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FCA release rejected by 2nd Circuit

FCA Release of ClaimsImagine the following scenario: After an employee of a company reports his or her suspicions of fraud to upper management, the employee suddenly finds him or herself the target of false or unfair allegations of workplace misconduct and/or poor performance.  As a result, the employee finds him or herself in the position of being terminated from the company.  However, as the employee is being forced out the door, the company floats an attractive severance package in front of the employee.  The company premises the severance package upon the employee signing a broad waiver releasing any claims against the company the employee might have, including a release of False Claims Act (“FCA”) claims.  While this may seem like a good business practice, the Second Circuit Court of Appeals recently held that, while a FCA release is allowed by law, such release is only effective under limited circumstances.

Second Circuit Holds that FCA Release is Unenforceable as a Matter of Public Policy

In US ex rel. Ladas v. Exelis, Inc., et al., the Second Circuit Court of Appeals ruled that a pre-filing FCA release is unenforceable as a matter of public policy – the encouragement of qui tam suits to uncover fraud against the government – unless the government is informed of the fraud allegations prior to time the FCA release is signed.  The Second Circuit’s holding in Ladas is an extension of the Fourth Circuit’s decision in US ex rel. Radcliffe v. Purdue Pharma L.P., and fully accepts the Ninth Circuit’s holdings in US ex rel. Green v. Northrop Corp. and US ex rel. Hall v. Teledyne Wah Chang Albany.

Ladas Alleged Employer Made Fraudulent Representations to Government in Connection with Contract Specifications

In Ladas, plaintiff Michael A. Ladas, a former employee of defendant ITT Power Solutions, Inc. brought a qui tam suit against his employer on behalf of the United States, which alleged that Ladas’s employer made fraudulent representations to the United States in connection with certain equipment supplied to the government pursuant to a procurement contract.  Ladas’s employer subsequently moved to dismiss the qui tam suit.  The lower district court dismissed the qui tam suit on the grounds that Ladas’s employer’s notification to the government was sufficient, such that the FCA release Ladas signed was not void as against public policy.  The lower court’s decision relied on the holdings in Radcliffe, Green, and Hall, which, when taken together, stand for the proposition that a release of qui tam claims is not contrary to public policy if, prior to the release being signed, the government is advised of the allegedly fraudulent conduct and has the opportunity to fully investigate it.  Ladas appealed the lower court’s decision to the Second Circuit Court of Appeals.

By way of background, in 2005, Ladas’s employer was awarded a contract to provide the U.S. with certain devices and the ability to power those devices.  As part of the contract, ITT Power Solutions was required to meet certain specifications as it related to the devices and their supporting power apparatus.  Any changes in the devices that deviated from the contract’s specifications had to be tested, and those changes also had to be submitted to the government for approval.

In 2007, a subcontractor contracted by ITT Power Solutions to manufacture casing components for the devices’ power supply apparatus, made substantial changes in the materials used to manufacture the devices’ power supply apparatus.  However, no qualifications’ testing was performed on the newly manufactured power supply apparatuses, and the changes were never submitted to the government for approval.

In 2009, ITT Power Solutions began documenting problems with the power supply case components, noting various types of degradation in the casing.  After some back and forth between ITT Power Solutions and the subcontractor manufacturing the cases, the subcontractor admitted that it changed the materials used to manufacture the cases for the power supply apparatuses in 2007.  ITT Power Solutions and its subcontractors met to discuss the changes from 2007, but, Ladas, who was responsible for ensuring and improving the quality of ITT Power Solutions products, was not included in the meeting.

Eventually, it was agreed upon that ITT Power Solutions would inform the government of the changes from 2007, and would request for a government waiver of the deviations and a proposal for corrective action.  The deviation request waiver was initially approved by the assembly division but was never sent to the government.  Instead, the assembly division sent the government “white paper” and an accompanying letter stating falsely that ITT Power Solutions had only recently become aware of a change in the subcontractor’s application process–a change they described misleadingly–stating that no tests had identified degradation or failure in the metalized area of the components, and stating falsely that the adhesive used had not changed.  A further deviation waiver request was prepared in 2010, but it was also never sent to the government.

