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CAS 404 Doesn’t Apply to Leases, According to ASBCA

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Recently the ASBCA ruled on Exelis’ appeal of a Contracting Officer Final Decision (COFD) and government demand for $3.8 million, based on Excelis’ alleged noncompliance with the requirements of CAS 404. Judge D'Alessandris, writing for the Board, partially sustained the appeal and partially dismissed it.

According to the decision, Exelis (and its predecessor entity, ITT Corporation) leased the Summit Park Building in Fort Wayne, Indiana. Exelis, as many readers may know, was acquired last year by Harris Corporation. According to news reports, Harris has already closed the facility that may have formed the basis of this dispute.

Anyway, ITT Corporation, or Exelis, or Harris, treated its facility lease as an operating lease. In 2007, during it audit of Exelis’ FY 2004 proposal to establish final billing rates (aka incurred cost submission), DCAA questioned the lease costs, asserting that “the building lease was a capital lease, and that Exelis could only include building depreciation in its indirect cost pool rather than the entire lease cost.” Questions and discussions between the contracting parties ensued, and in June, 2015, the contracting officer issued the COFD, finding that Exelis failed to comply with the FAR cost principle at 31.205-11(m) as well as the requirements of CAS 404. “The final decision found that Exelis improperly accounted for the Summit Park Building lease as an operating lease when it should have been treated as a capital lease because the present value of the lease payments, at the inception of the lease, was greater than 90 percent of the fair market value of the building.” Because the CAS noncompliance opened up fixed price contracts to price adjustment—which led to a greater damage quantum—the government used the CAS noncompliance cost impact method to calculate its damages, which extended back to 2003.

Yes, the government asserted 12 years’ of damages.

Yes, the government waited eight years to assert its damages. (We don’t know when or if the Contract Disputes Act Statute of Limitations will be asserted as an affirmative defense. But in our non-attorney viewpoint, it should be.)

Because the government asserted 12 years’ of damages and because it waited eight years to assert its claim, the quantum included $806,000 of compound interest. Had the government asserted its claim earlier, the interest amount would have been significantly decreased.

Because the government asserted its claim in the form of a CAS noncompliance, it was able to calculate damages on firm-fixed priced contracts. (This accounted for nearly 85 percent of the damages before interest.) Had the government asserted its claim solely in the form of a violation of the applicable FAR cost principle (i.e., as an unallowable cost), the amount of its claim would have been not more than $429,459 before interest.

Judge D’Alessandris dismissed the government’s CAS noncompliance case, finding that “by its terms” CAS 404 “applies only to ‘tangible capital assets’ and does not apply to a lease because a lease is an intangible asset.” Thus, “at most, the mischaracterization of a capital lease as an operating lease would create a FAR allowability issue.”

Although the Judge found the government’s claim to be overstated because of its flawed damage calculation methodology, he did not dismiss the case entirely. The parties will have a chance to brief and to argue about the FAR-based damages. That being said, the government’s case loses a lot of momentum since it has been whittled down by some 85 percent—at a minimum. The government will need to calculate its damages in an entirely new way, since its CAS noncompliance argument failed.

And how will those FAR-based damages be calculated?

Providing a hint of the required methodology, the Judge quoted Darrell Oyer: “"The rule is that any capital lease costs in excess of the prescribed depreciation charges are unallowable." Thus, the government will have to calculate the difference between Exelis’ claimed facility lease expenses, year by year, and the amount of depreciation that Exelis should have claimed, had it properly claimed depreciation only.

But that’s not the end of the matter.

The unallowable difference needs to be input into Exelis’ model for calculating its indirect rates.( Many contractors use the DCAA ICE Model, but they were not required to do so until 2011.) The delta difference needs to be input into Exelis’ model, reducing claimed allowable lease expense for each year. Then the resulting indirect rates need to be recalculated, and then the rates need to be reapplied to each of Exelis’ contracts. The aggregated amount by which contract costs are reduced as the result of that exercise is the measurement of the government’s damages, before interest. We strongly suspect that value will be significantly less than $429,459. It might even be immaterial in amount.

