Recent FCA Settlement Highlights Small Business Certification Issues in Private Equity Transactions

With Macy Climo

The Department of Justice ("DOJ") recently announced a $1.75 million false claims settlement with a contractor that "improperly obtained government contracts that were set-aside for small businesses." The DOJ settlement highlights the criticality of accurate small business representations and certifications in government contracting, and in particular, those that may arise during or after an M&A transaction involving a small business.

Briefly, the False Claims Act ("FCA") is the primary enforcement tool in the government's arsenal to combat fraud in government contracting. Indeed, in FY 2022, the government recovered more than $2 billion from FCA actions. Broadly, the FCA provides that any person who knowingly submits, or causes to submit, false claims to the government is liable for treble damages plus penalties tied to inflation. In government contracting, FCA actions and settlements have involved a host of issues, including the Buy American Act, improper billing practices, failure to comply with contractual manufacturing specifications, cybersecurity requirements, and the SDVOSB set-aside program.

In DOJ's latest settlement, the government alleged that a company no longer qualified as a small business after its predecessor company was acquired in 2016 by a private equity firm. The government further alleged that, after its acquisition, the company (and two subsidiaries) falsely certified themselves as qualified small businesses in SAM.gov and won over 100 contracts from 20 federal agencies. By way of background, to qualify as a small business in the services industry, SBA's rules provide that a concern's, and its affiliates, 5-year average receipts must fall below the size standard for the North American Industry Classification System ("NAICS") code assigned to a procurement. SBA publishes its size standards here. Thus, where that 5-year average exceeds the NAICS code size standard, the company is no longer a "small business" for purposes of obtaining set-aside contracts under that size standard.

Notably, the DOJ settlement also shows that while the company and its subsidiaries were awarded 117 set-aside contracts after the private equity transaction, the impetus for the FCA settlement was due to the company's "written contractor disclosure" to the government. In its disclosure, the company said that it "discovered its conduct during post-acquisition" activities and described the corrective actions it was taking to prevent misrepresentations from happening again. While unstated, it appears that the disclosure may have been due to the government's mandatory disclosure rules, which require contractors to "timely disclose" to the government when they have "credible evidence" of a violation of a federal criminal law involving fraud or a violation of the FCA.

Takeaway

As the DOJ settlement shows, false size representations and certifications can have major consequences (beyond just SBA size protests) for small businesses and their private equity owners.? Indeed, in addition to paying to settle the FCA allegations, the company also likely spent considerable time, energy, and money in defending and investigating the FCA action. And although it is possible that the company may have received some credit for cooperating with the government during the FCA investigation, the settlement nevertheless provides a timely reminder that SBA's size (and status) issues should be at the forefront of M&A due diligence efforts in transactions that involve small businesses.

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