Counterfeit Prevention Clauses and Potential False Claims Act Exposure

In an earlier essay, I described how the pace and exuberance of counterfeit prevention requirements flow down activity on the part of prime and upper tier contractors has accelerated with the introduction of NDAA2012§818. Many observe that it has become commonplace for a number of prime and upper tier contractors to include overly broad counterfeit parts clauses in their purchase order term and conditions, largely due to speculation on the details of forthcoming regulations.

Contractors that include overly broad counterfeit parts clauses in their purchase order term and conditions should reflect on whether or not they themselves can meet the requirements of these clauses. While a company may perform as the prime contractor on some contracts, the same company many also perform as a subcontractor on other contracts subject to similar overly broad clauses which, in the interest of keeping up with the trend, are likely influenced by its own overly broad clauses. In some instances, one business unit within a company may perform as a lower level contractor where another business unit within the same company performs as the prime contractor on the same program.

A colleague recently shared insights with me concerning the flow down of overly broad counterfeit prevention clauses and potential liability under the False Claims Act (FCA). According to a noted expert in procurement fraud and criminal prosecutions associated with counterfeiting …

[S]elling counterfeit electronic parts to the military or other government agencies can result in civil (Federal False Claims Act) and administrative (Suspension and Debarment) action as well as criminal prosecution. A criminal prosecution will focus on the devices sold (including all parts markings) and all representations (verbal and in writing) made to the buyer by the seller and its employees and representatives. Such charges could include Trafficking in Counterfeit Goods or Services, (18 U.S.C. 2320), Mail Fraud (18 U.S.C. 1341), Wire Fraud (18 U.S.C. 1343), and Conspiracy (18 U.S.C. 371).

As I reflect upon the insights offered by my colleague, I think that now is an opportune time to reconsider requirements that attempt to boil the ocean to address all potential forms of counterfeits. Now that the long awaited proposed DFARS on ‘detection and avoidance of counterfeit electronic parts’ has been published (DFARS Case 2012-055), contractors should focus its counterfeit prevention requirements based on facts and data revealing known targets of counterfeiters.

Below are the insights shared by my colleague …

A colleague attended courses on the DoD counterfeit electronic parts law recently conducted by The American Bar Association (ABA). The speakers for these courses were from law firms, prime contractors, and the Department of Justice who are noted experts in Government contracts and procurement fraud. The last course was about the DoD counterfeit electronic parts law and potential liability for civil or criminal fraud. At each of the three courses an attendee shared observations about overly broad counterfeit parts prevention clauses and certifications that many contractors and subcontractors currently include in their terms and conditions. After sharing these observations, the attendee asked…

If a subcontractor accepts such prime contractor counterfeit parts prevention clauses, but does not implement systems to comply with the prime contractor’s special requirements, can the subcontractor be held liable under the civil False Claims Act (FCA) for submitting invoices for payment even if no counterfeit parts are delivered to the prime contractor?

The speakers answered yes in response to this question during each of the ABA courses.

The following is a summary of the explanations offered by the speakers about why there is potential liability under the civil FCA:

Several circuits have held that the act of submitting a claim for payment is considered an implied certification that the prime contractor or subcontractor, as the case may be, has complied with all applicable statutes, regulations, and contract terms that are material for payment. For example, a prime contractor or subcontractor may be held liable under the FCA where it fails to test products as required by the contract or subcontract, regardless of whether the products are in fact defective. In such circuits, if a prime contractor or subcontractor submits a claim for payment under a Government contract or subcontract containing a broad counterfeit parts prevention clause, with the knowledge it does not have systems in place to comply with the counterfeit parts prevention clause, and compliance with the clause is material for payment by the Government or the prime contractor, the submission of the invoice may be held to be a false claim under the civil FCA.

To be material under the civil False Claims Act (FCA), the falsity must either: (1) have a “natural tendency to influence,” OR (2) be “capable of influencing” the payment of money. Examples:

–The Government or prime contractor relied upon the false information in deciding to pay the claim; or

–The falsity had the potential to influence the Government’s or prime contractor’s payment decision.

To violate the civil FCA, a false claim must be submitted “knowingly” to the Government or a prime contractor, subcontractor, grantee or other recipient of federal funds. Under the civil FCA, the terms “knowing” and “knowingly” mean that a person, with respect to information:

(i) has actual knowledge of the falsity of the information;

(ii) acts in deliberate ignorance of the truth or falsity of the information; or

(iii) acts in reckless disregard of the truth or falsity of the information.

No proof of specific intent to defraud is required.

Case law has held (and the Department of Justice’s position is) that the failure to have an adequate system in place to comply with material contract requirements is “reckless disregard for the truth” for purposes of the civil FCA.

Damages do not need to be proven to violate the civil FCA. Therefore, the prime contractor’s or subcontractor’s mere submission of an invoice for payment, with the knowledge it does not have systems in place to comply with the broad counterfeit parts prevention clause, is arguably a false claim, and subject to a fine of between $5,500 and $11,000 for each invoice submitted, plus treble actual damages, if compliance with the counterfeit parts prevention clause is considered to be material for payment by the Government or prime contractor. The fact the part for which payment is requested may be genuine and not counterfeit is irrelevant, except with respect to the amount of damages, which arguable is none in such cases.

In cases where a prime contractor or subcontractor provided an express certification of compliance with the counterfeit parts prevention clause before the Government contract or subcontract was issued, there could be liability under the civil FCA for “fraud in the inducement.” This is where a false representation is made by a prime or subcontractor to induce the Government or prime contractor to enter into a prime contract or subcontract that it would not have entered into absent the misrepresentation. In fraudulent inducement FCA cases, the Department of Justice commonly argues that every payment made under the fraudulently induced contract constitutes actual damages, even when the Government has not lost any money as a result of the fraud. In other words, in fraudulent inducement cases, the actual damages arguably consist of the total payments made under the prime contract or subcontract, which are to be trebled under the FCA.

The greatest risk at this point in time for failure to comply with prime contractor counterfeit parts prevention clauses is most likely with qui tam (whistle blower) actions being brought under the civil False Claims Act for failure to comply with the requirements in such clauses. The greatest risk of qui tam actions would be with products that DoD would consider to be “critical materiel.”

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