DOJ Civil Division Gives Clarity on “Inability-to-Pay” Determinations in the Midst of Ongoing Pandemic
In Short
The Situation: Companies facing the twin prospects of a significant Department of Justice ("DOJ") settlement and financial distress have historically had little insight into how the DOJ evaluates an assertion by a company that it is unable to pay the government's settlement demand. However, on September 4, 2020, Ethan Davis, acting assistant attorney general of the DOJ, circulated to the Civil Division a memorandum addressing factors to consider when assessing such "inability-to-pay" assertions. This guidance comes nearly a year after a similar memorandum was issued in October 2019 for the Criminal Division on essentially the same topic: how to assess an organization asserting its inability to pay a criminal fine or monetary penalty.
The Result: Defendants can now leverage the newly public "analytical framework" that the DOJ reportedly will use to assess an entity's assertion of an inability to pay a settlement of civil claims, such as False Claims Act matters. Defendants, who bear the burden of persuading the DOJ to reduce settlement amounts on the basis of a defendant's inability to pay, now have some transparency as to the factors the DOJ relies upon to guide their discussions.
Looking Ahead: With businesses in all sectors hard hit by the COVID-19 pandemic—health care certainly included—entities facing False Claims Act and other civil cases may increasingly need to avail themselves of the DOJ's "inability-to-pay" process. Armed with the Civil Division memorandum, defendants have an opportunity to more persuasively demonstrate that the government's demands will result in undue financial hardship.
Historically, the DOJ's Civil Division has used its discretion to reduce claims of the United States where the amount of the claim cannot be collected in full due to the financial condition of the defendant/debtor. Minimal guidance previously existed regarding the contours of the government's decision-making. Last month, the DOJ issued a memorandum outlining the analytical framework the government will reportedly utilize to assess the merits of an "inability-to-pay" claim.
In instances where a defendant has asserted that the government's settlement demand will result in undue financial hardship, the Civil Division has required submission of a robust Financial Disclosure Form to collect financial information justifying these "inability-to-pay" assertion. Submission of the Financial Disclosure Form typically has been followed by extended "inability-to-pay" discussions with the DOJ. These discussions extend beyond a defendant's current financial picture and have taken unexpected detours into topics such as executive compensation, bonuses, the disposition of assets, and distribution of profits. Thus, the new guidance is a welcome tool for companies and advocates to be able to anticipate and appropriately respond to the government's concerns when the DOJ considers whether to compromise a claim as a result of financial hardship. This guidance comes nearly a year after a similar memorandum was issued in October 2019 for the Criminal Division on the same substantive topic.
Despite the guidance, uncertainties remain. The DOJ indicates that it uses a "qualified financial expert" to assist its evaluation, but then states the DOJ's analysis and conclusions are determined by the "specific facts and circumstances." In addition, the DOJ makes clear that the factors identified in its memorandum "are not exhaustive" and that the Civil Division may consider other relevant information. Nevertheless, the factors provide guideposts for organizations to determine how and whether to make such a claim in light of particular hardship experienced in 2020 and beyond.
The Relevant Factors
The Civil Division makes "inability-to-pay" assessments in accordance with the general principles outlined in Justice Manual § 4-3.200. More particularly, the Civil Division will also reportedly review and analyze the following factors:
- Entity's Certified Completion of the Division's Financial Disclosure Form. This form requires the entity to identify assets and liabilities, current and anticipated income and expenses, cash flow, projections, working capital, and other relevant information and to certify the accuracy of the information provided.
- Background on Current Financial Condition. This factor not only focuses upon the current status of the entity's financial situation, but also "what gave rise to it" and projected financial earnings and expenses. If negotiations extend over a period of time, the DOJ may request updated data until final settlement is reached.
- Alternative Sources of Capital. The DOJ will consider what other opportunities for value are feasible for the entity. Options might include an ability to borrow funds or raise capital in a number of ways. Insurance or indemnification claims are also explicitly noted under this category.
- Timing of Payments. The DOJ acknowledges that payment may not be immediate and will consider ability to pay a settlement obligation over time. However, these arrangements "typically" are not to exceed three to five years, and in such cases, the defendant/debtor must pay interest over that period at a rate negotiated with the DOJ.
- Tax Deductibility of the Payment. The DOJ actively considers the extent to which the entity's settlement payment will be tax deductible
- Contingency Arrangements. The DOJ expressly acknowledges that anticipated future assets or opportunities can be used in an acceleration or escalation contingency arrangement. However, such arrangements have been used only infrequently.
- Collateral Consequences. The DOJ takes into account "any significant adverse collateral consequences" of a settlement that "exceeds an entity's financial capacity." While not explicitly mentioned, this factor suggests that consideration would be given to disproportionate impacts on communities that may be served by the relevant entity. The DOJ also lists areas that are explicitly excluded from its analysis, such as adverse impacts on growth or on future opportunities, dividends, or executive compensation.
- Third-Party Liability. The DOJ also will evaluate whether, in certain circumstances, third parties (e.g., related parties, family members) may also be liable for the debt as a result of, for example, fraudulent transfers or successor liability.
It comes as no surprise that the defendant continues to bear the burden of demonstrating to the government why a particular settlement demand would constitute an existing undue financial burden. Entities should also be mindful that any information provided voluntarily may be utilized in that particular matter and could be discoverable in other litigation.
Three Key Takeaways
- The DOJ's decision to compromise a claim as a result of undue financial hardship is not based simply on a current snapshot of a defendant's financial condition, but can be a far-reaching and nuanced review, taking into account a company's current financial condition, as well as a wide range of factors, such as any transfers or depletion of assets, a company's ability to tap alternative sources of capital, future prospects, and disproportionate collateral consequences.
- Entities seeking an "inability to pay" settlement bear the burden of persuasion and should closely review the new guidance and tailor their presentations to the factors that will be considered by the Civil Division in making its determination.
- While the factors outlined in the memorandum are significant, the DOJ still can consider additional unenumerated factors in its analysis. The government's ultimate determination regarding any "inability to pay" settlement is discretionary, and there are no enforceable rights to obtain such an outcome. Entities should be mindful that submissions are likely discoverable in the particular matter or other litigation, should settlement negotiations be unsuccessful.
