Ormat1 is a successful developer of geothermal energy projects. Two former employees have brought a lawsuit alleging that Ormat made inaccurate 1603 Cash Grant2 submissions to obtain grants for projects that should not have qualified for such grants. The complaint filed in the U.S. District Court for the Southern District of California by the ex-employees is available here.3 The venue has been changed to Nevada.4
The complaint arises under the Federal False Claims Act (the Act). In contrast to typical civil litigation, the Act provides for treble damages that may not be waived by a judge.5 There is also an additional penalty of up to $11,000 per false claim per project application.6
False Claims Act Background
The False Claims Act was enacted in 1863 to address improprieties by government contractors supplying the Union Army during the Civil War. However, its scope is far in excess of just government contractors; it is commonly asserted in the case of improprieties associated with federal research grants and Medicare payments to medical providers.
Further, the Act authorizes private citizens to assert claims that the federal government made payments in response to a false statement or submissions. Such suits are referred to as “qui tam” suits.
If a court finds there was a false claim that resulted in an improper payment, the private citizen (i.e., the qui tam relator) is awarded between 15 and 30 percent of the recovery. The potential recovery can be large enough that law firms are willing to invest substantial resources in cases, even if the client at first does not appear to have an airtight case.
Once the relator brings claim, the Department of Justice (DOJ) may opt to intervene in the case. DOJ has opted to not to intervene in this instance. DOJ’s decision is something of a setback for the relators as it means the experts at DOJ have determined the case is not worth their involvement. Nonetheless, the Act permits the relators to litigate the case on their own as the Ormat relators are proceeding to do.7
The Qui Tam Relators
Both qui tam relators could be viewed as either principled professionals who separated from Ormat due to improprieties or as disgruntled former employees eying a handsome payday. Without the benefit of an independent fact finding, it is difficult to determine which is the more apt description.
The first qui tam relator is Ms. Tina Calilung who, after graduating in 2004 from the University of Pennsylvania with a bachelor’s degree in economics, worked as an asset manager for Ormat. She resigned from Ormat in July of 2012 due to business practices “she felt were morally and ethically repugnant” that she purportedly had elevated to management while still employed there.
The second qui tam relator is Ms. Jamie Kell, who started at Ormat in January of 2008 as the administrative assistant to the business development department and in October 2011 was promoted to be the company’s travel coordinator. In April of 2010, she was diagnosed with cancer. Through the United States Equal Employment Opportunity Commission and its Nevada counterpart she brought complaints against Ormat “regarding Ormat’s actions towards her while she was undergoing cancer treatment.” She executed a severance agreement with Ormat in September of 2012.
Background to the Dispute
The subjects of the complaint are the geothermal projects known as Puna and North Brawley. North Brawley is located in Imperial County, California and Treasury paid Cash Grants of over $136 million with respect to it. North Brawley was designed and built to have 50 megawatts of generation capacity; however, it is functioning at approximately half of that capacity. Puna is an eight megawatt project co-located within an older 30 MW project. Puna is located in Hawaii and Treasury paid a Cash Grant with respect to it of over $105 million.
If both projects are found to have received all of their Cash Grants as a result of false claims to Treasury, that would be over $241 million in actual damages, which, after treble damages, would amount to over $723 million. If the court awards the relators the maximum 30 percent, that would earn them in excess of a $216 million “commission.”
The Cash Grant program is administered by Treasury without the formal involvement of the Internal Revenue Service. The Cash Grant is generally 30 percent of eligible basis of a qualified project, and eligible basis is determined using federal income tax principles.8 Thus, it is not a tax program, but it relies on the tax rules.
Certain of the tax doctrines involved are nuanced and when combined with complicated fact patterns can lead to questions that have less than clear answers. A number of Cash Grant applicants have, in fact, filed law suits under the Tucker Act in the Court of Federal Claims alleging that Treasury misapplied the tax law in determining their Cash Grant awards when they fell short of the amounts applied for. As discussed below, the qui tam relators appear to be trying to leverage the nuanced tax doctrines in question in their lawsuit against Ormat.
The Complaint’s Allegations
With respect to North Brawley, the qui tam relators assert first that the project was, in fact, placed in service in 2008 and thus fails to meet the 1603 requirement that a project not be placed in service prior to 2009. The income tax law’s placed-in-service doctrine is nuanced.9 The Treasury lawyer responsible for administering the Cash Grant program has characterized it as a “very grey” area in public remarks.10 It is difficult to view Ormat’s interpretation of a “very grey” area as a false claim, so long as it acted reasonably and disclosed the pertinent facts to Treasury.
