(Editor’s Note. Though much of our consulting activity used to focus on ways to increase cost recovery, the tougher competitive government market has changed some of our efforts to help clients lower their price proposals. Since a key to a successful proposalis to anticipate what your competitors may offer, the following common pricing tactics may be used by other offerors or you may wantto consider them for yourself. We have incorporated some of the ideas of Brian Fischer in the May 1997 issue of Contract Management and added some of our own.)
Some of the tactics we discuss below represent realoverall cost savings to contractors while others merelyshift costs away from the proposed contract beingsought.
1. Shift average direct rates to lower end of the spectrum. Rather than using an average rate for agiven labor category (or even the higher end citing the need for more years of experience, for example),price rates at the lower end with the intention of hiringnew employees or using lower paid employees on the contract.
2. Use and bid uncompensated overtime. Lower the hourly rate by dividing the yearly or monthly salaryby a number larger than the normal 40 hour workweek with the intention of having salaried employees working more hours. Remember that protests are common when only some offerors bid uncompensated overtime but they have rarely beensuccessful when the uncompensated overtime is notexcessive.
3. Propose a low or negative escalation rate. For out years, most current labor rates and other costsare multiplied by an escalation factor supplied by such firms as DRI McGraw Hill. In price sensitivecompetitions, proposing a low or negative rate canbe highly favored by selection personnel. Common ways of achieving these low escalation rates include
(a) promoting employees over the contract periodfrom lower to higher paid categories while hiring new employees at the floor level (b) proposing as a baserate an estimated average rate over the period ofperformance or (c) freezing wages.
5. Reclassify certain indirect functions as direct. Certain functions like contract and subcontract administration, purchasing, materials inspection, etc.can be identifiable with specific contracts rather thanincluded in an indirect cost pool spread over all contracts. Many of these costs can be charged to othercontracts and excluded from overhead.
6. Change the G&A base. If, for example, government contracts are likely to have a highersubcontract or material component compared to other contracts, you may want to shift from a totalcost input to a value added base (e.g. calculating andapplying G&A costs to labor and overhead only).
7. Exclude costs. This might be desirable if winninga government contract can substantially benefitcommercial work or reimbursement at less than cost might help retain highly skilled labor during a lull.Alternatively, you may want to consider a bottom line reduction from the indirect cost pool in the form ofa “customer concession”. This one time concession would not be considered a precedent on othercontracts but care should be taken to make sure other contracts do not absorb these deleted costs.
8. Reduce proposed profit/fee. Propose lower feesor eliminate fees on certain type of costs (e.g. subcontractors).
9. Create a new business unit. A separate business unit (e.g. producing only for the government or oneproduct or service) could justify a disproportionate
allocation of home office expenses such as marketing,research and development, etc. Also, a new unit couldbe staffed with personnel having lower direct rates and fringe benefits without impacting other businessunits.
11. Find outsourcing opportunities. In addition to the cost savings benefits of shifting less criticalfunctions to more efficient subcontractors, a lower subcontract rate could be developed and applied tooutsourcing costs. This would shift some indirect costs out of overhead or G&A and still achieve a lower cost than applying the old, higher indirect cost rates to the direct labor replaced by subcontractors.
12. Base pricing on aggressive performanceimprovement estimates. Instead of using normalestimates of performance (e.g. history), price theproposal according to aggressive estimates ofimprovements being planned. You can use these prices as a project budget and, if you wish, developcompensation bonuses that if attained, can be included in fringe benefits.
Some of these measures will create changes to currentaccounting practices. If your firm is covered by costaccounting standards some form of cost impactanalysis on your other contracts may be required. If not CAS covered, there is considerably more leewayin making these changes. Careful planning and communication with government auditors and yourCO will likely avoid problems associated with theseaccounting and pricing actions while helping yourorganization remain competitive in today’s government marketplace.
(Editor’s Note. For other cost reduction ideas and how to presentthem to help favorably sway source selection officials, see ourlast issue.)
(Editor’s Note. We have been receiving inquiries from clientsand subscribers about a recent case we reported on – US v. Newport News Shipbuilding – that disallowed IndependentResearch and Development costs. The case significantly changesthe ground rules on when costs can be charged to IR&D andwhen they must be charged direct to a single contract which hasthe effect of narrowing the conditions when research and development effort may be allocated indirectly to all of acontractor’s work. Now, many of these costs must be allocableto specific contracts whether or not the related costs are recoverable.Before discussing the case, we thought it would be a good idea topresent the basics of the cost principle and review some of thelegislative history and decisions affecting the issue of when R&Dcosts may be charged to IR&D and when they need to be chargedirectly to a cost objective. For the background material on theIR&D cost principle and the legislative/board history we haverelied on an article in the November 2003 Briefing Papers bKaren Manos of Howrey Simon Arnold & White. The discussion of the Newport News case and comments are anamalgam of recent published articles and private position paperswe have encountered, all of which are all highly critical of thedecision.)
