--Mark Twain

The statutory phrase "known to be false" does not mean "scientifically untrue"; it means "a lie"... Likewise, the statutory phrase "known to be false" does not mean incorrect as a matter of proper accounting methods; it means a lie.

--United States ex rel. Hagood v. Sonoma County Water Agency, 81 F.3d 1465, 1478 (9th Cir. 1996) cert. denied, 519 U.S. 865, 117 S.Ct. 175 (1996)

One of the more common substantive defenses to a federal false claims action is the "contract interpretation" argument. The core of this argument is the assertion that the claim is not false because it is grounded in a legitimate, reasonable interpretation of relevant contract provisions (or Cost Accounting Standards or statutes or regulations). The argument addresses both the "falsity" and the "scienter" requirements of the False Claims Act ("FCA")1:

• the claim is not "false" because the law requires objective falsehood2 and, at worst, a claim based on a legal argument lies in the gray area between truth and falsity; and
• where there is a legitimate difference of opinion, there can be no knowing intent to defraud, as "knowing" is defined in the Act.

In other words, a claim based on a disputed contract interpretation or legal argument is not a lie because it is not false, and it certainly isn't a damn lie, because under the circumstances there could have been no intent to defraud.

A 1999 decision from the Ninth Circuit, however, flatly held that even where a contractor's contract or statutory interpretation is reasonable, its claim can still be false. In United States ex rel. Oliver v. Parsons Co., 195 F.3d 457 (9th Cir. 1999), cert. denied, 530 U.S. 1228, 120 S.Ct. 2657 (2000), the relator asserted that the defendant violated Cost Accounting Standards ("CAS") by fraudulently using an affiliated subcontractor to reduce its direct labor expense and increase its overhead rate. The district court had ruled that the defendant's interpretation of CAS was reasonable, so that the "falsity" requirement was not met. The Ninth Circuit disagreed:

[T]his case involves regulations that, while unquestionably technical and complex, are not discretionary. Their meaning is ultimately the subject of judicial interpretation, and it is [defendant's] compliance with these regulations, as interpreted by this court, that determines whether its accounting practices resulted in the submission of a "false claim" under the Act....

195 F.3d at 463. In other words, truth or falsity can be determined retroactively; when one makes a legal argument grounded in an interpretation of a regulation (or a contract provision), one may not know whether it is "false" until later, when a court finally decides the issue.

In fairness, the Ninth Circuit also noted that where there is a good faith issue of interpretation, a defendant may be able to avoid liability because there will have been no scienter.3  But the notion that one cannot know whether one's statement is "objectively false" until months or years later when a court finally issues a decision, is disconcerting. Despite the Ninth Circuit's careful parsing of the distinction between "falsity" and "knowingly false", it is difficult to reconcile that concept with the courts' frequent description of a false claim as a "lie."

What has been the outcome when courts address a contract interpretation/legal argument issue? Many of the decisions are, in fact, based on the scienter argument, i.e., because there was a good faith disagreement, or good faith reliance on the advice of counsel, even if the claim was false it was not knowingly false. But there are other decisions in which the scienter analysis was more indirect, and where the courts relied on other types of evidence in their evaluation of this issue. In many of these decisions, the outside evidence is more relevant to the question of falsity than to the scienter analysis.

The following discussion focuses on a few of these other cases, looking at the kind of evidence that is most likely to legitimize a particular contract interpretation. The cases are grouped into three general categories. First are those in which the government's position on a regulatory or contractual interpretation is not clear, either because the issue is novel or because the evidence shows an actual disagreement within the government. Second, there are a few decisions in which the court is outraged at some egregious conduct or heavy-handed interpretation posed by the government. In both of these instances, the courts are likely to make a finding of no liability. The third category of cases involves those in which the contractor's interpretation is unsupported by any extraneous evidence whatsoever and is deemed to be implausible; in these cases, courts are apt to regard "intent" as a foregone conclusion and make an affirmative finding of liability.

