Welcome to the third edition of Legal Landscape, a series we have developed with Onvia’s blog to provide government contractors with a quick, but thorough, summary of important legal developments and regulations in government contracting, as well as a plain-English explanation of how those developments may affect contractors at all levels of government. In this issue, we discuss recent trends in federal, state and local government contracting. Contractors should keep in mind that state and local agencies often look to changes in federal regulations as a guide for future changes at their respective levels. Changes recently made in the federal arena are likely to trickle down to state and local governments soon.
1) The SBA Offers Some Specifics on the Expansion of the Mentor-Protégé Program
As many government contractors may know, in February 2015, the U.S. Small Business Administration (SBA) issued a proposed rule aimed at expanding its mentor-protégé program. The proposed regulations would implement changes introduced by the Small Business Jobs Act of 2010 and the National Defense Authorization Act of 2013, and would permit a wide array of small businesses to participate in the SBA’s mentor-protégé program. Currently, only 8(a) certified firms can take advantage of the many benefits offered SBA’s mentor-protégé program, including a broad exception to affiliation for mentor-protégé joint ventures.
While this was great news for many back in February 2015, it has been nine months since this proposed rule was issued and we have yet to see an interim, or a final, rule. The delay has many government contractors asking when the SBA is actually going to put these changes into effect. Well, we now have some idea: Sometime in the first quarter of 2016.
On October 27, 2015, the U.S. House of Representatives’ Committee on Small Business Subcommittee on Contracting and the Workforce, chaired by U.S. Representative Richard Hanna, held a hearing entitled “Maximizing Mentoring: How are the SBA and DoD Mentor-Protégé Programs Serving Small Businesses?” Based on the testimony given at the hearing, and the information compiled in the Subcommittee’s related memorandum, it appears that a final rule will be issued in the first quarter of fiscal year 2016, and that the agency hopes to launch a pilot program sometime in the summer of 2016.
Key Takeaway for Government Contractors:
The expansion of the mentor-protégé could mean a lot more flexibility for small businesses. HUBZone, SDOVSB and WOSB/EDWOSB companies would have the ability to joint venture with larger mentors without the risk of affiliation. This, in turn, would make these small companies much more competitive.
2) The Importance of Complying with the Specific Requirements of Bond Claims
Ok, so this isn’t really a “new” legal development, per se. The requirements relating to bond claims is an issue that has been discussed among government contractors since, well, since bonds have been a requirement. However, while bond claims are often discussed, they are also commonly misunderstood. Many contractors do not fully understand their obligations concerning timing, notice, or procedure to perfect a bond claim. This is particularly true when it comes to performance bond claims against bonded subcontractors. In this context, contractors often fail to comply with their obligations and are adversely impacted. A recent Missouri case is just the latest example of this, and serves as a harsh reminder that the failure to comply with bond requirements can nullify an otherwise legitimate bond claim.
In that case, a plaintiff-general contractor, Curtiss-Manes-Schulte (CMS), subcontracted work to Balkenbush Mechanical, Inc. (BMI) on a renovation project located at Fort Leonard Wood, MO. Safeco Insurance Company of America (Safeco) provided the performance bond for BMI. As the project progressed, BMI fell significantly behind schedule. CMS informed Safeco, through a “Contract Bond Status Query” that BMI was not progressing satisfactorily, the contract was 9 months past due and liquidated damages would be assessed. However, CMS did not declare the subcontractor “in default,” a requirement under the bond. BMI ultimately abandoned the project, and then filed for bankruptcy protection. After completing BMI’s work itself and incurring significant additional costs, CMS made a claim against Safeco under BMI’s performance bond, citing BMI’s failure to perform. Because CMS never technically defaulted BMI, Safeco refused to pay CMS’ demand, asserting that CMS had failed to satisfy the bond requirements. CMS then sued Safeco.
In assessing CMS’ performance bond claim, the United States District Court for the Western District of Missouri noted that the performance bond specifically provided that the subcontractor had to be declared in default, and, further, that Safeco had to be notified of that default. Because CMS never formally defaulted BMI, and, in any case, never informed Safeco that BMI had been defaulted, the Court found that Safeco’s obligations under the bond were never triggered.
Key Takeaway for Government Contractors:
Make sure you are aware of the specific terms of each and every bond that could affect your interests. Contractors tend to pay close attention to “upstream” bonds relating to payment but forget about how important the rules are when it comes to “downstream” performance bond claims. It is imperative that all government contractors understand the terms of all relevant bonds, and their obligations thereunder, as well as any federal, state or local statutory or regulatory requirements relating to those bonds. Otherwise, they risk forfeiting a perfectly legitimate claim. If you have any questions about the terms of a particular bond, or the applicable regulatory or statutory requirements, consult a legal professional.
