False Claims Act settlement underscores importance of government contracts-specific M&A diligence
The US Department of Justice (DOJ) recently announced a settlement that highlights a key diligence consideration when acquiring a government contractor that performs work set aside for small business concerns.
Specifically, Numet Machining Techniques, LLC (Numet); Numet Industries, Inc.; KCO Numet, Inc.; and Kidd & Company, LLC (collectively the Numet Entities) recently entered into an agreement with the DOJ under which the Numet Entities paid approximately $5.2 million to resolve allegations that they violated the False Claims Act by erroneously certifying small business status in connection with 22 set-aside contracts, which were awarded to Numet following a 2011 acquisition of the company. Notably, the alleged fraud that precipitated the settlement was discovered in connection with diligence performed when Numet was in the process of being sold to another entity in late 2019.
This alert provides an overview of the Numet settlement and discusses diligence considerations when acquiring a company that performs, or has performed, government contracts set aside for small business concerns.
In August 2011, Numet was acquired by Numet Industries, Inc., which was owned by KCO Numet, Inc., an entity that ultimately owned by individuals associated with Kidd & Company, LLC, an investment company. According to DOJ, the 2011 acquisition rendered Numet affiliated with the acquirer entities. As such, given the regulatory requirement to aggregate the headcount and receipts of all affiliates when determining an entity’s size, the DOJ asserted that Numet exceeded the size standards applicable to the 22 set-aside contracts that were awarded to the company after the 2011 acquisition. In other words, the DOJ asserted that Numet falsely certified itself as a small business concern, which led to the company being awarded contracts that it was ineligible to receive.
In 2019, another entity sought to acquire Numet and, in connection with that acquisition, performed diligence relating to Numet’s government work. It was discovered that Numet was potentially affiliated with other entities and, therefore, potentially ineligible for the small business set-aside contracts it had been awarded since August 2011. In November 2019, Numet voluntarily disclosed these potential issues to the government.
In June 2022, the DOJ announced that the Numet Entities agreed to pay approximately $5.2 million to settle allegations relating to the 22 small business set-aside contracts that Numet had been awarded following the 2011 acquisition. The settlement announcement provides that the “Numet Entities received credit in the settlement for Numet’s voluntary disclosure and cooperation with the government during its investigation.” Thus, the diligence performed in connection with the 2019 acquisition not only identified a potential violation of law, but facilitated its proper disclosure and an ultimately more favorable resolution of the matter with the government.
M&A considerations for government contractors
At a high level, the False Claims Act imposes criminal and civil liability on an individual or entity that knowingly presents, or causes to be presented, a false claim for payment or knowingly makes, or causes to be made, a false statement material to a false claim. A party civilly liable under the False Claims Act is subject to civil penalties per violation, plus damages that are equal to three times the amount of damages the government suffered. Parties may also face criminal liability, including imprisonment, restitution and fines, and administrative and contractual consequences (eg, disbarment and disclosure in future proposals).
One of the theories of liability under the False Claims Act is known as “fraud-in-the-inducement,” which occurs when a contractor uses a fraudulent initial misrepresentation to obtain a contract. Notably, in the context of small business set-aside grants (as opposed to set-aside contracts) that were obtained through initial fraudulent representations, courts have held that damages may be equal to the three times the entire value of the grants.
The government has attempted to expand the reasoning in those grant cases to instances in which an agency has relied on a false eligibility certification when awarding a small business set-aside contract. The government’s argument produces potentially massive damages, even when the government received all of the work required under the contract. Although courts are generally reluctant to accept such a damages calculation, the risk of such liability often spurs grantees and contractors to proactively settle False Claims Act allegations based on inaccurate size certifications.
Moreover, potential criminal and civil liability under the False Claims Act are just some of the consequences that a contractor may experience if its small business certifications are fraudulent or inaccurate. The contractor also risks being suspended or debarred from US government contracting opportunities, as well as from state and local government contracting opportunities. Additionally, the contractor may have to disclose the fraud allegations in future proposals, which could raise questions as to whether the contractor is a responsible offeror. For a small business contractor whose primary source of revenue is government contracts, such consequences could be disastrous for the company.
Given the risks and liabilities associated with inaccurate small business size certifications, it is important to thoroughly perform diligence on size status in connection with a pending merger or acquisition involving a contractor that performs, or has performed, government contracts set aside for small business concerns. Because the size regulations promulgated by the US Small Business Administration (SBA) are nuanced and the resulting analysis is highly fact-specific, it is not surprising to uncover inaccurate size certifications in the course of buy-side diligence or, when representing the target, in preemptively reviewing the target’s SAM.gov profile, as well as the target’s active and historic contract documents to be made available to prospective buyers.
If an incorrect size certification is discovered, steps should be taken both within the parameters of the M&A transaction and with regard to the government to address, and ideally mitigate, the potential liability and reputational risks. In this regard, it is necessary for counsel experienced with SBA matters and DOJ investigations to assess, including but not limited to, the following considerations:
- the scope and volume of the company’s set-aside contract portfolio and other state, local and federal government contracts portfolio
- the scope and nature of the inaccurate size certifications that have been submitted to government and higher-tier contractors (and/or published on SAM.gov)
- the impact on the revenue pipeline if the company loses its small business status or faces other collateral government contracting consequences
- whether any government and/or internal investigations have been initiated addressing the company’s size certifications
- the remedial measures and related strategy for informing the government and/or higher-tier contractors of the erroneous certifications
- the potential deal strategies that might be employed to appropriately allocate risks and responsibilities stemming from the topic and
- how DOJ will analyze the wrongdoing, such as:
- the nature and seriousness of the alleged wrongdoing
- the adequacy and effectiveness of the company’s compliance program
- history of prior allegations, settlements or findings
- the ability of the company to timely and voluntarily disclose the wrongdoing
- the pervasiveness of the alleged wrongdoing within the company and individuals involved in the potential misrepresentations and their respective seniority (ie, what is the pervasiveness through the company) and
- the potential criminal, civil and administrative consequences.
As highlighted by the Numet settlement, a contractor’s failure to accurately certify its size in connection with government contract opportunities set aside for small businesses can potentially result in significant liability, which ultimately could be passed along to an acquirer if not thoroughly subject to diligence by counsel informed and experienced in this area. We regularly advise both buyers and sellers with regard to the liability, remediation and deal considerations relevant to erroneous size certifications, as well as with regard to investigations brought by DOJ.
We will continue to monitor developments in this area. If you have any questions, please contact the authors or your DLA Piper relationship attorney.