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Equity and Contract Disputes

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Equity and Contract Disputes

 

Companies considering entering into a contractual relationship with the U.S. Government might think they are entering into a relationship based on mutual good will. They may think they are entering into a partnership with their government customers, a partnership based on the mutual goal of having work performed and a need met. Sadly, too often that is not the case.

Too often, government contractors are surprised to learn that somebody on the government side doesn’t like them, or has an intent to harm them (usually financially). Too often, government contractors are surprised to learn that auditors may take credit for “questioning” costs that the contractor believes to be legitimate business expenses—perhaps years after the costs were incurred. Too often, contracting officers who are supposed to be independent, and who are supposed to resolve contractual disputes before they ripen into litigation, essentially rubber stamp those audit findings (for one reason or another) and dare the contractor to take them to court—knowing that the expense and time associated with litigation virtually guarantees that the biased decision will be accepted, and the money paid.

And far too often, when a contracting officer final decision is appealed in accordance with the contract’s Disputes clause, the courts rule against the contractor on a procedural technicality—effectively jettisoning notions of equity in favor of administrative procedures.

Is that always the case? No, clearly not. But it happens sufficiently often that contractors entering the Federal government acquisition environment should be aware of the risk. They should be aware that they may become targets for overzealous auditors and poorly trained and/or biased contracting officers. They should be aware that the courts in which they will be forced to pursue litigation—should they wish to—may not be serving justice so much as administrative procedures.

Some Thoughts from Others

  • Equity’s role within the courts ‘is to prevent the law from adhering too rigidly to its own rules and principles when those rules and principles produce injustice’.” – Aristotle’s Ethics, from Allan Beever’s Aristotle on Equity, Law, and Justice (Cambridge University Press, 2004)

  • When the United States enters into contract relations, its rights and duties therein are governed generally by the law applicable to contracts between private individuals.”Lynch v. United States, 22 U.S. at 579

  • Extortion – “The obtaining of property from another induced by wrongful use of actual or threatened force, violence, or fear, or under the color of official right.” – Black’s Law Dictionary 6th Ed. (Emphasis added)

The Presumption of Good Faith

The current doctrine of the contract dispute appeal forums presumes government employees always act in good faith, a presumption that can only be overcome by “well nigh irrefragable proof” which, for obvious reasons, is nearly impossible to provide. Another legal practitioner wrote of this difficult hurdle, “[w]henever a contractor pleads a violation of good faith duties, DOJ [Department of Justice] argues that the allegation is essentially that the government acted in bad faith, which (they argue) requires ironclad proof of intentional misconduct targeted at the contractor, which is almost always impossible to demonstrate.”1

The Contract Disputes Act (CDA) of 1978, codified at 41 U.S.C. 71, established the rules for pursuing claims against the Federal government. It is relatively prescriptive, as befits a limited waiver of sovereign immunity. Contractors must follow the rules exactly or risk having their claims dismissed by the courts. The CDA also provided remedies against fraudulent claims asserted by contractors. At 41 U.S.C. 7103(c)(2), the statute states:

(2) Liability of contractor.—If a contractor is unable to support any part of the contractor's claim and it is determined that the inability is attributable to a misrepresentation of fact or fraud by the contractor, then the contractor is liable to the Federal Government for an amount equal to the unsupported part of the claim plus all of the Federal Government's costs attributable to reviewing the unsupported part of the claim. Liability under this paragraph shall be determined within 6 years of the commission of the misrepresentation of fact or fraud.

Importantly, no such provision exists with respect to claims first asserted by the Federal government that require a contractor to appeal to an agency board or to the Court of Federal Claims. While the contractor’s claim must be grounded in a good faith belief in its accuracy, any government claim is not subject to those same requirements.

What’s good for the goose is emphatically not good for the gander.

Recent Board Decisions Viewed in Light of Equity

  1. Quimba Software

Quimba Software was a small, innovative, software development contractor that made the mistake of accepting a cost-reimbursement contract from the Department of Defense. Its treatment at the hands of the Court of Federal Claims (as affirmed by the Federal Circuit) is illustrative of how a company may run afoul of auditors, contracting officers and, ultimately, the courts.

The 2015 Gibson Dunn Year-End Government Contracts Litigation Update2 discussed the Quimba situation thusly:

Quimba Software, Inc. entered into a cost-plus-fixed-fee contract with the Air Force. Co-owner Robert Dourandish signed the contract in his capacity as one of the company’s officers. After the completion of contract performance, the Air Force disputed the allowability of certain costs, and the contracting officer issued a final decision seeking the recovery of approximately $92,000 from the contractor.

