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United States v. Sodexho

March 6, 2009

UNITED STATES, PLAINTIFF,
ROBERT PRITSKER, RELATOR,
v.
SODEXHO, INC., ET AL., DEFENDANTS.



The opinion of the court was delivered by: Schiller, J.

MEMORANDUM AND ORDER

This case concerns alleged fraud in the school lunch room. In order to understand the allegations in this case, it is important to understand the players and agencies involved. For the reader's convenience, the following is key of acronyms used throughout this opinion:

Acronym Definition

FNS Food and Nutrition Service FSMC Food Service Management Company GAO Government Accountability Office (previously known as the General Accounting Office)

NSLP National School Lunch Program OIG Here, the USDA Office of Inspector General OMB Office of Management and Budget RFP Request for Proposal SA State Agency SFA School Food Authority USDA United States Department of Agriculture Relator Robert Pritsker brings this qui tam action on behalf of the United States against Defendants Sodexho, Inc.; Sodexho America, LLC; Sodexho Marriott Management, Inc. (collectively "Sodexo"); Aramark Corporation; Aramark Educational Services, Inc. (collectively "Aramark"); and Compass Group, USA, Inc. d/b/a Chartwells ("Chartwells"). The Defendants are Food Service Management Companies ("FSMCs") that manage food services for local School Food Authorities ("SFAs") participating in the federally-funded National School Lunch Program ("NSLP") and School Breakfast Program ("SBP"). Relator alleges that Defendants violated the False Claims Act ("FCA") by failing to pass rebates, discounts and credits through to the SFAs, thereby causing the SFAs and overseeing State Agencies ("SAs") to falsely certify that their programs complied with applicable federal regulations. Relator also alleges that Defendants failed to comply with federal procurement regulations, causing SFAs and SAs to falsely certify compliance with those regulations. Currently before the Court are Defendants' motions to dismiss for lack of subject matter jurisdiction pursuant to the FCA's jurisdictional bar, 31 U.S.C. § 3730(e)(4), and for failure to state a claim. For the following reasons, Defendants' motions are granted.

I. BACKGROUND

A. Administration of the NSLP and SBP

The NSLP and SBP are federally-funded entitlement grant programs that provide cash and United States Department of Agriculture ("USDA") commodities to non-profit school food services. The USDA administers the NSLP and SBP through the Food and Nutrition Service ("FNS"). 7 C.F.R. §§ 210.3(a), 220.3(a) (2009). FNS contracts with SAs, which contract with local SFAs, which, in turn, implement the federal programs. Both FNS's contracts with SAs and SA's contracts with SFAs require the parties to abide by applicable federal regulations. (Clark-Weintraub Decl. Ex. 1 [FNS contract with Conn. Dep't of Educ.] & Ex. 2 [Conn. Dep't of Educ. form contract with SFAs].) To obtain reimbursement from the federal government, SFAs must certify to SAs the number of meals served. Pursuant to these reimbursement requests, FNS reimburses SFAs, through SAs, on a cost-per-meal basis.*fn1 See 7 C.F.R. §§ 210.7, 210.8, 220.11. The SFA representative who signs the certification must attest that the claim is correct and supported by available records and that the claim is made in accordance with the terms of existing agreements. Id. § 210.8(c); (Clark-Weintraub Decl. Ex. 4 [Claim Reimbursement Form].)

Federal regulations permit SFAs to contract with FSMCs to manage food service operations and purchase food products on behalf of the SFA. 7 C.F.R. § 210.16. SFAs solicit bids from FSMCs by issuing a request for proposal ("RFP"), which specifies the contract requirements. When the relationship is governed by a cost-reimbursable contract, as is true here, the FSMC purchases food on the SFA's behalf and submits the invoices to the SFA for repayment from the nonprofit school food service account.*fn2

