U.S. v. Davis Casts Doubt on the Future of (Some) DBE Fraud Cases

Disadvantaged business enterprise (DBE) fraud in the construction industry is a topic frequently covered on this blog.  My posts on DBE fraud are some of my most read posts and the ones that generate the most questions from readers and inquiries.  Many of the posts cover the increased pace of criminal prosecutions involving DBE fraud. One case I blogged about involved the indictment of the steel erection contractor on the new World Trade Center project, DCM Erectors, Inc.

Earlier this month, a federal jury found the defendant in that case and DCM’s owner, Larry Davis, guilty of one count of wire fraud and one count of conspiracy to commit wire fraud for allegedly operating a DBE pass-through scheme for steel erection services on the WTC project.  Then, in a remarkable (to say the least) turn of events, the Judge granted the defense’s motion for acquittal and overturned the jury’s guilty verdict against Mr. Davis.

The Judge’s decision to acquit Mr. Davis hinged on the nuisances required to prove a wire fraud and conspiracy to commit wire fraud.   The case also cast doubt on the ability to prosecute individuals for DBE fraud not involving federally funded projects, like DOT, FTA, FAA, and VA projects.

I.  The Background

The scheme Davis was alleged to have engaged in was a fairly straightforward DBE pass through scheme.  As I have talked about before, a pass through scheme is where a certified DBE does not perform any commercially useful function and the work is actually performed by a non-DBE firm.  That is what prosecutors alleged Davis did.

The WTC project was subject to the New York and New Jersey Port Authority’s DBE program.  Like most DBE programs, the Port Authority’s program had a goal of seeing that DBE firms performed a certain percentage of the overall dollar value of the prime contract.

DCM executed two separate steel erection subcontracts for two different buildings at the project.  DCM was not a DBE firm.  However, on one contract it certified that it had subcontracted with a DBE firm to perform its payroll and survey services.  On the other contract, it entered into a joint venture with a DBE firm.

According to the indictment, no employees of the DBE firm performed work on the JV project.  On the other project, the indictment alleged that the DBE firm performed no survey work and the work and DCM employees actually performed the work.

The indictment alleged DCM and Davis defrauded the Port Authority by “fraudulently claimed MBE credit for One WTC and the WTC Hub in excess of $70 million based on the value of work Solera/DCM purportedly performed” on the World Trade Center project; and b) “fraudulently claimed WBE credit for $6.3 million of surveying and payroll management work GLS purportedly was performing as a subcontractor to DCM on One WTC and the WTC Hub.”

II.  The Wrinkle

There are some critical wrinkles in case that ultimately were important in the Judge acquitting Davis.  First, unlike the DOT’s program, the Port Authority’s DBE program was not the law, i.e. a legislative mandate.  Rather, the Port Authority’s program was its own self-created independent program.  Second, unlike many DOT contracts, compliance with the DBE program was not expressly made a material term of DCM’s contract.  The consequences of a contractor’s failure to comply with the program were apparently limited to potentially not being invited to bid on future projects or having its bid rejected as non-responsive.

III.  The Decision

The Court began its analysis by laying out the elements of a wire fraud claim: “(1) a scheme to defraud, (2) money or property as the object of the scheme, and (3) use of the mails or wires to further the scheme.”  The Court focused on what Courts have determined amounts to a “scheme to defraud” that satisfies the first element and its nuisances. The Court concluded that “where the purported victim received the full economic benefit of its bargain, an essential element of the bargain is not implicated, and thus the wire fraud statute does not apply.”  Therefore, the Court’s decision hinged on is whether DCM’s compliance with the Port Authority’s DBE requirements “was an essential element of the contracts.” 

The Court then stated that wire fraud goes to an essential element of the contract when (a) the fraud causes economic harm, or (b) where defendant fails to comply with an underlying law.  The Court cited several cases where the defendant’s conduct violated a law independent of the mail and wire fraud statues and where compliance with that law was incorporated into the contract.  The Court also cited several cases where the counter party “did not get what they paid for.”

