False Claims Act Developments

October 1999

Co-Authors: Brian C. Elmer, John A. Macleod and Mark R. Koehn.

Developments in high stakes litigation prompt us to remind you again about potential liability under the False Claims Act ("FCA"). The FCA is a Civil War-era statute that allows citizens to bring suits against companies alleged to be cheating the government. The financial incentives to sue are lucrative. Successful FCA "relators" (as citizen plaintiffs are known under the Act) can collect up to 30% of trebled damages and penalties and 100% of their attorneys' fees.

On October 18, 1999, the U. S. Department of Justice announced that a coal company, and certain of its current and past affiliates, agreed to pay $11 million to resolve claims under the FCA and related administrative claims for underpaying royalties.

The suit and its settlement suggest that multi-million dollar royalties litigation under the FCA in the oil and gas areas has expanded to the coal area as well. This is not the first FCA case brought against a mining company. (See False Claims Act Litigation Notes, in the February 1998 issue of the C&M Mining Law Monitor.) Nor is it surprising given the pending oil and gas royalties cases under the FCA and the similarity between oil, gas, and coal royalty payment schemes. (See Federal Court Throws Out $60 Billion Whistleblower Claim Against Mining Companies, in the May 1998 issue of the C&M Mining Law Monitor.) It is significant, however, because it leaves coal royalty payors little reason to delay reviewing their royalty payment procedures to develop strategies to avoid and minimize potential FCA liability for arguable royalty underpayments.

Apparently, in this most recent case, the government contends that: (1) a coal company affiliate mined coal from federal lands and sold the coal to a utility company; (2) the utility company sold the coal to another affiliate of the same coal company; and (3) the second coal company affiliate sold the coal to its customers. The government further contends that coal royalties were paid based solely upon the first affiliate's sale to the utility company. The government's press release asserts that the coal royalties should have been based on the value of the gross proceeds received by both affiliates and not solely on the proceeds received by the first affiliate. A Minerals Management Service auditor discovered the alleged underpayments during an audit of the second affiliate in 1992. The Interior Department's Office of Inspector General and the United States Attorney subsequently investigated the transactions. (Interestingly, the government apparently did not target the utility company for its role in the alleged transactions.)

Under the FCA, a company commits a so-called "reverse false claim" if it knowingly makes a false statement to conceal, avoid, or decrease an "obligation" to pay the government. A key question in the mineral royalties cases is whether a mineral lessee's contractual duty to make royalty payments to the government qualifies as an FCA "obligation."

The Sixth, Eighth, and Eleventh Circuits have held that the "obligation" sought to be avoided must be a specific, quantified legal obligation at the time the alleged false statement was made or used and not merely potential or inchoate liability. The Eleventh Circuit, however, recently vacated its ruling sua sponte and conducted a rehearing en banc, prompting speculation that the Circuits may soon be split on this issue.

In the Eighth Circuit case, United States v. Q International Courier, Inc., the federal government alleged that the defendant owed an obligation to the United States to pay full domestic postage, which it attempted to avoid through false statements coupled with a practice known as "ABA remail." An ABA remailer ships bulk mail from the United States to Barbados for remail to the United States for as little as a tenth of the amount of postage charged for delivery if the items had been individually mailed within the United States. The Eighth Circuit held that the government must demonstrate that the defendant had some specific obligation to the government to pay money or property, which it sought to evade or reduce by using false statements. According to the Eighth Circuit, a "debt, and thus an obligation under the meaning of the False Claims Act, must be for a fixed sum that is immediately due." The court stated that a regulation which merely provided a range of potential penalties which might be assessed did not "create an immediate duty to pay a specific sum."

Although now vacated, the Eleventh Circuit panel ruling, United States v. Pemco Aeroplex, Inc., adopted the Eighth Circuit's Q International analysis. In Pemco, a government contractor offered to purchase government property held by the contractor and submitted an inventory schedule to the government that knowingly undervalued the property. The Eleventh Circuit affirmed the district court's entry of summary judgment in favor of the contractor because the submission of the false inventory schedule, while it initiated a plant clearance procedure that would lead to the Government's sale of the property at the reduced value, did not create the type of obligation that the FCA requires. In fact, the false inventory schedule ultimately led to a government decision to sell the contractor five aircraft wings (falsely identified as older model wings) for less than $2,000. Shortly thereafter, the contractor sold two of the five wings for about $1.5 million. The government alleged that the estimated total market value of the wings was over $2 million.

