Describes motivation process for creativity with emphasis on intrinsic motivation by Corey K Katir

By Christopher Loveland and Jonathan Aronie

While the False Claims Act (“FCA”) generally is understood to be a “whistleblower” statute, it has been a tool of choice in recent years for opportunistic qui tam relators who lack any inside information regarding the very companies they sue. Not surprisingly, this lack of inside information has resulted in many qui tam cases being dismissed either because they merely mimic the allegations of a previously-filed case or do not plead their allegations of fraud with sufficient particularity.

A very recent example of this trend is United States ex rel. Sandager v. Dell Marketing, L.P., C.A. No. 08-4805, 2012 U.S. Dist. LEXIS 59714 (D. Minn. Apr. 25, 2012).[1] In that case, the relator, Bryan Sandager, filed suit against nineteen information technology (“IT”) government contractors in the U.S. District Court for the District of Minnesota alleging that they violated the FCA by misrepresenting the country of origin of products that were sold to the government through the GSA Advantage! website. Nowhere in his complaint or amended complaint did Sandager allege – let alone intimate – that he had any inside knowledge or information regarding any of the defendants. Instead, he based his allegations entirely on publicly available information that he had gleaned “through his long-held position in the industry.” Sandager had worked as a corporate compliance officer at one of the defendants’ competitors.

The defendants moved to dismiss on several grounds. First, in an issue of first impression in the Eighth Circuit, nine of the defendants argued that the case should be dismissed pursuant to the so-called “first-to-file bar,” 31 U.S.C. § 3730(b)(5), because Sandager’s allegations were based on the same underlying fraudulent conduct as earlier-filed qui tam suits that were pending when Sandager filed his action, and his claims did not give rise to a separate and distinct recovery by the Government. The relator contended that the first-to-file bar was inapplicable because the IT products at issue in his action were different from the IT products in the first-filed cases. The court disagreed, noting that “[u]ltimately, the question is whether the Government has sufficient notice of the fraudulent scheme through the first-filed complaint.” The court found the previously-filed cases provided the government sufficient notice to uncover the same facts alleged by Sandager and “the product distinction is immaterial because the fraudulent scheme alleged [by Sandager] is in material respects the same as alleged” in the prior cases.

The court also addressed the Circuit Court split regarding whether a procedural dismissal of a first-filed case precluded application of the first-to-file bar. Citing to the Sixth Circuit Decision in Walburn v. Lockheed Martin Corp., 431 F.3d 966 (6th Cir. 2005), the relator contended that the first-to-file bar did not apply because, as to most of the defendants, the previously-filed cases had been dismissed on procedural grounds. The defendants urged the court instead to follow the standard enunciated by the D.C. Circuit Court of Appeals in United States ex rel. Batiste v. SLM Corp., 659 F.3d 1204, 1209 (D.C. Cir. 2011), which held that the plain language of the statutory text mandates that “as long as a first-filed complaint remains pending, no related complaint may be filed.” Thus, because the earlier-filed qui tam suits were pending at the time that Sandager filed his action, the plain language of the first-to-file bar mandated that the amended complaint be dismissed. The court agreed with the defendants and followed Batiste, noting that “Walburn has been criticized and distinguished.”

All nineteen of the defendants also argued that the amended complaint should be dismissed because it contained only conclusory allegations, and failed to plead the “who, what, when, where, and how” of alleged fraud as required by Fed. R. Civ. P. 9(b). For example, the amended complaint did not include details regarding any sales that allegedly violated the FCA, including “the precise Government purchasing agency, the exact purchase order, the price of the goods sold, and the amount the Government paid for the goods.”

The defendants also argued that “in no instance does [the relator] provide any details as to when and, more importantly, if the Defendant actually sold non-conforming products to the Government.” In response, Sandager contended that he did not need to allege details regarding actual sales. Instead, because products allegedly were “offered for sale . . . the ‘logical conclusion’ is that actual sales occurred.” In addition, because he alleged a scheme extending over a long period, Sandager contended that he was not required to “allege the specific details of every fraudulent claim.”

The court recognized that Sandager is not required to allege the details of each and every fraudulent claim. However, he is required “to plead at least one representative example of an actual false claim.” The court noted that “[t]here is abundant caselaw in support of the court’s conclusion that Sandager’s failure to allege—and acknowledged inability to allege—actual sales is fatal to his claims.”

Each of the Defendants sought dismissal of the amended complaint with prejudice on futility grounds, while the relator requested 30 days to seek leave to file a second amended complaint. The court again sided with the defendants. It did not believe that Sandager could resolve the “fundamental flaws” in his amended complaint simply by re-pleading. Nor would discovery be appropriate as it “would contradict the FCA’s purpose and procedure.” Accordingly, the court dismissed the action with prejudice.

The court’s ruling in Sandager was in line with the holdings of several other courts that recently have addressed similar situations where an opportunistic relator either alleges the same fraudulent scheme as a previously-filed action or fails to plead with particularity even one example of a false claim. Relators cannot avoid the first-to-file bar merely by alleging sales of different products if the government already had notice of the same underlying scheme based on allegations in an earlier-filed case; nor is it enough for a relator merely to allege a theory or methodology as to how a company could have violated the False Claims. Instead, compliance with Rule 9(b) mandates that specific details be alleged by a relator showing the “who, what, when, where, and how” of the alleged fraud. Were courts to hold otherwise, it would open the floodgates of baseless lawsuits by opportunistic relators and cause companies to needlessly incur significant resources fending off countless discovery fishing expeditions.

[1] In the interest of full disclosure, Sheppard Mullin represented three of the defendants in this matter. Christopher Loveland and Jonathan Aronie were lead counsel.

By Christopher E. Hale

Contractors pursuing claims against the government under the Contract Disputes Act (“CDA”) can often fall victim to the jurisdictional pitfalls of the Act from the very start of the claims process, i.e., with the claim itself. After a contracting officer denies a claim under the CDA, a contractor can appeal the decision to either a Board of Contracts Appeals or the U.S. Court of Federal Claims. However, there is no shortage of cases in which such appeals are dismissed for lack of jurisdiction because the original requests for payment did not constitute “claims” under the CDA.

One recent illustration of this problem involved the distinction between routine and non-routine requests for payment, as addressed by a recent split-panel decision of the United States Court of Appeals for the Federal Circuit, Parsons Global Services, Inc. v. Secretary of the Army, No. 2011-1201 (Fed. Cir. Apr. 20, 2012).

The case centered on the termination for convenience of several task orders under an indefinite-delivery-indefinite quantity contract awarded by the Army to Parsons for design-build work in Iraq. Parsons had entered into a subcontract with Odell International, Inc. (“Odell”) to construct health care facilities and deliver medical equipment in Iraq pursuant to the prime contract.

