Fraudulent Inducement Theory Need Not Plead the Materiality of Fraud on Claims, as Fraud Occurred at Contract Formation; United States District Court for the District of Columbia No. 14-cv-1339 (RCL), U.S. ex rel. Andrew Scollick v. Vijay Narula, et al.


The district court denied a motion to dismiss a qui tam complaint alleging the defendants formed sham SDVOBS in order to fraudulently induce the government into awarding them contract set-asides. According to the defendants, the complaint alleged they fraudulently certified their company’s eligibility as an SDVOSB, but did not show that this misrepresentation was material to the agency’s decision to pay its invoices. However, the court explained that under a fraudulent inducement theory, the relator need only show that the alleged fraud was material to contract formation, not to the eventual submission of claims. Once the relator alleged that the contract was awarded solely due to fraud, it followed that any claims submitted under the contract were fraudulent by definition. The defendants also argued the court should ask VA to decide on its eligibility as an SDVOSB, but the court declined, finding the regulation clearly defined the eligibility requirements and that the necessary fact-finding was within its scope. The court concluded the eligibility question did not require any special expertise that resided only within VA.

Defendants Optimal Solutions and Technologies Inc., OST CEO Vijay Narula, and OST COO Ajay Madan moved to dismiss a second amended complaint alleging they falsely represented their eligibility to compete and win federal construction contracts set aside for small businesses.

In 2014, Scollick filed this complaint against 18 defendants, including five businesses that submitted fraudulent bids, two businesses that controlled firms that submitted fraudulent bids, the companies’ officers and owners, and two companies that provided the surety bonds needed to obtain the set-aside contracts, those companies’ insurance broker, and the insurance broker’s president.

The three OST defendants relevant to these proceedings were alleged to have formed a new limited liability company, Centurion Solutions Group LLC, which they registered as a service-disabled veteran-owned small business. While the LLC included a disabled veteran as a local site manager, he was never in control of the company, did not have an office at the headquarters, and always reported to Narula, Madan, and a third owner. The complaint described instances when the owners threatened to remove the disabled veteran from his position. Despite this situation, the defendants registered CSG as an SDVOSB, falsely certifying that 100 percent of the business was owned and operated by a disabled veteran.

Once the company was registered, it began to fraudulently obtain contract set-asides, the relator alleged. In its first proposal, the defendants misrepresented CSG’s eligibility for an SDVOSB set-aside, and falsely represented the company’s past performance and construction experience. Hundreds of additional bids and proposals followed, all of which falsely attested to CSG’s SDVOSB status. Eventually, CSG won eighteen construction contracts from the Department of Veterans Affairs, totaling over $6.4 million. The complaint maintained that all claims for payment under these contracts were false and that VA would not have paid the claims had it known the truth.

Based on information that came to light during discovery, the plaintiff did not add new counts or allegations, but sought leave to add a new defendant to his complaint. The court granted the request. The OST defendants moved to dismiss.

First, the defendants argued that the complaint failed to meet the materiality standard. Based on their reading of Escobar, the defendants asserted the relator did not argue that the allegedly fraudulent statements were material to the government’s decision to pay CSG for its work under those contracts. They also argued that the court should permit VA to decide whether CSG was eligible to bid on the set-asides.

As a threshold matter, the court addressed whether the “law of the case” doctrine governs the court’s resolution of the motion to dismiss. The “law of the case” doctrine is a prudential bar that directs courts not to revisit questions already decided in an earlier phase of the litigation absent extraordinary circumstances or new developments in the law. Issues already decided include a court’s explicit decisions, as well as those issues decided by necessary implication.

The relator argued that the current motion was foreclosed by the court’s prior rulings denying motions to dismiss the initial complaint, granting the motion for leave to amend, and denying the motion to dismiss the amended complaint. According to the relator, in those decision, the court explicitly fond that the allegations in the pleadings sufficiently stated claims for relief under the FCA, and that finding necessarily includes the finding that the allegations met all requirements to state claim.

However, the court concluded the relator misunderstood what a court holds when it denies a motion to dismiss for failure to state a claim. The court explained that its previous rulings did not necessarily hold that the pleadings were flawless. Rather, the court rejected the specific legal theories the defendants advanced to attack the pleadings, none of which included the two legal theories raised in the present motion. In other words, when a defendant moves to dismiss a complaint under one theory, the court does not simultaneously evaluate the sufficiency of the pleadings under alternate theories.

The court found the relator’s interpretation would lead to an absurd result. Unlike other defenses, the defense of failure to state a claim upon which relief can be granted may be renewed at other states of the litigation. Under the relator’s understanding, this would not be possible.

Next, the court considered the merits of the motion to dismiss, beginning with the defendants challenge to the materiality of the allegations. According to the defendants, while the complaint adequately alleged that the misrepresentation of CSG’s SDVOSB eligibility was material to contract bid and formation, it did not allege the misrepresentation was material to the government’s decision to pay invoices for the work performed.