Second, the relators assert that the eligible basis of the project was $20 per watt11 of energy generation capacity, making it according to the relators the most expensive geothermal plant ever and at such an excessive cost should not be fully eligible for a Cash Grant. If Ormat, in fact, incurred $20 per watt in eligible expenses, it should be entitled to a Cash Grant based on those expenses. Just because a grant applicant is inefficient or unlucky is not grounds to deny it a grant based on the amounts it genuinely incurred for eligible expenses. Treasury has indicated that in sale-leasebacks and transactions involving related parties it will scrutinize whether the amount incurred by the grant applicant exceeded fair market value. However, the facts provided by the relators do not suggest such “peculiar circumstances” are at a play in this instance.
Third, the relators assert that the North Brawley project running at only 50 percent of its expected capacity is equivalent to Ormat removing half of the project from “service” and should have resulted in recapture (i.e., repayment to Treasury) of half of the Cash Grant. The relators appear to misunderstand the tax concept of removing an asset from service. Recapture as a result of removal from service is tantamount to abandonment, and a project operating at half the level that was expected does not meet that threshold.12 If the court permits this case to proceed, it at a minimum should require the relators to amend their complaint to remove this allegation.
Fourth, the relators assert that the fact that Ormat recorded “write downs” of the “carrying value” of the North Brawley project for financial accounting purposes means the project should have been shut down and the Cash Grant recaptured. There is no tax doctrine that provides that a write down for financial accounting purposes has any corresponding tax effect with respect to tangible property. Financial accounting principles and the income tax law are separate sets of rules that often reach different conclusions because they have different policy objectives. Again, if the relators’ case proceeds, the court should require them to amend their complaint to remove this allegation.
With respect to Puna, the relators first assert the project was not a “new” facility for tax purposes but was in fact merely an expansion of a facility constructed by Southern Company and placed in service in 1993. Treasury’s Cash Grant guidance provides that an eligible facility may include used or refurbished parts, so long as the cost of those parts does not exceed 20 percent of the total cost.13 The complaint does not reference this rule but rather focuses on the fact that “The 8 MW Expansion depended on the 30 MW plant’s [brine] byproduct to operate.” Despite the relators’ apparent confusion about the law, this allegation appears to be a question of fact that merits discovery and potentially a trial. At the end of the day, it would be surprising if Ormat and its tax advisors misapplied the 80 percent new equipment standard in applying for the Cash Grant.
Second, the project was not in service in December in 2011 as reported on the Cash Grant application because the project at that time was not being paid for electricity. Again, the doctrine of placed in service is “grey,” and this should not be a false claim so long as the facts were disclosed to the Treasury and Ormat acted reasonably.
Third, the cost of the purported expansion that resulted in the new facility should have been allocated between the eight megawatts of expanded capacity and 30 megawatts of original capacity and the portion allocated to the 30 megawatts of original capacity should not have qualified for the Cash Grant. This allegation appears inconsistent with the first Puna allegation (i.e., that the facility that applied and received the Cash Grant was not “new”) because it appears to be acknowledging there was a new facility constructed. This is a highly factual issue that cannot be evaluated without an independent fact finding.
Ormat’s Motion to Dismiss
Ormat filed a motion to dismiss the case due to either (i) the district court’s lack of subject matter jurisdiction or (ii) a failure to state a claim upon which relief can be granted. For a defendant’s motion to dismiss to prevail, the defendant must persuade the court that either (a) it lacks the jurisdiction to adjudicate the case or (b) even if all of the plaintiff’s factual allegations were true, the law would grant the plaintiff no relief. The motion to dismiss is available here14 and the relators’ response is available here.15
Ormat’s motion to dismiss contains three primary rationales as to why the case should be dismissed. First, the legal doctrine that permits only the federal government (and not private citizens) to enforce the tax law bars this case. Although DOJ has not joined the case, DOJ did submit a statement of interest supporting the relator’s position that this doctrine should not bar the relators’ claims. The statement of interest is available here.16 Further, Treasury’s guidance provides: “funds that must be repaid… are considered debts owed to the United States and … will be collected by all available means…, including enforcement by [DOJ]. Debts arising under these rules are not considered tax liabilities.”17 It appears likely that the court will side with the relators and DOJ on this issue because Congress could have made the Cash Grant a refundable investment tax credit, in which case Ormat would be right; however, Congress created a program outside of the tax system: the Cash Grant is not a tax benefit and is not administered by the Internal Revenue Service. Thus, this doctrine should not bar these claims.