Some might argue that Exelis should be subject to the penalty provisions of FAR 42.709-1. The FAR provides that if a contractor claims an indirect cost that is expressly unallowable under a cost principle in the FAR, or an executive agency supplement to the FAR, the contractor must pay a penalty equal to (a) The amount of the disallowed costs allocated to contracts that are subject to this section for which an indirect cost proposal has been submitted, plus (b) interest on the paid portion, if any, of the disallowance. We don’t think so.

First, the penalty provisions only apply to cost-type contracts, which are about 15 percent of the Exelis’ total activity. Second, there is a real question as to whether the claimed cost in question were “expressly unallowable” as that term is defined. (We wrote about that topic here.) Expressly unallowable costs are a small subset of unallowable costs. Given that the parties here took some eight years to conclude the costs were unallowable, we strongly suspect it’s going to be difficult to convince a Judge that the costs in question were expressly unallowable.

In any case, Exelis, like Raytheon, disputed a COFD with which it disagreed. That COFD was based on an audit report prepared by DCAA, an audit report whose methodology was so flawed Exelis was able to have the vast majority of claimed damages tossed without a trial on the merits.

We are forced to wonder: if the DCAA auditors had been in less of a rush to question millions of dollars of costs, if the auditors and Supervisory Auditors had simply stuck to the FAR instead of zooming into CAS noncompliance land, would the resulting quantum have been worth litigating? Maybe the contracting officer and Exelis could have negotiated a settlement acceptable to both sides? We will never know.

In any case, let’s note that any reports regarding DCAA questioned cost sustention rates need to be modified. In addition to noting when questioned costs are not sustained by the contracting officer, the taxpayers also need to know when sustained questioned costs are laughed out of court.

Last Updated on Friday, 23 September 2016 09:51

DCAA’s New Cost Allowability Guidebook

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A while ago we noted that Darrell Oyer believed DCAA was going to do away with its Contract Audit Manual (CAM). For those who don’t know, the CAM has been the “go-to” manual for government contracting compliance practitioners—as well as Federal contract auditors—for (quite literally) many decades. It has been the Number One resource for quite a while. To hear that it might disappear causes us to wonder what resources the next generation of practitioners is going to use.

That’s not to say that we always agree with the CAM. Many times we use the CAM as but one (probably biased) data point in our analysis of a thorny problem. But it’s been nice to have. We have used it extensively when researching DCAA’s probable position on certain types of transactions (e.g., uncompensated overtime). We have used it when preparing to rebut an audit report with adverse findings, to make sure that the auditors followed their own guidance in reaching those findings. We know it’s been used by auditors of other, non-DOD, agencies. In short, it has been an invaluable resource and we hope its sticks around for some time.

In what Darrell might view as another piece of evidence to support his assertion, CAM Chapter 7 (Selected Areas of Cost) was recently removed—or, to use DCAA’s phrase, it was “reserved”. In its place, DCAA created a new resource, the Selected Areas of Cost Guidebook. DCAA describes its new Cost Guidebook as follows (sic - misspelling in original)—

This Guidebook addresses FAR 31.2 and other areas of cost audited. In this first edition of the guidebook, we have expanded what used to be included in Chapter 7 by adding 23 additional chapters to address FAR 31.2 cost principals that had not previously been included in CAM. Initially, many sections of the guidebook are a replica of what was in Chapter 7; however, we have rewritten and updated 13 areas of cost. We will be continuing to rewrite the other chapters in this guidebook and will publish them as completed. 

Right now, the intent is to have 75 individual Chapters in the Guidebook. As the blurb above states, the starting point of the Guidebook is the former CAM Chapter 7. But there will be 23 new “selected areas of cost” addressed in the Guidebook that were not addressed in the former CAM Chapter 7. Further, the guidance with respect to 13 areas of cost that were covered in the former CAM Chapter 7 has been “rewritten and updated.” In many cases, the revisions add FAQs to assist the audit teams.

