Court Holds Surety May be Liable for Reverse False Claims Act Damages Due to Agent’s Knowledge of Principal’s Fraudulent DBE Scheme
U.S. District Court in D.C. Holds That Reverse False Claims Liability May Be Extended to a Surety Where, Through Its Agent, the Surety Becomes Aware of Its Principal’s Fraudulent DBE Scheme, but Nevertheless Continues to Issue Bonding
In a case of first impression, a U.S. District Court judge, sitting in the District of Columbia, recently ruled that reverse false claims liability, and the potential for treble damages in connection therewith, can extend to a surety where its agent became aware of its principal’s fraudulent participation in a government set-aside program and nevertheless continued to issue Miller Act bonds on behalf of the principal.
In United States ex rel Scollick v. Narula, 2017 WL 3268857 (D.D.C. July 31, 2017), plaintiff-relator Andrew Scollick alleged that a number of individuals engaged in a scheme to fraudulently claim or obtain service-disabled veteran-owned small business (“SDVOSB”) status, HUBZone status, or Section 8(a) status for certain companies to bid on and obtain set-aside contracts, when in fact the bidders did not qualify for the status claimed. The defendants are alleged to have falsely certified their status, made false claims regarding past performance, hid certain aspects of the management and control of the companies at issue, and hid or falsified certain information regarding the employees of the companies at issue. Some of the defendants established a number of “front companies”, including Centurion Solutions Group, for the purposes of allowing them to bid on and obtain SDVOSB set-aside contracts. To qualify for SDVOSB status, one of the defendants, Amar Gogia (who is a service-disabled veteran), was falsely identified as a 100% service-disabled owner of Centurion even though he did not actually exercise control or ownership over the entity. Centurion secured millions of dollars of government contracts. One of the defendants, Neil Parekh, established another entity, Citibuilders Solutions Group, to branch out his fraudulent SDVOSB contracting activity. Parekh falsely certified Citibuilders as a service-disabled veteran-owned entity, utilizing defendant Melvin G. Goodweather’s service-disabled veteran status, even though Parekh was the de facto owner and controller of Citibuilders. He is also alleged to have misrepresented Citibuilders’ past performance and project personnel. Citibuilders similarly obtained millions of dollars in government contracts. There were a number of other entities and individuals involved in the alleged scheme. Plaintiff claimed that, to varying degrees, the individuals and the companies established by them were alter egos of each other.
With respect to the surety defendants, plaintiff alleged that the bond broker, allegedly serving as the sureties’ agent and attorney-in-fact, had a long-standing relationship with Parekh and knew that the companies shared a single office and that parties, other than service-disabled veterans, were in functional control of one or more of the front companies. Plaintiff further alleged that the sureties, through their agent, understood that the front companies shared common ownership, requiring corporate resolutions acknowledging this fact, and “deliberately disregarded this fact when issuing bonds in connection with the false certifications contained in the bidding proposals submitted to the government.” Narula, at *13. On these facts alone, the court initially dismissed plaintiff’s reverse false claims allegations against the sureties.
However, plaintiff subsequently amended its complaint and further alleged that, among other things, during the underwriting process, the sureties conducted an on-site inspection1 of one of the front company’s offices, after which the sureties “necessarily understood that [Centurion] was a shell company dependent on the resources and capabilities and capital of [the other front companies] and the experience and knowledge and financial backing of Parekh, Narula, and Madan”, and that underwriting and due diligence “would reasonably have revealed that [Centurion] did not possess the necessary construction history or financial capabilities to carry out the scope of the contracting activity ultimately undertaken in the name of [Centurion].” Id. at *14. The Amended Complaint further alleged that the underwriting and due diligence reasonably led to the conclusions that “Parekh, Narula, and Madan exerted dominance and control over [Centurion],” that “Gogia lacked the skill, knowledge, resources, and past performance to engage in the scope of contracting activity undertaken by the [Centurion] conspirators,” and that “[Centurion] was not a service-disabled small business operating out of Harrisonburg.” Id. The court held that these additional facts were “sufficient to allege that the [sureties] had knowledge of [Centurion’s] and Citibuilders’ fraud, i.e., that they were fraudulently asserting status as SDVOSBs…” and that the sureties “continued to do business with [Centurion] and Citibuilders even though they were aware that [they] were committing fraud.” Id. at *14-15.