Shortly before the task orders were terminated for convenience by the Government, the Defense Contract Audit Agency (“DCAA”) determined that Odell had been mistakenly billing Parsons using a lower overhead rate than was specified in the subcontract. Odell then invoiced Parsons for the difference, but Parsons refused to pay the invoice and submitted a termination settlement proposal to the Termination Contracting Officer (“TCO”) without including the disputed Odell costs. Two years later, as part of settlement of the prime contract, DCAA audited Parsons’ billed costs, including Odell’s costs, and determined that Odell’s costs at the higher overhead rate were supported and appropriate. Odell submitted a new invoice for the difference, and Parsons submitted three payment requests for the additional Odell costs to be paid directly by government. The TCO declined to act on the requests to settle directly with Odell. Parsons then submitted a sponsored “Certified Claim for Payment” under the CDA on behalf of Odell to the Procurement Contracting Officer (“PCO”), and appealed the PCO’s denial of the claim to the Armed Services Board of Contract Appeals (“ASBCA”).

The Government moved to dismiss for lack of jurisdiction, arguing that Parsons’ routine request for payment to the PCO did not amount to a claim under the CDA. Parsons countered that, because its requests for payment occurred two years after the termination of the task orders and thus could not be subject to routine invoicing and termination procedures, the request was non-routine and sufficient by itself to constitute a claim. The ASBCA sided with the Government and dismissed the claim.

On appeal, the Federal Circuit affirmed the ASBCA’s decision, holding that Parsons’ request for payment was not a claim as defined in FAR 2.101. Under the FAR, demands for payment can be classified as either “routine” or “non-routine.” If the request is “non-routine,” then it constitutes a claim under the CDA so long as “it be (1) a written demand, (2) seeking, as a matter of right, (3) the payment of money in a sum certain.” However, if the request is “routine,” a pre-existing dispute is necessary for it to constitute a claim under the CDA.

As the Federal Circuit detailed, non-routine requests for payment typically spring from additional or unforeseen costs not covered by the contract:

Such requests include requests for equitable adjustments for costs incurred from “government modification of the contract, differing site conditions, defective or late-delivered government property or issuance of a stop work order” and other government-ordered changes; for damages resulting from the government’s termination for convenience and termination settlement proposals that have reached an impasse; for compensation for additional work not contemplated by the contract but demanded by the government; for the return of contractor property in the government’s possession; and for damages stemming from the government’s breach of contract or cardinal change to the contract.

In contrast, according to the Federal Circuit, the request for payment of Odell’s costs made to the PCO was routine because the costs were explicitly covered by the contract and, but for the billing error, would have been subject to routine invoicing during contract performance. Furthermore, the routine request was not subject to a pre-existing dispute because the PCO, the appropriate official to evaluate the request, never received a proper request for payment prior to the improper “Certified Claim for Payment.”

In a somewhat scathing dissent, Judge Newman posited that major billing errors, such as Odell’s, are neither foreseen nor intended and cannot be characterized as routine. However, stepping away from the esoteric classification of routine and non-routine requests for payment, Judge Newman threw the facts of the case – in which “a simple correction of a billing error has morphed into a nearly four-year litigation, with no end in sight” – into sharp relief:

The agency’s refusal to pay Parson’s claim, having acknowledged the obligation and having audited it through its own Audit Agency, is contrary to the guiding principle that “The Federal Acquisition System will [c]onduct business with integrity, fairness, and openness.” . . . . This lengthy litigation of a conceded governmental obligation is an embarrassment.

To avoid being caught in such an “embarrassment,” contractors should take care when submitting claims pursuant to the CDA to ensure that a request for payment that could be classified as routine is subject to a pre-existing dispute. Otherwise, the contractor might find years later that its claims process was flawed from the start and must begin anew – assuming the statute of limitations has not already run its course.

By Louis D. Victorino

The United States Court of Appeals for the Federal Circuit (CAFC) recently issued a so-called en banc (all judges of the court) decision with great importance to Federal Government contractors. In Zoltek Corp. v. United States, Fed. Cir., No. 2009-5135, March 14, 2012 (“Zoltek II“), the Court redefined the scope of the statute underlying the Federal Acquisition Regulation (FAR) “Authorization and Consent” clause, 28 U.S.C. §1498. In so doing, the Court confirmed Federal Government contractor immunity from patent infringement suits in instances where the patent infringement may have occurred in whole or in part outside of the United States. The more fundamental holding of the case was to reverse its own prior decision in the same case (“Zoltek I”), in which the CAFC had held that §1498 does not waive Federal Government patent immunity from certain patent infringements occurring in part outside the United States.

Zoltek Corporation (Zoltek), is a U.S. corporation headquartered in St. Louis, MO, and is the assignee of rights in a U.S. patent related to manufacturing processes and methods used for the production of carbon fiber sheets. Two types of fiber carbon products allegedly were manufactured through the use of methods covered by the Zoltek patent. The allegedly infringing resulting products were used by Lockheed Martin Corporation (Lockheed) in the manufacture of F-22 jet aircraft, designed and built, of course, under a U.S. Government contract. The carbon fiber products were manufactured from fiber carbon components in one instance manufactured in Japan and finished in the U.S. and in a second instance manufactured entirely in Japan and imported into the U.S.

In its original complaint, Zoltek sued the United States under 28 U.S.C. §1498(a) in the United States Court of Federal Claims (COFC) alleging, in relevant part, that its patent was infringed because the F-22 related carbon fiber products were used or manufactured by or for the U.S. without a license or other legal right. No claims were asserted against Lockheed. In relevant part, 28 U.S.C. §1498(a) provides:

(a) Whenever an invention described in and covered by a patent of the United States is used or manufactured by or for the United States without license of the owner thereof or lawful right to use or manufacture the same, the owner’s remedy shall be by action against the United States in the United States Court of Federal Claims for the recovery of his reasonable and entire compensation for such use and manufacture.

                                              * * *

For the purposes of this section, the use or manufacture of an invention described in and covered by a patent of the United States by a contractor, a subcontractor, or any person, firm, or corporation for the Government and with the authorization or consent of the Government, shall be construed as use or manufacture for the United States.

The U.S. (Government) moved for summary judgment on this portion of the Zoltek lawsuit based on the language of sub-section (c) of 28 U.S.C. §1498. That sub-section provides, in total, “[t]he provisions of this section shall not apply to any claim arising in a foreign country.” The Government argued that this section precluded recovery by Zoltek under its “methods” patent claims because some or all of the infringement occurred in Japan and, thus, arose “in a foreign country.” The COFC held, in part, that §1498 did not waive Government’s sovereign immunity to all infringements (direct infringements but not indirect infringements) but ultimately denied the Government’s motion. Both parties appealed the court’s decision on various grounds.

On appeal, the CAFC held, in its first decision in the Zoltek matter, that a “direct infringement” of a patent under 35 U.S.C. §271 was a predicate for Government liability under §1498(a). The CAFC further held that a “process” asserted to be covered by a method patent cannot give rise to an infringement “within” the United States unless each and every step of the process is performed in the U.S. Since some or all of the processes at issue in the litigation occurred in Japan, the §1498(a) remedy was not available. Zoltek Corp. v. United States, 442 F.3d 1345, 1350 (Fed. Cir. 2006) (“Zoltek I“). The CAFC did not address contractor patent infringement immunity under §1498(a). The case was remanded to the COFC for further proceedings. Id. at 1353.

