Small Business Contract Fraud Under the False Claims Act
The federal government is the world’s largest purchaser of goods and services, and 23% of those purchases are designated for small businesses. To further this objective, the government limits competition for certain contracts to small businesses. These contracts are known as “small business set-asides,” and are intended to award federal contracts to small businesses. Some companies take advantage of these opportunities even though they are not qualified or eligible to do so. As a practical matter, the government is unable to verify all information submitted by small businesses participating in these programs. The government must therefore rely on whistleblowers to help identify companies that fraudulently claim eligibility as qualified small businesses.
A business must make certain representations and/or certifications regarding their eligibility for participation in a government small business program. For example, a Washington, D.C.-area contractor was charged with violating the False Claims Act by fraudulently obtaining small business set-aside contracts based on misrepresentations that its subsidiaries were eligible small businesses. The misrepresentations included false certifications regarding eligibility as a service-disabled veteran-owned small business and a socially or economically-disadvantaged small business under the 8(a) program administered by the Small Business Administration (SBA). The company agreed to pay $16 million to settle allegations relating to violations of the False Claims Act.
Sham Teaming Agreements
The SBA authorizes small businesses to subcontract a portion of their set-aside contracts to other companies unless specifically prohibited by statute, regulation or solicitation. Teaming agreements enable small businesses to compete by combining resources, management abilities, and technical knowledge with other businesses. However, teaming agreements can violate SBA regulations when the businesses share common ownership or control; have identical business interests; or are considered as having an “ostensible subcontractor” relationship based on tasks being performed by the prime contractor.
For example, a contractor was charged with creating a system whereby the small business subcontractor did not actually perform the work for which it was contracted. The subcontractor instead contracted with another large business to do the work while giving the appearance that the work was being performed by the small business in accordance with the subcontracting plan. The subcontractor was deemed to be merely a pass-through entity designed to evade SBA regulations.
Types of Contract Fraud
Small Business Set Asides
To help provide a level playing field, the government reserves certain contracts, known as “set-asides,” for small businesses. There are two kinds of set-aside contracts: competitive set-asides and sole-source set-asides. The determination to make a small business set-aside can be made unilaterally by a government contracting officer or jointly by a contracting officer and an SBA procurement center representative.
Unscrupulous individuals have formed sham small businesses in order to circumvent these restrictions. Misrepresentations regarding ownership, size or status can create liability under the False Claims Act.
Joint ventures between large and small businesses generally cannot qualify for small or disadvantaged business status. However, a small business participating in the SBA’s 8(a) Mentor- Protégé Program can qualify for small business and small disadvantaged business opportunities. A certain percentage of work must actually be performed by the small business in order to comply with SBA regulations. A large business is not permitted to commandeer the contract by performing all of the work.
For example, the government alleged that a large construction company did not form a qualifying joint venture with a smaller company. It was therefore ineligible to jointly bid on or perform primary functions involving certain contracts with the smaller construction company. The larger company nevertheless allegedly prepared bids for 8(a) contracts, and its employees served as project managers who submitted invoices and performed payroll and other accounting functions. The government also alleged the larger company concealed its extensive involvement in performing the 8(a) contracts by misrepresenting that its employees were employees of the smaller company. The larger company agreed to pay the government $928,000 to resolve alleged violations of the False Claims Act relating to false statements and submission of false claims under the SBA’s Section 8(a) program.
Disadvantaged Business Enterprise Fraud
The Disadvantaged Business Enterprise (DBE) Program offers opportunities for transportation contracts to socially or economically disadvantaged individuals. The program is administered by the Department of Transportation. DBE programs are targeted to women-owned, minority-owned, veteran-owned, disabled-owned, and other “disadvantaged” businesses. “Disadvantaged” refers to a particular group that has been historically underrepresented in bidding for and winning contracts for public projects.
One of the most common types of DBE fraud involves the issue of actual control of the DBE. Qualified DBE owners must have authority over the management and policies of the business as well as control of daily operations. Unscrupulous companies certify that a qualified individual controls business operations when another person actually runs the business.
Another type DBE fraud is a pass-through scheme which is specifically prohibited by Department of Transportation regulations. This type of arrangement typically involves a legitimate DBE that acts as intermediary that allows a contractor to obtain DBE participation credits on a project. The DBE receives payment from a prime contractor and then passes the majority of that payment through to a non-DBE contractor that actually performs the work.
In one case, a Tennessee-based contractor and its affiliate were the prime contractors on several federally-funded construction projects in which they agreed to use DBEs to perform certain subcontracted work. Although a certified DBE was contracted for the work, it was alleged that the prime contractors claimed their own employees as DBE employees for purposes of obtaining payment. It was also alleged that the prime contractors improperly leased equipment to the DBE, which was counted against the DBE goals established for the project. The prime contractors agreed to pay more than $2.25 million to settle their alleged violations of the False Claim Act.
The Historically Under-Utilized Business Zone (HUBZone) Program helps small businesses in economically distressed areas obtain federal contracts. The purpose of the HUBZone program is to stimulate job growth in areas that have historically had low business investment. A business can be HUBZone certified if it: (1) meets the definition of a small business; (2) has its main office is in a HUBZone; (3) has at least 35% of its employees live in a HUBZone; and (4) is at least 51% owned and controlled by a U.S. citizen or other qualified entity. The federal government’s goal is to award 3% of money spent on prime contracts to qualifying small businesses under the HUBZone program.
The most common type of HUBZone fraud involves a business falsely certifying that its principal office is located inside a HUBZone when its main office is actually in another location. For example, a Florida-based company was alleged to have used its fraudulently-obtained HUBZone certification to secure contracts with the U.S. Coast Guard, U.S. Army, and other government agencies. The company was alleged to have falsely claimed that its main office was located in a HUBZone when that location was merely a “virtual office” where no company employees worked. The company’s principal office was actually located in a non-HUBZone location, and the company allegedly submitted a fabricated lease agreement and other falsified documents to the SBA. The company agreed to pay $250,000 and five percent of its gross revenues over the next five years to settle alleged violations of the False Claims Act.
Small Business Subcontracting Plans
The Small Business Act requires that contracts in excess of a certain amount ($700,000 for non-construction contracts or $1,500,000 for construction contracts) to include a formal subcontracting plan with established goals for the participation of small businesses and small disadvantaged businesses. If there are no set-asides for small businesses, all contractors are required to submit a compliant subcontracting plan if they are a non-small business.
Government Contracting Officers must also provide “maximum practicable opportunity” for the participation of small and small disadvantaged businesses in awarding contracts of $150,000 or more if there are two or more small businesses that can do the work. First consideration for these opportunities is given to businesses certified as 8(a), HUBZone, service disabled veteran-owned, and women-owned small businesses.
If a small business is awarded a contract but does not qualify as a small business under the SBA, both the prime contractor and the subcontractor can face liability for misrepresentations relating to compliance with the subcontracting plan requirement.
Small Business Loans
The SBA provides financial assistance to small businesses through various lending programs. Under these programs, the SBA will guarantee up to 85 percent of the value of loans made by private lenders. Lenders commit fraud when they falsely certify compliance with SBA regulations when issuing a loan. For example, one lender was charged with violating the False Claims Act for submitting false claims for payment of defaulted loans made through the SBA. Several borrowers defaulted on their loans shortly after they were made by the lender. The lender was alleged to have disregarded the SBA’s regulations and underwriting requirements when the loans were made. The lender agreed to settle the fraud claims related to its small business lending for $26.3 million.