The Basics of the Cost Principle
FAR 31.205-8, IR&D/B&P costs must be read inconjunction with Cost Accounting Standard 420, “Accounting for independent research anddevelopment costs and bid and proposal costs” whichis incorporated in its entirety in the FAR cost principle.IR&D and B&P costs will be allocated to final cost objectives (e.g. contracts, subcontracts, funded taskor delivery orders) in the same manner as G&A expenses for that business unit unless it results in aninequitable allocation. IR&D/B&P costs are generallyallowable as indirect costs provided they are otherwisereasonable and allocable. The Armed Services Board of Contract Appeals has consistently rejectedgovernment arguments that IR&D/B&P costs are not allocable when incurred in conjunction withcommercial work. To qualify as IR&D, the effort (a)must fall within one of the following four categories (1) basic research (2) applied research (3) developmentor (4) systems and other concept formulation studiesand (b) not be “sponsored by a grant or required in the performance of a contract.” It is the part (b) above – “sponsored by a grant or required in the performance of a contract” – that isthe source of controversy of whether costs must becharged direct to a contract or can be charged indirectto IR&D and it is that feature we will address in this article.
The History of the Regulation
The development of the cost principle has had acontroversial history in determining when IR&Deffort is “required in the performance of a contract” or “sponsored by a grant or cooperative agreement.”
The Armed Services Procurement Regulation 15 205.35 in 1959, which predated the FAR, providedthat IR&D “is that research and development whichis not sponsored by a contract, grant or other arrangement.” The ASPR Council considered changing “not sponsored by” to “not sponsored byor in support of a contract” but industry oppositionprevailed when it asserted the change could beinterpreted as including IR&D work completelyunrelated to a contractor’s government contracts. The ASPR was changed in 1971 to state that IR&D “isthat technical effort which is not sponsored by, orrequired in the performance of, a contract or grant.”
In 1974, the General Accounting Office attempted tobroaden the type of development effort not allowableas IR&D to exclude not only that technical effortexplicitly required by the terms of the contract but also the effort implicitly required to fulfill the contract’s objectives. Both industry and the Department ofDefense opposed GAO’s interpretation where theDOD stated the concept that all work implicitlyrequired by a contract should not be allowed as IR&Dleaves “a great deal of impreciseness in the definition.”
Case Law History for “Independent” vs. “Sponsored” or “Required” Effort
In interpreting the term “sponsored” as used in thecost principle, the Armed Services Board of ContractAppeal (ASBCA) has held that the cost of researchprojects in excess of contributions from outsidesources are allowable as IR&D costs because, at least to that extent, the projects are not “sponsored” byoutside sources (General Dynamics Corp., ASBCA No. 10254). In that case the Board adopted thecontractor’s “common sense” argument that becausethere was no question the costs were allowable if thecontractor had undertaken the research without any financial assistance from outside help, the contractorshould not be penalized for obtaining privatecontributions that effectively reduced thegovernment’s cost.
Cases that construe the term “required by” are notconsistent. One case involved costs incurred under a cost-plus-fixed-fee contract where after reaching the funds limitation amount the contractor continued to work, charging the costs to its IR&D account. The government argued the effort was “required” under the terms of the contract and therefore should be an unallowable cost overrun. The ASBCA disagreedholding the costs were properly charged to IR&Dbecause the contractor was not contractuallyobligated to perform the work (Unisys Corp., No. 41135).
In another rather famous case, the contractor was working on a firm fixed price (best efforts) contract to develop two prototypes for the Divisional AirDefense System (DIVAD) where the nature of thecontract required the contractor to only provide its“best efforts” to meet the contract requirements andhad no obligation to continue work so when it did soit charged its IR&D accounts. Apparently not aware of the difference between a firm fixed price contracand a firm fixed price (best efforts) contract, thegovernment erroneously claimed the contractormischarged over $8 million asserting even if the workwas not required the costs had to be charged directlyto the DIVAD contract because the work could be specifically identified with that contract and hence could not be charged to IR&D. The Court disagreed statingthe IR&D regulations state work required in theperformance of a contract cannot be charged toIR&D but they never use the term “specificallidentifiable” nor do they in any way suggest the term has significance with respect to what is and is notIR&D. The Court stated that the proper inquiry intdetermining whether something should be chargeddirect to the contract or to IR&D is to determine what is required under the contract’s statement ofwork (General Dynamics Corp. v. United States, No.CV89-6726).
The Newport News Case
This is the first case that squarely addresses the issueof whether work implicitly required by a contractqualifies as IR&D. Newport News Shipbuilding(NNS), a long time government ship buildingcontractor, was charged with violating the FalseClaims Act because it included total IR&D costs in its G&A pool for development of a line of tankersintended for the commercial shipping market after itreceived two commercial contracts for the new tankers. The total IR&D cost at issue was $74 million and the basis for the questioned costs and fraudallegation is that NNS knew such costs were “required in the performance of a contract” and therefore couldnot properly be characterized as IR&D costs.
The Court acknowledged that the meaning of“required in the performance of a contract” has beena subject of much controversy and it stated there were three potential interpretations of that language. First, the phrase could be read narrowly, such that only thoseefforts “explicitly called for in the contract” wouldbe subject to exclusion under the cost principle.Second, the phrase could be read more broadly, toexclude “everything implicitly necessary to carry out” the contract. Finally, the phrase could be read as notfocusing on whether the contract requirement wasexplicit or implicit but rather whether the effort wasrequired by more than one contract. That is, if the effort was required by more than one contract, itcould not be said to be required by “a” contract and therefore the cost would be an allowable IR&D expense.
