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Time Charging Problems Haunt Northrop Grumman for Years

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In 2013, Northrop Grumman Mission Systems identified that certain employees stationed in OCONUS locations had perhaps mischarged some of their time between 2010 and 2013. For example, it was alleged that some employees charged labor hours to government contracts for time spent on recreational activities such as attending movies. Upon discovery of the issues, the company “took disciplinary action against those who we found acted improperly and violated company policy, and we took corrective action to strengthen our time-charging processes even further. We cooperated with the government as it investigated the issues over the following years.” (See this article.)

Upon discovering its time charging problems, Northrop hired outside attorneys (who likely hired forensic accounting consultants) to investigate. Normally, such investigations do more than simply quantify the amount of the problem; they also look at internal controls to see where they may have failed, and they attempt to identify those employees responsible for the alleged wrongdoing and the control breakdowns. Such investigations are never cheap. In this case, it appears that Northrop Grumman incurred roughly $15 million over a four-year period related to this matter.

Think that’s a lot of shareholder money? Well, Northrop’s “support” of the government investigation involved “collecting more than 25 million records from employees in the United States, and overseas, producing over 1.3 million pages of documents, and interviewing over 100 employees.” Such efforts do not come cheaply.

In 2018, Northrop and the government entered into a settlement agreement, in which the company agreed to pay $30 million, in addition to $1.65 million in burdened labor costs it had already refunded to its US Air Force customer. The DoJ press release headline understates the settlement amount because it omits the $4.2 million paid to the U.S. Attorney’s Office of the Southern District of California (as explained in the first article.) So: $31.65 million would be the settlement amount—an amount that does not include the cost of hiring outside attorneys and consultants to investigate the problem and reach a settlement.

Flash forward to 2020—seven years after the initial wrongdoing was reported to the government—and Northrop’s DCMA contracting officer issued a Final Decision in which he “determined that from FY 2012 to 2016 NGMS had included expressly unallowable legal costs of more than $15 million related to the BACN criminal matter in its final indirect cost proposals. Of this amount, $10,120,681 had been allocated to covered contracts and had been reimbursed through interim billings. He assessed a penalty in this amount, plus interest of $1,432,201, for a total claim amount of $11,552,882.”

Note that this amount was in addition to the $31.65 million that Northrop Grumman had already agreed to pay through its False Claims Act settlement.

The CO determined that Northrop’s costs were expressly unallowable under the 31.205-15 cost principle, which states that—

Costs incurred in connection with, or related to, the mischarging of costs on Government contracts are unallowable when the costs are caused by, or result from, alteration or destruction of records, or other false or improper charging or recording of costs. Such costs include those incurred to measure or otherwise determine the magnitude of the improper charging, and costs incurred to remedy or correct the mischarging, such as costs to rescreen and reconstruct records.

(Emphasis added.)

In addition, the CO found that the costs would also be unallowable under the cost principle at 31.205-47 (Legal Proceedings).

You may be wondering why Northrop claimed the costs in the first place. The answer is that the costs may have been allowable when incurred, but only became unallowable at a subsequent point in time. This is why the issue of allowability is so challenging: costs may be retroactively unallowable, based on what the contractor learns and how it interacts with the government.

For example, if you were to locate and read the FAR Council’s promulgating comments on 31.205-15, you’d learn that the cost principle does not make the normal operation of a contractor’s internal control system unallowable. The cost of evaluating internal controls and assessing whether transactions violated those controls is entirely allowable. Even when the outcome of such evaluations is a disclosure to the government under the contract clause 52.203-13 (“Contractor Code of Business Ethics and Conduct”), all the costs of getting to that disclosure (and supporting that disclosure through government review) are still normal operations and 100% allowable. (Despite what certain DCAA auditors may assert.)

It is only when the matter moves into the legal arena that the costs become unallowable. For example, if the government files a suit under the False Claims Act and the company enters into settlement agreement discussions, then those costs become unallowable from that point forward. And if the company enters into a settlement agreement, then it needs to look backwards at the costs it has incurred, and stratify those costs between allowable internal controls analyses and unallowable litigation support. Apparently, Northrop didn’t do that in this situation, leading to the COFD.

The requirement to assess allowability retroactively is especially important when, as in this case, the settlement agreement expressly addressed the issue, and stated—

Within 90 days of the Effective Date of this Agreement, NGSC shall identify and repay by adjustment to future claims for payment or otherwise any Unallowable Costs included in payments previously sought by NGSC or any of its subsidiaries or affiliates from the United States. NGSC agrees that the United States, at a minimum, shall be entitled to recoup from NGSC any overpayment plus applicable interest and penalties as a result of the inclusion of such Unallowable Costs on previously-submitted requests for payment . . .

So here we are, in 2021, dealing with costs incurred between 2012 and 2016, related to alleged wrongdoing that took place between 2010 and 2013—wrongdoing that was the subject of an FCA settlement agreement in 2018. Lovely to see justice more forward so swiftly, isn’t it?

Northrop appealed the COFD and, in its appeal, made a motion for summary judgment. In June, the ASBCA denied that motion. (ASBCA No. 62596, June 21, 2021.) The denial took only 11 pages.

At this point, the parties look to be moving towards a trial on the merits. However, given the Board’s quick dismissal of Northrop’s arguments, we suspect it’s more likely that the next Board decision we’ll be seeing is a statement that the dispute has been settled and is being dismissed with predjudice.

