Government Contracts, Investigations & International Trade Blog

Teaming Agreements Called Into Question Under Virginia Law

Sheppard Mullin — Mon, 29 Apr 2013 15:20:22 -0800

In 1997, the Virginia Supreme Court sent a chill down the spines of many companies operating under teaming agreements with a Virginia choice of law provision. In W.J. Schafer Associates, Inc. v. Cordant, Inc., 493 S.E. 2d 514 (Va. 1997), that court held a teaming agreement to be unenforceable on the ground that “agreements to agree in the future” are “too vague and too indefinite to be enforced.” After an initial outpouring of articles and commentaries on the future of teaming agreements under Virginia law, the dust appeared to have settled and, in 2002, the Virginia courts actually issued an affirmative injunction compelling specific performance of a teaming agreement in EG&G, Inc. v. Cube Corp., 63 Va. Cir. 634, 2002 WL 31950215 (Va. Cir. Ct. Dec. 23, 2002).

It’s now 2013 and as Bob Dylan penned so long ago, “The times they are a changing.” On April 3, 2013 the United States District Court for the Eastern District of Virginia (Cacheris, J.) issued a summary a judgment ruling that is sure to call into question many teaming agreements that opted for a Virginia choice of law provision.

Cyberlock Consulting, Inc. v. Information Experts, Inc., click here, involved the second of two teaming agreements entered into between the same two parties. It called for Cyberlock to perform 49% of the work awarded to Information Experts under a prime contract they were pursuing with the Office of Personnel Management. Although the agreement stated (1) that the defendant/prime contractor had agreed “to execute a subcontracting agreement to provide [Cyberlock] 49% of the prime contract for the work anticipated to be performed by [Cyberlock]” and that, upon award of a prime contract, the defendant/prime contractor “will perform 51% of the scope of work with [Cyberlock] performing 49%,” the court found the teaming agreement to be unenforceable. The court held that

. . . the agreement read as a whole indicates that this particular language was not meant to provide a binding obligation but rather to set forth a contractual objective and agreed framework for the “negotiate[ion] [of] a subcontract in the future along certain established terms.

What were the other terms of the teaming agreement that, “as a whole,” confirmed the absence of a binding obligation? They are far from uncommon:

(1) The award was subject to the negotiation and future execution of a subcontract – Commentators have long recognized this type of provision as a potential risk to enforceability and it is one that, in Virginia, was clearly vulnerable under W.J. Schafer Associates. Interestingly, the parties had avoided this trap in their prior teaming agreement, which physically appended the subcontract agreement to the teaming agreement.

(2) The teaming agreement was subject to termination upon the failure of subcontract negotiations – This type of provision is a customary (but not necessary) complement to the requirement for a successful negotiation of the subcontract and, under W.J. Schafer Associates, should have raised at least some red flags for the subcontractor. Again, there was no such termination provision in the parties’ prior agreement.

(3) The subcontract was subject to Government approval – This condition was accompanied by an obligation on the part of the prime contractor/defendant to “exert reasonable efforts” to secure customer approval. This is a common provision in teaming agreements, rising almost to the level of “boilerplate.” The court does not explain why this particular condition should render the agreement unenforceable – there are many conditions precedent to the effectivity of contracts that do not render them unenforceable. But the court’s focus on this issue should serve as a warning to reconsider the uncritical acceptance or insertion of such provisions in teaming agreements. Not all subcontracts require Government approval. At a minimum, such provisions should be reserved for subcontracts where that requirement actually exists.

(4) The allocation of work in a future subcontract was subject to change “as it merely was based on the work anticipated to be performed by Cyberlock as then-presently understood by the parties” – At first blush this seems to suggest a lack of appreciation by the court for the way in which Government programs evolve. But the court here was focused on the deal ab initio, i.e., the ability, based on the teaming agreement, to identify with any predictability the substance of the work to be performed by the subcontractor upon award of the prime contract. Finding that lacking, the court cited it as a fourth reason for holding the agreement to be unenforceable. This is a vulnerability that parties should be able to avoid with more care, precision, and foresight in drafting the teaming agreement.

Perhaps lost in the holding is another key determination by the court, one that was, in this case – and could well be in many others -- outcome determinative, i.e., the exclusion of extrinsic evidence under the parol evidence rule. In fact, the court went out of its way to criticize the 2002 opinion in EG&G on precisely this ground:

To the extent that EG&G suggests that teaming agreements are a special arrangement to which Virginia’s standard rules of contract interpretation, including the parol evidence rule do not apply, the Court concludes that that case is incorrect and should not be followed.

So, if you choose Virginia law, you may want to deep six that boilerplate integration clause. Or – you may just want to jettison the Virginia choice of law clause and roll your dice in some other jurisdiction that is more hospitable to teaming agreements.

"Buy American" Compliance Tips

Sheppard Mullin — Mon, 29 Apr 2013 15:19:49 -0800

By David Gallacher

1. There is no single “Buy American” requirement – there are numerous statutes with differing requirements. Make sure you know which one applies.

2. Whether you are a prime or a subcontractor, certify only to the specific “Buy American” requirements in the RFP; do not make a broader certification than is required.

3. The Buy American Act (“BAA”) and the Trade Agreements Act (“TAA”) are different animals. Compliance with one is not compliance with the other.

4. Country of origin requirements vary from procurement to procurement based on: (i) the buying agency; (ii) what is being bought; and (iii) the value of the contract. See Tip No. 1 above.

5. The Government often includes multiple, contradictory country of origin requirements in an RFP. Do not be afraid to discuss the issue with your customer to eliminate the inconsistency – the customer may be just as confused as you are.

6. The BAA does not prohibit the purchase of foreign-made products; it merely provides a price preference (ranging between 6-50%) for domestic “end products.”

7. The TAA does prohibit the purchase of products and services that are not “substantially transformed” in the U.S. or a “designated country.”

8. China and India are not “designated countries.” But Tawain and Singapore are. Know what countries are on the list, and be aware that the list is commonly updated.

9. There is a partial exception under the BAA for “components” of commercial off-the-shelf (“COTS”) products; if you are delivering a COTS “end product,” you do not need to worry about the origin of the “components.”

10. There is a broad exception under the BAA for purchases of commercial information technology.

11. Have a process in place to track and verify the country of origin of products that will be delivered to your government customers. You may need to validate your certifications later.

12. Some agencies, such as the U.S. Department of Defense (“DOD”), have additional “Buy American” restrictions relating to specific products (such as textiles, body armor and specialty metals). These DOD-unique requirements are in addition to those imposed by the BAA or TAA.

13. Just because a product qualifies under any of the various “Buy American” statutes does not mean that you can label the product as “Made in America.” Product labeling is separately regulated by the U.S. Federal Trade Commission.

14. U.S. Customs and Border Protection makes country of origin determinations for tariff purposes; this tariff classification does not necessarily correspond to the country of origin under the BAA or TAA.

15. Be aware that federal “Buy American” requirements can also apply at the State or local level where federal dollars are being spent; many States may also impose separate “Buy American” or “Buy Local” requirements of their own.

16. Free trade agreements (like NAFTA or the WTO GPA) may override certain “Buy American” requirements. Be aware of what you are providing and to what agency to understand the interplay. See Tip No. 3 and No. 4, above.

Playing Cards With a Government That Stacks the Deck - D.C. District Court Radically Expands The "Christian Doctrine" To Subcontracts

Sheppard Mullin — Mon, 29 Apr 2013 15:18:40 -0800

By Franklin Turner and David Gallacher

On March 30, 2013, the U.S. District Court for the District of Columbia issued a decision imposing certain socio-economic contract requirements on subcontractors operating hospitals associated with the University of Pittsburgh Medical Centers. See UPMC Braddock, et al. v. Harris, Civ. 09-1210 (PLF) (D.D.C. Mar. 30, 2013) (“UPMC Braddock”). Even though the hospitals’ subcontracts did not include these socio-economic clauses, the court applied the age-old “Christian Doctrine,” which assumes that certain contract requirements reflecting a “significant or deeply ingrained strand of public procurement policy” will apply to a Government contract even if those requirements have been omitted from the text of the actual contract. See G.L. Christian & Associates v. United States, 312 F.2d 418, 426 (Ct. Cl. 1963). Even though no court has ever before held in the 50-year history of the Christian Doctrine that this legal rule applies to subcontractors (Christian and its progeny apply only to prime contractors doing business directly with the U.S. Government), the court has now radically expanded the doctrine.

Background

The plaintiffs in UPMC Braddock were three hospitals affiliated with the University of Pittsburgh Medical Center (the “Hospitals”). In 1995, the Hospitals entered into subcontracts with a health maintenance organization (the “HMO”) to provide medical services and supplies to individuals enrolled in its coverage program. On January 1, 2000, the HMO contracted with the U.S. Government through the Office of Personnel Management (“OPM”) to provide insurance coverage for federal employees. The HMO’s agreement with OPM required the HMO to comply with several socio-economic requirements promulgated by the U.S. Department of Labor (“DOL”); but these requirements were not included in the HMO’s subcontracts with the Hospitals, even when the subcontracts were renegotiated after 2000. The DOL requirements implement various statutory and regulatory socio-economic requirements relating to “equal opportunity” for employees, disabled individuals, and veterans of the Vietnam era:

Executive Order 11246 (30 Fed. Reg. 12319 (Sept. 24, 1965), as amended by Executive Order 11375 (32 Fed. Reg. 14303) (Oct. 13, 1967) (the “Executive Order”) – directing the use in Government contracts of clauses that prohibit discrimination on the basis of race, color, religion, sex, or national origin, requiring prime contractors to include the clauses in “every subcontract or purchase order unless exempted by rule, regulations, or orders of the Secretary of Labor,” and mandating that subcontractors furnish DOL with audit rights to ensure compliance with the clauses.
Section 503 of the Rehabilitation Act of 1973, as amended, 29 U.S.C. § 793 (the “Rehabilitation Act”) – which requires that any Government contract or any subcontract in excess of $10,000 for the procurement of “personal property” or “nonpersonal services” contain a provision requiring “affirmative action to employ and advance in employment qualified individuals with disabilities.”
Section 402 of the Vietnam Era Veterans’ Readjustment Assistance Act of 1974, 38 U.S.C. § 4212 (“VEVRAA”) – providing that any Government contract or any subcontract in excess of $100,000 for the procurement of “personal property” or “nonpersonal services” contain a provision requiring “take action to employ and advance in employment qualified covered veterans.”