The federal regulations governing NSLP and SBP require SAs and SFAs, as grantees and subgrantees of federal funds, to abide by the federal procurement regulations at 7 C.F.R. Parts 3016 and Part 3019 "concerning the procurement of all goods and services with non-profit school food service account funds." 7 C.F.R. §§ 210.21(a) (governing NSLP), 220.16(a) (governing SBP). Part 3016 requires grantees and subgrantees of federal funds, like SAs and SFAs, to conduct procurement transactions "in a manner providing full and open competition." Id. § 3016.36(c). The regulations at that part pertaining to financial administration limit use of federal funds to "[t]he allowable costs of the grantees [and] subgrantees" and direct state and local governments to the principles of Office of Management and Budget ("OMB") Circular A-87 to determine which costs are allowable. Id. § 3016.22. OMB Circular A-87, codified at 2 C.F.R. Part 225, requires that to be allowable, costs paid from federal funds "[b]e the net of all applicable credits." 2 C.F.R. Part 225 Appx. A § (C)(1)(i). Applicable credits are "those receipts or reduction of expenditure-type transactions that offset or reduce expense items allocable to Federal awards as direct or indirect costs," such as "[p]urchase discounts, rebates or allowances, recoveries or indemnities on losses, insurance refunds or rebates, and adjustments of overpayments or erroneous charges." Id. § (C)(4)(a).

B. OIG Investigates FSMC Rebate Retention

In August, 1996 GAO issued a report that broadly reviewed the use of private food establishments by schools participating in federal programs. It found, among other things, "that some FSMC contracts contain provisions allowing FSMCs to receive some of the rebates and discounts obtained from vendors." GAO Report, School Lunch Program: Role and Impacts of Private Food Service Companies 37 (1996). The USDA Office of Inspector General ("OIG") subsequently initiated regional audits to investigate the extent to which FSMCs retained rebates, discounts and credits instead of passing them through to the SFAs. See Southeast Region Audit, OIG, USDA, Report No. 27601-10-At, Food and Nutrition Service National School Lunch Program Controls Over Food Service Management Companies, South Carolina School Years 1997 Through 1999 1 (Feb. 2001) ("Prior [OIG] audits and investigations disclosed that FSMC does not always pass on to SFA the full value of . . . discounts and rebates on commercial purchases."); Southwest RegionAudit, OIG, USDA, Report No. 27601-9-Te, Food and Nutrition Service National School Lunch Program Food Service Management Companies (Mar. 2001) (auditing New Mexico FSMCs); Western Region Audit, OIG, USDA, Report No. 27099-15-SF, Food and Nutrition Service National School Lunch Program Food Service Management Companies (Apr. 2001) (auditing Washington State FSMC).

In April 2002, OIG published an audit report compiling six regional investigations of the NSLP as operated by FSMCs nationwide. Midwest Region Audit, OIG, USDA,Report No. 27601-0027-CH , Food and Nutrition Service National School Lunch Program Food Service Management Companies (Apr. 2002) [hereinafter April 2002 Audit]. The audit's stated objectives were to "determine whether sufficient controls exist[ed] to ensure that (1) food service management companies credit SFA's for the full value of . . . purchase discounts and rebate[s] as applicable; and (2) that management companies and SFA's administered the NSLP in accordance with applicable laws, regulations, and FNS guidelines." Id. at 2.

The audit, which assumed that FSMCs engaged in cost-reimbursable contracts were required to pass discounts or rebates through to SFAs, concluded that "the purchase discounts . . . were used to enrich the management companies instead of benefiting [sic] the SFA's as required by Federal regulations." Id. at 5 (footnote omitted). Specifically, the audit revealed that:

Two management companies that maintained cost-reimbursable contracts nationwide profited at the expense of 7 of the 19 SFA's we reviewed by retaining over $280,000 in discounts and rebates they received on purchases made for their food service operations. To accomplish this, the management companies amended, eliminated, or ignored terms included in the requests for proposal issued by the SFA's.

Id. at ii. OIG's conclusions relied on the premise that OMB Circular A-87's allowable cost principles required FSMCs to bill costs net of all applicable credits. Id. at 11, 11 n.5.

