A Primer for Bond Producers on Contractor Liability Under The Civil False Claims Act
Fluctuating prices of building materials, labor shortages, delays and differing site conditions, among other things, can cause a formerly lucrative project to sustain big losses. But one of the more worrisome risks increasingly associated with federal construction contracting is the potential for liability exposure under the U.S. government’s antifraud statutes, specifically, the Civil and Criminal False Claims Act statutes. Both False Claims Act (FCA) statutes have potential applications when construction projects are funded, either in whole or in part, with federal money. This article focuses on liability issues arising under the Civil FCA that bond producers should understand.Overview of the Civil FCA

The Civil FCA, generally stated, punishes contractors when they improperly receive, request payment from, or seek to avoid making required payments to the government. The FCA states that anyone who “knowingly presents” a “false or fraudulent claim for payment” to the government, or who “knowingly makes” a “false record or statement material to a false or fraudulent claim” is liable to the government for treble damages and civil penalties. As discussed in this article, the interpretation of this language is extremely broad, creating significant risks for contractors that do not have effective internal controls in place to identify and mitigate the risks of potential Civil FCA situations as they arise.

Although the Civil FCA is characterized as an antifraud statute, the threshold for liability under the Civil FCA is much lower than that required in a common law fraud action. A Civil FCA case does not require a showing that a contractor actually intended to defraud its government customer of contract funds. Instead, the government can establish Civil FCA liability by demonstrating that a contractor knowingly, recklessly or with “deliberate ignorance” made a false statement, if the statement is connected in a reasonably direct way to federal contract requirements. Many events that would not rise to the level of common law fraud will meet the definition of fraud under the False Claims Act, a fact that often trips up unwary contractors.

What Is a “Claim” Under the FCA?

The Civil FCA defines “claim” to include “any request or demand, whether under a contract or otherwise, for money or property which is made to a contractor, grantee, or other recipient if the United States Government provides any portion of the money or property which is requested or demanded, or if the Government will reimburse such contractor, grantee, or other recipient for any portion of the money or property which is requested or demanded.” While the most obvious examples of a “false or fraudulent claim” include a contractor’s presentment of an invoice to the government for work it never performed, or for supplies never delivered, the U.S. Department of Justice (DOJ) and some federal courts in key judicial decisions have significantly broadened the definition of what constitutes a “false claim” for purposes of Civil FCA liability to include a number of situations far more subtle than flagrant mischarging and fraudulent invoicing.

A claim clearly includes an invoice that involves a direct request for payment, such as the following:

• An invoice that overcharges for construction materials or charges for materials never purchased; or
• An invoice that overcharges labor hours or is based upon false time records; or
• An invoice that covers work not actually performed.

A claim could also include a false record or statement that leads to the government paying or approving a request for payment, such as the following:

• Falsified small or disadvantaged business certifications; or
• Providing substandard materials or workmanship, or substituting materials without the government’s consent; or
• Failing to follow contract specifications; or
• Falsified progress reports or other documents.

In sum, there are a large number of contractor actions that qualify as a “claim” and thus can trigger liability under the Civil FCA.

What Constitutes “Falsity” Under the Civil FCA?

The False Claims Act does not provide a definition of what “false” means. Courts considering the issue have found that a “false” representation or claim is one that is objectively false–or based on an objectively false statement. Courts further have found that the contractor must either have known the claim or statement was false or was deliberately ignorant or had reckless disregard for the truth.

Accordingly, unintentional errors, bad math and good faith misinterpretations of plans or specs are not, in themselves, false claims or statements under the Civil FCA. However, if the contractor subsequently becomes aware of an unintentional error that caused the government to overpay and does nothing to correct it, that omission could form the basis of an FCA violation.

