Surety Liability Under the False Claims Act

The federal Miller Act requires government construction contracts over $100,000 to be bonded. This process involves insurance companies, known as “sureties,” who issue payment or performance bonds to contractors, who in turn furnish the required bonds to the federal government. The bonds guarantee that the contractor will comply with the terms of the contract and perform as required. Although the sureties do not interact directly with the federal government, a recent decision from the US District Court in DC suggests that sureties could face liability where the bonded contractor violates the civil False Claims Act (“FCA”), 31 U.S.C. § 3729. In Scollick ex rel. United States v. Narula, No. 1:14-CV-01339-RCL, 2022 WL 3020936 (D.D.C. July 29, 2022) the court held, under the facts of that case, that the sureties had no knowledge of the fraud allegedly committed by the bonded contractor, and thus did not violate the FCA. Although the sureties escaped in this instance, this case demonstrates the expansive reach of the FCA and puts the insurance industry on notice that they are not immune from FCA liability.

In Scollick, a qui tam relator (“Relator”) filed a lawsuit against thirteen contractors, including various construction entities and the insurers furnishing bonds to those companies, alleging that the defendants violated the FCA by misrepresenting their service-disabled veteran-owned small business status in order to obtain federal contracts set aside for small businesses by the Federal Aviation Administration. SDVOSB set-aside contracts are government contracts specifically set aside for companies owned by service-disabled veterans. To be awarded an SDVOSB set-aside contract, a company must be certified as an SDVOSB.

The FCA applies to those who knowingly submit false or fraudulent claims for payment to the federal government. To this end, the FCA creates liability for any person who, inter alia, “(A) knowingly presents, or causes to be presented, a false or fraudulent claim for payment or approval; [or] (B) knowingly makes, uses, or causes to be made or used, a false record or statement material to a false or fraudulent claim.” Thus, the party alleging an FCA violation must prove: (1) defendant made false statements or engaged in a fraudulent course of conduct; (2) with the requisite knowledge; (3) the statements or conduct were material; and (4) caused the government to pay out money or to forfeit monies due on a “claim.”

The Relator filed suit under various FCA provisions—§ 3729(a)(1)(A) (Presentment); 31 U.S.C. § 3729(a)(1)(B) (Make or Use); § 3729(a)(1)(C) (Conspiracy); and § 3729(a)(1)(G) (Reverse False Claim). Relator’s case was premised on the fraud-in-the-inducement theory of the FCA, which applies where a defendant fraudulently induced the government to enter a contract and later submits claims for payment under the contract. Under this theory, FCA liability attaches “for each claim submitted to the Government under a contract which was procured by fraud, even in the absence of evidence that the claims were fraudulent in themselves.” United States ex rel. Morsell v. Symantec Corp., 130 F. Supp. 3d 106, 120-21 (D.D.C. 2015). Here, Relator alleged that defendants fraudulently claimed SDVOSB status in order to win the contract, and thus liability attached to each claim submitted to the government during performance of the contract.

At the summary judgment stage, the court denied summary judgment for all defendants except for the sureties, for whom the court granted summary judgment. In doing so, the court held the Relator failed to establish the knowledge element under the FCA. There are three types of knowledge under the FCA—actual knowledge, “acting in deliberate ignorance,” or “acting in reckless disregard.” Actual knowledge is “subjective knowledge,” while deliberate ignorance is “the kind of willful blindness from which subjective intent can be inferred” and reckless disregard is “an extension of gross negligence, or gross-negligence-plus.” United States v. Speqtrum, Inc., 113 F. Supp. 3d 238, 249 (D.D.C. 2015). Here, the court found that there was no evidence suggesting that the sureties actually knew the bids were fraudulent, but rather they only knew the details of the bid proposals and certain details of company ownership. Moreover, the court found that there was no deliberate ignorance or reckless disregard under these facts—to create such a standard would “impose a significant duty on third party insurers to familiarize themselves with VA regulations before bonding companies.” In other words, sureties are not on the hook to know of the specific SDVOSB requirements and “double-check the government’s verification” of the same. Such a requirement would be a “significant leap in terms of liability.” Rather, the court held that contractor defendants are required to familiarize themselves with the SDVOSB regulations, as they are the ones ultimately seeking payment from the federal government.

Although the sureties avoided FCA liability in this instance, this case is a good example of the expansive application of the FCA, particularly with regard to “indirect presentment” claims—that while an entity did not did not directly present false claims or make false statements to the government, their actions “caused” the submission of false claims. Here, the sureties were third-parties, not seeking payment of government funds, but rather furnishing bonds to contractors who would in turn seek government funds. Regardless of the direct or indirect nature of the claim, courts will still examine the basic tenants of the FCA to see if those elements are satisfied—claim submission, falsity, knowledge, and materiality. Here, the sureties lacked knowledge—actual or constructive. However, sureties should be mindful of being looped in to future FCA claims where qui tam relators believe they can establish all requisite FCA elements. While this decision absolves sureties of performing further diligence on the contractors to whom they are furnishing bonds, it should serve as a good reminder to carefully vet with whom you do business.