On remand, Zoltek sought leave to amend its complaint to add an infringement claim against Lockheed based on 35 U.S.C. §271 and sought, further, to have the matter transferred to a federal district court in Georgia. The Government argued that §1498(a), while not waiving sovereign immunity for Zoltek’s patent claims, nevertheless provided Lockheed immunity from Zoltek’s suit and, therefore, there was no jurisdiction in the federal district court in Georgia. The COFC rejected the Government’s arguments and found that it was in the interest of justice to transfer the case to Georgia. Subsequently, the COFC certified for appeal to the CAFC the issue of Lockheed immunity under §1498(a).

In considering the merits of the appeal, the CAFC came to a disturbing conclusion regarding the implications of its prior decision in Zoltek I. It stated the issue as follows:

In confronting the question of whether a contractor acting under Government authority could be held liable for patent infringement, in a situation in which we had previously held the Government not liable for the allegedly infringing actions of its contractor, we realized that one of two consequences would result. Either we had to conclude that a patentee’s well-pleaded complaint of infringement in the United States of a United States patent in these circumstances fails to state a cause of action against both the Government and the Government’s contractor, or we would have to override the long-standing understanding of the statutory framework that a contractor working for the Government is immune from individual liability for patent infringement occurring in the course of conducting the Government’s contract.

Zoltek II, at page 8.

The CAFC concluded, with one dissent, that neither of these options was acceptable and, instead, ruled to overturn its earlier decision in several respects. First, the Court ruled that the COFC and the CAFC’s earlier decision had wrongly relied on case law to conclude that §1498(a) covered only direct infringements and not indirect infringements. The CAFC reviewed the prior case law relied upon in Zoltek I and found that statements used by the COFC to reach its decision regarding the scope of §1498(a) were dicta. Second, the CAFC found that unauthorized “sales” and “use” of products incorporating patented technology were indirect patent infringements falling within the coverage of §1498(a). Finally, the CAFC reversed its prior holding that all steps in a “process” or “method” patent must be infringed in the United States for §1498(a) to apply.

The practical result of Zoltek is that very few sales to the U.S. Government by contractors and subcontractors of products or services that infringe patents will not be covered by §1498(a). The Court’s holding that indirect patent infringements are covered by §1498(a) largely achieves this result since §1498(a) states:

For the purposes of this section, the use or manufacture of an invention described in and covered by a patent of the United States by a contractor, a subcontractor, or any person, firm, or corporation for the Government and with the authorization or consent of the Government, shall be construed as use or manufacture for the United States.

28 U.S.C. §1498(a) (emphasis added). This language, together with the Court’s holding that not all processes in a process or method patent need be performed in the U.S., encompasses the overwhelming majority of patent infringement cases covered by §1498(a). If a product or service of a contractor is produced through the unauthorized use of a U.S. patent with the authorization and consent of the Government, any resulting patent infringement action must be brought against the Government in the United States Court of Federal Claims. This is, of course, the result that most government contractors believed to be the case prior to the Zoltek I decision.

By Bruce Shirk and David Gallacher

In March 2010, the U.S. Government rolled out a new tool promised to provide a centralized source for all publicly available contractor past performance and integrity information – the Federal Performance and Integrity Information System (“FAPIIS”). We have written multiple times about it (in June 2010, March 2011, and January 2012), including the importance of monitoring the information entered to ensure that past performance evaluations are accurate, complete, and fair, and also to prevent release of proprietary information to the public. But the system continues to evolve and, as contractors try to manage the information in FAPIIS, many companies find the process baffling due to (among other things) the multiplicity of modules within the system and the acronyms used to identify them. In fairness, government personnel tasked with implementing FAPIIS have developed on-line training to assist contractors in navigating this complex system. That said, not everyone involved in government contracting can or will take the training, but everyone does need a basic understanding of FAPIIS. So keep reading, because you won’t find this information in the FAR.

“What’s in a name?” – Understanding the Past Performance Databases

Let us begin with a review of the terminology, to assure that we understand the various acronyms and government IT systems. Generally speaking, the government has three primary systems or modules that contain past performance data:

1. Contractor Performance Assessment Reporting System (“CPARS”). For more than a decade, the government has used the CPARS module to centralize and harmonize past performance information. The main input for this system is a written “Report Card” issued by a Contracting Officer, which (in most circumstances) is called a Contractor Performance Assessment Report (“CPAR”), on which contractors have the opportunity to comment and which they can challenge. In this regard, note that multiple reports are commonly abbreviated as CPARs (little “s”), which is not to be confused with CPARS (capital “S”), which is the acronym identifying the database as a whole. The CPARS database is available to source selection officials government-wide, but it is not publicly available.
    
2. Past Performance Information Retrieval System (“PPIRS”). PPIRS is a companion system to CPARS. It receives the completed CPARS report cards, including contractor comments, as well as other statistical reports on smaller-value contracts. Additionally, PPIRS receives reports of “adverse actions” reported by the Contracting Officer, with the information available government-wide. The “adverse actions” include: (i) a non-responsibility determination; (ii) termination for cause; (iii) termination for default; (iv) defective pricing; (v) a determination of contractor fault; (vi) a determination that the recipient is not qualified; (vii) a termination for material failure to comply; and/or (viii) entry into an Administrative Agreement to resolve a suspension or debarment proceeding. These “adverse actions” are, with the exception noted in our January 2012 posting, eventually made available to the public via FAPIIS, but the balance of the information in PPIRS remains unavailable to the public.

   The FAR, if read literally, would suggest that PPIRS contains only written past performance evaluations submitted pursuant to the requirement of FAR 42.1502 that “agencies shall prepare an evaluation of contractor performance” for certain types of contracts over the simplified acquisition threshold of $150,000 (with the Department of Defense having different and higher thresholds). Such information is indeed contained in PPIRS – but in a separate sub-module called PPIRS-RC (Report Card). Past performance information for contracts beneath the applicable dollar thresholds are contained in another PPIRS module – PPIRS-SR (Statistical Reporting), which collects quantifiable contractor past performance information regarding delivery, quality, etc., and uses sophisticated algorithms to compare the performance of comparable contractors and classify them accordingly. This past performance information is updated monthly and, like the information contained in PPIRS-RC, is accessible to contractors, who can review and challenge their classifications. Training on PPIRS is available at www.ppirs.gov.
    

3. Federal Performance and Integrity Information System. Created in 2008 by act of Congress (Pub. L. No. 110-417, Section 872), FAPIIS is, according to FAR 42.1503(f), a “module” of PPIRS, and includes publicly available information relating to a contractor’s integrity, which is provided by both the government and the contractor. This information includes: (i) whether a contractor is included on the Excluded Parties List or has entered into an Administrative Agreement with an agency Suspension and Debarment authority; (ii) a statement as to whether a company has been the subject of a criminal, civil, or administrative proceeding that resulted in a conviction, a finding of fault, or an admission of liability relating to performance of a government contract in the past five years; and (iii) reports of government “adverse actions” (as reported by the Contracting Officer through CPARS).

