Use of "pass through" material supplier results in $4,945,000 Penalty
A national supplier of construction materials (Supplier) has now agreed to pay a fine of $4,945,000 to the United States for participating in transactions in which a certified Disadvantaged Business Enterprise (DBE) acted “merely as a pass through” and did not perform a “commercially useful function.”
The U.S. Department of Transportation (DOT) has always had the most complete regulations on DBE participation goals. DOT regulations state that there are no DBE participation points unless the DBE contractor performs a “commercially useful function” (CUF). The regulations do not allow the DBE to be an “extra participant in a transaction, contract or project, through which funds are passed in order to obtain the appearance of DBE participation.” A DBE performs a CUF when it is actually performing, managing, and supervising the work. To perform a CUF with respect to materials, the DBE must be responsible for negotiating price, determining quality and quantity, ordering the material and installing materials (where applicable) and paying for the material.
The Environmental Protection Agency has adopted modified DOT commercially useful function regulations. The state of Maryland has passed regulations very similar to the DOT standards for any state public procurement. Virginia regulations state that any entity must perform a CUF in order to be a certified DBE.
The recently settled case involved a series of transactions on multiple projects by both the DOT and EPA. This resulted in a settlement agreement (Settlement Agreement) between the government and the Supplier, so there was no “court decision.” This is not a legal precedent and we do not know how a court would have ruled on these facts. Nonetheless, we know how federal prosecutors view conduct that is very common in the market place by suppliers, DBEs, subcontractors and general contractors. The use of pass through “paper pushers” or “brokers” that participate “in name only” for a 2% or 3% markup will result in investigations and prosecutions.
We have reported in the past on the increasing enforcement of CUF requirements, at http://www.fullertonlaw.com/newsletters/regulatory-enforcement-on-dbe-projects.html. Past cases have predominantly involved entities that had contracts directly with the government or one tier removed. Participation in more direct misrepresentations to the government has resulted in substantial fines, probation and even jail time.
The Settlement Agreement confirms that the Supplier “did not contract directly with a government entity for any of the federally-funded contracts.” Neither did the Supplier “certify –nor was it required to certify –to any government entity that it had or would comply with DBE regulations in connection with those contracts and projects. Nevertheless, the United States contends that . . . [the Supplier] was subject to the DBE requirements because [it] transacted business with a company that had itself contracted with a government entity to perform work on a project that was funded by DOT or EPA, and the DOT Regulations and EPA Regulations apply both to contractors in privity with government entities and to downstream contractors that are not.
It is also significant that the DBE in this case was a DOT certified “Regular Dealer” in the materials purchased. This emphasizes again that CUF requires a “transactional analysis.” A DBE must perform a CUF in every transaction. Proper certification does not mean that the DBE performance qualifies for DBE participation credit. Similarly, the fact that a DBE owns warehouses and trucks or has many employees may mean that the DBE is capable of performing a CUF. However, the proper analysis is the role the DBE played in this particular transaction.
Under the DOT regulation, the DBE must be responsible for negotiating price, determining quality and quantity, ordering the material and paying for the material to perform a CUF with respect to materials. The Settlement Agreement in this recent case confirms that “various prime contractors represented falsely that [the DBE] had performed a commercially useful function by negotiating price and other terms of sale when, in reality, the prime contractors had negotiated terms with [the Supplier] and used [the DBE] merely as a pass through. [The DBE] collected invoices from [the Supplier]; transferred the information from those invoices to [the DBE's] own invoices and added a markup; and passed [the DBE] invoices on to the prime contractors. The prime contractors then represented falsely to federal, state and/or local contract-letting authorities that [the DBE] supplied materials that, in reality, [the Supplier] supplied. In this connection, [the Supplier’s] conduct enabled various prime contractors to certify falsely that materials were supplied by [the DBE] when the parties –i.e. [the Supplier, the DBE], and the prime contractors - knew that was not the case, resulting in the submission to government entities of false or fraudulent claims for payment from federal funds.
Copies of the Settlement Agreement and the United States Attorney Office press release are available on request to the undersigned. The investigation of the DBE and prime contractors in this case may continue. The results will probably appear at the DOT Inspector General’s website in the future http://www.oig.dot.gov./