DOL also issued regulations implementing the socio-economic provisions (“DOL Regulations”), requiring that these equal opportunity clauses “shall” be included in “every” covered “contract and subcontract . . . whether or not it is physically incorporated in such contracts and whether or not the contract between the agency and the contractor is written.” 41 C.F.R. § 60-1.4(e). The DOL Regulations define the following key terms:

Subcontract: “any agreement or arrangement between a contractor and any person … for the purchase, sale or use of personal property or nonpersonal services which, in whole or in part, is necessary to the performance of any one or more contracts.” 41 C.F.R. § 60-1.3.
Subcontractor: “any person holding a subcontract” in the requisite monetary amount. 41 C.F.R. §60-1.3.
Nonpersonal Services: those that “include[] but [are] not limited to … [u]tilities, construction, transportation, research, insurance, and fund depository.” 41 C.F.R. §60-1.3.

Because the HMO required the Hospitals to render medical services to federal employees, among other people, the DOL’s Office of Federal Contract Compliance Programs (“OFCCP”) determined that the Hospitals qualified as Government “subcontractors” under 41 C.F.R. § 60-1.3, and were thus subject to the socio-economic contract requirements. Despite the fact that nothing in the Hospitals’ subcontracts obligated them to comply with these specific programs, OFCCP nonetheless demanded in that it be allowed to audit the Hospitals to monitor their compliance with the clauses. The Hospitals did not supply the information to OFCCP, arguing that they were not subject to the auditing authority of OFCCP because they held no Government subcontracts.

In November 2006, OFCCP filed administrative complaints against the Hospitals to enforce the socio-economic provisions. The Administrative Law Judge (“ALJ”) hearing the case agreed with OFCCP, and DOL’s Administrative Review Board (“ARB”) upheld the ALJ’s conclusion. See OFCCP v. UPMC Braddock, ARB Case No. 08-048 (2009) (previously discussed in our blog here). The ARB’s final decision and order permanently enjoined the Hospitals from failing or refusing to comply with the socio-economic requirements, reasoning that under the Christian Doctrine, the clauses were implied in the Hospitals’ subcontracts. The U.S. District Court for the District of Columbia affirmed the ARB’s decision.

Three New Wild Cards

In affirming the ARB’s ruling, the court reached a number of questionable key conclusions – all of which ignore the time-tested principle that a contract reflects the parties’ agreement and also introduce a number of “wild cards” into the contracting process.

1. Pay No Attention to the Plain Meaning of the Contract (or the Regulations, for that Matter)! The court concluded that the Hospitals qualified as “subcontractors” within the broad meaning of the DOL Regulations, even though the OPM procurement regulations, see 48 C.F.R. 1602.17-15, and the plain language of the OPM/HMO contract specifically limited the definition of “subcontractor” to exclude “providers of direct medical services or supplies,” such as the Hospitals. The court reasoned that, because the separately issued DOL Regulations do not define “subcontractor” as exempting direct medical service providers, and because it was the DOL (not OPM) that was empowered to enforce the socio-economic clauses, the separate DOL definition would over-ride. Furthermore, the court concluded that the Hospitals were providing “nonpersonal” services – even though they were plainly providing direct and personal medical services to individual patients (e.g., proctology exams and colonoscopies) – in concluding that the Hospitals were covered by the DOL definition of “subcontractor” from 41 C.F.R. § 60-1.3. Ignoring the plain meaning of the words, the contract, and the OPM regulations, the court concluded that the DOL regulations should separately override what the parties negotiated.

2. You’re A “Necessary” Subcontractor Because The Government Needed You Even If You Didn’t Need Them! Arguing that they did not meet the definitional requirement under 41 C.F.R. § 60-1.3 (relating only to subcontracts “necessary to the performance” of the prime contract), the Hospitals pointed out that providing services to federal employees was only part of their responsibility under their subcontract, where the Hospitals were also required to provide services to all other types of patients. But the court rejected this argument, reasoning that, because the Hospitals provided a portion of the medical care that the HMO agreed to supply to federal employees under the OPM contract, the Hospitals’ agreements with the HMO are “necessary to the performance of that contract” and therefore covered under the DOL definition of “subcontractor.” The problem with this result is that what is “necessary” to the performance of a prime contract may change during the course of performance, such that, based on the court’s reasoning, a lower-tier supplier may unwittingly become a “subcontractor” even if that was not the parties’ intent when they structured the supplier relationship.

3. Silly Rabbit! You Should Have Known What Constitutes a “Significant or Deeply Ingrained Strand of Public Procurement Policy.” Even though the Hospitals did not consent to enter into Government contracts, the court nonetheless held that the Christian Doctrine required that the socio-economic provisions be incorporated into the Hospital’s so-called “Government subcontracts” by operation of law because they reflected a “significant or deeply ingrained strand of public procurement policy.” In so holding, the court charged the Hospitals with “constructive knowledge” of the statutory and regulatory authority containing the socio-economic provisions, even though the Code of Federal Regulations and the procurement regulations are often a maze of impenetrable (and sometimes even conflicting) requirements. Taking a gigantic and unprecedented leap, the court concluded that there is essentially no distinction between incorporating extra-contractual regulations into a Government prime contract or a private subcontract.

Know When to Hold ‘Em; Know When to Fold ‘Em

The UPMC Braddock decision reflects exactly why you should not play cards with cheaters. Companies are reminded that any company doing business in the Government-space (whether medical, defense, energy, or the ever-growing civilian market) is doing business with a shifty customer – one that often cannot be trusted and cannot be taken at its word. Where the Government is empowered to swoop in at any time (as the OFCCP is often wont to do) and to impose extra-contractual obligations on any company in a supply-chain line, the risks of doing business in that market are incalculable. Moreover, granting the Government such a “right” simply tramples on the rights of the other commercial entities – entities that have actually negotiated and reached agreement as to the contractual terms that will control their ongoing relationship. But those considerations were simply brushed off by the court, which preferred to allow for the broad incorporation of regulations into private contracts, irrespective of the consequences.

The equal opportunity provisions that were incorporated into the prime contract between the HMO and OPM serve a valid and useful purpose. But there is simply no supportable rationale for transforming a private contract between two commercial entities into a Federal Government contract, and then further redefining that once-private contractual relationship by using the Christian Doctrine to impose a maze of complex, invasive, and extra-contractual legal requirements that were not even remotely foreseeable by the original parties to the agreement. One can only hope that the UPMC Braddock decision will be reversed on appeal or, at the very least, that it will not be expanded beyond its facts to apply to additional flow-down clauses.

Video Interview: Discussing Sequestrations' Impact on Government Contractors with LXBN TV

Sheppard Mullin — Fri, 01 Mar 2013 13:27:58 -0800

By John W. Chierichella

Following up on my post on the matter from some time ago, I had the opportunity to talk with Colin O'Keefe of LXBN regarding sequestration's impact on government contractors. In the interview, I explain how contractors will be forced to bear the brunt consequences of political mismanagement and why they should just say no to doing more with less.

What Does 2013 Have In Store for Government Contractors and Their Lawyers?

Sheppard Mullin — Mon, 11 Feb 2013 17:25:36 -0800

By Louis Victorino and Jonathan Aronie (originally published in the San Diego Business Journal)

It has been noted, the more things change, the more they stay the same. In the world of Government Contracts Law, however, the more things change, the more the phone rings. And while we’re only a few weeks into 2013, the phone has been ringing off the hook. Here are a few of the reasons why.

The Government’s anti-contractor bias continues unabated. From the moment President Obama stepped into office, his executive team made clear their distrust of defense contractors. Indeed, one of OMB’s first public pronouncements focused on curbing perceived rampant contractor fraud. Shortly thereafter, Congress passed the Close The Contractor Fraud Loophole Act, certainly not the title one gives to an Act intended to extoll the virtues of the long and critical partnership between Government and industry. In late 2008, the Government continued down the anti-contractor path when it created what is known as the Mandatory Disclosure Rule, a regulation that requires contractors to self-report “credible evidence” of an extremely broad list of potential wrongdoing. The purported rationale for the rule? The Government’s belief that contractors were affirmatively hiding their fraudulent activities from the Government. Putting aside for a moment the many flaws in the Government’s apparent view that contractors generally are not to be trusted, the fact is the anti-contractor bias remains strong in 2013 and shows no signs of abating.

Increased enforcement activities. Tied closely to the Government’s view that contractors are not to be trusted, is the Government’s ever-increasing efforts to police those contractors more aggressively. Like 2012 before it, 2013 is poised to see increases in federal audits, investigations, and False Claims Act lawsuits. DCAA, the Defense Department’s primary audit watchdog, for example, continues to reach new levels of aggressiveness. As one commentator put it not long ago, the DCAA “is out of control.” Suspensions and debarments also are likely to increase in 2013. The President has directed federal agencies to make better use of the suspension/debarment process, and the OMB is making sure the President’s direction is implemented. It would be naïve, of course, to think this increase in enforcement activity is due solely to a mistrust of contractors. The Government’s collection of $4.9 Billion (yes, that’s Billion with a B) in False Claims Act settlements and recoveries in 2012 no doubt feeds the Government’s view that contractors need more policing, and fuels the arguments of the enforcement community that they need to be more, not less, aggressive.

