United States ex rel. Craig v. Hawthorne Mach. Co.

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UNITED STATES OF AMERICA ex rel. ROGER S. CRAIG, Plaintiff, v. HAWTHORNE MACHINERY CO., BRIAN VERHOEVEN, TEE NESS, and DAVID NESS, Defendants.

No. 20-cv-1625-WQH-AHG

United States District Court, S.D. California

September 25, 2024

ORDER

HON WILLIAM Q. HAYES UNITED STATES DISTRICT COURT

The matter before the Court is the Motion to Dismiss (ECF No. 58) filed by Defendants Hawthorne Machinery Co., Brian Verhoeven Tee Ness, and David Ness (collectively, “Defendants”).

I. BACKGROUND

On August 21, 2020, Plaintiff-Relator Roger S. Craig (“Relator”) initiated this action on behalf of the United States of America by filing a Complaint under seal against Defendants Hawthorne Machinery Co. (“Hawthorne Machinery”) and Comerica Bank (“Comerica”), alleging violations of the False Claims Act (“FCA”). (ECF No. 1.)

On March 11, 2021, Relator filed a First Amended Complaint (“FAC”) against Hawthorne Machinery and Comerica, bringing two claims for violations of the FCA. (ECF No. 4.)

On November 16, 2022, the Court issued an Order stating that the United States declined to intervene and ordering that the Complaint, FAC, that Order, and all further matters be unsealed and served on Defendants. (ECF No. 13 at 1-2; see ECF No. 15 (Government's Notice of Election to Decline to Intervene).)

On August 17, 2023, the Court granted Relator leave to amend. (ECF No. 49.) On August 21, 2023, Relator filed the Second Amended Complaint (“SAC”), the operative complaint, against Hawthorne Machinery, Brian Verhoeven, Tee Ness, and David Ness. (ECF No. 51, SAC.)

On October 20, 2023, Defendants filed the Motion to Dismiss. (ECF No. 58.) On November 28, 2023, Relator filed a Response in opposition to the Motion to Dismiss. (ECF No. 64.) On December 15, 2023, Defendants filed a Reply in support of the Motion to Dismiss. (ECF No. 66.)

II. ALLEGATIONS IN THE SECOND AMENDED COMPLAINT

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was enacted as emergency legislation that authorized the Paycheck Protection Program (“PPP”) in response to the Coronavirus pandemic. (SAC ¶¶ 2-4.) The CARES Act “included clear and unambiguous statutory provisions concerning the application of both program-specific and general [Small Business Administration (‘SBA')] requirements for how employees should be counted to determine eligibility for PPP loans.” Id. ¶ 4. “Among other things, businesses that were not otherwise qualified as ‘small business concerns' under the laws and regulations administered by the [SBA] were only eligible to receive PPP loans if they had averaged 500 or fewer employees over the prior year, as calculated under relevant law, or if they met certain other industry-specific criteria, if applicable.” Id.

On or about April 5, 2020, Hawthorne Machinery, on behalf of itself and two of its affiliates, Hawthorne Pacific Corporation and Hawthorne of Samoa, Inc., submitted a PPP application that “claim[ed] a rolling average 12-month headcount of 489 employees.” Id. ¶¶ 7, 56. On April 6, 2020, Comerica approved Hawthorne Machinery's loan request. Id. ¶ 9.

Defendants Tee Ness and David Ness, as owners and directors of Hawthorne Machinery, and Defendant Brian Verhoeven, as Chief Financial Officer, caused submission of the PPP loan application to Comerica. Id. ¶ 57. Hawthorne Machinery did not meet statutory criteria to apply for a PPP loan because it was “a California company with over $200 million in annual revenue ... [that] did not qualify as a ‘small business concern' or otherwise meet the SBA's industry-specific size requirements for small businesses.” Id. ¶ 5. “[A]s calculated by longstanding SBA regulations and specific guidance related to the PPP program, Hawthorne Machinery-when counted together with the necessary affiliate entities under applicable federal laws and regulations-had more than 500 employees for the year preceding its submission of a PPP loan application to its commercial bank, Comerica Bank.” Id. Hawthorne Machinery was not eligible to receive a PPP loan but applied for and received an over $8 million PPP loan. Id. ¶ 19.