Disputes Within the Government

Perhaps the surest way to prevail on a contract interpretation argument is to demonstrate that there is a genuinely disputed legal issue pertaining to a mandatory statute or regulation that directly affects the contract--particularly if there is a dispute within the government's own ranks.

The premier example involving disputed legal issues is United States ex rel. Hagood v. Sonoma County Water Agency, 81 F.3d 1465 (9th Cir. 1996) cert. denied, 519 U.S. 865, 117 S.Ct. 175 (1996).4  In Hagood, the US Army Corps of Engineers ("Corps") began a dam construction project and in connection with that project, acting under the authority of the Water Supply Act of 1958,5  contracted with the Sonoma County Water Agency to shoulder a portion of the costs in return for access to the eventual water supply. The Water Supply Act "provides the relevant government officials with fairly wide discretion" to allocate costs among the ultimate beneficiaries of the construction:

The cost of any construction or modification authorized under the provisions of this section shall be determined on the basis that all authorized purposes served by the project shall share equitably in the benefits of multiple purpose construction, as determined by the Secretary of the Army or the Secretary of the Interior, as the case may be .... [B]efore construction or modification of any project including water supply provisions for present demand is initiated, State or local interests shall agree to pay for the cost of such provisions....

Hagood, 81 F.3d at 1477, quoting Water Supply Act (emphasis added).

The Water Agency's contract with the Corps stipulated that it would pay for 27.76 percent of the costs of the dam project, based on the Corps' calculation of relative benefit. Subsequent changes in the scope of the project made clear that the Water Agency's relative benefit would be substantially in excess of 27.76 percent, but the contract was never amended and the Water Agency paid only that amount.

The plaintiff (relator) who brought the qui tam action argued that the statute required an amendment of the contract between the Corps and the Water Agency to reflect the true percentage of benefits--so that the contract allocation itself was "false" because it had not been amended to comply with the statute. The Ninth Circuit disagreed for two reasons. First, it found that the statute gave "fairly wide discretion" to the government to negotiate an appropriate cost-sharing arrangement; second (and more importantly), there was a disagreement even within the Corps as to whether or not renegotiation of the contract terms was required by the statute.

How precise and how current the cost allocation needed to be in light of the statute's imprecise and discretionary language was a disputed question within the Corps.... As this court held in Hagood's prior appeal, "[t]o take advantage of a disputed legal question, as may have happened here, is to be neither deliberately ignorant nor recklessly disregardful."

81 F.3d at 1477-1478. In other words, even though the Water Agency was aware that some people within the Corps believed that its share of costs should be higher, its claims submitted under the unamended contract were not false. "Even viewing Hagood's evidence in the most favorable light, that evidence shows only a disputed legal issue; that is not enough to support a reasonable inference that the allocation was false within the meaning of the False Claims Act." Id. Nor were the Water Agency's cost submissions knowingly false:

Hagood's evidence does not suggest that the Water Agency lied; it suggests only that the Water Agency knew that the Corps' responsibility with regard to allocating costs was not clear, and that the Corps might exercise its authority in a number of ways. At most, Hagood has shown that the Water Agency took advantage of a disputed legal issue. This, as we have previously held, is not enough.

81 F.3d at 1478-1479.6  Thus, it was the lack of clarity in the Water Supply Act, as evidenced by a disagreement even among government personnel, that made it impossible to find either falsity or scienter in the contractor's interpretation.

Lack of clarity in contract requirements unrelated to statutes or regulations can also help avoid FCA liability, where the evidence suggests a split of opinion among the relevant government employees. For example, in United States ex rel. Ashok Bhatnagar v. Kiewit Pacific Co., 2000 U.S. Dist. LEXIS 14400 (N.D. Cal. 2000), the contractor had billed for additional work that the relator asserted was covered by the original contract price. The contractor argued that the extra work billings were proper because the work had expanded, and it pointed out that the government's authorized representative had approved the extra billings. The relator disagreed, largely because an audit by the authorized representative's superiors had determined that the billings were not proper additional charges. The court gave substantial credence to the relator's position but nevertheless gave summary judgment to the defendant: "These financial irregularities, however, are insufficient to state an FCA claim against Kiewit. A qui tam relator's allegation that a contractor failed to comply with contractual requirements is a contract dispute and not a proper basis for an FCA claim." 2000 U.S. Dist. LEXIS at 22. Here, one government employee accepted the contractor's interpretation, while others did not. In this court's view, that amounted to a contract dispute and nothing more.