Quimba Software challenged the Government’s claim in a lawsuit initiated in the Court of Federal Claims. Dourandish separately filed suit against the Air Force in the same venue in his individual capacity, alleging breach of contract and interference with his constitutional right to seek federal contracts. The Court of Federal Claims dismissed the Dourandish action for lack of subject matter jurisdiction. The Federal Circuit affirmed the dismissal on the basis that Dourandish, as an owner of Quimba Software, was not a party to the contract between the company and the Air Force. Therefore, the court had no jurisdiction under the Tucker Act to adjudicate his suit.

Meanwhile, at the ASBCA, Quimba’s appeal of the contracting officer final decision was dismissed as being moot.3 Quoting from the decision—

Following discovery in this appeal, the ACO rescinded the demand for repayment, and released the government claim. The government moves to dismiss the appeal as moot. Quimba opposes, arguing chiefly that the issue of government bad faith remains. …

Quimba's main argument is that, while the final audit report was issued in 2008, the government waited until December 2013, after expiration of the Contract Disputes Act statute of limitations, 41 U.S.C. § 7103(a)(4)(A), to issue the final decision. Quimba tells us that, ‘[i]n issuing the [final decision] after the expiration of [the statute of limitations], the Government deliberately, and with premeditation, is forcing frivolous and baseless litigation on Quimba since ... Quimba had no choice but to litigate - or accept an unjust determination’. Quimba adds that it is entitled to discovery to support its allegations of government bad faith.

The Board declined to permit Quimba to pursue discovery that it asserted would have supported its bad faith argument, writing “While Quimba stresses that Combat Support ‘includes an exception for Bad Faith behavior’, there is no prima facie showing, and no evidence of such conduct, here. We again follow ‘the presumption, unrebutted here, that contracting officials act in good faith.’

But Quimba persevered. After six long years of battle, another judge at the Court of Federal Claims found that the government’s position, as established by contracting officer final decision and (revised) counter-claim for an additional $50,000, was erroneous. The Court found for Quimba on a Motion for Summary Judgment, writing that “This Court finds that the deferred compensation costs are deductible under section 404 of the IRC and its accompanying regulations, and therefore, allowable under FAR 31.205-6(b)(2)(i).”

The Court did not discuss the auditors’ role or contracting officer’s role in this debacle. As is almost always the case, the government actors were presumed to have acted in good faith. The quality of the government’s initial finding (and subsequent modification of that original finding during litigation to add another $50,000) was accepted as being made in good faith, despite Quimba’s assertion that discovery might prove otherwise.

Quimba’s eventual victory was small consolation to the firm’s founders. The company had declared bankruptcy long before.

At least Raytheon—one of the largest defense contractors in the world—had the resources to litigate without filing bankruptcy.

  1. Raytheon

A recent ASBCA decision4 involved more than 100 pages of findings of fact and related decisions covering multiple areas of cost allowability and allocability. The short summary is that government auditors identified many questioned costs and those audit findings were sustained by several contracting officers—and Raytheon appealed.

The various contracting officers’ final decisions seemed to virtually rubber-stamp questionable DCAA audit findings. And by “questionable” we mean: the audit procedures appeared to represent significant departures from GAGAS requirements. They seemed to lack much (if any) pretense of objectivity. Instead, they seemed to be speculative—we could say fictitious—findings intended to provide the contracting officer with ammunition to extract from Raytheon as much cash as possible. (As we will quote below, at points the auditors’ testimony literally stated that.) Some of the audit findings were described by the Board as being speculations without supporting evidence; I would assert that was a charitable characterization.

For example, an auditor changed her findings from questioning a portion of Raytheon’s government relations costs to questioning 100% of such costs. When questioned under oath, “[the auditor] based her ultimate conclusion that all of cost center 90206’s costs should be disallowed on the fact that she did not find documentation ‘either way’ on whether the costs were allowable or not, or claimed or not.”

In another example, Raytheon provided evidence to its contracting officer in support of the allowability of claimed patent costs; however, the contracting officer declined to review that information because of concerns about the looming statute of limitations. In other words, the contracting officer was more concerned about protecting the government’s litigation position than getting to the right decision.

In another example, when explaining to the Board how DCAA developed its questioned cost position on premium airfares, the auditor stated “Because we were just trying to determine -- when we were doing the audit, we were just trying to determine a reasonable amount. We understand these are negotiations, so we were just trying to give the government some kind of platform to, kind of, base where they should start at.”

