Lender Liability Under the Federal False Claims Act

May 1, 2013

Best Practices: Lender Liability Under the Federal False Claims Act

By: Norman E. Greenspan, Esquire, Starfield & Smith P.C.

Recently, the U.S. Small Business Administration’s Office of Inspector General (“OIG”) reported to Congress that there has been a significant increase in the number of qui tam False Claims Act (31 U.S.C. §3729, et seq. (the “FCA”) suits filed by private sector parties with regard to the SBA. The SBA’s OIG used this increase in FCA suits to support its request for a 12% budget increase for FY 2014, despite sequestration. Clearly, the FCA is in the gun sights of the OIG.

The FCA allows either the Attorney General, or a private citizen acting on behalf of the United States, to bring a civil action (a “qui tam” action) against any person who knowingly submits false or fraudulent claims which are paid with funds provided by the federal government. Damages under the FCA can be considerable, with defendants liable for up to three times actual damages, plus penalties of between $5,500 and $11,000 per false claim, and attorneys fees.

Since the melt-down in the financial services industry in 2008, the FCA has been amended to, in part, combat financial fraud. Since the 2009 amendments, there have been a number of FCA cases brought against financial institutions for improper lending practices. Qui tam lawsuits were filed against several large national banks. The settlements of these lawsuits were in the hundreds of millions of dollars; yet, to date, there have been no criminal charges filed. Indeed, in the vast majority of investigations that result in FCA claims, there are no allegations of criminal wrongdoing.

The SBA is just learning how to use the FCA where there is no criminal wrongdoing. The SBA recently settled an FCA claim with an SBA lender where the gravamen of the claim was the lender’s having “failed to engage in prudent underwriting practices” by relying on unaudited financials provided by the Borrowers. Apparently, the SBA was not satisfied with just declining the demand to purchase the loan guaranty.

To be liable under the FCA, a person must have submitted, or caused the submission of, the false claim (or made a false statement or record) with “knowledge” of the falsity. 31 U.S.C. §3729(a). “Knowledge” of false information is defined as (1) actual knowledge, (2) deliberate ignorance of the truth or falsity of the information, or (3) reckless disregard of the truth or falsity of the information. 31 U.S.C. § 3729(b)(1). The Act does not require actual knowledge of the false statement for a person to be liable; “reckless disregard” is enough.

Potential Lender liability under the FCA may not be as remote as most Lenders think. As an example, a Borrower provides inadequate information in applying for an SBA loan. The Lender does not catch the inadequate information, and approves the loan relying on this information. Subsequently, the Loan defaults and the Lender makes demand on the SBA to purchase its guaranty, making the following required statements to the SBA:

“ALL information and documentation submitted to the U.S. Small Business Administration…is ACCURATE, GENUINE and COMPLETE….”

“[Lender] has MATERIALLY COMPLIED with the SBA Loan Program Requirements (as defined in 13 CFR 120.10) applicable to this loan.”

However, in making the loan, the Lender did not follow all of the requirements of an applicable SBA SOP. The argument for FCA liability goes as follows: had the Lender followed the SOP, the inadequacy of the Borrower’s information would have been discovered; by failing to follow the SOP, the Lender acted in “reckless disregard of the truth or falsity of the information”; therefore, in making the required certifications in demanding the SBA purchase its guaranty, the Lender knowingly made a false statement, making the Lender liable under the FCA.

The FCA applies to a broad range of conduct that goes far beyond what a layperson thinks of as being criminal, and provides for significant financial exposure to SBA Lenders for what is often viewed as merely negligent lending practices.

For more information about the False Claims Act and its effect on SBA lenders, contact Norman at (215) 542-7070 or email him at ngreenspan@starfieldsmith.com.