RECOVERY OF COSTS WHEN WORK IS DELAYED BY THE GOVERNMENT
(Editor’s Note. We have been involved in several consulting engagements lately where we have helped clients quantify costs related towork stoppages and suspension due to a variety of reasons as well as when those delays result in an eventual termination. We have been boning up on the rules related to delays and decided to offer some of our insights to our readers. The sources of this article are many – an old article by Rand Allen and Phil Harrington in the long defunct Government Contract Audit Report, FAR and DCAA audit guidance as well as our own experience.)
It is quite common for a contractor’s performance tobe delayed or disrupted by any number of unforeseen events. To address these situations, the governmenthas created three clauses that allow it to suspend orstop contract performance – FAR 52.233-3, ProtestAfter Award; FAR 52.242-14, Suspension of Workand; FAR 52242-15, Stop Work Order. While these clauses give the government the right to interfere withcontract performance they also create acorresponding responsibility for the government tocompensate the contractor for the interference.However, this entitlement is not automatic but rather the burden of proof falls on the contractor todemonstrate it suffered financial harm as a result of the government ordered delay. In addition, the proofrequired and the amount due can vary depending onthe clause the government invoked to delay the work.
The FAR Clauses
Of the three clauses, this clause is the least generousand places the most burdens on the contractor. This clause is often used for construction and architect-engineering services but we have seen it in manyothers. The clause imposes a number of hurdles thatmust be cleared to recover extra costs. First, the contractor must demonstrate not only thegovernment delayed the work but the delay was foran unreasonable period of time. What constitutes unreasonable can vary widely where, for example, 110 hours have been ruled as unreasonable while in other circumstances 12 days have been held to be reasonable.
Second, the delay must not be attributable tocontractor fault or negligence. So, for example, ifthe contractor could not perform the work, did not furnish material the government required or refusedto cooperate cases have ruled the contractor wouldnot be entitled to compensation under this clause.
Third, the clause prohibits recovered of government-ordered delays “for any costs incurred more than 20days before the contractor shall have notified the COin writing of the act or failure to act.” This does not require the contractor to file a claim without this 20day period but rather requires it to put the CO onnotice of a triggering act or failure to act within the20 day period. The final step is for the contractor tosubmit a written claim to the CO. Though the clauserequires the claim to be filed “as soon as practical”following the end of the delay, it does provide that aclaim is considered timely if it is submitted by thedate of the final payment under the contract. The Suspension of Work does contain a provision thatprevents recovery of an important element – profit,which cannot be part of a contractor’s claim.
It is becoming more and more common to find afterreceiving a contract that a losing competitor isprotesting the award to the GAO. If the protest isfiled on time, the government is required to suspendcontract performance. Upon notice of the protest,the government will usually order the contractor tostop all work on the contract and take reasonable stepsto minimize costs allocable to the contract. After the GAO issues a decision on the protest, it may eithercancel the stop work order, let it expire on its ownwhich would permit the contractor to resume workor terminate the work covered by the order. In anyevent, the contractor is entitled to recover not onlythe costs incurred during the stop work period butprofit on those costs also. Unlike the Suspensionclause discussed above, there is also no requirement for the contractor to show the government-causeddelay extended for an unreasonable delay of time.
In practice we have encountered several methods thegovernment has tried to use to escape its obligationsunder this clause:
1. Stop work means stop incurring costs. In spite ofthe stop work notice, the contractor is not requiredto stop all costs that may be allocable to a contract.Rather, its obligation is to take prudent steps tominimize the incurrence of those costs – “Upon receiptof the order, the contractor shall immediately complywith its terms and take all reasonable steps to minimizethe incurrence of costs allocable to the work covered.” Thus in some circumstances it may be less costly tothe government for a contractor to continue to incurcosts at some reduced level. This confusion of stopwork being the same as stop all costs is quite common.We are now challenging questioned costs by the COand DCAA who are disallowing all costs incurred byour client after a stop work notice even though theywere able to persuasively show the costs werenecessary and in fact saved the government money.
2. No NTP was issued. In some contracts the agencyis supposed to issue the contractor a Notice toProceed (NTP) before the contractor can beginperformance. We have seen agencies try to escapepayment by saying a NTP was not issued but caseshave held that withholding a NTP subsequent to aprotest will be treated as if it were a stop work orderdiscussed next.
3. The Protest After Award clause was not in the contract. This clause is covered under the so-called “Christian Doctrine” that provides if the solicitationand resulting contract do not expressly contain certainclauses they are nonetheless considered to be part ofthat contract by operation of law.
This clause allows the government to stop all or anypart of work for 90 days or longer if the parties agree.The provisions of the clause virtually duplicate thoseunder the Protest After Award clause where the StopWork clause (1) does not require the contractor toshow the period of delay was unreasonable (2) entitledto profit on its incurred costs caused by the delay (3)not required to stop all costs but only to minimizethem and (4) entitled to an equitable adjustment tothe contract. Like the Protest after Award clause, the CO, after 90 days, must either cancel the stop workorder or terminate the contract. If the stop work order is cancelled (or the period of the order expires)the contractor “shall resume work” and the CO “shall make an equitable adjustment” in either or both thedelivery schedule or contract price.
Recovering Costs and Profit
Though not common in the commercial work, thegovernment has the right to suspend or stopperformance but if this happens it has the obligationto compensate the contractor for the additional costsit incurred for the delay. However, the burden is on the contractor to show what it is entitled to. It is essential that once work is delayed to immediately startidentifying all of the costs related to the delay. A separate charge number is advisable and all employeesshould be told to charge their delay-related costs tothat charge number no matter how long the delay lasts.