Those 13 revised areas are:

  • Alcoholic Beverages (Chapter 2)

  • Bonus and Incentive Compensation (Chapter 7)

  • Consultants (Chapter 58)

  • Depreciation (Chapter 19)

  • IRAD/B&P (Chapter 33)

  • Legal Costs (Chapter 41)

  • Patents (Chapter 52)

  • Royalties (Chapter 64)

  • Pensions (Chapter 53)

  • Manufacturing and Production Engineering (Chapter 45)

  • Joint Ventures and Teaming Arrangements (Chapter 37)

  • Insurance (Chapter 34)

  • Idle Facilities/Idle Capacity (Chapter 32)

We are not going to critique the new Guidebook, no more than we would have critiqued the CAM chapter by chapter. But rest assured, as issues arise during audits we’ll make sure to refer back to the Guidebook and, if appropriate, we’ll discuss here in this blog.

That being said, here are some chapters in the Guidebook that looked interesting to us. We suggest you consider reviewing them in more detail. The “interesting” chapters include:

  • Banked Vacations (Chapter 5)

  • Correction of Internal Control Deficiencies (Chapter 17)

  • General Services Administration Schedule Contracts (Chapter 29)

  • Mentor-Protégé Program Costs (Chapter 47)

  • Military Operations—War Hazard, Reserve Supplements, and Celebrations (Chapter 48)

  • Weather-Related Closure (Chapter 74)

  • Workforce Investment Act (Chapter 75)

(Also, we noted the Chapter 9 title is incorrect on the website. Somebody may want to look into that.)

To sum this all up, the new Guidebook generally seems like a good idea. While we have already noted several areas where we would disagree with the guidance provided (see, e.g., Chapter 17), we do appreciate the effort that has gone into this new resource, and we believe it will be beneficial for all contracting parties.

Which is exactly how we feel about the CAM.


Last Updated on Tuesday, 20 September 2016 06:00

The Time We Walked Away

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This is a true story. Some of the people involved are probably reading it right now. If so – Hi. We’re talking about you.

This is the story of the time when Apogee Consulting, Inc., walked away from a potentially lucrative consulting gig because the client didn’t meet our standards. To be fair, this isn’t the first time we’ve suggested to a client that they would be better served by another consultant. And once a client stiffed us on a $9,000 bill because they didn’t like our advice and didn’t pass a DCAA audit after they refused to follow our advice. So this isn’t really about the almost-but-not-quite client we are now going to discuss.

Except it is.

It’s also about you and your company.

The almost-but-not-quite client is a very large engineering services corporation. By “very large” we mean annual revenues measured in the billions of dollars. A true multi-national engineering services provider, with stock publicly traded. And the company had a compliance team staffed with really good people, folks that we knew personally, and liked quite a bit. We were really looking forward to taking our relationship to new levels.

The gig was going to be “on-call consulting,” which is our specialty. We don’t have teams of specialists to deploy at the client site, so what we do is sit back and wait for emails and phone calls. We respond and in responding we provide advice and assistance. It’s what we do, and for the most part it works out for everybody. In this case the client wanted an SME to bounce notions and theories off of, to brainstorm possible audit responses and to discuss compliance concerns. We’re good at that.

As part of the on-boarding process the company had us submit several documents, including a 5 page set of FAR-based Reps and Certs. (Which is weird because, as far as we know, we were not going to be a subcontractor under any Federal government prime contract.) One of the documents to be completed was a IRS Form W-9. We filled out the forms, including the Reps & Certs, and we also submitted an executed W-9 that we have on hand for such things.

We keep an executed W-9 on hand because everybody wants a W-9, even though as a registered Corporation we don’t receive a 1099 Form at year-end and so, strictly speaking, a W-9 form is not required. Rather than argue we just submit our executed W-9 and everybody is happy.

But not this time.

Before we get into that, let’s note that the company apparently was eager to hire us, because we started to get emails and phone calls and text messages before any consulting agreement had been signed. We think it’s important to understand that, apparently, there was a real need to engage Apogee Consulting, Inc.

