Introduction
This article delves into the evolving legal landscape surrounding surety liability under the False Claims Act (FCA). It examines various legal theories that plaintiffs have employed to hold federal construction sureties accountable under the FCA. Through a review of key judicial decisions, we highlight how government whistleblowers have managed to sustain fraud claims against sureties, emphasizing the significant financial implications these cases can have. The discussion underscores the importance for sureties to be vigilant, as even circumstantial allegations can lead to substantial defense costs and potential liabilities.
The False Claims Act
The FCA imposes civil liability on any a person or company who "knowingly presents, or causes to be presented, a false or fraudulent claim for payment or approval" or "knowingly makes, uses, or causes to be made or used, a false record or statement material to a false or fraudulent claim."1 To establish an FCA violation, the plaintiff must prove: (1) the defendant presented a claim or made a statement to the government; (2) the claim or statement was false or made in a fraudulent course of conduct; (3) with knowledge of its falsity; (4) the claim or statement was material; and (5) caused the government to pay or forfeit money.
Allegations that a construction surety violated the FCA arise most commonly in connection with information submitted in response to a government solicitation. Although not traditional "claims" under the guise of the FCA, such situations give rise to the "fraud-in-the-inducement" theory of the FCA (also known as "promissory fraud"), where the government alleges that a false statement, omission, or misrepresentation caused or induced the government to enter into a contract (and that, but for the misrepresentation, the government would not have awarded the contract or made any payment).2 Under this theory, the pre-award fraudulent conduct taints each subsequent claim as false under the FCA.3 As described by one district court, the difference between fraud in the inducement and false certification theory is "temporal," in that "[w]hile the false certification theory alleges that a contractor certified that it did comply with a statute, regulation, or contractual term when it knew at the time that it did not do so, the promissory fraud theory may allege that a contractor originally certified that it would comply with a law, regulation, or term when it knew at the time that it would not do so."4
The "presentment" element of an FCA claim can be a hurdle to surety liability. Presentment is a practical issue; sureties who underwrite bid bonds, payment bonds, and performance bonds do not typically present any information to the government. The would-be contractor, as the party undertaking performance obligations, drives the process of collecting and packaging information regarding its past performance and technical capability, qualifications and references, compliance documentation, suspension and debarment history, experience of key personnel, details of pricing, and any other information required by the government's solicitation. In this process, bonds are transmitted to the procurement office by the offeror—not the surety.5
The requirement to prove knowledge can also shield sureties, who are one-step removed from the information collected by the principal. Whereas the principal has no basis to claim that it lacked knowledge of itself and its practices, sureties—especially those working with relatively new bond principals—have a more plausible defense that they lack knowledge of the alleged fraud. Notably, however, the "knowing" presentment of a false claim can include one of three mental states. A person knowingly submits a false claim where he: (1) has actual knowledge of false information; (2) acts in deliberate ignorance of the truth or falsity of the information; or (3) acts in reckless disregard of the truth or falsity of the information.6
Pleading Fraud with Particularity
One unique procedural element of FCA actions is the heightened pleading standard that governs fraud allegations. Federal Rule of Civil Procedure 9(b) provides: "In alleging fraud . . . a party must state with particularity the circumstances constituting fraud."7 FCA plaintiffs are required to "at a minimum, describe 'the time, place, and contents of the false representations, as well as the identity of the person making the misrepresentation and what he obtained thereby' . . . 'These facts are often referred to as the 'who, what, when, where, and how' of the alleged fraud.'"8 Failure to plead false claims with particularity may result in dismissal of an FCA action.
Case Studies: FCA Claims Against Sureties
The most notable judicial decisions involving claims of FCA liability by a surety were issued relatively recently. In 2017, two decisions—one from the United States Court of Claims and another from a federal court in the District of Columbia—opened the door for sureties to be dragged into FCA litigation. A 2024 decision from the United States District Court in Texas may keep the momentum moving toward greater exposure for sureties under the FCA.
1 Hanover Insurance Company v. United States
134 Fed. Cl. 51 (2017)
Hanover is, in our view, the earliest reported decision containing a meaningful discussion of a construction surety's potential exposure under the FCA.9 In that case, the FCA arose as both a government claim and an affirmative defense to the surety's equitable subrogation rights.10 The surety and its principal sued as joint plaintiffs challenging the government's default termination of a contract to construct a levee in the Everglades. The surety had tendered a new contractor and pursued equitable subrogation to recoup $24 million it paid to the government as excess reprocurement costs. The government's original answer to the complaint did not include any affirmative defenses or counterclaims. However, toward the very end of discovery, the government amended its pleadings to include a fraud defense and counterclaim based on the principal's alleged submission of a false claim.