Hopefully, we have managed to clarify (at least a little bit) your understanding of FAPIIS as a system and how it relates to the other past performance data repositories. In the coming months, we will follow up with additional postings discussing questions that we commonly receive from contractors in these regards, including: “Exactly what information must I report in FAPIIS?” “What must I certify with regard to FAPIIS?” and “What past performance information should I be monitoring, how and when, and what can I do about it?” Stay tuned.

By Keith Szeliga and Franklin Turner

On December 2, 2011, Federal Acquisition Regulation Subpart 3.11 – Preventing Personal Conflicts of Interest for Contractor Employees Performing Acquisition Functions — took effect. The new Rule imposes a host of compliance obligations on contractors, including the requirement to screen for and prevent personal conflicts of interest when supporting acquisition functions. The Rule also requires contractors to prohibit covered employees from utilizing non-public information for personal gain and to obtain from covered employees executed non-disclosure agreements prohibiting the dissemination of such information.

Two of our Government Contracts lawyers – Partner Keith Szeliga and Associate Franklin Turner – recently published a Briefing Paper that assists contractors in understanding the Rule and complying with its requirements.

Click here to view a PDF copy of the article.

By David S. Gallacher and Kerry O’Neill

Last April, we wrote about proposed changes to Department of Defense (“DoD”) reporting requirements for independent research and development (“IR&D”), raising concerns about how the proposed change would tie recoverability of IR&D costs to new reporting and disclosure requirements. Recently, Defense Federal Acquisition Regulation Supplement (“DFARS”) 231.205-18(c) was finalized, with changes. See 77 Fed. Reg. 4632 (Jan. 30, 2012). This final rule is a mixed bag that got some things right, but also leaves some of the most serious issues unresolved.

First – three things that DoD got right.

1. Elimination of the $50,000 Threshold. The proposed rule required IR&D reports from all major contractors generating more than $50,000 annually in IR&D costs. However, the regulations define “major contractors” as contractors whose covered segments are allocated more than $11,000,000 in total IR&D costs during the preceding fiscal year. The two different dollar thresholds created confusion as to who should be reporting and what projects should be included in these reports. The final rule removed the redundant $50,000 threshold, clarifying that all “major contractors” with more than $11,000,000 in allocable IR&D costs must submit reports on all of their IR&D projects, regardless of the dollar value of a specific project. Other non-major contractors, the final rule noted, are welcome to submit reports voluntarily.
2. Clarification Regarding Classified IR&D Projects. The proposed rule would have established a broad-ranging disclosure requirement for all IR&D projects, without regard to whether a project was classified. The final rule clarified that only unclassified projects should be submitted through the DoD’s Defense Technical Information Center (“DTIC”) website (www.dtic.mil/ird/dticdb/index.html).
3. Reiterating that Submissions Will Be Protected as Proprietary. The proposed rule required general descriptions of IR&D projects, with no guidance on what should be submitted and no assurances of how the information would be handled within the government. The final rule made clear that information reported through the DTIC website would be considered proprietary under the Freedom of Information Act (“FOIA”), 5 U.S.C. § 552(b)(4), and that it would not be subject to public disclosure. Furthermore, DoD clarified that companies are in control of the level of specificity to be included in the reports.

Whether requiring these reports is a good idea is now a moot point – the rule is final and all major contractors are required to report so that the DoD can regain greater visibility into IR&D funding and better evaluate whether the funded projects have a discernible technological purpose that benefits DoD. But, beyond the increased audit scrutiny, we think that this new reporting requirement reflects a continuing shift in DoD’s overall policy approach to IR&D, with DoD hungry for more rights and more visibility into research and development projects that, by regulation, must remain independent. Given the high value that is inevitably associated with this incessant search for more, we are quite sure that companies would rest easier if their concerns were actually addressed in the final rule in a substantive manner.

By David Gallacher and John Bonn

On January 2, 2011, the President signed the James Zadroga 9/11 Health and Compensation Act of 2010, Pub. L. No. 111-347, which set up a relief fund for victims, first responders, and construction workers who were injured in the September 11 terrorist attacks in New York City. To pay the estimated $4.3 billion price tag for the Act, Section 301 of the Act imposed on any foreign person a tax equal to 2% of federal procurement payment received by that foreign person. See 26 U.S.C. § 5000C. In addition, any person who makes or otherwise is a withholding agent with respect to such a payment is required to withhold the 2% tax from the federal procurement payment and remit the tax withheld to the Internal Revenue Service (“IRS”) under tax laws and regulations applicable to withholding of United States taxes from payments made to foreign persons. Although the tax has been in place for more than 14 months and the IRS has issued a revised Form 1042 with revised instructions to implement withholding and reporting obligations, the Government is only now turning to the details of how this tax will be accounted for in connection with the procurement process. And – as is often the case – there is quite a lot of devil in those details.

A proposed Federal Acquisition Regulation was issued on February 22, 2012 stating that the 2% tax cannot be recovered by foreign offerors on any new flexibly-priced or fixed-price contracts. See 77 Fed. Reg. 10461. Exactly how this will play out in the world of government contracting remains to be seen, but foreign companies should be aware of how this new tax may impact their bottom line, and U.S. companies should be aware of the IRS withholding and reporting requirements imposed by the Act with respect to the 2% tax. Companies should pay particular attention to the following points:

• Be aware that “foreign person” does not necessarily mean the same thing under the tax code as it does under the procurement or export laws. As such, companies could be subject to this tax even if they are organized under U.S. law.
• This tax poses significant risks for withholding agents, who are required under tax laws to withhold certain taxes owed by foreign persons. If the foreign person fails to pay the tax, the withholding agent could be on the hook for the tax liability.
• Determining what payments this tax applies to will be a nightmare because it could apply to a host of different persons and products in a host of different circumstances, none of which are clearly spelled out in the statute, the IRS guidance, or the proposed acquisition rules. Consider that the statute imposes the tax on certain specified Federal procurement payments, which are made to certain foreign persons, for the purchase of certain foreign-made products or foreign-performed services, with the tax being applied consistent with certain international agreements (including, presumably, free trade agreements and international tax treaties). It will be difficult for a company to craft a “one size fits all” solution to identify taxable transactions and to ensure that the tax is withheld and paid appropriately.

Good advice here would be “Consult your tax counsel,” particularly for those government contractors who are most likely to be dealing with taxable “specified Federal procurement payments” in the regular course of business.

The Office of the Inspector General of the Department of Defense recently changed its mailing address. Unfortunately, some contractors have failed to notice the change, and have used the old address in attempting to submit their disclosure letters. Unfortunately, these disclosures were returned to sender. The new address(es) are below, and detailed information can be found here. For further information regarding the mandatory disclosure rule, please see our previous posting on the ABA’s Guide to the Mandatory Disclosure Rule or an article authored by two of our government contracts partners, Louis D. Victorino and John W. Chierichella, republished with permission from The Government Contractor.