In other words, the auditors viewed their role as providing government negotiators (and litigators) with “some kind of platform” on which to base a position. This is classic gamesmanship. Had the roles been reversed, and had Raytheon presented its claims based on such tactics, we would not be surprised to learn that it would be facing legal consequences. The Board of Appeals did not address the apparent lack of good faith in the government’s positions.

Raytheon faced a choice, as all government contractors face in similar situations: they can try to negotiate a lower amount (i.e., engage in horse-trading) or they can appeal. Appeals are expensive and can take years. At a minimum, Raytheon was required to pay its attorneys quite a bit of money (all unallowable) in order to prevail. At least Raytheon is a multi-billion-dollar entity with deep pockets—unlike Quimba Software.

  1. L3 Technologies

In March the ASBCA dismissed L3’s appeal of several contracting officer final decisions that sought more than $11 million in various questioned direct and indirect costs.5 While recognizing that L3 “has been to the Board quite often in recent years as a consequence of COFDs stemming from incurred cost audits” and that “none of these appeals has led to a decision on the merits” (because the contracting officer rescinded the COFDs during the litigation)—the Board continued to permit the government to engage in behavior that (from the view of a layperson) seems quite evocative of the term “extortion.”

The dissenting opinion discussed the cycle of what might be characterized as extortive behavior, noting that—

In its opposition to DCMA’s motion to dismiss, L3 summarizes similar audit disputes between L3 and DCAA/DCMA from 2006 through 2018.These disputes all followed a similar path: DCAA conducts Audits challenging costs, DCMA issues COFDs implementing the DCAA Audits and demanding repayment of the challenged costs, L3 appeals the COFDs to the Board and DCMA either withdraws the COFDs or the parties settle for a nuisance amount resulting in dismissal of the appeals with prejudice. The disputes involved in this decision followed a similar path but remain unresolved. There are several similar appeals that have been stayed pending resolution of the appeals in ASBCA Nos. 61811, 61813 and 61814.

The dissenting opinion was on the right course, but it fell short because it did not take the final leap to the right conclusion. L3 Technologies’ appeal should have been heard in order to serve the principle of equity. The Board should have explored whether the DCAA and DCMA behaviors of repeating a wrongdoing until L3 gave up—essentially a war of attrition if not rising to the level of extortion—constituted bad faith.

The three examples above serve as warnings to companies considering entering the government contracting environment. Be advised: you are not partnering with your government customers. There is a chance that you may find yourself in the crosshairs of an auditor or a contracting officer. And if you take your case to the courts expecting justice, don’t be surprised if you lose on a technicality.

1 A Twice-Told Tale: The Strangely Repeated Story of “Bad Faith” in Government Contracts, Fredrick W. Claybrook, Jr., The National Quarterly Review of the United States Court of Appeals for the Federal Circuit (2014).

3 ASBCA No. 59197, 5/13/2019. Citations omitted from all quotes.

4 Raytheon Company and Raytheon Missile Systems, ASBCA Nos. 59435, 59436, 59437, 59438, 60056, 60057, 60058, 60059, 60060, 60061 (Feb. 2021). Motion for Reconsideration denied.

5 L3 Technologies, ASBCA Nos. 61811, 61813, 61814, March 2, 2021. Internal citations omitted from quotes.

Last Updated on Friday, 23 July 2021 07:04
 

Defense Acquisition in the UK

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There are many similarities between the defense acquisition environments of the USA and the United Kingdom of Great Britain. Perhaps that’s not too surprising, given the “special relationship” between the two countries that goes back over 75 years. Because of those similarities, we take an interest when somebody publishes a report addressing “persistent challenges” in the UK’s defense acquisition environment, because the analysis may hold some applications for the US.

Recently, the RAND Corporation (Europe) published such a study. It’s not a very long analysis, and you can easily read it for yourself. But we know our readers, so we thought we’d note some of the report’s highlights because, otherwise, you’d just skip the whole thing.

Warning: British spelling and grammar ahead.

The RAND report begins with a summary of the defence acquisition environment: “Defence acquisition is complex, uncertain and constantly exposed to the chance of failure, requiring sound risk management.” That would seem to ring true for both the US and the UK.

The report identifies three main drivers that lead to cost or schedule problems, or “performance shortfalls” in the delivered products. Those drivers are: (1) skills/capabilities of both the buyer (in this case, the UK Ministry of Defence or MOD) and the seller (the contractors), (2) supplier performance, including contracting issues such as incentives, and (3) programme management, budgeting, and delivery.

