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Construction Litigation

Avoiding False Claim Allegations in Pricing

By Patrick A. McGeehin and Margie Collins – January 30, 2013


The Federal False Claims Act (FCA), 31 U.S.C. § 3729, has been around since 1863 and has been the basis for many investigations by the federal government in a variety of industries, including defense, health care, and construction. Sweeping changes to the FCA came about as a result of the Fraud Enforcement and Recovery Act of 2009 (FERA). FERA provides for expanded protections for whistleblowers; permits the government to trace funds through subcontractors, grants, and state programs while conducting investigations; and provides for the sharing of information with states. In its most important aspect, it removed the “intent” requirement. In the past, the language of the FCA at section 3729(a)(2) attached liability to “any person who knowingly makes, uses, or causes to be made or used, a false record or statement to get [emphasis added] a false or fraudulent claim paid or approved by the Government.” FERA eliminates the words “to get” from section 3729(a)(2) in order to make clear that this provision does not contain an intent requirement. The relevant section of section 3729(a) now reads:

(a) Liability for certain acts. (1) In general. Subject to paragraph (2), any person who – […] (B) knowingly makes, uses, or causes to be made or used, a false record or statement material [emphasis added] to a false or fraudulent claim [ . . .] is liable to the United States Government . . .

To avoid confusion, FERA defines the term “material” in section 3729(b)(4): “[T]he term ‘material’ means having a natural tendency to influence, or be capable of influencing, the payment or receipt of money or property.” This definition does not require the party alleging FCA liability to show that the false statement actually caused the government to pay the false or fraudulent claim. Instead, the requirement is only to show that the false statement could have influenced the decision to pay or approve a false or fraudulent claim. Last, FERA did not amend the terms “knowing” and “knowingly,” and the FCA continues to define these in section 3729(b)(1) to mean “(A) that a person, with respect to information— (i) has actual knowledge of the information; (ii) acts in deliberate ignorance of the truth or falsity of the information; or (iii) acts in reckless disregard of the truth or falsity of the information.” However, the terms related to knowledge “(B) require no proof of specific intent to defraud.”

In the same year FERA was enacted, Congress also passed the American Recovery and Reinvestment Act of 2009 (ARRA), which authorized a total of $789 billion for spending—$135 billion of that amount for construction. ARRA provided contractors the incentive to bid on federal construction projects. Contracts under ARRA were subject to Federal Acquisition Regulation (FAR) requirements and were covered by the FCA provisions. In a sense, the perfect storm was created for the construction industry because many construction contractors were motivated by the economic downturn to enter into the public contracting arena, yet they possessed little or no government contracting experience and were not versed in the requirements and penalties set forth in the FAR, Cost Accounting Standards (CAS), or the FCA.

Contractor awareness of the FCA is imperative in order to avoid severe monetary penalties, as well as prosecution of individuals and suspension or debarment of companies, company executives, and others who may be “responsible” for violations. The FCA may impose liability when a construction contractor or subcontractor provides false certifications or makes misrepresentations material to a false or fraudulent claim related to negotiated contract prices, contract modifications, requests for equitable adjustments, termination for convenience settlement proposals, or claims. The FCA is a major risk factor, and a contractor’s awareness of the pitfalls of not complying with the various FCA’s and regulations is more important than ever.