Under 31 U.S.C. § 3729, “knowingly mak[ing], us[ing], or caus[ing] to be made or used, a false record or statement material to an obligation to pay or transmit money or property to the Government, or knowingly conceal[ing] or knowingly and improperly avoid[ing] or decreas[ing] an obligation to pay or transmit money or property to the Government,” violates the False Claims Act. Reverse false claims occur when “the defendant’s alleged deception results in no payment to the government when a payment is obligated. In contrast to typical false claims actions, a typical reverse false claim action involves a defendant knowingly making a false statement in order to avoid having to pay the government when payment is otherwise due.” Narula, at *15. Plaintiff argued that, in issuing Miller Act bonds, the sureties:
agreed to compensate the government for losses sustained should the specifications found in the contract, including the specification that the construction activity be paid a service-disabled, veteran-owned small business entity, fail to occur. The [sureties] exercised due diligence to obtain facts from the other defendants that the [sureties knew or should have known violated the government’s service-disabled, veteran-owned contracting requirements. For example, each time the [sureties] knew that the government made a payment that violated the service-disabled, veteran-owned specification they knowingly avoided an obligation to compensate the government for that loss. The [sureties] also knowingly concealed information and committed other acts that facilitated the fraudulent scheme and caused the other defendants to violate the FCA.
Id. at *16.
The court agreed that plaintiff plead a viable theory of liability, noting that the Miller Act bonds “were separate instruments entered between the United States government [and the sureties] and although submitted with the contract, did separately obligate the [sureties] to compensate the government for losses sustained if the specifications found in the contract, including the specification that the construction activity be paid a service-disabled, veteran-owned small business entity,” were not followed. Id.
It is critical to note that, as a threshold matter, this decision does not actually hold that the sureties are or ultimately will be held liable under the False Claims Act. Instead, the court held that, for purposes of deciding a motion to dismiss for failure to state a claim, under certain circumstances, the sureties may be held liable for their principals’ fraud. The circumstances in Narula are narrow. The sureties’ bond broker2 appears to have become intimately familiar with the business dealings of the defendants involved in the alleged scheme. And since the bond broker/agent was aware that the defendants were bidding on set-aside contracts, even though they were not qualified to submit such bids, the court implied that the sureties should not have issued the bonds, which assisted the defendants in perpetrating the fraud.3
The Narula decision is, therefore, not a blanket pronouncement that sureties are now generally liable, under the False Claims Act, for all of their principal’s actions or inactions. The decision is a product of the facts of the case. Nevertheless, the decision is noteworthy in that it represents one of the first, if not the first, occasions in which a court has found that a surety may be held liable, under the False Claims Act, on account of its principal’s actions or inactions through the knowledge of an agent. Sureties and their underwriting departments would be wise to carefully consider the facts of the case and take steps to safeguard themselves against similar claims in the future.
1 It is not clear from the decision whether one or more representatives from the sureties’ underwriting departments participated in this on-site inspection or if the court is referring solely to the sureties’ broker/agent.
2 The court imputed the broker’s knowledge to the sureties on account of the broker’s status as the sureties’ agent and attorney-in-fact. The decision does not set forth whether, or the extent to which, the broker/agent communicated its knowledge to the sureties. The court, likewise, does not elaborate on the nature of the agreements between the broker/agent and the sureties. Thus, whether the court intended to pronounce a rule that a broker/agent’s knowledge will always be imputed to a surety is unclear.
3 The court observed that “the actions of the [sureties] were critical to [Centurion’s] and Citibuilders’ ability to bid on and obtain the contracts at issue.” Id. at *15.