In deciding which specific costs for the delay arerecoverable, most courts have ruled that the rules for equitable adjustments should government changeorders. As such the contractor should “remain whole” where the basic pricing formula is the differencebetween what would have reasonably been the cost asoriginally required and what it reasonably cost toperform the work as changed. The following costs,which are supported by court and board decisions,are normally recoverable (keep in mind that if thecontract is subsequently terminated, additional costsunder termination settlement rules are also recoverable):
Standby labor and related costs. The costs of personnel who become idle as a result of the stoppedor suspended work should be separately identified andall burdened costs of that labor (fringe benefits,overhead, G&A) should be recovered.
Retention of personnel. The cost of retaining keypersonnel that may become unavailable due to the delay.
Severance payments. Such payments incurred because of the delay.
Recruiting costs to replace staff. Staff recruited for the contract may take other employment after the workis stopped so the added expense of recruitingreplacements are allowable.
Idle and underutilized equipment and facilities. The cost of equipment and facilities that would have beenused on the contract that become idle or underutilized are recoverable. Normally, the best gauge of thisthese costs are either costs for the facilities (e.g. rent)and depreciation for the equipment. Be aware that the assets need not be totally idle – some may be usedfor other work, for example – so the idle portion maybe charged to the delay.
Demobilization and remobilization. These costs are recovered if they are caused by the stopped work eventhough they may not have been had there been no delay.
Material and labor escalation costs. The cost of performance should be increased to account forinflation due to the slippage of work.
Loss of efficiency. If the contract envisioned lower prices due to efficiency or learning curve effects theimpact of loss of efficiency in contract performanceis recoverable. These computations that may havebeen used during preparation of the original proposalshould be maintained.
Unabsorbed overhead. Because disruption of workprevents direct costs from being incurred, the amountof indirect costs that would have been applied as anindirect cost rate are recoverable because they are not“absorbed.” The so-called Eichleay formula isnormally the only method available to compute thisunabsorbed overhead.
Increased subcontractor costs. Any subcontractorcosts that are affected by the delay will have the samerights as the prime contractor so these subcontractorcosts should be included in the adjustment claim.
Profit. Profit is allowed if the stop work was orderedunder either FAR 52.233-3 or 52.242.15 but not 52.242.14.
Proposal preparation costs. The costs of preparingthe equitable adjustment request are recoverable asdirect costs of the claim, even if they are normallyindirect costs (just be sure to deduct them from therelevant pool of costs when calculating the indirectcost rates applicable to the claim).
Many cases have ruled that quantification of these costs“is not an exact science” so it is normally not essentialto have the same level of precision or documentationrequired under say an incurred cost or invoice audit.Rather the standard is evidence that permits a “fairand reasonable approximation” of the costs. A reasonable segregation of costs along with areasonable approximation of costs related to the delayshould be enough to ensure the contractor is madewhole. Auditors may need to be reminded of thisguideline at the entrance conference of the audit ofthe proposal to avoid too high a level ofdocumentation requirements.
(Editor’s Note. Increasingly, we are seeing contractorsbuying and selling whole or parts of businesses to beable to more effectively compete in the governmentmarketplace. Our consulting practice has becomemore involved in the due diligence process of thesetransactions where we provide insights from ourgovernment cost and contracts expertise. We have written about the issue in the past and put togethersome basic considerations from both those articles and new insights from our consulting practice)
We have been seeing many instances where acquiringanother federal contractor has been seem as creatingmany potential advantages. Whether by eliminatingduplication of effort or combining two business basesto increase the denominator of the indirect rate calculation, combining two can lead to reduction inoverhead and G&A rates making the new businessmore cost competitive. A purchaser can gain theexperience of the company it buys thereby creatingthe opportunity to create new areas of work. One company can compliment the strengths of another –for example, we have seen one company with a strongspecialty or positive relationship with an importantbuying office while the other company brings muchneeded financial backing needed to take advantageof great new opportunities. We have seen the much discussed “synergy” become a reality under the rightcircumstances. Done correctly the acquisition processcan be a smooth transition to a combined strongerentity. Done incorrectly, the acquisition process canbe frustrating, creating distrust and misunderstandings often landing in court where onlythe lawyers benefit.
Contracting Considerations
A critical consideration in acquiring a federalcontractor is the transfer of its contracts to the new owner. Thought the Anti-Assignment Act generallyprohibits the transfer or sale of government contractsthe FAR establishes novation procedures where thegovernment will consent to the transfer. When federalcontracts are transferred as part of the sale of all orsubstantially all of the company’s assets to anotherentity the government may consent if the new entityhas the capability to perform, has required securityclearances and other applicable qualifications and hasthe ability to assume all obligations under the contract.
Where the government consents to a transfer, anovation agreement is signed by the buyer and sellerand the government formally recognizes the buyer asthe successor-in-interest to the contracts.
The novation process can be burdensome. It can take months to complete depending on the number ofcontracts and capabilities of the government agency.Usually the acquisition must be made before thenovation request is made so the purchase agreementneeds to make certain that the successful novation of the contracts is a condition to the closing where, ifunsuccessful, the buyer can rescind the transaction or,at a minimum, reduce the purchase price.
Under a stock acquisition, a novation of contracts isnot required. This is because a stock acquisition meansthere is a change in ownership of the company ratherthan a transfer of the contract to a new entity. Thoughthis is often more attractive, it is common followinga stock acquisition for the seller to become a whollyowned subsidiary of the buyer where when the twocompanies are merged, the novation requirement willbe triggered when the new contracts are transferredto the newly merged entity. In such cases, the novation process is not avoided.
