In 1973, economists Michael Darby and Edi Karni wrote the path-breaking article in the Journal of Law and Economics, “Free Competition and the Optimal Amount of Fraud.” They systematically argue that the costs of intensive detection and enforcement of fraud can outweigh the benefits of eliminating the fraud.
Flash forward in a time machine nearly 50 years later for proposed legislation intended to restrict false claims by government contractors and reduce unnecessary federal expenditure. For the fiscally conservative, the headline goals are laudable — reduce false claims of effort for work not actually completed and subsequently not reimbursed.
The False Claims Amendments Act of 2021 seeks to potentially limit the Department of Justice’s (DOJ) authority to dismiss suits at will. This runs against the power of the Executive Branch to enforce laws and control federal “officers,” raising significant issues under the Constitution’s Due Process Clause, Appointments Clause, Take Care Clause, and Executive Vesting Clause.
One major concern with the proposed legislation is that it counters a recent Supreme Court decision. In Universal Health Servs. v. U.S. ex rel. Escobar, 136 S. Ct. 1989, 2002-03 (2016), Justice Thomas, writing for a unanimous Court, explained that the False Claims Act (“FCA”) materiality element is “demanding” and “rigorous” because of its potentially penal application. The Court underscored that the FCA “is not ‘an all-purpose antifraud statute’ or a vehicle for punishing garden-variety breaches of contract or regulatory violations.”
To ensure that the penal FCA stayed within appropriate bounds, the Court required the government to prove that the alleged misrepresentation “went to the very essence of the bargain.” “[I]f the Government pays a particular claim in full despite its actual knowledge that certain requirements were violated,” the Court stated, “that is very strong evidence that those requirements are not material.”
The proposed legislation repudiates this statement from a unanimous Supreme Court and would send an opposite message to courts — that continued payment matters little, so long as the government can come up with any alternative reason for payment — a seemingly very low bar, indeed. That would expand the universe of violations that enterprising plaintiffs’ attorneys might use as the basis for False Claims Act allegations to include minor violations and “garden variety breaches of contract” — the precise result the Supreme Court was seeking to avoid.
To be clear, there is no argument suggesting fraud is just fine and should persist unfettered. The issue at hand is that the cost to detect a false claim could be massive for defendants and mostly a boom market for trial lawyers. The FCA Amendments bill would encourage frivolous litigation and thereby increase costs. Attorneys pursuing remediation under the False Claims Act are often entitled to a portion of the recovery, ranging from 15 to 30 percent, if the case is successful.
The financial incentives propelling meritless actions in the hopes of negotiating a nuisance settlement with a defendant create costs that do not outweigh the benefits. The bill would likely increase frivolous costs to defendants by limiting the Department of Justice’s (“DOJ’s”) ability to dismiss lawsuits that it finds to be meritless. Disallowing the government to control these cases strongly suggests that this bill is not about protecting against fraud and abuse, but rather about supporting meritless efforts by aggressive attorneys.
Nearly 50 years ago when Messrs. Darby and Karni wrote about the benefits to exposing all fraud outweighing the costs, the illustrations were simply unfortunate transactions between an unscrupulous auto repair person and surgeon aggressively practicing unnecessary but not life-threatening medicine. Today the stakes are much higher with huge business-to-business and business-to-government contracts.
No amount of fraud is legitimate. But the effort to empower attorneys with incentives to create frivolous lawsuits that can mire the delivery of necessary contract services and work should not be treated lightly. If successful, the most likely conclusion is a net increase in contract bids to compensate for the financial risk of an extensive, debilitating lawsuit seeking damages from false claims.
Unfortunately, the most likely outcome of the FCA Amendments bill is a new industry of trial lawyers opportunistically specializing in cases for the goal of settlement rather than exposing legitimate false claims that cause true waste in the system. The better alternative is to allow the reputations of those committing false acts, serves, and representation to be revealed at contract end and suffer a public loss of reputation they seek to ameliorate or leave the marketplace.