Largest-Ever Small-Business Contracting Fraud Settlement Related to Pass-Through Subcontracting

March 28, 2022

Federal contractors should take note of a recent, record-setting False Claims Act (FCA) settlement between the Department of Justice (DOJ) and TriMark USA LLC involving alleged fraud with respect to small-business set-aside contracts. Specifically, food-service equipment supplier TriMark USA LLC, agreed to pay $48.5 million to resolve allegations that its subsidiaries, TriMark Gill Marketing and TriMark Gill Group Inc. (together, TriMark), which are other-than small businesses (OTSBs), improperly engaged in a “pass-through” subcontracting scheme, through certain resellers and distributors, to obtain federal small-business set-aside contracts they were ineligible to receive. This is the largest-ever False Claims Act settlement based on allegations of small-business set-aside contracting fraud.

Given the government’s focus on this area, suppliers, developers and distributors that sell products or software to the federal government through resellers or partners should ensure that they have adequate compliance policies and procedures in place to avoid similar conduct and repercussions.

DOJ alleged, and the settling defendants admitted, that TriMark engaged in a scheme to circumvent small business concern (SBC), veteran-owned small business (VOSB) and service-disabled veteran-owned small business (SDVOSB) contracting requirements by providing significant assistance to three small companies in obtaining set-aside contracts they would then pass along to TriMark for performance. The small companies were distributors and resellers for TriMark products. As part of the settlement agreement, TriMark admitted that it, as opposed to the small companies, performed substantially all of the work under the contracts, while the small companies served only as the face of the contract, billed the government for the work and used their small-business status to obtain the set-aside contracts. Under this arrangement, the small companies were allowed to retain only a small percentage of the total contract value, typically 1% to 5%, and “added no value to the transaction aside from the set-aside status.”

DOJ indicated that a key factor in this fraud scheme was the significant amount of influence and control TriMark exerted over each of the small companies’ decision-making processes during the bid, award and performance of these contracts. As part of the settlement agreement, TriMark admitted that its employees, as opposed to the employees of the small companies: (1) identified federal set-aside contract opportunities; (2) dictated on which contract opportunities the small companies should and should not bid; (3) instructed the small companies specifically on how to prepare their bids and what prices to propose; and (4) “ghostwrote” emails for the small companies to send to government officials to make it appear as though the small companies were performing work that TriMark was in fact performing. Further, TriMark admitted that, in the specific case of one of the small companies in which TriMark owned a minority of voting stock, TriMark employees had access to and used email accounts belonging to the small company to conduct business with the government related to set-aside contracts.

DOJ alleged and TriMark admitted that, in connection with the award of contracts to the small companies, its conduct violated federal regulations. Similarly, TriMark admitted that it knew the small companies did not meet the requirements to be a SDVOSB, a VOSB or an SBC (based on their relationship with TriMark) but failed to take any actions to prevent them from submitting material misrepresentations to the government.

Manufacturers, suppliers, developers and distributors that closely control their distribution networks and reseller partners should take note of this settlement agreement and its record-setting $48.5 million settlement amount. It is not uncommon in the federal contracting industry for large companies to leverage channel partners and reseller networks that maintain a specific set-aside status related to federal government procurement. This sort of distribution model can be advantageous to both the upstream supplier and the small-business federal contractor.

The Small Business Administration (SBA) has recognized that small-business resellers play an important role within the federal contracting industry. Specifically, through the non-manufacturer rule, an otherwise qualified small-business set-aside contractor may sell products to the federal government, even when the small business has not taken physical possession of the products. The SBA’s non-manufacturer rule allows a drop shipper to qualify as a small business, so long as the drop shipper takes legal ownership of the items in question.

As indicated by DOJ, though, the key issue with respect to the conduct here did not relate to the nature of the distribution structure used by TriMark. Instead, DOJ focused primarily on the significant amount of influence and control TriMark exerted over each of the small companies’ decision-making processes during the bid, award and performance of these contracts, which created affiliation between the entities.

Affiliation, which factors into the size calculation used for determining eligibility for set-aside contracts, exists when one business controls or has the power to control another or when a third party (or parties) controls or has the power to control both businesses. To determine whether two companies are affiliated, the SBA considers the extent that one company directly or indirectly controls or has the power to control the other. Affiliation can result from common ownership, common management and contractual relationships, as well as through, as alleged here, the so-called “ostensible subcontractor” rule. Under this principle, the SBA may find an OTSB subcontractor affiliated with an otherwise qualified small-business prime contractor pursuant to the ostensible subcontractor rule when either an OTSB subcontractor will perform “primary and vital” contract requirements, or the prime is otherwise unusually reliant on the OTSB subcontractor for performance.

The settlement agreement with TriMark serves as an important reminder to federal contractors that affiliation can arise solely from a purely contractual relationship between two companies. FCA liability for false statements related to small-business contracting fraud presents a significant risk for OTSB subcontractors within the government contracting space. Therefore, federal contractors should seek the advice of experienced counsel when establishing channel partnerships or distribution networks aimed at accessing federal set-aside sales. Specifically, OTSB distributors or Value-Added Resellers (VARs) should ensure that they do not exert excessive control over lower-tier reseller partners that maintain a federal set-aside status. Proactive steps to appropriately identify affiliates and ensure corporate compliance are vital to avoid running afoul of the complex and often detailed SBA regulations.

McGuireWoods regularly assists clients in government contract interpretation and small-business affiliation analysis, and in responding to government inquiries. Please contact the authors if you have any questions about small-business affiliation or SBA set-aside requirements, or if you require assistance interpreting current governing rules and regulations or responding to a government investigation.

About McGuireWoods’ Government Contracts Team

The Government Contracts team at McGuireWoods has decades of collective experience assisting contractors and subcontractors in government contracting, including the navigation of proposal submission and compliance issues. Based strategically in the Washington, D.C., area, our full-service practice leverages McGuireWoods’ strong defense and national security credentials at every step in the procurement process. Our attorneys counsel clients ranging from small businesses to the nation’s largest government contractors on issues arising under the Federal Acquisition Regulation and its agency-specific supplements, and our team regularly assists clients in negotiating significant federal contracts and contract modifications.

We also have the deep experience necessary to defend our clients’ interests in bid protests, in litigation with the government and other contractors, and in investigations and regulatory enforcement actions involving a wide range of federal and state agencies, inspectors general, and law enforcement personnel. We provide these services to clients operating in a broad variety of industries and sectors, including defense, national and homeland security, intelligence support, technology, construction, healthcare, aerospace and energy.