Sentencing Set-Aside Contract Fraud: Are Changes Coming in the Fourth Circuit?

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The law provides for valuable set-aside contracts for construction companies that qualify as “disadvantaged business entities” (DBE). Navigating the statutes and regulations for government set-aside work can be difficult, especially for the small businesses those laws are supposed to benefit. One of the most important regulations is 49 C.F.R. § 26.55(c)(1), which requires a DBE to perform its own work under its own supervision in order for its work to be counted toward a DBE goal. Violations of this rule can lead to criminal penalties. This article examines how those penalties are determined in the Fourth Circuit.

Before getting into the case law, the reader may appreciate a short background on federal sentencing. Federal courts apply the United States Sentencing Guidelines.  Simply stated, for fraud cases, a federal sentencing court first determines a base offense level, then increases the offense level pursuant to the amount of loss suffered by the victim. The penalty corresponds to the offense level. There are two provisions of the Guidelines that are relevant to determining loss in DBE fraud cases, the “Government Benefits Rule” and the “Credits Against Loss Rule.”

• The Government Benefits Rule states that “[i]n a case involving government benefits . . . , loss shall be considered to be not less than the value of the benefits obtained by unintended recipients or diverted to unintended uses.”  U.S.S.G. § 2B1.1(b)(1).
• The Credit Against Loss Rule, added to the Guidelines in 2001, states that “[l]oss shall be reduced by the following . . . [t]he money returned, and the fair market value of the property returned and the services rendered, by the defendant or other persons acting jointly with the defendant.”  U.S.S.G. § 2B1.1 cmt. n.3(E)(i).

The Fourth Circuit last addressed sentencing for DBE fraud cases in United States v. Bros. Const. Co. of Ohio, 219 F.3d 300 (4th Cir. 2000). That case is worth a read for any company or attorney working with DBE contracts in the Fourth Circuit.

In Brothers Construction, the prime contractor, Tri–State Asphalt Corporation, won the bid for a highway construction project in West Virginia. The bid solicitation included a DBE goal of eight percent for the prime contract. Tri–State was required to name its DBE subcontractors within twenty days of the award. Tri–State decided to subcontract the underdrain work to a DBE to satisfy the DBE requirement. However, Bunn Construction, a non-DBE, submitted the low bid. Bunn Construction suggested that Tri–State split the underdrain work between Bunn Construction and Brothers Construction, a certified DBE, and Tri–State agreed.

Tri–State drafted subcontracts for Bunn and Brothers to receive $180,000 and $186,000 for their respective parts of the underdrain work. As construction began, no Brothers Construction employees appeared on the worksite. Bunn Construction supplied the workforce that performed Brothers Construction’s portion of the underdrain work, and an inspector from the West Virginia Department of Highways (WVDOH) noticed.

Eventually, the WVDOH de-certified Brothers Construction as a DBE but permitted Tri–State to use a different certified DBE to perform additional work that was counted toward the DBE requirement. Id. at 317–18. In the end, the work was completed and the WVDOH credited Tri–State as having satisfied the DBE requirement for the project. Id. at 318.

Despite all of this, the feds came in and charged Tri–State, Brothers Construction and the president of Brothers Construction with conspiracy to commit wire fraud and with making false statements in a matter within the jurisdiction of a United States agency. All of the defendants were convicted. Tri–State, the prime contractor, paid a fine of $500,000 even though the work was completed and the WVDOH certified that Tri–State met its DBE goal. The president of Brothers was sentenced to ten months imprisonment and a three year term of supervised release.

The Fourth Circuit affirmed the sentence. Applying the Government Benefits Rule (“loss shall be considered to be not less than the value of the benefits obtained”), the Fourth Circuit reasoned that the loss amount comprised the entire amount of money earmarked for DBE purposes, even though the DBE work was eventually completed by a DBE. The court stated that even though the DBE goal was met, the $186,000 earmarked for DBE purposes was not put towards its intended use — i.e., to compensate Brothers Construction for its work on the underdrain construction. The Fourth Circuit reasoned that if the WVDOH had not audited the project, the earmarked money would not have eventually made it to a DBE. Thus, the Fourth Circuit held the sentences were proper, even though the work was completed—and completed by a DBE.

