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A Closer Look At The SBA's New Presumed Loss Rule
Law360, New York (October 31, 2013, 1:30 PM ET) -- On Aug. 27, 2013, the so-called “presumed loss
rule” went into effect. This is the new regulation of the U.S. Small Business Administration that
establishes a rebuttable presumption: If a concern willfully misrepresents its size or status to receive the
award of a federal contract, subcontract, grant or cooperative agreement that has been set aside for
small businesses, the loss to the government is presumed to be the total amount expended by the
government under the contract, subcontract, grant or cooperative agreement.[1] Basically if you lie to
get a $10 million small business set-aside contract, do great work under the contract and are paid $10
million for the work, you may have to pay $10 million back to the government — three times over.[2]
Your instinct may be to say, “No big deal, just don’t lie to the government.” And that’s the government’s
point. But the final regulation casts a broader net. For starters, think about all of those cases before the
SBA’s Office of Hearings and Appeals (“OHA”) challenging the size or other status of a business. Every
time OHA sustains an appeal, does that mean that the contractor lied? Likely no, as application of rules
regarding issues such as affiliation can be both fact intensive and counter-intuitive.
The now-final regulation implements portions of the Small Business Jobs Act of 2010 — the statute that
codified the so-called presumed loss rule. That statute (and the final regulation) effectively reject the
reasoning in Ab-Tech Construction Inc. v. United States.[3] In that case, the Ab-Tech court rejected the
government’s argument that a contractor deemed to have misrepresented its size/status should have to
pay, as damages, three times the amount of progress payments the contractor received from the
government.[4] In its decision, the court noted that the government had received the contract-required
building. The court explained:
Damages represent compensation for a loss or injury sustained. Here, however, no proof has been
offered to show that the Government suffered any detriment to its contract interests because of AbTech’s falsehoods. Rather, viewed strictly as capital investment, the Government got essentially what it
paid for — an automated data processing facility built in accordance with the contract drawings and
specifications. Thus, the court can discern no basis upon which to uphold the Government’s demand for
treble damages.[5]
The 2010 act and the new regulation create a statutory/regulatory presumption of loss that is “equal to
the value of the contract or other instrument when a concern willfully seeks and receives an award
based on misrepresentation.”[6]
To address the “willfull” requirement, the new regulation creates new “deemed certifications” that
equal an “affirmative, willful and intentional certification of small business size and status” by a
concern.[7] Actions classified as deemed certifications include:
Submitting a bid, proposal, application or offer for federal grant, contract, subcontract,
cooperative agreement, or cooperative research and development agreement (each “an
instrument”) that is reserved, set-aside or otherwise classified as intended for small business
concerns (and/or specific small business status);
Submitting a bid, proposal, application or offer for an instrument which in any way encourages a
federal agency to classify the bid or proposal, if awarded, as an award to a small business
concern (and/or specific small business status); or
Registration in any federal electronic database (think “SAM” or System for Award Management
— the database that now retains records formerly kept in CCR and ORCA) for the purpose of
being considered for award of an Instrument to a small business concern (and/or specific
status).[8]
Thus, a contractor that submits a proposal for a small business set-aside contract is deemed to have
certified that it is a small business concern by virtue of the proposal submission. Similarly, a
subcontractor that submits a bid for a federal subcontract that has been set aside by a prime contractor
for a service-disabled veteran-owned small business concern is deemed to have made an “affirmative,
willful and intentional certification” of its small business size/status by submitting the bid. And, a
concern that registers in SAM as a women-owned small business concern for purposes of being
considered for the award of an instrument intended for a WOSB is deemed to have made an affirmative,
willful and intentional certification as a WOSB.
And, just in case the “deemed certification” does not do the trick, the new regulation also mandates
that each bid, proposal, or application for an Instrument contain a size/status certification that is signed
by “[a]n authorized official” of the concern — on the same page as the size/status certification
submitted with the bid, proposal, or application.[9] Thus, should the “deemed certification” be
challenged, the government, in theory, still will have a separate size/status certification signed by an
authorized official from the concern affirmatively stating the concern’s size/status required for award.
Think False Statement Act.
In comments regarding the proposed rule, some voiced concern that prime contractors ultimately would
be held liable for the misrepresentations of their subcontractors. And, others were concerned that
otherwise well-intentioned, but mistaken contractors ultimately could be subjected to the harsh
penalties in the regulation.
Perhaps recognizing that the SBA’s size rules can be confusing to the uninitiated, the final regulation
(now in effect) provides for a limitation of liability in certain cases. Specifically, the fact finder in any
given litigation (not the SBA) can determine that the regulation’s “presumed loss rule” and “deemed
certifications” do not apply in certain circumstances. Title 13 C.F.R. § 121.108(d) states:
Paragraphs (a) through (c) of this section [presumed loss rule and deemed and signed certifications] may
be determined not to apply in the case of unintentional errors, technical malfunctions, and other similar
situations that demonstrate that a misrepresentation of size was not affirmative, intentional, willful or
actionable under the False Claims Act, 31 U.S.C. §§ 3729, et seq. A prime contractor acting in good faith
should not be held liable for misrepresentations made by its subcontractors regarding the
subcontractor’s size.[10]
Under the regulation, whether the limitation of liability provision applies will be a factual determination
by the trier of fact. The regulation identifies the following factors for consideration:
1) the firm’s internal management procedures governing size representation and certification;
2) the clarity or ambiguity of the representation or certification requirement; and
3) the efforts made to correct an incorrect or invalid representation in a timely manner.[11]
The SBA’s general counsel recently said that the presumed loss rule likely would permit the government
to pursue more cases where concerns were misrepresenting their size/status. Undoubtedly, the new
regulation exposes concerns misrepresenting their size/status — as well as prime contractors that do
not act in good faith — to significantly increased liability.
