v. King-Vassel, 728 F.3d 707, 712 (7th Cir. 2013) U.S.C. 3729(b)(1). [T]he terms knowing and knowingly (A) mean that a person, with respect to information (i) has actual knowledge of the information; (ii) acts in deliberate ignorance of the truth or falsity of the information; or (iii) acts in reckless disregard of the truth or falsity of the information; and (B) require no proof of specific intent to defraud[.] Id. 18 See United States ex rel. Sheet Metal Workers Int l Ass n, Local Union 20 v. Horning Invs., LLC, 828 F.3d 587, 593 (7th Cir. 2016) (finding contractor did not know payroll certifications falsely supported claim). 19 See 31 U.S.C. 3729(b)(2) U.S.C (b)(4) S. Ct. 1989, 2003 (2016). 22 Id. 4

5 Claim occurs when one knowingly makes, uses, or causes to be made or used, a false record or statement to conceal, avoid, or decrease an obligation to pay or transmit money or property to the government. 23 V. Specific Types of FCA behaviors A contractor may engage in risky behaviors to obtain, or acquire payment under, a government contract. Many of these behaviors will expose the contractor to liability under the FCA. Examples include: Fraudulent inducement in winning the contract, false certification of compliance, substandard work not in compliance with the contract documents, inflated invoices, and requests for equitable adjustments and claims. A. Fraudulent Inducement in winning the contract Fraud in the inducement to the contract is a recurring category of False Claims Act cases. 24 The fraudulent conduct, or original fraudulent misrepresentation, originally used to obtain the contract will render subsequent claims for payment false or fraudulent, even if those claims contain no false statements. 25 In United States ex rel. Longhi v. United States, the Fifth Circuit Court of Appeals found a technology company fraudulently induced contracts under the federal Small Business Innovation Research Program (SBIR), violating the FCA. 26 The company s grant proposal contained a slew of misleading information, including implied working relationships with both the University of Houston and Polyhedron Laboratories, an incorrect date of incorporation, and lies regarding the existence of facilities. Finding the false statements material, the court upheld the district court s assessment of actual damages at $1,657,455, and trebled the damages, as allowed under the FCA, to the amount of $4,972, B. False Certification of Compliance False certifications of compliance are violations of the FCA. In Lamb Engineering & Construction Co. v. United States, the court found the government contractor, Lamb, violated U.S.C. 3729(a)(7). 24 United States ex rel. Wilkins v. North Am. Constr. Corp., 173 F.Supp.2d 601, (S.D. Tex. 2001), overruled on other grounds, 575 F.3d 458, 469 (5th Cir. 2009); see also, United States ex rel. Marcus v. Hess, 317 U.S. 537 (1943) (finding contractors liable under the False Claims Act for claims submitted under government contacts which defendants obtained through collusive bidding); United States ex rel. Hagood v. Sonoma County Water Agency, 929 F.2d 1416, 1420 (9th Cir. 1991) (stating claim where county water agency and Army Corps of Engineers employee conspired to illegally lower the agency's contractual repayment obligations); United States v. General Dynamics Corp., 19 F.3d 770 (2d Cir.1994) (holding defendant liable for submitting inflated cost estimates in subcontract submitted for approval to government). 25 United States ex rel. Laird v. Lockheed Martin Eng g & Science Servs. Co., 491 F.3d 254, 259 (5th Cir. 2007) F.3d 458, 471 (5th Cir. 2009). 27 Id. at

