Smith Pachter McWhorter constantly tracks current events, issues, and trends in Government Contracts to keep clients on the cutting edge of legal and policy developments. This e-letter highlights the most important issues, and the attached index provides weblinks to the source documents of these and many more developments.

I. Proposed FAR Poses Substantial Issues for Compliance

While the newspaper headlines have highlighted major Congressional efforts to roll back changes made 15 years ago under Acquisition Reform, the government contractor community should not lose sight of a proposed Federal Acquisition Regulation (FAR), “Contractor Code of Ethics and Business Conduct.” 72 Fed. Reg. 7588 (February 16, 2007).

That proposed regulation would impose requirements for contractors to establish a code of ethics and business conduct, implement a compliance training program, and establish internal control systems incorporating specific duties. The proposed rule would also impose significant reporting and cooperation obligations on contractors.

The proposed rule is similar to the regulation contained in DFARS Subpart 203.70, but, unlike the DFARS provision, the proposed rule would be mandatory, except for commercial item contracts and contracts performed outside the United States. The proposed rule would impose the most stringent requirements on contracts awarded in excess of $5 million with a performance period of 120 days or more. In that instance, the proposed contract clause would require the contractor to have a written code of ethics and business conduct within 30 days after award, and within 90 days after award to establish (a) an employee ethics and training program; and (b) an internal control system. “Such program and system shall be suitable to the size of the company and its involvement in Government contracting.”

The proposed rule would mandate that the internal control system:

(i) facilitate timely discovery and disclosure of improper conduct in connection with Government contracts; and

(ii) ensure corrective measures are promptly instituted and carried out.

By way of example, the proposed rule states that a contractor’s internal control system should provide for:

(i) periodic reviews of company business practices, procedures, policies, and internal controls for compliance with the contractor’s code of ethics and business conduct and the special requirements of Government contracting;

The proposed contract clause would also require prominent posting of a fraud hotline poster in common areas and on the company website. Remedies for violation of these requirements would include withholding of contract payments or loss of award fee. The proposed clause would be a mandatory subcontract flowdown clause.

The impact of such a regulation would be substantial. While major companies within the defense industry have implemented codes of ethics and business conduct, and compliance programs, many other, smaller companies within and outside the defense industry have not, or have not implemented programs to meet the above criteria. The threshold for imposing this kind of stringent requirement is, by any measure, very low – a single contract or subcontract award in excess of $5 million with a performance period of at least 120 days.

The proposed clause’s requirement that the contractor provide “full cooperation with any Government agencies responsible for either investigation or corrective actions” also presents serious issues. What does “full cooperation” mean? Is this a requirement for employee interviews? If so, what is the contractor’s duty with respect to the rights of its employees? Will an employee’s refusal to submit to an interview implicate a breach of the clause and therefore the government’s right to withhold payments? Does “full cooperation” require waiver of attorney-client privilege?

No one would argue that compliance in government contracts is unimportant. But the proposed FAR rule is a “meat cleaver” approach to compliance, and will lead to significant increased costs for contractors and subcontractors to do business with the government.

The court discussed at length the inconsistencies in testimony from Daewoo's witnesses. For example, the project manager testified that he expected the government to pay the entire $64 million and then, later that same day, testified that the claim was only for $13 million. The court noted that Daewoo's management "could not or would not explain how they calculated the bid." The court also noted that Daewoo would not present its own weather calculations in discovery or during trial. The court characterized the testimony of Daewoo's experts as "obtuse." The experts, according to the court, "emphasized that they had not read the certified claim," and "they wished to distance themselves from any numbers or supporting data that had been a part of that claim." Daewoo's experts testified to an amount $22 million less than the certified claim.

At the end of Daewoo's case, the government moved to amend its answer to add fraud counterclaims. The court granted the motion, and the government counterclaimed under the Contract Disputes Act, 41 USC § 604, the Forfeiture Statute, 28 USC § 2514, and the civil False Claims Act, 31 USC § 3729. The court found that the government was not liable for the $13 million of costs incurred, and that the remaining $50 million had been submitted as a negotiating ploy. The court determined that the entire claim was an attempt to defraud the government, and found Daewoo liable to the government under the CDA "for an amount equal to such unsupported part of the claim" -- $50.6 million.

The AMEC case involved payment and performance bond costs on several federal construction contracts. The government moved for summary judgment on its counterclaims under the Anti-Kickback Act, 41 USC §§ 51-58, and the civil False Claims Act, 31 USC § 3729. The facts showed that the contractor's parent company had established a "rebate" program with its bond brokers, whereby the parent company received an amount equal to the actual bond cost. The court found that this practice violated the Anti-Kickback Act. The court also granted summary judgment to the government based on the civil FCA because the contractor had billed the bond costs, including the "rebate," as part of its progress payment requests, thereby inflating those progress payment requests. Finally, the court determined that AMEC's claims for equitable adjustment filed under the contracts at issue were forfeit under the Forfeiture Statute.

Neither Daewoo nor AMEC should come as a surprise. Both cases involved claims that the court determined were either fraudulent or tainted by fraud. In Daewoo, the court found that $50 million of the contractor's claim was unsupported and filed as a negotiating ploy, a tactic the CDA was designed to stop. In AMEC, the "rebate" constituted a kickback and also led to inflated progress payment requests, thereby tainting the contractor's other claims for equitable adjustment. The message from the US Court of Federal Claims is clear: tactics such as these are impermissible and will have severe consequences.

While the statutes at issue in these two cases are not new, recent experience indicates that government counsel, from both the Department of Justice and agencies, are asserting fraud counterclaims and arguments on a more frequent basis to counter contractor claims. The most effective way to oppose these government positions is to make certain that contract claims are fully supported with adequate facts, and that the company implement a compliance program to ensure that only appropriate costs are bid, incurred, charged to the contract, and billed to the government.

LINKS TO RECENT DEVELOPMENTS IN GOVERNMENT CONTRACTS

I. LEGISLATION

III. CASES

IV. REPORTS