There’s probably nothing earth-shattering about those root causes. We probably all knew them intuitively or through our experience. Still, it’s nice to have an independent analysis to point to when the discussion arises.

According to the report, the first driver (skills and capabilities of buyer and seller) include: “a sufficient quantity of suitably qualified and experienced personnel (SQEP) and appropriate design and production systems, processes, tools, materials and facilities.” In addition, the report identifies: poor requirement setting, production inefficiencies, and “workforce and skills challenges” as drivers in this area. The report dives a bit deeper; the authors assert:

Where technical specifications are set out in too much detail (instead of, for example, setting out the broad military requirements and use cases), industry has little manoeuvre in defining how the requirement could be delivered in a most efficient and effective way in terms of the key criteria: performance, cost and schedule. In these circumstances, programmes basically start off trying to deliver an end product that may not be the best solution from a capability perspective in the first place and is likely to end up being more costly than necessary due to the ambitious nature of the design.

With respect to inefficient production methods, the authors assert:

Long gone are days when most defence manufacturers benefited from economies of scale, driving down unit production cost through mass manufacturing. In fact, many large equipment programmes have relatively short production runs, with only limited number of units produced (e.g. ships, submarines, combat aircraft, helicopters) and there is a wider trend in recent decades towards ever more complex, expensive and ‘exquisite’ designs and a decades-long acquisition cycle. This means that each unit could almost be its own prototype and there are only limited opportunities for economies of scale, reducing the productivity benefits to be derived from learning or use of new technology over the lifetime of a production run.

Finally, with respect to workforce skills (SQEP), the authors assert:

Defence is a niche business where skills are critical and costly to rebuild, particularly in areas where unique skillsets require years of experience and may only reside in a relatively small number (even single digits) of key individuals. Once the appropriately qualified and experienced workforce is diminished – whether due to demographic changes such as retirement, departure of employees to other industries, or a lack of sufficient demand to justify the expense of new recruitment – it can be prohibitively costly in both time and financial terms to train up the SQEP from a low or zero base.

Similarly, long gaps between programmes mean that critical skills, particularly in the design and development stages of the equipment lifecycle, are not sufficiently exercised and tend to atrophy. … Rebuilding, retraining, recruiting or sourcing these skills from sources external to the programme (or seeking to bring in external subcontractors or partners to fill known gaps) can be costly and time-consuming, and can jeopardise the programme’s overall performance.

Looking at contracting, the report identifies “misaligned assumptions” and “poor understanding” of the technical, integration, and other business risks associated with the programme. As the authors wrote:

This lack of understanding then makes risk management less effective and can result in a mismatch between risk sharing approaches and contractual arrangements and incentives. As a result, cost overruns, schedule slippages and quality issues may be difficult to identify, foresee, track, quantify and address, also because liability can be difficult to apportion and there may be limited visibility for the MOD to see what is happening in the supply chain below the prime contractor level.

Other points made in the RAND report include:

  • A culture of optimism permeates defence equipment programme decision making, distorting assumptions and planning outcomes.

  • Lack of institutional memory means that lessons from the past are not learnt as quickly and efficiently as they could be – or not learnt at all.

  • The UK defence acquisition system is prone to moral hazard whereby poor delivery results in only limited negative consequences.

Do those points apply to the US defense acquisition environment? We believe they do.

To wrap this up, let’s one of the RAND-recommended corrective actions.

Acquisition best practice suggests that ‘chaos’ (i.e. red teaming and challenging of underlying assumptions) should be introduced at the early stages of the programme set-up in order to identify weak assumptions, appropriately assess risk and prevent unrealistic estimates from becoming contractual milestones. … well-functioning independent cost and risk analysis and assurance have an important role to play in mitigating the adverse impact of optimism and other biases.

Though the recommendation is pointed at the UK MOD, it would seem to be applicable not only to the US DoD, but also to many large defense contractors. If you want to understand where the program is likely to end up, you need to be rigorous in evaluating the initial assumptions. On the other hand, we also understand that, given the predilection of the US DoD to buy via Lowest-Price, Technically Acceptable (LPTA) methods, it may not be in the contractor’s best interest to actually price the realistic cost estimates. But at least such an approach would help to quantify the size of the program buy-in, so that the company could reserve for losses upon award, rather than recognizing losses piece-meal over the life of the program.

In any case, the RAND (Europe) report presents another independent analysis of what’s wrong with the defense acquisition system, and points to some things that might be done to address those root causes. Though largely focused on the UK, it seems to be applicable to the US environment as well.