Mailing address:

Office of Inspector General of the Department of Defense
Investigative Policy and Oversight
Contractor Disclosure Program
4800 Mark Center Drive, Suite 11H25
Alexandria, VA 22350-1500

For FedEx and UPS packages use the following address:

Department of Defense Office of Inspector General
ATTN: ALSD/PMD Podium Warehouse – HL-02
SA Frances Lynn McCormick
Investigative Policy and Oversight Suite 11H25
4800 Mark Center Drive
Alexandria, VA 22311

By Kerry O’Neill

Under the Small Business Administration’s (“SBA”) 8(a) Mentor-Protégé program, large businesses provide various forms of business development assistance to small businesses participants, including, for example, technical and/or management assistance, financial assistance, and assistance in performing prime contracts. The program, whose governing regulations are set out in 13 C.F.R. Part 124, offers substantial opportunities for large businesses to participate in performance of federal government contracts through partnering with 8(a) program participants on a variety of contractual arrangements, including set-aside procurements, subcontracts, and prime contracts.

Mentors and Protégés: How to Qualify

• Any business or non-profit entity that “demonstrates a commitment and ability to assist developing 8(a) Participants” may act as a mentor.

By John W. Chierichella and Alexander W. Major

Under FAR 42.709-1, penalties for expressly unallowable costs are to be waived when the expressly “unallowable costs under this proposal” are less than $10,000. Although there are other bases for the waiver of the penalties, those other bases are discretionary. The $10,000 exclusion is mandatory.

In Thomas Assoc., Inc., ASBCA No. 57126, May 17, 2011, 11-1 BCA ¶ 34,764, the ASBCA considered an appeal from the imposition of penalties for five expressly unallowable “cost items”. One item involved costs of $44,959, which was in excess of the $10,000 exclusion and thus ineligible for the mandatory waiver. Each of the other four cost items involved costs of less than $10,000. Although the total expressly unallowable costs included in the indirect cost proposal exceeded $10,000, the Board considered the four cost items individually and held that the Contracting Officer was required to waive the penalty for each of the expressly unallowable cost items that was less than $10,000.

Not for long.

The Government moved for reconsideration of the Board’s decision and introduced on reconsideration, for the first time, the FAR/DFARS case file relating to the drafting of FAR 42.709-5. Relying on that newly adduced administrative history, to which the Appellant did not object, the Board concluded that waiver applies only when the expressly unallowable costs, in the aggregate, are less than $10,000. Thomas Assoc., Inc., ASBCA No. 57126, Oct 18, 2011, 11-2 BCA ¶ 34,858. The Board was persuaded by the drafting history, which specifically addressed the issue and added to the final rule parenthetical language linking the waiver to expressly unallowable costs of $10,000 or less allocable to the contracts in question. The Board noted that FAR 42.709-1, which establishes the basic penalty rule, speaks in the singular to any “indirect cost” that is expressly unallowable. By contrast, FAR 42.709-5, which establishes the waiver, speaks in the plural, dispensing with the penalty when “the amount of the unallowable costs under the proposal . . . is $10,000 or less.”

The result of the Board’s decision on reconsideration is obvious – “little things mean a lot.” A few relatively minor inadvertent errors can and will trigger penalties. Moreover, the penalties attach to the submission of the final indirect cost proposal unless the proposal is withdrawn before the initiation of the proposal audit, even if Uncle Sam never pays the costs. Contractors apparently will no longer be able to count on a “free pass” for individual cost errors at or below the $10,000 threshold if, in the aggregate, they exceed that threshold. The cost of minor mistakes just went up. Caveat venditor.

By Alex Major

In March 2010, a federal district court in Texas ruled that the deaths and injuries sustained by a group of civilian convoy drivers in Iraq during insurgent attacks were not “accidents” caused by conditions of their employment and were, therefore, outside the scope of the protections afforded to contractors by the Defense Base Act (“DBA”). 42 U.S.C. § 1651, et seq. Fisher v. Halliburton, 703 F. Supp. 2d. 639 (S.D. Tex. 2010). We previously described and criticized the district court decision in this blog, noting that it was now unclear how, exactly, the DBA would fare in future litigation. But on January 12, 2012, the Fifth Circuit restored clarity— and common sense—to the application of the DBA by recognizing that the facts in Fisher presented “the quintessential case of a compensable injury arising from a third party’s assault”. Holding the DBA to be the exclusive remedy for damages, the Fifth Circuit vacated the district court’s decision and remanded the case for further proceedings. Fisher v. Halliburton, 2012 WL 90136 (5th Cir. 2012).

The Fifth Circuit efficiently disposed of the district court’s decision, beginning with a determination that the third party, i.e., insurgent, acts were directed against Plaintiffs “because of [their] employment.” Forcefully disagreeing with the district court’s conclusion that the employees were targeted for simply being Americans and not because they were providing logistical support to the U.S. Military, the court cautioned that such reasoning threatened the applicability of the DBA “on foreign soil” or to “those that support a war.” Moreover, the court stated, if the reasoning of the district court were sustained, then “[t]he argument could always be asserted that an employee was killed or injured not because of her employment, but because she was an American.” Accordingly, the circuit court found it to be “self evident” and “a matter of common sense that when insurgent forces in Iraq attack an Army-led fuel supply convoy, the insurgents are attacking the convoy because of its role in supporting the Army’s operations in that country.”

The Fifth Circuit then disposed of another argument raised by Plaintiffs in Fisher, i.e., that the Plaintiffs’ injuries were caused by the defendant-contractor, who, they alleged, committed an intentional tort by failing to act to protect Plaintiffs from “substantially certain” injury at the hands of the insurgents. This argument, premised on intelligence reports and open-source news reports, reasoned that the defendant knew that the assaults would occur and did nothing to stop the convoys from moving forward. While recognizing that the “intentional tort exception” has not been applied in the Fifth Circuit to the either the DBA or the Longshore and Harbor Workers’ Compensation Act (“LHWCA”), upon which the DBA is based, the court noted that, when applying this exception, other courts “consistently require that the employer have had a specific intent or desire that the injury occur” and that neither circumstance existed here. Moreover, the circuit court reiterated the purpose of the DBA and concluded that its “provisions admit of no exception for cases in which an employee claims his employer was ‘substantially certain’ that the employee would be assaulted by a third party because of his employment.” The circuit court essentially recognized the difficulty in applying a “substantially certain” exception premised on purportedly informed conjecture derived from military intelligence and open-source news. To allow a “substantially certain” exception would undercut the very purpose of the DBA of “providing prompt relief for employees, and limited and predictable liability for employers.” Therefore, the court concluded, coverage under the DBA precludes an employee from recovery from its employer “under a ‘substantially certain’ theory of intentional-tort liability.”

Finally, the Fifth Circuit did agree with the district court that the DBA prevents an employee from bringing a fraud claim to recover damages for a DBA-covered injury. Echoing the sentiment of the lower court, the circuit court held that any deceit proven against the employer that led to the compensable injury “merges into that injury for purposes of compensation coverage.”