“[T]hrough two separate means,” Defendants “omitted necessary information” from Hawthorne Machinery's PPP application “that caused Comerica to determine Hawthorne Machinery was eligible for its PPP loan when it was not.” Id. ¶ 14. First, Hawthorne Machinery “inaccurately characterized its employee counts on the PPP application in a manner that was irreconcilable with the very support documents it sent Comerica,” “provided incomplete payroll information to Comerica that bears indicia of having been altered to remove a material number of employees,” and “claimed employee counts that were irreconcilable with other public disclosures made by Hawthorne Machinery covering the same time period.” Id. ¶ 62. “Hawthorne Machinery submitted payroll materials in support of its PPP application that were materially altered and/or misrepresented to support its representation that it and two disclosed affiliates, Hawthorne Pacific Corporation (‘Hawthorne Pacific'), and Hawthorne of Samoa, Inc. (‘Hawthorne Samoa'), had fewer than 500 employees.” Id. ¶ 7. “Hawthorne Machinery then falsely represented on its PPP loan application that it and these disclosed affiliates had only an annual average of 489 employees, when the correct calculation of its employee size under applicable laws would have been over 500.” Id.

Second, “[i]n addition to failing to accurately disclose the correct employee count of the entities it disclosed, Hawthorne Machinery also was ‘affiliated' with numerous related companies by means of overlapping management and ownership, including at least one other company-CQ Pacific LLC (d/b/a CarQuest) (‘CQ Pacific').” Id. ¶ 10. “CQ Pacific separately applied for and received a PPP loan in the amount of $564,000.” Id. ¶ 11. “The SBA and PPP rules require that loan applicants disclose all ‘affiliates' and aggregate their employee headcount for purposes of determining eligibility, unless certain tailored and unambiguous exceptions apply.” Id. Hawthorne Machinery did not disclose its affiliation with CQ Pacific, which allowed it to “present a purported average employee count of under 500.” Id. ¶ 12. If Hawthorne Machinery had disclosed all affiliated companies and correctly aggregated their employee headcount, Hawthorne Machinery would have been ineligible for the PPP loan and would not have caused “the SBA to guarantee and then ultimately forgive the loan.” Id. ¶ 14.

Relator now brings two claims under the FCA against Defendants. Relator seeks damages, penalties, attorney's fees, and any such relief the Court deems appropriate.

III. LEGAL STANDARD

Rule 12(b)(6) of the Federal Rules of Civil Procedure permits dismissal for “failure to state a claim upon which relief can be granted.” Fed.R.Civ.P. 12(b)(6). In order to state a claim for relief, a pleading “must contain ... a short and plain statement of the claim showing that the pleader is entitled to relief.” Id. 8(a)(2). Dismissal under Rule 12(b)(6) “is proper only where there is no cognizable legal theory or an absence of sufficient facts alleged to support a cognizable legal theory.” Shroyer v. New Cingular Wireless Servs., Inc., 622 F.3d 1035, 1041 (9th Cir. 2010) (citation omitted).

“To survive a motion to dismiss, a complaint must contain sufficient factual matter, accepted as true, to ‘state a claim to relief that is plausible on its face.'” Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009) (quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007)). “A claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged.” Id. (citation omitted). However, “a plaintiff's obligation to provide the ‘grounds' of his ‘entitle[ment] to relief' requires more than labels and conclusions, and a formulaic recitation of the elements of a cause of action will not do.” Twombly, 550 U.S. at 555 (alteration in original) (quoting Fed.R.Civ.P. 8(a)). A court is not “required to accept as true allegations that are merely conclusory, unwarranted deductions of fact, or unreasonable inferences.” Sprewell v. Golden State Warriors, 266 F.3d 979, 988 (9th Cir. 2001). “In sum, for a complaint to survive a motion to dismiss, the non-conclusory factual content, and reasonable inferences from that content, must be plausibly suggestive of a claim entitling the plaintiff to relief.” Moss v. U.S. Secret Serv., 572 F.3d 962, 969 (9th Cir. 2009) (citation omitted).

Additionally “[a]s with all fraud allegations, a plaintiff must plead FCA claims ‘with particularity' under Federal Rule of Civil Procedure 9(b).” Winter ex rel. United States v. Gardens Reg'l Hosp. & Med. Ctr., Inc., 953 F.3d 1108, 1116 (9th Cir. 2020) (quoting Cafasso ex rel. United States v. Gen. Dynamics C4 Sys., Inc., 637 F.3d 1047, 1054 (9th Cir. 2011)). Under the heightened pleading requirements of Rule 9(b), “[i]n alleging fraud or mistake, a party must state with particularity the circumstances constituting fraud or mistake.” Fed.R.Civ.P. 9(b). “To comply with Rule 9(b), allegations of fraud must be specific enough to give defendants notice of the particular misconduct which is alleged to constitute the fraud charged so that they can defend against the charge and not just deny that they have done anything wrong.” Bly-Magee v. California, 236 F.3d 1014, 1019 (9th Cir. 2001). Rule 9(b) “requires more specificity including an account of the time, place, and specific content of the false representations as well as the identities of the parties to the misrepresentations.” Swartz v. KPMG LLP, 476 F.3d 756, 764 (9th Cir. 2007). “This means the plaintiff must allege ‘the who, what,...