Shrinking pots of money mean more bid protests. The number of bid protests (that is, disputes between a contractor and an agency over the non-award of a federal contract) has increased every year since 2008. In 2008, 1,652 actions were filed with the General Accountability Office (GAO), the primary arbiter of procurement award disputes. That number steadily increased to 2,475 in 2012. Whether or not that number will rise again in 2013 remains to be seen, but the likelihood that larger award decisions will be protested by a disappointed bidder will increase. As federal opportunities become fewer, the competition for those that remain almost certainly will heat up. In short, some companies simply cannot afford not to protest.

The Government will take more work in-house. With shrinking budgets and the elimination of programs, the Government will bring more work in-house in 2013 to maintain their internal funding levels and workforce headcounts. The move to in-sourcing will be advocated by Government labor “unions” and supported by the Democratic administration. See, e.g., Subtitle C of Title III of the National Defense Authorization Act for Fiscal Year 2012. This won’t just be in-sourcing of traditional Systems Engineering and Technical Assistance (SETA) work and weapons depot work, but will extend to major weapon systems repairs and overhaul, as well as design, development, and implementation of major Government software system upgrades. We also likely will see that Government engineering centers and laboratories will move to keep in-house significant research and development funding and activities. These efforts will have an obvious significant impact on contracting opportunities available to private companies, large and small.

The Government will become more aggressive with respect to securing intellectual property. As a consequence of bringing more work in-house, the Government will need the intellectual property necessary to perform that newly in-sourced work. As a result, 2013 likely will manifest an acceleration of recent trends to a more confiscatory Government policy regarding rights in data, including patents and copyright. Regardless of the standard rights in data delineated in applicable regulations and contract clauses, in connection with the solicitation of contracts for major programs, the Government will seek to obtain, at a minimum, a Government Purpose Rights License not only to data first produced or developed under the contract but also to a significant portion of all data used in the performance of the contract. Definitions of “Commercial Items” will be narrowed, expanding the Government’s rights in data, including software. Formal challenges to current contractor claims of data rights will increase. And, unfortunately, in some instances, contractor intellectual property simply will be used by the Government, with the propriety of the use left to be determined by years of litigation.

Greater competition for fewer dollars will prompt industry consolidation. The reduced number of contracting opportunities will have many collateral impacts on the Government contracting community and their legal advisors. As occurred with the end of the “cold war,” there likely will be an upswing in industry consolidation. With a reduction in funding and new programs available to contractors, the industry base will need to shrink. Some commercial and “dual use” companies simply will abandon the market. Others, with shrinking backlogs, will seek strength and economies through corporate combinations or “spin-offs.” Some companies, particularly smaller companies, will be targets of acquisition because of their success in winning large or significant program contracts. A business that wishes to be the leader in a particular technology may well need to acquire the winning competitor of the next and only large, long term contract involving that technology.

The increased pressure that comes with increased competition will cause some to stray. While the federal contracting community is, far and away, one of the most self-policed industries in the country, every industry has its exceptions. While most contractors will assess the new environment and adapt their business strategy accordingly, some will bend to the new fiscal pressures and adapt their strategies in more reckless ways. When contractor managers and employees see their livelihoods hitched to the success of the next proposal submission, some will do foolish things – some will seek inside information regarding the procurement, seek proprietary information about their competitors, provide false information to support their offer such as “inflated” resumes or product performance claims, and any number of other prohibited activities. In short, some people do pretty stupid things when they are under pressure. Fortunately, these events are the exception rather than the rule, but companies cannot afford to take any chances. If contractor leadership is not extremely vigilant and committed to internal integrity and compliance, the increased audits and investigations described above may well negate all efforts to be successful in the new smaller, Government contracting market.

Contractors continue to embrace ethics and compliance as a core element of success. Years ago, the implementation of an in-house ethics and compliance program was viewed by many contractors as a necessary evil; something needed to keep the lawyers happy, but rarely embraced by the “revenue generators.” Over the last 5-10 years, however, there has been a cultural shift among contractors. Contractors now embrace the benefits of an effective ethics and compliance program. Codes of Conduct are the rule rather than the exception. Training programs are standard fare for Government contractors. While the Government can take some credit for this evolution – there is nothing like a few multi-million dollar False Claims Act settlements in your industry to highlight the importance of compliance – contractors also deserve much of the credit for embracing the benefits of such programs. As the Government’s enforcement activities become more and more aggressive, one can expect to see a continued increase in the roster of Company’s embracing the benefits of an effective internal control system and ethics/compliance program.

In short, we are reminded of an observation provided by an astute securities law school professor who noted: When the stock price of a company goes up, stock sellers will sue the buyers. When the stock price goes down, the buyers will sue the sellers. When the stock price remains the same, each will sue the other. Government contracting is a challenging market. Challenges exists in up-times and they exist in down-times. They likely will be different challenges from year to year, but challenges always are present. The astute contractor understands this and guides the organization accordingly.

The 2013 market clearly counsels in favor of enhanced care in the pursuit of new business. With respect to new solicitations, assure that the proposed terms and conditions and the statement of work/specifications are reviewed carefully and risks identified. Assure decisions to accept risk are fully informed and made at an appropriate level within the company. Finally, refresh your internal personnel training regarding Government and company rules delineating what are prohibited activities in connection with the submittal of a proposal. And, if all else fails, pick up the phone and give your Government Contracts lawyer a call. You won’t be alone.

* This article formed the basis, in part, for an article appearing in the January 21-27 issue of the San Diego Business Journal (www.sdbj.com) and special thanks to the editors of that publication for permission for its re-use.

Country of Origin for Computer Software - U.S. Customs Finally Sheds Some Light on the Issue

Sheppard Mullin — Mon, 11 Feb 2013 17:15:27 -0800

By David Gallacher

One of the most perplexing questions that has plagued the government contracting community in recent years relates to the country of origin for computer software. Where most government procurements restrict the purchase of products that were not manufactured or substantially transformed in an approved country, the question of where software is “substantially transformed” is one of critical importance – particularly where the government buys more and more software products, and particularly where those software products are distributed via direct download. The Department of U.S. Customs and Border Protection has long resisted issuing any authoritative guidance on the country of origin for computer software, leaving industry to reach its own conclusions, conclusions that hopefully will be adjudged as reasonable in the event of later Government scrutiny or challenge. But Customs has recently issued an advisory opinion that may finally shed some light on this dark and murky topic.

In an advisory opinion issued on June 8, 2012 (but not released publicly until December 2012), Customs concluded that computer software was “substantially transformed” in the country where the software was compiled (or “built”) and converted into object code. See HQ H192146 (Jun. 8, 2012).

Viewing software through a “manufactured product” paradigm, industry has long tried to consider where software was “built” or “manufactured.” This has commonly forced companies to consider where the underlying source code was written – the component “parts” that are assembled together into the “final” software product. But determining where the code was written is often an extremely difficult exercise, particularly where software is designed and developed all around the world by individuals of different nationalities, often incorporating pre-existing source code (some of it open source) from unknown origins. Looking to where the source code was “written” has always been an unsatisfying, if not impossible, task. But this new Customs decision provides a more definite, more easily fixed point in the software development process that companies can use to determine the country of origin under the Trade Agreements Act (“TAA”) for their software products.

This new guidance is of critical importance because it appears to be the first time that Customs has opined on where downloaded software is “substantially transformed” under the TAA (as opposed to where hardware incorporating new software was “substantially transformed”). Customs has long advised that CDs or hard-media containing computer software are “substantially transformed” at the location where the software is burned to or installed on a tangible medium. See, e.g., HQ 732087 (Feb. 7, 1990); HQ 561011 (Sep. 22, 1998). But where most software is now distributed via direct download, those decisions offered little authoritative guidance.

While this decision is a non-binding advisory opinion, it should be helpful in shedding a little light on the question of where computer software is “substantially transformed.” Sheppard Mullin specializes in helping companies assess their hardware and software products in order to determine whether the products satisfy the legal requirements of the TAA. Particularly with regard to companies selling software products to the U.S. Government, our team of specialists can help government contractors ensure that they are in full compliance with their contract’s country of origin requirements.

Free Trade Agreement Updates for 2012

Sheppard Mullin — Mon, 11 Feb 2013 17:10:07 -0800

By David Gallacher

2012 saw several updates with regard to free trade agreements (“FTAs”) between the U.S. and its international trading allies. The most notable of these was the U.S.-Korea FTA (“KORUS”), but several other changes were made to the U.S. procurement regulations implementing other free trade agreements. Regrettably, negotiations with China remain stalled with no firm promises on the horizon. Following is a summary of some of the key changes over the last year.

New Designated Countries

During 2012, three countries were added to the list of “designated countries” under the Trade Agreements Act (“TAA”). The changes, at Federal Acquisition Regulation (“FAR”) 25.003 and Defense Federal Acquisition Regulation Supplement (“DFARS”) 225.003, are as follows:

Country	Effective Date	Relevant FTA	Reference
Armenia	March 2012	World Trade Organization Government Procurement Agreement (WTO GPA)	77 Fed. Reg. 12935 77 Fed. Reg. 4631
Colombia	May 2012	U.S.-Colombia Free Trade Agreement (Pub. L. No. 112-42)	77 Fed. Reg. 27549 77 Fed. Reg. 30359
Panama	November 2012	U.S.-Panama Free Trade Agreement (Pub. L. No. 112-43)	77 Fed. Reg. 69723 77 Fed. Reg. 68699

The FAR and DFARS were also updated in 2012 to reflect new changes from the United States-Korea Free Trade Agreement (Pub. L. No. 112-41), signed into law in October 2011. See 77 Fed. Reg. 13952; 77 Fed. Reg. 56739. While South Korea has long been a member of the WTO GPA, the new FTA allows for lower dollar thresholds at which South Korean products and services will qualify under U.S. procurements.

Country	New Thresholds			Old Thresholds
Country	Supplies	Services	Construction	Supplies	Services	Construction
South Korea	$100,000	$100,000	$7,777,000	$202,000	$202,000	$7,777,000

Additionally, DFARS 252.225-7017 was updated to allow exceptions to the “Buy American” restrictions on the purchase of photovoltaic devices, consistent with the new KORUS FTA. See 77 Fed. Reg. 30356. We have previously written about these “Buy American” restrictions on photovoltaic devices (click here and here), with the DOD publishing final rules (without substantive changes) in May 2012. See 77 Fed. Reg. 30368.