After noting no case law squarely addressed the issuethe Court adopted the second interpretation whichhad the effect of imposing the greatest restriction onIR&D cost allowability. The Court said the costs of efforts “required in the performance of a contract”must be read to include efforts which are not explicitly stated in the contract but are nonetheless necessary toperform the contract and thus implicitly required bit. The Court continued, saying the practical effect ofits interpretation is the “required in the performanceof a contract” exclusion is to create a temporaldividing line between IR&D and direct work that must be billed to a contract at the point the contractrequiring the effort is signed. Prior to such a contract the research and design effort is independent and iseligible to be charged to IR&D provided the effortmeets the definition of IR&D. Once a contract is signed, the research and design efforts that are explicitly or implicitly required in the performanceof that contract are no longer IR&D. Thus, once a contact is signed the performance of which requires,explicitly or implicitly, a certain effort then that effortmay thereafter no longer be charged as IR&D even ifit also stands to benefit other existing contracts, potential future contracts or class design.
Commentary
The commentaries say though this is only a singledecision by a single district court it is the only definitivedecision of the issue and hence will likely be reliedupon heavily by DCAA, contracting officers and theDepartment of Justice. They state not only will the“explicitly required” or “multiple contracts” (e.g. benefiting more than one contract) interpretationsused by so many contractors change but now contractors who rely on legal interpretations of theIR&D cost principle that are not challenged aresubject to False Claims Act liability. Further, since it is highly unlikely the government would accept R&Drelated costs allocated to a government contract thatwere formerly charged to IR&D, the effect is todisallow such costs once a contract is signed.
The commentaries believe the NNS decision adoptsa “remarkably simplistic and entirely unworkabletiming rule” for application of the IR&D costprinciple. The Court’s decision that cost-charging should proceed along a “temporal” path – that is, theeffort can be charged to IR&D up to the point acontract is signed and then must be charged to thatcontract – runs counter to the history and purposof the IR&D cost principle. It was created so contractors and the government can derive the benefits of contractual R&D and closely-relatedIR&D efforts and both will suffer if closely relatedR&D efforts can no longer be pursued in parallel.
As for guidance to contractors, Ms. Manos offers afew suggestions: (1) ensure your employeesunderstand the importance of appropriatelycharacterizing and charging IR&D efforts (2) before undertaking an IR&D project determine anddocument your determination that the effort is notrequired in the performance of a contract or grant (3) when in doubt about the appropriatecharacterization of certain efforts, consider making written disclosure of your plan to the cognizant ACO or auditor and if possible, seek an advance agreementand (4) when performing on IR&D projects, ensurethere is a mechanism in place for determining whether(and when) you are awarded a contract that requiresthe same effort.
In addition to Ms. Manos’ guidance, we recommendto our clients they:
1. Either draft or revise existing policies on IR&D toprovide full disclosure of accounting for IR&D to avoid the type of fraud claims encountered byNewport News. The policies should addressquestions like (a) when was the IR&D projectestablished (b) which cost objectives is the IR&Dproject intended to benefit and which objectivesactually benefit (c) what technical objectives does the IR&D project fund and (d) are contract requirementsclearly defined.
2. If contractors choose to follow their prior practicesthen they should be prepared to demonstrate why the facts surrounding their IR&D costs are different thanthose faced by NNS (e.g. materiality of the costs,contract mix results in different allocation – NNS had primarily cost type work, new products are intendedfor sale to the government rather than the commercialmarket, the efforts are continuing while NNS soondropped the commercial tanker business).
(Editor’s Note. Most firms want to know how they compare with others. Unfortunately, most useful information isproprietary and almost all surveys we encounter are limited togenerally useless financial data extracted from annual reportsof publicly traded companies. The exception to this rule is anannual survey published by Wind2Software, Inc. Wind2 Software is a software development company providingaccounting and information systems to government contractorsand though we do not endorse products we believe their accountingsoftware should be considered in any purchase decision. The survey is unique because it surveys actual firms of varyinsizes and offers very relevant data for government contractors.It surveys a broad range of professional services companiesuch as engineering, architecture, environmental, etc. and wefind the results closely mirror those of most professional serviceorganizations. This is not surprising since most labor intensivebusinesses incur similar costs. For a copy of the survey, contactNick Bettis of Wind2 Software at 800-779-4632)
The Wind2 Software survey presents a wide range ofuseful information: comparison of data for each yeafrom 1978-2003, profit and loss statements, kefinancial ratios (e.g. current ratio, average collection periods), identification of key overhead cost elements(e.g. all fringe benefits, insurance, indirect labor,depreciation, marketing costs etc.), key measures ofproductivity, and other financial measures (e.g. workin-process incurred but not billed, number of firmsthat charge interest on late accounts). The following table and explanations represents a selection ofmeasurements for 2003 we chose that will provideinteresting comparisons for our government
contractor readers. For those who (like us) forgetstatistics terms, “mean” refers to an average while“median” refers to a midpoint.