Pending proposals are typically transferred to a buyerwithout difficulty provided they are transferred as partof the business sale and the transfer is to a legal entitywhich is the complete successor-in-interest. The parties need to promptly notify the contracting agencyof the transaction so the agency can confirm the buyeris a true successor-in-interest. (Editor’s Note. Timingof transactions needs to be carefully considered. One of us was a CFO of a company on the verge of winning a $100million contract partly because of our association with our large parent company. A day before announcement of the award wehad to notify the government of our impending sale to a smallercompany which resulted in our loosing the contract, negatingmost of the benefit of the sale.)
An acquisition raises additional issues for smallbusinesses and 8(a) companies where the buyer needsto determine whether the combined entity, togetherwith other affiliates that may exist, will still fall intothe small business size standards of the relevant NAICS codes. (See our article on small business affiliation rules in the 4Q09 issue of the DIGEST). In the case of 8(a) firms, the SBA generally prohibits the transfer of8(a) contracts to another firm no matter if they arestructured as an asset or stock deal. Some waivers are permitted but they are quite limited so it is wiseto pursue a waiver prior to any closing of thetransaction unless there is a formula to reduce the price in case the contracts are not transferred. Also, if the buyer is an 8(a) firm, only the buyer can obtain8(a) contracts, not the new subsidiary. Consequently,if an 8(a) firm wants to use the newly acquired company in the performance of 8(a) contracts it willtypically merge the subsidiary into the parent.
Structuring the Deal
Choose the form. The first step to offering a deal isto decide on the preferred form of acquisition –merger, stock exchange or consolidation whichcomes down to a stock versus asset transaction. Generally, buyers tend to choose the asset routebecause of favorable tax treatment (too far afield hereto discuss). Another factor to consider is assumptionof liabilities which also favors an asset purchase.From an administrative point of view a stocktransaction is usually more simple because (1) itavoids complexities involved in transferring title ofreal and personal assets to the new entity and (2) mostcontracts of the seller (e.g. teaming arrangements,subcontracts) are not easily transferred quicklywithout consent of all parties.
Reduce buyer risk. When a buyer acquires the stockof a company it inherits all the liabilities of thecompany whether known or not. Therefore the due diligence process must be thorough. In addition to extensive due diligence other ways of reducing riskfor the buyer is (1) include specific representations inthe purchase agreement regarding the condition of theseller and (2) require the seller to indemnify the buyerif any representation or undisclosed liability arises afterthe close. It is quite common to hold back or escrowa portion of the price for a period of time (e.g. oneyear) to apply those funds to any surprises.
Letter of intent. A letter of intent – expression ofdesire to sell – should have a clear statement the terms are non-binding. The letter of intent is typically signedearly, well before much due diligence has occurred,so the buyer wants to make sure they can restructureor even walk away from the deal. Make sure a lawyercarefully reviews the letter.
Compliance Related Considerations
When evaluating the company, usually during the duediligence phase, certain aspects of the sellers’ contractwork needs to be examined to ensure there are no surprises. Areas that we commonly examine include:
1. Valuation of Backlog. The variations of governmentcontracts make assertions about contract backlog problematic. For example, use of IDIQ, MultipleAward Schedule and Blanket Purchase Agreementcontracts does not obligate the government topurchase significant items or services. Though thesecontracts may be awarded with great fanfare and largedollar amounts announced, they often only providethe contractor with the right to compete for futureorders and those orders may never be funded. What really counts when assessing a seller’s backlog is thereceipt of funded orders. Hence the buyer needs tocarefully examine orders actually received underIDIQ, MAS and BPA vehicles when conducting duediligence of seller’s backlog with particular focus onthe amount of funding, terms and scope of the orders.
2. Claims & Terminations. The buyer needs to assessall existing claims, potential claims and terminationsettlements and estimate the likelihood of recovery.In our due diligence, we have found manycircumstances of exaggerated assertions of potential recovery. We have also encountered the oppositecircumstances where though the seller did not identifyany potential claim and termination benefits, our closeexamination of the likelihood of certain recoveries provided a significant source of unexpected value toour buyer client that was later realized.
3. Cost Allowability/Indirect Rate Submissions. Other than firm fixed price contracts (though defectivepricing audits can adjust prices paid), there can besignificant retroactive adjustments to interim billingand forward pricing rates based on audits of thecontractor’s actual incurred costs experience for agiven year. The amounts of these readjustments arenot often clear at the time of a buyer’s due diligenceefforts resulting in potential time bombs in the future.Incurred cost proposals for relevant years may nothave been prepared. If prepared, they may not havebeen audited. If audited, the rates for a given yearmay not have been settled, where the contractor,government auditors and contracting representativesmay be in the middle of resolving numerousquestioned cost issues. If settled, the seller may have(inadvertently or not) not disclosed the results andthe impact on relevant contracts and subcontracts.The due diligence efforts need to identify the potentialliability of these potential time bombs. An estimate of liability needs to be taken. For example, at thevery least, the buyer may want to ascertain the seller’shistorical experiences (e.g. ratio of billed to settledcosts), adequacy of financial reserves, etc.