In the year following the Brothers Construction decision, the United States Sentencing Commission amended the Guidelines to add, among other things, the “Credit Against Loss Rule.” Since that amendment, several Courts of Appeals have concluded that the fair market value of performance should be subtracted from a defendant’s loss value. United States v. Near, ––– Fed.Appx. ––––, 2017 WL 3868019, at *10 (11th Cir. 2017) (finding “textual support in the Guidelines for crediting the value of services against losses under the Government Benefits Rule,” and therefore, the defendant's loss value was zero because the Government received the full benefit of its bargain); United States v. Martin, 796 F.3d 1101 (9th Cir. 2015) (finding that for a defendant who “fraudulently obtained government contracts by misrepresenting her assets to qualify for programs designed to aid disadvantaged businesses,” “it would be unjust to set the loss resulting from her fraud as the entire value of the contracts”); United States v. Harris, 821 F.3d 589, 606 (5th Cir. 2016) (“Treating the loss amount under these circumstances as the difference between the contract price and the fair market value of services provided properly focuses the loss inquiry on the pecuniary impact on victims.”); United States v. Nagle, 803 F.3d 167, 183 (3d Cir. 2015) (“[W]e see nothing ... that convinces us that Notes 3(E)(i) and (F)(ii) do not work together to allow a credit for the full fair market value of the services rendered against the face value of the contracts.”).

Since the Brothers Construction decision, Congress, in the Small Business Jobs Act of 2010, codified the following presumption:

• In every contract...which is set aside, reserved, or otherwise classified as intended for award to small business concerns, there shall be a presumption of loss to the United States based on the total amount expended on the contract... whenever it is established that a business concern other than a small business concern willfully sought and received the award by misrepresentation.

15 U.S.C. § 6329(w)(1)(2012) (emphasis added). Thus, Congress specifically excluded small business from the presumption that the loss amount is the total amount expended on the contract.

Since the addition of the Credits Against Loss Rule and the enactment of the Small Business Jobs Act of 2010, the Fourth Circuit has not directly addressed whether the Credits Against Loss Rule applies to Government Benefits. See United States v. Crummy, 249 F. Supp. 3d 475, 483 n. 2 (D.D.C. 2017) (explaining that the Fourth Circuit has not yet considered the impact of the Credits Against Loss Rule).

At least one district court ruling in the Fourth Circuit suggests that the loss amount in DBE fraud cases should account for the fair market value of performance. In United States v. Wadhawan, No. CR RDB-17-0250, 2017 WL 4618454, at *3 (D. Md. Oct. 16, 2017), the defendant, a founder of a DBE, was convicted of soliciting bribes in connection with securing contracts with the United States. The United States Probation Office’s Pre-Sentence Report recommended a loss amount of $37 million, which was the entire amount paid under the contracts. The defendant objected and argued loss should be the amount received minus the fair market value of the services rendered, which amounted to $2.2 million.

The district court agreed with the defendant and held that the value of the “benefit received or to be received,” in light of the Small Business Jobs Act of 2010 and the Credits Against Loss Rule, was $2.2 million, not $37 million. Id. at 3. While Wadhawan was a bribery case, not a DBE fraud case, it applied the Credit Against Loss Rule and the Small Business Jobs Act of 2010 to distinguish Brothers Construction.

The harm to the government in DBE cases where the underlying project is completed (and sometimes completed by another DBE) is different in-kind from losses suffered in theft and embezzlement cases. Federal sentences should reflect that difference. Perhaps, if presented with similar facts, the Fourth Circuit Court of Appeals will agree with the reasoning in Wadhawan.

Chris Hampton is an Associate with Nexsen Pruet’s Construction practice and is based out of the firm’s Greensboro office. He continues to assist Nexsen Pruet’s Governmental Investigations and White Collar Criminal Defense team. The team is led by Billy Wilkins, former Chief Judge of the 4th Circuit Court of Appeals and Mark Moore, a former state and federal prosecutor; the team also includes former federal prosecutors Dan Boyce & James Galyean, who provide advice and counsel to business leaders and individuals who find themselves the target of governmental (both federal and state) criminal and civil investigations.