Court Expands Scope of False Claims Act Liability

Federal contractors, beware: A recent appeals court decision could substantially expand the scope of liability under the False Claims Act when bidding on government contracts.

The California-based Ninth Circuit Court of Appeals, no stranger to prodding the borders of legal interpretation, ruled earlier this month that submitting an unrealistically low bid simply to win a government contract can indeed be a violation of the FCA if the contractor then pushes the price back up through change orders or other revisions.

The decision marks the first time that a court has held that an underbid can be a false claim. Previous decisions around false bidding have typically involved collusion to overbid on fixed-priced contracts; here, the case involved a “cost-plus” contract where the government ultimately wasn't going to pay the cost first stated in the contract, but rather the actual cost of producing the product—which can include any number of adjustments along the way.

The case, Hooper v. Lockheed Martin, stems from a lawsuit filed by Nyle Hooper, a former Lockheed employee. Hooper accused the company of fraudulently underbidding a contract with the U.S. Air Force related to a space launch operation project. The complaint alleges that Lockheed employees were ordered to “lower their estimates without regard to actual costs.” According to court documents, Lockheed Martin originally proposed that work would cost $432 million, but has been paid more than $900 million since being awarded the contract in 1995.

Hooper's attorney, Joseph Black, says the decision could encourage more whistleblowers to come forward if they know, and have documentation to prove, that a company bided on a cost-plus contract with prices the company knew it could never meet. That, in turn, might result in more FCA cases. “It could be a game-changer in terms of the way defense contractors approach bids of cost-plus contracts,” Black says.

In the case, Lockheed Martin argued that bids and estimates cannot constitute “false statements” within the meaning of the FCA, because they are subjective, judgment-based opinions. U.S. District Judge Dale Fischer agreed, granting Lockheed's motion for summary judgment on the grounds that Hooper didn't present enough evidence of fraudulent underbidding.

The district court did not, however, address whether fraudulent underbidding or false estimates constitute an FCA liability in general. Hooper appealed, and the Ninth Circuit said the district court erred by requiring him to prove Lockheed Martin's intent to deceive. Rather, the correct standard of proof under the False Claims Act is whether the company knowingly submitted the fraudulent bid.

Citing the U.S. Supreme Court ruling Marcus v. Hess, the Ninth Circuit used the “fraud-in-the-inducement” theory of FCA liability. That theory says that if there is a fraud in the making of the contract, it taints the entire process. “The idea is that if the government knew about the fraud, it wouldn't have entered the contract in the first place,” says Sarah Graves, an associate with law firm Husch Blackwell.

The case will now go back to district court for trial.

Chris Williams, a spokesperson for Lockheed Martin, says: “We're disappointed in the court's decision to partially reinstate this claim. We believe the case lacks merit and we will vigorously defend ourselves against this frivolous lawsuit.”

Wider Implications

One murky issue is at what point an inaccurate cost estimate becomes “false or fraudulent.” Under-bidding and cost overruns are standard fare for defense contracts, given the unpredictability of costs that may be necessary to fulfill contract specifications. The risk that the Hooper decision creates for contractors is that it “blurs the line between contract administration and False Claims Act liability,” Graves says.

“[The Lockheed Martin Decision] could be a game-changer in terms of the way defense contractors approach bids of cost-plus contracts.”

—Chris Williams,

Spokesperson,

Lockheed Martin

Black counters that the harm caused by under-bidding is that it leaves Congress no way of knowing what the actual cost of a proposed program will be. “So it's a serious problem in defense contracting,” he says. “There is a fair amount of incentive on the part of defense contractors to underbid.”

Graves says the decision could have just the opposite effect. If such rulings continue to come along, federal contractors will be much more cautious about their cost estimates—primarily by raising their numbers to cover unforeseen surprises. “It raises the prices the government is paying, perhaps unnecessarily, just because contractors are afraid of taking too many risks in their estimates,” she says.

Determining whether a bid is false is not all that difficult, Black says. “If the estimate is based on objectively false facts, it can be a false claim,” he says.

Jon Burd, an associate with Wiley Rein who counsels government contractors, says it would be “premature” for a whistleblower, a court, or the Justice Department to presume that any kind of causal connection exists between an overrun and fraud. The Ninth Circuit's opinion contains “a lot of really bold allegations … that are not necessarily facts, and I think we all need to keep that in mind,” he says.

CONCLUSION

Below is the court's conclusion in Hoover v. Lockheed Martin:

We affirm in part and reverse and remand in part. We

AFFIRM the district court's conclusion that Hooper failed to

establish his claims of fraudulent use of FOSS and defective

testing procedures because there is no genuine issue of material

fact as to whether Lockheed ‘knowingly' submitted a

false claim.

We also AFFIRM the district court's evidentiary rulings.

We REVERSE and REMAND the district court's dismissal

of Hooper's wrongful discharge claim under 31 U.S.C.

§ 3730(h) as barred by California's two-year statute of limitations.

We hold that in a case arising under federal question

jurisdiction, when a federal statute directs federal courts to

borrow the most closely analogous state statute of limitations,

a transferee district court must apply the state statute of limitations

that the transferor district court would have applied

had the case not been moved on forum non conveniens

grounds pursuant to 28 U.S.C. § 1404(a). Therefore, Maryland's

three-year statute of limitations applies here.

We also REVERSE and REMAND the district court's dismissal

of Hooper's claim that Lockheed violated the FCA by

knowingly underbidding the contract. Having determined that

FCA liability may be premised on false estimates, we hold

that there is a genuine issue of material fact whether Lockheed

acted either knowingly, in deliberate ignorance of the

truth, or in reckless disregard of the truth when it submitted

its bid for the Air Force RSA IIA contract.

The parties shall bear their own costs of appeal.

Source: Hoover v. Lockheed Martin.

Cost overruns do have legitimate causes. The price of raw materials might go up; specifications could change, or unforeseen engineering hurdles might appear. “More often than not, those [overruns] are going to be based on legitimate cost increases,” Burd says.   Graves agrees. “The fact that [overruns] happen, I don't think is necessarily indicative of a fraud on behalf of the contractor,” she says.

The Justice Department took no formal position in the case, but did an amicus brief with the appeals court arguing, “There is no reason to insulate from FCA liability a contractor who provides a deliberately understated cost estimate to win a contract, but who has no intention of actually fulfilling the contract at that estimated cost.”

The Justice Department's position signals that it may take a similarly aggressive enforcement stance on false estimates, or fraudulent underbidding, says Burd. “It could be a theory of fraud that the Department of Justice might pursue in the future,” he says.

“The Justice Department always complains about cost overruns and never seems to focus on the fact that the original bid may have been faulty,” Black says. This case gives them the basis for going back to the contractor.

The decision ought to warn federal contractors that the Justice Department or whistleblowers “could start holding contractors' feet to the fire to justify the legitimacy of their cost estimates in a proposal,” Burd says. Thus, contractors should take even more care to be prepared to justify the technical and business judgments used to prepare proposal cost estimates, he says.

Where the contractor uses judgment to fill in gaps, “make sure you're using good judgment and documenting the basis for that judgment,” Burd advises. Some allegations could be based on contracts several years old, “so contractors may need to give a little more thought at the front-end at documenting and tracking the basis for these estimates.”