In addition to the quantitative issues discussed above,the protection of the seller’s intellectual property needs to be evaluated. A contractor doing businesswith the government needs to exercise considerablecare to assure it does not grant an “unlimited rights”license to the government for its technology or other assets. Such a license could entitle the government togive the design – either in the form of technical dataor computer software code – to other companies andto authorize those companies to copy and sell theproduct illustrated in the data or code to anycustomer, anywhere. On the other hand, a contractor that developed its intellectual property at privateexpense or, to some degree, not at government orpublic expense can protect it, the company’s policiesrelated to protecting its intellectual property and thestatus of its intellectual property, especially if theseller’s proprietary technology accounts for asignificant share of its value, needs to be examinedduring a due diligence.
(Editor’s Note. In the government contracting world, we arealways faced with the question of whether this or that contractis covered by such rules as Cost Accounting Standards, FederalAcquisition Regulation, Truth in Negotiations Act, etc. The question relates not just to the dollar threshold that triggerscoverage but under today’s circumstances particularly, what partsof a contract may apply. The proliferation of IndefiniteDelivery, Indefinite Quantify (IDIQ), basic orders of agreement(BOAs) and letter contracts as well as traditional elementssuch as contract mods and options constantly raises the questionabout whether, for example, the task order or contract itself iscovered. We came across an interesting article in the Nov 2009issue of Costs, Pricing & Accounting Report by Karen Manosand Darrell Oyer that addresses many of these points thoughits main focus is on how CAS applies to these various contractelements so we thought it would be instructive to recount someof their main points(don’t hold the authors responsible for morethan their discussion of CAS).
Common questions related to the cost accountingstandards are when do they apply, which contractsare covered either fully or modified and when is adisclosure statement required. The threshold for theseare when a CAS-covered “award” or “net award” are received by the contractor or subcontractor. For example the threshold for full CAS-coverage applieswhen a single CAS covered award of at least $50million is made or at least $50 million in net CAS-covered awards in the previous fiscal year. Similarly, a disclosure statement is required if a business unitreceived a CAS-covered award of at least $50 million or if a company, together with its segments, receivednet awards of at least $50 million in its most recent accounting period.
Definition
Other than a definition, the CAS Board provided littleguidance on what “net awards” mean. The term “award”, which is not defined, is used interchangeablywith “CAS-covered contract” which is defined as “anynegotiated contract or subcontract in which a CASclause is required to be included.” “Net awards” are “the total value of negotiated CAS-covered primecontract and subcontract awards, including thepotential value of contract options, received duringthe reporting period minus cancellations, terminationsand other related credit transactions.” This definition is similar to the FAR. In addition to mentioning theanticipated dollar value including options the FARstates “if the action establishes a maximum quantityof supplies or services to be acquired or establishes aceiling price or final price to be based on future events,the final anticipated dollar value must be the highestpriced alternative to the government, including thedollar value of options.” Though similar there aretwo noticeable differences between the FAR and CAS: (1) the FAR does not take into account cancellations,termination or other credit transactions and (2) theFAR requires use of the maximum quantity andhighest final priced alternative to the government. The authors state the FAR definition applies tointerpretations of the FAR.
Most of the CAS guidance comes in the form ofWorking Group publications which was a Board of“experts” who from 1976 through 1981 published 25“Working Group Items” (WGI) The items are intended as internal guidance for the DOD and arenot necessarily binding on contractors though theyare considered useful starting points for analyzing CASthresholds.
Contract Modifications
A determination of whether a contract or subcontract (we will allude only to contracts where the meaning will applyto subcontracts as well) is subject to CAS is made at thetime of award and is not affected by modificationssubsequently made, regardless of dollar value.DCAA’s position is that their interpretation of WGINo. 76-2 is a modification that adds new funds is be treated for CAS coverage as if it were a new contract.
Options
Options are defined in the FAR as a unilateral rightfor a specified time for the government to elect topurchase additional items called for in the contractor it may extend the terms of the contract. With respect to the option amounts that should beconsidered in net awards the authors put forth apersuasive argument that it should apply for the mostlikely or probable amounts. However, they warn thatmost auditors usually take the position that themaximum amount of unilateral, priced options apply.
Basic Agreements and Basic Ordering Agreements
The FAR states a basic agreement is not itself a contract but is a written instrument of understandingcontaining clauses applicable to future contracts andcontemplates future contracts will incorporate theapplicable clauses agreed to in the basic agreement.The FAR describes a BOA as a written instrument of understanding that contains terms and clausesapplying to future contracts (orders), description ofsupplies or services, method of pricing, issuing anddelivering future orders. It states its use is to expeditecontracting for uncertain requirements and quantifiesthat are not known but a substantial number are expected to be required. WG 76-2 correctly observesthat basic agreements and BOAs are not contractsand concludes that orders issued under either typeof agreement must be considered individually indetermining applicability of CAS where only ordersthat exceed the CAS threshold are CAS covered. BOA and basic agreements need not be included whencalculating CAS thresholds where only individualCAS-covered orders are to be included.
Letter Contracts
A letter contract is defined by the FAR as a writtenpreliminary contract instrument that authorizes workto begin. WG 77-16 states that CAS applicability isdetermined based on the value at time of award where the subsequent definitization would not trigger CAScoverage since definitization is a contractmodification, not a new contract.
IDIQ Contracts
IDIQ contracts are the most difficult. It is used to acquire goods and services when neither the exacttimes or exact quantities are know at the time ofcontract award. They are particularly popular fortechnical services contracts where multiple awards are made through the contract award process and whenspecific work or task orders are needed the agencysolicits awardees to price the task order using ratesestablished in the contract award. The initial competition obtained offered rates and the task ordercompetition obtained pricing of labor hours.
