As we discussed during Crowell & Moring’s webinar last week Top Headlines, Headaches, and Developments for Government Contractors to Watch in 2015, the recent ASBCA decision in Laguna Construction is likely to reverberate in 2015 and beyond. This case introduced the doctrine of “antecedent breach” in the ASBCA as a means of denying legitimate contractor claims.

In Laguna, after the completion of the contract, the contractor submitted a $3 million claim based on a dozen separate task orders under a large IDIQ contract. Mid-way through litigation, two contractor employees pled guilty to receiving kickbacks from subcontractors on some, but not all, of the Task Orders at issue in the litigation. The Government then added Fraud as an affirmative defense at the Board, arguing that Laguna’s entire claim should be denied because Laguna’s employees had pled to Fraud on some of the Task Orders.

It is worth noting that:

• The company was not criminally charged or convicted of fraud;

• The employees who pled to fraud were a Project Manager and a VP; and

• Many of the invoices subject to Laguna’s claim were unrelated to the employee fraud;

Nevertheless, the Board denied the contractor’s claim for unpaid invoices in its entirety. The Board held that the employees’ acceptance of kickbacks should be imputed to their employer, because they were “operating…within the scope of their employment.” Thus, the employee-fraud constituted the company’s “material breach” of the contract, and this first material breach excused the government’s subsequent breach of failing to pay routine invoices.

The Board held that it was irrelevant whether kickbacks were actually paid under every task order under appeal because, applying Federal Circuit precedent, “any degree of fraud” is “material” as a matter of law.

One of the big takeaways from Laguna as we move into 2015 is the recognition that Fraud may increasingly be wielded as a shield to deny claims, including “employee fraud” committed not by the company, and even including claims on invoices and Task Orders unrelated to Fraud.

This is different than the scenario where the Government uses fraud convictions to uphold terminations. It is also different than prior ASBCA case law, where the company itself had been convicted of Fraud or the fraudulent conduct related to the specific invoices under appeal. Neither of those facts was present in Laguna, but the Board still found that Laguna’s vicarious liability for its employees’ fraud constituted a material breach sufficient to deny Laguna’s monetary claim for work performed.

Going forward, in addition to ensuring proactive ethics and compliance controls during contract performance, contractors must closely evaluate and be aware of the impacts of any employee fraud on potential claims, including the otherwise “uninfected” parts of its claim.

(This post is part of a new Claims series on the Government Contracts Legal Forum – have a question or an idea for a future topic? E-mail us at smcbrady@crowell.com and smathieson@crowell.com.)