Will anything be done? Doubtful. Tacking some of these challenges will take a lot of political will; we don’t think it’s there.

Last Updated on Monday, 28 June 2021 16:58
 

Air Force One, Maybe

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The VC-25A aircraft, commonly known as “Air Force One,” needs to be replaced. This has been known for several years. The existing Boeing 747 aircraft—highly customized to meet Presidential needs—have been operating for more than 20 years (one report says nearly 30 years). The replacement aircraft, dubbed the VC-25B, has been in the works since contract award (to Boeing) in 2015.

It has not been a smooth ride.

President Trump tweeted his opposition to the Air Force One replacement program before he was sworn into office, complaining about excessive cost (“more than $4 billion”). In an effort to placate the Commander-in-Chief, the US Air Force bought a couple of used aircraft originally intended for a Russian airline, but that didn’t really work out in terms of cost control. At the moment, the replacement program is expected to cost $5.3 billion, even though Boeing’s contract is firm, fixed-price and valued at $3.9 billion (reportedly). One report says the tech manual used for maintenance and repairs costs $84 million all by itself. We didn’t confirm, but at least one report asserted that Boeing has taken a $486 million charge against earnings to cover its program overrun. Ouch.

But Boeing’s program is in even more trouble than simple budget pressures. It is also late.

If you were looking for “on-time, on-budget,” this is not your program.

As the Financial Times reported

The programme represents a sliver of Boeing’s top-line, which totalled $58bn in 2020. Yet it concerns some analysts because it is another black eye in a string of problems ranging from minor to catastrophic: debris left in the USAF’s KC-46 refuelling tankers, the Starliner crew capsule that failed to reach the International Space Station, the halted 787 deliveries and the two crashes of the 737 Max that killed a combined 346 people.

The Air Force One problems contribute ‘to an overall impression of Boeing having serious programme management and execution deficiencies, both in their commercial and military businesses’, said Teal analyst Richard Aboulafia.

‘It’s one on top of another, on top of another,’ added Bank of America analyst Ron Epstein. ‘That’s the issue, not Air Force One per se. It’s yet another fumble . . . It really makes you question what’s going on in their engineering organisation.’

Why is the program now estimated to be a full year behind original schedule?

According to reports, Boeing has offered two excuses for the program delay. The first is COVID-19. Apparently, the pandemic impacted Boeing’s ability to work on the aircraft. We expect that’s going to be a common excuse used by many contractors for schedule delays. Indeed, epidemics are one of the expressly listed causes for “excusable delays” found in the FAR. Reports state that Boeing has filed a Request for Equitable Adjustment (REA) with respect to its COVID-19 impacts. We’ll have to see what happens with that REA request.

The other rationale offered by Boeing is more interesting. Boeing is blaming a supplier, GDC Technics, for at least a part of the delay. According to various reports, GDC Technics was the supplier that was responsible for the aircraft’s interior. Obviously, the interior is a fairly critical aspect of a Presidential aircraft.

News reports indicate that Boeing terminated its subcontract and filed suit against GDC Technics in April, 2021. In its suit, Boeing alleged that the company had fallen more than a year behind schedule on designing the VC-25B interiors. GDC then countersued Boeing, claiming that Boeing had mismanaged the program.

Somewhere in the middle of the lawyer-led “He Said, She Said” battle, GDC Technics filed for bankruptcy, citing Boeing’s withholding of $20 million in payments the company said it was owed for completed work.

Regardless of the merits of the parties’ litigation allegations, this is but the latest example of the importance of diligent supply chain management. Responsible prime contractors don’t let their suppliers fall a year behind; they deploy leading risk indicators and take effective action when the risk indicators start flashing yellow. We’re going to assert (without knowing) that Boeing didn’t do that in this case.

This blog has emphasized the importance of effective supply chain management over and over. We’ve written so many articles on the subject we felt the readership had tired of our rants. Apparently, the folks at Boeing aren’t readers of the blog.

They could have read this 2010 article, in which we pontificated that—

Your preoccupation with internal matters, your management metrics that focus only on internal issues (such as headcount), your application of Lean and Six Sigma solely to your own production line, your attempts to control cost growth by forcing suppliers into firm fixed-price development contracts or into making huge program ‘investments’—these actions betray a management naïveté, an erroneous impression that the management approach that worked to put a man on the Moon is the same approach that will lead to successful program execution in the 21st century.

Newsflash: it will not.

