Since the 1980s, projects funded by the federal government have come with mandatory DBE participation requirements. Similar DBE participation requirements exist at the state and local level in jurisdictions across the country. Designed to increase the participation of minority and women-owned businesses (“DBEs”) in industries in which they have been historically underrepresented, DBE programs oblige contractors bidding on public work to employ a specific percentage of certified DBE subcontractors and material suppliers. Waivers from such requirements are available in limited circumstances.
While efforts to promote DBEs might be admirable in theory, the mechanism created to implement those goals—minimum participation requirements—has led to recurring instances of fraud. Some believe fraud in the DBE procurement process is rampant, widespread and pervasive, and has gone on for many years.
Allegations of DBE Fraud
Examples of DBE fraud are surprisingly easy to come by. In March 2011, Skanska USA, one of the world’s largest general contractors, agreed to pay $19.6 million to settle a federal investigation into DBE fraud in connection with projects as prominent as the new World Trade Center transportation hub and a terminal project at John F. Kennedy International Airport. Skanska USA retained Environmental Energy Associates LLC, a certified DBE, but who did not have the labor, equipment or finances to actually perform work on the World Trade Center project. According to formal charges, Skanska USA mostly self-performed the work it claimed it subcontracted out to EEA. Skanska USA allegedly placed its own employees on EEA’s certified payrolls to create the appearance that EEA had done commercially useful work. In a related case, Moretrench American Corp., Rockaway, N.J., a geotechnical and engineering services company also retained EEA as subcontractor on the World Trade Center project. Moretrench was required to pay over $3 million in fines for similar allegations of DBE fraud.
In May 2014, James McHugh, president of James McHugh Construction Co., Chicago, was convicted of a felony, sentenced to 30 months of probation, and was ordered to pay $800,000 in restitution for his participation in a DBE “front” scheme. McHugh represented that we would employ certified DBE subcontractors to perform a specific percentage of work, when in fact those DBE subcontractors did not perform any work nor supply any materials to the project.
Before he took his own life in March 2011, Zohrab B. Marashlian, president of Perini Corporation’s Civil Division, faced up to 12 years in prison and $34.5 million in fines after being convicted of fraud and conspiracy to launder money after a four-week criminal trial related to DBE fraud. Marashlian was also involved in a DBE “front” scheme where he falsely represented on multiple government projects that certified DBE subcontractors would be used when in fact non-DBE subcontractors and suppliers completed the work.
The materials supply sector has experienced its own allegations of DBE fraud. In August 2012, Lafarge North America, Inc. agreed to pay $950,000 to the U.S. government without admitting liability for its alleged involvement in DBE fraud. Lafarge was charged with fraudulently obtaining subcontracts between June 2001 and March 2006 on eight highway construction projects in the Buffalo area that were to go to DBEs.
Between 2001 and 2007, a certified DBE construction company, Rayford Enterprises Inc., obtained supply contracts on several Federal Highway Administration projects in Western New York. Rayford represented that it was a DBE manufacturer of concrete. In reality though, Rayford lacked a concrete batching plant and other equipment and machinery necessary to manufacture concrete. Ultimately, Oscar E. Rayford, 71, the owner of Rayford Enterprises, pled guilty to felony mail fraud and forfeited $1.8 million in connection with the charges.
Of course, these examples include only those instances where companies or individuals have been caught by enforcement officials for their role in DBE fraud. Many other examples escape scrutiny. Yet penalties in these cases demonstrate that the risk of getting caught far out-weighed any short-term benefit gained.
Renewed Enforcement Efforts
With effective enforcement mechanisms in place, the federal government has begun to clamp down on DBE-related fraud. Under the Federal False Claims Act, individuals and companies involved in DBE fraud can be prosecuted under federal criminal law. The FCA also provides a private right of action to private citizens, including employees and former employees, who can bring their own claims against contractors, subcontractors and material suppliers for fraud against the government. The incentive to report instances of DBE fraud can be tempting. The plaintiff in a whistleblower suit keeps 15 to 30 percent of the ultimate judgment, plus their attorneys’ fees. State and local authorities have also re-doubled their enforcement efforts to prosecute DBE-related fraud.
With this much attention paid to DBE contract procurement, it is essential for contractors, subcontractors and material suppliers to become familiar with DBE procurement requirements. While failing to meet DBE procurement requirements on a particular job can mean losing that particular contract, DBE “fronts” or other DBE fraud can lead to millions of dollars in fines, possible barring from future government work and even criminal prosecution of individual owners. With that in mind, here are some basics of DBE contract procurement that are worth knowing.
Basics of DBE Contract Procurement
Certification. Certification of DBEs is typically done at the local or regional level. Because requirements vary from jurisdiction to jurisdiction, it is difficult to make general observations. However, the following criteria are widely used:
- At least 51 percent of the business must be “owned and controlled” by a “socially and economically disadvantaged” individual or individuals.
- The socially and economically disadvantaged owner must “control” the company’s daily management and operations.
