8(a) Contractor Fraudulently Evades 8(a) Sole Source Threshold–With Procuring Agency’s Knowledge

A soon-to-graduate 8(a) contractor submitted a fraudulent proposal designed to evade the 8(a) Program’s sole source limits, with the full knowledge of the procuring agency in question, according to a decision issued by the U.S. Court of Federal Claims.

As described in Veridyne Corporation v. United States, No. 06-150C (Fed.Cl. 2012),Veridyne Corporation greatly underestimated the cost of a contract in order to slip it under the 8(a) Program’s sole source threshold, but the scheme eventually collapsed, leaving Veridyne liable for false claims and procurement fraud–and leaving the procuring agency in question with egg on its face and a lot of explaining to do.

The Veridyne Corporation case began innocently enough, when the DOT’s Maritime Administration, or MARAD, awarded Veridyne an 8(a) sole source IDIQ contract.  However, although the 8(a) Program places limits on sole source awards to most 8(a) companies (tribal companies and Alaska Native Corporations are an exception, but Veridyne did not qualify), MARAD ultimately awarded Veridyne more than $20 million over the five-year term of the initial contract, far exceeding the sole source limit.

When the end of Veridyne’s initial contract drew near, MARAD was pleased with Veridyne’s performance, and wanted to continue working with Veridyne on a sole source basis.  However, both parties knew that if the estimated value of the new award exceeded $3 million, the 8(a) Program regulations in place at the time would require the award to be competed.  Based on the more than $20 million expended under the previous contract, it appeared certain that the follow-on would greatly exceed the sole source threshold.

Veridyne submitted a cost proposal to MARAD for a new five-year contract, providing an estimated price of $2,999,949.00 for a five-year term, despite the fact that it had been billing more than that amount each year under the incumbent contract.  In order to achieve the $3 million price, Veridyne proposed to phase out approximately 80% of its workforce over the course of the new contract–conveniently, subject to MARAD’s request that it not do so.

MARAD held internal discussion over the new cost proposal, where the issue of the labor phase-out was raised.  MARAD dismissed concerns over the cuts, noting that they were only included in order to bring the proposal under the $3 million threshold.  MARAD forwarded the proposal to the SBA to request the SBA’s approval, which was granted.  After executing a written justification, MARAD awarded Veridyne a new five-year contract.

Not surprisingly, MARAD quickly burned through the $3 million, and then some, awarding more than $4 million in work to Veridyne in the first year of the new contract alone.  Internal discussions at MARAD began about adjusting Veridyne’s estimated price, which MARAD documents acknowledged had been “artificially constructed” to meet the 8(a) Program’s sole source limit.  These documents suggested that a more accurate estimate of the full contract value was ten times the limit–$30 million.

After most of the new contract had been performed and paid, the scheme eventually collapsed under the weight of internal funding allocation problems at MARAD.  Although Veridyne continued to perform, it was not paid for some of its work, and the dispute over non-payment ultimately landed in federal court.  In court, MARAD took the position that the new contract was “void ab initio,” a legal term meaning that it had never been valid, because Veridyne had submitted a fraudulent cost proposal.

The court rejected this argument, pointing to a number of internal MARAD documents making it clear that MARAD had known from the outset that Veridyne’s cost proposal did not reflect an accurate estimate of the cost of its work.  “In the face of this mountain of record evidence, it is inconceivable that MARAD justifiably relied on Veridyne’s $3-million proposal,” the court wrote.  The court continued, “Absent justifiable reliance—a necessary element of common law fraud—the record cannot support a finding that [the new contract] was void ab initio.”  The court held that Veridyne was entitled to recover for the work invoiced and accepted by the government.

Unfortunately for Veridyne, this was not the end of the story.  The court found Veridyne liable under the government’s False Claims Act counterclaim for almost $1.4 million, and additional damages of more than half a million dollars under the Contract Disputes Act.  All told, Veridyne was entitled to almost a million dollars in recovery, but required to pay the government nearly $2 million, leaving Veridyne facing a very large bill.  (Although it is not addressed in the case, Veridyne will also be lucky if it escapes suspension or debarment from government contracting).

The Veridyne Corporation case is a troubling example of a federal agency turning a blind eye to 8(a) program fraud in order to allow a favored contractor to be awarded sole source work.  Here’s hoping that the situation in Veridyne Corporation does not occur again–and that Veridyne’s large financial penalty serves as a warning to anyone else who might consider a similar scheme.

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