LawFlash

Defense Production Act, Rated Orders & the FCA: Long-Term Liability Amid a Current Crisis?

March 26, 2020

Companies complying with orders under the Defense Production Act should be aware, and prepared to manage, potential False Claims Act liability that arises with government funding.

As the current global and national crisis of the coronavirus (COVID-19) is developing, the US government is weighing its options in connection with the procurement of goods and services to meet the needs of its citizens. One of the tools available to the government is the Defense Production Act (DPA), which allows the government to assign a priority rating to a contract and to direct companies operating in the private sector to meet government delivery requirements before addressing the requirements of a company’s commercial customers.

These orders may require private companies with a US presence to prioritize delivery of materials and services to the federal government ahead of existing commercial orders when those materials or services have been designated as strategic or critical as part of a national emergency. These designations allow the government to require companies to meet the needs of the emergency prior to completing existing commercial orders.

Although orders received under the DPA may be novel for companies that generally do not deal directly with the government, events like this have occurred before. The private sector has been similarly called on to assist the government during the aftermath of Hurricane Katrina and the related relief and rebuilding of New Orleans and the Gulf Coast region. The government also infused money into the economy during the 2008 financial crisis. While these circumstances allow companies to be involved in assisting communities to deal with an emerging crisis, and may even provide additional opportunities, companies should consider the implications associated with acceptance of federal funds and prepare to manage any additional risks.

Despite the need to respond quickly to government orders for goods and services under the DPA, any time the government infuses money into commerce, the potential for liability arises. This is no less true during times of crisis. This paper addresses the potential liability that can arise under the False Claims Act (FCA), which holds companies receiving federal funds liable for a variety of false and fraudulent conduct. When providing goods and services to the federal government, companies should be particularly alert to flags for risk that may arise when responding to federal demands.

It also is important to understand that the statute of limitations is particularly long and issues may not come to light until years later. Moreover, the FCA permits individual whistleblowers, or “relators,” to file an action on behalf of the federal government and seek a portion of any recovery. As such, companies tasked with assisting during this national emergency should be aware of the risk factors that, if left unattended, could be used by the potential whistleblowers seeking to benefit personally from such actions, to allege violations of the FCA. 

What is the Defense Production Act?

The Defense Production Act of 1950 (DPA), 50 USC § 4501, et seq., was enacted during the Korean War and gave the president authority to direct production in the private sector to support the war effort. The DPA has been reauthorized many times since its inception and expanded beyond just wartime needs to include efforts to support national emergencies and preparedness. Once the DPA is invoked, federal agencies can use it to direct US companies and non-US companies with a US presence to prioritize sale of essential goods and materials to the federal government.

On March 13, US President Donald Trump issued a determination of emergency under the Robert T. Stafford Disaster Relief and Emergency Assistance Act, 42 USC § 5195, et seq. (Stafford Act) as a result of the expanding Coronavirus Disease, SARS-Cov2 which causes COVID-19. On March 18, President Trump issued an executive order authorizing use of the DPA to acquire “health and medical resources needed to respond to the spread of COVID-19.”

As a result, all companies in the United States now must comply with the provision of the DPA’s regulations if their services are requested under an appropriately issued “rated” order. All US companies are already subject to US jurisdiction, but the invocation of emergency authority under the Stafford Act and the DPA has expanded the manner in which that jurisdiction may apply¾e.g., the government may now require companies to reallocate distribution or manufacturing of products and services which previously were not subject to such action.

The DPA is effectively carried out through a number of actions, including through “rated orders” which, when received, must be given preference over all unrated orders as necessary to meet the required delivery date. When appropriately issued, this requires the reprioritization of orders to fulfill the government orders prior to completing existing customer orders. Rated orders can be designated through the assignment of one of two codes, in increasing priority: A “DO” rated order or a “DX” rated order. DX orders take priority over DO orders; both DX and DO orders take priority over all commercial orders. In addition to the DO/DX rated orders, the government, through the Department of Commerce, may also issue a “Directive” requiring performance of a particular action. Directives take precedence over rated orders, even DX rated orders.

Should your company receive a rated order, you must provide the requested products or services to the government by the requested delivery date, even if that results in delay for preexisting commercial orders. While companies are required to comply with rated order requests or Directives, the regulations permit a few exceptions that can allow a company to reject a rated order. For more detailed information regarding the DPA and rated orders, please see our March 23 LawFlash, “Government Mandatory Orders of Company Products and Services during COVID-19 Emergency.”

Compliance with rated orders highlights the need to identify how and where this compliance may increase a company’s risk of potential FCA liability. This is especially true for companies that have never before contracted with the government, or who previously only have provided limited goods or services under federal government contracts.

What is the False Claims Act?

The FCA, another wartime statute, was enacted in 1863 by President Abraham Lincoln in response to defense contractor fraud occurring during the American Civil War. The FCA was designed to ensure that companies contracting with the government dealt fairly and honestly, and it provides for substantial penalties for those who do not. The FCA prohibits any person from knowingly submitting or causing others to submit false claims to the government and provides for treble damages as well as substantial penalties and fines. It also allows whistleblowers to share in a portion of any recovery. The four elements for the FCA: submission of a claim, falsity, materiality, and knowledge are discussed below.

