Fraud-in-the-Inducement
Northern District of Texas Refuses to Enforce Purported Pre-Filing Qui Tam Claim Release on Public Policy Grounds
On April 30, 2021, a Northern District of Texas judge denied a motion to dismiss an FCA qui tam action alleging “a fraudulent scheme to obtain Government subcontracting opportunities reserved for eligible small businesses under the Small Business Act.” United States ex rel. Haight v. RRSA (Commer. Div), LLC, 3:16-CV-1975-S, 2021 U.S. Dist. LEXIS 82894, at *1-4 (N.D. Tex. Apr. 30, 2021). In the complaint, the relator alleged that one or more of the defendants received several lucrative government construction subcontracts by falsely claiming small business eligibility. Id. at *4. According to the relator, Defendant RRSA Residential, a large, national roofing company, and its related entities “devised a scheme to obtain subcontracting opportunities that are reserved for small businesses under the Small Business Act.” United States ex rel Haight v. RRSA (Commer. Div.), 3:16-CV-1975-S, 2020 U.S. Dist. LEXIS 195267, at *4-5 (N.D. Tex. Oct. 20, 2020) (hereinafter “Haight I”). Certain government contracts are reserved, or set aside, for business that qualify as “small” under the SBA size standards set forth in 13 CFR 121. The relator alleged that RRSA Defendants falsely certified that an affiliated entity, RRSA Commercial, was an eligible small business, and calculated that it would have an advantage over legitimate small businesses due to the “combined resources, materials, industry connections, and ‘bondability’ that most legitimate small businesses do not have.” Id. at *6. After certifying that RRSA Commercial was an eligible small business on the System for Award Management (“SAM”) database, RRSA Commercial received “dozens” of small business subcontracts. Id. at *7. The relator also alleged that prime contractor defendants were aware that RRSA Commercial was in reality a large business and variously participated in and enabled the scheme. Id. at *7-8. Accordingly, the relator alleged that these false representations caused false claims for payment to be submitted to the government under an implied false certification theory. United States ex rel. Haight v. RRSA (Commer. Div), LLC, 3:16-CV-1975-S, 2021 U.S. Dist. LEXIS 82894, at *4 (hereinafter “Haight II”). Defendants moved to dismiss, arguing that the relator failed to satisfy the pleading standards of Federal Rule of Civil Procedure Rules 8(a), 12(b)(6), and 9(b). Haight I, 2020 U.S. Dist. LEXIS 195267, at *11. The court granted the motion in part and denied the motion in part, granting the relator an opportunity to replead dismissed claims. Id. at *24. Plaintiff filed an amended complaint in 2020. Dkt. 104. Defendants again moved to dismiss, this time arguing the relator lacked standing under Federal Rule of Civil Procedure 12(b)(1) because she had allegedly signed a settlement agreement that contained a broad release provision of “any and all claims” prior to the filing of the present qui tam action. Haight II, 2021 U.S. Dist. LEXIS 82894, at *5-6 (internal quotation omitted). The court rejected Defendants’ standing argument and denied the motion to dismiss. In discussing Defendants’ standing argument, the court first noted the plain language of the FCA provides that “a qui tam relator may not unilaterally enter into an enforceable settlement agreement or release after filing an FCA action.” Id. at *11. Although the Fifth Circuit has not directly considered enforceability of pre-filing releases, the court noted that several circuits apply the balancing test articulated by the Ninth Circuit in United States ex rel. Green v. Northrop Corp., 59 F.3d 953, 956 (9th Cir. 1995) when assessing enforceability. Id. at *11-17. Under the balancing test, courts must determine “whether the interest in enforcing the release was outweighed in the circumstances by a public policy harmed by enforcing the release.” Id. at *12 (citing Green, 59 F.3d at 958, 962). Applying the balancing test to the facts alleged, the court found dispositive the factor that the government did not know of the alleged fraud at the time of the alleged signing of the release. Because qui tam suits serve a valuable role in notifying the government of instances of fraud and a contrary holding would incentivize defendants to settle cases of fraud pre-filing without ever informing the government, the court refused to enforce the release as “contrary to well-established public policy.” See id. at *13, 17. The court noted the case’s similarity to Green, where the Ninth Circuit likewise “concluded that enforcement of the prefiling release would ‘impair a substantial public interest’ because the release ‘would threaten to nullify’ the ‘central purpose of the qui tam provisions of the FCA’—to incentivize insiders privy to fraud on the Government to ‘blow the whistle on crime.’” Id. at *12-13 (quoting Green, 59 F.3d at 963). The case serves as a reminder of the underlying policy justifications for the qui tam provision of the FCA, and, moreover, as a cautionary tale of the skepticism that courts will apply to pre-filing releases.
