Defense Contractor Fraud

Fraud by defense contractors is as old as the False Claims Act (FCA) itself.  The FCA dates back to the Civil War when contractors were selling the Union Army ailing mules, rancid food and bullets filled with sawdust instead of gunpowder.  The modern amendments to the FCA in the mid-1980’s came at a time when defense contractors were regularly under investigation for massive fraud in their Cold War era contracts.  The same companies under investigation for fraud in defense contracts more than thirty years ago are the same companies who are regularly awarded massive defense contracts today, and who continue to defraud the government along the way.

The one weapon the federal government has been able to rely on to combat defense contractor fraud since the Civil War is the whistleblower.  For more than 150 years, whistleblowers have been exposing defense contractor fraud by filing qui tam complaints under the False Claims Act.

Types of Defense Contractor Fraud

Cross Charging

Generally speaking, the government awards “fixed price” contracts and “cost-plus” contracts. Large contracts may be hybrids of these. In the fixed price contract, the government contractor receives a set price for goods and services no matter what the contractor’s ultimate cost of the goods or services. In a “cost-plus” contract, the government contractor is paid a set amount by the government, plus a negotiated percentage for actual costs as profit. Many defense contractors will have numerous contracts open with the government at any given time. Some of these may be fixed price contracts, others may be cost-plus contracts.  Each contractor is required to track the work done under each contract and to account for costs accordingly.

Cross-charging may occur if the government contractor charges time and materials it spends working on a “fixed-price” contract to a “cost-plus” contract. In this kind of fraud, the government is harmed in both contracts because it did not get the fixed price it bargained for in one, and it got additional, unauthorized charges in the other.

Cross-charging may also occur if a defense contractor performs a government contract at the same time as a contract for a private customer.  The contractor may benefit by shifting more costs to the government contract, and away from its private commercial contracts, to maximize the potential profits on each contract. Some costs are obviously allocated to one contract or the other. For example, the time spent by an employee designing and producing a propeller for a navy ship is properly charged to the government. However, overhead charges or shared expenses for all the contractor’s contracts must be reasonably divided and apportioned among the respective contracts. Government contractors that intentionally shift a disproportionate share of those kinds of costs to the government by cross-charging from a private contract deprive the government of the benefit of its bargain and may violate the False Claims Act.

Improper Product Substitution

Product Substitution Fraud occurs when a government contractor intentionally switches a part (often one of lesser quality) for the part specified in the government’s contract. Defense contracts routinely specify the quality or grade of parts the government wants used. They may also require certain parts to be sourced from American companies to support what are sometimes known as “Buy American” programs. Government contractors may be tempted to use different, cheaper parts or to source them from non-American subcontractors to increase profits. If a government contractor switches a part that has clear specifications without getting approval from the government, it may be in violation of the False Claims Act.

Cost-Plus Fraud

Improper Cost-Plus Charging occurs when a government contractor improperly manipulates a cost-plus contract awarded by the government. In the government’s cost-plus contracts, it agrees to pay a set price for the product (i.e. an airplane) plus a percentage of the contractor’s costs for producing the product. Since there is no negotiated amount for those costs, there is risk that improper costs will be allocated to the cost-plus contract. This commonly happens in two ways.

The first occurs when the government agrees to pay only a percentage of the costs.  A contractor may, in this case, artificially inflate the actual costs on the contract in order to maximize the amount of money reimbursed by the government. This clear-cut fraud is often hard for the government to detect because the contractor may alter its own records, invoices and reports to falsely document its higher costs.

Another way cost-plus fraud occurs is when a contractor manipulates a cost-plus contract by cross-charging, that is, improperly allocating costs from another contract to the government’s cost-plus contract. These are not the only ways a contractor may exploit a cost-plus contract. However it happens, it improperly increases the cost of this kind of contract to the government.

Worthless or Substandard Products or Services Fraud

The federal government spends hundreds of millions of dollars each year buying defense related goods and services, according to the Government Accounting Office.  It procures everything from new weapon systems and munitions to troop supplies.  It also contracts for services to support in logistics, facility maintenance and repairing and upgrading existing equipment.  Because of the sheer number of purchases the government makes, it cannot perform quality checks and testing on all its purchases.  Instead, it relies on the government contractors to be truthful in their representations about the products and services provided.

Unfortunately, representations that a contractor makes to the government about the quality of the product or service provided are sometimes false and intended to conceal the fact that the government is not getting what it paid for.  In cases where the government contractor sells a product or service to the government that it knows is not up to the standard provided for in the contract, or is of such poor quality to be of little to no use to the government, the government contractor may be liable under the False Claims Act.

The government has a strong interest in exposing these frauds not just because of the potential loss of taxpayer dollars.  It is equally important that the government identify faulty or defective equipment that may not perform at critical times because it may present life-threatening risks to service men and woman who use the equipment in performing their jobs.

Violations of the Truth in Negotiations Act (TINA)

When two parties enter a contract, the common law imposes a duty of good faith and fair dealing on each of the parties. It’s a simple premise: each party agrees to act honestly with the other party during the contracting process.  The Truth in Negotiations Act (TINA) is a federal statute dating back more than 60 years that codifies this basic concept.  In no-bid contracts where the government relies solely on one contractor, it requires the contractor to be truthful during all aspects of the contract negotiation, including in disclosing the price charged to the government.

Although TINA originally applied only to defense contracts, it now extends to contracts with other agencies and applies to contracts and subcontracts worth more than $2 million dollars.

A contractor who violates TINA may be overcharging the government under the contract, or otherwise causing the contract pricing to be defective.  The contractor may also trigger additional violations for certifying compliance with TINA when it is not dealing truthfully with the government.  When these violations go to the heart of the contract, they may violate the False Claims Act.