As it concerned the surety, the government alleged that by knowingly joining a lawsuit that involved a pass-through claim for amounts the surety knew to have been previously settled, the surety was also liable under the FCA. The government did not limit its fraud arguments to defenses—it also asserted a direct cause of action against the surety under an apparent theory of indirect presentment. The court found that fraud was a viable defense against the surety, and that the allegations of fraud had been pled with sufficient particularity under Rule 9(b). The government adequately pled that the surety "has attempted to practice fraud by seeking to obtain any funds that might be due to [the principal] including [the principal's] $1.1 million pass-through of [subcontractor] claims," despite knowledge that such claims had been settled for $370,000. While the court did not decide the merits of the claim, it indicated that any fraud perpetrated by the performance bond principal would nullify the surety's right to equitable subrogation to funds payable by the government. Thus, not only did the surety face the prospect of losing its rights to subrogation for the entire $24 million damages, it was also potentially liable for the penalties under the FCA. By alleging that the surety "knew or should have known" of fraud in the principal's claim, the government put the surety's entire stake in the project at risk.
2 Scollick ex rel. United States v. Narula,
No. 1:14-CV-01339-RCL, 2017 WL 3268857 (D.D.C. July 31, 2017)
In Scollick, a whistleblower filed a lawsuit against thirteen contractors and named as defendants sureties who furnished bid and performance bonds to those companies, as well as an agent who brokered the bonds. The plaintiff alleged that the defendants misrepresented their service-disabled veteran-owned small business ("SDVOSB") status in order to obtain federal set-aside contracts.11 The sureties, claimed the plaintiff, had issued bonds as attorneys-in-fact for the contractors and deliberately ignored known false statements in SDVOSB certifications. While the court in Scollick initially dismissed the sureties, it allowed the plaintiff to amend and denied the sureties' attempts to dismiss the amended complaint, holding that plaintiff adequately pled theories of indirect presentment and reverse false claim.
In support of its indirect presentment claim, the plaintiff contended that the sureties facilitated schemes to commit fraud by "obtaining facts that [they] knew or should have known violated the government's contracting requirements," concealing those facts from the government, and issuing bonds such as to "give the misleading appearance that [the principals] were qualified to bid on these SDVOSB construction contracts." As indicia of the sureties' knowledge, the plaintiff alleged that the sureties had conducted on-site inspections and tours of the principal's office during the underwriting process; and that they knew or should have known of the principal's non-SDVOSB status based on that due diligence. The plaintiffs also asserted that the sureties should have known that non-veteran operators of the business exerted undue control over its operations, and that the non-veteran operators of the business lacked the skill, experience, and knowledge to have any meaningful involvement.
The court also found a viable reverse false claim against the sureties. According to the court, the performance bond was a representation to "compensate the government for losses sustained should the specifications found in the contract, including the specification that the construction activity be [performed by] a service-disabled, veteranowned small business entity, fail to occur." For every payment made to the allegedly fraudulent principal, the surety was alleged to have actual and constructive knowledge of the fraud, and to have "knowingly avoided an obligation to compensate the government" to the loss associated with that payment. The court rejected the argument that the bonds omitted any express obligation to reimburse for payments made to non-SDVOSB companies because the bond form (Standard Form 25) "extends to 'all the understanding, covenants, terms, conditions, and agreements of the contract.'" Under the court's construction, the surety is the guarantor of all the contractor's underlying obligations—not just the basic obligation to provide labor, materials, and supervision for construction.12
In the end, the sureties in the Scollick case prevailed, but only after a 5-year discovery battle. In July 2022, the court granted summary judgment in favor of the sureties, holding that the evidence did not establish their actual or constructive knowledge of the underlying fraud. The court found that there was no deliberate ignorance or reckless disregard of VA regulations, and that setting such a standard would "impose a significant duty on third party insurers to familiarize themselves with VA regulations before bonding companies." Sureties are not required to master SDVOSB requirements or "double-check the government's verification" of SDVOSB entities. The plaintiff's failure to provide actual or constructive knowledge of fraud under these regulations further precluded any conspiracy claim against the sureties.
3 Wibracht v. Travelers Casualty & Surety Company of America
731 F. Supp. 3d 761 (E.D. Tex. 2024)
Sureties fell out of the FCA picture for a couple of years until last spring, when a surety and its agent were named as a defendant in Wibracht. There, a whistleblower plaintiff alleged fraud in connection with another SDVOSB set-aside contract. The plaintiff alleged that entities presented as SDVOSBs, who were awarded several construction contracts over an 8-year span, were involved in a scheme because a service-disabled veteran did not actually control the entity. The suretydefendants, they claimed, conspired to provide bonds with knowledge that the principals were sham entities.