Mean Median
Net Profit on Total Revenue 6.6 7.7
Before Tax & Distribution
Net Profit On Net Revenue 7.9 9.8
Before Tax & distribution
Contribution Rate 60.8 63.7
Overhead Rate
(Before Distribution) 151.5 150.5
Overhead Rate 166.4 168.7
(After Distribution)
Net Multiplier 2.89 2.92
Unallowable Overhead as a 18.6 12.1
Percentage of Direct Labor
Unallowable Overhead as a
Percentage of Total Overhead
-Before Distribution 25.0 8.0
-After Distribution 23.2 6.6
Net Revenue Per
Total Staff $90,710 87,381
10.Net Revenue Per
Technical Staff $111,563 108,483
11.Chargeable Ratio 63.1 62.2
12.Marketing Per Total
Revenue 3.4 2.6
13.Marketing Per Net
Revenue 4.2 3.1
14.Errors and Omissions
(E&O) Insurance as a Percent
of Total Revenue 1.2 1.1
a Percent of Net Revenues 3.7 3.5
1. Net Profit on Total Revenue before Tax and Distribution. Total revenue includes revenue generated from in-house labor (representing 85-90%of total revenue) as well as consultants orsubcontractors and billable reimburseable expenses.Before distribution is before bonuses and profit distribution – since these items vary widely, the survecompares results before and after such distributions.
2. Net Profit on Net Revenue Before Tax Distribution. Net revenue refers to revenue generated only byemployees and may be more relevant for firms havingunusually high outside consultants and/or large reimburseable expenses.
3. Contribution Rate. This measures the portion ofeach dollar of net revenue remaining after all directproject costs (both labor and expenses) are covered.
4. Overhead Rate (before distribution). This is the percentage of total office overhead to direct labor. What the survey calls “office overhead” is really whatmany contractors call overhead and G&A includingthe portion of employees labor not direct charged to projects. Adjustments for unallowable costs areaddressed below.
5. Overhead Rate (after distribution). Same as above but the overhead includes bonuses, employee profitsharing and other distributions but not distributionof profit.
6. Net Multiplier. This is the effective multiplierachieved on direct labor and is calculated by dividingnet revenue by direct labor. Consultants and reimburseables are excluded in order to determine an actual multiplier achieved by the firm’s own efforts.The figure indicates participating firms received $2.89for each $1.00 of direct labor spent.
7. Unallowable Overhead as a Percentage of Direct Labor. This consists of total overhead that contractors either voluntarily delete or governmentauditors disallow as a percentage of direct labor.
8. Unallowable Overhead as a Percent of Total Overhead Before and After Distributions. Lookingat unallowable costs from a different vantage.
9. Net Revenue for Total Staff. This rough productivity index measures net revenue for eachemployee or part-time equivalent. It is calculated bydividing net revenue by average total staff, includingprinciples and part time equivalents.
10. Net revenue Per Technical Staff. This is probablymore relevant because it measures revenue by those directly responsible for generating it.
11. Chargeable Ratio. Measures the percent of totalstaff time charged to projects (whether billed or not)and is calculated by dividing total direct labor by totalfirm labor (direct labor plus indirect labor, vacation,sick leave and holidays actually paid).
The Survey seeks to identify key overhead costcomponents expressed in numerous ways such aspercent of direct labor, gross revenue, net revenue.A few examples are:
12. Marketing Costs Per Total Revenues. Takes all marketing expenses (principal and staff salaries plus expenses) divided by total revenue.
13. Marketing Costs Per Net Revenues. Net revenue is the denominator.
14. Errors and Omissions (E&O) Insurance as aPercent of Total Revenues.
15. Health Insurance as a Percent of Net Revenues. This new measurement reflects the relative increase
of this significant insurance cost that now far exceedsE&O insurance.
(Editor’s Note. Advertising and public relations expensesrepresent”hot” areas for audit scrutiny. These costs are oftensignificant and since they are considered “expressly unallowable”often include penalty provisions. The regulation covering “publicrelations” expenses is one of those cost principles that can besubject to many interpretations. FAR 31.205-1 defines publicrelations costs as functions and activities dedicated to enhancingan organization’s image or products and maintaining orpromoting favorable relations with the public and intends forsuch costs to be unallowable. But the same regulation makescertain public relations costs allowable so disputes will arise onwhether a given transaction is an unallowable public relationsexpense or meets one of the many allowable activities. Belowis a summary “case study” of a response our consulting groupmade to a DCAA draft audit report that questioned certainvendor charges as unallowable advertising and public relations expenses. The client is an engineering firm and we will refer toit as “Contractor.”
Background
During its audit of two years of incurred cost proposals, DCAA examined numerous transactionsand isolated the invoices of one vendor that producedthe material discussed below. The invoices included design and production of the material and DCAAquestioned over $250,000 of the invoices in each year.It referenced FAR 31.205-1 as grounds for disallowing the costs stating the design and productioncosts associated with the material was “unallowable advertising and public relations costs.” Also, since FAR 31.205-1 “expressly disallowed the costs”DCAA recommended imposition of penalties on thequestioned costs.
The costs being questioned relate to various printed material Contractor produces and makes available towhoever asks for information. Contractor receives numerous requests from a large number ofconstituents to provide information about itstechnologies, capabilities, nature of its projects,experience of personnel, analyses of risks, contacts for follow-up technical questions, etc. Rather than respond individually to these requests, Contractor prepares material in advance to provide the requestedinformation. The constituents who regularly requesinformation include actual and potential clients (government and non-government), actual andpotential vendors, various community groups, actualand potential teaming partners, security analysts,representatives of the media, etc.
