By Jaimie Nawaday, Matthew Luzadder and Constantine Koutsoubas

Law360 (June 9, 2020, 6:10 PM EDT) --

Jaimie Nawaday

Matthew Luzadder

Constantine Koutsoubas

The worldwide demand for personal protective equipment has drawn many new entrants to the market and opportunities for fraud and other illegal activity abound. In particular, there has been a rise in resellers, consultants and middlemen who offer to secure PPE in a competitive environment.

Companies should not approach these transactions as ordinary retail sales contracts and should be aware of the particular risks that can arise in cross-border transactions that may involve foreign officials.

Often, this risk mitigation involves conducting increased due diligence on potential business partners. Although these contracts may be entered into under pressure both due to market conditions and from counterparties eager to close a deal, lack of due diligence can lead to negative headlines.

In March, a Republican fundraiser and others started Blue Flame Medical LLC, a PPE supply company that managed to win a $12.5 million contract from the state of Maryland roughly a week after the company's incorporation,.

Blue Flame received a $6.25 million down payment for providing the state with masks and ventilators within weeks.[1] When Blue Flame failed to deliver the PPE, Maryland moved to cancel the contract and referred the matter to the state attorney general.

In the same time frame, Blue Flame also won a $600 million deal for masks in California, promising that it could deliver masks "that were sitting at the Port of Long Beach," at below market prices.[2] After the state agreed, however, Blue Flame's bank, using its normal vetting process, held up a $450 million down payment as a potentially fraudulent transaction.

California eventually cancelled the deal. Blue Flame is being investigated by California, Maryland, the U.S. Department of Justice and Congress.[3]

In Chicago, Willie Wilson, a well-known local entrepreneur and former mayoral candidate, offered to procure masks for the city. Mayor Lori Lightfoot has alleged that Wilson required the entire payment upfront — and in cash.

Although there are a number of accounts of his conversations with government officials, Wilson explained that he needed the up-front payment to pay the manufacturers.[4]

The risk to the purchaser in these cases extends beyond fraud that where a seller demands a substantial up-front payment to acquire and deliver PPE with greater speed and efficiency than established market players. Many of these offers involve leveraging the seller's relationships on a number of public and private levels.

For example, third parties may appear in the transaction — often as purported consultants — claiming to have special connections to foreign officials or sources of PPE. This red flag most often appears in deals involving countries, such as China, where many of the suppliers of PPE are state-owned.

It is also important to remember that employees of state-owned companies, including laboratories and hospitals in China, have been found to be foreign officials, and bribes and other inducements authorized, offered, or paid to them to use their official discretion to obtain business have been found to violate the Foreign Corrupt Practices Act.

Purchasing companies must therefore be alert to the possibility that its substantial upfront payment is being used, in part, to bribe a foreign official in violation of anti-bribery requirements of the FCPA.[5]

The FCPA's anti-bribery provisions prohibit payments to vendors made with the knowledge of, or willful blindness to, the fact that some of the money will be given to a foreign official for an improper purpose.[6]

The FCPA's prohibition applies not only to direct corrupt payments to a foreign official. It also applies to indirect payments made through third parties, such as consultants.

Any company conducting business abroad through third parties should therefore perform a risk-based evaluation of the parties based on the specifics of the proposed relationship.[7]

If law enforcement discovers an improper payment, a purchasing company's liability may turn on an assessment of its willful blindness, assuming that the company did not know of the payment. In particular, law enforcement and regulators may ask what questions the company asked prior to engaging the third party and what the company did to resolve any red flags that arose during the due diligence process.

Accordingly, a purchasing company should utilize a questionnaire based on the potential FCPA and fraud issues and maintain the responses received in its compliance files.

Another helpful, inexpensive diligence step is asking the U.S. Commercial Service to conduct basic diligence, or a site visit, to a vendor or intermediary's factory or office.