New Qualifying Countries

In recent months, the U.S. Department of Defense signed reciprocal defense procurement agreements with the Czech Republic and Poland, adding these countries to the list of “qualifying countries” under the DFARS. See 77 Fed. Reg. 38736; 77 Fed. Reg. 76941.

“Qualifying countries” are a distinct subset of U.S. allies that are treated the same as domestic companies for purposes of certain procurements by the DOD. See DFARS 225.003. “Qualifying countries” are different from “designated countries,” which include countries with which the U.S. either has a FTA (e.g., Canada or Mexico) or that U.S. policy chooses not to discriminate against in U.S. procurements (e.g., Afghanistan). See FAR 25.003. Each “qualifying country” has a specific Memorandum of Understanding with the DOD, which supplements any other pre-existing FTAs and/or promises that neither country will discriminate against the other in defense procurements – effectively waiving many (albeit not all) DOD “Buy American” restrictions with regard to products or services from that ally country. While there is some overlap between the list of “qualifying countries” and “designated countries” – with both Poland and the Czech Republic having already been “designated countries” since 2004 when they joined the European Union and WTO GPA – the two lists are not co-extensive.

The addition of the Czech Republic and Poland as “qualifying countries” will give companies increased flexibility for DOD procurements in using products that would normally be TAA compliant.

Updates Under the WTO GPA

Several countries remain in talks to join the WTO GPA.

China. Since 2007, China submitted two offers to join the WTO GPA, but each was rejected as insufficient because (among other reasons) the offers did not guarantee access to provincial procurements. In December 2012, China submitted a third offer, promising access to approximately 100 additional government agencies in three Chinese provinces. However, the U.S. and other countries criticized this latest offer as insufficient because it still did not allow access to the totality of Chinese procurements (at both the national and local levels). The offer also insisted upon dollar thresholds that were far higher than the norm under the WTO GPA – $770,000 vs. $200,000 for purchases of supplies, and $77 million vs. $7.7 million for construction projects. China claims that its offers are reasonable, given China’s status as a developing economic power, but the other members of the WTO GPA insist on greater concessions before allowing China to join. This means that while a FTA with China remains “in progress,” any definitive agreement with China remains in the far-off future.
New Zealand. In September 2012, New Zealand submitted its first offer to join the WTO GPA. But this offer was rejected, with individuals from the U.S. claiming that New Zealand needed to guarantee coverage in certain industries (such as public health, education, and welfare) and with sub-central governmental entities. New Zealand countered that it does not have “sub-central entities” to be covered by the FTA, with all governmental functions handled by the central New Zealand government. While there are several issues that remain to be worked out, it appears that New Zealand is well on the way to joining the WTO GPA.
Vietnam. In December 2012, Vietnam stated that it was interested in joining the WTO GPA. Vietnam is already engaging in negotiations as part of a Trans-Pacific Partnership agreement (among the U.S., Australia, Singapore, and other South Pacific and South American countries), so it seems likely that a FTA with Vietnam will eventually happen. But the timing remains unclear.
India. In February 2010, India became an observer to the WTO GPA, initiating the first steps to joining the WTO GPA. While India has not made any additional formal steps to join the FTA, India remains in progress and will hopefully formalize its membership in the near future.

The ABC's of Government Contract Claims - 10 Ways to Maximize Your Chance of Success

Sheppard Mullin — Mon, 28 Jan 2013 17:47:05 -0800

By John W. Chierichella

1. Understand the Basic Contract Requirement – Every contract lawyer will begin an assessment with a very simple, fundamental question, i.e., “What does the contract say?” Your obligation is to perform to the contract; nothing more; nothing less.

2. Identify Variances Between What the Contract Says and What You Actually Are Doing – If you are doing something other than what the contract actually says, you may be entitled to relief.

3. Ask Yourself “Why Am I Doing This?” –You cannot blame Uncle Sam for your or (generally) your suppliers’ inefficiencies and delinquencies, but there are many Government acts or omissions that might entitle you to relief, e.g., Government direction, a defective specification, an acceleration order, late or defective GFP/GFE/GFI, and Government delinquencies relating to contractually prescribed review periods.

4. Do a Disciplined “Root Cause” Analysis – You perform these kinds of analyses in reporting on discrepancies to the Government. Require no less when analyzing a possible claim. Do not accept the easy answer, e.g., “We missed it.” If that is the response, probe – “What did you miss exactly?” “Show me where it was.” “Let me see the documentation you missed.”

5. Notify the Contracting Officer – Tell the PCO, in writing, of the circumstance that you believe gives rise to a change. Deprive the PCO of the ability to claim, later on, “If only I had known, I would have told you to stop doing that.”

6. Accept No Substitutes – No one but the Contracting Officer has the authority to change the contract. COTR’s, contracting specialists, Program Managers, general officers – they all love to issue orders and they will jawbone you to follow them. Don’t. Report the order to the PCO and ask the PCO to confirm the order to you in writing.

7. Trust But Verify – This one is simple. Never act on an oral direction. Send a letter to the PCO asking for confirmation.

8. Read Your “Changes” and “Notification of Changes” Clause(s) – They impose time limits for notification of a change. Failure to comply can be overcome in many cases, but why take that chance?

9. Use Change Order Accounting – A valid changes claim is only as good as your ability to prove quantum. Establish separate job numbers to collect the costs of the changed work.

10. Earn Interest – An REA can linger without closure for months, and years. If there is no progress, transform the REA into a certified claim and start the accrual of interest. And remember, the statute of limitations for submission of a certified claim is six years from the date of its accrual.

And for those of you who read this far, here is your bonus eleventh tip:

11. Read Those Unilaterally Issued Change Orders – They invariably say the work is not a change and ask you to sign. Don’t.

Smash & Grab Redux - Congress Seems to Give DCAA Permission But Forgets to Give It Authority

Sheppard Mullin — Mon, 28 Jan 2013 17:37:52 -0800

By David Gallacher

Last month we wrote about a provision in the proposed 2013 National Defense Authorization Act (“NDAA”) that would have given the Defense Contract Audit Agency (“DCAA”) statutory authority to demand a company’s internal audit reports in order to audit the efficacy of a company’s internal business systems. Surprisingly, the authorization, as originally proposed, was modified in the final legislation. While Congress directed DCAA to issue new guidance regarding auditor access to internal audit reports, Congress stopped short of giving DCAA actual authority to demand such reports. As such, contractors will remain at loggerheads with DCAA auditors who try to exceed their statutory authority.

The Proposed Legislation

The Senate version of the 2013 NDAA (S. 3254, 112th Congress, § 843) included a provision that would have amended 10 U.S.C. § 2313(a)(2) to give DCAA access to internal audit reports in order to assess “the efficacy of contractor or subcontractor internal controls and the reliability of contractor or subcontractor business systems.” This proposed change would have given DCAA statutory authority to demand internal audit reports – authority that the courts have long recognized does not exist. See also United States v. Newport News Shipbldg. & Dry Dock Co., 862 F.2d 464, 468-69 (4th Cir. 1988). Contractors have long relied on the Newport News line of cases to resist DCAA demands for internal audit reports, but the proposed change would have effectively overruled the Newport News decisions.

The Final Legislation

Surprisingly, the final legislation took a different approach. Section 832 of the final 2013 NDAA (Pub. L. No. 112-239) directed the DCAA to issue new guidance regarding auditors’ limited access to internal audit reports. Congress set forth the general policy as follows:

A determination by the Defense Contract Audit Agency that a contractor has a sound system of internal controls shall provide the basis for increased reliance on contractor business systems or a reduced level of testing with regard to specific audits, as appropriate. Internal audit reports provided by a contractor pursuant to this section may be considered in determining whether or not a contractor has a sound system of internal controls….

Congress emphasized that DCAA should use these internal audit reports only for the limited purpose of assessing a company’s internal business systems (not as a basis for expanding the scope of the audit), responding to concerns raised by industry. But Congress declined (or perhaps simply forgot) to give DCAA any actual authority to implement this new policy. The final Act did not amend 10 U.S.C. § 2313(a)(2) and did nothing to override the Newport News decisions. As such, while Congress may have stated an opinion as to what DCAA should do with regard to internal audit reports, Congress provided no basis by which DCAA could actually do it.

Anticipating Contractor Difficulties

DCAA will no doubt be emboldened by Section 832 and auditors will continue to demand internal audit reports. But even though auditors may claim that the use of the audit reports will be limited, contractors will still be wary of volunteering such reports. Particularly where Section 832 does nothing more than direct DCAA to issue new guidance – doing nothing to give DCAA actual authority to request such documentation – contractors should still be able to rely on the Newport News decisions to resist DCAA’s demands. Contractors may choose to work cooperatively with DCAA auditors, and contractors should be prepared to respond to DCAA claims that Section 832 now gives them statutory authority to review internal audit reports, but contractors should be aware of the fact that the new Section 832, on its face, does nothing to change the fact that DCAA continues to lack any real authority to demand internal audit reports.

Siemens Whistleblower Complaint Underscores Need for "Top-Down" Anti-Corruption Compliance

Sheppard Mullin — Mon, 28 Jan 2013 17:35:54 -0800

By Anthony N. Moshirnia

In 2008, Siemens AG paid $800 million to settle charges that it had violated the Foreign Corrupt Practices Act, which generally prohibits bribery of foreign officials for the purpose of obtaining or retaining business. That settlement amount remains the largest in the history of FCPA enforcement. In addition, the company agreed to substantially improve its procedures for identifying and preventing improper payments that could be used as bribes. According to a recently filed whistleblower complaint, however, since the 2008 settlement, Siemens employees have regularly circumvented the company’s internal controls, allowing “intermediaries” to pay kickbacks to government officials.