But there was a glitch. According to the company’s Procurement Department, we had submitted an invalid Form W-9, and “the system” would not accept it. Intrigued by the notion that a signed and correctly executed W-9 – one that had just been accepted by two other clients – would be so incorrect that its information could not be input into the appropriate fields in the vendor master file, we attempted to engage. Turns out we had submitted the 2013 version but there was a 2014 version that we (allegedly) should have used.

You need to understand that Apogee Consulting, Inc. is not focused solely on regulatory compliance per se. We also engage on contractor business systems, program management effectiveness, and in business process improvement. When we encounter a client process that seems weird or broken or bloated, we see it as an opportunity to understand and recommend improvements. Thus, our reply to the news that our 2013 W-9 was invalid:

I'm confused. Apogee Consulting, Inc. is a subchapter S corporation and, as far as I know, we do not receive a Form 1099. So there should be no need to submit a W-9 of any variety. In any case, the information would be exactly the same whether we use a 2013 or 2014 form. Our EIN is exactly the same and our business address is exactly the same. I really do not want to redo a form that I believe to be unnecessary in the first place. If XXXXXXXX requires me to resubmit a current form then please let me know WHY. Thanks.

The answer we received was disheartening, to say the least. It was short and sweet.

our system won't pay you unless you can be entered you into it....and [the Buyer] is saying they cannot enter you into the system without the more current form.

We compared the 2013 and 2014 versions. To our eyes, they are identical with respect to information provided. There is no information on the 2014 version that is not also found on the 2013 version. To our eyes, there was no substantive difference whatsoever.

Many consultants would have shrugged, perhaps rolled their eyes, and filled out the 2014 version and proceeded to start billing the mega-corporation. But not us.

The response we received, and the lack of rationale for not accepting a valid form and the lack of rationale for requiring submission of a “current” form that was identical in all substantive respects, and the inability of the company’s Procurement Department to understand that what is input into “the system” is not a piece of paper but information contained on that paper, when coupled together, sent a clear signal to us that we needed to walk away. The company has its own processes and it is satisfied with them, and it is not open to engaging on process improvement. We hadn’t seen a consulting agreement and nobody had agreed on payment terms, but we strongly suspected that those terms were not going to be favorable to Apogee Consulting, Inc. Based on the role “the system” had and how it dominated common sense and standard business practices, we suspected we were going to be in for a rough ride.

Life’s too short for that.

So we walked away.

If you’re reading this and you realize we’re talking about you and your company, please understand why we won’t work with you under these conditions.

If you’re reading this and you know we are not talking about you and your company, please consider whether we could be. Are your Procurement Department processes dominated by bureaucrats and bloated processes that defy common sense? Do you do engage with suppliers based on true requirements, or because somebody says “the system” requires it – when clearly it does not. Are you taking a streamlined approach to compliance, or are you layering process on top of process? Are you open to continuous process improvement, or are you satisfied with the status quo, which is based primarily on “the way it’s always been done”?

If you think we could be talking about your company, then consider the notion that you can do better. And we can help you do better. But first you have to want to do better.


Last Updated on Thursday, 15 September 2016 23:04

DACO “Abused Discretion” for Failing to Consider Materiality in CAS Cost Impact

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How_ExcitingWhen last we wrote about Raytheon’s three appeals of Contracting Officer Final Decisions (COFDs) related to concurrent changes in cost accounting practice made at its Space and Airborne Systems (SAS) business unit, we opined that “Raytheon is one of the few big defense contractors that seems to be willing to litigate its positions, when it believes that is positions have merit.” While many other large defense contractors seem eager to settle based on an analysis of legal costs likely to be incurred, Raytheon seems to base its decision more on principle. (It’s not the only contractor who seems to do this; there are others—and we’ll be writing about Exelis soon.)

In that last article (link in the first sentence) we recapped Raytheon’s win/lose statistics in the three appeals as follows:

Revision 1 – Government sought $1,176,600. Raytheon will have to pay nothing. Victory for Raytheon SAS.