OIG recommended that states require new contracts with FSMCs to expressly declare that the FSMC will pass rebates and other discounts through to the SFA. Id. at iii. It also recommended that FNS issue a statement providing guidance to SAs so as to ensure compliance with regulations mandating the pass through of rebates. Id. at 14-15. A June 2002 news article reported on the audit, publicizing its findings to the food service industry. Paul King, USDA Report Contractors Skimmed Millions From Lax Education Clients, Nation's Restaurant News (June 3, 2002), available at, http://findarticles.com/p/articles/mi_mi3190/is_22_36/ai_86762976/print?tag=artBody;col1 (last visited Feb. 26, 2009).

C. FNS determines that OMB Circular A-87 does not apply to cost-reimbursable contracts between FSMCs and SFAs

Shortly after the large-scale audit was conducted, FNS changed its position regarding the applicability of OMB Circular A-87 to cost-reimbursable contracts between SFAs and FSMCs. On November 26, 2002, Stanley Garnett, Director of the Child Nutrition Division of FNS,*fn3 issued a management alert to the Regional Directors of Child Nutrition Programs announcing that:

Recently, we met with officials of [OMB] concerning the applicability of OMB circulars to contracts between [SFAs] and [FSMCs]. OMB has determined that its circular requirements for net costs, i.e., allowable costs must be net of all credits, discounts and rebates, do not apply to the nonprofit school food service account for expenditures resulting from the contracts between the SFA and FSMC. (Aramark Mot. Ex. H [Nov. 26, 2002 Management Alert]). Accordingly, explicit contract terms were necessary to require FSMCs to pass through rebates to SFAs. However, FNS "strongly encouraged" SFAs to include such provisions in their cost-reimbursable contracts with FSMCs. (Id.)

FNS reiterated this position in a December 17, 2002 memo: This memorandum is intended to rescind the prohibition against FSMCs receiving the value of credits, discounts and rebates under certain conditions. The OMB determined its circular requirements for net costs, i.e., allowable costs must be net of all credits discounts and rebates do not apply to the nonprofit school food service account for expenditures resulting from cost reimbursement contracts between the SFAs and FSMCs.

In light of this interpretation [FNS] strongly encourages the inclusion of provisions in all cost reimbursable contracts that require FSMCs only charge allowable costs that are net of credits, discounts, and rebates received by the FSMC. Please realize that SFAs failing to include such a provision in its contracts may be liable to the FSMC for payment of costs in excess of the actual net costs incurred by the FSMC.

Since the OMB made it clear that State agencies and SFAs can impose compliance with net cost requirements through contractual terms, FNS will fully support State agencies and SFAs that elect to require contract terms that protect the financial integrity of the program. (Clark-Weintraub Decl. Ex. 7 [Dec. 17, 2002 Rankin Memo].) FNS subsequently restated this position three times. (Sodexo's Mot. to Dismiss Furey Aff. Ex. 12 [Jan. 15, 2003 Memo] ("OMB Circular requirements stating that allowable costs must be net of all credits, discounts and rebates, do NOT apply to the nonprofit school food service account for expenditures resulting from the contracts between the school food authority (SFA) and the FSMC."); Ex. 13 [May 20, 2003 Letter from Dir. of Child Nutrition Div.] at Question 5 ("FNS strongly encourages, but does not require, that all cost reimbursable contracts include provisions to ensure SFAs are only charged net, allowable costs."); Ex. 14 [July 9, 2004 Letter from Dir. of Child Nutrition Div.] (declaring that position expressed in May 20, 2003 letter "remains unchanged").

D. FNS Takes Regulatory Action

On July 9, 2003, Phyllis K. Fong, Inspector General of the USDA testified before the United States House of Representatives Committee on the Budget regarding fraud, waste and abuse in mandatory spending programs. (Furey Aff. Ex. 15 [Fong Testimony].) During her testimony, Fong identified "local school food authority contracts with food service providers" as susceptible to fraud, waste or abuse. (Id. at 20.) She testified that:

OIG is working with FNS to address cost reductions in the form of contract discounts, rebates, and allowances. Federal cost principles require that such benefits accrue to the program. However, [OMB] has recently determined that Federal cost principles do not apply to local contracts with ...


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