Meng-Lin Liu, a former Siemens compliance officer, filed a complaint in the United States District Court for the Southern District of New York on January 15, 2013, claiming that “senior Siemens executives, compliance officers and legal officers knowingly allowed Siemens due diligence and anti-corruption internal controls to be evaded and consciously disregarded, and deliberately ignored numerous ‘red flags’ that should reasonably have alerted them to an extremely high probability that bribes were being paid to Chinese officials.” Siemens allegedly sold medical equipment to middlemen designated by Chinese procurement officers, who then resold the equipment to state-owned entities in China and North Korea at marked-up prices. According to the complaint, the middlemen’s resale prices ranged from 20 to 130% above Siemens’ prices. Liu alleges that “this had all of the hallmarks of a classic bribery or ‘kickback’ scheme [as] there was no legitimate explanation for the huge price differentials that existed between the prices at which Siemens sold the equipment and the prices paid by the end-user[s].” Implicit in Liu’s allegation is that the price differentials were used to fund corrupt payments.

These transactions should have triggered heightened scrutiny under Siemens’ anti-corruption policy, the complaint says, because they involved third parties in China and North Korea – known hotbeds of public corruption. To the contrary, Liu claims, the CEO of Siemens’ health care division directed subordinates to ignore the middlemen, thereby shielding the sales from mandatory risk assessments and due diligence. Had the sales gone through the proper review process, Liu believes, any improper payments would have been avoided.

Liu’s allegations, if they prove to be true, provide a vivid illustration of the executive-level misconduct that the DOJ and SEC warned against in their jointly published Resource Guide to the FCPA. “A well-designed compliance program that is not enforced in good faith, such as when corporate management explicitly or implicitly encourages employees to engage in misconduct to achieve business objectives,” the Guide opines, “will be ineffective.” It continues, “DOJ and SEC have often encountered companies with compliance programs that are strong on paper but that nevertheless have significant FCPA violations because management has failed to effectively implement the program even in the face of obvious signs of corruption.”

Could Siemens be one of these companies? We will have to wait to see whether the allegations hold water. In the meantime, however, Liu’s allegations provide a poignant reminder that, in the words of the Resource Guide, “compliance with the FCPA and ethical rules must start at the top” because “managers and employees take their cues from . . . corporate leaders.” A robust and sophisticated anti-corruption compliance program isn’t worth much if no one bothers to use it.

Happy Holidays!

Sheppard Mullin — Mon, 17 Dec 2012 14:33:03 -0800

The lawyers and staff of Sheppard Mullin's Government Contracts, Investigations & International Trade Group wish you and yours the happiest of holidays in 2012 and all our best for 2013.

DOJ and SEC Release New FCPA Resource Guide

Sheppard Mullin — Mon, 17 Dec 2012 12:35:51 -0800

By Anthony Moshirnia

On November 14, 2012, the SEC and the DOJ released their long-awaited Resource Guide to the Foreign Corrupt Practices Act, which can be found here. The Resource Guide consolidates and summarizes the government’s previously stated positions and case law regarding the FCPA and, unsurprisingly, confirms that FCPA enforcement will remain a priority for the foreseeable future. The publication uses hypotheticals to provide helpful clarification and practical advice on issues such as gift-giving and hospitality. The hypotheticals are also discussed in a recent posting on our Global Trade Law Blog, which can be read here.

The Resource Guide emphasizes the need for effective anti-corruption compliance programs for all companies who do business internationally. thereby signaling that the Government will have little patience with companies whose management has failed to implement an effective FCPA compliance program. Put simply, the best strategy to minimize FCPA exposure is to focus on identifying and preventing violations before they occur. A presentation discussing the “hallmarks of effective compliance programs” as identified in the Resource Guide is available here.

Smash & Grab - DCAA Poised to Gain Access to Contractor Internal Audit Reports

Sheppard Mullin — Mon, 17 Dec 2012 11:59:08 -0800

By David Gallacher

The Defense Contract Audit Agency (“DCAA”) has long sought access to contractors’ internal audit reports in connection with the routine audit of contractors’ business systems. Contractors have, in most cases, successfully resisted requests for such access on the grounds that DCAA has no statutory authority to request such documents. But that may soon change. Section 843 of the Senate version of the 2013 National Defense Authorization Act (S. 3254) would grant DCAA broad access to contractor internal audit information.

No Statute, No Access, No Problem

DCAA has long coveted contractors’ internal audit reports, apparently in the hope that candid admissions within the reports and the associated work papers might give DCAA additional leverage in negotiating reductions with contractors. But the Court of Appeals for the Fourth Circuit held in two separate decisions in 1988 that DCAA did not have the authorization to obtain, via subpoena or otherwise, contractors’ internal audit reports. See U.S. v. Newport News Shipbuilding & Dry Dock Co., 837 F.2d 162, 170 (4th Cir. 1988). The Fourth Circuit observed that, under 10 U.S.C. § 2313(a)(1), DCAA is only permitted to “review cost and financial data…[and] only material related to the performance of that contract.” Under 10 U.S.C. § 2313(a)(2), DCAA’s right to seek information is also limited, most notably, to material necessary to review or verify the “accuracy, completeness, and currency of cost or pricing data” – objective factual information concerning contract costs, “such as invoices, vouchers, and time logs,” not the type of subjective assessments included in internal audit reports. See also United States v. Newport News Shipbldg. & Dry Dock Co., 862 F.2d 464, 468-69 (4th Cir. 1988) (noting that the statutes “intended to provide DCAA access to objective financial and cost information, contained in a defense contractor’s books, records, and other documents, that reflects upon the accuracy of cost charges submitted to the government”). Accordingly, the Fourth Circuit rejected the notion that DCAA had the authority to request internal audit reports, concluding that DCAA was not operating within its statutory authority when it sought such materials. However, and as every defense contractor knows, DCAA has persisted in its efforts to obtain access to contractor internal audit information (albeit without success in most cases).

In December 2011, the Government Accountability Office (“GAO”) criticized DCAA for its failure to access internal audit reports, noting that generally accepted government auditing standards require evaluation and testing of contractor internal controls (including the work of the contractor’s internal audit activity). See GAO-12-88, “Actions Needed to Improve DCAA’s Access to and Use of Defense Company Internal Audit Reports” (Dec. 8, 2011). GAO did recognize, however, that a contractors’ refusal to provide internal audit reports and work papers would be consistent with the holdings of the Newport News decisions.

Emboldened by the GAO report, DCAA submitted its first annual report to Congress in March 2012, requesting statutory authority to access a wide range of internal audit information and arguing as follows:

It is essential for DCAA to have access to contractor reviews, inquiries, investigations, and internal audits in order to evaluate contractor business systems. DCAA audits contractor accounting systems before and after contract award to assess whether the systems are adequate for accumulating and billing costs that comply with contract requirements. For major contractors, DCAA audits contractor business systems as a basis for relying on those systems during other DCAA audits.

See U.S. Department of Defense, “Report to Congress on FY 2011 Activities at the Defense Contract Audit Agency” (March 30, 2012), at 11.

In August 2012, DCAA followed up its report to Congress by issuing a Memorandum for Regional Directors (“MRD”) setting out the procedures by which DCAA auditors should continue to demand internal audit reports. See DCAA MRD No. 12-PPS-019(R), “Audit Guidance on Access to Contractor Internal Audit Reports” (Aug. 14, 2012). Notably, the MRD did not cite to any additional authority that would allow DCAA access to internal audit reports, merely directing Field Audit Offices to monitor all requests for internal audit reports, as well as contractor refusals to cooperate. The MRD was accompanied by another Memorandum reminding auditors how to respond to contractor claims of privilege on work papers. See DCAA MRD No. 12-PPS-018(R), “Audit Guidance – Denial of Access to Records Due to Contractor Assertion of Attorney Work Product Doctrine or Attorney-Client Privilege” (Jul. 25, 2012). In issuing this guidance, DCAA appears to have anticipated favorable Congressional action on its request for access to contractor internal audit information.

New Statute, If Enacted, Will Mean New Access and New Problems

As noted above, Congress is now considering DCAA’s request for authority that it has long desired. The Senate version of the 2013 National Defense Authorization Act (“NDAA”) includes a provision that would amend 10 U.S.C. § 2313(a)(2) to give DCAA access to documents relating to “the efficacy of contractor or subcontractor internal controls and the reliability of contractor or subcontractor business systems.” See S. 3254 (112th Congress), § 843. Specifically, the purpose of the amendment is “to ensure that the Defense Contract Audit Agency has sufficient access to contractor internal audit reports and supporting materials.”

Of course, the Senate version of the 2013 NDAA must still be reconciled with the House version (H.R. 4310) and, for reasons unrelated to the access provision, the White House has threatened to veto the 2013 NDAA if the Senate version is passed without certain changes. That said, the protections afforded to internal audit reports by the Newport News decisions are plainly in peril. It may only be a matter of time, and time may be running short.

GAO Issues FY 2012 Bid Protest Report - Protests and Sustains Up From FY 2011

Sheppard Mullin — Mon, 26 Nov 2012 12:19:12 -0800

By John Chierichella

On November 13, 2012 the Government Accountability Office issued its annual report to Congress regarding its bid protest activity. GAO-13-162SP, GAO Bid Protest Annual Report to the Congress for Fiscal Year 2012, November 13, 2012.

The report revealed a slight increase both in the number of protests filed and in the number sustained. Total protests filed numbered 2,475, a 5% increase over FY 2011. This was the largest number of protests filed in any of the last five years and may well reflect industry concern over sequestration, as previously discussed on the blog, and the resulting increased importance placed by competitors on each contracting opportunity.

Not surprisingly, the increased number of protests yielded an increase in the number of protest sustained. The sustain rate increased from 16% in FY 2011 to 18.6%. The 106 sustains represented the highest number for any of the last five years, although the percentage was lower than the 19% and 21% sustain rate experienced in FY 2010 and FY 2008, respectively.