As an illustration, every construction contractor working on a government project has at some point disagreed with the contracting officer about the scope or nature of contract requirements. The parties with conflicting interpretations either resolve it amicably or resolve the dispute through litigation or arbitration. In a typical case, no one would ever argue that the contractor’s interpretation was a lie. However, there have been cases where a contractor’s stated interpretation has been found to be objectively unreasonable and implausible, most often where a claim or request for equitable adjustment is submitted. It is, therefore, extremely important that a contractor’s claim be well grounded in fact and law to avoid Civil FCA liability. Submission of a claim that has questionable merit is never a good idea, even as a negotiation strategy.

Common Examples of Civil FCA Violations in the Construction Industry

Generally, the Civil FCA imposes civil sanctions against a contractor for submitting a false claim for payment to the federal government. However, contractors are often unaware of the extremely broad reach of the FCA or fail to understand the situations that routinely arise over the course of a construction project where violations can occur. In the construction industry, in particular, a Civil FCA violation can occur in a number of situations having nothing to do with the direct submission of an invoice. Some of the more common circumstances in which FCA violations arise include the following:

• Bid and Proposal Preparation – False information or misrepresentations within the contractor’s bid or proposal can serve as the basis of an FCA violation. Once the contractor is awarded the contract, every pay application submitted by the contractor may be deemed a false claim. The pay application itself may have otherwise been perfectly truthful and accurately reflect the sums due for work performed. But the pay application is still a false claim because the underlying contract itself was procured through misrepresentations or fraud. A prime example is a false certification that the contractor is a small or disadvantaged business concern in a procurement set-aside for the benefit of small or disadvantaged businesses.
• Statutory or Regulatory Violations – Liability can also arise under the Civil FCA if a contractor fails to comply with the various laws and regulations incorporated into most federal contracts, including wage and hour laws, equal employment opportunity laws, OSHA regulations, environmental laws, and the like. In theory, if a contractor is required to comply with such laws and regulations in the performance of its contract, and the government’s payment under the contract is contingent upon a contractor’s compliance with these laws and regulations, a contractor that violates any such regulation but still gets paid may be liable under the Civil FCA for submitting a false claim. Moreover, because government contractors must certify compliance with these and other federal laws and regulations to obtain a government contract in the first place, and to remain eligible to perform it, any false certification of compliance with applicable laws and regulations may also constitute a violation of the Civil FCA. If a contractor falsely certifies that it pays applicable prevailing wages in accordance with the federal Davis Bacon Act, such a false certification could form the basis for a Civil FCA violation against that contractor.
• False Certifications Embedded in Monthly Pay Applications – Most contractors’ monthly pay applications contain Federal Acquisition Regulation Subpart 52.232-5(c) “Payments Under Fixed-Price Construction Contracts.” This FAR clause contains three extremely important certifications: (1) the amounts requested in a claim for payment are only for work performed in accordance with the specifications, terms and conditions of the contract; (2) all payments due to subcontractors and suppliers from previous payments received under the contract have been timely paid; and (3) the current claim for payment does not include any amounts that the contractor intends to withhold from its subcontractors or suppliers. Failure to timely pay subcontractors can lead to allegations of FCA noncompliance because the government will only pay the contractor if it certifies on a monthly basis that it has timely paid its subcontractors. Moreover, if at the time that the contractor executes the certification that it will not withhold payments, it has the intention to retain or withhold the requested monies from its subcontractor, this, too, could be deemed a false certification.
• Contract Disputes Act Claims and Requests for Equitable Adjustment – Pursuant to the Contract Disputes Act (CDA), in order to obtain a contracting officer’s final decision on claims in excess of $100,000, the contractor is required to submit a certification that states the claim was made in good faith and that it is based on accurate, complete and current information. Several agencies, including the Department of Defense and the General Services Administration, require similar certifications for Requests for Equitable Adjustment (REA) in excess of $100,000 as well. These certifications may be considered false if any aspect of the claim or REA is inaccurate or untrue. It is extremely important that the price adjustment requested be supported by solid and credible data; inflated claims are a frequent target of FCA allegations.