6 the FCA. 28 Lamb entered into a contract with the Department of Energy on an approximately $3.5 million fixed-price construction contract, and was subsequently terminated for default. 29 In the course of performing the contract, Lamb submitted four false certifications that its subcontractors were each paid in compliance with the Prompt Pay Act. The court held the false certifications of payment failed to comply with the contract requirements, violating the FCA. 30 Similarly, in United States v. Sequel Contractors, Inc., a federal district court held that false certifications of contractor compliance with federal environmental laws, when the contractor knowingly failed to comply, violated the FCA. 31 The court explained, Defendants characterization of the claim as an attempt to sue for violations of environmental laws misses the point it is not the violation of environmental laws that gives rise to an FCA claim but the false representations to the government that there has been compliance. 32 C. Substandard Work not in Compliance with the Contract Documents Just as above, where false certifications of compliance formed the basis of FCA actions, substandard work can also lead to FCA claims when the work is not in compliance with the contract documents. Substandard, defective, and nonconforming work may become impliedly certified when the contractor seeks payment from the Government for its nonconforming work. In Shaw v. AAA Eng g & Drafting, Inc., the contract provisions required that the contractor, a photographer, recover silver from the contractor s photography chemicals. 33 Addressing the legislative history of the FCA, the court stated: Permitting FCA liability based on a false certification of compliance with a government contract, whether the certification is express or implied, is consistent with the legislative history of the 1986 Amendments to the FCA. The Senate Committee on the Judiciary noted a false claim under the FCA may take many forms, the most common being a claim for goods or services not provided, or provided in violation of contract terms, specification, statute, or regulation. 34 The court held the contractor impliedly certified compliance with the provisions in the contract when it submitted work orders and invoices for payment. 35 When FCA liability is based upon Fed Cl. 106 (Ct. Fed. Cl. 2003). 29 Id. at Id. at F.Supp. 636, 638 (W.D. Wis. 1995). 32 Id F.3d 519 (10th Cir. 2000). 34 Id. at 531 (citing S.Rep. No at 9 (1986)). 35 Shaw v. AAA Eng g & Drafting, Inc., 213 F.3d 519 (10th Cir. 2000). 6

7 implied certification, the contractor must know, or recklessly disregard the risk, that the implied certification of compliance is wrong. 36 D. Inflated invoices Inflated invoices, which pursue unearned payment from the Government, are violations of the FCA. In United States v. Sequel Contractors, Inc., a contractor and its subcontractor inflated the value of work the subcontractor performed for the Federal Aviation Administration ( FAA ) 37. The court held that the inflated invoices were false records used to defraud the FAA in violation of the FCA. 38 E. Requests for Equitable Adjustments/Claims A request for equitable adjustment from the Government, made without merit, is a fraudulent and false claim violating the FCA. In Daewoo Engineering and Const. Co., Ltd. v. United States, the contractor made an initial bid far below the Government s own evaluation of the project. 39 The Government permitted the contractor to reassess and increase its bid, which it did, from $73 million, to $88 million. 40 The court found there was no justification for the amount of the initial bid or the $15 million increase in the second bid. Instead, the court determined the intent of the contractor was to acquire the contract and then profit through claims for equitable adjustments. 41 Holding for the Government, the court found the contractor violated the FCA when it presented its knowingly false claim for equitable adjustment. 42 VI. Potential Impact to the Surety The surety can be impacted by the False Claims Act in two major ways. First, the bonded principal can be impacted triggering a cascade of events which either directly or indirectly lead to surety exposure by virtue of claims made against the bonds. Second, the surety can create its own FCA liability by adopting the false claims of its principal and pursuing them. The majority, if not all of the claims made against a surety on a construction project emanate from either a lack of money or lack of quality on the project. Not having enough time is also an issue, but that either involves compensable delays by the Owner or design professional, or it is a symptom of not having enough money to obtain and retain the trades you need to perform the work or there is a delay caused by a quality issue on the project, such 36 Id. (citing 31 U.S.C.A. 3729(b)) F.Supp.2d 1142, (C.D. Cal. 2005). 38 Id. at Fed. Cl. 547, 560 (2006), aff d, 557 F.3d 1332 (Fed. Cir. 2009). 40 Id. at Id. 42 Id. at