The percentage of cases in which ADR was used, in which it succeeded, and in which hearings were held all declined. The incidence of hearings has in fact experienced a straight lien decline since FY 2009, from 12%, to 10%, to 8% last year, and to 6% in FY 2012.

The report can be found at http://www.gao.gov/products/GAO-13-162SP.

NLRB Ruling Condemns Blanket Confidentiality Policies During Internal Investigations

Sheppard Mullin — Mon, 26 Nov 2012 12:15:03 -0800

By Bora Rawcliffe

In Banner Health System d/b/a Banner Estrella Medical Center, 358 N.L.R.B. No. 93 (2012), the National Labor Relations Board (NLRB) held that an employer’s maintenance and application of a general confidentiality rule prohibiting employees from discussing ongoing investigations of employee misconduct violates Section 8(a)(1) of the National Labor Relations Act.

The Banner Health System Case

In Banner Health System, a human resources consultant asked a complaining employee not to discuss the matter with coworkers while the investigation was pending. According to the NLRB, this request constituted a “blanket approach” that clearly lacked a legitimate business justification. Although the employer did not give the confidentiality instruction in all cases, it was given here and the instruction was included in the employer’s standard “Interview of Complainant Form” that human resources used during investigation interviews. The NLRB reasoned that the confidentiality instruction “had a reasonable tendency to coerce employees, and so constituted an unlawful restraint of Section 7 rights.”

The NLRB found that an employer’s generalized concern with protecting the integrity of its internal investigations is insufficient to justify a general prohibition on employee discussion of ongoing internal investigations. The NLRB reasoned that such a generalized concern would not outweigh employees’ Section 7 rights, which include the right to discuss their terms and conditions of employment. Rather, the NLRB concluded that an employer can require confidentiality of employees during an internal investigation only if one of the following legitimate business justifications exists:

Witnesses in the investigation need protection
Evidence is in danger of being destroyed
Testimony is in danger of being fabricated, or
There is a need to prevent a cover up

Accordingly, the NLRB ordered the employer in Banner Health System to cease and desist from maintaining or enforcing the rule that employees may not discuss with each other ongoing investigations of employee misconduct.

Importantly, however, the NLRB has previously recognized an employer’s interest in protecting the attorney-client privilege and attorney work product protection in connection with internal investigations, and Banner Health System did not overrule or limit those decisions. As such, depending on the circumstances surrounding the investigation and applicable state law, an employer may require employees to keep the investigation confidential to protect the attorney-client privilege and/or attorney work product immunity.

Lessons Learned

Although this case arose in the context of an employee complaint about the misconduct of a coworker, it is important for employers to consider the application of this ruling to all internal investigations. Despite the requirements set forth in Banner Health System, employers likely will not find compliance difficult in the context of government contracts investigations involving potential fraud, waste, or abuse. For example, most government contracts internal investigations centered on detecting fraud or other types of misconduct will generally meet at least two of the legitimate business justifications discussed in Banner Health System, including the need to prevent cover ups and spoliation of evidence.

A confidentiality instruction may also be permissible to protect the attorney-client privilege and/or attorney work product protection. Banner Health System did not affect prior decisions sanctioning confidentiality directives to protect the attorney-client privilege and/or attorney work product doctrine, and such an instruction may therefore be appropriate depending on the nature of the investigation and applicable state law.

Employers may take a number of steps to ensure compliance with Banner Health System in future internal investigations. First, employers should check their applicable internal policies and guidelines to ensure no blanket confidentiality requirements exist that prohibit employees from discussing with each other ongoing investigations. Secondly, human resources personnel and other employees involved in internal investigation interviews should avoid giving general confidentiality instructions without documenting that at least one of the above business justifications exists. Lastly, even outside the interview context, employers should document the existence of one or more of the four justifications listed above before they give any type of confidentiality instruction to employees or witnesses involved in an investigation.

Sixth Circuit: FERA False Claims Act Amendment Applies Retroactively to Cases Pending as of June 7, 2008

Sheppard Mullin — Mon, 26 Nov 2012 11:57:53 -0800

By John Hynes

On November 2, 2012, the Sixth Circuit held that a 2009 amendment Congress made to the liability provisions of the False Claims Act ("FCA") applies retroactively to civil FCA cases pending as of June 7, 2008. U.S. ex rel. Sanders v. Allison Engine Co., Nos. 10-3818/10-3821, at *17-20 (6th Cir. Nov. 2, 2012).

Background of the Allison Engine Case

In 1995, whistleblowers filed an action under the qui tam provisions of the FCA against various subcontractors alleging that they submitted claims for payment to the Government relating to the construction of generator sets used in Navy Arleigh-Burke-class Guided Missile Destroyers despite knowing that the sets failed to conform to contract specifications and Navy regulations. The district court dismissed the claim on the ground that relators failed to satisfy the presentment element under the FCA, i.e., relators failed to show that defendants presented a false claim to the Government. Sanders v. Allison Engine Co., No. 1:95-cv-970, 2005 U.S. Dist. LEXIS 5612, at *32 (S.D. Ohio Mar. 11, 2005).

On appeal, the Sixth Circuit reversed the decision, holding that presentment was not required for a violation of the FCA. U.S. ex rel. Sanders v. Allison Engine Co., 471 F.3d 610, 622-23 (6th Cir. 2006). The U.S. Supreme Court, however, reversed the Sixth Circuit and remanded the case to the district court, holding that contrary to the Sixth Circuit’s holding, the FCA requires the plaintiff to prove that the defendant intended that the false record or statement be material to the Government’s decision to pay or approve a false claim. Allison Engine Co. v. U.S. ex rel. Sanders, 553 U.S. 662, 665 (2008).

The FERA FCA Amendments

In response to the Supreme Court's decision, Congress amended the FCA as part of the 2009 Fraud Enforcement and Recovery Act (“FERA”) to expand FCA liability to anyone who "knowingly makes, uses, or causes to be made or used, a false record or statement material to a false or fraudulent claim" (“FCA Liability Amendment”). As such, the amendment removed the requirement that a false claim be actually presented to the Government for FCA liability to attach – the element that the trial court found unsatisfied in Allison Engine. The FERA also contained a retroactivity clause providing that the FCA Liability Amendment "shall take effect as if enacted on June 7, 2008, and apply to all claims under the False Claims Act . . . that are pending on or after that date" (“FERA Retroactivity Clause”). (emphasis added.)

The Allison Engine Holding and Resulting Circuit Split

On remand, the Allison Engine district court held that the word "claims" in the FERA Retroactivity Clause meant claims for payment from the government, not civil actions. Because there were no such claims for payment pending on or after June 7, 2008, the trial court dismissed the action. U.S. ex rel. Sanders v. Allison Engine Co., 667 F.Supp.2d 747, 752 (S.D. Ohio 2009). The district court further held that even if the FERA Retroactivity Clause rendered the FCA Liability Amendment applicable, its application would have violated the ex post facto clause of the Constitution because Congress intended to impose punishment when it amended the FCA. Id. at 752-56.

The Sixth Circuit reversed the trial court's decision, holding that "claims" in the FERA Retroactivity Clause refers to a “civil action or case,” not a "claim for payment" from the Government. U.S. ex rel. Sanders v. Allison Engine Co., Nos. 10-3818/10-3821, at *17-20 (6th Cir. Nov. 2, 2012). The court also found that such retroactive application did not violate the ex post facto or due process clauses of the Constitution. Id. at 20-33.

The Sixth Circuit's decision adds to an existing circuit split on the interpretation of "claims" in the FERA Retroactivity Clause. The Sixth Circuit joins the Second and Seventh Circuits holding that "claims" means "cases," and is at odds with the Ninth and Eleventh Circuits as well as various district courts holding that "claims" means "claims for payment" from the government. Given the circuit divide and the importance of this issue to FCA litigation, one should not be surprised to see the U.S. Supreme Court resolve the question once and for all.

Impact of Allison Engine

The Allison Engine decision is the latest in a line of cases from various circuits interpreting the word "claims" in the FERA Retroactivity Clause. The interpretation of this term is important because the subsection of the FCA imposing liability for making or using a "false record or statement material to a false or fraudulent claim" and not requiring presentment of a claim can only apply in pre-FERA cases if the requirements of the retroactivity clause are met. There can be a wide gap of time between an alleged claim for payment from the Government and the time at which a resulting FCA action is filed. As such, whether "claims" is interpreted to mean a claim for payment from the government or an FCA action can have a great impact on the number of defendants with potential FCA exposure for making or using a false record or statement material to a false or fraudulent claim.

If and when the U.S. Supreme Court steps in and resolves this issue, we will have an answer in all circuits as to the proper application of the FERA Retroactivity Clause to claims under the FCA Liability Amendment. Until then, however, companies must deal with the current circuit split. In the Second, Sixth, and Seventh Circuits, the FCA Liability Amendment applies retroactively to FCA cases filed as of June 7, 2008, while in the Ninth and Eleventh Circuits, it applies retroactively to claims for payment from the government pending as of June 7, 2008. FCA defendants must be mindful of the rule applicable in their circuit and plan their defense strategy accordingly.

What Happens In Vegas Doesn't Seem To Stay In Vegas: A Different Take on GSA's Recent Woes

Sheppard Mullin — Wed, 24 Oct 2012 12:53:31 -0800

By John Chierichella and Jonathan Aronie

Note: The following post is adapted from the forthcoming 2012/2013 GSA Schedule Handbook, published by ThompsonWest, due out later this year.

The past 12 months were interesting ones for the Multiple Award Schedule Program. To the dismay of many, and the embarrassment of some, the General Services Administration seems to find it hard to stay out of the press these days.

First, in April, GSA hit the press following an OIG investigation into excessive spending at a Public Building Service conference in Las Vegas. According to the OIG, GSA’s “excessive” and “wasteful” spending included unnecessary “scouting trips” to Las Vegas, excessive in-room catering, and impermissible tuxedo rentals. Subsequent reports revealed that such spending also included the cost of a clown, a mind-reader, and a $75,000 bicycle building exercise. The revelations not only threw GSA headlong into the press (and onto the Hill), but also prompted the resignation of GSA’s Administrator and other senior officials. Among the counterproductive responses to the scandal was GSA’s decision to disinvite most of its personnel from the annual “GSA Expo” conference – a conference that historically has provided an opportunity for industry and GSA staff to meet and work together in mutually beneficial fashion.

