Big block letters displayed prominently on the side of a mezzanine at the United States Air Force Academy (“Academy”) stand as a stark warning to all who enroll there. Well known is the Academy’s zero tolerance forthe garden-variety academic fraud: “lifting” an advance copy of tomorrow’s exam, leering at a classmate’s answer sheet, or the stealing of personal property will invariably lead to an abrupt and shameful exit from the school. However, some cadets have been found in violation of the Academy’s Honor Code for less clear acts of wrongful conduct, such as failing to disclose the entire truth of a code violation when asked, or failing to report a known violation by others. Regardless, the result canbe the same – expulsion!

In some ways, the federal government’s False Claims Act (“FCA” or “Act”) bears similarity to the Academy’s Honor Code, and vice versa. Both are codified, adaptive to changing situations and can be subjectively enforce–allowing for differing treatment for varying degrees of fraud and dishonesty. As with the cadet, the government contractor is advised to walk a straight line, know and follow regulations, and avoid engaging in anything resembling a knowingly false act or omission. The limitations on space for this article will prevent delving into the litany of FCA violations or exhausting the fine details of the Act itself. Instead, this article presents a high-level review of the FCA followed by discussion of two often overlooked areas of potential FCA liability that have seen heightened scrutiny by the federal government in recent years – Underbidding and False Pricing.

Origins And A Brief Summary Of The FCA

The federal FCA was enacted in 1863, duringthe Civil War, in response to abuses and dishonesty by the defense contractors of the day– mostly blatant acts of “inflated invoicing” and shipment of “faulty goods to the government.” Hooper v. Lockheed Martin, 688 F.3d 1037,1047 (9th Cir. 2012) (citation omitted). From its inception, the FCA has been a statutory cause of action intended to combat fraud against the government. United States ex rel.Wilkins v. N. Am. Constr. Corp., 173 F. Supp. 2d601, 619 (S.D. Tex. 2001).

In a most basic summary, the FCA provides: Any person who —

  1. Knowingly presents a false or fraudulent claim to the United States Government or a member of the Armed Forces of the United States;
  2. Knowingly makes or uses a false or fraudulent record or statement to geta false or fraudulent claim paid or approved by the Government; or
  3. Conspires to defraud the Governmentby getting a false or fraudulentclaim allowed or paid.

— is liable to the United States Government.

The FCA defines the term “knowingly” as the contractor having actual knowledge of the information or acting in either deliberate ignorance or reckless dis-regard of the of the truth or falsity of the information.

Notwithstanding the litany of published courtdecisions and commentary on the FCA, somecontractors continue to believe that the mere attempt to “pad” a claim or play “fast and loose”with pricing will not result in any meaningful action by the government agency in charge–so long as the government discovers the error without first making payment. That notion is both dated and dangerous to the government contractor. The rule is clear that exposure to FCA liability does not require that the government actually tender payment or suffer a loss in response to a false or fraudulent claim. In fact, the mere submission of such a claim is enough to support the government’s FCA action and to prevail against the offending contractor.

Major amendments to the FCA were made in 1986 which were intended to modernize “the Government’s primary litigative tool for combating fraud.” Id.at 629. The amendments resulted in, among other things, (1) an expanded definition of “claim” under the Act to include any request or demand for money or property made to any person or entity to whom the government provides any portion of the money or property that is the subject of the request or demand including reimbursement by the government to the person or entity who is subject to the claim, 31 U.S.C § 3729(c); (2) clarification that specific intent to defraud is not an element of a cause of action under the FCA, id. at 624, and (3) reaffirmation that “materiality” is an implicit element in a FCA cause of action. Courts later clarified that the existence of materiality is determined by answering “whether the false statement has a natural tendency to influence agency action.” United States ex rel. Harrison v. Westinghouse Savannah River Co., 176 F.3d 776, 785 (4th Cir. 1999).

Further modifications to the FCA came about in 2009 with the Fraud Enforcement and Recovery Act (FERA). Not coincidentally, FERA was enacted in advance of the American Recovery and Reinvestment Act (ARRA) that funneled nearly $140 billion for construction spending. Among other things, FERA clarified that to satisfy the “materiality” standard under the FCA the government need only show that the false statement “could have influenced” the decision to pay or approve a false of fraudulent claim.

Thus, the modifications to the FCA in 1986 and 2009 put contractors on notice that (1) the courts had broadened the application of the materiality standard, (2) they could no longer safely circumvent FCA liability by submitting a false claim to a third party or proxy for the government, and (3) proving intent to defraud was no longer required.

Tough Times Can Heighten Government Scrutiny

Our national economy remains in a very precarious position as it struggles to climb out of the rubble of 2008. Although merely anecdotal, good economic times usually produce plentiful government projects and spending that may trend towards a more relaxed oversight by agency personnel. Intuitively, the reverse is also generally understood to be true – difficult times and budgetary constraints tend to produce greater oversight and scrutiny by the government and its various agencies. Gone are the proverbial “salad days” before 2008. In recent years, the number of projects and funding has waned, the field remains crowded with residential and commercial contractors who began chasing the federal programs as a means of survival, and word has it that strict program management and cost oversight has returned. The result is a smaller pool of available projects married up with increased competition – a marriage that can breed desperation to win the job in order to survive. With this less friendly landscape, contractors should be wary of missteps in two particular areas that may now be under increased government scrutiny – False Pricing and Fraudulent Underbidding.