The decision in U.S. v. Davis is interesting in two regards.  First, it provides one of the most thorough analysis of wire fraud as it related to DBE fraud that I have seen.  Second, it is a bit of an outliner.   Indeed, it is in opposite to Circuit Court opinions that have concluded that non-compliance with a DBE program, by itself, can satisfy the essential element prong of a wire fraud count.  However, those cases provide a much less detailed discussion than Davis.  And, those cases involved DBE programs that fell under the DOT’s DBE program, which, unlike the Port Authority’s program, is the law or where the contracts made compliance a material term of the contract.  Then again, those cases conclude “you used deceit to obtain the contract and payment and therefore the evidence is sufficient for a conviction.”  But, as Davis makes clear the analysis is more nuisanced.

While the Davis decision is significant, it still is only a District Court opinion.  So, it has no precedential value. Furthermore, it would appear to be limited to cases alleging DBE fraud involving a independent DBE program administered by a regional transportation authority, like the Port Authority, a county government, or local municipal government.  Those programs are not typically the result of some legislative action requiring them.

Also, even where program is not the result of a legislative mandate the contract language itself is important because the contract may still made compliance with a DBE program an essential element of the contract.  Many contracts do make compliance a material term.  Also, most construction contracts contain some general duty clause that states the contractor will perform its work according to all applicable codes, laws, and regulations.  It would be interesting to see if the Davis Court would reach the same decision if the DBE fraud were pursuant to a contract which made compliance mandatory (I think it would) or if the prosecution raised a the contract’s general duty clause, which I am sure existed.

It is nonetheless important for attorneys representing defendants in DBE fraud cases to (a) understand the legislative scheme (or lack thereof) giving rise to the program; and (b) to understand whether the contract or subcontract makes compliance with the program a material term.

It is also important, perhaps, more important, for appellate lawyers arguing that a conviction under for wire fraud is not supported by sufficient evidence where the defendant provided the essential services that were bargained for, which in mostly what happens in DBE fraud cases.

Is the City of Philadelphia’s DBE Program Unconstitional?

Probably.  Based on the City’s 2016 Disparity Study the City DBE program is no longer being used to remedy past discrimination but to further a political agenda designed to direct maximum public funds to female and minority owned businesses.  In doing so, the City’s current program runs afoul of the Supreme Court’s seminal decision in City of Richmond v. Croson Company, 488 U.S. 469, (1989) and its progeny, which blessed such programs.  However, they blessed them only when (a) there is evidence of discrimination, (b) the program is narrowly tailored to remedy that discrimination, and (c) all race neutral alternatives have been exhausted.

What are DBE Programs?

Like many public agencies, the City of Philadelphia maintains a program that is designed to funnel public fund to female and minority owned firms.  These programs are usually called “disadvantaged business enterprise” programs or DBE programs for short (Sometime they are referred to D/M/WBE the “M” standing for “minority” and the “W” for “woman.”)  DBE programs require that a prime contractor use its best efforts to subcontract a certain percentage of the contract price to DBE firms.  In certain cases, the public authority can restrict bidding to only DBE firms.

The DBE contracting goal will appear in the bid specifications.  (I have seen goals range anywhere from 4% to 30% of the contract.)  So, if a prime contractor is awarded a $1,000,000 contract and the DBE goal is 15%, the prime contractor will have to subcontract $150,000 of the prime contract to DBE owned firms.  In replying to the bid, the contractor will have to list the DBE owned firms it intends to enter into subcontracts with to meet the DBE goal.

The History of DBE Programs

One of the first DBE programs was the Department of Transportation’s DBE program, which is basically the godfather of all DBE programs.  All state and local DBE programs more or less track the DOT’s DBE program rules. The DOT’s DBE program started almost 40 years ago.  The program requires State Transportation agencies to establish a DBE program as a condition of receiving federal highway and transportation funding.