The court disagreed, finding the defendants’ reliance on Escobar misplaced. Escobar’s materiality standard applies only to FCA suits alleging falsity under the implied false certification theory, while the plaintiff did not plead his allegations under that theory. He did not allege that CSG’s bids contained misleading half-truths, but that CSG blatantly lied to the government about its eligibility for SDVOSB set-asides. Therefore, the relator pled fraud in the inducement, which placed the allegations outside Escobar’s orbit.

The court noted that Escobar leans heavily into the materiality standard. Otherwise, the FCA could be misused to litigate against defendants who violated a regulation that had no bearing on the government’s willingness to pay a claim. The Supreme Court explained that the FCA was not intended as a vehicle for punishing garden-variety breaches of contract or regulatory violations.

In contrast, under a fraud in the inducement theory, the court reasoned it would make no sense to require a plaintiff to plead that false statements were material to the government’s decision to pay a claim. First, under this theory, the initial fraud used to induce the government to enter into a contract also taints all subsequent actions, including the submission of claims for payment. Thus, the relator need only plead the materiality of the initial fraud, not the materiality of the payment of claims.

Further, the court noted that the fraud in the inducement theory has its own strict materiality requirement. For a claim to be false or fraudulent under the fraud in the inducement theory, the contract must have been procured by fraud. In other words, a misrepresentation in the defendant’s bid must have caused the government to award the defendant the contract. Once the defendant has obtained that contract through fraud, the only way it can be paid for work under that contract is by continuing the initial fraud. Therefore, while an undisclosed violation of a regulatory or contractual requirement might be immaterial to the payment decision, a fraudulent statement that secures a government contract will always be material to the government’s decision to pay the contractor under that agreement.

Further, the court in Escobar explicitly recognized that a party can be liable under the False Claims Act for securing a government contract by fraudulent means. When the defendant-petitioner argued that False Claims Act liability should be limited to undisclosed violations of expressly designated conditions of payment, the court rejected that argument, noting that this standard would create the arbitrary result that misrepresenting compliance with a requirement that the government expressly identified as a condition of payment could expose a defendant to liability, whereas misrepresenting compliance with a condition of eligibility to even participate in a federal program when submitting a claim would not. In so holding, the Supreme Court explicitly declined to shield parties who fraudulently procure government contracts from False Claims Act liability.

Because the relator need not argue the materiality of his allegations against the government’s willingness to pay the defendants’ invoices, the court denied the motion on this basis.

Following on, the court held that the relator had adequately pled falsity under the fraud in the inducement theory. The relator alleged that the defendants fraudulently registered CSG as an SDVOSB in order to qualify for set-asides, using an actual disabled veteran as the purported owner and controller of the company, even though he was neither. The relator also alleged the defendants controlled a likeness of the veteran’s signature, which they could affix to documents as they wished. Once they registered the company as an SDVOSB, they relied on this registration to bid on hundreds of contracts, eventually winning eighteen awards worth $6.4 million. The relator maintained that VA relied on the false certification when awarding the contracts, which were intended solely for SDVOSBs, and subsequently paid numerous invoices which it would not have otherwise paid, but for the fraudulent representations.

The court found these allegations plausible. From the face of the complaint, the court found it clear that VA would not have awarded the contracts, but for the false certification of SDVOSB eligibility. Not only were the funds intended for SDVOSBs, but by law could only be provided to such entities.

Further, the court found the relator pled fraudulent inducement with particularity. The SAC provided the dates that each of the eighteen contracts were awarded by VA to CSG, as well as the amount paid to CSG under each of those contracts. The SAC also described which facts were misrepresented. Accordingly, the court declined to dismiss the case on these grounds.

Next, the court considered the defendants’ assertion that VA should decide whether CSG was eligible to participate in the SDVOSB program. The defendants invoked the primary jurisdiction doctrine, which states the court may suspend the judicial process pending referral to another administrative body for its view, in cases when resolving a claim would require the court to decide an issue that has been placed within the purview of that body.

The court rejected this argument for two reasons. First, the court held that the issue of CSG’s eligibility need not be decided at the pleading stage. Instead, the court takes all the factual allegations as true and asks whether the relator had adequately stated a claim. Further, the court found the argument and the proposed remedy mismatched. The defendants sought dismissal of the complaint, but referring the eligibility question to VA would result in a stay, not dismissal. Therefore, the court found the primary jurisdiction doctrine unavailing.

Alternatively, even if the question of eligibility were before the court, the court would decline to stay proceedings pending an administrative resolution of the issue. While no fixed formula exists, courts typically invoke the doctrine when an issue arises that is within an agency’s expertise or when resolving the issue judicially could lead to inconsistent outcomes. The district court held that neither justification applies here.

First, the court noted that the question of whether CSG was an SDVOSB is hardly one that requires VA’s expertise, as the regulation is clearly defined. The court held that the fact-finding required to determine whether CSG qualified as an SDVOSB was squarely within its province, as applying the regulations various definitions did not require special knowledge or expertise that is held only by VA. Further, this question did not require VA to make a policy judgment. Finally, the court reasoned that a judicial resolution of this question would not lead to inconsistent outcomes. In fact, the court noted that an entity’s SDVOSB status is a fact-specific inquiry that will differ from case to case. Therefore, the court denied the motion on these grounds as well.

FCA Scollick v Narula