Client Alerts
March 25, 2016

Contractors: The G-Man Cometh, Are You Ready?

Stites & Harbison Legal Update, March 17, 2016

by Stites & Harbison, PLLC

Contractors are accustomed to taking a lot of risks. Many of those risks are obvious. Consider the contractor who agrees to build a pipeline at a fixed price per foot. If his crews can’t excavate, lay, and backfill as fast as his estimators thought they could, the contractor is most likely on the hook for the increased cost. Similarly, a contractor who agrees to fixed prices for finish work that won’t be completed until the end of the job typically owns the risk that the costs for the finish materials will rise before the work is done. Most contractors understand these types of performance risks are part of the bargain and can be controlled by good management and making sound deals. Contractors who successfully manage performance risks are rewarded with profits. However, those profits can quickly be depleted if contractors fail to manage other, less obvious risks.

Among the less obvious is the risk of non-compliance with laws and regulations that govern contractors and their activities. Safety, for example, is heavily regulated across the country. The purpose of the regulations is to protect workers. Of course, no reputable contractor sets out to create an unsafe job site. Safety can, however, take a back seat in the daily grind of a construction project. Contractors too often succumb to the temptation to postpone needed training when a project is behind schedule or let untrained operators run equipment when a crew is a man short. The consequences of those decisions may seem unlikely or even trivial; but over time, that type of short-term, high-risk management can have serious consequences when they run contrary to regulations or the contractor’s own safety policy.

Recent examples of contractors who have run afoul of their safety obligations offer valuable lessons on the consequences of noncompliance. For example, a contractor who allegedly failed to comply with trench excavation safety requirements was recently fined more than $500,000 by OSHA. In a February 2016 case, a roofing contractor received a citation with an initial penalty of more than $100,000—$70,000 of which related to the employer allegedly failing to provide adequate fall protection. Too often, seemingly minor infractions of regulations—like allowing workers to work in front of trench boxes or get on elevated platforms without being properly tied off—are justified by the financial burden of compliance. As both of these cases clearly show, however, the financial cost of compliance can be far less than the cost of noncompliance—to say nothing of the moral and ethical costs. $70,000 would have bought a lot of harnesses and lanyards. While contractors may get away with what are perceived as minor infractions from time to time, each decision increases the organization’s exposure to potentially devastating consequences. Moreover, communicating to project management that safety should yield to productivity or cost concerns runs the risk of establishing a culture of noncompliance.

Safety isn’t the only compliance issue contractors face. Other, less obvious, legal compliance issues include those relating to public contracting and antitrust violations. Contractors operate in a highly competitive environment. That competition drives, among other things, a culture of deal making. For example, it isn’t uncommon for contractors to joint-venture with other contractors on large jobs or where the other contractor has particular expertise or equipment. Contractors may also develop special relationships with owners, designers, competitors, or key suppliers. In fact, many contractors have full-time staff devoted to developing these types of relationships. These activities are usually completely above board. Under certain circumstances, however, they could cross lines many contractors may not be aware exist.

The Department of Justice (DOJ), for example, continues to pursue contractors who violate the False Claims Act and antitrust laws. During February 2016 alone, the DOJ announced it resolved two significant cases resulting in contractors paying nearly $5 million in restitution and fines. In the first case, a construction management company cut deals with two SBA 8(a) contractors whereby the 8(a) firms obtained federal set-aside contracts. The problem was that under the terms of their deals, the 8(a) contractors weren’t doing any of the work. Instead, the construction management company performed all the work and, according to the DOJ, the 8(a) contractors simply received 3% of the contract price. That case led to criminal charges which were settled by the construction manager paying nearly $1.8 million in fines.

The second case is even more eye-opening. It involved a contractor who paid cash to a purchasing manager of a utility in exchange for the purchasing manager sending the contractor bids he received from other contractors on various projects. This case also involved unscrupulous contract modifications based on allegedly fabricated emails showing material price increases that did not occur. This case led to those involved being sentenced to more than 16 years in prison, not to mention having to pay over $3 million in fines and restitution.