Program quality and execution risk cannot be transferred to suppliers. The prime contractor is responsible to the customer for the program. Period. If your attorney counsels otherwise, you should hire another attorney. If your subcontract manager or buyer or procurement specialist tells you that cost or schedule or quality or performance risk has been controlled by pushing it downwards in the supply chain, you should put a better support team in place.

Because you cannot build a wall between team members on a program; you cannot say, “This is your responsibility and this is my responsibility.” You cannot transfer risk; the most you can do is to share it. The more that design information and risk information is shared, and communicated, and managed as a team, the better the outcome. When you treat your suppliers as individual entities that succeed, or fail, on their own, then you will always suboptimize your outcome. That is axiomatic. It is a nearly inviolate law of 21st century program management.

Or they could have read this 2014 article, in which we opined that—

One of the truisms we have learned about creating an effective program management culture is that effective subcontractor management may be the most important single factor driving program outcomes. The success or failure of your program very likely hinges on how well you are managing performance that you have pushed outside your factory to external suppliers. We have observed this axiom over and over, whether discussing the Boeing 787 program or the Airbus A380 program or major defense acquisition programs. We have also observed that program execution risks found in the supply chain are, as a rule, under-managed.

Or they could have read this 2015 article, which focused on counterfeit electronic parts, in which we asserted that—

Many of the largest prime contractors have made a specialty of subcontracting out large portions of the SOW, to the point where they like to call themselves ‘system integrators’ and point to subcontract management as one of their (few) core competencies. Their program win strategy is to lock-up and deliver large teams of individual corporations (along with those corporations’ local Congresspersons and Senators). And it tends to work for them often enough that they keep on doing it. Either they have figured out how to manage the risks associated with supply chain management or, perhaps, they haven’t noticed that those risks keep increasing … and so they keep on with what has been working for them.

But make no mistake, those risks do keep increasing.

Point is, we’ve got a fairly strong pedigree in the area of effective subcontractor management (including supply chain risk management). We’ve got more than thought leadership on the topic—we’ve got hands-on experience in helping large program management teams at very large contractors get a handle on how to manage their supply chain risk. That thing that people now call SCRM (Supply Chain Risk Management)? We were practicing it more than a decade ago.

Based on what we guess about Boeing’s Air Force One replacement program, the program team didn’t read our articles and didn’t implement effective supply chain management techniques.

Thus, when a British Bank of America analyst states “It really makes you question what’s going on in their engineering organisation,” we believe we know the answer.

Dear Boeing, our contact information is on the website. You might want to give us a call.

Last Updated on Tuesday, 15 June 2021 18:26
 

Inadequate Business Systems

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You might remember, as we do, the time when DCAA blasted “inadequate” contractor business systems, and blamed those systems for “millions of dollars” of contractor overbillings to the Department of Defense. Of course, DCAA was talking about LOGCAP contractors in Southwest Asia (including Iraq and Afghanistan) but – as we predicted – very few people caught that nuance and, instead, the unsupported comments were taken to apply to all defense contractors.

Thus, it wasn’t long before we had a series of proposed rules and public law revisions that led to the current DFARS contractor business system oversight regime, a regime about which we’ve written at length.

Maybe those LOGCAP contractors had deficiencies in their business systems; maybe not. That was more than a decade ago and times were different. In particular, at the time DCAA had been under intense criticism for poor quality audits, and there is no reason to think that the audits they performed on LOGCAP contractors’ business systems were of any better quality than the audits they performed of other contractors’ business systems. We’ll likely never know the truth of the assertions made by the DCAA Director at the time—which were made under oath.

What we do know is that, today, almost all contractor business systems audited by DCAA (or “reviewed,” if performed by DCMA) are found to be adequate.

We know this because, from time to time, DCMA publishes statistics on the status of contractor business systems. These statistics aren’t published in the Federal Register. For the most part, the average Joe doesn’t get to see them. However, sometimes they get handed out to industry groups and passed around within the membership. (We’ve written before about the benefits of joining an industry group such as AIA or NDIA. You really should.) Sometimes one of our clients gets a copy and gives it to us as an FYI.

The last set of contractor business system statistics we have seen was dated April, 2021. That’s a bit dated now but, if you have nothing, then even a bit dated view of business system status is interesting. But before we recap the stats, let’s talk about the methodology. First, DCMA measures contractor business systems by CAGE Code. Basically, a CAGE Code is issued at the intersection of a facility and a geographic location. As you might guess, some contractors only have one CAGE Code while other contractors have dozens of them. (Government entities have CAGE Codes too, but that’s not relevant to this article.)