Revision 5 – Government sought $512,732. Raytheon will have to pay not more than $153,000 (plus interest), which is the portion of the impact applicable to flexibly priced contracts. There will be a trial to adjudicate the application of a 30 percent mark-up factor by DCAA and whether the CFAO should have found the cost impact to be immaterial.

Revision 15 – Government sought $172,363. Raytheon will have to pay not more than $83,800 (plus interest), which is the portion of the impact applicable to flexibly-priced contracts. However, to the extent that the impact applies to pre-2005 contracts, Raytheon will be permitted to offset the impacts, which will reduce that value by roughly one-third. In addition, there will be a trial to adjudicate the application of a 30 percent mark-up factor by DCAA and whether the CFAO should have found the cost impact to be immaterial.

The parties settled the dispute regarding the Revision 5 changes in August 2015, just a few weeks after they learned about the decision. We don’t know what the settlement amount was but, as we noted above, it was going to be significantly less than the government had sought.

Which leaves us with the final set of concurrent changes to cost accounting practices, those disclosed in Revision 15 of SAS’ Disclosure Statement, which was litigated as ASBCA No. 58068. Judge O’Connell wrote the decision for the Board and it was issued August 9, 2016 (though it was published weeks later). Today’s article recaps that decision.

As we summarized previously

There were three (3) individual changes described in Revision 15. Raytheon’s GDM cost impact analysis showed that one change ‘caused a $251,500 decrease to flexibly-priced contracts and an increase of $195,200 to fixed-price contracts’ while the other two changes ‘had the opposite effect.’ According to Raytheon’s calculations, change 2 (communications) ‘caused an increase of $47,800 to flexibly-priced contracts and a decrease of $41,600 to fixed-price contracts’ whereas change 3 (inventory maintenance) ‘caused an increase of $36,000 to flexibly-priced contracts and a decrease of $17,400 to fixed-price contracts.’ DCAA recognized that the aggregate or net effect of all the changes, when considered together, was to decrease costs to the government in the amount of $304,000. However, because of the then-recent rule changes to FAR 30.606, DCAA maintained that the impacts of the three changes could not be combined. Instead, each had to be considered individually. Using that logic, DCAA calculated a cost increase to the government of $157,080 related to two of the three changes.

Remember, at this point the government had already lost on the impacts related to contracts awarded before the 2005 FAR changes took effect (since Raytheon was allowed to offset the impacts from concurrent changes) and it had already lost on the “double-counting” issue, such that it would only be able to claim the impacts to one contract type (which we assume would be flexibly priced contracts). Left to be adjudicated were two remaining issues: (1) was DCAA allowed to mark-up the contractor’s cost impact calculations by 30% to protect the government’s interests, and (2) was the Cognizant Federal Agency Official (CFAO) required to consider the materiality of the cost impact before deciding to issue a COFD? The decision issued by Judge O’Connell answers one of those two questions. (Unfortunately, because the Board’s decision was based on other grounds, it never answered the question as to whether or not DCAA was permitted to add an arbitrary amount of additional costs to a contractor’s cost impact analysis.)

As Judge O’Connell found, “In her final decision, the contracting officer noted that Raytheon had requested that she determine the changes were immaterial. The contracting officer did not specifically stated in her decision whether the changes were material [in amount], but the parties agree that she determined that the changes were material because they resulted in increased costs to the government.” (Internal citations and redactions omitted.)

The debate to be decided by the Board concerned a discrepancy between the contracting officer’s affidavit (offered as testimony) and her deposition. She was under oath for both sets of testimony, but they differed in crucial respects. In her affidavit, she testified that “she considered the materiality criteria in 48 C.F.R. § 9903.305 before issuing her final decision but had based her materiality determination solely upon the increased costs to the government.” However, in an earlier deposition, the contracting officer “appears to indicate that she focused on the mere fact that there was an increased cost” and did not consider any other criteria. As Judge O’Connell wrote—

… we find that [the contracting officer] determined that the amount at issue was material based solely upon the dollar value, and that she did not properly consider the other factors in section 9903.305. … We conclude from this testimony that her analysis never progressed beyond the dollar amount, because she viewed the recovery of increased costs as necessary to protect the interest of the taxpayers.