In order to prevail on a "disputed legal issue" argument, however, it is not necessary to prove the existence of an internal dispute within the government. The argument may also prevail where there simply is no established interpretation of a contract term or regulation. For example, in United States ex rel. Swafford v. Borgess Med. Ctr., 98 F. Supp. 2d 822 (W.D. Mich. 2000), a qui tam plaintiff argued that various physicians falsely charged for venous ultrasound studies because the physicians did not review the raw ultrasound technical data, relying instead on summaries of that data prepared by non-physician technicians. The plaintiff relied, in part, on the definition of "physician-delivered services" that was included in a handbook published by the Health Care Financing Association ("HCFA") to provide guidance to doctors in submitting claims. The relator argued that without looking at the actual underlying test data, the physicians were not themselves providing the services and therefore could not charge for them.

Relying on Hagood, as well as Luckey v. Baxter Healthcare Corp., 183 F.3d 730 (7th Cir. 1999) cert. denied 528 U.S. 1038, 120 S. Ct. 562 (1999), the court in Swafford explained:

[T]he dispute over whether defendants performed an "interpretation or reading" of the "results of the test" merely highlights the ambiguity of those undefined terms in the Provider Handbook. Accordingly, plaintiff's attempt to distinguish Luckey devolves to a dispute over the meaning of the terms governing the delivery of the professional components of physician services, rather than a factual claim as to whether defendants (at a minimum) actually performed some work by reading and/or reviewing work performed by the technician/technologists. Such a legal dispute is, however, insufficient to establish falsity under the FCA....

Swafford, 98 F. Supp. 2d at 831.7  The terms in the quasi-regulatory Provider Handbook had never been defined or addressed by the courts or even by HCFA, and the court was unwilling to predicate FCA liability on resolution of that particular novel legal issue.

The Moral Outrage Cases

Occasionally, defendants win these cases when the government's strained interpretation or questionable conduct succeeds in arousing the court's righteous indignation. In United States v. Data Translation Inc., 984 F.2d 1256 (1st Cir. 1992), then-Judge Breyer analyzed an old version of the Multiple Award Schedule "Certificate of Established Catalogue or Market Price" and decreed that he did not really care what the literal words meant; no reasonable person would read them that way. Thus the defendants were entitled to a directed verdict on the government's breach claim even though they had not disclosed each and every piece of information relating to their commercial customer discounts, as required by the literal words of the contract; and a fortiori, a directed verdict on the breach claim dictated a finding in favor of defendants on the False Claims Act count. Judge Breyer was influenced by the government's admission that no contractor had ever interpreted the certification as the government now claimed it should be interpreted:

[A] system that lays down a literal rule with which compliance is inordinately difficult, turning nearly everyone into a rule violator, and then permits the agency to pick and choose when and where to enforce the rule, is obviously undesirable. It destroys in practice the very hope of rationally cabining agency discretion that the rulemaking process promises in principle.

984 F.2d at 1262. See also, United States v. Krizek, 859 F. Supp. 5, 10 (D.D.C. 1994) ("The Court will not impose False Claims Act liability based on such a strained interpretation of the [relevant regulation]. The government's theory of liability is plainly unfair and unjustified.")