The point is, you can’t correlate CAGE Codes to contractors. So when we report that DCMA is tracking roughly 8,900 CAGE Codes in its contractor business system reporting, don’t think that that means DCMA is tracking roughly 8,900 individual contractors. They’re not.

Also, remember that the focus of the DFARS business system oversight regime is on the largest defense contractors. Mandatory payment withholds for system inadequacies will only be implemented on contractors that are subject to Full CAS coverage. Thus, don’t over generalize the data to the entire defense industrial base.

Now, having set the stage, we know that, as of April 30, 2021, DCMA was tracking 8,871 contractor business systems by CAGE Code. That is to say, DCMA reported business system status for 8,871 individual CAGE Codes.

Of the 8,871 CAGE Codes, only 62 had disapproved business systems. That’s a vanishingly small percentage.

Note, however, that those 62 disapproved contractor business systems had generated $45.4 million in cumulative payment withholds.

Which systems had the most disapprovals?

The Accounting System was, by far, the system with the most disapprovals (27/62). That said, disapproved Accounting Systems only drove $90,000 in payment withholds. That implies the disapprovals were being experienced by smaller contractors—i.e., those not subject to Full CAS coverage.

Next was the Estimating System (15/62). Payment withholds associated with disapproved Estimating Systems were, cumulatively, $3.4 million.

No other contractor business system broke double-digits, in terms of disapprovals. But we did note that Earned Value Management (EVMS) accounted for 62 percent of all cumulative payment withholds, even though there were only 9 CAGE Codes with disapproved EVM Systems.

The point of this article is that, unlike the asserted findings within the 2010 DCAA testimony about LOGCAP contractors, todays’ contractor business systems are very much adequate. That is a factual statement based on reported DCMA statistics.

Was the 2010 DCAA testimony inaccurate?

Or has the past decade of focus on contractor business systems led to significant improvements by contractors?

It’s not likely that anybody reading this blog article will ever know the answers to those questions for sure. But what we do know is that DCAA and DCMA continue to audit, and review, contractor business systems. Payment withholds continue to be levied against the largest contractors, and sometimes those payment withholds reach high levels, significantly impacting contractor cash flow.

If you are a larger defense contractor—or want to become one—then you need to focus on your business systems.

Last Updated on Monday, 21 June 2021 16:48
 

Executive Compensation Failure

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Claiming only allowable compensation is tricky. It requires a decent amount of analysis. One of the trickier aspects of the compensation analysis is understanding that the compensation ceiling changes over time. One may also need to understand that the compensation ceiling applies to different groups of employees, or even different groups of customer contracts, depending on the year in which the costs were recorded (and/or the year in which the contract was awarded).

And this doesn’t really even apply to challenges to compensation reasonableness. That’s a whole ‘nother thing. No, we’re simply talking about compliance with FAR 31.205-6(p). It’s tricky, and contractors are required to get it right.

It’s so tricky, that DCAA has so far failed to issue comprehensive guidance to its auditors via the Selected Areas of Cost Guidebook. Chapter 10 of the Guidebook (Compensation for Personal Services) is “under construction,” and has been that way for years.

Nonetheless, it is DCAA’s position that a contractor who claims compensation costs in excess of the 31.205-6(p) ceiling(s) has claimed an expressly unallowable cost. (See the Contract Audit Manual at 6-414.8.) Recently, this position was put to the test at the Armed Services Board of Contract Appeals (ASBCA).

Ology Bioservices, Inc. (Ology) appealed a Contracting Officer Final Decision applying a penalty for Ology’s inclusion of claimed executive compensation costs in excess of the FAR ceiling in its Fiscal Year 2013 proposal to establish final billing rates, which was submitted on time six months after the close of Ology’s fiscal year. However, DCAA had some issues with Ology’s submission and Ology was required to fix those issues and resubmit its proposal, which it did about six months later. DCAA audited the proposal and questioned costs. After the audit report was issued, and after a “lengthy negotiation” with the DCMA contracting officer—a period that lasted nearly six years (December 2014 through May 2020)—the COFD was issued, in which the contracting officer determined that Ology had claimed executive compensation costs that exceeded the FY 2013 ceiling by $1,749,890. As Judge O’Connell of the Board wrote, “The CO found that $979,938 of this amount was allocated to covered contracts and assessed Ology a penalty in this amount. In addition, she demanded interest that brought the total government claim to $1,109,160.”

In the Board’s analysis of the situation, the matter was not nearly as straight-forward as DCAA and DCMA claimed it was. Of particular import was the fact that OFPP had not published the FY 2013 compensation cap until March 15, 2016. “The government has not provided any explanation as to why there was such a delay in establishing the FY 2013 cap.”