The disputed material includes the following:
1. Statement of Qualification. These are spiralednotebook-like items consisting of 10-50 pages printedon two color paper. The cover sheet is full colored and glossy while all the pages inside are either one or two colors printed on plain paper. All contain a description of Scope of Services, Project Profile andProfessional Profiles for distinct engineeringspecialties (e.g. OSHA, environmental services, etc.).
2. Comprehensive Resources Strategic Solutions. These are full colored items printed on glossy paper usuallyincluding photographs. They are either in the formof a one page foldout with six individuals pages or a small spiraled notebook. For the 6 page foldouts,there is a cover page followed by page(s) containing alist of services (1-5 pages). Some have additional information such as list of offices and information about the company. Like the Statement of Qualification there is separate material for various industries.
3. Financial Reports. These include annual reports for various years.
4. Environmental Regulatory Agency Atlas. This is a 192 page, three color 5″ by 3″ small manual that listsagencies with maps and directions.
5. Information Sheets. One or stapled four paginformation sheets that are primarily two color plaisheets that cover a wide range of information. For example, a random selection of five Information Sheets included Environmental Site Assessment, Community Outreach In Oakland, RepresentativeClient List, List of Nevada Offices and Projects andBioremediation Services
6. Folders. These are two page two colored foldersprinted on glossy paper which are intended to holdthe other material.
The material is usually located in one back area ofeach office so employees may collect and distribute relevant information to their constituents.
Our Response
Allowability
Though DCAA’s reference to FAR 31.205-1 isappropriate, we believe sections FAR 31.2051(e)(2)(i), (ii), (iii) and (f)(3) are the relevant sections of the cost principle to consider. Specifically:
FAR 205-1(e)(2)(i). “Allowable public relations costs include costs of responding to inquiries on companypolicies and activities.” Rather than respond to largenumbers of inquiries with individualized responses,Contractor believes it is prudent to anticipate inquiryareas and have ready responses that can be selectedand sent out quickly. All the material in question is material used to respond to inquiries aboutContractor’s policies and activities.
FAR 205-1(e)(2)(ii). “Allowable public relations costsinclude costs of communicating with the public, press,stockholders, creditors and customers.” The material in question is used frequently to communicate witheach constituent identified in the above FAR section, especially customers and creditors (e.g. vendors).
FAR 205-1(e)(2)(iii). “Allowable public relations costs include costs of conducting general liaison with newsmedia and Government public relations officers…”The material in question is also frequently distributedto representatives of various media (e.g. numerousindustry publications, various media groups) andgovernment representatives including government public relations officers, project managers, technicaland contracting personnel. The material is providedeither when requested or when Contractor decidesthe public needs to be informed about its experienceor capabilities.
FAR 205-1(f)(3). “Costs (are unallowable) osponsoring meetings, symposia, seminars, and other special events when the principal purpose of the eventis other than dissemination of technical information.” The nature of the material in question can mostaccurately be characterized as “dissemination oftechnical information.”
Discussion of Material
In our response, we selected a broad range of samplesof the materials and discussed in detail the nature of each type of publication. Whereas some of the material clearly related to dissemination of technicalinformation other were not so we, at the least, hoped to demonstrate where a majority of the costs wereallowable so there would be only a minimal amountof questioned costs. We summarize our presentation below.
The Statement of Qualification meets the allowable function of “dissemination of technical information.” The Atlas is primarily used by Contractor personneland the folder is merely a vessel to hold the informationdistributed to constitutes. The Comprehensive Resources Strategic Solutions and some of the single sheet inserts are used for, at least, one of the following purposes – “technical information” to a constituent, liaison with news media or government and most commonlyresponses to inquiries on company activities andpolicies or communication with various constituentssuch as the “public, press, stockholders, creditors andcustomers.”
Some of the material consists of plain paper with one or two colors while some use glossy paper and multi-colors where the latter may be associated withtraditional advertising material. However, the dayswhen there was a significant price difference betweenone to three colors printed on nondescript paper andmulti-colored, glossy paper where the later was reserved only for “advertising” are gone. Now, there is little price difference between the two types ofmaterial so the existence of material printed on glossypaper using multiple colors does not mean thematerial is for advertising – we maintain that differenttypes of printed material can and is used for allowable communications purposes.
Penalty
Since the cost is unallowable in accordance with FAR 31.205-1 DCAA is recommending that a penalty beimposed equal to 100% of the questioned costsapplicable to relevant cost type contracts inaccordance with FAR 42.709-1 and FAR 52.242-3, “Penalties for Unallowable Costs.” (Editor’s Note. The purpose of responding to the imposition of penalties is not smuch to change DCAA’s mind as to lessen the contractingofficer’s interest in seeking penalties. Though its guidance doesnot necessarily require it to do so, DCAA often takes a rather expansive view of what is expressly unallowable – if a FAR 31.205 cost principle can be cited the questioned cost is usuallyconsidered expressly unallowable and hence subject to penalties. When DCAA does take this position, we usually find themunwilling to budge but we are frequently successful when arguinthe point at the contracting officer level.)
