Potential Changes Ahead for Payments in Federal Fraud Cases

Vol. 10 No. 8

AuthorThe Department of Justice (“DOJ”) trumpeted 2013 as another “banner year” for litigation filings and recoveries under the False Claims Act (“FCA”).1  The DOJ reported a 15 percent increase over the number of qui tam cases2 filed in 2012, the previous record-holding year, and $3.8 billion in fraud settlements and judgments, the second largest annual total.3  That total included $2.6 billion related to healthcare fraud, “with some of the largest recoveries” derived from pharmaceutical or medical device cases.4
The trends suggest that federal fraud cases will continue to result in record recoveries.  Yet recent developments in the courts and in Congress are injecting potential uncertainties into the size of future fraud penalties and into the size and number of future fraud settlements.

I. Increased Flexibility on Penalties

The FCA provides that a defendant is liable to the federal government for treble actual damages.5  A defendant is also liable for a civil penalty of “not less than” $5,500 (and not more than $11,000) per false claim.6  While the fact finder determines the number of false claims for which a defendant is liable, the court assesses, within the statutory range, the per-claim amount used to calculate the total penalty.7

In December, in United States ex rel. Bunk v. Gosselin World Wide Moving, the United States Court of Appeals for the Fourth Circuit became the first federal appellate court to hold explicitly that a court can assess an FCA penalty lower than the statutory minimum of $5,500 per false claim.8  The jury in Gosselin found that the defendant shipping company had violated the FCA by colluding with competitors to obtain a contract for transporting the possessions of Defense Department personnel. The company submitted 9,136 invoices under the contract.  Although the government paid only about $3 million for the company’s services, counting each invoice as a separate false claim would have generated a penalty in excess of $50 million. 

The United States District Court for the Eastern District of Virginia ruled that the disproportionality of that penalty to the harm the government had endured violated the Excessive Fines Clause of the Eighth Amendment.9  The district court, however, also rejected the relator’s proposal for a reduced penalty of $24 million because it fell below the per-claim statutory minimum.  The court therefore entered a judgment that included no penalty.10

The Fourth Circuit agreed that applying the statutory penalty would constitute an excessive fine, but reversed the district court’s decision to impose no penalty at all.  The appellate court focused on the concept that the government (or a relator as the government’s assignee) stands like any civil plaintiff as “master of his complaint.”11 The court also noted the high degree of control that the FCA vests in the government regarding the course of an FCA action,12 including settlement, and that “an award of nothing at all because the claims were so voluminous provides a perverse incentive for dishonest contractors to generate as many false claims as possible.”13 Accordingly, the Fourth Circuit held that “injustice is avoided … by the discretion accorded the government and a relator” to accept a penalty based either on multiplying the number of false claims by an amount less than $5,500 per claim or on multiplying a smaller number of claims by the statutory minimum.14

Gosselin is hardly a win for defendants.  It allows for penalties below the FCA minimum, but likely only when the payment a defendant faces would otherwise be unconstitutionally high — and therefore prohibited.15  Even a defendant who successfully challenges application of the minimum statutory penalty will under Gosselin only reduce the amount paid, not avoid payment altogether.

II. Restricting Flexibility on Settlements

At the same time that Gosselin has potentially increased flexibility in fraud recoveries for the government, several proposals pending in Congress may significantly restrict such flexibility. 

On January 8, 2014, United States Senators Elizabeth Warren (D-Mass.) and Tom Coburn (R-Okla.) introduced the Truth in Settlements Act of 2014 (“the Truth Act”).16  The legislation brought together the “super-liberal” and “arch-conservative” senators in pursuit of increased transparency in settlements with the federal government.17

The Truth Act primarily aims at disclosure of the “actual value” of a settlement to a defendant by requiring public reporting of tax deductions that a defendant receives for settlements over $1 million.18  The Internal Revenue Code allows an entity to deduct, as a business expense, a settlement payment that is remedial or compensatory, but prohibits deductions for a payment that constitutes a “fine or similar penalty.”19  The Truth Act would require a federal agency that has engaged in a settlement to make available publicly, among other information, the amount of a defendant’s payment that “has been designated as a civil penalty or fine, or otherwise specified as not tax deductible” under the settlement.20