In his book recounting his leadership of the American Expeditionary Forces in World War I, My Experiences in the World War, General John Pershing reflected that “military science is based on principles that have been deduced from the application of common sense in the conduct of military affairs.” The Fifth Circuit’s defense of the DBA in vacating and remanding the lower court’s ruling in Fisher v. Halliburton, recognizes that the same application of common sense should be brought to bear in the application of U.S. law in the battlespace.

By Mike Emmick

In the fervor of the U.S.’s current anti-foreign-corruption efforts, a particularly misguided proposal has occasionally reared its ugly head: Requiring “mandatory debarment” for any company that violates the Foreign Corrupt Practices Act (“FCPA”).

On the merits, such a proposal is completely wrong-headed. Debarment is a severe, forward-looking administrative remedy – the corporate “death penalty” – not a vehicle to “boost” the penalties for past criminal FCPA violations.

Nonetheless, in 2010, such a “mandatory debarment” bill was passed by the House, only to die in Congress due to Senate inaction. Optimistic multinational contractors might therefore have concluded, “Whew, we dodged that bullet.”

However, a recent law-review article has sought to resurrect the debarment idea, contending that no other remedy will deter large global companies from violating the FCPA.

Below is a snapshot of the relevant law, recent developments, and pertinent arguments. As will be explained, despite the recent article, the notion of “mandatory debarment” is unlikely to gain traction – even the Department of Justice (“DOJ”) opposes it – but the article and the current anti-corruption frenzy may cause authorities to reconsider the idea. Any multinational company that does substantial government contract work should therefore monitor and resist such efforts.

As nearly everyone who operates in this market knows by this time, the FCPA prohibits U.S. companies from paying bribes to foreign officials in order to obtain or retain business. The FCPA also requires accurate books and records and meaningful internal accounting controls. Violations of the FCPA can result in huge criminal and civil fines, disgorgement of profits, and payment of interest, not to mention a wide range of collateral consequences. The FCPA is enforced by DOJ and the SEC.

Over the past five years DOJ has been extremely aggressive in its prosecution of FCPA violations. Eight of the ten largest FCPA fines in history occurred in 2010, and multi-million-dollar fines have now become routine. There are currently dozens of pending FCPA investigations – many more than in previous years. Indeed, DOJ has dubbed this “the new era of FCPA enforcement.”

Congress attempted to climb aboard this FCPA-enforcement bandwagon when, on September 15, 2010, the House unanimously passed a “mandatory debarment” bill – H.R. 5366, known as the 2010 Overseas Contractor Reform Act. The bill would have created a government-wide policy that no contracts be awarded to companies or individuals that violated the FCPA. H.R. 5366, § 3. Procedurally, the law would have required the contracting agency to propose for debarment all contractors found to be in violation of the FCPA.

The bill was flawed in many ways. It did not define a “finding” of an FCPA violation, so it was unclear whether the debarment would be triggered by a non-prosecution or deferred prosecution agreement. The bill failed to differentiate between major and minor FCPA violations, or between different kinds of violations (i.e., bribe payments versus “books and records” or accounting violations). The bill did not require or permit consideration of how the violation occurred, whether the company self-reported the violation, or whether the company dramatically improved its anti-corruption compliance program thereafter.

Shortly after the bill was passed, DOJ answered questions about the FCPA generally, as the Chamber of Commerce was proposing FCPA amendments. DOJ expressed its opposition to “mandatory debarment,” stating that mandatory debarment “would likely be counterproductive, as it would reduce the number of voluntary disclosures and concomitantly limit corporate remediation and the implementation of enhanced compliance programs.” According to DOJ, such a debarment program could also hurt the government’s ability to investigate and prosecute transnational corruption. Linking debarment to criminal conviction would “fundamentally alter the incentives of a contractor-company,” because an FCPA resolution would then cause the company to suffer a dramatic reduction in revenue. That, in turn, would negatively impact prosecutorial discretion and the flexibility to reach an appropriate resolution given the facts and circumstances of the particular case.

DOJ’s opposition would ordinarily be enough to ensure that “mandatory debarment” would not be taken seriously. And in fact the Senate took no further action on the House bill, perhaps because of DOJ’s opposition after the House bill was passed.

However, a recent law-review article has sought to resurrect this misguided debarment notion. In November 2011, Fordham Law Review published a 70-page article entitled “FCPA Sanctions: Too Big to Debar,” available here, which was written by Professor Drury Stevenson of the South Texas College of Law, along with one his law students. The article took the position that debarment should be considered as an additional punishment for FCPA violations. According to the article, corporations can only be punished via fines, and government contract revenues are so large that fines often become a mere “cost of doing business,” which prevents those fines from having deterrent value. In addition, the public may interpret a failure to debar a company as suggesting that companies can buy their way out of FCPA violations.

The article acknowledged that mandatory debarment might discourage self-disclosure – one of DOJ’s concerns – but proposed that self disclosure might be meaningfully rewarded through a reduced criminal fine. The article also acknowledged that debarment might be the contractor’s “death knell”; it might even raise an “Arthur Andersen” problem by driving an important and responsible company out of business entirely, which might harm the contracting market, foreign relations, national security, and the company’s shareholders. As an alternative to mandatory debarment, the article proposed an increase in discretionary debarments based on FCPA violations.

For a number of reasons, “mandatory debarment” for FCPA violations is a bad idea. In fact, In January 2012, two months after “Too Big to Debar” was published, Fordham Law Review published a responsive article authored by Jessica Tillipman, a professor at George Washington Law School. Jessica Tillipman, “A House of Cards Falls: Why “Too Big to Debar” is All Slogan and Little Substance”, available here. Tillipman disagreed with nearly all of Professor Stevenson’s conclusions and analysis, and her remarks warrant summarizing here.

First, the debarment provision in the Federal Acquisition Regulations (FAR) is itself inconsistent with “mandatory debarment.” FAR 9-402(b) states that “the serious nature of debarment and suspension requires that these sanctions be imposed only in the public interest for the Government’s protection and not for purposes of punishment.” (Emphasis added.) The point of debarment is to ensure that the government works with “responsible partners.” Indeed, that is why the prosecutors handle the fines, and the debarring officials handle the debarment.

Second, the FAR expressly requires the debarment officials to consider whether the contractor undertook remedial measures or whether the violation involved mitigating factors that demonstrate that the contractor is still “presently responsible.” FAR 9-406-1. Mandatory debarment would make those provisions meaningless, and would shift the focus of debarment from future conduct to past conduct.

Third, imposing the remedy of “mandatory debarment” would unfairly focus on government contractors, not on other companies or individuals that may violate the FCPA. Why should contractors be discriminated against – especially automatically discriminated against?

Fourth, debarment is an inappropriate “all or nothing” remedy. Its use might destroy responsible companies – even essential companies – that have thousands of employees and contribute immensely to the economies of the U.S. and the world. That is why debarment should be used only rarely, and only after an extensive review of what prompted the transgression, how the company responded, and other important factors.