- The DBE must be an independent business whose viability does not depend on its relationships with other companies.
- The DBE must employ its own workforce and equipment necessary to perform its work.
- The DBE must meet its financial obligations.
Businesses owned and controlled by minorities or women are typically presumed to meet the “socially and economically disadvantaged” requirement. Minority groups are generally defined as U.S. citizens who are Asian; Black; Hispanic; Native American; Asian-Indians whose origins are from India, Pakistan and Bangladesh; and Asian-Pacific citizens whose origins are from Japan, China, Indonesia, Malaysia, Taiwan, Korea, Vietnam, Laos, Cambodia, the Philippines, Thailand, Samoa and Guam.
Keep in mind also that “DBEs” actually come in a variety of forms, each with their own certification requirements. Minority Business Enterprises (MBEs) are minority-owned businesses interested in obtaining government-funded contracts. Women’s Business Enterprises (WBEs) are similar businesses owned by women. Full-fledged Disadvantaged Business Enterprises (DBEs) are businesses owned by “economically and socially disadvantaged” individuals, and are typically smaller businesses with annual revenues below a specific dollar amount set by each jurisdiction’s DBE regulations. Your jurisdiction might provide different minimum participation requirements depending on the type of DBE.
Good Faith Efforts. When DBE minimum participation requirements are applicable, general contractors working on that project must make “good faith” efforts to meet DBE goals. One of the foremost criticisms of DBE programs is that many (if not all) programs leave the term “good faith” undefined. But, generally speaking, “good faith” requires commercially reasonable business practices and actual effort on the part of the construction company to meet minimum participation goals. The list of Dos and Don’ts at the end of this article should prove useful in meeting your good faith goal.
Commercially Useful Function. Once retained on a construction project, the DBE must perform a “commercially useful function” before the general contractor can count that DBE toward its minimum participation goal. In most instances of DBE-related fraud, whether the DBE performed a “commercially useful function” quickly became the most important question.
A “commercially useful function” is often defined by applicable regulations. The United States Department of Transportation provides its own regulations and definitions, which are widely followed by state and local authorities. DOT regulations explain that a DBE performs a “commercially useful function” “when [the DBE] is responsible for execution of the work of the contract and is carrying out its responsibilities by actually performing, managing, and supervising the work involved.” Conversely, DOT regulations provide that a DBE does not perform a commercially useful function “if its role is limited to that of an extra participant in a transaction, contract or project through which funds are passed in order to obtain the appearance of DBE participation.”
The DBE must have the labor, equipment, financial resources and expertise to perform the work itself. The DBE must also perform work with its own active workforce and have an active role in negotiating price and ordering materials. “Pass-through” DBEs are not allowed.
Specific Rules for Material Suppliers. For material suppliers, DOT regulations require the supplier to be responsible “for negotiating price, determining quality and quantity, ordering the material, and installing (where applicable) and paying for the material itself.”
Claiming DBE credit for DBE material suppliers requires a general contractor to evaluate the material supplier’s business and that DBE’s actual participation in the project. A GC seeking DBE credit must disclose whether the material supplier was a “regular dealer” or merely a “broker.”
A contractor who retains a “regular dealer” DBE material supplier can earn DBE credit equal to 60 percent of the value of the materials supplied to a project by that DBE. A “regular dealer” engages as its principal business, and under its own name, in the purchase, sale or lease of products of the same general character as those involved in the contract for which DBE credit being is sought. “Regular dealers” must maintain a store, warehouse or other establishment where materials are bought, stocked, sold or leased to the public in the regular course of business.
If the DBE material supplier instead serves in the limited role of “broker,” the DBE credit is reduced to the amount of the fee or commission the DBE broker receives for its work. DBE credit cannot be claimed for the value of materials delivered by DBE brokers.
No Excuse to Be “Willfully Blind.” Anyone involved in DBE-related fraud can be subject to liability, including those individuals who actively participate in the fraud but also including individuals and companies that are “willfully blind” to fraudulent conduct. Even businesses not intentionally involved in a “front” can be prosecuted in some circumstances. If a particular company avoided learning the truth and chose deliberately to be ignorant of the facts surrounding a transaction, that company (and its owners) typically can be prosecuted to the same extent as if it had actively participated in the fraud. Contractors, subcontractors and material suppliers must do their own due diligence and avoid participation in fraudulent DBE schemes, intentional or otherwise.
Do’s and Don’ts of DBE Contract Procurement
With the stakes so great, the following “do’s and don’ts” may prove useful to ensure compliance with regulations and avoid fines, bad publicity and possible criminal prosecution.
Do – Document Your Good Faith Efforts. You should always document the efforts you make to obtain commitments from DBE participants. Even if you do not ultimately reach your DBE participation goal, you should always document that you have made a good faith effort to do so. The U.S. Department of Transportation has explained that “a one-size-fits-all checklist is neither desirable nor possible” in determining whether a contractor has met its good faith requirement. Instead, what constitutes a showing of good faith in a particular procurement requires a fact-specific judgment that your company must make. Because enforcement efforts have recently re-doubled, it may be prudent to err on the safe side. Short answer: Make a conscious effort to obtain your DBE goal, and always document your efforts.
