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Precontract Costs

(Editor’s Note. The following represents our continuing presentation of important FAR Cost Principles and Cost Accounting Standards. This is particularly timely since some recent cases addressing precontract costs are challenging long held rulings that these costs are clearly allowable. Our source for this article is an article written by Karen Manos in the November 2013 issue of the Cost and Pricing Report.)

The cost principle covering precontract costs at FAR 31.205-32 constitutes two sentences and has not changed since it was first published in the Armed Services Procurement Regulation in 1959. However, several cases and expert commentary do provide some important clarifications. The cost principle states “costs incurred before the effective date of the contract directly pursuant to the negotiation and in anticipation of the contract award where the incurrence of such costs is necessary to comply with the proposed contract delivery schedule. Those costs are allowable to the extent that they would have been allowable if incurred after the date of the contract (See 31.109).”

Overview

As a general rule, government contractors may recover only those costs incurred after award of a contract. However, FAR 31.205-32 makes an exception for costs incurred in anticipation of a specific contract provided the costs satisfy the circumstances prescribed by the cost principle. In referencing FAR 31.109 the cost principle suggests, but does not require, the parties enter into an advance agreement to avoid disputes over the allowability of the precontract costs. But many agency FAR supplements do require an advance agreement in order for the precontract costs to be allowable.

Case Law Interpretations

For a simple two sentence rule, the provision has generated a surprising amount of litigation. Some of the cases involve a termination for convenience of a fixed price contract under which the fixed price presumably includes all the contractor’s anticipated costs of performance regardless of when performance occurs. If the contract was not terminated the contractor would presumably be entitled to be paid the full amount of the fixed price. However, the government has argued the costs are not allowable because they were not incurred in the performance of the work terminated. In other circumstances when the contract was cost type the government has argued the contractor was improperly trying to recover as a direct charge to the contract what should have been an indirect cost including IR&D, bid and proposal and selling costs.

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To recover precontract costs the contractor must establish three elements: (1) the costs were incurred directly pursuant to the negotiation of the contract and in anticipation of award (2) the costs were necessary to comply with the proposed delivery schedule and (3) the costs would have been allowable if they were incurred after award (Penberthy Electromelt Int’l Inc. v US, 11 Cl. Ct. 307). Though the cost principle does not expressly state the precontract costs that do not meet these conditions are not allowable, it has been interpreted as making such costs unallowable by implication (Codex Corp., ASBCA No. 17983).

Lets clarify the meaning of these three elements.

1. “Directly pursuant to the negotiation and in anticipation of the contract award.”

The two phrases “directly pursuant to the negotiation” and “in anticipation of contract award” are generally read in tandem rather than as two separate elements. The FAR Council has interpreted the two phases as meaning as a result of the solicitation and award process.

It is not necessary for the government to agree to pay for the precontract costs for them to be allowable. In fact, the precontract costs need not even have been discussed during the negotiation (AT&T DOT, BCA No. 2007, 893). For example in one case precontract costs were allowed even though it was a sealed bid contract.

Precontract costs have been held to be allowable even when the government told the contractor not to incur them. During negotiations of a sole source cost type contract Radiant was told not to incur costs for providing liners for Navy aircraft where shortly after award it gave notice under the Limitation of Cost clause it was about to exceed authorized funds due largely to precontract costs it had incurred. The CO denied the request for precontract costs stating (a) because the hardware was not due until six months after contract award there was no reason to start work before the award and (b) precontract costs are allowed only if the CO authorizes them in writing. The Appeals Board rejected both arguments saying it had satisfied each of the requisite conditions for allowability. With respect to the government assertion it should be precluded from recovering precontract costs because the government told it not to incur the costs it was “without contract significance” because Radiant was fully aware it was taking a risk in incurring the expenses where if it was not awarded the contract it would not be entitled to recovery of the costs it incurred since it had no advance agreement. The Board also rejected the government’s assertion that there was no advanced written approval by the CO stating FAR 31.109 makes it clear though advanced agreements are desirable they are not mandatory (Radiant Techs, ASBCA No.38324).

However, if a contractor who has incurred precontract costs and subsequently is awarded a fixed price contract without ensuring the precontract costs are part of the price or without reserving the right to make a claim for them the contractor will be precluded from later trying to recover them (Mid States Mgt L td, ENG BCA No. 5203).

The author strongly warns that two recent cases do confuse the results of these earlier cases holding that precontract costs are not allowable unless the government has agreed to pay for them. In one case, ILSS spent a lot of money before contract award on numerous items that were rejected and excluded from the statement of work. Though it would have been non-objectionable to disallow the costs because they were not needed for the contract the Board went a step forward ruling that for the preaward costs to be recoverable the government must agree not only to the scope of work but it must also agree to reimburse the costs (Integrated Logistics Support Sys. Int’l vs. US, 47 Fed. Cl. 248). In its ruling on this case the Court cited many of the cases we discussed above asserting they confirm the proposition that the government must provide its prior approval for expenditures for them to be allowable where in fact the cited cases support exactly the opposite proposition.

In another recent case, the government refused to reimburse the contractor for consulting services and other expenses that were incurred prior to an engagement to prepare a financial plan where the Court stated “generally, except in special circumstances not shown here, those costs incurred prior to the actual execution of a contract are not recoverable” where it cited the Codex case that had actually ruled the opposite. The author states that “regrettably” other cases are starting to cite Integrated Logistics’ incorrect conclusion that in the absence of an advanced agreement precontract costs are not allowable.

2. “Necessary to comply with the proposed contract delivery schedule.”

This second element is the one most likely to make otherwise allowable costs unallowable because they

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were incurred before the effective date of the contract. Seaworthy performed tasks under an ID/IQ contract where some of the tasks were incomplete by the end of the contract. Since the agency wanted a continuity of service Seaworth continued performing the tasks during the brief period between the time the first contract ended and the second follow on one was awarded. The Appeals Board held the costs incurred before the second contract was awarded were unallowable because the contractor did not establish they were necessary to meet delivery schedules but it allowed costs after the second contract was awarded even though no task orders were issued reasoning that nothing states the contractor shall not be reimbursed costs on a task order after the second contract was awarded but prior to issuance of a task order as long as the work was within the scope of that task order once it was issued (Seaworthy Systems Inc., ASBCA No 41202)

In a dispute about the allowability of legal costs for a pre-award and post-award protest of an unsuccessful offeror, the Board ruled that the pre-award costs were not allowable because the protester did not present any evidence to indicate the costs were incurred “in order to meet the delivery schedule” (Jana Inc., ASBCA No 32447

In another case, the government rejected Radant’s claim for precontract costs on the grounds that at the time the delayed contract was awarded the government schedule for the flight test had slipped and hence it was unnecessary to incur the flight tests to meet the schedule. The Board sided with Radiant ruling it is not necessary for the contractor to prove that the incurrence of the costs was actually necessary to meet the delivery schedule but rather what is required is for the contractor to reasonably believe it was necessary where here, Radiant did believe the test was required (Radiant Techs., ASBCA No. 38324)

3. Advance Agreement and meaning of “at risk.”

As many of the cases have observed, the contractor that begins work before a contract is awarded undertakes a significant risk in doing so since if the award is not made it cannot recover the costs. The advance agreement contemplated in FAR 31.109 does not obviate this risk.

A contracting officer generally has no authority to obligate the government outside of a contract under the FAR and is prohibited under the Anti-Deficiency Act to obligate the government in advance of or in excess of appropriated amounts. The risk that is mitigated by an advanced agreement only applies if a contract is awarded where if a contract is not awarded the advance agreement does not provide a way for the contractor to recover its precontract costs.