3) Third Circuit Creates “Offset” Exception for Damages Relating to State DBE Fraud
In the last issue of Legal Landscape, we talked about the increased importance of the False Claims Act and the uptick in fraud actions by the Federal Government, as use of the FCA has expanded. As previously discussed, state and local governments have followed suit by aggressively prosecuting contractors for making false statements, or claims, of various types and kinds. As part this process, many local governments have increased the amount of monetary damages, and broadened the types of penalties, associated with fraud and false claims actions, including suspensions and debarments. Overall, there has been a marked trend over the past five years toward the draconian enforcement of fraud-related regulations and statutes, the expansion of liability, and the imposition of increasingly serious penalties.
A good example of the above is the Federal Government’s Presumed Loss Rule, introduced by the Small Business Jobs Act of 2010. The Presumed Loss Rule provides that, if a concern willfully misrepresents its size or status to receive the award of a federal contract, subcontract, grant or cooperative agreement, the loss to the government is presumed to be the total amount expended by the government under that contract, subcontract, grant or cooperative agreement. In other words, if you lie to the government about being small to get a contract, the damages assessed against you will be equal to the total amount of that contract. That’s a pretty stiff penalty, but it is entirely consistent with the trend toward escalating enforcement and prosecution.
One recent case may signal a slight shift in the other direction. In United States v. Nagle, the Third Circuit found that the damages assessed against a contractor found guilty of fraud on a state government contract had to be “offset” against the fair market value of the services provided under that contract. In Nagle, the co-owners of Schuylkill Products Inc. (SPI) and its wholly owned subsidiary, CDS Engineers, Inc. (CDS), engaged in fraud-related crimes in connection with PennDOT and SEPTA contracts. In order to take advantage of contracts with Disadvantaged Business Entity (DBE) participation requirements, SPI and CDS – both non-DBE entities – set up a “front” DBE subcontractor, Marikana. SPI and CDS “subcontracted” to Marikana, but, in reality, they performed all of the work on Marikana’s subcontracts. SPI and CDS paid Marikina a fixed fee for its participation, but otherwise kept the profits for themselves.
When this scheme was uncovered, the owners of SPI and CDS were charged with fraud. In analyzing the appropriate damage assessment against the owners, the U.S. District Court for the Middle District of Pennsylvania determined that the amount of loss each defendant was responsible for would be equal to the face value of the contracts that the DBE front company was awarded. Such an assessment was consistent with the Presumed Loss Rule outlined above.
However, on appeal, the Third Circuit disagreed with the lower court’s damage assessment. The appellate court held that, in a DBE fraud case, the amount of loss attributable to defendants should be calculated by taking the face value of the contracts and subtracting the fair market value of the services rendered. The court further clarified that “fair market value” can be calculated by the value of the materials supplied, the cost of the labor necessary to assemble the materials and the value of transporting and storing those materials. In other words, the damages assessed to a defendant for DBE fraud must be decreased to account for the fair value of services actually provided by that defendant.
Key Takeaway for Government Contractors:
Nagle dealt with DBE fraud committed in connection with Pennsylvania state contracts, which were funded through the U.S. Department of Transportation. The Nagle decision was rendered by the Third Circuit, which means the case could be considered controlling in Pennsylvania, New Jersey and Delaware. It is not yet clear whether other jurisdictions will carve out similar exceptions, or whether the majority of other states will adhere to something more similar to the Federal Presumed Loss Rule. It is further unclear as to whether the exception in Nagle would apply if SPI or CDS had misrepresented their own DBE status, rather than arranging for a front DBE subcontractor. In any case, the damages associated with a potential fraud matter can be quite severe. It is important to understand the rules and make sure that you and your subcontractors are not engaging in any conduct that might constitute fraud.
We hope that you check back for more government contracting legal updates in the next edition of Legal Landscape.
Edward T. DeLisle is Co-Chair of the Federal Contracting Practice Group. Ed frequently advises contractors on federal contracting matters including bid protests, claims and appeals, procurement issues, small business issues and dispute resolution.
Maria L. Panichelli is an Associate in the firm’s Federal Contracting Practice Group. Her practice includes a wide variety of federal contracting and construction matters, as well as all aspects of small business procurement.