May 19, 2021
by Scott Mah
Fraud-in-the-Inducement
$4.47 Million False Claims Act Settlement Targets Set-Aside Contractors, Affiliates, and Even Third-Party Bonding Company
Over three years after the filing of the initial sealed complaint, a New York-based construction company and several affiliates—including its bonding company—have agreed to pay a combined $4.47 million to settle a False Claims Act case alleging a decade-long scheme to fraudulently obtain federal contracts set aside for Service-Disabled Veteran-Owned Small Business Concerns (“SDVOSBCs”) and small businesses operating in Historically Underutilized Business Zones (“HUBZones”). United States of America, ex rel. James Hagan v. Northland Associates, Inc., et al., No. 5:17-cv-00036-GTS-TWD (N.D.N.Y.). The Small Business Administration (“SBA”) maintains several programs that provide small and disadvantaged businesses exclusive opportunities to procure certain set-aside contracts with the federal government, i.e., contracts that non-eligible companies cannot compete for. These programs are governed by an extensive set of statutes, regulations, and rules. Under the Small Business Act, certain size standards apply when determining if a business qualifies as a “small business” for government contracting purposes. See 13 C.F.R. § 121.201. When assessing size, small businesses must consider whether any relationship rises to the level of “affiliation,” which exists when another business controls or has the power to control the small business. See 13 C.F.R. § 121.103. Control by an affiliate may arise in several ways, including through ownership, management, financial support, employee sharing, or other relationships or interactions between the parties. Id. Small business must meet additional standards set forth by the SBA to obtain more specialized SBA certifications. For instance, the SDVOSBC program requires a small business to be 51% owned and controlled by a military veteran injured in the line of duty. 15 U.S.C. § 632(q); 38 U.S.C. § 101(2), (16); 13 C.F.R. § 125.10; 38 C.F.R. § 74.4. Under the SBA’s separate HUBZone program—designed to encourage investment and employment in historically underutilized communities—a small business may obtain a HUBZone certification if it is located in a designated underutilized business zone. 13 C.F.R. § 126. In Northland Associates, two former-employee relators filed a complaint alleging that Northland Associates, Inc. (“Northland”) created a sham company—Diverse Construction Group, Inc. (“Diverse”)—to bid for and fraudulently obtain over $50 million in construction set-aside contracts for the SBA’s SDVOSBC and HUBZone programs. The complaint alleged that Northland and its owner, James Tyler, worked with a service-disabled veteran, the late Hunter Grimes, to establish and certify Diverse as a SDVOSBC. According to the complaint, the parties further certified Diverse as a HUBZone business by setting up an office for the company in Plessis, New York. The complaint, however, alleged Grimes lacked the experience or capabilities to run a construction company, and that he did not take part in the management of Diverse or any day-to-day decision-making. Instead, the complaint alleged Northland controlled Diverse at all relevant times—including the bid process and the performance of contracts awarded to Diverse—from Northland’s office in Liverpool, New York. Going beyond certification-related misrepresentations, the relators’ complaint alleged that Northland, Tyler, and Diverse took several affirmative actions to prevent discovery of their scheme. For instance, the complaint alleged that after a competitor initiated a bid protest involving Diverse in September 2009, the SBA conducted a size determination and concluded that Diverse did not qualify as a small business due to its affiliation with Northland. According to the complaint, Diverse successfully appealed the determination based upon declarations in which Tyler and Grimes allegedly misrepresented that: (1) Northland did not control Diverse, (2) Northland did not assist Diverse in the bid process; (3) Northland did not share employees, equipment, or facilities with Diverse; and (4) Northland did not financially assist Diverse or help it obtain bonding. The companies also allegedly attempted to hide their financial affiliation by transferring money through a Northland subsidiary, Maple Ridge Plateau, Inc., and using different bonding companies. The Department of Justice (“DOJ”) opted to intervene and simultaneously filed its settlement agreement with Northland, Defense, and Tyler. In the settlement agreement, Northland, Diverse, and Tyler admitted to their involvement in “a scheme devised and engaged in . . . to circumvent service-disabled veteran-owned small business and HUBZone contract requirements.” They further admitted to the undisclosed affiliation between Northland and Diverse—including employee-sharing, funneling of funds through a Northland subsidiary, Northland’s involvement in the bid process, and Northland’s performance under the Diverse contracts—and that the declarations submitted in response to the bid protest contained material misrepresentations. In addition, the DOJ filed a separate settlement agreement with Rose & Kiernan, the bonding company used by Northland and Diverse. Notably, Rose & Kiernan had not been named as a defendant in the complaint. In the settlement agreement, Rose & Kiernan admitted that it “knew or should have known . . . that Diverse and Northland were affiliated in violation of SBA regulations and that [Northland and Diverse] took steps to hide their affiliation from the government to obtain and receive payment on government set-aside contracts.” Rose & Kiernan further admitted that “[w]ithout the surety bonds that [Rose & Kiernan] helped Diverse procure . . . Diverse’s fraud would not have been possible.” Combined, the defendants and bonding company agreed to pay $4,470,000 to settle the allegations, although the bonding company’s share was only $120,000. The relators—two former Northland employees—will receive $1,000,000. This resolution provides three important reminders for all those who contract with the United States government. First, companies applying for any small or disadvantaged business certification must carefully and accurately assess their eligibility. This includes, importantly, assessing whether they have any affiliates and whether those affiliates affect eligibility. Second, bonding companies should look closely at the DOJ’s settlement agreement with Rose & Kiernan. Although FCA liability is most frequently applied to contractors who submit claims to the government, this settlement evidences an expansive reading of the FCA in which a bonding company knowledgeable of underlying fraud can be held liable under the FCA. Finally, the government eagerly and aggressively investigates fraud in its contracting programs—particularly where funds earmarked for veterans and small businesses are involved. As the DOJ reiterated in its press release, “those who contract with the United States government must do so fairly and honestly,” and “[p]roviding false information to gain access to SBA’s preferential contracting programs is fraught with peril and is especially egregious when it involves programs intended to benefit our nation’s service-disabled veterans.” Given the large number of set-aside contracts that have been awarded under tight deadlines in response to the current COVID-19 crisis, we are likely to see an increase in small business-related FCA investigations and prosecutions in the coming months and years.
May 13, 2020
by Caitlin L.D. Hull
Fraud-in-the-Inducement
First Circuit Rejects Fraud-on-the-FDA Theory of FCA Liability
Affirming an earlier order handed down by the United States District Court for the District of Massachusetts, the First Circuit recently denied Plaintiff D’Agostino leave to amend his complaint, finding the proposed claims were futile. D’Agostino, et al. v. EV3, Inc. et al., 2016 WL 7422943 (1st Cir. Dec. 23, 2016). D’Agostino’s complaint alleges False Claims Act (“FCA”) violations related to the Onyx and Axium medical devices, which are used in embolization procedures. D’Agostino alleged that the defendants made false statements during the FDA approval process for the devices, including disclaiming uses of the devices they later pursued, misstating the training that would be provided to physicians using the device, and omitting relevant information about the devices’ safety. To link the alleged false statements to a claim for payment, D’Agostino relied on a theory of fraud upon the FDA, arguing that these statements constituted false claims because they could have influenced the FDA’s decision to approve the devices, and but for the FDA approval, CMS would not have reimbursed physicians for the use of these devices. The First Circuit presented numerous reasons for rejecting D’Agostino’s request for leave to amend. Some of those reasons rest on basic legal principles, such as the lack of sufficient allegations to satisfy federal pleading requirements under Rule 9(b) and 12(b)(6). The design defect claim, which argued that improvements to the design of Axium demonstrate that previous versions of the device were defective, was similarly and succinctly dispatched as nonviable. The court remarked that if this standard were applied “most every car sold to the government would be per se defective.” In less charted territory, the court also rejected D’Agostino’s fraud on the FDA theory of liability. The court noted that this theory would require D’Agostino to show that the allegedly false statements actually caused the FDA to grant approval it otherwise would not have granted—a mere showing that the statements could have influenced the FDA’s decision would be insufficient. D’Agostino attempted to salvage his argument by relying on the FCA’s materiality standard, which only requires plaintiffs to show that a statement has “a natural tendency to influence, or [is] capable of influencing, the payment or receipt of money or property.” In addition to finding that this argument misconstrued the FCA’s “demanding” standard of materiality, the court found that this approach improperly conflated the FCA’s materiality and causation requirements. The court’s analysis also considered that allowing the fraud on the FDA theory to proceed would effectively permit a jury to overrule the FDA’s approval of medical devices. Although the FDA has the authority to temporarily or permanently revoke its prior approval of a medical device, it has not done so for either Onyx or Axium in the six years since D’Agostino’s complaint has been made public. The court found this to be persuasive evidence that the alleged false statements were not material to the FDA’s decision to approve the devices. Although the court rejected D’Agostino’s use of the fraud on the FDA theory of liability in this case, the decision acknowledges that this theory may support viable FCA claims in instances where the FDA withdraws its approval of a device after discovering fraud.
January 3, 2017
by Katherine Arnold
