Friday, April 5, 2013

FYI: 7th Cir Rules "Net Trebling" Applies to False Claims Act, with Base Damages at Amount Paid on Guaranty Less Value of the Collateral

Reversing the lower court in a case involving alleged fraud in procuring federal mortgage loan guarantees, the U.S. Court of Appeals for the Seventh Circuit recently ruled that the proper calculation of treble damages for violations of the federal False Claims Act was a "net trebling" approach rather than a "gross trebling" approach, thus applying the traditional contract measure of damages to the federal government's claims. 


However, the Court upheld the lower court's ruling as to the issue of the defendants' liability, concluding that they had the requisite state of mind under the FCA in knowing that statements made to the federal government were false, given that the defendants used bogus certificates indicating that down payments had been made on the properties securing the loans and had misrepresented that the defendants had not paid anyone for business referrals.  A copy of the opinion is attached.


Defendants, a mortgage company ("Mortgage Company") and its CEO ("CEO"; collectively, the "Defendants"), supposedly violated the federal False Claims Act ("FCA") by making fraudulent representations in the process of applying for federal guarantees on a number of mortgage loans.  Specifically, Defendants supposedly used bogus certificates falsely showing that down payments were made when Defendants knew that the down payments had in fact not been made.  Additionally, Defendants falsely represented that Mortgage Company had not paid anyone for referring clients to it.


Concluding that the Defendants made false claims against the federal government, the lower court imposed treble damages under the FCA on eleven claims, using a "gross trebling" calculation method.  In so doing, for each subject property, the lower court added up the amount the federal government had paid to a lender under a loan guarantee and trebled that total.  Next, the court subtracted the amount realized from the sale of the property that secured the loan.  According to the lower court, the result, plus the applicable penalty, represented the amount of treble damages sustained by the government on each property.  Defendants appealed as to both liability and the amount of damages awarded.


The Seventh Circuit affirmed as to Defendants' liability, but reversed as to the gross trebling calculation method used to determine damages, and remanded.


As you may recall, under the FCA, the mens rea required to impose liability consists of either actual knowledge that material statements were false, or a suspicion that they were false plus reckless disregard of their accuracy.  See 31 U.S.C. §3729(b)(1)(A).  In addition, the FCA provides for trebling "the amount of damages which the Government sustains" as the result of a false claim.  31 U.S.C. § 3729(a)(1).   


Agreeing with the lower court on the issue of liability, the Seventh Circuit pointed out that Defendants made two types of false statements to the federal government:  (1) the use of the bogus certificates; and  (2) representations that they had not paid anyone for referring clients to Mortgage Company.   In so doing, the Court noted that the two statements were factually incorrect and rejected Defendants' assertion that the CEO did not "know" they were false even though the CEO ran the company and was aware that, contrary to federal requirements, Defendants had failed to establish a "controlled business arrangement" to accept payments.


With regard to the calculation of damages, while noting that the FCA generally requires treble damages but allows for double damages in certain circumstances which the Court concluded did not apply here, the Seventh Circuit examined Defendants' argument that the damages should have been calculated according to a "net trebling" approach whereby the amount for a which a particular piece of collateral sold should have been immediately subtracted from the amount the federal government paid on a guarantee.  The Defendants argued that this "net" loss number should then be trebled and added to the FCA penalty amount, thus yielding a lower treble damages amount than would otherwise be the case using a trebling calculation method based on so-called "gross loss," the critical distinction between the two methods being the point at which the trebling occurs.


Observing that the FCA does not specify whether damages should be calculated according to gross-trebling or net-trebling, the Seventh Circuit pointed out that courts typically employ net trebling.  The Court noted in part that the mitigation of damages is almost universal, and that contract cases involving the delivery of goods traditionally calculate damages based on the difference between the contract price and the price of cover, the difference being the usual contract measure of loss.   


The Seventh Circuit therefore rejected the position of the federal government that gross trebling should be employed here and, further, with respect to any collateral that remained unsold, suggested that the parties select a valuation method for those properties.  Stressing that net trebling must be employed, the Court explained that the federal government's loss in this case was the amount paid on the guaranty less the value of the collateral, regardless of whether the collateral was actually sold.


Accordingly, the court upheld the lower court's ruling on the Defendants' liability but reversed to the extent that the lower court used the gross trebling method of calculating damages.




Ralph T. Wutscher
McGinnis Wutscher Beiramee LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
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