Other recent antitrust actions should also cause contractors to take notice. In particular, the Federal Trade Commission’s action against McWane, Inc., (a supplier of domestic ductile iron pipe fittings). In this case, the FTC alleged McWane violated antitrust laws when it required customers to either purchase all of their needed fittings from McWane or lose rebates those customers had already accrued. This case is presently being appealed by McWane after losing before the U.S. Court of Appeals for the 11th Circuit. The point here is not whether an exclusive dealings agreement violates antitrust laws where other competitors actually acquire market share—the precise point the Supreme Court is likely to decide—but that regulators and the DOJ are aware and have taken notice of supplier/contractor agreements that may be cast in an anti-competitive light.

The facts in the above cases seem fairly extreme. However, it’s not hard to change one or two facts and cast the deals in a more familiar light. Consider these hypotheticals:

  • An 8(a) contractor becomes overloaded with work and, in order to meet its contractual obligations, subcontracts with a larger firm to perform all or most of the work on a set-aside project it has been awarded;
  • A contractor treats a purchasing manager to dinner or tickets to a ball game after which the purchasing manager gives the contractor the prices other contractors have submitted for upcoming work; or,
  • A supplier offers special pricing to its exclusive customers, provided they agree to buy all their supplies from the supplier.

With these facts, the activities may not sound any alarms. However, under the wrong circumstances, particularly in public contracting, they should! Federal regulations generally require 8(a) contractors to perform at least 15% of the contract work with their own employees on construction projects. 13 CFR 125.6(a)(3). Thus, an 8(a) contractor on a set-aside contract likely violates this requirement in the above hypothetical. Moreover, giving (or even offering) a public official anything of value to influence that official could violate state or federal anti-bribery laws if there are circumstances indicating a corrupt intent, collusion, fraud, or other illegal result. See, e.g., 18 U.S.C. § 201, et seq. Thus, the dinner or tickets in the second hypothetical could be construed as a bribe or illegal quid pro quo. Finally, market participants may violate antitrust laws if they, for example, make agreements that fix prices or divide markets amongst competitors. See 15 U.S.C. §§ 1–7, 41–58. Therefore, with some additional facts, the exclusive supply agreement in the third hypothetical may run afoul of antitrust laws if the agreement prevents new competitors from entering a market dominated by the supplier. See, e.g., McWane, Inc. v. FTC, 783 F.3d 814 (11th Cir. 2015). Even if these activities are not clear violations of any rules, they warrant further investigation to ensure that a zealous regulator or prosecutor could not take the facts out of context or paint them in a more incriminating light.

The risk of legal compliance is real and, unfortunately, complex. Contractors face an increasing burden of local, state, and federal compliance risks. From prevailing wages to procurement laws, employment discrimination to environmental pollution, contractors face a seemingly unending row of obstacles. Navigating these obstacles may seem difficult; but ignoring them won’t make them go away. Successfully navigating compliance issues is not an isolated task. Contractors must continually identify applicable laws and regulations, develop internal compliance processes, enforce those processes, and periodically review the processes to ensure they comply with any new or changed rules.

And this process must be developed and applied throughout the organization. Another common problem is compartmentalizing compliance within a division or business unit. For example, a government contracting business unit must ensure that not only its own internal operations are compliant, but that some other business unit is not undertaking activities that affect that government contracting business unit. Legal counsel can help most organizations identify applicable regulations, assist with the development of processes, and review those processes on a periodic basis; however, the organization must create a culture in which individual employees are aware of those processes and ensure they are enforced on a daily basis. Likewise, contractors should be sure their contracts, organizational structure, and other transactions do not run afoul of applicable regulations. The reality for organizations of any size is that compliance can be a substantial burden. The key is to create a culture of compliance and take steps to mitigate the risk of noncompliance.

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