The U.S. District Court for the District of Columbia, in U.S. ex rel. Bid Solve, Inc. v. CWS Marketing Group, Inc., et al., recently issued a decision in a False Claims Act (FCA) case that has potentially far-reaching implications for small-business government contractors and how they calculate and report their average annual “receipts” for size purposes. The key facts, holdings, and takeaways from this noteworthy case are discussed below.

The Facts

The defendants, a federal contractor and its owners, submitted a bid for, and were awarded, a small business, set-aside contract with the Internal Revenue Service (IRS). To qualify for this procurement, contractors were required to have averaged under $7.5 million in annual “receipts” over the past three years.

The plaintiff, a disappointed bidder, filed a size protest with the U.S. Small Business Administration (SBA) and lost.

Subsequently, the plaintiff filed a qui tam whistleblower lawsuit under the FCA, alleging that the defendants had falsely certified that their average annual receipts were under $7.5 million. After discovery, the parties cross-moved for summary judgment on various issues, including whether the defendants’ certifications regarding their average annual “receipts” were, in fact, false. On this issue, the court ruled in favor of the plaintiff, finding that the defendants had wrongly deducted “flowthrough income” — i.e., “reimbursement for expenses incurred on behalf of and for the benefit of customers” — when calculating the company’s “receipts,” rending their size representations false.

The Holding

In reaching its conclusion on the issue of “falsity,” the court parsed the applicable version of the SBA’s regulations at 13 C.F.R. § 121.104(a), which address how “receipts” are to be calculated for federal contracting size purposes. Those regulations state, in relevant part:

(a) Receipts means all revenue in whatever form received or accrued from whatever source, including from the sales of products or services, interest, dividends, rents, royalties, fees, or commissions, reduced by returns and allowances. Generally, receipts are considered “total income” . . . plus “cost of goods sold” as these terms are defined and reported on Internal Revenue Service (IRS) tax return forms . . . . Receipts do not include net capital gains or losses; taxes collected for and remitted to a taxing authority if included in gross or total income, such as sales or other taxes collected from customers and excluding taxes levied on the concern or its employees; proceeds from transactions between a concern and its domestic or foreign affiliates; and amounts collected for another by a travel agent, real estate agent, advertising agent, conference management service provider, freight forwarder or customs broker. For size determination purposes, the only exclusions from receipts are those specifically provided for in this paragraph. All other items, such as subcontractor costs, reimbursements for purchases a contractor makes at a customer’s request, investment income, and employee-based costs such as payroll taxes, may not be excluded from receipts.

(1) The Federal income tax return and any amendments filed with the IRS on or before the date of self-certification must be used to determine the size status of a concern. SBA will not use tax returns or amendments filed with the IRS after the initiation of a size determination.

(2) When a concern has not filed a Federal income tax return with the IRS for a fiscal year which must be included in the period of measurement, SBA will calculate the concern’s annual receipts for that year using any other available information, such as the concern’s regular books of account, audited financial statements, or information contained in an affidavit by a person with personal knowledge of the facts.

According to the court, “§ 104(a) provides a clear formula: receipts are ‘all revenue . . . reduced by returns and allowances,’ and ‘the only exclusions from receipts are those specifically’ listed in § 104(a). Tax returns may be used to calculate receipts, but they cannot override § 104(a)’s basic rules.”

The court went on to state that, “Yet here, Defendants excluded one of those prohibited items by removing ‘flowthrough income.’” The court then noted that, by the defendants’ “own books, its average gross receipts were either $8.8 or $9.3 million, depending on whether that was calculated on an accrual or cash basis.” Accordingly, the court found that, when the defendants’ “flowthrough income” was added back into the “receipts” calculation, the defendants’ averaged annual receipts were above the $7.5 million size limit. Thus, the court concluded that the defendants were not a small business for purposes of the subject procurement and that their representations to the contrary were false.

The Takeaways

The court’s decision in this case has potentially far-reaching and drastic implications for small business federal contractors.

First, it is likely that many federal contractors have been unknowingly calculating their average annual “receipts” in a way that is potentially inconsistent with the court’s interpretation of the SBA’s regulations. Thus, federal contractors will need to analyze their revenue structure and cashflow to determine whether the routine exclusion of such “flowthrough income” could impact their small business status. This issue will need to be addressed by the SBA and will likely be raised in future size protests and FCA litigation.

Second, the court’s decision could have a significant impact on how the SBA conducts its size analyses. Absent legislation or notice-and-comment rulemaking to revert back to the SBA’s practice of tax-return-only reviews, this new ruling likely necessitates a more complex analysis for SBA size specialists during size determinations.

Third, in support of their interpretation of the SBA’s regulations, the defendants submitted a declaration from an SBA size specialist, who attested that tax returns trump other information, and that the SBA is limited to reviewing tax returns when making size determinations. The court, however, rejected the SBA’s assertion as being contrary to the plain language of the SBA’s regulations. This aspect of the court’s decision has the potential to change how size protests are argued by contractors and decided by the SBA. We also anticipate that plaintiffs will cite the court’s rejection of the SBA’s attestation concerning its own regulations to counter agencies’ deference arguments where those interpretations clash with a statute or regulation.

Finally, the plaintiff’s successful pursuit of FCA litigation as a follow-on to a failed size protest creates a new litigation strategy for unsuccessful protesters who are convinced of their position. Given the compelling threat presented by FCA litigation in this arena, contractors approaching the size threshold should exercise caution in calculating their annual receipts.  

In sum, this significant development has the potential to fundamentally change the small business landscape for federal contractors, may lead to a legislative or regulatory fix, and will certainly lead to new size protest and FCA litigation tactics.