Casting Upstream: Fishing For False Claims Act Liability Among Subcontractors And Component-Part And Raw-Materials Suppliers

Monday, May 4, 2009 - 01:00

Companies that sell products directly to government entities are not the only companies that need to be concerned about lawsuits brought under the False Claims Act or equivalent state laws. The federal and state governments, as well as private plaintiffs, have used the broad language of the various False Claims Act laws to assert claims against subcontractors of government contractors as well as the component-part manufacturers and raw-material suppliers to those subcontractors. Indeed, in recent cases claims have been brought against component-part and raw-material suppliers where it is not even clear that they knew that their product was going to end up in a product being sold to a federal or state government agency. What makes these cases even more relevant to upstream suppliers today is that they may be on the increase given the government response to the current economic conditions. The billions of dollars that are flowing from the federal and state governments to stimulate the economy by improving the nation's infrastructure will lead to more government contracts being entered into and an increase in the use of subcontractors and component-part and raw-material manufacturers to perform those contracts. Because each of these parties could be subject to claims arising under federal and state False Claims Acts, it is crucial that they know not only their own customers, but also their customer's customer, so that they can appropriately manage the risks of doing business with government agencies.

The federal False Claims Act, as well as various state false claims acts, provide that a person or entity may be held liable if they knowingly present a false claim for payment to the government.1But liability may also be triggered when a party causes a false claim to be submitted or makes false statements, or causes false statements to be made, in order to get a claim paid by the government.2Put another way, "any time a false statement is made in a transaction involving a call on the [Government] fisc, False Claims Act liability may attach."3

Courts have made clear that subcontractors and materials suppliers cannot avoid liability by arguing that they do not have a direct contractual relationship with the government. For example, in United States v. Bornstein ,4the United States sued a subcontractor who had deliberately and falsely marked electron tubes that were incorporated into radio kits sold to the government. The tubes were falsely marked in order to hide the fact that they did not meet the specifications in the government's contract with the primary contractor. The United States Supreme Court held that despite its lack of contractual privity with the government, the subcontractor could be held liable for a violation of the False Claims Act since it caused the contractor to submit false claims to the government in the form of invoices certifying that the radio kits met the contract specifications.5

Suppliers of raw-materials and manufacturers of component parts that are incorporated into various end-products have been named as defendants in False Claims Act cases. For example, in United States v. Zan Machine Co., 6 the Department of the Air Force contracted for the production of safety belts for military aircraft. In fulfilling its obligations under the contract, the primary contractor purchased safety-belt parts from component-part manufacturers. Even though it knew that the component parts did not conform to the specifications in the Air Force contract, the primary contractor nevertheless decided to use them. The completed belts were then sent to the Air Force along with invoices for payment. The United States brought suit against not only the primary contractor, but also against one of the suppliers of the non-conforming component parts for violations of the False Claims Act. The government's apparent theory in pursuing liability against the component-part supplier was that the provision of the non-conforming component parts caused the contractor to submit a false claim for payment for the end-product seat belts that did not comply with the government's specifications. The result was a $38,000 jury verdict against the primary contractor and a $30,000 settlement by the component-part manufacturer.

Similarly, in United States ex rel. Roby v. Boeing Co. ,7Boeing contracted with the United States Army to remanufacture over three hundred Chinook-model helicopters. As part of the remanufacturing process, Boeing replaced the transmission gears in each aircraft with gears purchased from a parts supplier, Speco Corporation. After a remanufactured Chinook crashed during Operation Desert Shield, a qui tam relator and the United States government brought suit under the False Claims Act against Boeing and Speco. Both Boeing and Speco, the supplier of the faulty transmission gears, eventually settled these claims, but only after Speco was forced into bankruptcy.8