Technically an IDIQ contract is only a contract to theextent the work is completely priced and can beunilaterally ordered by the government. To the extent an IDIQ contemplates newly priced offers to performadditional work such work is not part of the originallyawarded contract but is more like a BOA.
On the one hand, unlike basic agreements and BOAs,IDIQ contracts are plainly contracts within themeaning of FAR Part 16. On the other hand, it is usually impossible to value an IDIQ contract at thetime of award, especially in the case of multipleawards. IDIQ must specify the total minimum andmaximum quantity of supplies or services to beacquired. Though the government is obligated topurchase the minimum amount the maximum neednot even be a realistic estimate. This is in contrast to options or requirements contracts where thegovernment must have a reasonable basis forestimating the contract work.
Determining the value of an IDIQ is very problematic. Only a nominal minimum amount isguaranteed while large maximum dollar amounts havelittle chance of being given to one contractor.Imposing CAS requirements on multiple awardedIDIQ contracts would be a disincentive to obtain competitive quotes. For example, if a contractor withno CAS covered contracts were to accept an IDIQcontract with a $10,000 minimum and a $50 million maximum and the maximum amount was used to determine CAS coverage then that IDIQ contract –and all negotiated contracts over $650,000 – wouldbe subject to full CAS coverage even though it maynever receive orders totaling more than $10,000.
As of this time there have been no cases directly addressing the issue though the authors provide ananalogous one. For now, the authors state that operationally, IDIQ contracts are most like BOAswhich recognizes awards only as task or delivery ordersare awarded. Awarded IDIQs should be carefullyanalyzed to determine the reasonably anticipatedamount the government will order at pre-establishedprices. That figure should be used for CAS threshold purposes. Possible additional task orders requiringnew pricing orders should be then treated as separatecontracts if they materialize.
(Editor’s Note. The following article continues our practice ofpresenting real life situations from our consulting practice. It is a highly edited opinion memo addressing a possible challenge toa government’s insistence that a company alter its indirect ratestructure by creating two overhead rates after it added anotherfacility (Many of the original memo’s references to FAR,CAS, Cases and even DCAA guidelines are highlyabbreviated here.). Though the circumstances are not likely tobe duplicated by others, the regulation citations and argumentsput forth by the government and ourselves should be instructiveWe were aided in this memo by Len Birnbaum of Birnbaumand Associates, a renowned consultant and attorney in contractcosting issues who happens to be a member of our “Ask theExperts” board.)
Background
Contractor has two facilities. In Facility 1, employeespredominately engage in research and development,program management, contract administration andgeneral and administrative activities. Prior to 2008, this is where the contractor conducted all of its operations since the company’s inception twenty yearsearlier. Facility 2, started in 2008, is dedicated tomanufacturing operations. The company has alwaysused one overhead rate. Since Facility 2 is new, itincurs a significant portion of the company’sdepreciation expenses. It also incurs abut 86% of the firms direct labor which is the base in which overhead costs are allocated.
Adult Position
A large cost type research and development proposal with the Department of Energy triggered an auditby DCAA DCAA’s position is that the currentmethod of allocating overhead expenses (particularlydepreciation expenses) cause developmentalcontracts to absorb a disproportionate amount ofindirect costs since the direct labor is incurred primarily in Facility 1 whereas the bulk of depreciationexpense is incurred in Facility 2. The current systemresults in an “inequitable” distribution of costs wherethere is no “causal/beneficial relationships betweenthe indirect expense and the direct labor activity.”Consequently, the contractor should be required tosegregate its overhead expenses into two separate“homogeneous expense pools” at each facility startingin fiscal year 2010.
DCAA cites FAR 31.203(b) and 31.203(d) in supportof its position. The relevant sections in FAR 31.203(b)states “Indirect costs shall be accumulated by logicalcost groupings with due consideration of the reasonsfor incurring such costs. Each grouping should bedetermined so as to permit distribution of the groupingon the basis of the benefits accruing to the several costobjectives…The base should be selected so as to permitallocation of the groupings on the basis of the benefitsaccruing to the several cost objectives.” FAR 31.203(d)states that the cost accounting standards should governif a contractor is CAS covered and otherwise, generallyaccepted accounting principles (GAAP) should dictateaccounting treatment. The method of allocatingindirect costs may require examination when (1)“substantial differences occur between the cost patternsof work under the contract and the contractor’s other work (2) significant changes occur in the nature of thebusiness, extent of subcontracting, fixed-assetimprovement programs, inventories, volume of salesand production, manufacturing process, the contractor’sproducts or other relevant circumstances or (3) indirectcost groupings developed for a contractor’s primarylocation are applied to offsite locations. Separate costgroupings for costs allocable to offsite locations maybe necessary to permit equitable distribution of costson the basis of the benefits accruing to the several costobjectives.”
Our Response
Assessment of the Facts. The contractor conducted its manufacturing operation at both facilities during FY 2008 and in the second quarter of 2009, it moved most of its manufacturing operations to Facility 2. While Facility 1 is designed for R&D effort goingforward, Facility 2 includes both manufacturing and R&D effort. The contractor’s DOE contract requires a manufacturing facility to qualify for award. This contract identify tasks that specify process, product and performance improvements of manufacturing operations and products. These tasks cannot be accomplished in Facility 1 since it does not have the requisite manufacturing capability. Therefore, there is a direct relationship between the indirect expense and labor activity since the developmental DOE contract is conducted at Facility 2. Consequently,these expenses should be included in one cumulative overhead rate calculation as proposed.