Similarly, the court in H.B. Mac Inc. v. United States, 36 Fed.Cl. 793 (Fed. Cl. 1996) rev'd on other grounds, 153 F.3d 1338 (Fed. Cir. 1998), made short shrift of the government's fraud counterclaim, which was based on an allegedly false certification of small woman-owned business status. The court found the SBA regulations governing size status to be "at least confusing and ambiguous," 36 Fed.Cl. at 814, and the decision might have relied on that conclusion alone. However, the Mac opinion also gave substantial weight to the apparent sincerity of the contractor, which had diligently consulted with counsel in an attempt to stay within the limits of the regulations. More significantly, the court focused on the outrageous conduct of the government's investigators, who showed up with their guns to ask questions about who controlled the business, then lied about their purpose and referred disparagingly to the president of the company as a "housewife" and a "diaper changer." The court clearly was outraged by this conduct, and refused to find "knowing falsity" in the company's small disadvantaged business certification.

Implausible Interpretations

As the previous cases suggest, where a contractor baldly asserts that its claim was proper under its own reasonable interpretation of a contract term, its success may depend on whether there is independent corroboration of its interpretation so that some level of reasonableness attaches. The more far-fetched and unsupported the interpretation, the more likely it is that the courts will assume that only someone acting with an intent to defraud or in reckless disregard would assert such a position.8 

In Commercial Contractors Inc. v. United States, 154 F.3d 1357 (Fed.Cir. 1998), the Federal Circuit clearly articulated the standard for a "reasonable interpretation." There, the contractor submitted claims for full payment even though it had failed to excavate the entire quantities called for by its contract, on grounds that it reasonably interpreted an allegedly ambiguous provision. The court found no ambiguity and ruled against the contractor, despite its argument that "the effect of such a decision would be to expose any contractor who submits claims under an erroneous contract interpretation to liability under the FCA or the CDA [fraud provisions], even if the contractor did not deliberately conceal or misstate any facts to the government." 154 F.3d at 1366. As the court explained:

The question for the court in cases involving issues of contract interpretation is whether the contractor's asserted interpretation is so plainly lacking in merit that the requisite state of mind can be inferred.

If a contractor submits a claim based on a plausible but erroneous contract interpretation, the contractor will not be liable, absent some specific evidence of knowledge that the claim is false or of intent to deceive. Yet when a contractor adopts a contract interpretation that is implausible in light of the unambiguous terms of the contract and other evidence (such as repeated warnings from a subcontractor or the fact that the interpretation is contrary to well-established industry practice), the contractor may be liable under the FCA or the CDA even in the absence of any deliberate concealment or misstatement of the facts. Under such circumstances, when the contractor's purported interpretation of the contract borders on the frivolous, the contractor must either raise the interpretation issue with the government contracting officials or risk liability under the FCA or the CDA.

154 F.3d at 1366. In this case, both widespread industry practice and the repeated warnings of a subcontractor supported the government's interpretation, not the contractor's.

This concept of plausibility is found in a number of other cases. For example, in UMC Elec. Co. v United States, 43 Fed.Cl. 776 (Fed. Cl. 1999), a contractor who submitted a final invoice for materials based on "actual costs" was unsuccessful in persuading the court that it interpreted that term to mean "purchase order price" rather than "actual costs incurred." Previous invoice submissions by the contractor demonstrated that it knew the difference between the price stated on a purchase order for materials, and the actual cost of the materials, so that its hyper-technical interpretation of these terms on the final invoice was not credible.

Similarly, in United States ex rel. Cantekin v. Univ. of Pittsburgh, 192 F.3d 402 (3rd Cir. 1999), defendant's argument that he reasonably interpreted the instructions on a grant application was not enough to support summary judgment in his favor, where he failed to disclose non-federal research grants that he was receiving from pharmaceutical companies even though the instructions printed on the grant application stated that he was to list "all" of his other sources of funding. Although the district court had found that the instructions, taken as a whole, were ambiguous and unclear, the Third Circuit disagreed because of the literal words and also because there was no evidence that any other grant applicants had adopted the defendant's interpretation. In short, his alleged interpretation was deemed to be implausible.