Fifth, if mandatory debarment were to become the law, it might even discourage large companies from engaging in business with the U.S., because their devotion of time to and their monetary investments in government contract work could be lost at the whim of federal prosecutors, perhaps as the result of actions by rogue employees who clandestinely refused to adhere to the companies’ anti-corruption compliance program.

Finally, as DOJ itself pointed out in 2010, “mandatory debarment” might actually hurt the US’s FCPA-enforcement efforts by discouraging corporate self-disclosure and cooperation as part of the remediation process. Those procedures are currently a critical source of information for DOJ to use in its prosecution of FCPA violations.

In light of DOJ’s opposition, “mandatory debarment” for FCPA violations is unlikely ever to become law. Nonetheless, because the consequences would be potentially devastating, any such possibility should be monitored closely by and vigorously opposed by global contractors.

By David Gallacher and Curt Dombek

Last year in January 2011, the President signed the 2011 National Defense Authorization Act (Pub. L. No. 111-383, Section 846), which included a “Buy American” requirement for photovoltaic devices being purchased by the U.S. Department of Defense (“DoD”). We previously discussed this new requirement in our blog. Twelve months later, the DoD has issued an interim rule to implement this new requirement. See 76 Fed. Reg. 18858 (Dec. 20, 2011). The interim rule appears to be straightforward, implementing exceptions and manufacturing requirements with which most companies are already familiar under the Buy American Act or the Trade Agreements Act, but there is some fine print of which all companies selling photovoltaic devices to the DoD should be aware.

Key Definitions

The interim rule includes a new subsection at Defense Federal Acquisition Regulation Supplement (“DFARS”) 225.7017, as well as a new contract clause at DFARS 252.225-7017, Photovoltaic Devices, and a corresponding certification requirement at DFARS 252.225-7018. Defining its key concepts, the interim rule largely restates the statutory language from Section 846 by defining “covered contracts” and “photovoltaic device.”

• “Covered contracts” means “an energy savings performance contract, a utility service contract, or a private housing contract awarded by DoD, if such contract results in DoD ownership of photovoltaic devices, by means other than DoD purchase as end products. DoD is deemed to own a photovoltaic device if the device is – (1) Installed on DoD property or in a facility owned by DoD; and (2) Reserved for the exclusive use of DoD for the full economic life of the device.” Note that a “covered contract” will not include government contracts valued at less than $150,000 (the simplified acquisition threshold).

It is doubtful whether Section 846 was even necessary in the first place – after all, the statute merely directed DoD to ensure that the purchases of photovoltaic devices comply with the Buy American Act and the Trade Agreements Act, two statutes that would have applied to DoD purchases even if Section 846 were never passed. Nevertheless, now that the DFARS has been amended with this interim rule, there should be greater clarity for contractors regarding the types of products that will satisfy the new requirement, as well as the specific procedures on how this new “Buy American” requirement will be implemented (particularly with regard to the valuation of photovoltaic devices being procured as part of a larger government contract). DoD is accepting comments on the interim rule through February 21, 2012.

By David Gallacher

2012 will see changes regarding U.S. free trade agreements relating to, first, the dollar thresholds at which the various agreements apply to federal purchases and, second, the likely expansion of the scope of the World Trade Organization Government Procurement Agreement (“WTO GPA”). The updated dollar thresholds are important for government contractors because the thresholds determine when a contract is subject to the Buy American Act (“BAA”) or the Trade Agreements Act (“TAA”). As to the WTO GPA, its expansion should provide significant increased access to the U.S and many of its trading partners in international procurements, although the hoped for accession of China to the WTO GPA remains stalled

Updated Dollar Thresholds

On December 8, 2011, the U.S. Trade Representative (“USTR”), Ronald Kirk, announced the dollar thresholds at which free trade agreements (“FTAs”) will apply to U.S. procurements beginning in 2012. See 76 Fed. Reg. 76808. The USTR has raised some thresholds, maintained others, and even lowered some:
 

As we discussed previously in this blog when the thresholds were last adjusted in 2010, it is unclear whether the FAR will need to be amended to incorporate the new thresholds or whether the new thresholds automatically become “effective January 1, 2012″ as directed by the USTR. However, on January 30, 2012, the DFARS was amended to incorporate the new dollar thresholds. See 77 Fed. Reg. 4630. While the FAR Councils are no doubt also working on updating the relevant FAR clauses at FAR Subpart 25.4, any new rules will probably not be issued until February or March 2012. Contractors should be aware that Contracting Officers may take even longer to update individual contracts, or, for that matter, to agree that modifications to existing contracts are appropriate in the first place.

Pending Updates to the WTO GPA

In December 2011, the members of the WTO met in Geneva to revise the WTO GPA. Ever since Canada and the U.S. negotiated amendments to the U.S.-Canada FTA allowing Canada greater access to procurements by state and local governments (one of the primary outlets for stimulus funds through 2009 and 2010), members of the WTO have clamored for expanded access under the GPA. FTAs typically apply only to governmental agencies that are specifically listed in the free trade agreement; the new December 2011 agreement allows expanded access by foreign companies to U.S. procurements by listing twelve previously uncovered federal agencies (including the Social Security Administration and the Transportation Security Administration) as now covered by the WTO GPA. In exchange, U.S. companies will gain access to hundreds of foreign “central and sub-central” government procurements in countries such as Japan, South Korea, Israel, and many other E.U. countries. The new WTO agreement is expected to open significant international procurement markets, and the USTR hailed the new agreement as a major breakthrough for free trade. The changes to the WTO GPA are expected to be formalized by March 2012.

Meanwhile, in November 2011, China updated its submission to accede to the WTO GPA. But the submission fell short of U.S. and E.U. expectations, setting extremely high dollar thresholds and exempting a large number of Chinese sub-central agencies and state-run enterprises. China joined the WTO in 2001 and China has reiterated that it intends to accede to the WTO GPA. However, given the above high dollar thresholds and exemptions, China has thus far been unable to make the kind of aggressive offers demanded by the international community to complete its accession. Therefore, at least for the time being, products made in China will continue to be noncompliant under the Trade Agreements Act.

Current signatories to the WTO GPA include more than 40 countries: the U.S., the 27 member states of the European Union, Canada, Armenia, Aruba, Hong Kong, Iceland, Israel, Japan, Liechtenstein, Norway, Singapore, South Korea, Switzerland, and Taiwan. Armenia is the most recent addition to the WTO GPA, having just recently acceded to the WTO GPA on September 15, 2011. See 76 Fed. Reg. 58856; 77 Fed. Reg. 4631.

The Government Proposes To Increase Certainty With Respect To Worker Classification

Current Law

For both tax and nontax purposes, workers must be classified into one of two mutually exclusive categories: employees or self-employed (sometimes referred to as independent contractors).

Worker classification generally is based on a common-law test for determining whether an employment relationship exists. The main determinant is whether the service recipient (employer) has the right to control not only the result of the workeras services but also the means by which the worker accomplishes that result. For classification purposes, it does not matter whether the service recipient exercises that control, only that he or she has the right to exercise it.