We disagree that the costs are “expressly unallowable.”(For a detailed discussion of Penalties on Unallowable Costs see our GCA DIGEST article in the Fourth Quarter 1999 issue). “Expressly unallowable cost” is really a narrowterm where both the FAR and CAS 405.30(a)(2) define it as “a particular item or type of cost whichunder the express provisions of an applicable law,regulation or contract is specifically named and statedto be unallowable.” In explaining the term, PreambleA to the original promulgation of CAS 405 refers to“costs whose unallowability is obvious” and costs that are “obviously unallowable.” In their discussion of an example, entertainment costs, the authors of thePreamble concluded the definition of “expresslyunallowable cost” is limited to obvious costs that are explicitly unallowable in all circumstances under the FAR 31.205 cost principles.
Court and board decisions have further confirmed this narrow definition and limited “expressly unallowable costs” to those cost principles where thecost is unallowable under “any circumstance”. In Emerson Electric Co. (ASBCA 30090) the Board definedexpressly unallowable cost as a type of expense thata cost principle states is unallowable in its entirety,using the term “clear beyond cavil.” Several cases have pointed to specific costs being expresslyunallowable because they were unallowable in “all”circumstances (e.g. entertainment, claim prosecutionbad debts, amortization of goodwill, alcoholicbeverages). Few other types of costs found in FAR31 are “obviously unallowable” because some type of costs are allowable while similar costs are not. Just because the cost principles make a cost unallowabledoes not make it “expressly unallowable.” The courts have also ruled that the existence of a reasonable dispute as to a costs’ allowability means that cost isnot expressly unallowable. In Martin Marietta (ASBCA 35895) the court ruled a reasonable dispute existswhen the contractor’s position that the cost isallowable has sufficient validity to create more than alittle doubt regarding its allowability.
Here, the questioned costs do not meet the conditionsfor being expressly unallowable. First, FAR 31.2051 does not make every advertising (e.g. help wanted adds, disposition of excess material) and publicrelations expense unallowable. Since not all costs addressed by this cost principle are unallowable, theydo not meet the condition of being unallowable“under any circumstance.” Second, the nature of the costs in dispute plausibly correspond to allowable types of public relations costs. As a reasonable dispute certainly exists hence the disputed costs donot meet the condition of “clear beyond cavil.”
(Editors Note. Where we have traditionally addressedsignificant GAO, Appeals Board and Court decisions fromthe previous year, we have received some requests to addimportant regulatory changes. The following briefly summarizesthe significant statutes and regulations of 2003 where we haveused the Briefing Papers January 2004 edition written byMarshall Doke of the law firm of Garere Wynne Sewell L.L.P. as well as the 2003 issues of the GCA Report. We will report on the significant decisions in the next issue.)
FAR Amendments
1. Federal Acquisition Circular (FAC) 2001-12provides for award fees and performance and deliveryincentives to be used on commercial item acquisitions (Fed. Reg. 13,201).
2. FAC 2001-13 states that progress billing requestsunder IDIQ contracts must be submitted under each individual order as if each order were a separatecontract (Fed. Reg. 13,206).
3. FAC 2001-14 deleted the transportation costprinciple (FAR 31.205-45) and revised Cost of Mone(FAR 31.205-10) to state it must be measured,assigned and allocated in accordance with Cost Accounting Standard 414 or 417. Also, the same FACrequires agencies to pay interest penalties when itmakes payments on cost type contracts for serviceslater than 30 days after receipt of a proper invoiceand agencies may now accept electronic signatures inconnection with government contracts (Fed. Reg. 28,091).
4. FAC 2001-15 revised the compensation forpersonal services cost principle (FAR 31.205-6) byproviding a new definition for compensation, adding“closely held corporations” to types of organizationsrequiring special consideration for individuals andadded a new section addressing severance pay. FAC 2001-15 explained that a clarifying restructuring tothe selling cost principle was intended to make anygray areas (e.g. not made specifically allowable by thFAR cost principles) unallowable (Fed. Reg. 43,871).
5. FAC 2001-16 requires all contractors to register in the Central Contractor Registration (CCR) databasebefore award of any contract or blanket orderagreement and also requires existing contracts whose
period of performance goes beyond the end of 2003to be amended to require such registration (Fed. Reg.56,669). The same FAC also provides that the Federal Business Opportunities website at www.fedbizopps.gov become the singlegovernmentwide point of entry for electronic publicaccess to procurement actions exceeding $25,000(Fed. Reg. 56,676).
6. FAC 2001-18 merged Standard Forms 254 and255 into a new SF 330 to create a single streamlinedform to provide essential information about qualifications and experience, to facilitate electronicusage and reflect disciplines and technologies (Fed.Reg. 69,227). The same FAC also provided newdebriefing information that must be provided tounsuccessful bidders such as an agency’s evaluationof weak or deficient areas, overall evaluated cost or pricing and technical rating of successful anddebriefed offerors, overall ranking of offerors whenranking was developed, a summary of the rationalefor award and reasonable responses to questionsposed by the debriefed bidder (Fed. Reg. 69,257).
Agency Regulations
The Defense Department (1) provides an alternativeto the FAR clause 52.232-7 that requires the CO to withhold 5% of the amount due to a maximum of $50,000 under T&M and Labor hour contracts until the contractor executes a release to the governmentof final payment. Now, the CO is not required twithhold the 5% and if they do, substitutes the$50,000 requirement for an “adequate reserve” not to exceed $50,000 (Fed. Reg. 69,631). (2) Provides for payment of provisional award fees under costplus-award-fee contracts where payments may bemade not more often than monthly and are limitedto no more than 50% of the fee evaluation for the initial evaluation period and 80% of the evaluation score for the prior evaluation period times the awardfee available for the current period (Fed. Reg. 64,561).