In March 2010, Ladas’s employment with ITT Power Solutions was terminated.  As part of his termination, Ladas signed a separation agreement, wherein, Ladas agreed to release all claims he had against ITT Power Solutions, which naturally included a release of any FCA claims.

Ladas subsequently commenced a qui tam lawsuit under the FCA against ITT Power Solutions and its subcontractor in July 2010.  After being notified that the government would not intervene in the suit, the defendants moved to dismiss Ladas’s qui tam case.  This appeal followed.

Second Circuit Agrees that an Employee may Release FCA claims, but Failure to Disclose Fraud Allegations Doomed Release in Ladas’s Case

The Second’s Circuit’s opinion begins by analyzing the enforceability of the FCA release signed by Lada before he commenced his qui tam suit.  There, the Second Circuit held: “Ladas’s release is unenforceable as a matter of public policy because the record belies the district court’s conclusion that the government had sufficient knowledge of Ladas’s allegations of fraud or of any related fraud allegations.”  Thus, while the Second Circuit agreed that a FCA release signed prior to the time a qui tam lawsuit was commenced is enforceable, the defendants did not properly inform the government of the allegations of fraud against them.  As a result, the release was held to be unenforceable as a matter of public policy.

The Second Circuit said:

Notably, the district court’s factual description of the disclosure ITT made to the government is not supported by the record.  Although the district court stated that “ITT notified the [government] of the process and epoxy change in the ‘white paper’ and accompanying note,” the White Paper and the accompanying letter in fact disclosed only a change in “method” or “process,” not the change in adhesive.  Indeed, the conclusion the White Paper expressed, that the change in process should have no significant effect, was premised on its explicit–and false–statement that the adhesive used in the original process and the new process was “the same.”  Moreover, the ITT representations repeatedly emphasized that the change in process was inconsequential.  The White Paper stated that there would be “no difference” in electrical conductivity and that the process change would not impact electrical performance.  Similarly, the accompanying letter claimed that “there was not a functional change” that had the “potential to affect any specification requirement.”  The letter even characterized the change as so minor that ITT was not contractually required to notify the government of it.  The letter’s partial disclosure–and the White Paper’s affirmative misrepresentation as to the lack of change in the material used–did not give the government any notice as to false statements or allegations of fraud. Further, even if the White Paper or the accompanying letter had disclosed both the change in process and the change in adhesive, those disclosures would not have alerted the government that the proffered statements as to the effect of the changes were false.  Nothing in these two documents indicated to the government that there was any fraud or that anyone had alleged fraud.

Ultimately, the Second Circuit concluded that “although the right to bring a quit tam suit can be released when the government has knowledge of the relator’s fraud allegations, we do not endorse the district court’s conclusion that the government had such knowledge in this case.”

The upshot of Ladas is that, while an employer may enter into a FCA release with a soon to be terminated employee, that release will only hold muster if the fraud allegations are reported to the government.  Thus, where a company fails to disclose the fraud allegations to the government, sufficient to put the government on notice, then the FCA release will be held to be void as against public policy, and the terminated employee will be allowed to pursue his or her qui tam claims under the FCA.

Contact our Whistleblower Attorney Team Today

Following the holding in Ladas, both employers and employees need to be aware of what procedures to follow in order to ensure that a FCA release will be enforced and/or whether the company’s disclosure to the government is sufficient to block a later filed qui tam lawsuit.  If you or someone you know is in the process of being terminated from a company, or have been terminated from a company under a separation/severance agreement, it is important to understand your rights regarding a potential release of claims, including FCA claims against your employer.  Before you or someone you know signs any FCA release, or other release of claims, please contact our whistleblower attorney team for a consultation.  Our whistleblower attorney team can properly advise you on the ramifications of a pre-qui tam lawsuit release, as well as advising you on your ability to still bring that suit even if you signed a FCA release.

You can contact us via email at kporter@chrisjen.com, by phone at (801) 323-5000, or by filling out our online form.

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