The DOT’s DBE program is an interesting paradox.  It is almost 40 years old.  It was designed to remedy past discrimination in the construction industry.  However, many of the firms and people that would have played a role in that discrimination are long gone.  Moreover, if the purpose is to remedy past discrimination and 40 years later discrimination still exists (dispute a rigorous regulatory scheme against it) then the program is doing a lousy job of achieving its goal.  Yet, DBE programs are more entrenched than ever.

City of Richmond v. J.A. Croson Co.

In Croson, the United States, Supreme Court provided the rules which all state and local DBE programs must be judged against. Richmond’s DBE plan required that prime contractors subcontract at least 30% of the dollar amount of the prime contract to certified DBE firms.  The Plan declared that it was “remedial” in nature, and enacted “for the purpose of promoting wider participation by minority business enterprises in the construction of public projects.”

The Supreme Court struck down Richmond’s program holding that Court’s must apply strict scrutiny to any racial preference program.  To survive strict scrutiny, a local or state authority advancing a DBE program must show that there exists a compelling state interest in the form of actual racial discrimination in the construction industry.  The agency must support its interest by evidence and it cannot be merely anecdotal.  Once the agency puts forth sufficient evidence of existing discrimination, then the remedy must be narrowly tailored to remedy that discrimination.  Finally, the agency must demonstrate that it exhausted race neutral means to remedy the discrimination.

In Croson, the Supreme Court first found that the City of Richmond introduced no evidence that there was racial discrimination in the Richmond area construction industry.  However, the Court said that if Richmond could show that there existed a significant statistical disparity between available minority owned firms and the percentage of subcontracts award to such firms that may support a finding of discrimination.  Second, the Supreme Court found that the 30% figure had no rational connection to the the alleged discrimination that it sought to remedy.  Indeed, the Court found the figure to be arbitrary.

Following Croson, state and local agencies that did not introduce statistical evidence of racial discrimination in the construction industry saw their DBE regimes struck down.  (One of those local government agencies that saw their DBE program struck down for lack of evidence was the City of Philadelphia.  Contractors Ass’n of E. Pennsylvania, Inc. v. City of Philadelphia, 945 F.2d 1260 (3d Cir. 1991))  Therefore, borrowing from Croson’s holding that a statistical disparity could be evidence of discrimination, local and state government began commissioning disparity studies to use as evidence to support their DBE program.  Preparing disparity studies has become a cottage industry.

While disparity studies come under attack for faulty methodology, if they tend to show a disparity between the number of minority firms available for subcontracting and the actual amount of subcontracted work, Courts tend to uphold them.  Thus, disparity studies showing an actual disparity usually satisfy the first prong of strict scrutiny that the government show that discrimination exists.  With the first prong satisfied, the government must then show that the subcontracting goal is narrowly tailored to remedy the discrimination.

Is it time to revisit Croson?

This bring us to the City of Philadelphia DBE program.  The program shows that it has been a resounding success in remedying any past discrimination that may have existed at least for public works (construction) projects.  For public works contracts, the City’s showing that there is an over-utilization of DBE firms.  This means the percentage of prime contract subcontracted to DBE firms exceeds the number of firms available.  The study makes no effort to hide this fact and highlights it in several areas.  This over-utilization is not an anomaly.  In fact, the over-utilization of DBE firms on public works contracts has now existed for several years.

However, if there is an over utilization of DBE firms on public works projects, what evidence does the City have to show that there is discrimination in the Philadelphia construction industry?  There appears to be none.  Without that evidence, the program would fail the first prong of strict scrutiny miserably.  Indeed, its hard to see how the program would survive a challenge applying Croson.