In most cases, a purchasing company's due diligence should focus on any third-party consultants or facilitators of the transaction, as these parties have featured in many recent FCPA enforcement cases.

A third party's involvement in the transaction should have a legitimate rationale or business purpose, and its compensation should reflect market realities, without being designed to disguise a hidden bribe to a foreign official.

The third party's services should be well defined by any agreement the purchasing company considers. Because a number of entities are entering the PPE space from other industries, perhaps out of altruism or because their core business has slowed, there are many new entrants who are legitimate actors.

But there are others — including narcotraffickers who look to conceal contraband in PPE shipments — trying to take advantage of the pandemic for illegal purposes. [8]

Therefore, when evaluating a potential partner, it is particularly important that the company follow know-your-partner, or KYP, procedures. These include evaluating the business track record of any counterparty, its qualifications to perform these types of services, documentation supporting a conclusion that its fees are customary and reasonable, and appropriate banking and credit references.

Of course, basic due diligence questions left unanswered, or answered in an evasive way, indicate areas that require enhanced due diligence. In some cases this may entail going to a number of independent sources to confirm the potential business partner's claims.

Finally, although beyond the scope of this article, a company needs to make sure that its products are safe and effective. The U.S. Centers for Disease Control and Prevention has noted that several counterfeit respirators made their way into the U.S. market, and has started posting examples on its website.[9]

A purchasing company can use a number of methods as part of the KYP process to address risks associated with counterfeit goods. Federal customs agents are seizing import shipments of certain counterfeit and nonqualifying PPE, and getting these items released from seizure can be time consuming at best.

Companies should work to ensure that the financial and regulatory risk of seizure is allocated to the supplier, not themselves as the importer, or to be sure that the goods definitely qualify for the stated end use. Making assumptions in this area has been very costly to many companies.

Although the worldwide demand for PPE creates time pressure and a sense of urgency while securing a contract, companies must keep in mind that high pressure tactics to close a deal can also be a red flag, as many cross-border transactions require additional due diligence that may take more than a few days.

At a minimum, the company should consider, before entering into any contract — and certainly before supplying any down payment — what due diligence policies and procedures will protect it from unknowingly participating in a corrupt payment or other unlawful activity during the course of the transaction.

Will the company be able to demonstrate that it knew and could justify the presence, role and qualifications of each party in the transaction? If not, the company should pause and conduct further diligence before proceeding.

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Jaimie Nawaday is a partner and chair of the white collar, investigations and compliance practice group at Kelley Drye & Warren LLP.

Matthew C. Luzadder is a partner at the firm.

Constantine Koutsoubas is special counsel at the firm.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] https://www.washingtonpost.com/politics/maryland-cancels-125-million-ppe-contract-with-firm-started-by-gop-operatives/2020/05/02/b54a14f0-8cbe-11ea-8ac1-bfb250876b7a_story.html.

[2] https://calmatters.org/health/coronavirus/2020/05/blue-flame-deal-masks-investigation-wire-transfer-lawmakers-oversight-ma/.

[3] https://www.wsj.com/articles/congress-to-investigate-protective-gear-supplier-blue-flame-11589299028.

[4] https://www.chicagotribune.com/coronavirus/ct-coronavirus-chicago-lightfoot-wilson-20200420-gjrb3olrpvburpiecrmhgoahqi-story.html?outputType=amp.

[5] See 15 U.S.C. §§78dd-1, et seq.

[6] 15 U.S.C. §§ 78dd-1(a)(3).

[7] See generally U.S. DOJ Resource Guide to the FCPA, available at https://www.justice.gov/sites/default/files/criminal-fraud/legacy/2015/01/16/guide.pdf.

[8] https://www.khaleejtimes.com/coronavirus-pandemic/drug-traffickers-using-covid-19-ppe-consignments-to-hide-contraband.

[9] https://www.cdc.gov/niosh/npptl/usernotices/counterfeitResp.html.

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