Submission of a claim can occur in various ways. This includes direct claims for payment submitted to government entities, such as to the Department of Health and Human Services or Department of Commerce. This also occurs when one party causes a claim to be submitted to the government, such as when subcontractors make misrepresentations leading a government contractor to provide false claims to the government.

Falsity may be established either by proving the claim to the government was factually false or legally false. Factual falsity occurs whenever a claim to the government is incorrect based on a factual discrepancy: such as billing the government for a shipment of 1,000 face masks when, in reality, only 900 had been shipped. The more nuanced legal falsity occurs because of a violation of a legal condition of payment. A violation of one of these legal requirements, such as licensing requirements for supply procurement or other industry specific regulations, may be used to argue that a claim was legally false, depending on the circumstances.

False claims submitted to the government are only actionable if the falsity of the claim was material to the government’s decision to purchase. The US Supreme Court has explained that this is a rigorous and demanding standard and does not encompass minor or insubstantial noncompliance with statutory or regulatory requirements.  But, for omissions or noncompliance of material facts or regulations that strike at the very essence of the bargain, companies risk liability.  And while the government may not simply assert that every applicable regulation is material, companies should nonetheless be familiar with all applicable regulations and statutes and understand that materiality can generally be viewed through an analysis of whether some aspect of the goods or services might be important to a customer in making a decision to pay for those goods or services.

The final element, knowledge, can be established through actual knowledge, reckless disregard, or deliberate ignorance. Individuals who knowingly and intentionally submit false claims are said to have acted with actual knowledge. But FCA liability may be premised on reckless disregard and deliberate indifference, holding accountable even those who did not possess literal knowledge of the wrongdoing and those who caused others to submit false claims. Reckless disregard, akin to a gross negligence standard, can be established when there are such red flags that the purported “falsity” was known or should have been known. Similarly, deliberate ignorance, while less commonly relied upon, holds liable those companies who choose to remain oblivious to “clear risks” and take deliberate action to avoid the confirmation of wrongdoing.

The FCA has been one of the government’s most effective recovery tools in the past several decades and those recoveries have been aided by qui tam whistleblowers, known as relators. The FCA provides for generous awards for these qui tam relators who inform the government of purported misconduct. Many relators were former employees who raised issues of potential noncompliance first within their companies. The FCA also allows their lawyers to recover attorneys’ fees.  

Potential Risk Factors Related to the DPA

Companies can monitor several key risk factors to minimize litigation exposure when responding to DPA rated orders during the COVID-19 crisis. Some of the potential risk factors include: pricing; supply chain; timing; and contractual waivers.

Pricing Support

Government contracting officers have certain duties and obligations to ensure that the government spends taxpayer dollars judiciously. In addition, the DPA provides price protection for the government:

No person shall discriminate against orders or contracts to which priority is assigned or for which materials or facilities are allocated … by charging higher prices or by imposing different terms and conditions for such orders or contracts than for other generally comparable orders or contracts, or in any other manner. [DPA, at Section707]

Because rated orders often are placed to a single company on an emergency basis, the contracting officer frequently will look to the company to provide documentation demonstrating that the price offered to the government is fair and reasonable. The contracting officer relies on this documentation when agreeing to the prices to be paid by the government. Similarly, the company should consider terms and conditions offered to commercial customers such as quantity discounts, FOB freight, and prompt-pay discounts when determining the government’s price for products and services included in a rated order. Additionally, if the supplier provides ancillary support for products, whether through product maintenance or usage guidance, then the government purchaser must also receive similar support as part of its pricing. Because FCA liability is often looked at in hindsight, it will be important to maintain all documentation supporting the pricing structure.

Capacity and Supply Chain Compliance

Rated orders require strict compliance with the requested delivery date in the order and, unless companies have vertically integrated their supplies, companies rely on a network of vendors and suppliers to manufacture, assemble or produce their products or provide their services. When analyzing capacity and capabilities, the company should consider downstream suppliers of necessary components or materials.

While the company is required to issue rated orders to suppliers from which they are purchasing in support of their own rated orders, they may need to look for alternate sources of supply to meet the delivery date required by the government. This requires companies to understand who is in their supply chains and to ensure that requirements related to manufacturing or production account for the ability of suppliers to impact the process and the delivery schedule. While most companies have a general understanding of their supply chain—whether domestic or global—the level of details and overall knowledge vary and, in a DPA context, can introduce additional risk related to, at least, delivery delay, if not quality.

Downstream suppliers of materials or components should meet the same standards as required of downstream suppliers for commercial purchasers (e.g., if the manufacturer requires suppliers to meet certain minimum specifications, use those suppliers or suppliers that are able to meet the minimum specifications of usual suppliers). If your company evaluates suppliers in a standardized way, that same procedure should be utilized in these circumstances.  This may result in additional complications particularly with new suppliers or sub-contractors, and may warrant heightened due diligence of the workmanship by suppliers.