Second, Ormat’s 1603 applications filed with Treasury were effectively a “public disclosure” of the pertinent facts and relators may not bring actions under the Act based on facts that have been publicly disclosed. The legal principle in play here is that every time a false claim is unearthed by the media or otherwise made public, there should not be hopeful relators racing to the courthouse to file a claim and cash in. Further, if the false claim is public, DOJ does not need a relator to bring it to its attention, and the federal government should not have to pay a commission. It appears that the facts of this case were not made available or public prior to the relators’ complaint.
Third, Ormat asserts it disclosed all of the facts to Treasury, so it could not have possibly made a false claim. However, the judge in considering Ormat’s motion to dismiss must assume that all of the relators’ factual allegations are true. The relators allege that there were pertinent facts that Ormat did not disclose, so it appears that this theory is not grounds for a dismissal. As the relators’ response notes, this may be a “potential affirmative defense” that Ormat may wish to raise during the trial.
The parties are waiting for the judge’s ruling; however, it appears likely that the relators’ complaint will survive the motion to dismiss, although the court is likely to require a number of the allegations to be struck from the complaint as discussed above. Then the parties will have to proceed with the discovery process, which will likely be burdensome for Ormat and possibly Treasury as well.
Merits of the Case
As the court has yet even to rule that the case should proceed to discovery, it is arguably premature to speculate as to its merits. Further, if the case proceeds, it is entirely possible that the discovery process reveals that there were no false statements made in the Cash Grant applications. Assuming that the court finds that there was a false statement, such a false statement would likely be the result of the court finding that Ormat misapplied the tax law with respect to nuanced issues like determining the placed-in-service date or calculating the eligible basis.
However, the Act does not provide for strict liability for the mere existence of a false statement. For the relators to prevail, they would have to prove that Ormat (i) had actual knowledge the information was false; (ii) acted in deliberate ignorance of the falsity or (iii) acted in reckless disregard of the falsity.18 If Ormat sought and followed advice with respect to the Cash Grant applications from a qualified independent tax advisor, then it seems unlikely that a court would conclude that Ormat tripped any of these elements. Ormat will have a more difficult time prevailing if it (a) did not obtain advice from tax advisors expert in these matters, (b) obtained tax advice but did not follow it or (c) was not candid when communicating the pertinent facts to its tax advisors.
1 Ormat Industries, Ltd. is a corporation organized under the laws of Israel and is one of the 25 largest companies traded on the Tel Aviv Stock Exchange (TASE: ORMT). Ormat Technologies, Inc. (NYSE:ORA) is a Delaware corporation and a subsidiary Ormat Industries, Ltd. and is the parent company for Ormat’s operations in the United States.
2 The cash grant is provided for in Section 1603 of division B of the American Recovery and Reinvestment Act, as amended (Cash Grant). For geothermal projects, the Cash Grant is 30 percent of “eligible basis.” Geothermal projects must have been originally placed in service between January 1, 2009, and December 31, 2011, (regardless of when construction begins) or placed in service after 2011 and before January 1, 2014 if construction of the property begins between January 1, 2009, and December 31, 2011. More information is available at http://www.treasury.gov/initiatives/recovery/Pages/1603.aspx.
3 First Amended Complaint, U.S. ex rels. Calilung & Kell v. Ormat Industries Ltd., et al., U.S.D.C. of S.D. Cal., Case No. 13-CV-0261-BEN (DHB), May 14, 2014.
4 There were originally seven Ormat affiliates named as defendants. The plaintiffs voluntarily dismissed their claims against Ormat Industries, Ltd. and First Israel Mezzanine Investors Ltd. Joint Stipulation of Voluntary Dismissal Without Prejudice, U.S. ex rels. Calilung & Kell v. Ormat Industries Ltd., et al., U.S.D.C. of Nev., Case No. 3:14-CV-325-RJC (VSP), Dec. 19, 2014. The remaining defendants are Ormat Technologies, Inc., Ormat Nevada, Inc., Puna Geothermal Venture II, L.P., Puna Geothermal Venture, G.P. and ORNI 18, LLC.