The Truth Act closely followed the related and also bipartisan Government Settlement Transparency and Reform Act (“Government Settlement Act”),21 introduced in the Senate, and the Stop Deducting Damages Act (“Damages Act”),22 introduced in the House of Representatives.  These bills, unveiled last fall, would each restrict the tax deductibility of settlement payments.  The Government Settlement Act would do so by attempting to clarify which settlements or portions of settlements are punitive (and therefore non-deductible), a determination traditionally left to be made and, if necessary, defended to the IRS by the taxpaying entity.23 The Damages Act would prohibit deductions for any settlement payments, compensatory or punitive.24 

The goal of the current legislative efforts, according to their supporters, is to “shine[] a light on” “backroom deal-making” between the government and defendants, while “clos[ing] a loophole” on the tax treatment of those settlements.25  Senator Warren explained that “settlements that seem tough and fair can end up looking like sweetheart deals” once the ramifications for defendants, including tax treatment in particular, are examined.26

Yet the primary if perhaps unintended impact of the proposed reforms, if enacted, would likely be to reduce the size and number of settlements.  Restricting or eliminating the tax deductibility of a potential settlement amount of course increases the “actual” cost, and therefore the economic palatability, of that amount to a defendant.27 Defendants facing the proposed new tax restrictions would therefore be less likely to agree to settlement amounts as high as they would currently.  The government, on the other hand, would face the public relations cost of agreeing to significantly reduced settlement amounts as the price of pretrial resolution.  These dynamics would make reaching settlement in many federal fraud cases more difficult, and the necessity of trial in those cases more likely.

Conclusion

As a single appellate decision, Gosselin does not herald across-the-board below-minimum FCA penalties, particularly given that the opinion is rooted in relator’s acceptance of a lower amount as the only constitutionally permissible penalty.28 Yet Gosselin may require both the government and defendants to do some new math to determine the penalty payable in circumstances that combine relatively low damages with a large number of false claims.

The current congressional initiatives may bring new math as well to each side’s assessment of a potential fraud settlement.  Admittedly, the present bills are in their legislative infancy, and comprise “the latest in a long line of legislative attempts to rein in settlement deductions.”29  However, with the continued focus on massive federal settlements, and bipartisan support for restricting the terms of such deals, the horizon for settlement reform — and with it, potentially fewer and smaller federal fraud settlements — appears to be drawing closer.

 ***

1

31 U.S.C. §§ 3729 – 3733, available at http://www.law.cornell.edu/uscode/text/31/subtitle-III/chapter-37/subchapter-III; see Press Release, Justice Department Recovers $3.8 Billion from False Claims Act Cases in Fiscal Year 2013 (Dec. 20, 2013) (“DOJ Press Release”), available at http://www.justice.gov/opa/pr/2013/December/13-civ-1352.html.

2

 Qui tam cases are those filed under the FCA’s whistleblower provisions, which allow a private citizen (the “relator”) “to file lawsuits alleging false claims on behalf of the government” and if successful “receive[] up to 30 percent of the recovery.”  DOJ Press Release, supra; see also § 3730(b) (qui tam provisions of the FCA).

3

 See DOJ Press Release, supra.

4

Id.

531 U.S.C. § 3729(a).
6

Although the text of the statute provides for a penalty range of $5,000 to $10,000, “[p]ursuant to 28 C.F.R. § 85.3(a)(9), persons adjudged liable under the FCA are, as of September 29, 1999, subject to increased civil penalties amounting to a minimum of $5,500 and a maximum of $11,000.”  Gosselin, slip. op. at 22 n.10 (citing Federal Civil Penalties Inflation Adjustment Act of 1990, Pub. L. No. 101-410, § 535, 104 Stat. 890 (1990), as amended by Pub. L. 104-134, 110 Stat. 131 (1996)); see also 31 U.S.C. § 3729(a).

7

See, e.g., United States ex rel. Purcell v. MWI Corp., No. 98–2088 (GK), 2014 WL 521524, at *10 (D.D.C. Feb. 10, 2014).

8

No. 12-1369, slip. op. (Dec. 19, 2013), available at http://caselaw.findlaw.com/us-4th-circuit/1652862.html; accord United States v. Mackby, 339 F.3d 1013 (9th Cir. 2003) (examining only whether government-requested penalty based on fewer than total number of false claims violated Excessive Fines Clause).The Fifth Circuit previously articulated the same principle in dicta.  See Peterson v. Weinberger, 508 F.2d 45, 55 (5th Cir. 1975).

