Background: In Appeal of Laguna Construction Company, Inc., the Armed Services Board of Contracts Appeals (“ASBCA”) found that a contractor’s receipt of kickbacks from subcontractors was both criminal fraud and a material breach of the contract, which eliminated the Government’s obligation to reimburse the contractor for additional work, even if that work was not itself related to the fraud.  The ASBCA denied Laguna Construction Company, Inc.’s (“LCC”) certified claim for $2,874,081 in payments disallowed by the Defense Contract Audit Agency (“DCAA”).  LCC had received sixteen cost-reimbursable task orders to perform work in Iraq under an Air Force Worldwide Environmental Remediation and Construction contract.  Following the filing of its claim, LCC’s Program Manager and Vice President of Operations pled guilty to taking kickbacks with regard to three of the sixteen task orders. 

In making its determination, the ASBCA relied on the principle of antecedent breach — the theory that when each party claims that the other has breached the contract, liability will be imposed “on the party that committed the first material breach.”  Applying this theory, the ASBCA found that LCC’s program manager and vice president of operations’ acceptance of kickbacks constituted the first material breach under the contract, thus providing the Government with a legal excuse not to pay LCC’s invoices. 

Specifically, the Board found that  LCC had breached the covenant of good faith and fair dealing, which creates a duty for each party under a contract to perform with integrity and to avoid interfering with the other party’s rights under the contract.  The actions of LCC’s Program Manager and Vice President of Operations could be imputed to LCC as a whole, according to the Board, because both were operating under the contract and within the scope of their employment.  Thus, the bad actors’ acceptance of kickbacks violated the covenant, as it destroyed the “reasonable and justifiable expectations” of the Government in the performance of the contract. 

The ASBCA then determined that LCC’s breach of the covenant of good faith and fair dealing was material because “kickbacks are fraudulent, and any degree of fraud is material as a matter of law.”  Critically, the Board found that even though the Government had not proven that kickbacks had been paid in connection to every LCC task order, the existence of kickbacks under some task orders was sufficient to find material breach and prevent any recovery by LCC.

Impact on Contractors: This precedent demonstrates that the Government will react aggressively to any taint of fraud in a claim, even if the fraud impacted only a small portion of the claim.  This is consistent with Court of Federal Claims precedent that all claims based on a contract under which a contractor practiced fraud against the Government can be forfeited under 28 U.S.C. § 2514 (“Forfeiture of Fraudulent Claims”).  Additionally, if  the employee at issue was working within the scope of his employment under the contract, his fraudulent conduct likely will be imputed to the company — even if the employee was acting only to benefit himself.