Contractors must also be aware of comparable state statutes and regulations. Eighteen states and the District of Columbia have their own state false claims statutes, which mirror the federal FCA. California, Cal. Gov’t Code 12650-56; Delaware, Del. Code Ann. tit. 6, 1201-09; District of Columbia, D.C. Code 2-308.03 to 308.21;Florida, Fla. Stat. 68.081 to 68.09; Hawaii, Haw. Rev. Stat. 661-21 to 29; Illinois, 740 Ill. Comp. Stat. 175/1 to 175/8; Indiana, Ind. Code 5-11-5.5-1 to 55-11-5.5-18; Massachusetts, Mass. Gen. Laws Ch. 12, 5A(A)–(O); Minnesota, Minn. Stat. 15C.01 et seq.; Montana, Mont. Code Ann. 17-8-401 to 412; Nevada, Nev. Rev. Stat. 357.010 to 357.250; New Jersey, N.J. Stat. 2A:32C1 to 15, 17, and 18; New Mexico, N.M. Stat. 44-9-1 to 44-9-14, New York, N.Y. State Fin. Law 187-94; North Carolina, N.C. Gen. Stat. 1-605 to 618; Oklahoma, Okla. Stat. tit. 63 5053.1 to 5053.7; Rhode Island, R.I. Gen. Laws 9.1.1-1 to 9.1.1-8; Tennessee, Tenn. Code 4-18.101 to 108; Virginia, Va. Code Ann. 8.01-216.1 to 216.19.

The purpose of this article is to provide a practical overview of issues in the pricing of extra work and claims that can result in increased exposure under the FCA for construction contractors. Not intended as a legal analysis of the FCA at the federal or state level, it is more of a hands-on discussion of some of the issues that construction contractors face and how they might be addressed. Tips on reducing false claims exposure are also offered as part of the discussion.

The Relationship of False Claims to Defective Cost or Pricing Data
The concepts of defective pricing and false claims are closely related. Part 15 of the FAR, Contracting by Negotiation, codifies the Truth in Negotiations Act (TINA), 10 U.S.C. § 2306a and 41 U.S.C., which requires contractors to submit current, accurate, and complete cost or pricing data as of the date of agreement on contract price (handshake date) with the government. The price reduction clause for defective pricing, FAR 52.215-10/-11 (Price Reduction for Defective Certified Cost of Pricing Data (Aug. 2011); Price Reduction for Defective Certified Cost of Pricing Data—Modifications (Aug. 2011)), is applicable in the following circumstances: (1) when the contractor or subcontractor does not submit current, accurate, or complete cost or pricing data (the FCA parallel is “a false record or statement”); and (2) when the government has relied on the defective data in determining the contract price/contract modification price adjustment (the FCA parallel is “material to a false or fraudulent claim”). In instances of defective pricing, the government is entitled to a price adjustment, including a profit or fee, relating to the recovery of overpayments, interest, and penalties. It is not unusual for a defective pricing issue to become the subject of a false claim allegation by the government.

The DCAA Contract Audit Manual (DCAM) (14.102 DCAA Postaward Audit Program) describes when defective pricing occurs and specifies that certain “necessary prerequisite[s]” must be established to obtain a price reduction on the basis of defective cost or pricing data. These requirements are spelled out in the DCAM as follows:

To show that defective pricing exists, the audit must establish each of the following five points:

    (1) The information in question fits the definition of cost or pricing data.
    (2) Accurate, complete, and current data existed and were reasonably available to the Contractor before the agreement on price.
    (3) Accurate, complete, and current data were not submitted or disclosed to the contracting officer or one of the authorized representatives of the contracting officer and that these individuals did not have actual knowledge of such data or its significance to the proposal.
    (4) The government relied on the defective data in negotiating with the Contractor.
    (5) The government’s reliance on the defective data caused an increase in the contract price.

Establishing these five points is a necessary prerequisite to support recommended price adjustments and provide the contracting officer with the information to achieve price reductions to contracts.

 In certain instances, the government then requires that the cost or pricing data submitted be certified. Although federal government contracting officers are in some instances prohibited from obtaining certified cost or pricing data (e.g., acquisitions at or below the simplified acquisition threshold, commercial contracts based on competitive prices), contractors are often required to certify the cost or pricing data related to a contract or change order amount. Unless an exception to obtaining certified cost or pricing data exists, the contractor must certify all negotiated pricing actions of $700,000 or more. These pricing actions include prime contracts, subcontracts, change orders, and modifications. In providing certification, the contractor certifies that the cost or pricing data are accurate, complete, and current as of the date of agreement on price. The following is the language of the certification (FAR subsection 15.406-2) required of a contractor:

This is to certify that, to the best of my knowledge and belief, the cost or pricing data (as defined in section 2.101 of the Federal Acquisition Regulation (FAR) and required under FAR subsection 15.403-4) submitted, either actually or by specific identification in writing, to the Contracting Officer or to the Contracting Officer’s representative in support of [THIS PROPOSAL] are accurate, complete, and current as of [THE DATE OF AGREEMENT ON PRICE]. This certification includes the cost or pricing data supporting any advance agreements and forward pricing rate agreements between the offeror and the Government that are part of the proposal.

As mentioned above, if the pricing is later determined to be defective and is of a sufficiently egregious nature, the result may be a government allegation of a false claim based on reckless disregard for the truth. Furthermore, the government may assert defective pricing (and false claims) even if a signed certificate was not submitted. In addition, it is important to keep in mind that the possibility of a false claim is not limited to certified cost and pricing data and applies to “information other than cost or pricing data.”

To fully understand the scope of this issue, it is important to note that cost or pricing data are more than historical accounting data. Cost or pricing data include all facts that can be reasonably expected to contribute to the soundness of estimates of future costs and to the validity of determinations of costs already incurred. The data also include all facts that prudent buyers and sellers would reasonably expect to affect price negotiations significantly. This information would comprise vendor quotations; nonrecurring costs, information on changes in production methods and production or purchasing volume, and data supporting projections of business prospects and objectives and related operation costs. According to FAR section 15.408 and Table 15-2, the following cost elements are considered cost or pricing data requiring disclosure as part of a price negotiation with the government:

A. Materials and Services. Provide a consolidated priced summary of individual material quantities included in the various tasks, orders, or contract line items being proposed and the basis for pricing (vendor quotes, invoice prices, etc.). Include raw materials, parts, components, assemblies, and services to be produced or performed by others. For all items proposed, identify the item and show the source, quantity, and price . . .
B. Direct Labor. Provide a time-phased (e.g., monthly, quarterly, etc.) breakdown of labor hours, rates, and cost by appropriate category, and furnish bases for estimates.
C. Indirect Costs. Indicate how you have computed and applied your indirect costs, including cost breakdowns. Show trends and budgetary data to provide a basis for evaluating the reasonableness of proposed rates. Indicate the rates used and provide an appropriate explanation.
D. Other Costs. List all other costs not otherwise included in the categories described above (e.g., special tooling, travel, computer and consultant services, preservation, packaging and packing, spoilage and rework, and Federal excise tax on finished articles) and provide bases for pricing.
E. Royalties. . . .
F. Facilities Capital Cost of Money. . .

Examples of Defective Pricing and False Claims

Defective pricing and false claims may arise in the following ways, among others:

  • Providing journeyman rates in a bid and then using apprentices to carry out the work.
  • Bidding equipment as if rented equipment will be used when owned equipment will be used.
  • Including bonds or other costs, such as airfare, at full rates in a bid or proposal when costs for discounted rates will be incurred through rebates.
  • Applying overstated indirect rates in a bid or proposal, rather than projected or recent actual indirect rates.
  • Including FAR part 31 unallowable costs in indirect rate calculations.
  • Failing to disclose pricing histories for the same or similar parts and products.
  • Including non-cost-based charges such as intercompany profit, commissions, and fees as proposed “costs” without any disclosure that the amounts are prices, inclusive of profit or other mark-ups.
  • Failing to update proposed indirect rates for significant changes in business volume
  • Using a lower subcontractor quote during performance without having disclosed that quote to the government during negotiations.
  • Failing to update the bill of materials for changes.
  • Failing to include discounts (for volume, prompt payment, and the like) from suppliers and subcontractors.