Crucial to the court's analysis was the fact that the government could not accept the contractor's offer at the time that the contractor submitted the false inventory schedule. Nor could the government do so until the government completed the plant clearance procedure, including the government's review and verification of the inventory schedule and requests for correction, if any.

According to the Eleventh Circuit, although the contractor "may have created a future potential liability (an offer [by the contractor] to purchase the wings or return them after the occurrence of the plant clearance procedure), . . . [the contractor's false submission] did not create the specific legal obligation that the reverse false claim provision requires." In Pemco, there was no dispute that the contractor had a pre-existing contractual obligation to submit the inventory schedule for so-called "excess property" and, after the plant clearance procedure, either return or purchase excess property. The Eleventh Circuit, however, properly focused on whether the contractor had a specific legal obligation to purchase the falsely identified aircraft wings at the time the contractor submitted the inventory schedule.

In mid-September, the Sixth Circuit in United States ex rel. American Textile Manufacturers Institute, Inc. v. The Limited, Inc. ("ATMI"), expressly agreed with the Eighth Circuit's reasoning in Q International. ATMI involved alleged avoidance of fines, penalties, and forfeitures by improperly labeling certain imported goods. The Sixth Circuit reasoned that "a plaintiff may not state a reverse false claim unless the obligation attached before the defendant made or used the false record or statement." The court also noted that Congress intended the term "obligation" to be "more limited" than the defined term "claim." Finally, in expressly adopting Q International, the Sixth Circuit stated that:

[W]e hold that a reverse false claim action cannot proceed without proof that the defendant made a false record or statement at a time that the defendant owed to the government an obligation sufficiently certain to give rise to an action of debt at common law. . . . A defendant risks liability when making a false statement to conceal, avoid or decrease obligations such as his prior acknowledgment of indebtedness, a final court or administrative judgment that the defendant owes money or property to the government, or a contractual duty to pay or transmit money or property to the government.

A broader interpretation, the court observed, would permit suits based upon "contingent obligations - those that will arise only after the exercise of discretion by government actors" such as imposition of a civil penalty for a violation of law.

As of this writing, it appears that no oil, gas, or coal company defendant in an FCA action alleging underpaid royalties has yet moved for summary judgment on the basis of the "no obligation" defense. The ATMI decision suggests that a mineral lessee's contractual duty to make a royalty payment, because it is due before the government exercises discretion to determine the precise royalty owed, may not qualify as a FCA "obligation."

The Justice Department disagrees. In its en banc brief for the United States in Pemco, submitted days before the ATMI decision, the Justice Department argued that the scope of reverse false claims liability under the FCA does not turn on whether the "precise amount [of the debt to the government] has not yet been finally set[.]" Apparently hoping to develop case law helpful to its mineral royalty cases, the government's en banc brief in Pemco expressly referred to the royalties context for illustrative purposes, stating that "where oil, gas, coal, and minerals are mined from federal lands, the amount of royalties that the miner owes to the government may be based on the miner's self-reporting of how much he has taken from the ground."

On October 19, 1999, the Eleventh Circuit heard oral argument en banc in Pemco. Look for a future Mining Law Monitor article discussing the final result.

Together, the $11 million FCA settlement for coal royalty underpayment and the government's en banc brief in Pemco make two points abundantly clear:

• Coal royalty payors have little reason to delay reviewing their royalty payment procedures in order to develop strategies to avoid and minimize potential FCA liability for royalty underpayments; and
• The government is striving, in various contexts, to develop FCA case law supporting the government's theory of liability in all mineral royalty cases.

Coal companies having any doubts about the propriety of their royalty payment practices should evaluate their potential exposure to FCA liability. Unfortunately, profit-seeking whistleblowers already may be doing just that.