It also is important to evaluate whether those downstream suppliers are able to satisfy requirements that are part of the standard commercial requirements (e.g., country of origin requirements). Essentially, performance under the order, and any deviations from typical order processing, should be scrutinized more critically than a typical commercial contract—not only because of the urgency of the request and the logistical hurdles facing the private sector—but because of the added layer of potential FCA liability.

In addition, the regulations require that rated orders be “flowed down” to suppliers that assist in the fulfillment of those orders (e.g., that requirements within the order are conveyed to the downstream suppliers). A failure to properly flow down information to suppliers can also raise concerns. Information required to be provided to suppliers can include requirements for particular sourcing (e.g., domestic and not global), the use of particular manufacturing standards, or supplier qualification (such as meeting a particular US government MIL-STND or other similar requirement).

When companies inconsistently flow down these provisions, additional risks may arise regarding the company’s inability to meet a rated order—in essence, if a supplier is unaware that it is subject to rated orders through flow down provisions, that supplier could decline to shift production or delivery prioritization to meet its customer’s rated order requirements. Absent alternative sources that can meet the same mandates of the rated order, a company could be left with delivery or other delays or potential quality issues that increase potential liability.

Timing

Similar to the pricing component of the rated orders, the ability to perform in the time required is an essential risk factor to be analyzed substantively. If the company is not fulfilling the rated order from stock on hand, it should ensure that downstream suppliers are able to meet the needs of the supplier in a timely fashion, and obtain any and all confirmations in writing. The company is ultimately responsible for meeting the delivery schedule established in the orders received from the government.

Delays in delivery do not always enhance liability as there may be legitimate reasons for a particular delay. There is, however, enhanced risk in these circumstances. While the government may accept late delivery of a product or provision of a service, potential whistleblower liability may still arise years later if, for example, a whistleblower comes forward with evidence that a supplier knew that delay was likely to arise, but accepted the order regardless of that risk and the timing later is viewed as a material issue.  Heightened due diligence during this critical time can pay dividends later when establishing compliance and adherence to government contracting requirements.

Waivers

Due to the often-emergency nature of rated orders, the company may need to seek waivers of certain regulatory requirements. For example, as a result of the COVID-19 outbreak, the medical community is experiencing a significant shortage of personal protective equipment (PPE). The company may have PPE available to sell to the government that does not comply with country-of-origin requirements in government contracts. In such cases, the government can and may waive those requirements based on the non-availability of a sufficient quantity of compliant PPE.

While the waiver may be necessary to meet the government’s urgent need, it is incumbent on the company to protect itself in these circumstances by ensuring that the waiver is properly obtained. It is critical that the company clearly notifies the government of any noncompliance for which it requires a waiver, that the waiver is in writing, and that the waiver is issued by someone within the government with authority to provide the waiver. When seeking a waiver, it may later be critical to demonstrate who provided the waiver and that such person had authority to provide such a waiver for the entities receiving the goods. These waivers could become essential evidence. As a result, it is important that efforts are undertaken to ensure that the requisite person, with the requisite authority, is signing the waiver and that these efforts and the waiver itself are documented.

Compliance Issues to Remember

All of these risks require ensuring an operational compliance function within the entity and established record-keeping policies. This also requires taking concerns raised internally seriously. An employee raising concerns today may be the whistleblower filing a qui tam FCA complaint years from now, when the immediate health risk has subsided. Government entities that might be willing to overlook non-compliance or non-conformity in products in 60 days in the midst of the current crisis, may take a different view when a complaint has been filed years from now.

Conclusion

As with most legislation, violations of the FCA and the DPA are punishable by fines, treble damages (for the FCA) and jail terms (for the DPA). As such, the decisions made by your company in the days and weeks ahead could have significant repercussions for managing potential civil and criminal litigation. If your company receives a rated order, ensure that the order complies with appropriate regulations, includes an explicit delivery date, has a written or electronic signature, and explains that it is a rated order certified for national defense pursuant to the Defense Priorities and Allocations System regulations.

Internally, ensure that your team is acting in accordance with the same standards it adheres to during commercial transactions, reinforce or develop a strong compliance environment, ensure that an open line of communication is maintained to raise potential concerns within the compliance function, and pay additional attention to the above risk factors.

Coronavirus COVID-19 Task Force

For our clients, we have formed a multidisciplinary Coronavirus COVID-19 Task Force to help guide you through the broad scope of legal issues brought on by this public health challenge. We also have launched a resource page to help keep you on top of developments as they unfold. If you would like to receive a daily digest of all new updates to the page, please subscribe now to receive our COVID-19 alerts.

Contacts

If you have any questions or would like more information on the issues discussed in this LawFlash, please contact the authors, Shelia A. Armstrong, Giovanna M. Cinelli, and Nicholas E. Hakun, or a partner in our White Collar or National Security practices, or any of the following Morgan Lewis lawyers:

Philadelphia
Eric W. Sitarchuk
John C. Dodds
Lisa C. Dykstra

Dallas
Sheila A. Armstrong

Washington, DC
Giovanna M. Cinelli
Douglas W. Baruch
Jennifer M. Wollenberg
Stephen E. Ruscus