The Defense Contracting Audit Agency (DCAA) has two opportunities to identify “defective pricing”—in pre-award proposal audits and post-award audits. From a practical standpoint, however, the only situation that leads to a price reduction for defective pricing is in the post-award audit. That is because, if noncurrent, inaccurate, or incomplete information is identified in a proposal audit, the auditor and contracting officer inform the contractor of such issues, and costs are typically adjusted prior to the agreement on price. As a result, no price reduction can subsequently occur for these issues. It is important to stress that, even in a fixed-price contract environment, reviews for defective pricing and investigations for false claims can be initiated as part of change orders or claims that were settled after the submission of cost information or in those instances where the contract was negotiated at the outset and cost or pricing data was submitted as part of the negotiation.

Under TINA and the implementing FAR rules, defective pricing reviews can occur at any time up to and including three years after the date of final payment under the contract (FAR subsections 52.214-26 and 52.215-2). Under the FCA, the statute of limitations provisions become more complicated. The FCA statute of limitations provision, 31 U.S.C. § 3731(b), provides:

A civil action under section 3730 may not be brought:

    (1) more than six years after the date on which the violation of section 3729 is committed
    (2) more than three years after the date when facts material to the right of action are known or reasonably should have been known by the official of the United States charged with responsibility to act in the circumstances, but in no event more than 10 years after the date on which the violation is committed, whichever occurs last.

Tips for Reducing Exposure to False Claim Liability under the FCA
Provisions to price extra work and claims are elements of all government construction contracts. Because many construction contracts are firm fixed prices based on a proposal that did not include cost or pricing data, the major area of exposure for most contractors is in the pricing of these extra work items or claims relating to changed work, delays, or other impacts on performance caused by government action or inaction. Therefore, reducing exposure to false claim liability related to pricing issues, primarily in the area of change orders, is essential for contractors pursuing public construction work. The practices described below, which are presented as a guide for contractors doing public contract work, should significantly lessen a contractor’s risk of defective pricing or false claim allegations:

  1. Know what defective pricing is and understand the regulatory and case law in this area. Furthermore, the contractor should read and understand the contract pricing provisions, and not rely on past experience.
  2. Clearly disclose to the government details and explanations as to contract interpretations and costing methods used to prepare claims and payment requisitions, particularly any issues that are estimated or that are more aggressive than some bid assumptions.
  3. Establish internal systems to ensure that all forms and certifications are compliant, complete, and accurate. The contractor is well advised to develop, support, and “live by” company-wide ethics and compliance programs to foster due diligence in the development and review of claims.
  4. Conduct periodic seminars and training programs to inform employees of claim preparation and development issues and the repercussions of filing defective or false claim information to the government.
  5. Communicate with experts retained to assist with claim preparation, rather than thinking that by engaging them, it is possible to “walk away” from the claim process and let the consultant prepare reports and submit data without proper vetting by knowledgeable employees.
  6. Obtain actual costs and current labor, burden, and indirect cost rates from the accounting/finance department, and use such current information in all proposals.
  7. Whenever possible, use claim approaches consistent with  methodologies accepted in the construction industry (e.g., measured mile analyses, actual costs).
  8.  If total cost-type methodologies are being submitted as part of the claim approach, include explanatory information as to the reason for such use and what steps have been taken to assess the reasonableness of the baseline bid information used in the calculation. In addition, perform reviews and explain the steps taken to adjust the bid or actual performance results for issues that are due to bid errors or contractor issues during performance that should be excluded from the claim against the government.
  9. If estimates are to be used as part of a change order, REA, or claim, understand and follow the company’s established estimating system procedures so that only reasonable estimates are included in the submissions.
  10. “Scrub” the proposal or estimate so that no unallowable costs are included. Unallowable costs under federal contracts are found in FAR Part 31. Various state regulations also include other versions of costs deemed unrecoverable as part of a contract price or extra work change order.
  11. Review the claim for duplication. If some costs are being claimed under alternative approaches, these should be clearly identified and some type of credit should be calculated and included in the claim. Labor and material quantities as well as labor classifications between the cost and technical proposals should be checked to confirm that they correlate with each other.
  12. Review subcontractor claims in sufficient detail and request backup or inquire as to various elements of the subcontractor’s claim to allow the prime contractor to certify the subcontractor claim. For example, the prime contractor can request that subcontractors respond to written questionnaires or letters or e-mails outlining specific questions relating to the costs and claim submissions being proposed by the subcontractors.
  13. For monthly requisition to the government—for both base contract and extra work items—read the certification language carefully as it relates to representations being made about payments made or to be made to subcontractors. In most cases, a contractor is required to pay the subcontractor within a certain time frame, and almost always before submitting the next requisition to the government. Failure to read, fully understand, and follow the certification language associated with contract requisitioning and payment actions can result in a false claim allegation.
  14. Undertake this same procedure with subcontractors even when subcontractors certify their own claims as part of a global claim submission. In some cases in which the contractor was defrauded by the subcontractor, the government has taken the position that the contractor is liable for a false claim.
  15. Perform a review of cost or pricing data for a modification or claim by non-project personnel, prior to submission to the government.
  16. Revise cost estimates or proposals that have not been negotiated over 30 days before price negotiations begin. Conduct “sweeps” or extensive reviews of available cost or pricing data prior to the date of final price agreement. To ensure compliance with TINA requirements, sweeps should be performed after negotiations are complete, but before submitting the certificate of current cost or pricing data. Any new or revised data should be identified so that all cost or pricing data are accurate, complete, and current, and these should be submitted to the government with the certification.
  17. Use appropriate certification language and submission formats. Submission of cost/price proposals when certified cost or pricing data are required should be made using Table 15-2 as illustrated at FAR section 15.408. If the contractor elects to submit a proposal using the contractor’s own format, DCAA may deem the proposal inadequate for audit until the contractor provides the data as stipulated in Table 15-2.
  18. Document and retain the data provided as cost or pricing support. The data should be maintained so that an audit trail exists from extra work/claim calculations to contemporaneous project documents specifically noting and explaining any adjustments to the contemporaneous information (hours, rates, etc.).
  19. Keep a list and copies of all materials provided to auditors or claims consultants.
  20. In requisitioning for certain items on a fixed-price contract that may be based on cost (e.g., the performance or payment bond premium that is paid early in the project and billable as a line item when paid), ensure that the amount is, in fact, paid before including it on the requisition to the government.

As a great Indian poet said, “Know by knowledge; otherwise experience will teach you.” Experience can be a rough teacher. A Korean contractor, Daewoo Engineering & Construction Co., Inc., constructed a 53-mile road in the Republic of Palau under a U.S. Army Corps of Engineers contract. In Daewoo’s $64 million certified equitable adjustment claim against the Corps of Engineers, Daewoo was found to have had no basis for the claim in the first instance, and had filed the claim to get the government’s attention. In addition, it had included unallowable costs, unusual claim approaches, and one-time charges in the daily rate applied to claimed days of delay, thereby further flavoring the falsity of the claim filing. In its 2006 decision in Daewoo v. United States, the Court of Federal Claims found that Daewoo had submitted a false certification of an equitable adjustment claim. Daewoo not only failed to recover its claim of $64 million but also was required to pay $51 million to the United States government to satisfy the court’s FCA counterclaim judgment. Although there are no guarantees when it comes to protecting a company from FCA investigations by the government, exposure can certainly be reduced if a contractor implements and adheres to sound compliance program steps in its organization and follows the types of tips offered in this article when it comes to pricing, costing, and payment application actions.

Keywords: construction litigation, False Claims Act, Fraud Enforcement and Recovery Act of 2009, Federal Acquisition Regulation, Truth in Negotiations Act, defective pricing, audit

Patrick A. McGeehin, CPA, is a senior managing director at FTI Consulting, Inc. based in West Palm Beach, Florida, and Rockville, Maryland, and Margie Collins, CPA, is a senior director at at FTI Consulting's office in Rockville, Maryland.

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