Judge O’Connell recited the six factors that should be considered when determining whether costs are material or immaterial. If you are not familiar with them, we suggest you visit the CAS regulations and review them. He noted that FAR 30.602 requires a CFAO to “promptly evaluate a contractor’s general dollar magnitude proposal and to conclude the cost impact process with no contract adjustments if he or she determines the cost impact is immaterial.” Further (as Judge O’Connell noted), “FAR 30.602(a) provides that in determining materiality, the contracting officer ‘shall use the criteria in 48 CFR 9903.305’.”

After finding that the CFAO used but one of the six materiality factors to conclude that the cost impact was material, the Judge observed that use of some of the other factors might have led her to a different conclusion. Judge O’Connell wrote—

While both the original impact amount, $142,800, and even the reduced amount of $56,146 appear to be significant amounts of money, they pale in comparison to the vastness of the relationship between Raytheon and the government. … the cost impact will be an increase of less than 0.005%. … Assuming for the moment that the changes impacted 1,000 contracts, the cost impact was an average of about $142 per contract … Further, because this amount was spread over four years, the impact may have been as low as $36 per contract, per year.

In other words, the cost impact was obviously immaterial to any reasonable person.

Because the contracting officer failed to consider the six materiality criteria as required by FAR 30.602, the ASBCA found that “the contracting officer abused her discretion.” Further, “Because the government has failed to demonstrate that this error was harmless, the government cannot recover [any of] the cost increase.” The appeal was sustained.

Another victory for Raytheon.

It should be noted that Raytheon was represented by the firm of Arnold & Porter in its appeals. (At one point, years ago, we had a small role as well.) Paul Pompeo, lead counsel, penned his own view of the decision here.

In addition to our observations, he noted the following—

One of the CAS materiality rule's factors, § 9903.305(e), states that a contracting officer assessing materiality must consider whether cumulative impacts “[t]end to offset one another.” Although the ASBCA did not analyze this provision, the facts show that the overall decrease in cost to the Government on one change in cost accounting practice more than offset the total increased costs of the two other changes in cost accounting practice that were made to the CAS Disclosure Statement. An offset under these facts would have left an impact of zero, presumably another basis for the contracting officer to have found the cost immaterial and end the cost impact process. This is particularly important in light of a prior decision in this series of cases where the ASBCA held that the prohibition in FAR 30.606(g)(3)(ii)(A) of offsetting cost impacts showing increased costs to the Government against cost impacts for other cost accounting practice changes showing decreased costs to the Government was valid. Raytheon Co., Space & Airborne Sys., ASBCA Nos. 57801 et al., 15-1 BCA ¶ 36,024. Moreover, the ASBCA’s final decision, which sustained the appeal in Raytheon’s favor based entirely on the issue of materiality rendered that portion of the 2015 decision on the question of the validity of FAR 30.606(g)(3)(ii)(A) unnecessary to the decision—hence; under the law of the Federal Circuit, it is nothing more than dicta, and non-precedential. See, e.g., National American Ins. Co. v. U.S., 498 F.3d 1301, 1305 (Fed. Cir. 2007) (defining dicta).

In other words, he believes that this decision may have reopened the door to offset individual impacts from concurrent changes to cost accounting practice, despite the 2005 FAR revisions. If he is correct, that would be a stupendous outcome.