False Claim Allegations Can Attach To Dishonest Or Reckless Pricing

The FCA at section 3729(a)(2) attaches liability to “any person who knowingly makes, uses or causes to be made or used a false record or statement to get a false or fraudulent claim paid or approved by the Government.” The same rule applies to pricing for changed or extra work under the existing contract. If the government audits pricing data, it will ask the following questions:

  1. Was accurate, complete, and current pricing data reasonably available to the contractor at the time it submitted the same to the government?;
  2. Did the contractor submit or disclose to the government accurate, complete, and current pricing data?;
  3. Did the government have actual knowledge of such data or its significance to the particular proposal, claim, or change order?;
  4. Did the government rely upon the defective data in negotiating with the contractor?; and
  5. Did the government’s reliance on defective data cause an increase in the contract price?

Prime areas of interest include bids, proposals, and change orders for extra work. Examples of false or defective pricing that could lead to FCA allegations include:

  • Including full rates in a bid or proposal when the contractor knows that discounted rates will be incurred through available rebates (e.g., bonds, airfare); • Failure to update a bill of materials to account for changes that would benefit the government client;
  • Failure to include or account for discounts from suppliers and subcontractors (e.g., discounts for bulk/volume purchases, early payment discounts);
  • Bidding the rate for contractor-owned equipment at higher rental rates; and
  • Incorporating “journeymen” rates into the bid and then using apprentices (at their lower rates) to perform the work. McGeehin and Collins, Avoiding False Claim Allegations in Pricing, ABA Section of Litigation (Jan 30, 2013).

The allure of enhanced profits makes the abovereferenced moves tempting, but the smart contractor will find other, legitimate ways to improve its bottom line.

Contractors wanting to avoid the government’s FCA scrutiny on pricing claims or extra work will want to (1) know their own internal costs for all bid items, (2) put in place systems that will allow for real-time updating of rates and available rebates from outside vendors, (3) have a keen knowledge of the government’s contract pricing provisions applicable to the bid at hand and, specifically, consult with Federal Aquisition Regulation Part 31 for “unallowable costs,” (4) keep apprised of ongoing changes to the government’s pricing provisions, and (5) put in place a due diligence program for the development and submission of claims to the government that incorporate pricing of labor and materials.

Naturally, steps (1) through (5) require greater administrative effort at the home office, but the tradeoff is reducing exposure under the FCA and enormous savings in time and money that would be lost in defending against any resulting lawsuit.

Fraudulent Underbidding – “Bad, Bad Guesses” Is Likely No Excuse

In and of itself, the act of underbidding a job is not actionable under the FCA, although it most certainly falls under the balance sheet category of “things to avoid.” Accidental underbidding (a/k/a “bid bust”) is typically sourced to human error related to the chaos surrounding final preparation of the bid (e.g., miscalculation of labor hours or a completely missed scope of work). Ordinarily, a bid error is discovered by the contractor and the government client, and resolution of the matter is negotiated by the parties.

In contrast, FCA liability for underbidding comes into play where the government has evidence showing that the contractor knowingly underestimated the job, usually with a motive to increase its chance of winning the contract. Fraudulent underbidding usually includes the intent to recover the value of the underbidding through various mechanisms during the project, such as change orders, requests for equitable adjustment, and false pricing schemes.

Some have claimed that the act of knowingly underbidding a project is merely a type of opinion or prediction that is “purely judgmental  information” and, thus, is not actionable as a “false statement” under the FCA. Hooper v. Lockheed Martin, 688 F.3d 1037, 1047 (9th Cir. 2012). That school of thought has no known support in the courts. For example, the Ninth Circuit flatly rejected that very argument and held that fraudulent underbidding can, indeed, trigger FCA liability. Id. at 1046 n.5.

In Hooper, a former Lockheed Martin employee alleged that the company defrauded the United States Air Force by submitting an intentionally low bid that was compiled using knowingly low projections of its contract costs. According to the employee, the company instructed cost estimators to “lower their estimates without regard to actual costs” with the end-goal of increasing the company’s “best value” rating and, thereby, enhancing its chance for the contract award. Id. at 1042. The employees followed the company instructions and Lockheed Martin submitted its final offer at $433 million. The Air Force determined that Lockheed Martin was the “best value” and awarded it the contract. At the conclusion of  the contract, the Air Force had paid Lockheed Martin in excess of $900 million for its work on the project.

During the litigation, one Lockheed cost estimator testified that in his opinion the inputs used to compute the final bid were based on “bad, bad guesses” but were not false. Id.  Later, The U.S. District Court in California ruled in favor of Lockheed Martin on all counts of the FCA action and granted its motion for summary judgment, thereby terminating the complaint. However, on appeal, the Ninth Circuit refused to excuse the alleged “bad, bad guesses,” overruled the District Court, and concluded that “false estimates, defined to include fraudulent underbidding in which the bid is not what the defendant actually intends to charge, can be a source of liability under the FCA, assuming that the other elements of an FCA claim are met.”

The Ninth Circuit is not alone. The Fourth Circuit has held that “each and every claim submitted under a contract…or other agreement which was originally obtained by means of false statements or other corrupt or fraudulent conduct, or in violation of any statute or applicable regulation, constitutes a false claim.”  Harrison, 176 F.3d at 786. The Court in Harrison explicitly rejected the defendant’s argument that false statements in a bid are not actionable under the FCA because they were merely “estimates.” Id.at 792.

Conclusions

The “old school” belief that FCA allegations apply to only blatant fraud or dishonesty is a plainly wrong and dangerous interpretation of the modern scope of the FCA. Today’s FCA scrutiny extends to wrongful or reckless manipulation of one’s bid and/or false pricing in a claim or change order. Contractors should view the more aggressive oversight in these areas by the government as a form of “new normal” that should be factored into the contractor’s programs for bidding and pricing the work.

The information or opinion provided in this article is the author’s own and not necessarily that of Watt, Tieder, Hoffar & Fitzgerald, LLP. The author is solely responsible for the information and opinion that he or she has provided. The information contained herein does not replace seeking specific legal counsel to directly address individual client needs.