9

“Excessive bail shall not be required, nor excessive fines imposed, nor cruel and unusual punishment inflicted.”  U.S. Const. amend. VIII.

10

Slip. op. at 22-24.

11Id. at 34.
12Id. at 35-36.
13Id. at 40.
14Id. at 33, 40.
15

Gosselin provides little guidance regarding the determination that a penalty is unconstitutionally high.  See Dietrich Knauth, 4th Circ. Leaves 'Excessive' FCA Fines Up In The Air, Law 360 (Jan. 9, 2014), available at http://www.law360.com/articles/499860/4th-circ-leaves-excessive-fca-fines-up-in-the-air.

16

S. 1898, 113th Cong., available at https://www.govtrack.us/congress/bills/113/s1898.  The bill has been referred to the Senate Homeland Security and Governmental Affairs Committee.

17

See Darrell Delamaide, Hot air inflates big bank ‘fines’, USA Today, Jan. 14, 2014, available at http://www.usatoday.com/story/money/business/2014/01/14/delamaide-truth-in-government-bank-fines/4476147/.

18

See Fact Sheet, Truth in Settlements Act, available at http://www.warren.senate.gov/?p=press_release&id=310.  The Act would also require the government to justify publicly the confidentiality of confidential settlements with a federal agency, see S. 1898, supra, although DOJ policy generally prohibits confidentiality of settlements, subject to exceptions, see 28 C.F.R. § 50.23.

19

 See 26 U.S.C. § 162(a), (f); see also 26 C.F.R. § 1.162–21(b)(2) (“[c]ompensatory damages ... paid to a government do not constitute a fine or penalty”).

20

The Truth Act does not require that the government and a defendant agree regarding the designation of any part of a settlement payment as a penalty or fine, a practice in which DOJ does not currently engage anyhow.  See S. 1898, supra (proposed § 307(b)(1)(A)(VI)); IRS Coordinated Issue LMSB-4-0908-045, at 2 (Sep. 5, 2008) (referencing DOJ policy).

21

S. 1654, 113th Cong., available at https://www.govtrack.us/congress/bills/113/s1654.  Senators Jack Reed (D-RI) and Chuck Grassley (R-IA) introduced the bill, which has been referred to the Senate Finance Committee.  Unlike the Truth Act, the Government Settlement Act as introduced mandates that the parties to a settlement agree what portion constitutes “restitution” as a prerequisite to that portion being deductible.  See id. (proposed § 162(f)(2)(A)(ii)).

22

H.R. 3445, 113th Cong., available at https://www.govtrack.us/congress/bills/113/hr3445. The bill has been referred to the House Ways and Means Committee.

23

See S. 1654, supra; see also IRS, Att. I to Industry Director Directive on Government Settlements Directive #1 (outlining audit guidelines for settlement deductibility issues), available at http://www.irs.gov/Businesses/Attachment-I-to-Industry-Director-Directive-on-Government-Settlements-Directive-%231.

24

See H.R. 3445, supra; see also Reuters, Democrats’ Bill Would Block J.P. Morgan Settlement Deductions, WSJ, Nov. 1, 2013, available at http://blogs.wsj.com/moneybeat/2013/11/01/democrats-bill-would-block-j-p-morgan-settlement-deductions/.

25

 See Fact Sheet, supra; 160 Cong. Rec. S88-04, supra; Press Release, Sen. Jack Reed, Reed-Grassley: Fines and Penalties for Wrongdoing Should Not Be Tax Deductible (Nov. 6, 2013), available at http://www.reed.senate.gov/news/release/reed-grassley-fines-and-penalties-for-wrongdoing-should-not-be-tax-deductible.

26

160 Cong. Rec. S88-04, supra.

27

See Danielle Douglas, Deductions for payouts targeted, Washington Post, Nov. 7, 2013
(“[M]any of these firms are entitled to write off as much as 35 percent of their payout as an ordinary business expense.”).

28

 Slip. op. at 34-40.

29

Douglas, supra; see also U.S. PIRG, Subsidizing Bad Behavior: How Corporate Legal Settlements for Harming the Public Become Crucial Lucrative Tax Write Offs, with Recommendations for Reform, Jan. 2013, at 7-8, available at http://www.uspirg.org/reports/usp/subsidizing-bad-behavior.

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