Defendants filed motions to dismiss on several grounds, including failure to plead presentment of a false claim or knowledge of its falsity with particularity under Rule 9(b). In line with the holding of Scollick, the surety argued that it had no duty to investigate the rules of the SDVSOB program and that nothing in its underwriting program would have revealed facts suggesting that the bond principals engaged in the underlying fraudulent scheme. The court nevertheless denied the motion, finding that the plaintiff met the heightened pleadings standard for fraud. The complaint, according to the court, detailed how the defendants, including the sureties, knowingly participated in a scheme to submit false claims for payment to the government, with specific instances of fraudulent activities and the roles played by each. The Court also found that the conspiracy claims were sufficiently detailed, showing an unlawful agreement and overt acts in furtherance of the conspiracy.
The surety-defendants in Wibracht raised an additional argument—one that was not raised in Scollick—which the court also rejected. Specifically, the sureties alleged that FCA suits against bond issuers underwriting high-risk contractors are contrary to public policy, will increase the cost of bonds to the government, and will make it more difficult for small businesses to do business. In short, the sureties argued that "federal policy favors federal bonding . . . so allowing suits such as this one to proceed is contrary to federal policy." The court, with little discussion or analysis, declined to make such a finding. As of this writing, the case remains in litigation.
Conclusion
Surety liability under the FCA is a relatively new and evolving concept. Historically, sureties appeared insulated from FCA liability due to their indirect dealings with the government. However, recent judicial decisions have demonstrated that the theory of indirect presentment and the broad interpretation of "knowledge" under the FCA can be leveraged to involve sureties in FCA litigation based on minimal allegations related to their underwriting activities. These cases, primarily focused on small-business fraud, suggest that sureties can be implicated if there is any indication of their knowledge of fraudulent activities.
Courts have shown a reluctance to dismiss such suits at the early stages, provided that the plaintiffs meet the minimum pleading requirements. Additionally, federal trial courts have not been receptive to public policy arguments aimed at exempting sureties from FCA suits, as seen in the Wibracht case.
The implications for the surety industry are significant. The potential for increased litigation costs and the risk of substantial financial penalties underscore the need for sureties to be vigilant in their underwriting processes. As the legal theories and judicial interpretations continue to develop, sureties must stay informed and proactive in addressing these challenges to mitigate their risks under the FCA.
Footnotes
1 31 U.S.C. § 3729.
2 Harrison v. Westinghouse Savannah River Co., 176 F.3d 776, 787 (4th Cir. 1999).
3 United States ex rel. Marcus v. Hess, 317 U.S. 537, 543-44 (1943).
4 United States ex rel. Durkin v. Cnty. of San Diego, 300 F. Supp. 3d 1107, 1117 (S.D. Cal. 2018) (emphasis in original).
5 The Miller Act mandates that "a person must furnish" payment and performance bonds as a condition precedent to award of federal projects in excess of $100,000 and which involve the "construction, alteration, or repair of any public building or public work." 40 U.S.C. § 3131(b). The current FAR requirement is $150,000. See https://www.acquisition.gov/far/28.102-1. The "person" submitting the payment and performance bonds is almost always the would-be contractor. Additionally, most solicitations for construction require "the bidder" to furnish a bid guarantee securing its price proposal. 48 C.F.R. § 52.228-1 Bid Guarantee (SEP 1996).
6 31 U.S.C. § 3729(b).
7 Fed. R. Civ. P. 9(b).
8 United States ex rel. Kyer v. Thomas Health Sys., Inc., 756 F. Supp. 3d 75 (S.D.W. Va. 2024).
9 Earlier cases have named sureties as FCA defendants but lack meaningful discussion of the claims against the sureties. United States v. Macomb Contracting Corp., 763 F. Supp. 272 (M.D. Tenn. 1990) (surety was originally named as an FCA defendant, but was voluntarily dismissed with prejudice by the government before the case started); United States ex rel. McGough v. Covington Tech. Co., 967 F.2d 1391 (9th Cir. 1992) (whistleblower voluntarily dismissed FCA claims against surety). In one case filed under sealed, the surety was a defendant in a $4.47 million settlement of FCA claims of SBA fraud. United States ex rel. James Hagan v. Northland Associates, Inc., No. 5:17-cv-00036-GTS-TWD (N.D.N.Y. 2017).
10 The FCA is both a sword and a shield, meaning that false claims may be alleged as a cause of action, an affirmative defense, or both. In addition to the FCA, the Contract Disputes Act of 1978 may give rise to an anti-fraud remedy that, if proven, can result in forfeiture of part or all of a claim against the government. 41 U.S.C. § 7103(c); see generally Anthony LaPlaca and Edward Arnold, Fraud and Forfeiture: Cautionary Tales of a Construction Claim Gone Wrong, The Construction Seyt (Sep. 6, 2022), available at: https://www.constructionseyt.com/2022/09/ fraud-and-forfeiture-cautionary-tales-of-a-construction-claim-gone-wrong/.
11 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.
12 The Court did dismiss the reverse false claims count against the brokerage firm and individual owner of that firm, on the grounds that they were not obligors on the payment and performance bonds.
Originally published by Summer Edition of Surety Bond Quarterly
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