The False Claims Act generally requires a liable party to have acted with scienter ( i.e. , knowingly).9The government, however, has argued that a subcontractor or raw-material supplier's act of knowingly providing a non-conforming or defective part to a contractor, not necessarily its knowledge (or lack thereof) that its product is being incorporated into a product that is being sold to the government, is enough to trigger liability under the False Claims Act. Indeed, in cases brought under 31 U.S.C. 3729(a)(1) alleging that a party "caused" a false claim to be presented to the government, some courts have found that liability may exist where it is simply "foreseeable" that a troubled product may be sold to the government.10In United States ex rel. Franklin v. Parke-Davis ,11a pharmaceutical company was alleged to have violated section 3729(a)(1) of the False Claims Act. The court held that False Claims Act liability could attach even though the company's drug was marketed to doctors, who prescribed it to patients, who submitted the prescriptions to pharmacists, who only then filed claims for reimbursement with the government.12Despite these intervening links in the causal chain, the court found that it was foreseeable that the defendant's conduct would result in the eventual submission of a false claim to the government.13

In the summer of 2008, the Supreme Court gave subcontractors and material suppliers some respite with its decision in Allison Engine Co. v. United States ex rel. Sanders. 14In Allison Engine , two qui tam relators brought suit against a number of primary contractors and subcontractors alleging violations of the False Claims Act.15One of the allegations was that contractors who were charged with manufacturing a new fleet of Navy destroyers had knowingly made or caused to be made false records or statements to get false or fraudulent claims paid or approved by the government in violation of 31 U.S.C.§ 3729(a)(2).16At trial, the relators introduced evidence of false claims made by the subcontractors to the primary contractor, but failed to show that the primary contractor presented any false claims to the government.17

In arguing their case before the Supreme Court, the defendants maintained that in order to be held liable, a party must submit a false or fraudulent claim for payment to the government and not simply to a primary contractor or other grantee of federal funds.18The Supreme Court disagreed, but did so without throwing open the flood gates of litigation against raw-material and component-part manufacturers. It held that under section 3729(a)(2), actual presentment of a false claim to the government by a subcontractor or materials supplier was not a prerequisite to incurring liability under the Act.19The party that makes the false statement or record, however, must do so with the intended purpose of getting a false or fraudulent claim paid or approved by the government.20Thus, when a primary contractor submits a false claim to the government, the government and/or a relator may still turn to a subcontractor or raw-materials supplier and seek to impose liability under the False Claims Act. In doing so, the plaintiff must show that the upstream component-part manufacturer or raw-material supplier made a false statement or record with the intent to get the government to pay the primary contractor's claim.

What remains to be seen is whether Allison Engine will continue to be the law or whether Congress will move to curb its impact. In late 2007, bills were introduced in the United States House of Representatives and the Senate, both titled, the "False Claims Act Correction Act."21Neither bill was voted on in the 110th Congress, but versions have been reintroduced in the current Congress.22

What is particularly notable about each version of the bill is that they reject the law set forth in Allison Engine with respect to "presentment" of a false claim and increase the chances that subcontractors and raw-material suppliers could be held liable under the False Claims Act.23For example, the recently reintroduced House version of the bill would impose liability on any person who presents, or uses a false statement or record to get paid, "a false or fraudulent claim for government money or property."24Thus, not only would a false claim presented to the government still give rise to liability under the Act, but so too would a false claim presented to virtually any party charged with disbursing government money.

For companies whose products are incorporated into various end-products that are sold to an array of users, prudent risk management principles dictate that the risk of cases being brought under the federal or state False Claims Acts be considered and evaluated. As a starting point, it is incumbent on a company to know its customer, and where practicable, to know its customer's customer. Such due diligence is particularly important today as federal and state governments seek to stimulate the economy by increasing their spending. As more government contracts are entered into, more companies could find themselves in a chain of distribution of a product to a government agency, thereby subjecting themselves to the potential for claims arising under the False Claims Act.

If a company knows it is doing business with the government or knows it is selling parts that may be used or incorporated into a product being sold to the government, it should know the requirements of the operative government contract that are relevant to its product. Further, it should have in place - and should follow - an effective quality assurance and quality control ("QA/QC") program designed to ensure not only overall product quality, but also that its products meet the government's requirements.