Response to DCAA’s FAR Citations. DCAA’s recommendations infer that FAR 31.203(b) and FAR31.203(d) supports its position that in order for an expense pool to be homogeneous separate pools must be created. This is not correct. First, the cited regulations do not use the term “homogeneous expense pools” nor do they state separate manufacturing pools must be established for each location. FAR 31.203(b) provides, in part, “the base should be selected so as to permit allocation of the grouping on the basis of the benefits accruing to the several cost objectives.” Though FAR 31.203(d)provides that multiple overhead rates may be adopted,there is no stipulation they must be created. Further, GAAP does not address the number of overhead pools that need to be created.
Though the contractor is not CAS covered CAS 418 nonetheless does provide useful guidance with respect to defining homogeneous indirect cost pools. An authoritative text (Accounting for GovernmentContracts, Cost Accounting Standards by LaneAnderson) states that in assessing the homogeneity of an indirect expense pool, the following four things must be considered:
1. The cost in the pools should represent activitieshaving commonality of purpose.
2. The cost pools should be a logical group of costs.
3. The allocation base should have a direct causal relationship to the costs in the pool and to thecost objectives.
4. Diversity of products (final cost objectives)should be minimal for each cost pool.
The contractor’s use of a single overhead rate is in conformance with these four requirements. (We omit the analysis of the assertions here.)
The Cost Accounting Standards Board, Summary of Objectives, Policies and Concepts (May 1992) is instructive here. The Board states that homogeneity is a matter of degree. Homogeneity exists if the costsor functions allocated by a single base have the same or similar relationship to the cost objectives for which the functions are formed.
Finally there is also a seminal case that is relevant here. The Armed Services Board of Contract Appeals in Litton Systems Inc. Guidance and Controls Systems Division(ASBCA No. 37131) resolved homogeneous pool issues of a major contractor that used a composite overhead pool for two divisions in different geographic areas. The Board stated “the standard does not mention the location of cost incurrence as a relevant factor, nor is it relevant from a purely conceptual view…Nothing in CAS 418 or any other Standard indicates that location of facilities or cost levels of operation has any effect on the characteristics of homogeneity of indirect cost pools as describedin CAS 418.50(b)(1).”
Our conclusion is that use of a single overhead rateconforms to regulations, authoritative referencematerial and case law.
REVIEW OF PROCUREMENT AND COSTING ISSUES IN 2008
(Editor’s Note. Since the practical meaning of most regulationsare what appeals boards, courts and the Comptroller Generalsay they are, we are continuing our practice of summarizingsome of the significant decisions last year affecting grounds forsuccessful protests of award decisions and selected cost issues. This article is based on the January 2009 issue of BriefingPapers written by Miki Shager, Counsel to the Department ofAgriculture Board of Contract Appeals. We have referenced the cases in the event our readers want to study the cases.)
Protests of Award Decisions
To have standing to protest a procurement, a protester must be an interested party – an actual or prospective offer or whose direct economic interest would be affected by the award or failure to obtain the award. A protester is an interested party wheret here is a reasonable possibility its proposal would be in line for award if the protest is sustained (PhilipsHealthcare Informatics, Comp. Gen D. B-401249 – we will refer to GAO decisions by the case number). A protester is not an interested party if the record shows it would not have been in line for award (ALJUCAR LLC, B401249); if an intervening offer or would be in line (CLI Solutions, B-401176) or is not an approved source for an item (Standard Bent Glass, B-401212). A protester is an interested party when though it is an unqualified supplier (L-3 Communications EOTech vs US, 85 Fel. Cl. 667) or even a non-bidder (Global Computer v US, 88 Fed. Cl. 35). A subcontractor is not an interested party because it is not an actual or prospective bidder(Kling Cor Vs US, 87 Fe. Cl 473) nor is an “other than small” business when challenging a small business set-aside (Taylor Consultants v US, 90 Fed. Cl. 531).
A bid is unbalanced if it is based on prices significantlyless than cost for some work and significantlyoverstated for other work and there is some reason to doubt the bid will result in the lowest overall cost.
An acceptance of a proposal with unbalanced pricingis not, in itself, improper provided the agency hasconcluded that the pricing does not impose anunacceptable risk and the prices the agency is likelyto pay is not unreasonably high (Cherokee Painting, B400581). Below-cost pricing is not prohibited andthe government cannot withhold an award merelybecause its low offer is or may be below costs. An offer can have numerous legitimate reasons forproposing a low price, including a below-cost offer(JSW Maintenance, B-400581); an agency is free toaccept a below cost offer on a fixed price contract(DMS All Star JV, B0319932) and; a below cost offerdoes not itself create risks (General Dynamics, B401658). However, in other cases the agency erred infailing to conduct a sufficient price realism analysiswhen the total price was lower than the average andthe government knew it was significantly understated(Afghan American Army Svc V US, 90 Fed. Cl 341); theprotester’s price was risky because it would losemoney on every unit ordered (Bering Straights Technical Svcs, B-401560) or; the unusual low price indicated acritical failure to understand the degree of effortrequired (Mangi Environmental Group, B-401783).
The government is free to use a variety of evaluationfactors in evaluating proposals. However, the RFP must describe the factors and significant sub-factorsto be used to evaluate proposals and their relativeimportance and agencies must evaluate the proposalsaccording to the criteria established in the solicitation(DME Corp, B-401924). Agencies must applyevaluation criteria in the solicitation equally (Marinette Marine Corp, B-400697) where unequal evaluations areconsidered a violation of the solicitation (Red River Hldgs vs US 87 Fed. Cl 768) or where the agencycredited awardee but not the protester with experienceof subcontractors even though the agency viewedeach firms’ subcontractors as having relevantexperience (Ahtna Support and Trng, B-400947).However, there was no unequal treatment whendifferences in agency discussions are a result ofagency’s recognition of different underlying facts(Academy Facilities Management v US 87 Fed Cl. 441).