Some states provide detailed documents that must be completed. But whether you work in one of these states or not, you should always have proof that you acted in good faith.
Do – Place DBEs on Solicitation Lists. Contractors must make DBEs aware of contracting opportunities to “the fullest extent practicable through outreach and recruitment.” You should place DBEs on regular solicitation lists, and you should solicit DBEs whenever potential opportunities arise. DOT regulations require that advertisements remain open for a minimum of 30 calendar days before the bid or proposal closing date.
Do – Remain Competitive in the DBE Procurement Market. Take steps to make sure your company is competitive in the DBE procurement market. Your company will be assessed against your competition regarding your ability to obtain DBE contracts. If other bidders have been able to obtain the DBE goal but your company has not, that could count against a showing of good faith effort.
Do – Maintain Relationships with Reputable DBEs. By maintaining good relationships with reputable DBE firms, you can minimize risk associated with contracting with inexperienced DBE firms. Healthy relationships with DBEs can ensure you meet your DBE goal without sacrificing quality of work.
Do – Find Replacement DBEs. Always make an effort to replace DBEs that have dropped out of the project with other DBEs. While you are not required to replace DBEs that have fallen away with other DBEs, you are required to make a good faith effort to do so.
DOT regulations require you to make a good faith effort to replace fallen-away DBEs to the extent needed to meet your overall DBE participation goal.
Do – Use Government Resources. Government resources exist to help contractors find DBEs to work on their projects. Take advantage of services offered by the Small Business Association, the Minority Business Development Agency and the Department of Commerce. Following DOT DBE guidelines and regulations, even if not legally applicable to your job, may provide insulation from liability.
Do – Make Reasonable Inquiries. Make reasonable inquiries to ensure a DBE you are involved with is not a pass-through but is actually performing a “commercially useful function” on the project. Contractors, subcontractors and material suppliers that are “willfully ignorant” can be prosecuted to the same extent as companies that intentionally defraud the government.
Do – Maintain Monitoring and Enforcement Programs. Particularly if you run a large operation, maintaining compliance programs including adequate oversight and enforcement may be necessary to comply with DBE procurement laws. While these programs may add costs, the expense can save your company millions of dollars and help you avoid criminal prosecution.
Do – Cooperate with Enforcement Officials. You should comply with enforcement officials and set forth proof of good faith efforts made. A lack of cooperation often brings additional scrutiny.
Don’t – Abuse Your DBE Certification. Even minor involvement in pass-through DBE schemes can end in enormous financial penalties, including potential debarment from future contracting work and significant criminal consequences. A small short-term profit is not worth the huge risk.
Don’t – Reject Reasonable Price Offers. If you do not meet your DBE participation goal and yet rejected a DBE offer that was within a reasonable range of the offer accepted (1 to 10 percent), that could establish a lack of good faith. You should carefully consider “reasonable price” offers made by DBE firms.
Don’t – Use “Time and Material” or “Cost Plus” Unless Reputation Is Established. Using “time and material” or “cost plus” contracts with DBE subcontractors can be a risky endeavor. Unless the DBE can demonstrate a history of performing and managing its own work, this type of contracting is fertile ground for “front” companies.
Be on the lookout for companies with little more than an office and a handful of clerical employees to run a payroll, purchase materials or pay project invoices. Companies that offer “payroll” services for a fee should also be scrutinized. Using such firms will likely draw the attention of government investigators. You should contract on a “time and material” or “cost plus” basis only after assuring yourself the company performs a commercially useful function.
Don’t – Terminate for Convenience and Self-Perform. Do not terminate for convenience and then self-perform the work. Doing so without the DBE’s consent can constitute a lack of good faith.
Don’t – Bury Your Head in the Sand. As ignorance is not an excuse, do not ignore warning signs that a DBE is not really performing a commercially useful function.
Don’t Put Your Employees on the DBE’s Payroll. Companies that have placed their own employees on the payroll of the DBE to get work done have not fared well.
Companies that follow these guidelines will minimize the risk that a DBE minimum participation requirement will backfire into a significant legal problem.
Don Gregory, Esq. is director and chairman of the construction law practice at Kegler Brown Hill & Ritter in Columbus, Ohio. He maintains a Band 1 ranking by Chambers USA, the highest ranking possible for his practice. Gregory stays abreast of cutting-edge developments in the industry by serving many of the leading national construction trade associations, including the Association of the Wall and Ceiling Industry, as their general counsel.
Peter Berg is an associate at Kegler Brown Hill & Ritter in Columbus, Ohio. He counsels construction businesses and owners in all aspects of construction law, including contract negotiation, bid qualifications, risk management strategies, delay claims, preserving, perfecting and enforcing/defending mechanic’s liens, and resolving payment and performance bond claims.