Yet, that has not stopped the City.  To the contrary, the City wants to increase the percentage even more. The City calls them “stretch” goals.  While maximizing DBE contracting might be good social policy, it is not “good constitution,” at least according to Croson.  Using a DBE program as a means to achieve a policy of increasing DBE participation to the maximum extent becomes untethered from Croson’s mandate that such programs be designed to remedy past discrimination and narrowly tailored to achieve those ends.  Croson rejects any percentage aimed towards “outright racial balancing.”  Other courts have held that the goal needs to be at the lower end of what is needed to bring the disparity into balance.  Thus, it is hard to see how the City’s current “stretch goals” could survive the narrowly tailored prong of strict scrutiny.

Conclusion 

The reality is while it appears to be completely unconstitutional and susceptible to a challenge, the City’s DBE program will likely remain in place.  The major players in the industry are too political entrenched to bring a case challenging a program designed to assist minority and female owned firms.  They risk being called “racist” at best and being blackballed by the City at worst.  However, if a brave enough firm wished to challenge the program it is ripe for the taking and would be likely see the Court require the City to pay its attorneys fees.

Dear Clients: Step away from the C-Mail

Yes, c-mail. Let me explain.

I am part of a certain segment that came of professional age at the dawn of the internet revolution.  We spent the first 18-20 years of lives completely – or mostly – detached from the internet, and the other half completely immersed in it.  I guess that gives us a unique perspective on the whole thing.

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Huge Win for Economic Liberty

Sadly, in Philadelphia, the City that gave birth to the United States Constitution, respect for the Constitution by government officials is woefully lacking.  Luckily, the United States Federal Court for the Eastern District of Pennsylvania, which sits in Philadelphia, has served as a bulwark to Philadelphia bureaucrats who ignore the individual freedoms the Constitution guarantees. Last week, Judge Michael Baylson handed economic liberty advocates a huge win in Checker Cab Philadelphia v. The Philadelphia Parking Authority.  The importance of the decision has national implications.

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The Death of Retail and Legal Issues

The National Review recently published an article about the wide ranging economic and social impacts of the death of traditional mid-market shopping malls.  The article is not overtly political and at time waxes nostalgic about the prototypical 1980’s shopping mall.  However, the article highlights real problems facing the owners of these malls and other traditional shopping centers.

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How to Fund Your Lawsuit to Get the Justice You Deserve

This is a guest blog post from LexShares, a leading funder of commercial litigation. They can be reached by emailing info@lexshares.com or calling 877-290-4443. 

As many daily headlines in the business sections of newspapers across the country will attest, business is not for the faint of heart.  Meticulously planned deals can fall through at the eleventh hour; partners may prioritize their own short-term gains over the long-term well being of the company; competitors could engage in smear campaigns meant to expand their base at any cost, even at the expense of good will others took decades to build.  When your business suffers unfairly from the misdeeds of third parties, sometimes the only recourse is to resolve the dispute in court.

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District Court Allows DBE False Claims Act Case to Proceed

Last week, I posted about how whistleblowers continue to receive large settlements related to DBE fraud. A somewhat recent case from the federal court in Maryland shows how whistleblowers are ferreting out DBE fraud on construction projects receiving any form of federal funding.

The Case

The case involves a bridge painting project in Maryland that was let by the Maryland State Highway Administration. The contract required the prime contractor to meet a 15% DBE participation goal.  The prime contractor submitted a bid stating it would have 15.12% DBE participation.  After it was awarded the contract, the prime contractor – as is typical – submitted additional forms certifying to the MSHA that 15.12% of its contract price would be performed by a DBE firm.  The prime contractor indicated that one DBE subcontractor, Northeast Work and Safety Boats, LLC (“NWSB”), would perform the 15.12% of the work.

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Commonwealth Court Strikes Blow to Philly Window and Door Ordinance

On December 22, 2016, the Pennsylvania Commonwealth Court issued an important opinion that has flown under the radar somewhat.  The case Rufo v. Board of Licenses and Inspection Review, invalidates a major portion of Philadelphia’s so called windows and doors ordinance, which requires owners of vacant properties to install glass windows and doors with frames on vacant properties.   A copy of the opinion can be found here.  (I only learned about the case because of a tweet by a litigator with the pro-freedom group the Institute for Justice.)