Conclusion

In the final analysis, there is no bright-line test for establishing FCA liability--or avoiding it--when the issue revolves around matters of contract or regulatory interpretation. The mischief that is possible with effectively retroactive determinations of falsity is obvious, and there is some anecdotal evidence that prosecutors and relators are pushing the envelope on contract interpretation issues in the hope that, ultimately, a court will take their side of the argument. Once the claim is deemed to be "false", it is arguably easier to demonstrate that it was knowingly false.

Contractors seeking to rely on a contract or regulatory interpretation as to issues that are not well-established need to be mindful of the Federal Circuit's admonition in Commercial Contractors that ambiguities of interpretation should be highlighted and disclosed. Where that is not possible, their evaluation should focus on whether there is a genuine dispute and if so, what kinds of evidence of the dispute is available. A contract or regulatory interpretation that is unadorned by widespread industry practice, disagreement within the government, plausible construction of the literal words, reliance on the advice of competent counsel, or outrageous government conduct may ultimately be regarded by the government and the courts as a lie.

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1 31 U.S.C. §§3729-3733 (1999). In order to establish a violation of the Act, the government or the relator must establish that (a) a claim was submitted to the government; (b) the claim was false; and (c) the claimant knew that it was false.

2 See, United States ex rel. Roby v. The Boeing Co., 100 F. Supp.2d 619, 625 (S.D. Ohio 2000): "At a minimum, the FCA requires proof of an objective falsehood."

3 "[T]he reasonableness of Parson's interpretation of the applicable accounting standards may be relevant to whether it knowingly submitted a false claim...." 195 F.3d at 463 (emphasis added).

4 This case was brought and decided prior to the decision of the U.S. Supreme court in Vermont Agency of Natural Res. v. United States. ex rel. Stevens, 529 U.S. 765, 120 S.Ct. 1858, 146 L.Ed.2d 836 (2000), which held that States and State agencies are not subject to FCA liability.

5 43 U.S.C. §390b (2000).

6 Contractors have also prevailed in a few cases in which they have been able to demonstrate that there is a disagreement within the government over the factual issue that is at the heart of a False Claims Act complaint. In Crane Helicopter Servs. Inc. v. United States, 45 Fed.Cl. 410 (1999), the contractor submitted an equitable adjustment claim and the Forest Service counterclaimed, asserting violations of the False Claims Act, the Contract Disputes Act anti-fraud provision, and a Special Plea in Fraud. At issue was whether the contractor was providing a Bell 204B "super" helicopter, as called for in its Forest Service contract, or something else. The Forest Service adamantly maintained that the aircraft in question had either been altered so substantially as to make it something other than a Bell 204B, or that it had not been a Bell 204B to begin with. The contractor defended, based on repeated interpretations by the Federal Aviation Administration, on grounds that the aircraft was in fact a Bell 204B.

The court in Crane made a finding that the contractor and the FAA were correct in their conclusion that the helicopter was a Bell 204B, and that the Forest Service failed in its burden of proof. Thus, there was no false statement and no liability. The court also ruled that, even if there were a false statement, the government had failed in proving that the statement was made with the requisite intent to deceive. Contractor personnel had made reasonable inspections of the aircraft when it was purchased, had made repeated inquiries to the FAA when questions about the identity of the aircraft arose, and had consistently responded when the Forest Service raised concerns.

7 The court also held that there was no "knowing" falsity, 98 F. Supp.2d at 832-833.

8 If the government shares the contractor's interpretation (even though the relator does not), the matter is generally regarded as a contract dispute and not as a proper subject for False Claims Act liability. See, United States ex rel. Ashok Bhatnager, supra; United States ex rel. Butler v. Hughes Helicopter Co., 1993 WL 841192 (C.D.Cal. 1993). See also, United States. ex rel. Lindenthal v. General Dynamics Corp., 61 F.3d 1402 (9th Cir. 1999), where government witnesses actually testified in support of the contractor's interpretation of what the court acknowledged was an ambiguous contract provision.

Copyright © 2001 by The Bureau of National Affairs, Inc., Washington D.C.