8 as re-work. Sometimes these are all intertwined. The lack of quality issues tend to lead into uncompensated re-work which affects the available money, and/or they result in delays that extend overhead and general conditions incurred on the project, which affect the available money. Sometimes the lack of initial quality results in a need to replace a trade contractor which inevitably leads to increased replacement costs. The lack of quality can be brought on intentionally by a contractor who has run into money issues and attempts to recover a busted budget by cutting corners in material or workmanship quality. These things lead to terminations and warranty claims. The lack of money on a project definitely causes a number of problems, from payment bonds claims, to the inability to timely proceed with the work as a result of lack of cash flow and often times the tightening or stopping of available credit with vendors and trade contractors. The solution to the money problems on a project is to try to get more money from the Owner of the project. If it is indeed owed, then there are no concerns. If it is not owed, or the request for additional compensation outdistances the contract support for the request, the contractor can cause itself more problems. Time issues often involve delays from multiple sources, owner caused delays, trade contractor caused delays, design professional caused delays, lack of productivity stemming from poorly qualified trade contractors or sometimes the unavailability in the marketplace of enough qualified labor to perform the work. All of these sorts of issues create openings for FCA violations for the bonded principal. Attempts to recover the schedule or make up for unintended expenses lend themselves to the types of behaviors prohibited by the FCA. Improper substitution of cheaper unspecified goods, hiring extra help and paying them less than the Davis Bacon required wages, using a cheaper foreign alternative to materials governed by the Buy American Act, inflating invoices or improper requests for equitable adjustment are the types of behaviors that contractors employ to try to save a failing project. If the bonded principal is engaged on multiple federal projects and gets caught on one project the entire portfolio of work can come crashing down. Surety claims representatives must be aware of the FCA and the potential liability the surety is exposed to. In the event a federal project goes into claim, one of the natural steps a surety takes is to see if there is any potential monetary recovery to lessen the loss. At the forefront of that effort is to look to the Owner for any remaining contract balances. Coupled with that is a desire to push any claims the bonded principal has to increase the contract balances recovered from the owner. The surety can run afoul of the FCA if it asserts the claim of its bonded principal against the government and that claims contains matters that are subject to the false claim act. As discussed above, the element and surety would try to turn to avoid liability is the lack of knowledge of the falsity of the claim. But remember, a knowing violation only requires deliberate ignorance or reckless disregard. Accordingly, when faced with standing the in the shoes of the bonded principal in an attempt to recover on a claim against the federal government, the surety would be well advised to hire an independent expert to evaluate the claim from start to finish and to make sure that it contains only those elements that are firmly supportable. 8

9 It is important for a surety to consider its exposure to liability under the FCA when it pursues contract balances, performs completion of work by way of takeover, or when pursuing potentially inflated claims of principal. In addition, a surety should not request payment for any work that the surety knows does not comply with the contract s provisions, including work that includes unapproved substitutions. A surety must have a firm understanding of any payment requests and claims it chooses to stand behind when they are submitted to the government. VII. Conclusion The FCA protects all areas of federal contracting. A government contractor who knowingly makes a false claim a claim against the United States exposes itself, and the surety who provided its bond, to FCA liability. Surety involvement with Government payments requires that surety agents are familiar with, and understand the FCA s requirements. 9

10 Brian R. Gaudet Biography Brian R. Gaudet is a Director with the Coats Rose law firm. Brian's practice encompasses all aspects of the construction cycle from contract document preparation and review to litigation and dispute resolution of construction and surety related claims. Brian is Board Certified in Construction Law by the Texas Board of Legal Specialization. Brian s practice includes significant surety related matters as well as contract document preparation, creation and negotiation. Brian has had significant involvement in contract documentation for both domestic (Texas and other states) and international projects (South America & Asia) totaling more than a few billion dollars in the areas of Oil & Gas, Pipelines, Industrial, Pharmaceuticals, Manufacturing, Chemicals, Commercial, Education, Retail, Residential, Multi-Family Residential, Multi-Family Affordable Housing, Supply, Distributorships, etc. 10

11 Courtney M. Lynch Biography Courtney Lynch is a law clerk with the Coats Rose law firm. Courtney started as a summer associate at Coats Rose and continues to clerk at the firm while finishing law school. A third year student at South Texas College of Law Houston, Courtney is a member of the South Texas Law Review and a member of the Board of Advocates. Courtney served as Vice- President of the South Texas Real Estate and Construction Law Society and as President/Co- Founder of the Women s Law Society. Courtney has significant research and drafting experience on a variety of Surety and Construction law related matters. 11