The Windows and Doors Ordinance

The case concerns Section 306.2 of the Property Maintenance Code which requires “the owner of a vacant building that is a blighting influence, as defined in this subcode, [to] secure all spaces designed as windows with windows that have frames and glazing and all entryways with doors.”  Property owners found in violation of the ordinance can face stiff fines.  Property owners are subject to a daily fine for each door and window in violation of the Ordinance.   The fine is $300 per window or door.  However, because most vacant properties have multiple windows and doors the fines can add up exponentially.

The key part of the ordinance is the term “blighting influence” and how it is determined that a property is a blighting influence.  The Ordinance only applies to those properties that are a “blighting influence.”  In other words, a property could be missing windows and doors but if it is not determined to be a “blighting influence,” then the property owner is not subject to the fines.

Under the Property Maintenance Code, there are two ways that a property is determined to be a blighting influence. First, there is an objective standard.  If the property without windows and doors is located on a block where 80% or more of the properties are occupied, it is a blighting influence.  Second, there is the subjective standard.  The Commissioner of Licenses and Inspections in consultation with other City officials, can declare a property a blighting influence if it has a significant adverse impact on the community based on variety of factors including, the safety of the surrounding community, community morale, marketability of the property, and the value of surrounding properties.

The Property at Issue

The property at issue is a large commercial property that was formerly a brewery.  In 2012, the City cited the property owner for violating the Ordinance – among other things.  Because of the number of windows and doors involved, the fines equaled $33,000 per day.  Moreover, the cost to replace all of the windows and doors exceeded the assessed value of the property.

The Appeal

The owner appealed the fine.  The owner argued that installing windows and doors would not make the property safer.  To the contrary, it would make it less safe as vandals could easily enter the building by breaking the glass. The owner pointed out that when he installed three windows at the property they were broken in a matter of days.  The owner further argued that the ordinance was concerned with making the property aesthetically pleasing rather than safe.  Finally, the owner argued that the ordinance was unconstitutionally vague.

The Board’s Decision and Appeal to the Trial Court

The License and Inspection Review Board upheld the fine.  The owner then appealed to the Philadelphia Court of Common Pleas.  The trial court overturned the fine.  The trial court found that the ordinance had a purely aesthetic goal because it was not aimed at making the property safe and had a minimal impact on reducing blight – if at all.

The Commonwealth Court’s Ruling

The City appealed the trial court’s order to the Commonwealth Court.  The Commonwealth Court upheld the trial court.  Like the trial court, the Commonwealth Court held that a municipality’s police power may not be grounded solely on aesthetics.  Despite the City’s claims that “numerous studies” showed that installing windows and doors reduced blight, the City could not point to any.  The Court also found that the owner could install wood and blocking behind the windows and doors to secure the property and still be in compliance with the ordinance.  Therefore, the ordinance was purely aesthetic.

Conclusion

There are several takeaways.  First, property owners cited for violating the windows and doors ordinance under the subjective standard should challenge the fine.  Second, when bureaucrats hostile to private property rights bully property owners, the property owner should first check to see if the ordinance or law is it susceptible to a challenge before he cedes his freedom to the state.

Philadelphia Proposed Best Value Procurement Bill

An opinion piece in today’s Philadelphia Inquirer concerning proposed legislation that would change the way the City of Philadelphia awards public construction projects is causing quite a stir. The article concerns legislation that would allow the City to award public construction contracts based on a “best value” approach rather than the current requirement that the contract be awarded to the lowest responsible and responsive bidder.  The author worries that by removing the current objective criteria and replacing it with subjective ones, contracts can be steered to politically favored contractors.  The author cites the recent no-bid contract awarded to a law firm run by the friend of Mayor Jim Kenney as an example of the chaos would ensue if this bill was passed.

