The Federal Circuit recently affirmed the ASBCA’s grant of summary judgment to the Government based on the Government’s affirmative defense that the court described both as a defense of fraud and a defense of prior material breach. In a case called Laguna Constr. Co. v. Carter, the court initially determined that the ASBCA had jurisdiction over the Government’s affirmative defense. It then affirmed the ASBCA’s grant of summary judgment to the Government because the contractor committed the first material breach. Along the way, the court rejected several arguments advanced by the contractor.

Laguna Construction received a contract in 2003 to perform work in Iraq, and awarded numerous subcontracts. After completing the work, Laguna sought reimbursement of certain costs. In 2012, DCAA rejected costs claimed in 14 vouchers, and Laguna submitted a claim on the rejected vouchers for $3,031,925. Laguna appealed to the ASBCA after the contracting officer did not issue a decision.

Meanwhile, in 2010, a Laguna project manager pleaded guilty to, among other charges, violations of 41 U.S.C. § 53, the Anti-Kickback Act (now codified at 41 U.S.C. Chapter 87). The project manager admitted that he worked with subcontractors to submit inflated invoices to Laguna for reimbursement by the Government, and profited from the difference. Also, in 2013, a Laguna officer (Mr. Christiansen) pleaded guilty to conspiring to defraud the United States by participating in a kickback scheme.

After Mr. Christiansen’s plea, the Government moved to amend its answer in the ASBCA appeal to include the affirmative defense of fraud, and the Board granted the motion over Laguna’s objection. Laguna filed a motion for summary judgment, arguing in part that the Government’s claims were barred by the statute of limitations. The Government filed a cross-motion for summary judgment, arguing that Laguna’s claim should be denied because Laguna committed the first material contract breach when its employees committed fraud. The board agreed with the Government and declined to consider the merits of Laguna’s motion.

On appeal, the Federal Circuit first addressed whether the Board had jurisdiction over the Government’s affirmative defense of fraud. The court held that the board properly exercised its jurisdiction, explaining that while certain fraud-related claims are outside the Board’s jurisdiction—including claims relating to 41 U.S.C. § 7103, 28 U.S.C. § 2514 (Special Plea in Fraud), and the False Claims Act—the Government’s defense of prior material breach did not fall into any of those categories. Laguna argued that the board did not have jurisdiction because the Government’s defense was a “claim” that required a contracting officer’s decision.

The court disagreed, explaining that a “claim” is a written demand seeking, as a matter of right, payment of money in a sum certain, the adjustment or interpretation of contract terms, or other relief arising under or relating to a contract, and the Government’s defense did not seek payment of money, or adjustment or interpretation of contract terms. Further, in cases in which the board does not have jurisdiction over the underlying fraud actions—i.e., an Anti-Kickback Act claim—the board has determined it can maintain jurisdiction over an affirmative defense as long as it does not have to make factual determinations of the underlying fraud. In Laguna, the board did not have to make any factual findings of fraud because it relied on Mr. Christiansen’s criminal conviction.

The court then turned to the Board’s grant of summary judgment, noting that prior material breach is a federal common-law defense asserted when a party breaches a contract after another party has already breached the contract. Laguna argued that the Contract Disputes Act displaces the common-law rule, but the court found that nothing in the CDA suggests that Congress intended to displace this common law defense, nor was there any sound reason to do so.

The court further explained that in an analogous case, J.E.T.S., Inc. v. United States, the court had already permitted the Government to rely on a fraud-based affirmative defense in a contract governed by the CDA. The court agreed with the board’s determination that Laguna committed the first material breach by violating the Allowable Cost and Payment clause, which states that a cost is allowable only when it is reasonable and complies with the terms of the contract.

Finally, Laguna argued that the Government knew of the kickback scheme as early as January 2008 but continued to perform the contract until 2015, thereby waiving the prior material breach defense. The court disagreed, explaining that a waiver is an intentional relinquishment or abandonment of a known right, and it was reasonable for the Government to invoke the prior material breach rule after Mr. Christiansen’s guilty plea in 2013—prior to that date, the Government did not have a “known right” that would have invoked the prior material breach rule.

There are at least two concerns with the court’s decision. First, the conclusion that the Government’s affirmative defense does not meet the definition of a “claim” is problematic. At some points, the court refers to the defense as a defense of fraud, yet at other points, the court characterized the “prior material breach.” A breach of contract is a classic “claim.” Indeed, the court emphasizes the breach of contract aspect of the Government’s defense by referencing a specific contract provision in the introductory paragraph, noting that “Laguna committed the first material breach by violating the contract’s Allowable Cost and Payment clause.” While the court also relied on precedent concerning fraud (including cases involving criminal convictions and contracts “tainted” by fraud), the portion of its decision attempting to explain that a prior material breach defense is not a “claim” is not entirely convincing.

Second, the court’s conclusion that it was reasonable for the Government to invoke the prior material breach rule after Mr. Christiansen’s guilty plea in 2013 ignores the fact that, as explained earlier in the decision, a Laguna project manager pleaded guilty to violations of the Anti-Kickback Act in 2010. This fact appears to undermine the court’s conclusion that, prior to Mr. Christiansen’s guilty plea in 2013, the Government did not have a “known right” on which it could have invoked the prior material breach rule.

In any event, the case underscores the problems contractors face in CDA proceedings when employees and/or officers have been convicted of fraud in connection with the contract at issue.