Recent Developments in Civil FCA Law

On May 20, 2009, President Obama signed the Fraud Enforcement and Recovery Act of 2009 (FERA). Embedded in FERA are amendments to the FCA that significantly expand the circumstances in which contractors and subcontractors may be liable for false claims. FERA’s amendments to the FCA are likely both to escalate investigative activity and to greatly increase the number of investigations and resulting lawsuits against contractors.

Among its other provisions, FERA creates new potential liability for contractors under the FCA in several areas. Contractors are now liable under the Civil FCA if they knowingly fail to return overpayments to the government, even if no false claim or statement has been made. Before this provision was enacted, contractors were only liable if they used false records or statements to conceal, avoid or decrease obligations to pay the government. FERA, however, imposes liability if a contractor simply conceals, avoids or decreases its obligation to pay, regardless of whether a claim has been submitted. After FERA, overpayments must be reported and returned to the government within 60 days of the later of the date the overpayment was identified or the date a corresponding cost report is due. This provision will likely lead to an explosion of what are termed “reverse false claims” actions.

Another effect of FERA on the Civil FCA is that virtually any request for a payment that somehow has a connection to federal funding, even if presented to a private party, creates the potential for FCA liability. The elimination of the direct presentment requirement will have broad application to contracts and grants that are funded in whole or in part by the American Recovery and Reinvestment Act of 2009 (ARRA). In addition, the removal of the direct presentment requirement means that subcontractors at any tier may be liable for submissions made to a higher tier subcontractor or to the prime contractor, if those submissions eventually find their way into a claim for payment to the government. Because of FERA, subcontractors must be more careful when submitting claims to their prime contractors.

In sum, FERA aggressively expands the reach of the FCA and will almost certainly increase the number of investigations and FCA lawsuits against contractors.

Penalties for Civil FCA Violations

Lawsuits brought against contractors under the Civil FCA may be brought either by the U.S. Department of Justice or by a whistleblower, usually a competitor, or a disgruntled employee of the contractor being sued, in what is called a qui tam lawsuit. There are substantial incentives for an individual or entity to bring a qui tam lawsuit against a contractor; qui tam plaintiffs stand to get up to 30% of any money recovered from a contractor under the Civil FCA.

Civil penalties for FCA violations can be quite stiff. Under the Civil FCA, the government can recover an amount equal to three times the actual damages sustained, plus penalties of between $5,000 and $11,000 per violation. Such penalties can multiply as each false claim, invoice or material misstatement is counted as a separate violation. Significantly, a contractor does not escape liability under the Civil FCA even if the government ultimately does not pay the claim, which means that a contractor may be liable for civil monetary penalties under the Civil FCA even if the government has suffered no damage.

Courts have already considered whether the FCA treble damages and penalties provisions violate the constitutional prohibition against double jeopardy and excessive fines and have uniformly held that no such constitutional prohibitions apply.

Recommendations to Avoid Civil FCA Liability

Given the potentially drastic consequences of even an unwitting Civil FCA violation, contractors must proceed with care. They must be extremely careful in structuring their payment and invoicing systems and must take precautions to ensure that all information provided to the government in support of claims for payment, including any certifications supplied in support of invoices presented to the government, is true and accurate. In addition, to ensure compliance and mitigate the risk of liability stemming from Civil FCA violations, contractors must adopt standards of conduct for their employees; train and educate employees about the Civil FCA; conduct periodic audits for compliance; and develop systems and procedures to ensure that, when someone reports a possible violation, the company conducts an adequate investigation. Because contractors can be found liable not only for intentional acts but also for reckless or deliberately ignorant acts, a good compliance program is critical and may go a long way in heading off potential Civil FCA liability. Knowledgeable bond producers can assist their contractors and subcontractors by discussing the need for them to proceed with caution and mitigate the risks of FCA violations.

Heather A. James is Counsel at Whiteford, Taylor & Preston and head of the firm’s Government Contracts and BRAC practice groups. She can be reached at hjames@wtplaw.com

These materials are provided to NASBP members, affiliates, and associates solely for educational and informational purposes. They are 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 these materials without such advice.