Last Updated on Sunday, 18 September 2016 17:23

Application of Hazardous Duty and Danger Pay Uplifts

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In the fall of 2009, DCAA Director April Stephenson told the Commission on Wartime Contracting that “Through FY 2009, DCAA has reported total exceptions of $16.3 billion consisting of recommended reductions in proposed and billed contract costs of $8.8 billion and $7.5 billion of estimated costs where the contractor has not provided sufficient rationale for the estimate.” In addition, she told the Commission that “DCAA has issued over 140 Forms 1 under the Logistics Civil Augmentation Program (LOGCAP) III program that suspended or disapproved over $655 million.” (Stephenson Testimony, 11/02/2009) Based on Ms. Stephenson’s testimony, the Commission officially reported that it estimated “waste and fraud together range from $31 billion to $60 billion,” which was footnoted as being an estimate that 10 to 20 percent of every dollar spent in Iraq and Afghanistan was wasted, and that 5 to 9 percent of every dollar spent was fraudulently billed by contractors. As the Commission reported, “The Commission’s estimate of a 5 percent to 9 percent fraud rate would indicate that between $10.3 billion and $18.5 billion of the $206 billion in funds spent for contingency contracts and grants has been lost to fraud.” (Transforming Wartime Contracting: Controlling Costs, Reducing Risks, 8/31/2011)

Of course we all know today that the majority of DCAA’s questioned and suspended costs was not sustained, and that millions of dollars of such cost that were sustained were subsequently overturned on appeal. We know now – seven years later – that Ms. Stephenson’s testimony was self-serving at best and misleading at worst. In 2009 we linked the claims in Ms. Stephenson’s testimony (particularly those related to allegedly inadequate contractor business systems) to then-contemporaneous GAO and DOD IG reports blasting the audit agency’s audit quality. We wrote: “so long as the spotlight is turned on the contractors, DCAA can hide in the darkness.” It is unfortunate that the country’s perception of contingency contractors has been tainted by that testimony, just as it is unfortunate that we now have an expensive, nearly unworkable, and essentially valueless “contractor business system” administration and oversight regime as a direct result of that testimony.

Even before 2009, DCAA had issued audit guidance (04-PPD-023) that addressed the pay differentials contractors provided to their employees for working in combat areas such as Iraq and Afghanistan. The audit guidance was based on questionable statistics (e.g., a survey of the practices 37 contractors) rather than on an actual policy position based on contract terms and conditions. Some (unknown) amount of the questioned and suspended costs that were reported to the Commission on Wartime Contracting came from application of that audit guidance to contingency contractors. Importantly, the audit guidance focused on the Department of State Standardized Regulations (DSSR) as establishing allowability criteria, regardless of what the contract might have actually said. The audit guidance stated:

Most contractors justified providing the deployed employees with hardship pay differential due to the known difficult living conditions they would be working under. … However, the statistics that follow demonstrate that contractors did not adopt the DSSR specific percentage allowance or the salary base to which the percentage allowance was applied. The DSSR hardship pay differential for Iraq is 25 percent of an employee’s base pay, calculated on a 40 hour work week. … Since the predominant industry practice for the deployed contractor employees working on non-USAID contracts is to cite the DSSR as the basis for the hardship pay differential, auditors should evaluate contractors offering a hardship pay differential in excess of the DSSR hardship pay differential of 25 percent of base pay, calculated on a 40 hour work week. Review the contractor’s hardship pay policy and practices, the basis to calculate hardship pay, the deployed employees’ compensation agreements, and consider factors determined to be relevant by the contracting officer. In cases where there is inadequate contractor support to justify hardship payments beyond the DSSR allowances, challenges to these costs should be made in accordance with FAR 31.205-6(b) because the costs exceed compensation practices of other firms in the same geographic area (i.e., Iraq). In accordance with FAR 31.201-3(a), the burden of proof is then upon the contractor to establish that such a cost is reasonable. … The DSSR danger pay allowance for Iraq is 25 percent of an employee’s base pay, calculated on a 40 hour work week. … For those non-USAID contracts, auditors should perform an evaluation of contractors offering their deployed employees a danger pay allowance in excess of the DSSR danger pay allowance of 25 percent of base pay, calculated on a 40 hour work week. Review the contractor’s danger pay policy and practices, the basis to calculate the danger pay, the deployed employees’ compensation agreements, and consider factors determined to be relevant by the contracting officer. In cases where there is inadequate contractor support to justify danger pay allowances beyond the DSSR allowances, challenges to these costs should be made in accordance with FAR 31.205-6(b) because the costs exceed compensation practices of other firms in the same geographic area (i.e., Iraq). In accordance with FAR 31.201-3(a), the burden of proof is then upon the contractor to establish that such a cost is reasonable.