The event also prompted Representative Jeff Denham to propose abolishing the GSA at a Coalition for Government Procurement Conference shortly after the Las Vegas story broke. This proposal came not only as a shock to the room of GSA Schedule contractors, but also to the DOD, which quickly came to GSA’s defense, commenting that DOD values its partnership with GSA and believes that the partnership needs to be strengthened, not destroyed.

Then, just when you thought it was safe to go back into the GSA waters, Anderson Cooper broke a story on his Anderson Cooper 360 TV show involving GSA-sponsored all-day cooking classes for agency employees in Kansas City at a cost of approximately $20,000. This story not only prompted the GSA FAS Regional Administrator to take to the airwaves for damage control, but motivated newly appointed Administrator Tagliani to make himself available for interviews as well.

While that all would have been enough to give anyone within GSA an aversion to the press (and the Internet for that matter), as we sat down to put the finishing touches on the 2012/2013 edition of our GSA Schedule Handbook, another GSA story reared its ugly head. According to Bloomberg, subsequent to the PBS Las Vegas event, GSA spent approximately $269,000 for a separate awards ceremony that “featured a guitarist, violinist and $21,000 in drumsticks given to participants.” When it rains, it pours.

Against this continuing rainstorm of embarrassing news for GSA, there is no shortage of people taking potshots at the Agency and its people. Aside from Representative Denham’s aborted plan to abolish GSA, GSA’s own personnel seem as ready to dish out criticism as outsiders. Following the airing of the Kansas City cooking class story, for example, GSA’s Regional Administrator for the “Heartland Region” immediately criticized the cooking classes, the Agency, and the Agency’s prior management.

Before turning to the impact that these stories have had on the Schedule Program and on Schedule contractors generally, we do want to say something that the folks within GSA seem unwilling or afraid to say: GSA should not be criticized for looking for ways to make work more enjoyable for its employees, or for looking for ways to make Government employment a more attractive option for prospective new employees. It is perfectly logical to develop creative ways to make Government service more attractive. While we all can criticize the Agency in hindsight for some poor judgments in implementation, we question why no one in GSA is standing up at least for the underlying purpose of the events. In a time when there is no shortage of critics of the quality of GSA personnel, a few cooking classes designed to make working within GSA more attractive is not a silly or nefarious goal. Industry engages in these kinds of team and morale building exercises all the time.

That being said, the embarrassment suffered by GSA as a result of its recent missteps is having a ripple effect on Schedule contractors. We see it happening already – Contracting Officers (“Cos”) are so frightened of the OIG that they have all but dispensed with trying to be proactive and work with contractors to solve problems. Gone are the days when GSA’s contracting officers and their contractors worked together in partnership. Every day it has become more of an “us versus them” environment in GSA contracting. This is unfortunate for GSA and for industry.

We are not saying, of course, that some old school COs still don’t haunt GSA’s hallways – COs with a willingness to work collaboratively, listen to reason, and take a stand (even against an auditor) when appropriate. But these COs are becoming the exception. It is an unfortunate development.

Obviously, GSA’s recent public embarrassments are not entirely to blame for this development. Contractors must share some of the blame here as well. Every time a Schedule contractor finds its name in the papers under the heading “Schedule contractor violates the False Claims Act,” the entire MAS Program takes a hit, contracting officers become more skittish, and the historical trust between GSA and its industry partners deteriorates further.

But there are some bright spots on the horizon. Since we published the first edition of our book back in 2002, we have witnessed a sea change in industry’s appreciation for the risks inherent in the Schedule program, and in its concomitant commitment to compliance. We have seen a proliferation of comprehensive internal compliance programs, well-written Codes of Conduct, effective training programs, and impressive internal control systems. We have seen more contractors approach the MAS Program with their eyes open, and take the time to negotiate a sensible Schedule contract on the front end of the process.

On the Government’s side, we have seen committed GSA personnel working to enhance the MAS Program wherever possible. People like Robin Bourne, the director of the FAS MAS Program Office; Jeff Koses, the director of GSA’s Office of Acquisition Operations, Steve Kempf, the FAS Commissioner; the Agency’s several Acquisition Center directors, and many others, all believe strongly in the benefit and mission of the MAS Program and execute their responsibilities in a skillful and open-minded manner.

So, clearly, all is not lost. The MAS Program will endure because it provides an important service to federal agencies and excellent opportunities to contractors committed to compliance.

Sequestration: Funding Shortfalls and Unrequited Patriotism

Sheppard Mullin — Wed, 24 Oct 2012 11:19:05 -0800

By John W. Chierichella and Alexander W. Major

Sequestration is slated to start January 2, 2013. Under the terms of the Budget Control Act of 2011, OMB must trim $1.2 trillion evenly from the budgets of civilian agencies and the Department of Defense from 2013 through 2021, an annual reduction of $109 billion. In a report issued on September 14th, OMB started that process, providing initial estimates of what, exactly, would be sequestered from discretionary programs (i.e. non-entitlements) in the 2013 budget, including approximately $54 billion spread across the civilian agencies and $54 billion from the DoD budget, which includes a cut in funds for “overseas contingency operations,” i.e. war spending. The same requirement will continue for the next nine years. However, after 2013, the Appropriations Committees will be allowed to determine how it will apply the cuts to live within the Budget Control Act’s mandatory reduced spending caps.

The issue of sequestration is especially critical as we approach the first quarter of FY 2013, because it will affect contracts awarded on or after October 1, 2012 and contracts awarded before that date that were not fully funded with FY 2012 or earlier year appropriations.

No one can predict with certainty what will transpire on January 2nd. However, if past is prologue – and it usually is -- it is highly likely that Government procurement offices will lean on contractors to save the country from the consequences of political mismanagement. An all too familiar pattern that we anticipate is the one in which the Government:

Tells you it has no money
Stresses the importance of the at-risk contract to our Nation’s security
Emphasizes the Company’s patriotic duty
Offers assurances that the Government will “take care of” the Company later

There is a variety of legal terms that describe this empty promise. Bunk, poppycock, and drivel are three that come immediately to mind. All too often, contractors in the past have succumbed to this siren song and lived to regret it. What makes the scenario even more problematic in relation to sequestration, however, is that the money that the agencies do not have today is not going to materialize like the proverbial manna from heaven at any time in the future. Unless and until Congress solves the budget problem, the sequestration cuts are here for the next decade. Working without coverage under these circumstances – in a financially unstable environment, free of reliable assurances of future payments and possibly devoid of remedies for performance that will be characterized as voluntary – can be ruinous.

The prosecution of claims against the Government for sequestration is not likely to be successful. Sequestration will be characterized by the Government as a “sovereign act,” for which contractors will have no contractual recourse other than excusable delay. As a result, contractors are forced to “play defense” as the impacts of sequestration spool out into the market. How do they do that? There is no “one size fits all” defensive game plan, but we have some suggestions:

Review your contract portfolio to determine how your contracts are funded, which ones are not at risk of sequestration and which are
Get every dollar to which you are entitled – now
- Invoice immediately for all dollars to which you are entitled, including all fee that you have earned,
- Evaluate, prepare, and submit whatever valid claims you may have
- Submit claims for Prompt Payment Interest, if applicable to your payments, when the only basis for non-payment is the unavailability of funds
- Exercise your rights under the Limitation of Funds and Limitation of Cost Clauses of your cost reimbursable contracts – stop work when you reach the ceilings
- Be sure to include the costs of mass severance in the event of termination in your calculation of the costs incurred and to be incurred against the LOC and LOF ceilings. Contractors who do not will find that those costs are not reimbursable if they exceed the contract ceilings. See, e.g., Allied Signal Aerospace Co., ASBCA No. 46890, 95-1 BCA ¶ 27,462.
In a fixed price environment, consider the following –
- Will the Government have the money to pay for the last 10% of your performance?
- Will it have the money to pay any back-ended fee?
- Can the Government properly invoke the Changes Clause to reduce quantities? The conventional wisdom – and the terms of the Changes Clause itself – is that it cannot do so, that such reductions must be undertaken pursuant to a partial termination for convenience. That entitles you to termination costs, but will the Government have the money to pay them?
- Can you, in the face of lack of Government resources to pay what it owes, demand reasonable assurances of payment, like a commercial seller can? And who in the Government can provide those reasonable assurances? Who is authorized to provide such assurances? Let us not forget in this regard Federal Crop Insurance Corp. v. Merrill, 332 U.S. 380 (1947).
- If the Government cannot provide assurances of its performance, can you stop work?
  - Which Disputes Clause do you have? The standard clause, which has the narrower requirement to continue work pending the resolution of a dispute? Or the ALT I version, which includes the broader work mandate?
  - Is a Government funding shortfall a dispute within the meaning of the clause or simply a fact that is not in dispute? In other words, does the Disputes Clause’s “continue to work” mandate even apply?
  - Is a Government “direction” to continue work in the face of a funding shortfall a violation of the Ant-Deficiency Act?

The bottom line is this – the Government is likely to jawbone you into “doing the right thing for the country.” The right thing here is exercise your rights. Maybe, just maybe, if the contracting community actually stands on its rights it will communicate a clear message to Congress – like Howard Beale in “Network” – that "I'm as mad as hell, and I'm not going to take this anymore," and require the Congress to solve its own mess without riding on the backs of contractors.

FCPA and Anti-Corruption Enforcement Update: April - September 2012

Sheppard Mullin — Wed, 24 Oct 2012 10:47:04 -0800

By John Hynes

We regularly report on Foreign Corrupt Practices Act ("FCPA") developments and have furnished subscribers with a primer on the FCPA. As expected, 2012 has proven to be yet another busy year for the government in enforcing the FCPA. This article highlights some of the most important recent developments in the anti-corruption and FCPA enforcement world, while a more comprehensive update can be found here.