Even though it is generally recognized that more highly skilled workers may not require much guidance or direction from the service recipient, the underlying concept of the right to control is the same for them. In addition, only individuals can be employees. In determining worker status, the IRS looks to three categories of evidence that may be relevant in determining whether the requisite control exists under the common-law test:

(i) behavioral control, (ii) financial control, and (iii) the relationship of the parties.

For employees, employers are required to withhold income and Federal Insurance Contribution Act (FICA) taxes and to pay the employeras share of FICA taxes. Employers are also required to pay Federal Unemployment Tax Act (FUTA) taxes and generally state unemployment compensation taxes. Liability for Federal employment taxes and the obligation to report the wages generally lie with the employer. For workers who are classified as independent contractors, service recipients engaged in a trade or business and that make payments totaling $600 or more in a calendar year to an independent contractor that is not a corporation are required to send an information return to the IRS and to the independent contractor stating the total payments made during the year. The service recipient generally does not need to withhold taxes from the payments reported unless the independent contractor has not provided its taxpayer identification number to the service recipient. Independent contractors pay Self-Employment Contributions Act (SECA) tax on their net earnings from self-employment (which generally is equivalent to both the employer and employee shares of FICA tax). Independent contractors generally are required to pay their income tax, including SECA liabilities, by making quarterly estimated tax payments.

For workers, whether employee or independent contractor status is more beneficial depends on many factors including the extent to which an independent contractor is able to negotiate for gross payments that include the value of nonwage costs that the service provider would have to incur in the case of an employee. In some circumstances, independent contractor status is more beneficial; in other circumstances, employee status is more advantageous.

Under a special provision (section 530 of the Revenue Act of 1978 which was not made part of the Internal Revenue Code), a service recipient may treat a worker as an independent contractor for Federal employment tax purposes even though the worker actually may be an employee under the common law rules if the service recipient has a reasonable basis for treating the worker as an independent contractor and certain other requirements are met. The special provision applies only if (1) the service recipient has not treated the worker (or any worker in a substantially similar position) as an employee for any period beginning after 1977 and (2) the service recipient has filed all Federal tax returns, including all required information returns, on a basis consistent with treating the worker as an independent contractor.

If an employer meets the requirements for the special provision with respect to a class of workers, the IRS is prohibited from reclassifying the workers as employees, even prospectively and even as to newly hired workers in the same class. Since 1996, the IRS has considered the availability of the special provision as the first part of any examination concerning worker classification. If the IRS determines that the special provision applies to a class of workers, it does not determine whether the workers are in fact employees or independent contractors. Thus, the worker classification continues indefinitely even if it is incorrect.

The special provision also prohibits the IRS from issuing generally applicable guidance addressing the proper classification of workers. Current law and procedures also provide for reduced penalties for misclassification where the special provision is not available but where, among other things, the employer agrees to prospective reclassification of the workers as employees.

Reasons for Change

Since 1978, the IRS has not been permitted to issue general guidance addressing worker classification, and in many instances has been precluded from reclassifying workers a even prospectively a who may have been misclassified. Since 1978 there have been many changes in working relationships between service providers and service recipients. As a result, there has been continued and growing uncertainty about the correct classification of some workers.

Many benefits and worker protections are available only for workers who are classified as employees. Incorrect classification as an independent contractor for tax purposes may spill over to other areas and, for example, lead to a worker not receiving benefits for unemployment (unemployment insurance) or on-the-job injuries (workersa compensation), or not being protected by various on-the-job health and safety requirements.

The incorrect classification of workers also creates opportunities for competitive advantages over service recipients who properly classify their workers. Such misclassification may lower the service recipientas total cost of labor by avoiding workersa compensation and unemployment compensation premiums, and could also provide increased opportunities for noncompliance by service providers.

Workers, service recipients, and tax administrators would benefit from reducing uncertainty about worker classification, eliminating potential competitive advantages and incentives to misclassify workers associated with worker misclassification by competitors, and reducing opportunities for noncompliance by workers classified as self-employed, while maintaining the benefits and worker protections associated with an administrative and social policy system that is based on employee status.

Proposal

The proposal would permit the IRS to require prospective reclassification of workers who are currently misclassified and whose reclassification has been prohibited under current law. The reduced penalties for misclassification provided under current law would be retained, except that lower penalties would apply only if the service recipient voluntarily reclassifies its workers before being contacted by the IRS or another enforcement agency and if the service recipient had filed all required information returns (Forms 1099) reporting the payments to the independent contractors. For service recipients with only a small number of employees and a small number of misclassified workers, even reduced penalties would be waived if the service recipient (1) had consistently filed Forms 1099 reporting all payments to all misclassified workers and (2) agreed to prospective reclassification of misclassified workers. It is anticipated that, after enactment, new enforcement activity would focus mainly on obtaining the proper worker classification prospectively, since in many cases the proper classification of workers may not have been clear. (Statutory employee or nonemployee treatment as specified under current law would be retained.)

The Department of the Treasury and the IRS also would be permitted to issue generally applicable guidance on the proper classification of workers under common law standards. This would enable service recipients to properly classify workers with much less concern about future IRS examinations. Treasury and the IRS would be directed to issue guidance interpreting common law in a neutral manner recognizing that many workers are, in fact, not employees.

Further, Treasury and the IRS would develop guidance that would provide safe harbors and/or rebuttable presumptions, both narrowly defined. To make that guidance clearer and more useful for service recipients, it would generally be industry- or job-specific. Priority for the development of guidance would be given to industries and jobs in which application of the common law test has been particularly problematic, where there has been a history of worker misclassification, or where there have been failures to report compensation paid.

Service recipients would be required to give notice to independent contractors, when they first begin performing services for the service recipient, that explains how they will be classified and the consequences thereof, e.g., tax implications, workersa compensation implications, wage and hour implications.

The IRS would be permitted to disclose to the Department of Labor information about service recipients whose workers are reclassified.

To ease compliance burdens for independent contractors, independent contractors receiving payments totaling $600 or more in a calendar year from a service recipient would be permitted to require the service recipient to withhold for Federal tax purposes a flat rate percentage of their gross payments, with the flat rate percentage being selected by the contractor. The proposal would be effective upon enactment, but prospective reclassification of those covered by the current special provision would not be effective until the first calendar year beginning at least one year after date of enactment. The transition period could be up to two years for independent contractors with existing written contracts establishing their status.

Government workers and contractors share many things a office space, project goals and a drive to improve government programs and services.

Yet there are differences that can lead to tension when public-private partnerships approach a problem from their unique vantage points. As private-sector employees, contractors may want to be more innovative than bureaucracy allows, and being unable to push the envelope can cause frustration.Read full article >>

Is there tension between the government employees and the federal contract workers in your office?

As Joe Davidson wrote last week in the Federal Diary, some federal contractors got a 10 percent raise in April, while federal workers are in the midst of a pay-freeze. Read full article >>

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