Disadvantaged Business Enterprise Fraud: No Slowdown in the Prosecution for Criminal and Civil Liability

By: Shawn R. Farrell

The Office of Inspector General for the U.S. Department of Transportation (OIG) continues with an aggressive campaign to find evidence of Disadvantaged Business Enterprise (DBE) fraud in federal highway projects. This article shall focus on the challenges a contractor must face when engaging a subcontractor to meet DBE goals.

When dealing with the OIG, the old saying “you get what you look for” takes on new meaning. When the OIG starts to look for a violation, the OIG investigators tend to find them—because they can rely upon inferences from the evidence, rather than explicit statements or objective and undisputed facts.

The statements of a competitor or disgruntled employee are all the OIG needs to potentially charge a contractor with a violation of the False Claims Act, or even issue a criminal indictment. This is true whether the contractor acts as the DBE or hires a subcontractor to satisfy DBE goals.

Accordingly, contractors should understand that projects funded by the Federal Highway Administration (FHWA),  including state, municipal or local projects partially funded by the FHWA, must comply with the U.S. Department of Transportation Disadvantaged Business Enterprise rules.

DBE rules provide that a subcontractor must perform a “commercially useful function.” What work tasks must a DBE execute to satisfy that function is open for interpretation. In fact, determining whether a contractor or subcontractor provided a commercially useful function (CUF) is the gravamen of an OIG investigation.

A novice to this area of law might assume that the government would establish clear guidelines with a precise delineation of the services, per trade, that a DBE must fulfill to avoid any penalties. But no such rule book exists. This is analogous to telling a driver of a car not to speed on the highway, but failing to post exact speed limits. Subjective interpretation of a CUF, like speeding, can lead to some
very unwelcomed consequences.

Penalties for failure to comply with these rules include: the bid of a contractor can be thrown out; the contractor may be found to be in breach of its contract, resulting in the withholding of monthly progress payments; assessment of sanctions; assessment of liquidated damages; and potentially disqualify the contractor from future bidding as non-responsible.

In addition to these civil remedies, criminal charges can also be brought against the owners and employees of a contractor. Typical criminal charges include wire fraud, mail fraud, and engaging in unlawful monetary transactions. The criminal penalties for such violations could include imprisonment against the individuals within the company that are found responsible.

In 2019, the OIG referred 19 DBE fraud cases for criminal and civil prosecution. In one such case, a project manager for a painting contractor received a six-year prison sentence after he was convicted for conspiracy to commit wire fraud and making false statements for employing a pass-through company to meet DBE goals on two Philadelphia bridge projects.

Given the severity of these penalties, a contractor must take affirmative action to protect itself. But there exists no clear direction or “best practices” for what a contractor should do. For example, what if the contractor only hired subcontractors that received DBE certification from the public agency that is bidding on the work? Does the fact that a governmental agency instituted an application program to vet the subcontractor, by collecting relevant information on the business practice of a subcontractor, conducting interviews of that subcontractor, and issuing a DBE certificate to that subcontractor, protect a contractor? The simple answer is no.

That means if the agency incorrectly certified the subcontractor as a valid DBE, the contractor could still suffer monetary penalties and criminal charges. Accordingly, a contractor should take a more active role in conducting a background check of a DBE subcontractor.

Some questions worth asking a DBE subcontractor are:

• How long has your company been in business?
• How many employees does the company have?
• Will the subcontractor be performing the requested scope of work or subcontracting this work to another sub-subcontractor?
• Does the subcontractor own its own equipment?
• Who from the subcontractor will actively be participating in the supervision and management of the work?
• Who will attend project meetings on behalf of the subcontractor?
• Who will supervise workers in the field for the subcontractor?

The answers to these questions should lead you to modify your subcontractor agreement. Consider including in the subcontract that the contractor can require certain individuals of the subcontractor to act as its project supervision and attend project meetings. This type of clause is often called a “Key Employee” provision. By including these terms and making sure they are followed, the contractor will better protect itself against alleged fraud counts.

The contractor must also create a record-keeping system to store all good-faith attempts to utilize a legitimate DBE subcontractor. This record system should preserve the answers to the questions asked of a subcontractor, as well as the attendance of Key Employees at project meetings.

To find a DBE subcontractor, a contractor can also consult with the owner’s DBE program officer for assistance. Similarly, trade industry associations such as NUCA can help the contractor to identify legitimate DBE subcontractors. However, recommendations do not relieve the contractor from its own due diligence.

You need to make sure that the DBE is actually performing, managing, or supervising the work. If the DBE can reasonably be seen as just a paper-pusher, that is a red flag and a potential risk.

Across the country, public agencies have been increasing the percentages of DBE goals on their projects. Increasing the goals for DBE participation does not automatically increase the number of available DBE subcontractors to perform the work. Add to this environment an OIG willing to prosecute contractors that unwittingly use illegitimate DBE subcontractors and there exists a perfect storm for the unwary contractor to get caught up in. The earlier you act, with a plan, the better.