FCPA Trials

The past six months have seen their fair share of significant rulings and other milestones in FCPA trials. For instance, in April and May of this year, two more individual defendants pled guilty to FCPA violations in a case beginning in 2009 in which the Department of Justice (“DOJ”) charged Controlled Components, Inc. (“CCI”) and six of its employees with FCPA violations for allegedly paying $4.9 million in bribes to officials of state-owned oil, electricity, and nuclear energy companies in China, Malaysia, and the United Arab Emirates in exchange for business. After these two guilty pleas, only one defendant remains – a former CCI Korea employee who remains in South Korea and has not been brought before the court.

Additionally, in July 2012, the court sentenced the Government’s key witness to 18 months in prison and 36 months of probation in the now-infamous SHOT Show sting case that began when undercover FBI agents posed as officials from Gabon seeking $1.5 million in bribes in exchange for a $15 billion defense contract. Though 22 defendants were initially charged, the prosecution fell apart when the first two trials failed to result in any convictions, leading the DOJ to voluntarily dismiss the remaining indictments in March 2012.

In another case signaling the difficulty the Government is having in securing FCPA convictions, the DOJ dismissed its appeal in its FCPA prosecution of two executives of Lindsey Manufacturing Co. In May 2011, the jury convicted the executives of FCPA violations for allegedly paying $5.9 million in bribes through a Mexican sales representative to officials of Comisión Federal de Electricidad (“CFE”) – a Mexican state-owned electric utility company – in exchange for contracts. The judge, however, threw out the convictions in November 2011 on prosecutorial misconduct grounds. While the Government initially appealed the ruling, it voluntarily dismissed the appeal in May 2012, bringing the prosecution to a close.

We also recently have seen the beginnings of what could result in clarification of one of the most litigated aspects of the FCPA – the interpretation of “foreign official.” In August 2011, a federal jury convicted the former president and former vice president of Terra Communications Corp. of FCPA violations for paying more than $890,000 in bribes to officials of Telecommunications D’ Haiti (“Haiti Telco”), Haiti’s state-owned telecommunications company, in exchange for business. The defendants appealed their convictions to the 11th Circuit, arguing that the alleged payments could not have violated the FCPA because employees of a state-owned enterprise like Haiti Telco do not constitute “foreign officials” under the FCPA. Though this issue has been litigated in lower courts and hotly debated by legal scholars, this is the first time it has been brought before a federal appellate court.

FCPA Settlements

Companies and individuals also have entered into significant settlements with the government to resolve FCPA charges over the past six months. In August 2012, pharmaceutical giant Pfizer Inc. agreed to pay a total of $60 million to settle DOJ and SEC bribery allegations in Europe and Asia. In the criminal case, a Pfizer subsidiary admitted that between 1997 and 2006, it paid more than $2 million in bribes to officials in Bulgaria, Croatia, Kazakhstan, and Russia that resulted in more than $7 million in profits. Moreover, in the civil case, the SEC alleged that another Pfizer subsidiary engaged in widespread corruption dating back to 2001, including a rewards club for "high-prescribing” Chinese doctors; a bonus program for doctors in Croatia; and payments of cash, BlackBerrys, and travel incentives to doctors and other officials in China, Indonesia, Pakistan, and Saudi Arabia.

Moreover, in September 2012, the former CFO of Digi International, Inc. settled charges by the SEC that he violated the books and records and internal control provisions of the FCPA by using corporate funds to pay for unauthorized travel and entertainment expenses for Digi employees. The SEC alleged that he developed a system allowing employees in the company’s Hong Kong office to be reimbursed for personal expenses without approval by the CEO as required by company policy and approved cash payments in the Hong Kong office that were not supported by documentation. The amount of the civil penalty has yet to be determined.

Also in September 2012, Tyco International Ltd. agreed to pay more than $13.6 million in criminal penalties to the DOJ and $13 million in civil penalties to the SEC to settle FCPA charges. On the criminal side, the DOJ alleged that a Tyco subsidiary in the Middle East paid bribes to officials of Saudi Aramco, an oil and gas company controlled by the Saudi Arabian government, in exchange for contracts. In the civil case, the SEC alleged that Tyco paid bribes in Germany, China, Thailand, and Turkey, and falsely recorded payments to agents and other third parties as “commissions.”

Other Important FCPA and Anti-Corruption Developments

In addition to trials and settlements, there have been a number of other significant developments in FCPA and anti-corruption enforcement. For instance, oil giant Halliburton announced in July 2012 that it has initiated a new internal investigation into allegations that it paid bribes in Iraq and Angola in exchange for customs and visa clearances. This internal investigation is separate from the one disclosed by Halliburton in October 2011 concerning a whistleblower's accusations that employees bribed Angolan officials for oil contracts, and comes on the heels of a $579 settlement the company paid in February 2009 to resolve unrelated FCPA charges.

Additionally, in a case highlighting the cooperation between international anti-corruption regulatory bodies, the former CEO of Innospec’s U.K. operations pled guilty in June 2012 in a London court to two counts of conspiracy to corrupt in relation to bribery schemes in Indonesia and Iraq. The former CEO was never criminally charged in the U.S. but paid about $230,000 to settle a civil case with the SEC in January 2011. Back in 2010, Innospec agreed to pay $40 million to settle more than a dozen criminal charges in the U.S. and the U.K. relating to FCPA violations, U.N. oil-for-food program offenses, and violations of the U.S. embargo against Cuba.

There also has been an important development relating to the anti-whistleblower retaliation provisions of the Dodd-Frank Act. In July 2012, a federal judge threw out a whistleblower claim against GE Energy (USA) brought by a former employee who claimed he was terminated in retaliation for raising FCPA compliance concerns while GE was seeking a $250 million contract with Iraq’s Ministry of Electricity. The judge dismissed the claim on the ground that the Dodd-Frank anti-retaliation provisions did not cover his extraterritorial whistleblowing activity.

Conclusion

These important developments show that the government remains focused on punishing companies and individuals who violate the FCPA. Some important themes that we can take away from the recent enforcement activity are the continued cooperation between international regulatory authorities to combat corruption, the focus on prosecuting individuals for FCPA violations, and FCPA settlements that highlight the importance of having in place a robust and current anti-corruption program.

To minimize the risk of FCPA violations and to be best prepared in the unfortunate event that they find themselves in the middle of a government investigation, companies must ensure that their compliance programs contain all the elements necessary to prevent and detect corruption and that they periodically are reviewed and updated to adapt to shifts that come about in the anti-corruption landscape as a result of the global effort to eradicate corruption.

Predicating False Claims Act Liability On False Cost Estimates May Impact Contractors' Willingness to Take On Projects Involving Next Generation Technologies

Sheppard Mullin — Wed, 24 Oct 2012 10:34:38 -0800

By Joseph Barton

In 1995, the U.S. Air Force awarded Lockheed Martin the RSA II Contract (the “Contract”) for the provision of software and hardware used to support space launch operations at Vandenberg Air Force Base and Cape Kennedy. Importantly, the Contract is a cost-reimbursement type contract whereby a contractor is paid for the allowable expenses it incurs plus an additional payment to allow for a profit.

Lockheed Martin’s initial bid for the Contract was $439.2 million. However, Lockheed Martin reduced its bid to $432.7 million in its Best and Final Offer after receiving word that its initial bid was too high. To date, Lockheed Martin has been paid over $900 million on the Contract.

Nyle Hooper was a Senior Project Engineer on the Contract. He filed suit against Lockheed Martin under the False Claims Act, 31 U.S.C. §§ 3729-3733, (the “FCA”) alleging that Lockheed Martin knowingly underestimated its costs in its Best and Final Offer in order to improve its chances of winning the Contract. At trial, Hooper provided evidence that Lockheed Martin instructed its employees to lower its price for the Contract without regard to the actual costs it expected to incur on the project. One of the Lockheed Martin employees responsible for preparing cost estimates for the Contract testified that after Lockheed Martin learned its initial bid was too high, he was “asked [by management] to change the cost” despite the fact there was no engineering basis for the cost change. The employee further testified that the cost estimates Lockheed Martin submitted as part of its Best and Final Offer were based on “bad, bad guesses.” He clarified, however, that the cost estimates were not “false.”

The U.S. District Court for the Central District of California granted summary judgment in favor of Lockheed Martin on grounds that Hooper failed to present any evidence Lockheed Martin had intended to defraud the government by basing its Best and Final Offer on false cost estimates. In August 2012, the Ninth Circuit Court of Appeals in U.S. rel. Hooper v. Lockheed Martin Corp., No. 11-55278 (9th Cir. 2012), reversed the District Court holding: (1) a claim that a contractor fraudulently underbid or relied upon false cost estimates to obtain a government contract is cognizable under the FCA; (2) the FCA does not require a qui tam relator to identify evidence of specific intent to defraud the government in order to survive a motion for summary judgment as “reckless disregard” or “deliberate ignorance” of the truth is sufficient to establish liability under the FCA; and (3) Hooper had presented sufficient evidence to create a genuine issue as to whether Lockheed Martin acted with “reckless disregard” or “deliberate ignorance” in constructing its Best and Final Offer for the Contract to the Air Force.

The idea that an FCA action involving a cost-reimbursement type contract can be predicated on “fraudulent underbidding” or “false cost estimates” is troublesome because the main reason the government awards cost-reimbursement type contracts is the unpredictability of the costs that might be necessary to accomplish certain tasks. This is especially so when dealing with projects involving next generation technologies such as the communication networks, weather instrumentation, telemetry processing, pre and post-flight analysis tools, and network management capabilities Lockheed Martin has delivered to the Air Force on the Contract. The fact that the Ninth Circuit’s decision in Hooper now makes FCA actions possible whenever the actual costs on a contract exceed the estimated costs, no matter how difficult or unprecedented the contract’s tasks may have been, may well cause contractors to think twice before bidding on these types of contracts.