Agencies must consider cost or price in evaluating competing proposals (USGC Inc, B-400184). Relative price must be considered when determining competitive range (Medical Staffing JV, B-400705);even if price is less important than non-price factors,an agency must consider price meaningfully(ACCESS Stms, B-400623); in a “best value” competition a proposal’s superiority in the non-price factors must be shown to be worth the higher price(Coast Envir., B-401889) and; protester’s discounts were erroneously not considered in the technical evaluation(Humana Military Health, B-401652). The type ofcontract to be let is within the discretion of the CO and it was appropriate not to award a contract to acontractor who did not have in place an accounting system appropriate for cost type contracts (Wartsila Defense, B-401224).
There were many cases addressing firms’ organizational conflict of interest (OCI). While creation of a “firewall” might create the appearance of mitigation of OCI itdid not avoid an impaired objectivity OCI aspersonnel from both contracts still worked in the sameorganization with incentive to benefit it overall (Nortel Gov Sltns, B-299522). However, there was no OCI where it found no corporate relationship existedbetween the firms such that one firm was evaluatingitself or an affiliate was making judgments that woulddirectly influence its well being (L-3 Svcs, B-400134)or there was no financial relationship between theawardee and the contractor before contract award and that any potential benefit to the contractor was toospeculative and remote to establish an OCI (Marinette Marine). There were “biased ground rules” OCI wherethe relevant concern is not merely whether draftedspecifications are adopted into the solicitation butwhether a firm is in a position to affect a competition,intentionally or not (L-3), or whether the involvedcontractor titled the competition in favor of itself(Rhinocorps v US, 87 Fed. Cl. 261).
Many cases in the past ruled that “unequal access toinformation” can constitute an OCI but that incumbent status by itself is insufficient to create anOCI. Where an incumbent may have performedactivities identified in the solicitation where it could be expected to have a more informed understandingthan a first time contractor, any advantage was theproduct of experience rather than having access tononpublic information garnered from its specialrelationship with the government (PAI Corp vs US, No. 09-411C WL3049213). Mere employment of aformer government employee familiar with the typeof work required but not privy to the proposals orinside agency information does not constitute an unfaircompetitive advantage (Academy Facilities). However, unequal access OCI did exist when the agency reliedon a mitigation plan that was undisclosed, unevaluatedand unmonitored by the agency (L-3); an offeror’sprogram manager knowingly and improperlyobtained sensitive and proprietary information andthe offeror refused to segregate the program managerfrom the competition (Kellogg Brown & Root. B-400787) and; use of a former government official in proposalpreparation was considered indistinguishable from afirm having unequal access to information (Health Net Fed Svcs., B-401652).
FAR 15.304 requires that past performance (PP) beone evaluation factor that must be considered in all negotiated procurements and the boards and courtsare defining how this new factor will be applied.Where both offerors relied on experience of theirsubcontractors the protester successfully claimed theagency combined the relevant experience of theawardee and its subcontractor when determining itsPP rating while focusing separately on the protester’slack of experience without similarly combining its andthe subcontractor (Ahtna Support). In evaluating anofferor and their parent and related affiliatedcompanies, the agency identified the contracts“generically” as being performed by Aetna withoutevaluating the relevance of PP for the parent andaffiliates who would be involved in contract performance (Health Net). Proper evaluation of pastperformance occurred where the agency reasonablyconsidered the relevant experience of the awardee’skey personnel in determining the PP was highlyrelevant (Divakar Tech., B-402026); where both offerorshave relevant PP, the agency is not required to furtherdifferentiate on a more refined level (DETA SupportSvcs, B-401754); contracts determined to be relevantin the PP review involved many of the same activitiesrequired under the solicited contract (Advanced Envir.)and; it was proper to consider relevant PP experienceof awardee as a subcontractor where the solicitation did not prohibit it (George C. Sharp, B-401077).Though the awardee’s largest prior contract was for$35 million while the contract at issue was for $170 Million the agency ruled the protester did not provethe conclusions of relevant experience to beunreasonable (Gov Acquisitions Inc, B-401648).However, the GAO sustained another protest wherethe agency relied in material part for its PP rating ona contract’s low value without showing how it wassimilar in size or scope to the awarded contract(Honeywell Tech. Sltns, B-400771) and where thecontractor’s experience consisting of relatively lowdollar value compared to the estimated value of theprojects at issue was improperly considered to havethe requisite experience (Caddell Const., B401596).
FAR 15.306 requires the CO discuss with each offerorbeing considered for award significant weaknesses, deficiencies or other aspects of its proposal that couldbe altered or explained to enhance the proposal’spotential for award. Discussions should not be confused with clarifications which are limited exchangeswith offerors to allow correction of minor or clerical errors or to clarify proposal elements (VMD SystemsIntegrators, B-401688). Communications to permitofferor to correct obvious error in pricing is aclarification, not discussion (EMS Ice, B-401176);communications were clarifications where they did notresult in the submission of revised prices (CLI Slnts, B-401176) and; an agency may allow an offeror tocorrect missing reps and certs through clarificationand does not constitute discussions (Kuhuna-SpectrumJV, B-400803). But exchanges where offeror wasallowed to make a revision were not mere clarifications (Analysis Group, B-401726) and acceptance of protestor’s late submitted “clarification” letter constituted “discussions” since it materially altered the original quote.