Finally, because False Claims Act lawsuits can also be initiated by employees turned qui tam relators, counsel and upper management should be attuned to any concerns raised within the company about the integrity of the products that they provide. Any corporate compliance program should include, among other things, a formal and open reporting system where employees feel comfortable raising concerns without fear of retaliation. If a system like this is already in place, there is no time like the present to remind employees of its existence and to explain how the process works. 1See, e.g . , 31 U.S.C. § 3729(a)(1); Cal. Gov't Code § 12651(a)(1); D.C. Code § 2-308.14(a)(1); 740 Ill. Comp. Stat. 175/3(a)(1); Mass. Gen. Laws ch. 12 § 5(B)(1).

2See, e.g. , 31 U.S.C. § 3729(a)(1)-(2); Cal. Gov't Code § 12651(a)(1)-(2); D.C. Code § 2-308.14(a)(1)-(2); 740 Ill. Comp. Stat. 175/3(a)(1)-(2); Mass. Gen. Laws ch. 12 § 5(B)(1)-(2).

3Harrison v. Westinghouse Savannah River Co . , 176 F.3d 776, 788 (4th Cir. 1999).

4 423 U.S. 303 (1976).

5Id. at 307; United States v. Bornstein, 361 F. Supp. 869, 873 (D.N.J. 1973); see also United States ex rel. Schmidt v. Zimmer, 386 F.3d 235, 243 (3d Cir. 2004) ("These provisions [of the False Claims Act], considered together, indicate a purpose to reach any person who knowingly assisted in causing the government to pay claims which were grounded in fraud, without regard to whether that person had direct contractual relations with the government.") (quoting United States ex rel. Marcus v. Hess, 317 U.S. 537, 544 (1943)).

6 803 F. Supp. 620 (1992).

7 302 F.3d 637 (6th Cir. 2002).

8United States ex rel. Roby v. Boeing Co . , No. C-1-95-375, 1998 U.S. Dist. LEXIS 22456, at *2-3 (S.D. Ohio Jan. 20, 1998); see also United States ex rel. Gih-Horng Chen v. Zygo Corp . , No. 3:95-879(DJS), 1997 U.S. Dist. LEXIS 19708 (D. Conn. Mar. 27, 1997) (recognizing that "the [False Claims] Act creates a cause of action against a subcontractor who causes a general contractor to submit a false claim to the Government" in a case where a private relator brought suit against the component-part manufacturer).

9See, e.g., 31 U.S.C. § 3729(a)(1)-(2).

10See, e.g., United States ex rel. Schmidt . , 386 F.3d at 244-45 (holding that the defendant could cause a false claims for Medicare funds to be presented to the Government where the claim was a normal consequence of a situation created by a defendant's marketing scheme); United States v. President & Fellows of Harvard Coll . , 323 F. Supp. 2d 151, 187-88 (D. Mass. 2004) (finding that a defendant caused a false claim to be presented where it was foreseeable that invoices would eventually be submitted to the Government).

11 No. 96-11651-PBS, 2003 U.S. Dist. LEXIS 15754, at *1-2 (D. Mass Aug. 22, 2003) .

12Id. at *11.

13Id. at *15.

14 128 S. Ct. 2123 (2008).

15Id. at 2127.

16Id.

17Id. at 2127.

18Id. at 2129.

19Id. at 2129-30.

20Id. at 2130.

21See, e.g., "False Claims Act Correction Act of 2008" S. 2041 § 2, 110th Cong. (2007); "False Claims Act Correction Act of 2007" H.R. 4854 § 2, 110th Cong. (2007).

22See, e.g., "False Claims Act Clarification Act of 2009" S. 458 § 2, 111th Cong. (2009); "False Claims Act Correction Act of 2009" H.R. 1788 § 2, 111th Cong. (2009).

23See, e.g. , S. 2041 § 2; H.R. 4854 § 2.

24 H.R. 1788.

Konrad L. Cailteux is a Partner at Weil, Gotshal & Manges LLP. He concentrates his practice on the defense of products liability actions, mass torts, class actions and complex litigation. Stephen A. Gibbons is an Associate in the Litigation Department.

Please email the authors at konrad.cailteux@weil.com or stephen.gibbons@weil.com with questions about this article.