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Expense Reimbursement Fraud — What Companies Can Learn from Unsuccessful Lawsuits

By Qiao Peng and Molly Luo

Expense reimbursement fraud goes against the principle of integrity. It is a kind of fraud that harms corporate interests and benefits. Therefore, when companies discover an employee involved in such fraud, they tend to terminate the labor relationship for reason of material breach of corporate policies. However, as we found in practice, companies are still losing their lawsuits and have to make compensation for their employment termination, even though they have proven the employee’s engagement in expense reimbursement fraud.

We analyze a series of lawsuits with companies who intend to terminate labor contracts for reasons of expense reimbursement fraud, provide evidence for such claims, and end up on the losing side. We summarize the court judgements and share our advice on compliance, to provide you insights for precaution, post-investigation, and follow-up processes for employees’ fraudulent expense reimbursements.

Reason 1 for losing lawsuits: Employee’s expense reimbursement fraud does not constitute a material breach of corporate policy

Expense reimbursement fraud comes in many forms. For instance, an employee provides fake documents (generally invoices) for reimbursements, or an employee lies about the facts, or provides documents inconsistent with the facts i.e. the employee did not go on business travel, but he or she requested for reimbursements for the travel fees.

In practice, many companies have no detailed provisions regarding expense reimbursement fraud in their corporate policies. In some cases, the judge believes that the employee may have committed fraud, but their conduct does not constitute a material breach of the corporate policy. And if therefore the company terminates the labor contract with the employee, it would be “excessive and disproportionate punishment”.

In addition, there may be reimbursement customs that have been recognized internally by the company. For instance, the employee may be allowed to provide reimbursement documents inconsistent with the fact. If the company has confirmed such practice before attempting to hold the employee liable for expense reimbursement fraud, there are significant risks that the company will lose the lawsuit.

In other words, if the company has no specific provisions in this regard, employees will have certain rights to interpret their fraudulent conduct. In one case, an employee submitted invoices with continuous invoice numbers, but explained that they were accepted by the financial department as “make-up” invoices, and the judge thought it was reasonable. In another case, the employee claimed that some of the reimbursed amounts were the taxi fees of clients, not of himself. According to the nature and features of the employee’s job as a sales manager, the judge ruled that such conduct did not constitute a material breach of the company’s policies.

Reason 2 for losing lawsuits: The company has the right to review employee expense reimbursement applications

Companies usually have their financial department review and approve employee expense reimbursement applications. Some companies even request approvals from supervisors. Chances are a company finds an employee’s fraudulent conduct in an audit, after the company has approved and paid for the reimbursed amounts.

Regardless of whether an investigation finds fake invoices or false consumptions, does this constitute a legitimate reason for the company to punish the employee for fraudulent reimbursements that have already been paid? There is no consensus in judicial practice. But as we found in several court cases, if the company (1) fails to raise objections and refuse employees’ applications after review, (2) has communicated with the employees for suspicious information, or (3) fails to raise objections long after reimbursement, the company may have a significant risk of losing its lawsuit, since the judge may assume that the company has exercised its right to review, approve and pay the reimbursements. Even if such reimbursements are fraudulent, the company shall not therefore terminate the labor contract with the employee.

Reason 3 for losing lawsuits: The company has a heavy burden of proof in fraudulent expense reimbursement cases

In fraudulent expense reimbursement cases, the company usually has a heavy burden of proof. In practice, it is challenging for the company to preserve evidence and its chain of custody.

The financial department may find the reimbursements obviously questionable due to unverifiable invoices, invoices with sequential numbers, overlapping invoice time etc. and the company therefore notifies the employee to terminate the labor relationship. But in practice, some judges may assume that such reasons do not sufficiently prove the employee’s fraudulent conduct, and the company needs to provide more proof.

How can the company provide more proof? In some cases, companies choose to engage a third-party accounting firm or investigation company to prepare an investigation report by visiting the consumption places, interviewing the merchants etc. However, third-party reports are only indirect evidence and may not significantly support the company’s case. The judge may even only consider parts of the report, which further decreases the company’s chance of meeting the heavy burden of proof to win their case.

Attorney’s advice

Companies may learn from the above cases and reduce the risks of losing their lawsuits related to fraudulent expense reimbursements in the future by improving the corporate policies and investigation processes. Based on our analysis of these cases, we would like to share with you the following advice:

  1. Companies need to further improve the provisions regarding expense reimbursement fraud in their policies, specifying not only the various circumstances, but also the disciplinary punishments. In addition, the company may also clarify the company’s review scope, and explicitly express that even if the company has approved reimbursement applications, the company may still review employee reimbursement conduct and impose the corresponding punishments. This is not only for possible labor disputes, but also a precautionary measure, because many employees may lack sufficient compliance awareness. The more detailed the corporate policies are, the better will the employees understand what fraudulent expense reimbursements are and why they are illegal. This may actually help employees to avoid such conduct. Companies may also carry out compliance training in this regard, and have employees sign commitment letters.
  1. During the investigation, companies shall use their best efforts to obtain direct evidence. Regardless of whether collected on-site by the engaged attorneys or third-party investigation companies, the evidence can be photos, recordings etc. Companies may also protect the evidence by notarization. Of course, the scope of investigation and evidence collection by companies or lawyers is limited. On such occasions, companies may also report the case or resort to judicial forensics to gather further evidence. Also, after certain investigation and verification, companies may interview and record the employee for their explanation. On the one hand, this provides employees an opportunity to defend themselves, and the companies a quicker look at employees’ defense strategy. On the other hand, the interview may reflect employees’ admission of guilty or subjective malice of frauds.

R&P China Lawyers is a full-service law firm with a strong compliance practice. The firm advises clients on employment compliance and supports the development of internal and external compliance systems. It also represents companies that are the target of a complaint or government investigation. For more about our practice, please email Ms. Peng Qiao ([email protected]) or your usual contact at R&P China Lawyers. R&P can also assist with general compliance matters.