Discussions were found to be misleading where theagency advised the protestor its prices were lowcompared to the government’s estimate but did notso advise other offerors even though their prices werelower. Also, following these discussions thegovernment changed the estimate against which theproposals were measured and the court found thischange to have rendered the earlier discussionsmisleading, requiring a reopening of discussions(AshBritt v US, 87 Fe. Cl 344). Discussions were found not to be meaningful where the agency failed to discussthe offeror’s management plan then referenced thisitem as the sole technical discriminator in the award decision (Ashbury Intl Group, B-401123). However, an agency need not discuss all aspects of a proposalthat does not receive the highest possible rating (Struc Assoc/, etc. 89 Fe. Dc. 735).
Costs
Equitable Adjustments. An equitable adjustment is thedifference between the reasonable cost of the work required under the contract and the actual reasonablecost to the contractor of performing the changedwork, plus a reasonable amount for overhead andprofit. A contractor carries the burden of provingthe amount by which a change increased its costs ofperforming on the contract (Hedlund Const. v US, CBCA No. 105) while the government bears theburden of a downward adjustment in contract price(Osbourne Const., ASBCA No 55030). A contractor failed in its burden of proof where the Board foundthe design changes were contemplated by the contract’s structure and the contractor did no more than was required under the terms of its contract (DMJM H&N, ASBCA No 56557). Though bilateral contractmods usually cover cost of time of performing thechanged work, changed orders may also add to thecontractor’s time and effort if performing unchangedwork (Bell BCI Co v US fed. Cl 617).
Termination Settlement Costs. A termination for convenience is often characterized as converting a fixedprice contract to a cost reimbursement contract thatentitles the contractor to recover allowable costs incurred in the performance of the terminated work, areasonable profit on work performed and certainadditional costs associated with the termination. Once the termination for default is converted to one for convenience, the contractor becomes entitled to costs related to un-priced changes, constructive changes,suspension of work, differing site conditions, defectivespecs and even some work that might not have beencomplied with in all respects (Red River). Contractor was entitled to unrecovered portions of truck costs,including insurance, the contractor was unable to recoupover the full term of the contract as expected (Elton T. Calvin, Jr., PSBCA No 6220). The termination for convenience clause applicable to commercial itemsmake FAR Part 49 concepts inapplicable but the courtawarded contractor the contract price less costs ofnonconforming items and price paid to re-procurementcontractor for work not performed (United Partition Sys., v US, Fed. Cl. 74).
Legal and Accounting Costs. An appeals court reversed aboard decision that allowed defense and settlement costs associated with Title VII sexual harassment suit. It established if the alleged conduct would be a breachof contract then the costs associated with an adverse judgment would be unallowable – here sexdiscrimination was in violation of Title VII which would be a breach of the Equal Opportunity clause of FARthat is referenced in the contract. If the costs of the underlying judgment would be unallowable thensettlement costs are also unallowable unless the contractor can establish the private plaintiff had verylittle likelihood of success (Geren v Tecom, 566 F.3d 1037).
Executive Compensation. The Board held that the contract must be interpreted in accord with the FARcost principles in effect at the date of contract ratherthan those in effect at the time the costs were incurred (ATK Lauch Sys, ASBCA No. 55395).
Contract Administration. For a long time boards andcourts have distinguished between unallowable costs of prosecuting claims and allowable costs of contractadministration where in a seminal case (Bill Strong) thebasic guidance is that if the costs are incurred topermit a negotiated resolution of the problems thatarose during contract performance they arepresumably allowable costs of contract administrationwhile if they are incurred to begin the process oflitigation they are unallowable. The board found incurred costs for a claim preparation and consultingfees incurred before submission of the claim was for the purpose of furthering the negotiation process andhence allowable but quantified the amount due not atthe contractor’s claimed rate but the employee’s hourlyrate (SUFI Network Services, ASBCA No 55306).
Allocability. Costs of developing a software programwere not allocable under FAR 31.201-4 because the software did not benefit the government contract andwas not necessary to the overall operation of thecontractor’s business (Teknowledge Corp. v US, 85 Fed.Cl. 235 – see the last DIGEST issue for expanded discussionof this case). Though there were understandablereasons for loosing records in Iraq, the Board rejectedthe government’s assertion that absence of documentjustified not paying the contractor -though thecontractor bears the burden of proving allocabilityof costs, the Board allowed testimony of threeemployees saying the contract clauses do not imposethe stringent requirements of either “nice neat littlefiles” or contemporaneous records (Bearing Point,ASBCA No 55354).
Limitation of Funds. Both the Limitation of Cost (FAR52.232-20) and Limitation of Funds (FAR 52.232-22) clauses are prescribed for cost reimbursablecontracts where the LOC is used when the contract is fully funded and the LOF is used when incrementallyfunded. Both clauses require the contractor to givetimely notice of impending cost overruns and relievethe government of liability over costs in excess ofthe ceiling amounts. The dispute arose under two IDIQcost type contracts where the contractor experiencedcost overruns due to increased medical and workers comp insurance and use of higher cost contract labordue to the government’s sporadic and unpredictableordering. The Board found its oral notification of $1 million contract cost overrun insufficient saying (1) ithad to identify overrun amounts on each task anddelivery order and (2) its absence of a costinformation system did not excuse it, even thoughtabsence of cost documentation from its NYC office due to the 9/11 attacks was excused (George C. Sharp).
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