And so the DCAA auditors followed that audit guidance and questioned contractor compensation costs because they did not strictly follow the DSSR guidance (as interpreted by Fort Belvoir) and the contractor could not provide sufficient justification to the auditor as to why its practices deviated from those directed by the DSSR. (Note that second criterion is an entirely subjective factor, one that many if not all contractors likely would be unable to meet.) We don’t know how many millions of dollars’ worth of hazardous duty post and danger pay uplifts were questioned, but we know it was a lot (because we have worked with some of those contractors). Some contractors accepted the audit findings, others negotiated a compromise, and still others fought them.

One contractor that fought the audit findings was CACI.

CACI won at the ASBCA, on a motion for summary judgment. The decision may be appealed, but we think Judge Prouty’s logic is sound. Writing for the Board, he summarized the issue at the heart of the dispute as follows—

This appeal comes down to the interpretation of a contract provision permitting [CACI] to be reimbursed by the government for hazardous duty pay made to its employees assigned to work overseas …. . The pay at issue was 35% of the ‘basic compensation’ made by CACI to its employees. In its pending motion for summary judgment, the government contends that this ‘basic compensation’ is what the CACI employees are paid for non-overtime hours. After the employees were paid for the first 40 hours that they worked per week, the government argues, any additional hours that they worked should be considered to be overtime and not subject to the 35% pay supplement.

CACI urges the Board to recognize that the ‘normal hours’ that its employees were expected to work by the government (depending on the government task order at issue), were either 84 or 72 hours per week, without such hours being considered overtime. Thus, as CACI would have it, since 84 or 72 hours per week were the employees' expected hours, pay for the entirety of those hours was the employees' basic compensation to which the 35% pay supplement should apply.

As Judge Prouty wrote in his decision: “CACI prevails.”

This is an important decision, because it overturns 12 years of DCAA audit guidance, audit guidance based on a flawed interpretation of the DSSR. The contracting parties had incorporated the DSSR rules into the contract, but the flawed interpretation by DCAA, the Special Inspector General for Iraqi Reconstruction (SIGIR), and the Contracting Officer required CACI to litigate in order to prevail. Judge Prouty quoted the DSSR at length and compared the requirements therein to requirements found elsewhere in the contract. We urge readers with similar audit findings to read his decision in detail. But for this blog article, we’ll summarize as follows.

Despite the fact that contractor employees were working far in excess of 40 hours per week on a routine basis, the contract refused to recognize those excess hours as being overtime. Because the hours worked in excess of 40 were not overtime hours, they were part of the employees’ “basic compensation.” (This makes sense because the employees were expected to work those excess hours on a routine basis and did not get any overtime premium pay for working them, to which they might otherwise have been entitled.) Because the excess hours were part of the employees’ basic compensation, CACI properly used the employees’ total work hours as the basis for applying danger pay uplifts.

Although the dollars involved were relatively small, the issue is large. This decision, unless overturned on appeal, will establish proper application of salary uplifts for contractor employees assigned to support overseas operations.


Last Updated on Tuesday, 13 September 2016 17:57

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In March 2009, Nick Sanders’ article “Surviving Government Audits: Have the Rules of Engagement Changed?” was published in Government Contract Costs, Pricing & Accounting Reports (4 No. 2 GCCPAR P. 11). Apogee Consulting, Inc. is proud to announce that Mr. Sanders’ article was selected for reprint and publication in Thomson West’s The New Landscape of Government Contracting.  Mr. Sanders, Apogee Consulting’s Principal Consultant, joins such distinguished contributors as Professors Steven Schooner and Christopher Yukins, Luis Victorino and John Chierachella, Joseph West and Karen Manos, Joseph Barsalona and Philip Koos and Richard Meene, and several others.  The text covers a lot of ground, ranging from the American Recovery and Reinvestment Act (ARRA) to Business Ethics and Corporate Compliance, and includes several articles on the False Claim Act and the Foreign Corrupt Practices Act.  In addition, the text includes the full text of many statutory and regulatory matters affecting Government contract compliance.


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