5 Often the Department of Justice will agree to settle for less than treble damages (usually double damages), which provides a significant incentive for settlement.
6 Bryce Friedman, et al., The Impact of the False Claims Act on Municipal Lawyers, PLI Municipal Institute (Jul. 20, 2011).
7 For more information about the Act and the Cash Grant program, see David Burton, The False Claims Act: the Government’s Sword in Cash Grant Audits. Project Perspectives, Winter 2014, at 7; available at http://cdn.akingump.com/images/content/2/7/v2/27663/Project-Perspectives-Newsletter-Final.pdf.
8 “It is intended that the grant provision mimic the operation of the credit under section 48.” Jt. Explanatory Statement of the Comm. of the Conf. for Div. B of the American Recovery and Reinvestment Act of 2009, at 115 (2009).
9 For instance, the Tax Court held that an insurance salesman’s personal jet was not placed in service, despite being flown to multiple meetings, until the video monitor and conference table the salesman had special ordered were installed. Brown v. Commissioner, T.C. Memo. 2013-275. See also, 85 Gorgonio Wind Generating Co. v. Comm’r, T.C. Memo. 1994-544 (holding that wind turbines were not placed in service until equipped with controllers despite the fact that turbines could be manually controlled and could, under optimal wind conditions, generate electricity without the controllers).
10 Treasury Finalizes Sequestration Percentage and Cutoff Point for the Cash Grant Program, Mar. 4, 2013 and available at http://www.akingump.com/en/news-publications/final-sequestration-alert-burotn.html.
11 To provide some context as to the magnitude of this price, when Treasury published guidelines for California solar projects in 2011, the most expensive types of solar project were those installed on homes. Treasury’s guideline price for California residential solar was $6 per watt. U.S. Treasury, Evaluating Cost Basis for Solar Photovoltaic Properties (Jun. 30, 2011) and is available at http://www.treasury.gov/initiatives/recovery/Documents/N%20Evaluating_Cost_
12 Treasury published the following regarding removing a project from service: “Temporary cessation of energy production will not result in recapture provided the owner of the property intends to resume production at the time production ceases. Permanent cessation of production will result in recapture.” U.S. Dept. of Treasury, Office of the Fiscal Ass’t Secretary, Payments for Specified Energy Property in Lieu of Tax Credits Under the American Recovery and Reinvestment Act of 2009 (Jul. 2009, revised Mar. 2010 and Apr. 2011, p. 19 available at http://www.treasury.gov/initiatives/recovery/Documents/GUIDANCE.pdf.
13 U.S. Dept. of Treasury, Payments for Specified Energy Property in Lieu of Tax Credits Under the American Recovery and Reinvestment Act of 2009: Frequently Asked Questions, FAQ #31 and is available at http://www.treasury.gov/initiatives/recovery/Documents/A%20FAQs0411%20-%20general.pdf.
14 Motion to Dismiss Relators’ First Amended Complaint, U.S. ex rels. Tina Calilung, et al. v. Ormat Industries Ltd. et al., U.S.D.C. Nev., Case No. 3:14-CV-325-HDM-VPC, Jul. 2, 2014.
15 Relators’ Response to Motion to Dismiss First Amended Complaint by Ormat Technologies, Inc. et al., U.S. ex rels. Calilung & Kell v. Ormat Industries, Ltd. et al., U.S.D.C. Nev., Case No. 3:14-CV-325-RJC (VPC), Aug. 12, 2014.
16 U.S.’s Statement of Interest Regarding Defendants’ Motion to Dismiss Relator’s First Amended Complaint, U.S. ex rel. Tina Calilung, et al. v. Ormat Industries, Ltd. et al., U.S.D.C. Nev. Case No. 3:14-CV-325-HDM-VPC, Aug. 12, 2014.
17 U.S. Dept. of Treasury, Office of the Fiscal Ass’t Secretary, Payments for Specified Energy Property in Lieu of Tax Credits Under the American Recovery and Reinvestment Act of 2009 (Jul. 2009, revised Mar. 2010 and Apr. 2011) at 20 and available at http://www.treasury.gov/initiatives/recovery/Documents/GUIDANCE.pdf.
18 See Bryce Friedman, et al., The Impact of the False Claims Act on Municipal Lawyers, PLI Municipal Institute (Jul. 20, 2011).