(3) Requires more audit rights of traditional defensecontractors under “Other Transaction” Agreementsfor prototype projects in excess of $5 Million and“should” have audit rights of nontraditional defense contractors (Fed. Reg. 27,452).
The General Services Administration (1) amendedthe GSAR to allow state, local and tribal governmentsto make purchases for information technology itemsunder Federal Supply Schedule contracts. The ordersplaced by the state and local governments will beunder separate contracts and the FSS contractors are not required to accept the orders (Fed. Reg. 24,372).
(2) Gives the FSS the unilateral right to change thepercentage rate of the Industrial Funding Fee (IFF) in multiple award schedule contracts. The announcement stated the FSS intended to lower the IFF rate from 1.0% to 0.75%, effective January 1, 2004(Fed. Reg. 41,286).
The Department of Homeland Security issuedregulations to provide liability protection to sellersof “qualified anti-terrorism technologies” to giveincentives for needed development. The regulations provide procedures and criteria for (a) “designation”of qualified anti-terrorism technologies (b)“certification” of an approved product forestablishing a rebuttable presumption of theapplicable government contractor defense and (c)“indemnification” rights (Fed. Reg. 59,684).
The Department of the Treasury established interest rates at 4.25% for the period January 1 to June 302003 (Fed. Reg. 78,566) and 3.125% for the perioJuly 1 to December 31, 2003 (Fed. Reg. 39,185). Theserates apply to (a) interest contractors must pay thegovernment under the Interest clauses of FAR (b) therate the government must pay contractors for successful claims under the Contract Disputes Act (c)rates the government must pay under the PromptPayment Act and (d) cost of money calculations iFAR and CAS.
(Editor’s Note. The following is a guest article by Tim Poweof the Law Offices of Tim Power (925-975-0330). We asked him to provide some practical insights and discuss recentdevelopments he encounters in the bidding and awarding of contracts. We have worked with Tim on numerous claims and terminations for clients and have been quite successful inrecovering entitled funds.)
Bidder Beware: IDIQ Contract Risks
Indefinite Delivery Indefinite Quantify contracts provide the government flexibility for requirementsthat cannot accurately be anticipated. An IDIQ Request for Proposal typically provides estimatedquantities as well as a guaranteed minimum orderingquantity. The RFP may require the contractor tomaintain the ability to meet these estimated quantities but the government is only required to order whateverminimum is established by the RFP. When pricingsuch contracts, the contractor needs to be aware that they bear the risk that only the small minimum amountmay be ordered. When the minimum is not ordered, the contractor can only recover the profit it wouldhave made if the minimum was ordered, not the difference between what was ordered and the minimum. Estimated quantities are just that and are often developed with an eye toward soliciting the bestpossible pricing and responsiveness from the contractor.
Two cases decided by the Court of Appeals for thFederal Circuit point out risks contractors face whenbidding on IDIQ contracts and they also indicateimportant distinctions between IDIQ andrequirements contracts. In Travel Centre v. Barram, CAFC Nos. 00-1054 and 00-1126 the General Services Administration solicited bids for a base period andfour option years for travel management services. The RFP stated the terms would be an IDIQ contract with a “guaranteed revenue minimum of $100.” Bidders were told that several agencies would be ordering through the GSA contract and to base their offers onexpected revenue commissions of $2,500,000. The GSA learned before offers were submitted that half the agencies would not be ordering through the GSAbut did not divulge the expected reduction in orders.Travel Centre was awarded the contract and received only $500,000 in ordered services over nine monthsbefore the contract was terminated. It claimed the GSA had breached the contract by failing to disclosethe estimated quantities were overstated and soughtrecovery in lost business damages. The Court ruled against Travel Centre where it stated unlike a requirements contract that mandates the contractinggovernment entity fills its actual needs for suppliesand services from the contract awardee, an IDIQ contract provides only that the government ordersonly a stated minimum quantity of supplies andservices which was $100. The fact the estimated quantities were incorrect made no difference becauseTravel Centre had no right to rely upon them. Thelesson of the case is that contractors have no right torely on the estimates given in the solicitation and thatbidding on IDIQ contracts is often a gamble. Even though a lower court ruled that Travel Centre was improperly induced to base its proposal on quantitiesthe GSA knew were overstated and hence breached its contract, the higher court rejected this positionstating the government is free to include estimates ofwork in a solicitation that it knows are wrong. A few savvy questions asked in the pre-bid phase of the solicitation can help decide if it is worth pursuing orif there is too great a gamble. For example, Howwere the estimates developed? When were the estimates developed and has anything changed? What are the estimates for option years?
In Verilease Technology Group Inc. v. United States CACFNo. 01-5114 the contract called for a base year plusfour one year option years to provide maintenance toidentified computers for a maximum of $50,000,000and a minimum of $100,000 for the base period only.After award the government replaced several of the identified computers, canceling some orders placeand stopping the placement of new orders. The contract was terminated in the second option periodwhere orders were $3 million in the base period andtotal orders were $10 million. Because there was onlya minimum amount for the base period and none for the option years Verilease argued its contract was arequirements contract not IDIQ where a minimumamount is mandatory and if it prevailed thegovernment would have been required to order all itsrequirements from it rather than just the minimum amount. The Court ruled against Verilease saying option periods are not the same as a new contract butthat there is only one contract for the base period andoption years so the $100,000 minimum for the baseperiod covers the entire contract period. Once this minimum is met, there is no obligation of thegovernment to order anything in the option years.