This story is, unfortunately, a great example of how time charging problems can expand into a full-blown False Claims Act litigation matter. It also provides some insight into how government accounting and compliance folks ought to be looking at the costs incurred in evaluating internal control failures and supporting outside counsel.

As with so many of the blog articles on this website, the objective is to provide readers with lessons learned by other contractors, so that the readers can avoid similar situations. And, perhaps, save themselves a few million dollars in the process.

Last Updated on Wednesday, 15 September 2021 17:09
 

Business Systems – The Narrative

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Hi there, readers. It’s been awhile, hasn’t it? Truth be told, I basically took off the month of July. No consulting work, no blog. Why? Because I needed to! And I could.

And—speaking frankly once again—I don’t know how productive I will be the rest of this year, in terms of blog output. If I see something that compels me to write an article, then I will. But if nothing calls to me, then I’ll be doing other things.

You may want to adjust your expectations accordingly.

Now, on to the topic at hand: the business system narrative.

As you may know, we’ve been deeply involved in business system audits and/or reviews since the beginning. We now have roughly a full decade of experience with pretty much all of the six systems—building them, evaluating them, supporting them through governmental testing. What we’ve experienced in that decade is that the government’s approach to system audits/reviews has evolved over that timeframe.

Before going further, we perhaps should clarify that there are six business systems. DCAA is the lead agency for Accounting, Estimating, and Material Management/Accounting (MMAS), while DCMA is the lead agency for Purchasing, Property, and Earned Value (EVMS). DCAA audits business systems while DCMA reviews business systems. Regardless of who takes the lead, it is always a DCMA contracting officer that makes the final determination of system adequacy.

DCMA’s approach to reviewing EVMS has evolved in the sense that it’s gotten more automated—or, as DCMA calls it—more “data-driven.” A contractor is expected to provide the DCMA EVM specialists with various datasets, which are analyzed and evaluated for anomalies. To a large extent, once a contractor has passed the basics (e.g., adequate system description), it lives or dies by the data it provides. Here’s a link to a DCMA EVMS website, in case you want to dive in a bit deeper.

DCAA has evolved its audits of both Accounting and Estimating systems by requiring contractors to provide a system “narrative” for review. The narrative is the basis of what DCAA audits. The narrative is in addition to a system description and a formal walkthrough slide deck. It’s kind of duplicative, at least in our view, but your auditor will likely tell you that the narrative is your company’s “assertion” that will be tested.

The auditor may request that you or a knowledgeable company executive sign-off on the narrative. This request is a bit controversial. Some of the larger contractors have pushed back on that request, at the recommendation of their attorneys. They argue that there is nothing in FAR or DFARS that require such a sign-off, and they believe that having an executive sign the narrative exposes the company and/or the executive to downstream litigation risk, should there be an (inadvertent) error in the narrative.

We disagree and recommend that the narrative be signed if the auditors request it. In our view, if the company has done its diligence (as we would expect it to do) and the narrative is accurate, then the risk the attorneys worry about is minimal. In our view, the better relations with the auditors who are looking at your business system is worth the minimal risk involved.

The entire concept of a business system narrative seems a bit weird to us, frankly. If the company has a robust system description, and its walk-through package is detailed, then we really don’t see what value is added by a narrative. Still, DCAA will expect one.

Another concern we have is that the narrative is really the auditor’s job to prepare, not the contractor’s responsibility. The narrative should not be a contractor assertion; it should be a working paper prepared by the auditor in order to document the auditor’s understanding of the business system being audited. In support of our position, we note that the DCAA Contract Audit Manual (at 5-106e) states:

Once the auditor has gained an adequate understanding of the contractor's business system and applicable sub-systems it should be documented in the audit working papers and related permanent files. This documentation will typically take the form of system flowcharts, narrative descriptions, and copies of relevant documents and reports.

Thus, in our view, having the contractor prepare the narrative is basically asking the contractor to prepare the auditor’s working papers. By no means is this unheard of! However, when we add the narrative’s perceived lack of value to the audit to the fact that the contractor is basically being asked to do the auditor’s job, we find the concept of a system narrative just rubs us the wrong way.

But don’t let our feelings in the matter stop you from doing what makes sense in the context of your audit. If your auditor expects a narrative, it’s almost certainly in your best interest to provide one.

As we noted, we are aware of DCAA system narrative templates for both Accounting and Estimating systems. As far as we know, there is not a similar template for MMAS. Maybe one is one the way? We don’t know.

Looking at the Estimating System narrative template, there are two options available to a contractor. One option is tied explicitly to the DFARS system adequacy criteria, and the other option focuses on cost elements rather than adequacy criteria. There is no right template; there is only the one that works best for your company. Either one works.

If you’ve done your job with your system description and related command media, and if you’ve done your job identifying work flows and related internal controls, then preparing the narrative (and the walk-through slide deck) should be relatively painless. Of course, if your company has slacked-off (or if this is your first business system audit/review), then you’ll have a fair amount of work ahead of you.

Business system audits and/or reviews are a critical part of being a government contractor. It’s important to invest sufficient time and resources into documenting your systems and supporting them through audit. If you make the smart investments, you’ll find that you do well in the inevitable governmental oversight activities.

Last Updated on Wednesday, 04 August 2021 04:57
 

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
 

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
 

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
 

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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.