Considering that the Bill’s sponsor, Bobby Hennon, is under FBI investigation,  and some of the Mayor’s biggest supporters are as well, the author has ever right to be concerned.  However, article comes up short in explaining what the Bill says and what best value procurement, if adopted, would mean for public construction work in Philadelphia.

First, the Bill that Councilman Hennon is proposing is actually a Bill that would make the best value procurement question a ballot question next November.  In other words, the Bill, if passed, would but to a City wide vote the question of whether the City should change it procurement practices to permit the best value approach to be used in addition to the low bid approach that is current used.

Second, the best value approach that the citizens would be asked to vote on in November, would not permit the current administration – or any future administration – to steer contracts to favored contractors by fiat or decry. Rather, before the best value approach can be used, the Procurement Commissioner must determine in writing that the low bid approach may not yield the best value to the City.  This would be done proposals for the project are solicited.

This approach is similar to the approach that the Commonwealth uses and has been permitted to use since 2014 (the federal government also uses a best value approach).  Under 62 Pa.C.S.A Section 513, when a contracting officer determines in writing that the use of the low bid approach is not practicable or advantageous to the Commonwealth, a best value approach may be used.

While low bid does provide objective criteria that can prevent corrupting and favoritism, it also can cost the taxpayers more money because the contract has to be awarded to the low bidder who sometimes provides inferior work that has to be corrected.  Or, the contractor intentionally underbids the project only to make up the difference via change orders.  The key to best value working is to require that the criteria for evaluating each proposal be adequately set forth in the request for proposal.  That way if a proposal is simply steered to a favored contractor without regard to the evaluating factors, the award is subject to challenge.  I would suggest that the City go one step further an adopt requirements similar to the federal rules that mandate that the contracting officer support in writing the award to a specific contractor.

Details Matter: The Importance of Strictly Following Public Bid Statutes

Contractors bidding on public contracts know that failing to strictly following all of the technical aspects contained in the instructions to bidders can mean the difference between a winning and losing bid.  In the span of two weeks, I was involved with two cases that underscored the importance of this axiom.  Both cases involved New Jersey’s public bid laws.  While these cases show the importance of following a specific section of New Jersey’s public bid statute, the take away – that details matter – is universal.

The case involved a sewage authority project.  I represented the second low bidder.  The first low bidder submitted a bid package that was complete except for one technical aspect.  It failed to list the name of its electrical subcontractor on the “Subcontractor List” form provided by the authority in the bid package.  Both the instructions to bidders and Section 23.2 of the New Jersey Local Public Contracts Law required that the contractor list the names of its electrical, plumbing, and mechanical subcontractors.  The apparent low bidder listed the name of its plumbing and mechanical subcontractors but not the electrical subcontractor.  Notwithstanding our objections, despite the omission of the name of the electrical subcontractor, the authority decided to award the contract to the apparent low bidder.

Therefore, we challenged the award of the contract to the apparent low bidder in Court by seeking an injunction.  We argued that the instructions to bidders and the New Jersey Public Contracts Law were clear: if a contractor fails to list the name of its electrical subcontractor it is a fatal bid defect, which the local contracting agency cannot waive. The apparent low bidder argued that its failure to list the name of its electrical subcontractor caused no prejudice to the local agency (and ultimately the taxpayers) because the name of its electrical subcontractor was identified elsewhere in the bid package.

The trial court held that the apparent low bidder’s failure to list the name of the subcontractor on the bid form was a fatal non-waivable bid defect and concluded that the authority’s decision to award the contract was in error. Throughout its opinion the trial court emphasized that strict compliance with the bid statutes and instructions to bidders is required in order for a bid to be deemed responsive.  Importantly, the trial court noted bids containing technical defects should still be rejected even when there is an increased cost to the taxpayers because “the overriding interests in insuring the integrity of the bidding process is more important than isolated savings at stake.”