US v. Delta Construction Intl, CAFC No. 01-1253 addresses how much the government has to pay ifthe minimum guaranteed amount is not met. In the contract to replace rotten lumber in various areas ofa military base, the base period plus several optionyears provided for a minimum of $200,000 ofguaranteed work. After the first option period the contract was not renewed and Delta filed a claim of $125,000 for the difference between the value of orders placed and the $200,000 minimum guarantee.Though the Board sided with Delta ruling thecontractor was entitled to the difference between the value of orders placed and the minimum the higher Court rejected the Board’s position asserting such aposition put the contractor in a better position thanif the government had ordered the minimum. The Court stated the Board’s position would haveprovided the contractor with an additional $113,000without any reduction to reflect Delta’s additional costs of performing the work. Thus when the government does not order the minimum guaranteedamount the contractor is entitled to recover the difference between what was ordered and the minimum less the costs associated with performingthe work that should have been ordered to meet the minimum. Thus contractors need to track the costs of performing the work. An attempt should be madeto identify the period of greatest profitability to useto calculate the damage. For example, use of a periodwhere there is a shortage of orders might result inlower efficiency and low profit where in a period ofhigh level of orders, work is more efficient and so is profit.
Disclaimers are No Defense for Defective Design Claims
When design specifications are wrong contractors areentitled to recovery of extra costs while performancespecifications do not entitle contractor to such recovery. It is quite common for the government to attempt to disguise the existence of design specs byinserting different types of disclaimers in order tolessen the government’s liability. In White v. Edsall Construction Co.,CAFC No. 01-1628 the contract to construct a facility to house helicopters includedspecifications for hanging doors weighing 21,000 pounds. A government structural engineer insertedin the drawings a statement saying contractors “mustverify prior to bidding.” Though the contractor sawnothing obviously wrong with the specs beforebidding it discovered after award the door designwould not work and submitted a claim of $70,000 to correct the design.
After determining the contract contained design and not performance specifications, the Court stated therewas an implied warranty the design specs are free fromdesign defects. General disclaimers to check drawingdo not overcome this warranty. The drawings notedin this case only required the contractor to verify thedetails listed. It did not warn the contractor the design might be flawed nor require the contractor to verifythe design would work. This argument is frequentlyput forth by the government, apparently believing thatgeneral disclaimers can transfer the government’sresponsibility for design accuracy to the contractor.
Reliance on Bid Documents are Necessary for Winning a Differing Site Condition Claim
In order to win a differing site condition claim, it isnot enough to merely prove the government providedincorrect information about a site. Comtrol, Inc. v. United States, CAFC No. 01-5115 ruled a contractor also must have relied upon pre-award representations
made by the government about site conditions inorder to make a claim for a differing site condition.
Though the solicitation made were general remarksmade about the soil there were no specific referencesabout the soil but it did say a soils report was available at the architect’s office. The Court rejected thcontractor’s claim for differing site conditions rulingsince the contractor did not read the report it couldnot meet the condition for a differing site conditionclaim – reliance on the bid documents.
The case makes obvious that examination of anydocuments referenced or incorporated into a solicitation can be crucial if the information contained becomes important for performance. Failing toreview information incorporated into the contract,but not provided with bid documents holds twodangers. Even if the report contains misleadininformation the contractor cannot base a claim on it unless the contractor relied on the misinformation during bid preparation. If the report containsinformation about a problem area, the contractorcannot base a claim on the problem because it wouldhave learned of it if the report was read.
Don’t Wait for Contract Award to Protest the Solicitation
A protest can be either pre-award or post award.Examples of pre-award protests include omissionsof required provisions in the RFP, ambiguities,indefinite evaluation factors or elimination from the competitive range before award is made. Post-award protests are ones filed after an award is made and is usually to protest the award itself. Many contractorsmake the mistake of waiting until the award is madeto protest improprieties in the solicitation and when they do so they find they are too late.
The RFP for a commercial services landscaping contract broadly defined the type of relevantexperience that could demonstrate an offeror’s ability to successfully perform the required services. When the incumbent, Bella Vista Landscaping lost the bid to a lower rated, lower priced proposal it protestedthe award stating its past superior performance was“unique” and its higher price offered greater value tothe government. In rejecting its protest, the GAO ruled Bella Vista did not challenge the commercial services nature of the procurement prior to the closing time for submitting proposals and it is untimely todo so now. To the extent Bella Vista contends the solicitation should have included additional consideration of its experience as the incumbent itsprotest was too late since it concerned an alleged impropriety of the RFP and was not raised prior tothe closing time for submission of proposals.
The general protest time limit rules are:
General Rule 1. Ten days from adverse agency action including denial of agency protest if agency filed within time allowed by GAO rules.
General Rule 2. Ten days from the date you know orshould know of the basis for the protest. A timely (within 5 days) request for debriefing can extend thetime to protest until 5 days after the debriefing.
General Rule 3. Before submission date for bids or offers if the protest concerns something wrong with the solicitation. A solicitation defect that was not apparent must be protested within 10 days after it becomes apparent.
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