Two recent decisions, one from the Court of Appeals for the Federal Circuit and the other from the Court of Federal Claims (COFC), provide cautionary tales for contractors and reflect the increasing use of fraud counterclaims by the Government.
In Long Island Sav. Bank, FSB v. United States, 503 F.3d 1234 (Fed. Cir. 2007), issued September 13, 2007, the Federal Circuit reversed a COFC decision in a Winstar-related case that had awarded Long Island Savings Bank (LISB) over $435 million in breach-of-contract damages, finding that the contract was void ab initio as a result of fraud and that the damage award should be forfeited under the Forfeiture of Fraudulent Claims Act, 28 U.S.C. § 2514.
The case centered on a provision of an Assistance Agreement (under which LISB took control of a failing savings and loan) that required a certification from LISB that various representations and warranties, including compliance with applicable statutes and statements of material fact, were true and substantially correct. This certification was signed by LISB's Chairman of the Board (Conway). While Conway was a member of the bank's Board or its CEO, however, his law firm had received substantial compensation for performing mortgage closing services for the bank as LISB's "exclusive" mortgage closing counsel. Moreover, Conway continued to receive compensation from his firm for performing closing services while employed by LISB.
An investigation uncovered Conway's arrangement with his law firm, and Conway resigned. Shortly thereafter, LISB filed its Winstar complaint. The Government, however, counterclaimed for fraud, alleging that LISB had committed fraud in the inducement of the agreement and in its performance. The Government contended that Conway's conduct violated federal regulations that required LISB to maintain sound management and prohibited officers from breaching fiduciary duties for financial gain. Therefore, the Government contended LISB's certifications were false. The COFC granted LISB summary judgment, holding that LISB did not violate the Assistance Agreement, that LISB as a corporate entity had not acted fraudulently, and Conway's conflict of interest should not be imputed to LISB.
The Federal Circuit reversed. Applying common law principles, the court held that to establish that the contracts were void ab initio, the Government had to prove that LISB "(a) obtained the contract by (b) knowingly (c) making a false statement." The court held that the "false statement" element was met because of Conway's undisclosed conflict of interest and his subsequent guilty plea to certain criminal conduct. The "knowing" element was met because Conway had been advised that he could not take compensation from his firm before he submitted the certifications. The court then applied common law agency principles and, rejecting the COFC's reasoning on the "adverse interest" exception to agency actions binding the principal, held that Conway's false statements should be imputed to LISB because Conway had not entirely abandoned LISB's interests in favor of his own. In addition, the court held that there was a requisite causal link between LISB's fraud and the contract, citing to a declaration from a government witness that the Government would not have entered into a contract with LISB had it known of Conway's conduct. Lastly, the court held that LISB's false certification also constituted a prior material breach. Because the Government's obligations under the Assistance Agreement were completed before the disclosure of the fraud, the court held that the breach had not been waived.
What the court did not address, however, is whether LISB's conduct harmed the Government. The opinion does not cite monetary damage to the Government, or mismanagement by LISB, nor does it take issue with the work performed by Conway's firm. In fact, the court states that there was no evidence the firm's services were deficient and that LISB benefited from them. Citing this perceived absence of harm to the Government and the imputation of liability to LISB, some commentators have viewed LISB as a significant expansion of prior decisions involving allegations of fraud and forfeitures. See "The Federal Circuit Reaffirms Its Hostility to 'Fraud,' A Term It Applies Broadly, with a New and Completely Revised Opinion in Long Island Savings Bank v. U.S.," Vol 49, No. 39, The Government Contractor ¶401.
While LISB addressed liability issues for fraud, an October 31, 2007 decision from the COFC addressed damages and penalties. In Morse Diesel Int'l, Inc. v. United States, No. 99-279C, 2007 WL 3277293 (Oct. 31, 2007) (Braden, J.), the COFC awarded the Government maximum penalties under both the Anti-Kickback Act, 41 U.S.C. §§ 51-58 (AKA) and the False Claims Act, 31 U.S.C. § 3729 (FCA), holding that penalties under both statutes were permissible, non-duplicative, and constitutional.
The COFC's decision followed its previous grant of the Government's motions for summary judgment on liability under the AKA and FCA. In Morse Diesel Int'l, Inc. v. United States, 66 Fed. Cl. 788 (2005) (Morse Diesel I), the court held that an arrangement whereby various entities involved in contracts for the General Services Administration split commissions on bond arrangements violated the AKA. In Morse Diesel Int'l, Inc. v. United States, 74 Fed. Cl. 601 (2007) (Morse Diesel II), the court held that Morse Diesel violated the FCA and the Forfeiture of Fraudulent Claims Act by seeking reimbursement in the form of progress payments from the Government for bond costs that included undisclosed commissions to bond brokers.
The Government sought civil penalties under both the AKA and the FCA, but stated that it would not seek the AKA penalties if it was awarded the full amount of its FCA penalties, including treble damages. Morse Diesel contended that civil penalties under both statutes, along with treble damages under the FCA, would be duplicative. The COFC, however, held that nothing in the statutes precluded recovery under both statutes, including FCA treble damages. The court noted that Congress had authorized substantially increased monetary penalties under both statutes, signaling a desire for greater deterrence. The court further noted that a civil penalty of double the amount of the kickback was intended to compensate the Government for its costs in prosecuting kickback cases, that the additional $10,000 civil penalty per violation was intended as a deterrent, and that assessing both types of penalties was proper under the factual circumstances of the case. Accordingly, the court awarded the maximum statutory penalties available under the AKA.
With regard to FCA civil penalties, the Government sought the full amount of civil penalties and treble damages. Morse Diesel responded that the Government should be permitted to recover only the "time-value of money" as damages and not the full value of the submitted invoices, arguing that since the Government would have paid the bonds anyway, the time-value of money was an appropriate measure of restitution. Alternatively, Morse Diesel contended that the court should award only minimum penalties because the conduct at issue affected only portions of the contract and was committed by a few mid-level employees.
The court held that while it has discretion to calculate the damage and determine the civil penalty component, "[t]he trial court . . . does not have discretion to decline to award treble damages because the False Claims Act, as amended, provides for 'a civil penalty . . . plus 3 times the amount of damages.'" (quoting 31 U.S.C. § 3729(a)(2); emphasis original in opinion). Based on this reading, and the legislative history describing the deterrent effect of the statute, the court rejected Morse Diesel's time-value of money theory as "contrary to the text and purpose of the False Claims Act . . . ." The court also summarily rejected the alternative request for minimum penalties, finding that key executives had been involved in the conduct at issue and that the Government had incurred substantial time and expense prosecuting the case. Accordingly, based on the totality of the circumstances, the court awarded maximum penalties under the FCA as well as treble damages.
Finally, the court declined to find the penalties and damages assessed unconstitutional. First, although Morse Diesel claimed that damages other than the time-value of money would violate due process under State Farm Mut. Auto. Ins. Co. v. Campbell, 538 U.S. 408 (2003), the court held that there was a direct, rational and reasonable relationship between the civil penalties and treble damages under the statute and Congress's intent to eliminate fraudulent activity in contracting that negated a due process concern. Second, the court rejected the argument that the civil penalties assessed were excessive under the Eighth Amendment, finding that the penalties (2.37 times the amount of the kickbacks and 3.3 times the amount of the false claims at issue) were within constitutional bounds.
LISB and Morse Diesel reflect the seriousness with which the Federal Circuit and COFC consider allegations of fraud in contracting. These decisions, as well as legislative and regulatory initiatives to strengthen contractor compliance with regulatory and ethics standards, once again warn contractors that strong compliance programs are essential for contracting with the Government.