The regulation requires concerns to recertify their status annually. Concerns that do not already have in
place an internal procedure governing the size/status representation/certification process should think
carefully about implementing such procedures. While internal controls/procedures ultimately must be
tailored to the business processes/objectives of a given concern, at a minimum, each concern should
consider having written procedures in place that:
1) Assign responsibility for size/status representation and certification with one point of contact;
2) Require due diligence related to size/status representations/certifications before any bid, proposal,
application or offer for an instrument is submitted;
3) Require due diligence related to size/status representations/certifications before a concern registers
in any federal database (SAM) identifying itself as specific size/status;
4) Require contemporaneous documentation of the “due diligence” efforts undertaken by the concern
prior to taking any action defined as a deemed certification under the regulation and/or completing a
written representation/certification as to size/status;
5) Include a process for seeking appropriate legal advice/recommendation where potential size/status
issues may be present (e.g., affiliation and/or ostensible contractor) and ensure full disclosure of all
material facts to counsel as part of that process.
When acting in good faith, a prime contractor is permitted to rely on the written representation of its
subcontractor as to the subcontractor’s size/status. Thus, prime contractors should require written
certifications related to size/status from potential subcontractors as part of any subcontract
procurement intended for small business concerns (and/or other SB statuses). Any such written
representations/certifications should be retained by the prime contractor.
As to “good faith,” a jury instruction from a recent case is instructive.[12] In United States v. Blanchet,
two defendants appealed their convictions related to a set-aside small business contract that a jury
concluded the defendants had obtained by fraud. (The charges involved were conspiracy to defraud the
United States and wire fraud). The defendants asserted the affirmative defense of “good faith.” On
appeal, the Eleventh Circuit concluded that the trial court had not abused its discretion by giving the
following instruction related to the defendants’ good faith defense:
“Good faith” is a complete defense to a charge that requires intent to defraud. ...
An honestly held opinion or an honestly informed belief cannot be fraudulent intent — even if the
opinion or belief is mistaken. Similarly, evidence of a mistake in judgment, an error in management, or
carelessness can’t establish fraudulent intent.
But an honest belief that a business venture would ultimately succeed doesn’t constitute good faith if
the Defendant intended to deceive others by making representations the Defendant knew to be false or
fraudulent.[13]
Ultimately, whether the limitation of liability is applicable will be a question of fact to be decided by the
trier of fact. The idea is to put procedures in place that will objectively demonstrate to an outsider that a
concern was acting in good faith — without intent to deceive — at the time it made its representation
(or deemed certification) regarding size/status. And, the above suggestions are not exhaustive.
Going back to our $10 million example, the new rule means that if a trier of fact concludes that the
contractor misrepresented its size/status, whether the contractor gave $10 million of value is not
relevant. If the trier of fact determines that the misrepresentation was willful, the contractor may have
to return every cent it was paid — three times over — plus be liable for various penalties. This is a case
where an ounce of prevention will be worth more than a pound of cure.
--By Ken Weckstein and Tammy Hopkins, Brown Rudnick LLP
Ken Weckstein is a partner and Tammy Hopkins is counsel in Brown Rudnick's Washington, D.C., office.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its
clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general
information purposes and is not intended to be and should not be taken as legal advice.
[1] This rule also applies where a concern willfully misrepresents its size/status as a small disadvantaged
business (“SDB”), Service-Disabled Veteran-Owned Small Business Concern (“SDVO SBC”), HUBZone
SBCs, Economically Disadvantaged Women-Owned Small Business (“EDWOSB”), and/or WOSB concerns.
See 13 C.F.R. §§ 121.108(a); 124.521(a); 125.29(a); 126.900(a); 127.700(a).
[2] Per the regulation, penalties for size/status misrepresentation include suspension/debarment, civil
penalties under the False Claims Act and the Program Fraud Civil Remedies Acts, and/or criminal
penalties under the Small Business, the False Claim and/or the False Statement Acts. See 13 C.F.R. §§
121.108(e)(2); 121.411(h), 124.1015(e); 125.29(e); 126.900(e); 127.700(e).
[3] See Ab-Tech Construction Inc. v. United States, 31 Fed.Cl. 429 (1994), aff’d 57 F.3d 1084 (Fed.Cir.
1995).
[4] The Government also argued (unsuccessfully) that the contract was void ab initio. See Ab-Tech, 31
Fed.Cl. at 434, n.7.
[5] Ab-Tech, 31 Fed. Cl. at 434.
[6] See 78 Fed. Reg. 38811, 38811 (June 28, 2013).
[7] See 13 C.F.R. §§ 121.108(b); 121.41(e); 124.521(b); 124.1015(b); 125.29(b); 126.900(b); 127.700(b).
[8] See n.1.
[9] See, e.g., 13 C.F.R. § 121.108(c).
[10] See 13 C.F.R. §§ 121.108(d); 121.411(g); 124.521(d); 124.1015(d); 125.29(d); 126.900(d);
127.700(d).
[11] See n.10.
[12] See United States v. Blanchet, 518 Fed. Appx. 932, 954 (11th Cir. 2013); see also Arnold M. Diamond
v. Dalton, 25 F.3d 1006, 1010 (Fed. Cir. 1994) (explaining in common usage “good faith” denotes, in part,
“honesty of purpose, freedom from intention to defraud").
[13] Blanchet, 518 Fed. Appx. at 952, n.10. In Blanchet, the Eleventh Circuit also determined that the
total intended loss from the defendants’ fraud for purposes of the Sentencing Guidelines properly was
the ceiling price of the set aside contract that the jury concluded had been obtained by fraud. That is a
result that likely now will be uniform across jurisdictions under the Presumed Loss Rule.
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