Long-time readers of this blog know that we have complained about OFPP’s lack of diligence before. Several times. The fact of the matter is that OFPP didn’t like the ceilings that were calculated at the time, and expressed the dislike by failing to carry out the statutory duty imposed on the agency, the duty that required timely publication of the ceiling. The situation continued after the executive compensation ceiling became the contractor compensation ceiling and the new benchmarks were adopted during the Obama Administration. The situation is now so bad that even DCAA has told their auditors not to count on the OFPP and, instead, to calculate their own ceilings for audit purposes.

Back to Ology’s appeal.

Because the correct FY 2013 “cap” was not issued in time, the government’s position was that the FY 2012 cap applied to the costs that Ology had claimed. The rationale for that position was that, when OFPP had published the FY 2012 cap amount, the language used was ““amount applies to limit the costs of compensation for contractor employees that are reimbursed by the Government to the contractor for costs incurred on all contracts, after January 1, 2012 and in subsequent contractor FYs, unless and until revised by OFPP.” (Emphasis added.) Thus, even though the statute required an annual ceiling to be calculated and published, the government argued that the last published ceiling applied prospectively, on a flat-line basis.

The Board analyzed the statute that established the executive compensation ceiling (10 U.S.C. § 2324) based on the language in place at the time it would have applied to Ology. The Board concluded that the statute required publication of an annual cap value, and that it was unreasonable to hold Ology accountable for claiming costs in excess of an outdated ceiling. To be clear, the Board agreed that Ology had claimed unallowable costs; however, the Board found that the excess costs were not expressly unallowable and that Ology should not have to pay penalties and interest on the excess amounts.

Judge O’Connell wrote—

Neither the statute nor any FAR provision specified a date by which OFPP must establish the cap. While it is reasonable to infer that Congress granted OFPP some leeway as to when it would set the cap, we do not believe that Congress intended OFPP to have unlimited time to update the cap or for the government to apply an outdated cap for years on end. … Further, the government imposed on the contractor an obligation under the Allowable Cost and Payment clause to submit its final indirect rate cost proposal within six months of the end of its fiscal year, FAR 52.216-7(d)(2). The government required the contractor to certify at that time that the proposal did not include any expressly unallowable costs, FAR 52.242-4(c). To submit the proposal and make this certification, the contractor would have to know the cap for that year. …

While it is true that OFPP eventually met the statutory directive to establish an FY 2013 cap, it did so long after it would provide guidance to contractors, at least those who complied with their contracts by submitting timely indirect cost rate proposals. Applying the FY 2012 cap to 2013 compensation would have the odd effect of placing contractors who complied with their deadlines in a worse position than a contractor who waited until after the March 15, 2016 issuance of the FY 2013 cap to submit its proposal. The Board believes that Congress expected more of OFPP than a technical compliance with the statutory directive that was too late to be helpful. …

This dispute involves FY 2013 compensation and the FY 2013 would be the cap that applies, not the FY 2012 cap. The FY 2013 cap did not exist when Ology certified its FY 2013 indirect cost rate proposal and the government has, in any event, abandoned the argument that the FY 2013 cap could be applied retroactively to Ology’s FY 2013 proposal. Accordingly, there is no issue that requires a hearing. The government cannot carry its burden of demonstrating that Ology included expressly unallowable costs in its FY 2013 proposal and that a penalty was warranted. Ology is entitled to summary judgment that its FY 2013 executive compensation costs were not expressly unallowable at the time it certified its final indirect cost rate proposal because the FY 2012 cap was no longer applicable.

Although Ology won its victory, please don’t see this decision as a free rein to include the full amounts of contractor compensation in your final billing rate proposals. A ceiling still exists—albeit it must be manually calculated using the existing statutory formula because OFPP cannot be arsed to do its job. Costs claimed in excess of that (manually calculated) ceiling are still unallowable.

What this decision does, however, is provide support for the argument that costs claimed in excess of that ceiling are not expressly unallowable.

To that extent, it’s an important decision.

Last Updated on Saturday, 12 June 2021 19:00
 

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Newsflash

Effective January 1, 2019, Nick Sanders has been named as Editor of two reference books published by LexisNexis. The first book is Matthew Bender’s Accounting for Government Contracts: The Federal Acquisition Regulation. The second book is Matthew Bender’s Accounting for Government Contracts: The Cost Accounting Standards. Nick replaces Darrell Oyer, who has edited those books for many years.